Delhi H.C : The interest income on FDRs is not to be treated as income from other sources and is required to be reduced from preproduction expenses

High Court Of Delhi

CIT Vs. Madhya Bharat Energy Corporation Ltd.

Assessment Years : 1999-2000 To 2003-04

Section : 57

A.K. Sikri And M.L. Mehta, JJ.

ITA No. 950 Of 2008

July 11, 2011

JUDGMENT

M.L. Mehta, J. – This is an appeal under section 260A of the Income-tax Act, 1961 (hereinafter referred to as “the Act” for short) against the order dated September 21, 2007, of the Income-tax Appellate Tribunal (“the Tribunal” for short). This appeal was admitted on the following substantial questions of law :

“(a) Whether the Income-tax Appellate Tribunal was correct in law in holding that the reassessment order was invalidly made for the assessment years 1999-2000 and 2000-01 as no notice under section 143(2) was issued ?

(b) Whether the Income-tax Appellate Tribunal was correct in law in holding that the interest income on FDRs is not to be treated as income from other sources and is required to be reduced from preproduction expenses ?”

2. Though the impugned order is related to the assessment years (henceforth “AY” for short) 1999-2000 to 2003-2004, but the challenge is in respect to the order relating to the assessment year 1999-2000 and 2000-01. The facts leading to filing of the present appeal, being relevant need to be narrated.

3. The assessee-company entered into an agreement with AGIO Countertrade PTE Ltd., Singapore (hereinafter to be referred to as “the investing company”) and the Madhya Pradesh State Electricity Board (hereinafter to be referred to as “the MPSEB”). The assessee-company was established to set up a power plant in Madhya Pradesh. It participated in a bid which was called by the MPSEB. As per the requirement of the bid process, a security deposit of Rs. 11.65 crores was to be deposited with the MPSEB on or before August 17, 1998. The assessee-company requested the investing company to remit the requisite amount, but the same could only be received on August 18, 1998, and due to delay in remittance, the assessee could not deposit the security amount with the MPSEB on or before the stipulated date of August 17, 1998, and, consequently, the bid of the assessee was rejected. As per the arbitration agreement, the assessee raised claims against the investing company for the loss caused due to disqualification by the MPSEB. This claim of the assessee was resisted by the investing company. The amount of Rs. 6.00 crores submitted by the assessee to the MPSEB on August 18, 1998, was returned back by the MPSEB due to delay of one day and the balance amount of Rs. 5.65 crores which was deposited by the assessee on August 17, 1998, was also returned back by the MPSEB, vide their letter dated September 11, 1998. The assessee-company filed a writ against the MPSEB in the High Court of Jabalpur, Madhya Pradesh. In the meantime, on September 15, 1998, the assessee-company and the investing company referred the matter to the sole arbitrator for resolution of their dispute. The claim of the investing company before the arbitrator was that a sum of Rs. 6.77 crores was remitted by it to enable the assessee to make security deposit with the MPSEB to obtain the bid for setting up of a power plant. The said bid was rejected, but the assessee was holding the said money even though the purpose for which the amount was remitted had failed. The investing company pleaded that it apprehended that during the proceedings of arbitration, the assessee may appropriate these funds for the purposes other than repayment of amounts to the investing company, and if the funds are diverted by the assessee, the right of the investing company in the remittances would be adversely affected. On the other hand, it was pleaded by the assessee that since the investing company is not a resident of India, it will be difficult for the assessee to obtain remittance again. In case the investing company is allowed to take the funds out of India, then all the legal proceedings now initiated by the assessee against the MPSEB will be jeopardized and the assessee will not be able to make the payment of security deposit in time. It was also pleaded by the assessee that it being a statutory body is required to incur various expenses to comply with the statutory requirements, but its own capital is too inadequate to meet these expenses and the promoters have also not contributed, after the failure of the bid with the MPSEB. On September 25, 1998, the arbitrator passed the following directions :

“On the due consideration of the submissions by the claimant and the respondent, I find that the claims of the parties are justified in their own right. I fully agree with the claimant that if the respondent is permitted to take away the remittance sum of Rs. 6.77 crores out of India then its claim raised under the present proceedings shall be frustrated. Further, the claimant is still pursuing legal proceedings to obtain rights to set up power plant in Madhya Pradesh and for which it might be necessary to make payment of security deposit. If the respondent’s plea for retransfer of funds is allowed then the claimant’s bid to obtain these rights through judicial proceedings may also stand defeated. In these circumstance the respondent’s plea for retransfer of funds is not acceptable at this stage of the proceedings.

At the same time, however, I find that with the fears expressed by the respondent regarding diversion of funds by the claimant cannot be said to be misplaced. I, therefore, direct the claimant out of the remittance received from the respondent amounting to Rs. 6.77 crores shall make fixed deposits for a sum of Rs. 6.77 crores with any of the scheduled bank or banks and the FDRs shall be kept in the safe custody.

