Kearala H.C : granting deduction of estimated amount of expenditure against interest income

High Court Of Kerala

CIT, Kannur Vs. Dhanalakshmi Weaving Works

Assessment Year : 2001-02

Section : 57,36(1)(iii)

C.N. Ramachandran Nair And V.K. Mohanan, JJ.

IT Appeal No. 831 Of 2009

November 16, 2009

JUDGMENT

C.N. Ramachandran Nair, J. – The question raised is whether the Tribunal was justified in granting deduction of estimated amount of expenditure against interest income received by the assessee during the previous year on term deposits.

2. We have heard the senior Standing Counsel appearing for the Revenue and Adv. Sri T.M. Sreedharan appearing for the respondent-assessee.

3. The assessee is engaged in manufacture and export of textiles. During the previous year relevant to the assessment year 2001-02, the assessee received an amount of Rs. 69,87,702 towards interest on various term deposits. However, the assessee did not offer the entire income for the purpose of levy of tax under the head ‘Income from other sources’. The assessee claimed deductions of Rs. 31,80,176 under section 57(iii) of the Income-tax Act towards interest paid to the bank as borrowals. The Assessing Officer held that the entire interest paid by the assessee to the bank was Rs. 1,00,60,390 which was on funds borrowed for business purpose and it was not justified on the part of the assessee to bifurcate part of the funds as borrowed for deposit with the same bank for earning interest and to apportion the total interest liability on a proportionate basis. The Assessing Officer disallowed the claim of deduction of interest under section 57(iii), but allowed the entire interest paid on borrowing as deduction against business income. Even though the assessee’s claim was allowed in appeal, in second appeal by the department, the Tribunal allowed only 2/3 of the claim and disallowed 1/3. It is against this order of the Tribunal, the Department has filed this appeal. The assessee’s claim is that the deposits which earned interest are made by transferring funds from the cash credit account, upon request by the assessee. Since cash credit account again is loan amount, assessee’s case is that deposits are made from out of borrowed funds and, so much so, interest paid on borrowals should be allowed to be set off against interest earned on deposits. In other words, the strange and unusual claim is that the assessee borrows funds at a higher rate of interest for making deposit with the same bank at much lower rate of interest. However, the certificate issued by the bank in para 5 states as follows :

“We have extended the credit facility as export packing credit to procure raw materials to execute export orders. We have not granted any advances to the customer for the specific purpose of making term deposit.”

From the above, it is very clear that the assessee had not borrowed any funds for making deposit with the same bank for the purpose of earning interest. Since no amount is borrowed from the bank for making deposit, the claim of deduction of interest paid on borrowed funds in the computation of income from other sources under section 57(iii ) of the Income-tax Act is not tenable. In fact, if assessee’s claim is genuine, then the net result should be a negative figure because borrowed funds attract higher rate of interest than the rate of interest received on deposit.

4. The next aspect to be considered is whether the assessee will be entitled to deduction of interest under section 57(iii) of the Act against interest income received on term deposit merely because deposits are made by transferring funds from cash credit account/packing credit account. From the bank’s letter, what is clear is that after borrowing funds through withdrawal from cash credit/packing credit account, the assessee utilised the borrowed funds for purchase of raw materials, processing etc. Export proceeds are credited in the cash credit account, thereby reducing the loan amount and it may so happen that such credits may lead to surplus in the account. In our view, when the assessee requests the bank to transfer various amounts to fixed deposit account for retaining as term deposits, invariably, such transfers are not from borrowed funds but from export proceeds credited in the packing credit account. It is immaterial whether at the time of transfer, there is credit balance or debit balance because it is up to the assessee to reckon pending bills and to request the bank to transfer from out of cash credit account/packing credit account to deposit account. However, this transaction should not be taken as a loan availed by the assessee from the bank to make the deposit. Section 57(iii) provides for deduction of expenditure in the computation of income as follows :

“(iii)any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income.”

It is obvious from the above provision that unless funds are borrowed for making the deposit to earn interest, such interest paid on borrowed funds cannot be allowed as deduction in the computation of income from other sources which in this case is interest earned on deposit. From the facts stated above, there can be no doubt that funds transferred from cash credit/packing credit is nothing but assessee’s amount credited in such account and not borrowed funds converted to deposit account by assessee. Therefore in our view, there is no justification for the first appellate authority or the Tribunal to allow any deduction of estimated interest under section 57(iii) in the computation of interest income under the head ‘Income from other sources’. In our view, the Assessing Officer has rightly allowed the entire interest charged by the bank against income from business because cash credit/packing credit account maintained is for business purpose and the entire interest charged should be debited against business income. We therefore allow the appeal by reversing the orders of the Tribunal and CIT(A) and by restoring the assessment.

[Citation : 331 ITR 188]

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