While my plant is still being built I recover rent, hire charges and interest from my own contractors. Is that taxable income before the business starts?
No, where the receipts are inextricably linked with setting up the plant. The Supreme Court held that rent charged to contractors for housing their workers, hire charges for plant and machinery lent to them, interest on advances made to keep their work moving, and royalty for stone excavated from the company's own land are all capital receipts that go to reduce the cost of construction. They arise from arrangements intrinsically connected with building the plant, not from any independent source. Tuticorin Alkali was distinguished: interest on surplus borrowed funds parked in short-term deposits is an independent source and remains taxable.
Decided by the Supreme Court (Supreme Court of India - Sujata V. Manohar and G.B. Pattanaik JJ; judgment by Sujata V. Manohar J) on 1998-12-18, reported as Civil Appeal Nos. 2544-2545 of 1988 and Civil Appeal Nos. 642-648 of 1989. It bears on section 4, section 43(1), section 56, section 22 of the Income Tax Act 1961, in Assessment & Scrutiny matters.
This is the case that draws the line on the other side of Tuticorin Alkali, and the pair of them together decide almost every pre-commencement receipt dispute. The test it supplies is linkage, not timing: ask whether the receipt arises out of an arrangement intrinsically connected with the construction, or from a free-standing use of surplus money. The Court also gives the reason the linked receipts cannot be income - had the assessee not provided the quarters or the machinery, the contractors would have arranged them and charged more, so the receipt is really a reduction of what the plant cost. That mirrors Challapalli Sugars on the expenditure side, where pre-production interest was capitalised into actual cost. The judgment also contains a clean statement of the real income principle on a reversed book entry.
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The assessee was a corporation wholly owned by the Government of India, incorporated in January 1964 to construct and own an integrated iron and steel works, and assessed as a company. Through assessment years 1965-66 to 1972-73 its factory was still being built and the plant installed, and it had not started any business. Five kinds of receipt were in issue. It gave quarters to its contractors for the residence of their staff and workers engaged on the construction and charged for their use. Under supplementary agreements it advanced money to the contractors, on interest, so that they could carry on the large-scale work without raising outside funds; in substance this was early payment of their bills, and the interest was adjusted against their dues. It hired out its own plant and machinery to the contractors for the construction work, the charge being fixed, as the Tribunal found, to cover maintenance and wear and tear; letting machinery was not its business and it allowed use only to its own contractors. It allowed contractors to excavate stone lying on its land for the construction and charged royalty. Finally, in assessment year 1971-72 it had booked interest said to have accrued from Hindustan Steel Ltd on eight locomotives supplied to that company, and reversed the entry the next year when Hindustan Steel supplied it eight new locomotives instead. It had also invested borrowed money not immediately needed in short-term deposits. The Tribunal held the first four heads went to reduce the cost of construction and were capital receipts, and the High Court agreed. The Revenue appealed.
The appeals were dismissed, with no order as to costs. The rent from contractors for housing their workers, the hire charges for plant and machinery, and the interest on advances to contractors were all directly connected with or incidental to the construction of the plant, arose from arrangements intrinsically connected with it, had been adjusted against the charges payable to the contractors and had gone to reduce the cost of construction; they were rightly held to be capital receipts and not income from any independent source. The same reasoning applied to the royalty for stone excavated from the assessee's own land, which reduced the cost of the plant to that extent. The interest entry against Hindustan Steel reflected hypothetical income that never materialised, the original agreement having ceased to be operative and the entry having been reversed, and only real income can be taxed. On interest earned by investing surplus borrowed funds in short-term deposits, the Court noted that it had been held taxable as income from other sources, that the assessee had not appealed, and that the question was in any event concluded by Tuticorin Alkali Chemicals and Fertilizers Ltd v CIT (1997) 227 ITR 172, so it did not examine that issue.
The Court asked, of each receipt, whether it came from an independent source or from the process of construction itself. Had the assessee not provided quarters, the contractors would have made their own arrangements and their construction charges would have reflected the cost, so the recovery is in substance a reduction of the cost of the plant. Hire charges for machinery were fixed to compensate for wear and tear on the assessee's own asset. The advances were made as much to keep a very large project free of financial hitches as to help the contractors, and amounted to early payment of their bills. All of these were adjusted against amounts payable to the contractors. The Court approved the Delhi High Court's decision in Addl CIT v Indian Drugs and Pharmaceuticals Ltd (1983) 141 ITR 134, where receipts during construction from sale of tender forms, supply of water and electricity to contractors and sale of stones, boulders, grass and trees were held to be inextricably linked with the setting up of the business, directly related to its capital structure and therefore capital. It then took the mirror image from Challapalli Sugars Ltd v CIT (1975) 98 ITR 167, where pre-production interest on money borrowed to acquire and install plant was held to form part of actual cost, on the accepted accountancy rule that the cost of a fixed asset includes all expenditure needed to bring it into existence and into working condition. If expenditure linked to setting up is capitalised, receipts inextricably linked to the same process must reduce cost. Tuticorin Alkali was distinguished on exactly this basis: there the assessee had invested borrowed money to earn interest, which it was free to use as it liked, so the interest was an independent source unconnected with the construction, whereas here the payments arose from the utilisation of the company's own assets in setting up its plant. On the reversed entry the Court applied Godhra Electricity Co Ltd v CIT (1997) 225 ITR 746: whether the accounts are kept on a cash or a mercantile basis, there can be no income tax without real income, and an entry recording income that never accrued cannot be taxed.
if the assessee receives any amounts which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets.