I, further, accept the claimant’s submission that in order to meet the day-to-day business expenses and to meet the costs, charges and expenses of pursuing and defending, the court proceedings, the funds would have to be arranged. I, therefore, direct that interest earned on the FDRs made shall be used and or appropriated for meeting the day-to-day costs or for running of the organization of the claimant and to meet legal costs, charges and expenses. However, it is expressly provided that in case the respondent’s claims are upheld then the claimant may have to pay interest/ finance charges or appropriate compensation to the respondent for use of funds which now stands locked up in making the FDRs.”

4. After the aforesaid order the arbitrator adjourned the matter to December 7, 1998, but the investing company filed a suit before this court before December 7, 1998. In view of this, the arbitrator adjourned the proceedings sine die on December 9, 1998. This court on a petition filed by the assessee for release of various bank accounts passed the undermentioned order :

“By this application, defendant No. 1 seeks a direction to defendant No. 6 Corporation Bank to allow defendant No. 1 to operate its all other bank accounts except the seven fixed receipts bearing Nos. 981830 to 981836. Learned counsel for defendant No. 6 does not wish to oppose the application. Accordingly, the application is allowed and the Corporation Bank is directed to allow defendant No. 1 to operate its all other bank accounts including the fixed deposit receipts, etc., except the aforesaid seven fixed deposit receipts bearing Nos. 981830 to 981836.”

5. It is in this manner that the 7 fixed deposits of Rs. 1 crore each were maintained by the assessee. It may be noted here that in the meantime for making assessment for the assessment year 2001-02, the interest income earned by the assessee from FDRs and bank deposit were treated as “Income from other sources” and was allowed to be adjusted against the pre-operative expenses and, therefore, reassessment proceedings were initiated in respect of the assessment year 1999-2000 and the assessment year 2000-01. Undisputedly, the assessee was at the stage of precommencement of its business when the amounts as mentioned above came to be invested in the FDRs. For the assessment year 1999-2000, the assessee earned interest amounting to Rs. 93,81,222 out of which it had received interest of Rs. 48,65,812 from the MPSEB on security deposit of Rs. 5.22 crores. The balance amount of interest of Rs. 45,15,408 was earned by the assessee on FDRs of Rs. 7.00 crores.

6. The assessee filed a return of income (ITR) on December 28, 1999 under section 143(1) of the Act. Subsequently, the Assessing Officer noted that the assessee had adjusted the interest income of Rs. 93,81,222 against the pre-operative expenses. The Assessing Officer being of the view that the interest income in the pre-production stage was to be taxed as “Income from other sources” in view of the decision of the Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT [1997] 227 ITR 172 (SC) and CIT v. Coromandal Cements Ltd. [1998] 234 ITR 412 (SC), he formed reason to believe that interest income of Rs. 93,81,222 has escaped assessment. He also noted that on the same facts the interest income for the assessment year 2001-02 was also charged to tax as “Income from other sources”. The Assessing Officer, therefore, issued a notice under section 148 of the Act on March 21, 2003. In response to this notice, the assessee filed its return of income declaring nil income on April 25, 2003. The Assessing Officer issued a notice under section 142(1) of the Act and also a questionnaire to the assessee, but the same remained unreplied. Another notice along with a questionnaire was issued on January 21, 2004, in response to which the authorised representative of the assessee attended the proceedings on January 30, 2004, and asked for reasons for issue of notice under section 148 of the Act. He was given a copy of the reasons recorded on February 6, 2004, March 3, 2004, and March 15, 2004, and he also filed the requisite details. It was thereafter that the Assessing Officer passed an order of reassessment on March 23, 2004. The Assessing Officer had noted that the company was setting up a power plant in Madhya Pradesh and commercial operation had not started, but interest of Rs. 45,15,408 received on FDRs was adjusted against the pre-operative expenses. While passing the order on March 23, 2004, the Assessing Officer rejected the claims of the assessee that the money remained in the fixed deposits as per the order of this court which restrained it from encashment from FDRs till further order and that the money was for setting up a power project and thus the interest received during the pendency of the matter before this court was to be adjusted against the power project. In this regard the Assessing Officer noted that, vide order dated December 9, 1998, this court allowed the assessee to operate all its bank accounts except 7 FDRs which were already in existence prior to the filing of the suit in this court by the investing company on December 1, 1998. On December 2, 1998, this court issued restraint of all assets and bank accounts against the assessee. However, on December 9, 1998, the said restraint order was modified and the same remained restricted to FDRs of Rs. 7 crores. The operative part of the order passed by this court on December 9, 1998, has already been reproduced above in para. No. 4. We note that Rs. 10 crores was invested by the assessee in FDRs on September 28, 1998, after the MPSEB returned the security money and thus the investment in FDRs is in no way linked with the power project. The Assessing Officer also observed that these funds were surplus with the assessee at that stage and its business activities had not yet commenced and thus investment in FDRs was neither connected with nor was it incidental to setting up of a power project.

