In the case of Sion Panvel Tollways Pvt. Ltd. [1] (Taxpayer), one of the issues before the Pune Income Tax Appellate Tribunal (Tribunal) pertained to set-off of the interest expenditure, incurred on borrowing for the business of infrastructure construction, against the taxable interest income earned from fixed deposits made through temporary deployment of such borrowed funds.
In this case, the Taxpayer was incorporated as a special purpose vehicle for developing a highway under the build-operate-transfer (BOT) model under a concession agreement with National Highways Authority of India. The Taxpayer borrowed funds for the construction project and temporarily deployed them in fixed deposits yielding interest income pending utilization for the construction project. The project was completed in the subsequent tax year.
The Taxpayer offered such interest income on fixed deposits to tax under the head “income from other sources” after setting off interest expenditure on such borrowing. The Tax Authority rejected the claim of setting off of the interest expenditure. But it was allowed by the first appellate authority. The tax authority appealed further to the Pune Tribunal.
The Pune Tribunal noted that the activity of earning interest income was not directly connected with, nor was it incidental to the primary activity for which borrowing was made. The fixed deposits were made for utilization of idle funds and were not a condition precedent to obtain any letter of credit/guarantee necessary to carry on highway development. Accordingly, the Tribunal negatived the Taxpayer’s contention and held that such interest expenditure cannot be considered as an expenditure incurred “wholly and exclusively” for the purpose of earning such iterest income (which is a necessary condition for deduction as per the relevant provision of the Income Tax Laws[2] ).
The Taxpayer made an alternative claim to consider the interest expenditure on borrowing, along with all the other costs, as capital expense, and the interest from fixed deposits as capital receipt, reducing such capital cost and thus not taxable. In support of its claim, the Taxpayer placed reliance on the Supreme Court (SC) ruling in the case of Bokaro Steel Ltd.[3] wherein interest from advances given to contractors for construction work was considered a capital receipt.
However, the Tribunal distinguished the applicability of the SC ruling in Bokaro Steel Ltd. (supra) on the basis that in the present case, there was no business correlation between the transaction of borrowing the sums and interest income. Hence, the Tribunal, instead, applied the ratio of SC ruling in Tuticorin Alkali Chemicals & Fertilizers Ltd.[4] wherein on similar lines, the SC upheld the taxability of interest from short-term deployment of borrowed funds as “Income from other sources” without permitting the set off of interest expenditure.
Accordingly, the Tribunal held that such interest income would be taxable while the interest expenditure incurred on borrowed funds would form part of capital expenditure, forming part of capital work-in-progress.
