ACIT Vs MB Power (Madhya Pradesh) Ltd. (ITAT Delhi)

Income Tax Appellate Tribunal (ITAT), Delhi, recently heard an appeal by the Revenue concerning the taxability of interest income earned by MB Power (Madhya Pradesh) Ltd. during the pre-commencement phase of its business operations for the assessment year 2016-17. The Revenue challenged the Commissioner of Income Tax (Appeals)’s (CIT(A)) order, which had held that the interest income was not taxable under Section 56 of the Income Tax Act. The Revenue argued that the CIT(A) had erred in overlooking established judicial precedents, specifically citing the Supreme Court’s rulings in Tuticorin Alkali Chemicals and Fertilizers Ltd. Vs. CIT and CIT Vs. Coromandal Cement Ltd., which deal with the taxability of pre-commencement income.

The CIT(A) had previously allowed the assessee’s appeal, contending that the interest earned on fixed deposits was inextricably linked to the process of setting up the power plant. The CIT(A) distinguished the current case from Tuticorin Alkali, noting that in that case, the company had surplus funds available for investment, whereas in MB Power’s case, the funds were invested as margin money for bank guarantees, deposits with government authorities, and foreign buyers’ credit, all essential for project execution. The CIT(A) relied on the Supreme Court’s decisions in Commissioner of Income-tax v. Karnal Co­operative Sugar Mills Ltd. and CIT VS. Bokaro Steel Ltd., which established that receipts inextricably linked to the process of setting up plant and machinery are capital in nature and not taxable as income. These judgments hold that interest earned on funds used for acquiring and installing assets before commencement of production can be capitalized and added to the cost of those assets.

During the ITAT proceedings, both parties reiterated their positions. The Revenue stressed the Assessing Officer’s initial stance of taxing the interest income, while the assessee supported the CIT(A)’s findings. The ITAT, however, noted that a previous order concerning the same issue in earlier assessment years (2013-14 and 2014-15) had remanded the matter back to the CIT(A) for further consideration. The ITAT observed that the CIT(A)’s impugned order appeared to follow the principles established in those earlier assessments.

Acknowledging the complexities of the case and the need for a thorough review, the ITAT chose not to take a definitive stance at this stage. Instead, it opted to remand the Revenue’s appeal back to the CIT(A) for fresh adjudication. The ITAT directed the CIT(A) to consider the matter de novo, allowing the assessee to present all factual and legal arguments, including any distinctions between the current assessment year and the previous ones. The ITAT explicitly clarified that it was not commenting on the merits of the case at this juncture, ensuring an impartial and open review by the CIT(A). The Revenue’s appeal was thus allowed for statistical purposes, setting the stage for a renewed examination of the contentious issue of pre-commencement interest income taxability.

FULL TEXT OF THE ORDER OF ITAT DELHI

This Revenue’s appeal for assessment year 2016-17, arises against the Commissioner of Income Tax (Appeals), Circle-16(2) [in short, the “CIT(A)”], Delhi’s order dated 28.12.2018 passed in case No. ITBA/AST/S/143(3)/2018-19/1014644380(1) involving proceedings under section 143(3) of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’).

2. Heard both the parties at length. Case file perused.

3. The Revenue raises the following substantive grounds in the instant appeal:

1. Whether on facts and circumstances of the case, the Ld. CIT(A) is legally justified in holding that interest income of Rs. 7,64,07,627/- earned during the pre-commencement of business is not liable to tax u/s 56 of the Income Tax Act.

2. Whether on the fact and circumstance of the case, Ld. CIT(A) is legally justified in allowing appeal of the assessee by ignoring the fact that the ratio decided as laid down by Hon’ble Apex Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. Vs. CIT, (1997) 227 ITR 172 (SC) and CIT Vs. Coromandal Cement Ltd. (1998) 234 ITR 412 is applicable to the facts and circumstances of the present case.

