Interest On Funds Linked To Business Setup Not Taxable As 'Other Income': Delhi HC In VNG Automotive Case

The Delhi High Court has recently held that interest earned by VNG Automotive Pvt. Ltd. on funds earmarked for setting up its manufacturing unit cannot be taxed as “income from other sources”, finding that the funds were not surplus but were directly linked to project obligations.

The Division Bench of Justice V. Kameswar Rao and Justice Vinod Kumar said:

“We find that the funds in the present case were not lying as surplus but the same were earmarked to facilitate the balance payment for plant and machinery etc. for which advances were made by the assessee. The funds are inextricably linked to the setting up of the business of the assessee, and as such, would be covered by the judgment of the Supreme Court in Bokaro Steel Ltd (supra), and not Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra)."

The court was hearing appeals filed by the company, a manufacturer of ecological brake-shoes, against a 2004 order of the Income Tax Appellate Tribunal for assessment years 1993-94 and 1994-95.

The company had raised funds through share capital and loans from its directors and utilised them towards acquiring technical know-how, land and machinery. The remaining funds, which were not immediately required for meeting committed obligations, were deposited in banks, earning interest of Rs 1,33,151 and Rs 2,37,770 for the relevant years. The interest was adjusted against pre-operative expenses.

The Assessing Officer, however, treated the deposits as surplus funds and taxed the interest under the head “income from other sources” after reopening the assessment under Section 148, relying on the Supreme Court's ruling in Tuticorin Alkali Chemicals.

The Commissioner of Income Tax (Appeals) allowed the assessee's claim, holding that the deposits were directly linked to project requirements. The ITAT reversed this.

Setting aside the ITAT's order, the High Court held that the interest could not be treated as income from other sources as the funds were inextricably linked to the setting up of the business and were meant to meet committed liabilities.

On the issue of reassessment, however, the Court upheld the Revenue's stand, holding:

“The initiation of assessment under Section 143(1) of the Act cannot be treated to be an „assessment order‟ where the AO has formed an opinion and passed an order. In view of the conceptual difference between Section 143(1) and Section 143(3) of the Act, when no order under the latter provision has been passed, the AO is not precluded from re-opening the assessment, provided he has reasons to believe income has escaped assessment. Thus, the ITAT has rightly reached this conclusion.”

The court accordingly answered the question on reassessment in favour of the Revenue but ruled in favour of the taxpayer company on the taxability of interest income and allowed the appeals.