7. It is also gathered from the impugned order that the authorised representative of the assessee informed the Tribunal that, vide order dated February 20, 2002, this court passed a decree in the aforesaid suit vide which the assessee was permitted encashment of 7 FDRs and these FDRs were actually encashed on July 8, 2002 and the amounts were repatriated to the investing company on July 11, 2002.

8. The Assessing Officer accordingly assessed the interest income of Rs.45,15,408 earned from FDRs under the head “Income from other sources”. Before the Commissioner of Income-tax (Appeals) additional ground was taken by the assessee challenging the validity of the assessment alleging that no notice under section 143(2) of the Act was served upon the assessee before the reassessment. The Commissioner of Income-tax (Appeals) maintained the order of the Assessing Officer on the merits and also rejected the additional plea of invalidity of the assessment on account of non-issuance of notice under section 143(2) of the Act. Against this order of the Commissioner of Income-tax (Appeals), the assessee preferred an appeal before the Tribunal which came to be allowed by the impugned order.

9. We have heard Mr. Sanjeev Sabharwal, senior standing counsel for the Revenue and Mr. Devashish Bharuka, learned counsel for the assessee.

10. The reopening of the assessment under section 148 of the Act has been challenged on two grounds. Firstly, it is alleged that the assessment could not be reopened under section 148 of the Act as the assessee had given detailed note with the original return as to why interest income was not to be taxed, but was to be adjusted against the project cost, and so it cannot be reopened merely on account of change of opinion. Secondly, reassessment has been alleged to be a nullity in the absence of issue of notice under section 143(2) of the Act to the assessee. The submission that issue of notice under section 148 of the Act represented change of opinion has not been dealt with by the Tribunal. However, the Commissioner of Income-tax (Appeals) has rightly recorded that the change of opinion is only possible if there was application of mind in the first assessment, but in this case there was no assessment and the intimation under section 143(1)(a) of the Act was neither an assessment nor it involved application of mind. This court in the case of Mahanagar Telephone Nigam Ltd. v. Chairman, CBDT [2000] 246 ITR 173 (Delhi) has in regard to an argument similar to the assessee’s argument held that “Therefore, there being no assessment under section 143(1)(a) of the Act, the question of change of opinion, as contended, does not arise”. With regard to this ground of challenge, it may be stated that admittedly the assessee filed original return of income on December 28, 1999, and the same was processed under section 143(1)(a) of the Act. It was only during the proceeding of the assessment year 2001-02, that the Assessing Officer noticed that the interest income of Rs. 93,81,222 has escaped assessment and he also noticed that on the same facts, the interest income for the assessment year 2001-02 was charged to tax as “Income from other sources”. He accordingly issued notice under section 148 of the Act. It is settled law that the intimation with regard to assessment made under section 143(1)(a) of the Act is not an assessment. A reference in this regard can also be made to the decision in Mahanagar Telephone Nigam Ltd. [2000] 246 ITR 173 (Delhi).

11. As per Explanation 2(b) to section 147 of the Act, where a return income is furnished, but no assessment has been made and it is noticed by the Assessing Officer that an assessee had understated the income, it will be deemed to be a case where income chargeable to tax had escaped assessment. In the case of Ranchi Club Ltd. v. CIT [1995] 214 ITR 643 (Patna) it was held in a case where only intimation was sent, notice under section 148 of the Act could be issued in terms of Explanation 2(b) to section 147 of the Act. The case of Mahanagar Telephone Nigam Ltd. [2000] 246 ITR 173 (Delhi) confirmed that (page 185) : “So long as the ingredients of section 147 are fulfilled, the Assessing Officer is free to initiate proceedings under section 147 and failure to take steps under section 143(3) will not render the Assessing Officer powerless to initiate reassessment proceedings even when intimation under section 143(1) had been issued”.

12. It is noted that the impugned assessment is in response to notice under section 148 of the Act and the Act does not specifically provide that the assessment made under section 147 of the Act will be after issue of the notice under section 143(2) of the Act. In fact, the Assessing Officer has the basic jurisdiction to assess the income in terms of section 147 and section 148 of the Act where he has reason to believe that the income has escaped assessment. On the submissions of non-issuance of notice under section 143(2) of the Act, we are of the view that the findings of the Tribunal in this regard are not as per the scheme of the provisions of sections 147 and 148 of the Act.

13. Though no specific notice was required under section 143(2) of the Act, as noted above, the questionnaires dated November 11, 2003, and January 21, 2004, provided the assessee specific opportunity to support his return by seeking documentary evidence and details in regard to the following query : “As per the return, interest of Rs. 93,81,222 was received by you during the year, which is adjusted against pre-operative expenses. The interest income should be charged.”

14. On the merits, the submissions of learned counsel for the assessee was that the interest received on FDRs was incidental to acquisition of assets. In other words, his submission was that the interest received was inextricably linked with the process of setting up of plant and machinery and as such receipts are to go to reduce the cost of assets and the nature of capital and cannot be taxed as income. He submitted that the money which was deposited in the shape of FDRs was not lying idle or surplus and was not deposited for the purpose of earning interest. The learned counsel appearing for the assessee relied upon the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. [1997] 227 ITR 172 (SC).

15. As per the finding of fact as was recorded by the Assessing Officer, the assessee received share application money of about Rs. 18.37 crores from co-promoters including approximately Rs. 7 crores from the investing company. There is nothing on record to suggest that money received from the investing company was directly invested in FDRs. In fact, the assessee was regularly incurring expenses in pre-operative expenses account, fixed assets, as well as giving loans and advances out of funds received by it. This court only restrained the assessee on December 9, 1998, from encashing Rs. 7 crores FDRs, whereas share application money had been received in August, 1998. Therefore, till the passing of the order by this court on December 9, 1998, all surplus funds lying with the assessee were invested in the FDRs. It was after the return of Rs. 6 crores on August 19, 1998, and Rs. 5.65 crore on September 11, 1998 by the MPSEB due to delay in deposit of security money, that the assessee got issued ten FDRs of Rs. 1 crore each on September 28, 1998. This was in fact investment made by the assessee to earn interest from the surplus amount lying with it till the resolution of the issues with the investing company and the MPSEB. When the MPSEB had already rejected the bid, the assessee seemed to be fighting a lost battle. The investment in FDRs in such circumstances could not be said to be anyway linked with the power project. At that stage, the funds were lying surplus with the assessee and its business activities had not yet commenced. Thus, the investment in FDRs cannot be said to be connected with or incidental to setting up a power project.

16. In the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. [1997] 227 ITR 172 (SC), the assessee-company was incorporated on December 3, 1971, for the purpose of manufacturing heavy chemicals such as ammonium chloride and soda ash. The trial production of the factories of the company commenced on June 30, 1982. For the purpose of setting up of the factories, the company had taken term loans from various banks and financial institutions. That part of the borrowed funds which was not immediately required by the company was kept invested in short-term deposits with banks. Such investments were specifically permitted by the memorandum and articles of association of the said company. For the accounting year ending on June 30, 1981, i.e., the assessment year 1982-83, the company received total amount of interest of Rs. 2,92,440. The company disclosed the said amount of Rs. 2,92,440 as income from other sources. It also disclosed business loss of Rs. 3,21,801, after setting off the interest income, it was claimed by the company the benefit of carry forward of net loss of Rs. 29,360. Lateron revised return was filed showing business loss of Rs. 3,21,801. It was claimed that as per the accepted accounting practice, interest and finance charges along with the pre-production expenses had to be capitalized and thus interest income of Rs. 2,92,440 should go to reduce the pre-production expenses (including interest and finance charges) which would ultimately be capitalized. The claim of the assessee was rejected by the Assessing Officer and the Commissioner of Income-tax (Appeals). In this case, it was found that the company had surplus funds in its hands and invested the same for the purpose of earning interest. Therefore, it was held that the interest earned was clearly of revenue nature and the same had to be taxed accordingly.

17. Now, coming back to the facts of this case, it is seen that the assessee had retained money received from the investing company without any purpose as the bid of the assessee had already been rejected by the MPSEB. Though the assessee was contesting rejection of bid in the High Court, the amount was kept deposited in the shape of FDRs only to earn interest till such time the issues with the MPSEB and investing company were resolved. The interest earned on these investments cannot be related to setting up of business. In the case of CIT v. Monarch Tools P. Ltd. [2003] 260 ITR 258 (Mad), the interest earned by making FDRs with banks was not in any way linked to the business that the assessee was carrying on and, therefore, the interest income was held to be “income from other sources” and not “business income”.

18. In the given circumstances, the act of the assessee of making FDRs and earning interest thereon could not be said to be for the only definite purpose and project of setting up of a unit. Since the bid had already been rejected, the investment could not be said to be for the setting up of the said unit. It was a case of depositing unutilized and surplus money by the assessee to earn interest and, therefore, the interest earned by the assessee being revenue in nature is liable to be assessed as “income from other sources”.

19. In view of these discussions, we come to the conclusion that the interest earned by the assessee on FDRs is assessable as “income from other sources” and any set off of the same cannot be given to the assessee as pre-operative expenses.

20. In view of the above discussion, we answer both the questions in the negative and in favour of the Revenue and against the assessee. The appeal is accordingly allowed.

[Citation : 337 ITR 389]

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