DELHI G BENCH ASSISTANT PENCH POWER LTD. v. COMMISSIONER OF INCOME TAX September 30, 2005 JUDGMENT Per G.S. Pannu, Accountant Member.- This is appeal by assessee against orderof CIT(A) dated 14-3-2005 pertaining to assessmentyear 2002-03. 2.Although assessee has preferred multiple groundsof appeal but essentially grievance is against decision of CIT(A)in holding that Assessing Officer was correct in treating income of Rs.5,00,06,026 as income assessable under head 'Other sources'. 3.Brief background to impugned dispute can be summarized as follows: Theappellant is company incorporated under provisions of Companies Act, 1956and is, inter alia, having main object of carrying on businessof generators, procurers, suppliers, distributors, transformers, converters,manufacturers, processors, developers, transmitters, producers, storers, carriers, importers, exporters and dealers inelectricity, broadly classified as power sector. assesseefiled return of income for year under consideration declaring nilincome. Assessing Officer noted that assesseehad not commenced any business. However, it had earned interest on securitydeposit made with Madhya Pradesh State Electricity Board. Such interest incomewas considered by assessee as reducing theexpenses capitalized towards setting up of business. explanation of assessee, as can be seen from its communication dated29-12-2004 to Assessing Officer, placed in paper book was that it had acontract with Madhya Pradesh State Electricity Board (MPSEB) and as per theterms of contract security amount is to be deposited for setting up thepower project in State of Madhya Pradesh. Ultimately if project does nottake off, security deposit shall be refunded back to company. Thissecurity deposit shall earn interest at bank rate. company had borrowedmoney from 'GE' Capital on interest and was directly used for purpose ofthe security deposited with MPSEB. interest accrued for captionedassessment year on such loan as per books of account was Rs. 7,39,80,939. assessee hadnetted of income and capitalized difference as pre-operative cost,since expenses had exceeded income. Assessing Officer completed theassessment by assessing income of Rs. 5,00,06,026being interest income accrued on deposit with Madhya Pradesh StateElectricity Board as income from other sources. Assessing Officer, incoming to his conclusion, relied upon decision of Hon'bleSupreme Court in case of TuticorinAlkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172.Aggrieved, assessee carried matter in appealbefore CIT(A). 4.Before CIT(A), assesseecontended that decision of Apex Court has been misapplied by theAssessing Officer. assessee contended that it hadborrowed specifically for purposes of depositing money with MPSEB. saidloan was carrying specified rate of interest. assessee,accordingly contended that to extent of interest paid on loans borrowedfor said purpose i.e., interest paid of Rs. 7,39,72,162, has adirect nexus with interest earned on deposit with MPEB and therefore,the same was required to be set off. CIT(A) hassince sustained order of Assessing Officer. 5.We have heard rival submissions in aforesaid light. firstsubmission of ld. Counsel for assessee wasthat business of assessee had still not startedduring year. However, as pre-requisite for bidding of power projectsin State of Madhya Pradesh, it was required to make deposit with MPSEB ofRs. 50 crores. said amount was deposited by assessee during year out of borrowings made from M/s GECapital Services India. copy of loan agreement has been placed in thepaper book filed before us at pages 25 to 37. Our attention has been drawn toclause 2.2 of agreement whereby it is averred that loan was advanced tothe assessee for security deposits payable for filingthe bids for tender to be opened by MPSEB. It was, therefore submittedthat assessee had incurred interest liabilitytowards GE Capital Services to extent of Rs. 7,39,72,162. assessee had accounted for same after setting off theinterest income received and balance was carried forward as per-operativeexpenses pending capitalization. ld. Counsel submitted that decision ofthe Apex Court in case of Tuticorin AlkaliChemicals & Fertilizers Ltd. (supra) was inapplicable to thefacts of instant case. It was submitted that lower authorities had notdisputed that impugned deposit was made out of business necessity and itwas pre-condition to bid for tender by MPSEB. It was further submittedthat it was not case where assessee had surplusfunds which were invested to earn any interest income. Therefore, according tohim, decision of Tuticorin AlkaliChemicals & Fertilizers Ltd.'s case (supra ) was notattracted in instant case. Ld. Counsel further submitted that even if theimpugned income was assessable as income from other sources, yet in terms ofsection 57, assessee was to be allowed thededuction for interest liability accruing on loan funds utilized tomake deposits yielding interest income. Our attention was accordingly invitedto section 57(iii) in this regard. ld. Counsel accordingly assailedthe orders of lower authorities. 6.On other hand, ld. DR defended orders of lower authorities on thebasis of reasoning contained therein. Ld. DR has heavily relied on thedecision on Apex Court in case of TuticorinAlkali Chemicals & Fertilizers Ltd. (supra) in support of hissubmission. 