Interest on surplus fund during pre-commencement of the business – Whether Business Income or Other source Income?
The question of law framed by Hon’ble High Court in a recent case was “Whether the interest income earned on surplus fund deposited in the bank during pre-commencement of the business is liable to be taxed under Section 56 of the Income Tax Act, 1961”
Hon’ble High Court dismissed the appeal of the Revenue on the key issue whether interest on funds deposited in the short-term fixed deposit can be construed as incidental to setting up the business, and is required to be part of the capital cost and credited to Capital Work in Progress (CWIP).
The dispute arose from the addition made by the learned AO to the Assessee’s declared income. The AO observed an interest income of ₹11,45,92,550/- on funds from shareholders, with corresponding interest payments of ₹11,14,73,651/-. The AO treated the difference as taxable ‘income from other sources’, resulting in a total income assessment of ₹31,18,900/-.
Upon appeal, the learned CIT(A) upheld the taxation of short-term deposit earnings under ‘income from other sources’ as per Section 56 and disallowed deduction under Section 57(iii) for interest payable to promoters. The Assessee’s taxable income was determined at ₹11,58,59,615/-.
However, the Hon’ble ITAT, in its ruling, recognized that the Assessee received funds from promoters for business purposes, specifically acquiring a coal mine abroad.
Consequently, the interest paid was set off against interest received, with the balance capitalized to CWIP. The Hon’ble ITAT concluded that the interest from the deposit was not taxable under ‘income from other sources’, overturning the decisions of the CIT(A) and the AO.
Hon’ble High Court has admitted the appeal and framed the question of law. The key issue addressed was whether the interest earned on funds temporarily kept in fixed deposits during the acquisition process should be considered part of the capital value of the business/asset.
After thorough consideration of both parties’ arguments and analyzing relevant judgments, the Hon’ble High Court concluded that the Assessee’s primary objective was to secure coal resources for business operations. During negotiations for acquiring a coal mine, funds were raised from shareholders for the acquisition costs. These funds were temporarily held in a fixed deposit pending payment for the acquisition. However, due to the unsuccessful acquisition attempt, the borrowed funds were repaid. It was clarified that the funds in question were not surplus but specifically designated for the overseas coal mine acquisition, which was the core purpose of the Assessee’s establishment.
Based on these facts, the Hon’ble High Court determined that the interest received on borrowed funds held in an interest-bearing deposit should be considered part of the capital cost and must be credited to CWIP (Capital Work in Progress).
The copy of the order is as under:
