Law on non-taxing pre-construction interest good law despite s. 36(1)(iii) Proviso
The assessee was in the process of expansion of its business by setting up new units for generation of power. It borrowed funds for the project and incurred interest expenditure which was capitalized. A part of the funds were invested in temporary deposits and in deposits by way of margin or giving advances etc. for the purpose of expansion. Such deposits earned interest of Rs.331.58 lakhs. The assessee claimed, relying on Bokaro Steel 236 ITR 315 (SC) that the interest earned had to be reduced from the interest paid on the borrowings and was not assessable as “income”. The CIT(A) accepted the claim but the Tribunal rejected it on the ground that Bokaro Steel 236 ITR 315 (SC) and the other judgements on the point were not good law in view of the Proviso to s. 36(1)(iii) inserted w.e.f. 1.4.2004. On appeal by the assessee to the High Court, HELD reversing the Tribunal:
In Indian Oil Panipat 315 ITR 255 (Del) it was held that if the interest received was “inextricably linked” with the setting up of the plant, it could not be treated as income from other sources. This reasoning is in line with Bokaro Steel Ltd, Karnataka Power Corp 247 ITR 268 (SC) & Bongaigaon Refinery 251 ITR 329(SC). Though the proviso to s. 36(1)(iii) enacts that any amount of the interest paid towards (“in respect of”) capital borrowed for acquisition of an asset or for extension of existing business regardless of its capitalization in the books or otherwise, “for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use” would not qualify as deduction, in all these cases, when the interest was received by the assessee towards interest paid for fixed deposits when the borrowed funds could not be immediately put to use for the purpose for which they were taken, the Courts held that if the receipt is “inextricably linked” to the setting up of the project, it would be capital receipt not liable to tax but ultimately be used to reduce the cost of the project. By the same logic, in the present case too, the funds invested by the assessee and the interest earned were inextricably linked with the setting up of the power plant and, therefore, the interest earned on fixed deposit of amounts borrowed cannot be treated as a revenue receipt.