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Handle my notice → Ask a CA on WhatsAppNo, where the receipts are inextricably linked with setting up the plant. The Supreme Court held that rent charged to contractors for housing their workers, hire charges for plant and machinery lent to them, interest on advances made to keep their work moving, and royalty for stone excavated from the company's own land are all capital receipts that go to reduce the cost of construction. They arise from arrangements intrinsically connected with building the plant, not from any independent source. Tuticorin Alkali was distinguished: interest on surplus borrowed funds parked in short-term deposits is an independent source and remains taxable. This was decided by the Supreme Court (Supreme Court of India - Sujata V. Manohar and G.B. Pattanaik JJ; judgment by Sujata V. Manohar J) and bears on section 4, section 43(1), section 56, section 22 of the Income Tax Act 1961. It is reported as Civil Appeal Nos. 2544-2545 of 1988 and Civil Appeal Nos. 642-648 of 1989. This is the case that draws the line on the other side of Tuticorin Alkali, and the pair of them together decide almost every pre-commencement receipt dispute. The test it supplies is linkage, not timing: ask whether the receipt arises out of an arrangement intrinsically connected with the construction, or from a free-standing use of surplus money. The Court also gives the reason the linked receipts cannot be income - had the assessee not provided the quarters or the machinery, the contractors would have arranged them and charged more, so the receipt is really a reduction of what the plant cost. That mirrors Challapalli Sugars on the expenditure side, where pre-production interest was capitalised into actual cost. The judgment also contains a clean statement of the real income principle on a reversed book entry. If it applies to you, the first step is this: Trace each receipt to its arrangement. If it arises from a contract with the contractor building your plant, document that link, because linkage is what takes it out of charge.
The assessee was a corporation wholly owned by the Government of India, incorporated in January 1964 to construct and own an integrated iron and steel works, and assessed as a company. Through assessment years 1965-66 to 1972-73 its factory was still being built and the plant installed, and it had not started any business. Five kinds of receipt were in issue. It gave quarters to its contractors for the residence of their staff and workers engaged on the construction and charged for their use. Under supplementary agreements it advanced money to the contractors, on interest, so that they could carry on the large-scale work without raising outside funds; in substance this was early payment of their bills, and the interest was adjusted against their dues. It hired out its own plant and machinery to the contractors for the construction work, the charge being fixed, as the Tribunal found, to cover maintenance and wear and tear; letting machinery was not its business and it allowed use only to its own contractors. It allowed contractors to excavate stone lying on its land for the construction and charged royalty. Finally, in assessment year 1971-72 it had booked interest said to have accrued from Hindustan Steel Ltd on eight locomotives supplied to that company, and reversed the entry the next year when Hindustan Steel supplied it eight new locomotives instead. It had also invested borrowed money not immediately needed in short-term deposits. The Tribunal held the first four heads went to reduce the cost of construction and were capital receipts, and the High Court agreed. The Revenue appealed. The matter was decided on 1998-12-18 by the Supreme Court (Supreme Court of India - Sujata V. Manohar and G.B. Pattanaik JJ; judgment by Sujata V. Manohar J). On those facts the Supreme Court held as follows. The appeals were dismissed, with no order as to costs. The rent from contractors for housing their workers, the hire charges for plant and machinery, and the interest on advances to contractors were all directly connected with or incidental to the construction of the plant, arose from arrangements intrinsically connected with it, had been adjusted against the charges payable to the contractors and had gone to reduce the cost of construction; they were rightly held to be capital receipts and not income from any independent source. The same reasoning applied to the royalty for stone excavated from the assessee's own land, which reduced the cost of the plant to that extent. The interest entry against Hindustan Steel reflected hypothetical income that never materialised, the original agreement having ceased to be operative and the entry having been reversed, and only real income can be taxed. On interest earned by investing surplus borrowed funds in short-term deposits, the Court noted that it had been held taxable as income from other sources, that the assessee had not appealed, and that the question was in any event concluded by Tuticorin Alkali Chemicals and Fertilizers Ltd v CIT (1997) 227 ITR 172, so it did not examine that issue.