4. Both the learned representative next invited our attention to the CIT(A)’s detailed discussion reversing the assessment findings disallowing/adding the assessee’s interest on fixed deposits amounting to Rs.7,13,12,467/- as it’s taxable income, as under:

“4.2 Grounds of appeal Nos. 2 to 7 and 10 challenge the considering of the interest on fixed deposits with tank amounting to Rs. 7,13,12,467/- as taxable income. Since these grounds of appeal are interlinked, these are being adjudicated together.

4.2.1 The AO has brought to tax interest income by holding that the interest earned on FDRs made during the period of setting up of the power project should be taxed under the head income from other sources for which reliance has been placed by the AD on the decision of the Hon’ble Supreme Court in the Case of Tuticorin Alkali Chemicals and Fertilizers Ltd. vs. CIT (supra). The appellant has contended that the money is borrowed by a newly started company which is in the process of constructing and erecting its plant and the interest incurred before the commencement of production on such borrowed money can be capitalized and added to the cost of the fixed assets credited as a result of such expenditure. It has also been submitted that as a  necessary corollary, if the assessee receives any amount which is inextricably linked with the process of setting up of its plant & machinery, such receipts will go to reduce the cost of its assets. It has also been submitted that the receipts are capital in nature and cannot be taxed as income.

4.2.2 I have considered the assessment order and the submissions of the appellant. As was the case in the earlier years, te. AY 2013-14 and 2014-15, in the year under consideration also it cannot be conclusively said that there was an availability of surplus fund for the purpose of investment into deposit for earning interest. In the case of Tuticorin Alkali Chemicals and Fertilizers Lid, vs. CIT (upra), the company had surplus funds in its hand which were invested for the purpose of earning interest. In the case of the appellant, however, the amount was invested in FDRs as margin money for issue of bank guarantee and in form of deposits with Government authorities and for foreign buyers’ credit for the purpose of business. The interest earned on the FDRs was clearly inextricably linked with the process of setting up. Deposits under lien with government authorities and margin money deposit for bank guarantee and the execution of the project by the appellant company were found to be inextricably linked which was apparent from the copies of contracts submitted during the appellate proceedings for AY 2013-14, It is a fact that the appellant company is engaged in the business of power generation and infrastructure development. It has signed an agreement with the Madhya Pradesh Government for setting up on the thermal base power plant and signed a power purchase agreement with the Madhya Pradesh Government for setting up/commencement of power plant. The appellant had to comply with terms and conditions of various government authorities one of which is to give security deposit/bank guarantee for compliance. In the year under consideration, one of the units commenced operations while the other unit was still in the process of being set up. Accordingly, margin money in the form of FDRs had been given for getting bank guarantees issued in the name of the authorities from various banks. While deciding the appeal for AY 2013-14 it had been observed that as per clause 3.5 of the power purchase agreement, initial contract performance guarantee and contract performance guarantee had to be provided to the Madhya Pradesh Power Trading Company Lid. Similarly a security deposit was also required to be given as a part of the coal supply agreement between South Eastern Coalfields Lid, and the assessee.

4.2.3 In the case of Commissioner of Income-tax v. Karnal Co­operative Sugar Mills Ltd., [2000] 243 ITR 2 (SC), the Apex Court ruled as under:

“This is, therefore, not a case where any surplus share capital money which is lying idle has been deposited in the bank fer the purpose of carting interest. The deposit of money in the present case is directly linked with the purchase of plant and machinery. Hence, any income earned on such deposit is incidental to the acquisition of assets for the setting up of the plant and machinery. In this view of the matter the ratio laid down by this court in Tuticorin Alkali Chemicals and Fertilizers Limited v. CIT (1997) 227 ITR 172, will not be attracted. The more appropriate decision in the factual situation in the present case is in CIT v. Bokaro Steel Ltd. (1999) 236 ITR 315 (SC).

4.2.4 The Hon’ble Supreme Court in the case of CIT VS. Bokaro Steel Ltd. (1999) 236 ITR 315 (SC) had decided the issue which has been relied upon by the AR. The head note of the judgment is reproduced as under:

“In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalized and added to the cost of the fixed assets created as a result of such expenditure. By the same reasoning 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. These are receipts of a capital nature and cannot be taxed as income.

