My company is still building its plant. It parked the unused part of its term loans in short-term bank deposits. Can I set the interest earned off against the interest I am paying, or must I pay tax on it?
You must pay tax on it, under the head income from other sources. Interest earned on surplus borrowed funds parked in deposits before business commences is income the moment it accrues, and it cannot be adjusted against the interest payable on the term loans, because s.57 sets out exhaustively what may be deducted from income assessable under s.56 and interest on term loans taken to build the plant is not in that list.
Decided by the Supreme Court (S.P. Bharucha J, Suhas C. Sen J and M. Jagannadha Rao J (judgment delivered by Sen J)) on 1997-07-08, reported as [1997] 227 ITR 172 (SC); 1997 Supp (1) SCR 528; Tax Reference Case Nos. 1-2 of 1992. It bears on section 56, section 57, section 4, section 14, section 10 of the Income Tax Act 1961, in Assessment & Scrutiny, Deductions & Disallowances and How Tax Law Is Read matters.
This is the decision that decides most pre-commencement interest disputes, and it is the Revenue's decision. The taxpayer's escape route is narrow and factual: where the receipt is inextricably linked to the setting up of the plant itself, the Supreme Court in CIT v. Bokaro Steel Ltd. treated it as a capital receipt reducing the cost of construction, and Bokaro expressly says the Tuticorin question is 'now concluded'. So the fight is no longer whether interest on parked borrowings is taxable — it is whether your receipt is an independent source of income or is inextricably linked with the capital structure. Note too the second, wider proposition: accounting practice, including a view of the Institute of Chartered Accountants of India, cannot make a taxable receipt non-taxable.
Binding on every court and authority in India.
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The company was incorporated on 3 December 1971 to manufacture heavy chemicals such as ammonium chloride and soda ash. Trial production began on 30 June 1982. To set up the factories it took term loans from banks and financial institutions, and the part of the borrowed funds not immediately required was kept in short-term bank deposits, an investment its Memorandum and Articles expressly permitted. It had also deposited sums with the Tamil Nadu Electricity Board and given interest-bearing vehicle loans to employees. Up to AY 1980-81 it had shown the interest as income and been taxed on it. For AY 1982-83 it received interest of Rs 2,92,440 and originally returned it as income from other sources, setting it against a business loss of Rs 3,21,802 and carrying forward Rs 29,360. It then filed a revised return on 26 December 1984 claiming that on accepted accounting practice interest and finance charges and other pre-production expenses had to be capitalised, so the interest income should reduce the pre-production expenses, pointing to Rs 1,13,06,068 of interest and finance charges incurred that year. The same claim was made for AY 1983-84 on interest of Rs 1,08,336. The Income Tax Officer, the Commissioner (Appeals) and the Tribunal all rejected it. The Tribunal referred the question to the Supreme Court because the Madras High Court in CIT v. Seshasayee Paper and Board Ltd. (156 ITR 543) and the Andhra Pradesh High Court in CIT v. Nagarjuna Steels Ltd. (171 ITR 663) had taken opposite views.
The reference was answered against the assessee on both parts and disposed of with no order as to costs. Interest derived from borrowed funds invested in short-term bank deposits is chargeable under the head income from other sources and does not go to reduce the interest payable on the term loans. Neither the fact that business had not commenced nor the fact that the funds were borrowed affects taxability. The Madras High Court's view in Seshasayee Paper and Board was correct and the contrary views in Nagarjuna Steels, Electrochem Orissa and Maharashtra Electrosmelt were held to be erroneous.
The Court began from s.4 and s.14: total income is chargeable to tax and must be computed under the heads, and interest received from bank deposits and loans is in the usual course taxable under s.56. Income attracts tax as soon as it accrues, and the application or destination of income has nothing to do with its accrual or taxability; interest income is always of a revenue nature unless received by way of damages or compensation. If a person borrows money for a business purpose but uses it to earn interest, however temporarily, the interest generated is his income, and he is free to spend it as he likes — using it to pay interest on the loan is application, not diversion by overriding title. The Court accepted that the company would have to pay interest on the borrowings and might be entitled to capitalise that interest, but held that what it could not claim was adjustment of that expenditure against interest assessable under s.56, because s.57 sets out in clauses (i) to (iii) the expenditure allowable as a deduction from income assessable under s.56, and it was not even the assessee's case that the term-loan interest fell within s.57. On the accounting argument the Court held that where the question is whether a receipt is taxable or a deduction permissible, it is decided by the principles of law and not by accountancy practice, and that Challapalli Sugars was different because there the undefined statutory expression 'actual cost' had to be understood in its commercial sense, and Khanna J had in any event grounded the capitalisation principle in s.208 of the Companies Act and in English authority, not merely in the Institute's opinion.