7.We have considered rival submissions carefully, perused orders of thelower authorities and also authorities cited at Bar. undisputed facts,which have bearing on issue, are that assesseehas not commenced business operations during year under consideration.However, it deposited sum of Rs. 50 crores withMPSEB as security deposit to bid for tenders to be floated by MPSEB in thepower sector. assessee earned interest to theextent of Rs. 5,00,06,026 from MPSEB on such deposit.On other hand, assessee had raised amountof Rs. 50 crore by way of loan from M/s GE CapitalServices Ltd. and was paying interest on same. liability of interestaccrued for year under consideration was to extent of Rs. 7,39,80,939. In background of aforesaid facts, mootquestion is as to whether sum of Rs. 5,00,06,026 earned by way of interestdeposit with MPSEB was assessable in hands of assesseeas 'Income from other sources' or not. According to revenue, since thebusiness of assessee had not commenced during theyear under consideration, therefore in light of decision of ApexCourt in case of Tuticorin AlkaliChemicals & Fertilizers Ltd. (supra), aforesaid amount wasto be taxed as income from other sources. 8.In our view, stand of revenue does not conform to legal position onthe subject for more than one reason, which we shall discus hereinunder.First of all, it is undisputed position that interest expenditureincurred by assessee has direct nexus with theinterest income earned by it on deposits placed by it with MPSEB. This isevident from loan agreement, copy of which has been placed before us. Infact, ld. Counsel also stated at Bar that thelender M/s. GE Capital Services had directly deposited amount with M/sMPSEB, albeit on behalf of assessee. In this light, even if we accept plea of therevenue that income, by way of interest on deposits with MPSEB, isassessable as income from other sources, yet having regard to provisions ofsection 57(iii) of Act, interest expenditure by way of liablilty towards M/s GE Capital Services has to beconsidered as expended wholly and exclusively for earning of such incomeand is to be allowed as deduction. payment of interest to GE CapitalServices is expenditure which has been expended fully and exclusively forthe purposes of making deposit with MPSEB and, therefore, same isliable to be set off against income earned thereon. Therefore, if theinterest income of Rs. 5,00,06,026 is reduced by interest expenditure ofRs. 7,39,72,162, there does not remain any positive income under head'Income from other sources'. 9.Reliance placed by revenue on decision of Supreme Court in caseof Tuticorin Alkali Chenmicals& Fertilizers Ltd. (supra ) is misplaced. Apex Court wasdealing with situation where prior to commencement of business, assessee had surplus funds, whichwere not immediately required for purposes of business and which were usedto earn interest income. assessee therein,however, contended that since it was setting up its factory and that fundswere borrowed by it for purposes of setting up its factory, interestincome generated on temporary use of funds should be set off against thecost of setting up of factory. It was further argued by assessee that such interest income should be adjustedagainst interest payable on borrowed funds. aforesaid plea wasnegated by Hon'ble Apex Court on ground thatnone of two factors affected taxable income of income earned by assessee. According to Apex Court, interest incomereceived by assessee was on account of itsinvestment and that income was taxable even though such interest was earned byutilizing borrowed capital. It was case where surplus funds of assessee were utilized for earning interest income. Withregard to plea of assessee to adjust interestexpenditure related to its borrowing against interest assessable undersection 56 i.e., under head 'other sources', Apex Court heldthat same was purely governed by clause (iii) to section 57. In theinstant case, it is not anybody's case that assesseehas used its surplus funds temporarily to earn impugned interest income. Infact, deposit which has yielded interest income has been made as businessnecessity, as precondition enabling assessee tobid for tenders floated by Madhya Pradesh Electricity Board. Further,it is also borne out of material on record that loan has been raisedspecifically to make deposit with MPSEB, thus suggesting fact situationthat it had direct nexus with deposit which yielded such income. In thecase of Tuticorin Alkali Chemicals &Fertilizers Ltd. (supra) borrowings were not made for thepurpose of making investment, which yielded interest, but was made for thepurpose of setting up and implementing project of setting up factory.No nexus was established between purpose of borrowings and investmentsyielding interest. decision of TuticorinAlkali Chemicals & Fertilizer Ltd. case (supra) was rendered inthe aforesaid factual backdrop. Evidently, fact situation in instantcase stands on totally different footing and, therefore, said decisionhas been wrongly applied by lower authorities to instant case. 10.On contrary, parity of reasoning laid down bythe Apex Court in case of CIT v. Karnataka Power Corpn. [2001] 247 ITR 268, wherein Hon'ble Apex Court following its earlier decision in thecase of CIT v. Bokaro Steel Ltd.[1999] 36 ITR 315 opined that interest earned from contractors during theperiod of setting up of business of assesseecan be treated as abatement of capital costs provided same has aninextricable nexus between two. On this ground also, we find enough meritin pleas of assessee on alternativegrounds. alternative ground of assessee isthat since deposit yielding interest was contractually required to be madewith MPSEB to set up power project, interest thereon would have directnexus with costs incurred in setting up of power project and,therefore, said interest income would tantamount towards abatement of thecapital costs. 11.In view of aforesaid discussion, appeal of assesseeis allowed as above. *** Pench Power Ltd. v. Assistant Commissioner of Income-tax