The Hindu Business Line : An unresolved issue gets resolved

The recent Rajasthan High Court ruling will come in handy in defending attempts to tax interest on deposits earned in the period prior to commencement of business.

T. C. A. Ramanujam

Companies mobilise funds when they come out with public issues of share capital. Normally, such funds are deposited in banks pending commencement of the project for which the company was started. Interest on such deposits accrue from the time of deposits and should be considered taxable in the hands of the company.

Income vs capital receipts

Subsequently, the deposits may be applied for the objects of the company. That can be no consideration against taxing such interests as income under ‘Other Sources’ under Section 56 of the Income-Tax Act, 1961. After a prolonged controversy, this view was upheld by the Supreme Court in the Tuticorin Alkali Chemicals and Fertilizers Ltd case. It was reaffirmed in the Autokast Ltd and the Coramandal cases.

On the other hand, in the Bokarao Steel Ltd case, interest earned on amounts advanced to contractors during the course of construction of the factory premises was considered by the Supreme Court as capital in nature going to reduce the cost of construction. Such interest receipts were inextricably linked with the setting up of the capital structure of the company, such as plant and machinery. Such interest receipts were to be viewed as capital receipts. Both in the Tuticorin and Bokarao Steel cases, the amount in question related to interest earned before commencement of business.

How to distinguish between income and capital receipts on apparently similar facts?

Rajasthan HC ruling

We now get the answer from the Rajasthan High Court (in 306 ITR 102). It considered the judgments of the apex court on this issue. The company under consideration made a public issue for mobilising capital. The monies were deposited in the bank. The High Court reproduced Section 56 of the Act and pointed out that the Section referred to income by way of interest on ‘securities’, if the income is not chargeable to income-tax as business income. The term ‘security’ is defined in Explanation 2 to Section 2(42A), which declares that the expression shall have the meaning assigned to it under the Securities Contracts (Regulation) Act, 1956 and such definition does not take in bank deposits.

The High Court also referred to Section 73 of the Companies Act, 1956 which requires the amounts mobilised from the public to be kept in a separate account in trust and to be utilised with the permission of the stock exchange.

The company law requires such funds to be adjusted against allotment of shares or against repayment of monies received from the applicants in pursuance of prospectus.

Section 73 of the Companies Act does not compulsorily require the money to be kept in a bank account for interest. But interest, if any, earned cannot be regarded as amount fully available to the company for its own use. It is held in trust until the allotment is completed.

The amount with interest will remain within a trust in favour of the general body of applicants until the completion of the allotment process. Prohibition contained in Section 73 against the monies for being utilised for purposes other than those mentioned in the section is absolute. It cannot be transferred to any other account.

In the case before the Rajasthan High Court, interest earned against bank deposits made out of public issue was sought to be set off by the company against public issue expenses which are to be amortised in future.

Set off against expenses

The High Court took the view that such interest did reduce the cost of public issue expenses and was required to be adjusted by way of amortisation. The High Court permitted the company to set off such interest against public issue expenses and also claim amortisation under Section 35D of the I-T Act.

A similar view was taken by the Madras High Court (in 266 ITR 490). But that was a judgement rendered without taking into account the leading cases decided by the Supreme Court on the subject. The Rajasthan High Court has discussed the alternative views of the Supreme Court and decided the matter by reconciling the opposite viewpoints.

The interest earned in the Rajasthan High Court case was no doubt on deposits but the court pointed out that it cannot be said to be short-term deposits. The court has given a new twist to Section 56. If this view is to prevail, bank deposits cannot be considered ‘securities’ under Section 56(2)(id) and all such interest cannot be taxed under Section 56.

The High Court however did not refer to the views of the Madras High Court in this regard and decided the matter on its own by referring to Section 73 of the Companies Act and the definition of ‘securities’ under the income-tax law.

The latest ruling will come in handy in defending attempts to tax interest on deposits from banks earned in the period prior to commencement of business.

(The author is a former Chief Commissioner of Income-Tax. blfeedback@thehindu.co.in)