Accounting practice cannot override Section 56 or any other provision of the Act.
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Handle my notice → Ask a CA on WhatsAppYou must pay tax on it, under the head income from other sources. Interest earned on surplus borrowed funds parked in deposits before business commences is income the moment it accrues, and it cannot be adjusted against the interest payable on the term loans, because s.57 sets out exhaustively what may be deducted from income assessable under s.56 and interest on term loans taken to build the plant is not in that list. This was decided by the Supreme Court (S.P. Bharucha J, Suhas C. Sen J and M. Jagannadha Rao J (judgment delivered by Sen J)) and bears on section 56, section 57, section 4, section 14, section 10 of the Income Tax Act 1961. It is reported as [1997] 227 ITR 172 (SC); 1997 Supp (1) SCR 528; Tax Reference Case Nos. 1-2 of 1992. This is the decision that decides most pre-commencement interest disputes, and it is the Revenue's decision. The taxpayer's escape route is narrow and factual: where the receipt is inextricably linked to the setting up of the plant itself, the Supreme Court in CIT v. Bokaro Steel Ltd. treated it as a capital receipt reducing the cost of construction, and Bokaro expressly says the Tuticorin question is 'now concluded'. So the fight is no longer whether interest on parked borrowings is taxable — it is whether your receipt is an independent source of income or is inextricably linked with the capital structure. Note too the second, wider proposition: accounting practice, including a view of the Institute of Chartered Accountants of India, cannot make a taxable receipt non-taxable. If it applies to you, the first step is this: Separate the receipts. Interest on deposits of surplus funds is one thing; hire charges, royalties, or amounts recovered from contractors working on your own plant are another, and Bokaro Steel governs the second class.
The company was incorporated on 3 December 1971 to manufacture heavy chemicals such as ammonium chloride and soda ash. Trial production began on 30 June 1982. To set up the factories it took term loans from banks and financial institutions, and the part of the borrowed funds not immediately required was kept in short-term bank deposits, an investment its Memorandum and Articles expressly permitted. It had also deposited sums with the Tamil Nadu Electricity Board and given interest-bearing vehicle loans to employees. Up to AY 1980-81 it had shown the interest as income and been taxed on it. For AY 1982-83 it received interest of Rs 2,92,440 and originally returned it as income from other sources, setting it against a business loss of Rs 3,21,802 and carrying forward Rs 29,360. It then filed a revised return on 26 December 1984 claiming that on accepted accounting practice interest and finance charges and other pre-production expenses had to be capitalised, so the interest income should reduce the pre-production expenses, pointing to Rs 1,13,06,068 of interest and finance charges incurred that year. The same claim was made for AY 1983-84 on interest of Rs 1,08,336. The Income Tax Officer, the Commissioner (Appeals) and the Tribunal all rejected it. The Tribunal referred the question to the Supreme Court because the Madras High Court in CIT v. Seshasayee Paper and Board Ltd. (156 ITR 543) and the Andhra Pradesh High Court in CIT v. Nagarjuna Steels Ltd. (171 ITR 663) had taken opposite views. The matter was decided on 1997-07-08 by the Supreme Court (S.P. Bharucha J, Suhas C. Sen J and M. Jagannadha Rao J (judgment delivered by Sen J)). On those facts the Supreme Court held as follows. The reference was answered against the assessee on both parts and disposed of with no order as to costs. Interest derived from borrowed funds invested in short-term bank deposits is chargeable under the head income from other sources and does not go to reduce the interest payable on the term loans. Neither the fact that business had not commenced nor the fact that the funds were borrowed affects taxability. The Madras High Court's view in Seshasayee Paper and Board was correct and the contrary views in Nagarjuna Steels, Electrochem Orissa and Maharashtra Electrosmelt were held to be erroneous.
The Court began from s.4 and s.14: total income is chargeable to tax and must be computed under the heads, and interest received from bank deposits and loans is in the usual course taxable under s.56. Income attracts tax as soon as it accrues, and the application or destination of income has nothing to do with its accrual or taxability; interest income is always of a revenue nature unless received by way of damages or compensation. If a person borrows money for a business purpose but uses it to earn interest, however temporarily, the interest generated is his income, and he is free to spend it as he likes — using it to pay interest on the loan is application, not diversion by overriding title. The Court accepted that the company would have to pay interest on the borrowings and might be entitled to capitalise that interest, but held that what it could not claim was adjustment of that expenditure against interest assessable under s.56, because s.57 sets out in clauses (i) to (iii) the expenditure allowable as a deduction from income assessable under s.56, and it was not even the assessee's case that the term-loan interest fell within s.57. On the accounting argument the Court held that where the question is whether a receipt is taxable or a deduction permissible, it is decided by the principles of law and not by accountancy practice, and that Challapalli Sugars was different because there the undefined statutory expression 'actual cost' had to be understood in its commercial sense, and Khanna J had in any event grounded the capitalisation principle in s.208 of the Companies Act and in English authority, not merely in the Institute's opinion. In the words reproduced by the source cited on this page: "Accounting practice cannot override Section 56 or any other provision of the Act." The decision followed or applied CIT v. Seshasayee Paper and Board Ltd. (156 ITR 543) (Mad.) — approved; CIT v. Nagarjuna Steels Ltd. (171 ITR 663) (AP), CIT v. Electrochem Orissa Ltd. and CIT v. Maharashtra Electrosmelt Ltd. — held erroneous; Challapalli Sugars Ltd. v. CIT (1975) 98 ITR 167 (SC) — distinguished; Kedar Narain Singh v. CIT (6 ITR 157) — relied on; B.S.C. Footwear Ltd. v. Ridgway (Inspector of Taxes) [1972] 83 ITR 269 — relied on.
