Introduction
Embarking on capital-intensive ventures, such as infrastructure or real estate development, necessitates a substantial upfront capital outlay. This capital is crucial for acquiring assets like land, machinery, and buildings, and for initiating construction activities. To secure these funds, companies often resort to issuing shares or incurring debt. However, these funds may not always be immediately deployed due to procedural delays in asset acquisition, statutory or contractual obligations, or the phased nature of the project. To maximize returns, companies typically invest these idle funds in interest-bearing securities.
The taxability of the interest income generated from these securities has long been a contentious issue within Indian tax law, with numerous cases reaching the Supreme Court. The critical question which has been adjudicated by the Court is whether the interest earned should be taxed as ‘income from other sources’ (‘IoS’) or it should be reduced from the value of capital work in progress recognised as ‘asset’ in the books of accounts. While there are multiple judgments of High Courts, the issue is far from being settled.
This article delves into the evolving legal landscape surrounding this complex matter, including the recent landmark ruling in International Coal Ventures[1] and its impact on the taxpayers.
Legal landscape
The judicial precedent which is of seminal significance is the judgment of the Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers[2]. In this case, the assessee had borrowed funds for establishing a factory. It deposited a part of them, which were not immediately required for the factory, as short-term deposits. The Court held that interest income earned on deposited funds should be taxed as IoS. According to the Court, the factors such as non-commencement of business or borrowing of funds for establishment of the factory would not have an effect on the taxability of the interest income earned by the assessee. If the assessee had chosen to invest the funds fruitfully, instead of keeping surplus funds idle, the interest earned on such funds shall be taxable as IoS.
Subsequently, this question was dwelt by the Supreme Court in judgement of Bokaro Steel[3]. In this case, the assessee earned interest from two sources. In the first category, the assessee had earned an interest income on the short-term deposits made from funds borrowed for project. For said advances, the Court followed the ratio laid down in the case of Tuticorin and held the interest to be taxable under the head IoS. In the second category, the assessee had extended certain advances to the project contractors for executing large scale construction work smoothly and had earned interest on the same. In this relation, the Court held that the interest income will not be taxable as IoS. The differentiating fact as noted by the Court was that the advances on which the interest income was earned were paid to the contractors to facilitate the work of construction. It was to ensure that the work of the contractors proceeded without any financial hitches. Considering the same, it was observed that the receipts were inextricably linked with the construction of its steel plant and should be reduced from the value of capital work in progress.
The principles laid by the Supreme Court in cases of Tuticorin, and Bokaro Steels were applied in the case of Karnal Co-operative Sugar Mills Ltd.[4] In this case, the Supreme Court held that the interest income will not be taxable as IoS since the interest was earned on deposits made in the bank for opening a letter of credit to finalise the purchase of machinery for sugar mill. It was considered as being directly linked with the purchase of plant and machinery.
Further, in the judgment of Autokast Ltd.[5], funds were borrowed for purchasing machinery and its running and installation. The assessee earned interest income till the time funds were lying idle. The Court held that the interest is taxable under the head IoS following the judgment Tuticorin.
From the above judgments, it is to be noted that while the judgment of Tuticorin provided a blanket principle for taxation of interest income, the judgment of Bokaro and subsequently the judgment of Karnal Co-operative carved out an exception to the general principle. The exception appears to have been carved out only for those situations where the funds were deposited as a requirement of the project itself, and interest was earned on the same. In such situations, the Apex Court has considered the funds to be inextricably linked to the project, and hence not taxable as IoS.
The above judgments have been applied by the High Courts time and again. Interestingly, in some cases, the High Courts have extended the exception carved out in the case of Bokaro to even such cases where the funds were lying idle for commercial reasons such as delay in identifying the property to be purchased. The correctness of the same is yet to be tested before the Apex Court. For instance, in the case of Indian Oil Panipat[6], the Delhi High Court held that interest income earned from parking the funds temporarily which were infused for acquiring land, and the development of infrastructure was inextricably linked to the project, and hence not taxable as IoS.
Recent judgment of Delhi High Court in International Coal Ventures Pvt. Ltd.[7]
In the facts of this case, the assessee had borrowed funds from promoters for acquisition of coal mine overseas. However, due to certain commercial reasons, the acquisition did not materialise, and the funds were refunded. In the interim, the assessee earned an interest income by depositing the funds as short-term deposits. Upon appeal, the Court held that the interest income earned by the assessee was not chargeable to tax as IoS.
The Court refuted the applicability of Tuticorin on the premise that this is not a case of ‘surplus’ as the funds were borrowed for acquiring the coal mine. The Court relied on the judgments of Bokaro and Indian Oil Panipat to rule in favour of the assessee by holding that the interest income accrued on borrowed funds, which were temporarily parked as short-term deposits, was inextricably linked to the acquisition of overseas coal mines, and hence not taxable as IoS.
The Court also noted that that interest income can only be capitalised in situation where the asset takes a long time to be constructed or takes long time to come into existence, and not for off the shelf assets which immediately comes into existence.
Authors’ comments
Considering the legal landscape, one would appreciate that taxation of interest income arising from project funds is a highly fact-centric issue. Even after numerous judgments from the Supreme Court, the application of the judgments to the facts of a given case continues to remain a conundrum. The contradictory judgments of High Courts have further muddled up the situation. It is one such issue where even after a favourable ruling from the High Courts, the taxpayers may not have a sigh of relief. Rather, they would prefer to prepare for the final battleground upfront.
In Author’s view, the principle laid down in the case of Bokaro has been applied by the High Courts in a wider manner. While the Bokaro judgment created exception only for those situations where the funds were invested as an obligation of the project, the High Courts have extended said principle even to cases where the funds were invested for temporary period as per taxpayer’s own choice during procedural delays (such as in the recent case of International Coal Ventures). The High Court’s while arriving at the conclusion have noted that the funds did not qualify as ‘surplus funds’ in said cases as they were borrowed for the project and were invested only for a temporary period.
In authors’ view, the above interpretation dilutes the principles as laid down by the Supreme Court in the case of Tuticorin. In Tuticorin’s case, the phrase ‘surplus funds’ was used to indicate funds borrowed for the project which had not been immediately deployed. The fact that said funds were required for the project and were temporarily parked by the taxpayer was not considered relevant by the Supreme Court. Applying Tuticorin’s principle to the facts such as in case of International Coal Ventures, it can be argued that the funds qualified as surplus funds and interest income should be taxed as IoS. It may also be relevant to note that the principle laid down in Tuticorin case is de hors whether the funds generating the said income were own funds or borrowed funds.
It will be interesting to see whether the Supreme Court approves said position as taken by the High Courts. For the taxpayers planning to undertake similar transactions, it is important to evaluate the application of various judicial precedents to their factual matrix and take tax positions prudently.
[The authors are Associate Partner, Principal Associate and Associate, respectively, in Direct Tax practice team at Lakshmikumaran & Sridharan Attorneys]
[1] ITA 1174/2018.
[2] [1997] 93 Taxman 502 (SC).
[3] [1999] 102 Taxman 94 (SC).
[4] [2001] 118 Taxman 489 (SC).
[5] [2001] 116 Taxman 244 (SC).
[6] [2009] 181 Taxman 249 (Delhi).
[7] ITA 1174/2018.