4.2.5 The Apex Court had ruled as under

“We will take the first three heads under which the assessee has received certain amounts. These are, the rent charged by the assessee to its contractors for housing workers and staff employed by the contractor for the construction work of the assessee including certain amenities granted to the staff by the assessee.

Secondly, hire charges for plant and machinery which was given to the contractors by the assessee for use in the construction work of the assessee, and thirdly, interest from advances made to the contractors by the assessee for the purpose of facilitating the work of construction. The activities of the assessee in connection with all these three receipts are directly connected with or are incidental to the work of construction of its plant undertaken by the assessee. Broadly speaking, these pertain to the arrangements made by the assessee with its contractors pertaining to the work of construction. To facilitate the work of the contractors, the assessee permitted the contractors to use the premises of the assessee for housing its staff and workers engaged in the construction activity of the assessee’s plant. This was clearly to facilitate the work of construction. Had this facility not been provided by the assessee, the contractors would have had to make their own arrangements and this would have been reflected in the charges of the contractors for the construction work. Instead, the assessee has provided these facilities. The same is true of the hire charges for plant and machinery which was given by the assessee to the contractors for the assessee’s construction work. The receipts in this connection also go to compensate the assessee for the wear and tear on the machinery. The advances which the assessee made to the contractors to facilitate the construction activity of putting together a very large project was as much to ensure that the work of the contractors proceeded without any financial hitch as to help the contractors. The arrangements which were made between the assessee-company and the contractors pertaining to these three receipts are arrangements which are intrinsically connected with the construction of its steel plant. The receipts have been adjusted against the charges payable to the contractors and have gone to reduce the cost of construction. They have, therefore, been rightly held as capital receipts and not income of the assessee from any independent source.

In the case of Addl. CIT v. Indian Drugs and Pharmaceuticals Ltd. [1983] 141 ITR 134, the Delhi High Court considered a case where the work of construction of the factory of the assessee was in progress and production had not commenced. Receipts from sale of tender forms and supply of water and electricity to the contractors engaged in construction as also receipts on account of sale of stones, boulders, grass and trees were held to be receipts not from independent sources but were considered as inextricably linked with the process of setting up of business. These were directly related to the capital structure of business and were held to be capital in nature. We agree with this view taken by the Delhi High Court.

The appellant, however, relied upon the decision of this court in Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT (1997) 227 (TR 172. That case dealt with the question whether investment of borrowed funds prior to commencement of business, resulting in earning of interest by the assessee would amount to the assessee earning any income.

“This court held that of a person borrows money for business purposes, but utilizes that money to earn interest however, temporarily, the interest so generated will be his income. This income can be utilised by the assessee whichever way he likes. Merely because he utilised it to repay the interest on the loan taken, will not make the interest income as a capital receipt. The Department relied upon the observations made in that judgement (at page 179) to the effect that if the company, even before it commences business, invests the surplus fonds in its hands for purchase of land or house property and later sells it at profit, the gain made by the company will be assessable under the head Capital gains’. Similarly, if a company purchases a rented house and gets rent, such rent will be assessable to tax under section 22 as income from house property. Likewise, a company may have income from other sources The company may also, as in that case, keep the surplus funds in short-term deposits in order to earn interest. Such interest will be chargeable under section 56 of the income- tax Act” This court also emphasized the fact that the company was not bound to utilize the interest se carried to adjust it against the interest paid on borrowed capital. The company was free to use this income in any manner it like. However, while interest earned by investing borrowed capital in short-term deposits is an independent source of income not connected with the construction activities or business activities of the assessee, the same cannot be said in the present case where the utilization of various assets of the company and the payments received for such utilization are directly linked with the activity of setting up the steel plant of the assessee. These receipts are inextricably linked with the setting up of the capital structure of the assessee company. They must, therefore, be viewed as capital receipts going to reduce the cost of construction. In the case of Challapalli Sigars Ltd. v. CIT (1975) 98 ITR 167, this court examined the question whether interest paid before the commencement of production by a company on amounts borrowed for the acquisition and installation of plant and machinery would form a part of the actual cost of the asset to the assessee within the morning of that expression in section 10(5) of the Indian Income-tax Act, 1922, and whether the assessee will be entitled to depreciation allowances end development rebate with reference to such interest also. The court held that the accepted accountancy rule for determining the cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can he capitalized and added to the cost of the fixed assets created as a result of such expenditure. By the same reasoning 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. These are receipts of a capital nature and cannot be taxed as income