It was decided by the Supreme Court on 1997-07-08 and is reported as [1997] 227 ITR 172 (SC); 1997 Supp (1) SCR 528; Tax Reference Case Nos. 1-2 of 1992. 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 56, section 57, section 4, section 14, section 10, 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 department, and it appears in this library for that reason — you need to know what the Assessing Officer will cite against you. The reference was answered against the assessee on both parts and disposed of with no order as to costs. Interest derived from borrowed funds invested in short-term bank deposits is chargeable under the head income from other sources and does not go to reduce the interest payable on the term loans. Neither the fact that business had not commenced nor the fact that the funds were borrowed affects taxability. The Madras High Court's view in Seshasayee Paper and Board was correct and the contrary views in Nagarjuna Steels, Electrochem Orissa and Maharashtra Electrosmelt were held to be erroneous. It arises in Assessment & Scrutiny, Deductions & Disallowances and How Tax Law Is Read matters, on section 56, section 57, section 4, section 14, section 10 of the Income Tax Act 1961, and was decided by S.P. Bharucha J, Suhas C. Sen J and M. Jagannadha Rao J (judgment delivered by Sen 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. Do not argue capitalisation from accounting standards alone. The Court held expressly that accounting practice cannot override s.56, so an AS or ICDS-based argument without a statutory hook will fail. If you must resist, plead and prove the inextricable link with the setting up of the plant, with the loan and deposit trail, rather than pleading that business had not commenced — non-commencement was expressly held to be irrelevant. Do not claim the term-loan interest as a s.57 deduction against the deposit interest; the Court recorded that it was not even the assessee's case that it fell within s.57, and clauses (i) to (iii) are the whole of what is allowable. Check whether any part of the deposit interest can instead be shown to arise in the course of an already commenced business, which takes it to s.28 and out of this decision altogether.
Still good law. Later treatment was checked and read. In CIT v. Bokaro Steel Ltd. (Supreme Court, 18 December 1998) the Court recorded that the taxability of interest earned on short-term deposits of borrowed construction funds 'is now concluded by a decision of this Court in Tuticorin Alkali Chemicals and Fertilizers Ltd. v. Commissioner of Income-tax ([1997] 227 ITR 172)', and then distinguished it on the facts before it, holding that receipts inextricably linked with the setting up of the capital structure are capital receipts reducing the cost of construction. Tuticorin therefore stands, but confined to interest that is an independent source of income unconnected with the construction activity. No decision doubting or overruling it was located; a search for subsequent Supreme Court treatment returned Bokaro Steel, Karnal Co-operative Sugar Mills and Bongaigaon Refinery, of which only Bokaro was read in this pass. 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 judgment as served by indiankanoon carries no paragraph numbers at all, so no paragraph locator is given for the quote. The plain /doc/1084982/ URL returned HTTP 403 on two attempts; the text was read through ?type=print in three separate passes (opening, middle, closing) and the operative passages were then re-read through /docfragment/, which returned the same words. indiankanoon also lists a second Supreme Court document titled 'Tuticorin Alkali Chemicals & ... vs Commissioner Of Income Tax.' dated 8 March 1997 at /doc/695067/; that URL returned HTTP 403 and was not read, so it is not relied on here. The citation 227 ITR 172 is taken from the Supreme Court's own reference to this decision in Bokaro Steel, not from the report itself. 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 reference was answered against the assessee on both parts and disposed of with no order as to costs. Interest derived from borrowed funds invested in short-term bank deposits is chargeable under the head income from other sources and does not go to reduce the interest payable on the term loans. Neither the fact that business had not commenced nor the fact that the funds were borrowed affects taxability. The Madras High Court's view in Seshasayee Paper and Board was correct and the contrary views in Nagarjuna Steels, Electrochem Orissa and Maharashtra Electrosmelt were held to be erroneous.
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