The Court asked, of each receipt, whether it came from an independent source or from the process of construction itself. Had the assessee not provided quarters, the contractors would have made their own arrangements and their construction charges would have reflected the cost, so the recovery is in substance a reduction of the cost of the plant. Hire charges for machinery were fixed to compensate for wear and tear on the assessee's own asset. The advances were made as much to keep a very large project free of financial hitches as to help the contractors, and amounted to early payment of their bills. All of these were adjusted against amounts payable to the contractors. The Court approved the Delhi High Court's decision in Addl CIT v Indian Drugs and Pharmaceuticals Ltd (1983) 141 ITR 134, where receipts during construction from sale of tender forms, supply of water and electricity to contractors and sale of stones, boulders, grass and trees were held to be inextricably linked with the setting up of the business, directly related to its capital structure and therefore capital. It then took the mirror image from Challapalli Sugars Ltd v CIT (1975) 98 ITR 167, where pre-production interest on money borrowed to acquire and install plant was held to form part of actual cost, on the accepted accountancy rule that the cost of a fixed asset includes all expenditure needed to bring it into existence and into working condition. If expenditure linked to setting up is capitalised, receipts inextricably linked to the same process must reduce cost. Tuticorin Alkali was distinguished on exactly this basis: there the assessee had invested borrowed money to earn interest, which it was free to use as it liked, so the interest was an independent source unconnected with the construction, whereas here the payments arose from the utilisation of the company's own assets in setting up its plant. On the reversed entry the Court applied Godhra Electricity Co Ltd v CIT (1997) 225 ITR 746: whether the accounts are kept on a cash or a mercantile basis, there can be no income tax without real income, and an entry recording income that never accrued cannot be taxed. In the words reproduced by the source cited on this page: "if the assessee receives any amounts which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets."
It was decided by the Supreme Court on 1998-12-18 and is reported as Civil Appeal Nos. 2544-2545 of 1988 and Civil Appeal Nos. 642-648 of 1989. Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. On section 4, section 43(1), section 56, section 22, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The appeals were dismissed, with no order as to costs. The rent from contractors for housing their workers, the hire charges for plant and machinery, and the interest on advances to contractors were all directly connected with or incidental to the construction of the plant, arose from arrangements intrinsically connected with it, had been adjusted against the charges payable to the contractors and had gone to reduce the cost of construction; they were rightly held to be capital receipts and not income from any independent source. The same reasoning applied to the royalty for stone excavated from the assessee's own land, which reduced the cost of the plant to that extent. The interest entry against Hindustan Steel reflected hypothetical income that never materialised, the original agreement having ceased to be operative and the entry having been reversed, and only real income can be taxed. On interest earned by investing surplus borrowed funds in short-term deposits, the Court noted that it had been held taxable as income from other sources, that the assessee had not appealed, and that the question was in any event concluded by Tuticorin Alkali Chemicals and Fertilizers Ltd v CIT (1997) 227 ITR 172, so it did not examine that issue. It arises in Assessment & Scrutiny matters, on section 4, section 43(1), section 56, section 22 of the Income Tax Act 1961, and was decided by Supreme Court of India - Sujata V. Manohar and G.B. Pattanaik JJ; judgment by Sujata V. Manohar J. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Adjust such receipts against the contractor's bills and against capital work in progress rather than routing them through the profit and loss account, since the Court relied on the fact that they had been so adjusted. Do not extend the argument to interest on surplus funds placed in deposits. That is settled the other way, and running it weakens the rest of your case. Where a receipt never materialised, show the reversal and the change in the underlying transaction; a book entry for hypothetical income cannot be taxed, whichever method of accounting you follow. Keep the contract terms that explain why you provided the facility, since the reasoning is that the assessee absorbed a cost the contractor would otherwise have charged for.
Still good law. This is the settled counterpart to Tuticorin Alkali and is applied constantly to pre-commencement receipts; nothing in the judgment suggests doubt, though I checked no later authority. Read its limits carefully. It expressly leaves interest on surplus funds in short-term deposits taxable, and the assessee did not even appeal that finding. It turns on the receipts arising from arrangements with the contractors building the assessee's own plant and being adjusted against their bills, so a receipt from an unconnected party, or one retained free of the construction, is not covered. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The batch line carried no reporter citations, so reported gives the Supreme Court appeal numbers from the cause title. The judgment does not decide the treatment of interest on short-term deposits, which was concluded against the assessee below and not appealed, so nothing here helps on that. The referred questions for assessment year 1972-73 asked in the alternative under which head such receipts would fall if they were income, and since the Court held them capital that alternative is not answered. I have not read the High Court judgment under appeal. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeals were dismissed, with no order as to costs. The rent from contractors for housing their workers, the hire charges for plant and machinery, and the interest on advances to contractors were all directly connected with or incidental to the construction of the plant, arose from arrangements intrinsically connected with it, had been adjusted against the charges payable to the contractors and had gone to reduce the cost of construction; they were rightly held to be capital receipts and not income from any independent source. The same reasoning applied to the royalty for stone excavated from the assessee's own land, which reduced the cost of the plant to that extent. The interest entry against Hindustan Steel reflected hypothetical income that never materialised, the original agreement having ceased to be operative and the entry having been reversed, and only real income can be taxed. On interest earned by investing surplus borrowed funds in short-term deposits, the Court noted that it had been held taxable as income from other sources, that the assessee had not appealed, and that the question was in any event concluded by Tuticorin Alkali Chemicals and Fertilizers Ltd v CIT (1997) 227 ITR 172, so it did not examine that issue.
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