The same reasoning would apply to royalty received by the assessee company for stones, etc., excavated from the assessee-company’s land. The land had been allowed to be utilized by the contractors for the purpose of excavating stones to be used in the construction work of the assessee’s steel plant. The cost of the plant to the extent of such royalty received is reduced for the assessee. It is, therefore, rightly taken as a capital receipt…”

4.2.6 In my view the case of the appellant is covered by the ratio of the judgments referred above. Interest earned on deposit under hen with government authorities and margin money deposit for bank guarantee cannot be said to be a case of parking idle or surplus funds but a critical precondition to meet its obligation. The earning of interest on the said FDR was, therefore, only incidental and not the cardinal motive of the transaction. Since the facts of the case are similar to earlier years and no new facts have been brought on record by the AO, interest income of Rs. Rs. 7,13,12,467/- being inextricably linked with the activity of the setting up of the business of the appellant is treated as capital receipt. The treatment of interest income of Rs. Rs. 7,13,12,467/- as income from the other sources as held by the AO is not sustainable and, therefore, the addition made is deleted. Grounds of appeal Nos. 2 to 7 are allowed.”

5. Both the learned representatives next reiterate their respective stands wherein the Revenue vehemently argues that the Assessing Officer had rightly taxed assessee’s interest income and the taxpayer has drawn support from the CIT(A) above extracted findings. It is in this backdrop that we sought to know about the finality of the instant issue in the preceding assessment years as CIT(A) has himself placed reliance thereupon the corresponding discussions made in assessment years 2013-14 and 2014-15. The Revenue informs us that this tribunal’s earlier learned coordinate bench’s order dated 3^rd August, 2022 has restored the very issue(s) back to the CIT(A) with certain specific directions in paragraph 14(a) to (f) thereof; which forms part of the case file.

6. Learned counsel on the other hand has further sought to draw a distinction between the facts of the said earlier assessment years as well as that in the impugned assessment year on the ground that the assessee’s actual business has already commenced in this year and therefore, we ought to decide the Revenue’s sole substantive grievance in light of the changed circumstances. He further quotes (2009) 315 ITR 255 (Del) Indian Oil Panipat Power Consortium Ltd. Vs Income Tax Officer (ITO) and submits a brief synopsis that the Revenue’s foregoing contentions do not carry any merit.

7. We have given out thoughtful consideration to the above vehement contentions and find no reason to accept either side’s stand in entirety at this stage for the reason that the earlier coordinate bench has already restored the matter to CIT(A) (supra). We further wish to make it clear that the learned CIT(A)’s impugned lower appellate discussion extracted in the preceding paragraphs has prima facie adopted judicial consistency in light of the conclusion drawn in assessment years 2013-14 and 2014-15 (supra). We thus deem it appropriate in the larger interest of justice to restore the Revenue’s instant sole substantive ground back to the CIT(A) to be adjudicated afresh as per law in very terms, subject to a rider that the assessee shall indeed be at liberty to raise all factual and legal arguments in consequential proceedings including those seeking to draw a distinction between the relevant factual aspects which shall be duly considered after offering it adequate opportunity of hearing.

8. We clarify before parting that we have not commented anything on merits of the case at this stage.

9. This Revenue’s appeal is allowed for statistical purposes in above terms.

Order pronounced in the open court on 5^th December, 2024