INTEREST ON FDR OUT OF TEMPORARY SURPLUS BUSINESS FUNDS IS BUSINESS INCOME- Bombay High Court.

[C.A. DEV KUMAR KOTHARI]

Deposits and advances from customers and clients:

In the course of business and profession many times advance money is received from customers and clients. The advance money or deposits are received for the purpose of execution of agreed work to be done which may involves supply of goods, rendering of services, execution of contracts, payments to other concerned parties, incurring expenses on behalf of customers and clients etc. Therefore, such advances and deposits have direct linking with business or profession of assessee.

Some deposits are obtained in nature of security deposits, for example deposits from service users in case of telephone service providers, electricity companies, regular customers of petrol pumps who avail credit facility and make payments periodically instead of at each time of purchase of petrol or diesel.

Few examples of deposits or advances:

Advance against contract for supply of goods or execution of work.

Trade deposits for regular supply of goods.

Advance for execution of contract and / or transfer of immovable properties where the dealing in property is business of the transferor.

Annual payments for annual contracts- in such cases payment is received at one time and services are to be rendered over a longer period of time.

Advance subscription for news papers, magazines, websites. Etc.

Development of landed properties and then selling the same.

Security deposits from dealers, agents, franchisee, licensee etc.

Money received from clients for payment to other concerned parties as incidental to business or profession of assessee.

These deposits or advances are received in the course of business or profession and for the purpose of business and profession.

Use of money:

The money received from customers and clients as deposit or advance is on account payment which will be adjusted against agreed value of goods to be supplied, services to be rendered or other work to be carried out. For execution of contracted work, such money may be used over a period of time during which execution of work is to be completed. Therefore, for time being some advance received may remain with the recipient of such money. However, the same will be  required over a period of time. Therefore, it is essential that the money received as advance is kept in a safe and secure manner so that the same is available as and when required.

In case of security deposits, the same may be adjusted against other dues at the time fo final settlement of account and excess if any is refunded.

 It can empirically be noticed that a major part of deposits and advances are utilized in execution of contracts and only minor part is usually kept as security deposits against certain assets provided to customers or against charges for few months. The usual period of use of such deposits is three to six months. Even in case of long-term contracts it is general practice that system of making deposits or advance is such that the recipient has to use those funds within a short period of 3-6 months, on satisfactory progress of work, further advances are made. This is to keep check and balances and to ensure that the recipient of money do not use the same for other purposes so as to cause a trouble to the work for which advance is paid.

Deployment of temporary idle funds:

It is therefore, desirable that temporarily idle funds out of trade advances should be kept in safe, secure and liquid manner so that money is available readily. Therefore, preferred mode is to make fixed deposits with banks. Considering other financing matters, other funds available etc. one can decide to keep money in other forms also. In case of large contracts from large customers many times, the customer also imposes condition as to keep the funds in a separate account with designated banks they may also monitor utilization of funds.

Whatever be the situation, the fact will always be that the money is received in the course and for the purpose of carrying business activities for which such money is received. Therefore, interest income earned on such temporarily idle fund invested in deposits with banks or invested elsewhere is closely linked to the business.

Advance against sale of fixed assets- distinction:

When a person receives advances not in course of business but  against sale of his ' personal capital assets', the matter will be different. Suppose a person agree to sell his house and receives advance money, sale is completed after six month, the advance money is kept in a fixed deposit ( may be jointly with buyer), in such case the advance money received is not in course of business but it is in course of disposal of capital asset that is not connected with business. Therefore, the rule as applicable in case of trade advances will not apply.

As against the sale of personal house, if a person sells his surplus land from factory premises, or old vehicles used for business, the sale is of capital asset, yet it has connection with business. The land being a capital asset of business, the advance money received is connected with business. In this case it can be said that the advance money received is in course of business.  

Earning on temporarily idle business advances:

When temporarily idle business advances are deployed as fixed deposits with banks, or other persons, the interest earned is an income in the course of business or profession. In fact such advances are made to earn some income so that costs of execution of work is reduced to that extent. Such deposit is not an independent investment of own surplus funds. Therefore, interest earned from such deposits which are made out of trade deposits or advances is in nature of business income. When assessee offers such earning as taxable business income there should not be any dispute by the  revenue, however, as usual, the revenue try to raise disputes just to collect more tax. Particularly when the assessee has brought forward business loss, the revenue would try to bring current business income under the head 'other sources' just to deny the benefit of set off of past business loss.

Recent judgment of Bombay high Court:

In CIT Vs. LOK HOLDINGS  2009 -TMI - 32351 / [2009] 308 ITR 356 (Bom.)  Decided on 15 January 2008 a matter relating to treatment of interest earned  by the assessee who is engaged in business  of development of properties, on deposits made out of advance money received from customers who booked properties came for consideration. The high Court while confirming the decision of ITAT, held that such interest income is to be assessed as business income and not income from other sources.

The relevant questions on the issue before the high Court was as follows:

   "Whether, on the facts and circumstances of the case and in law, the Tribunal is right in holding that the interest income cannot be assessed as income from other sources without referring to section 56 of the Income-tax Act and contrary to the decision of the apex court reported in Tuticorin Alkali Chemicals and Fertilisers Ltd. v. CIT [1977] 227 ITR 172?

  "Whether, on the facts and circumstances of the case and in law, the Tribunal is right in coming to a conclusion that the interest income received by the respondent is nothing but business income and, therefore, the same cannot be assessed as income from other sources?"

Facts as found are as follows:

The respondent/ assessee  M/s. Lok Holdings was engaged in the business of development of properties.

 In the course of its business, the assessee-firm received monies in advance from customers intending to purchase flats out of the  properties as developed by the assessee.

 These monies were of the nature of booking/advances.

 Since these monies received could not be immediately utilised for the business of the firm, the surplus amounts from such money received came to be temporarily invested with banks and other concerns.

Such deposits with accrued interest thereon which was received by the assessee-firm was deducted from the work-in-progress till the conclusion of the project.

 For the assessment year 1992-93, the income from such interest was Rs. 52,28,289. The Assessing Officer assessed this interest income as income from other sources and thus made an addition in this regard under the head "Income from other sources".

CIT (Appeals), following the decision of the Tribunal dated April 29, 2002, delivered in the case of East Coast Enterprise, deleted the income.

On appeal by the  Revenue, the  Tribunal dismissed the appeal  and confirmed the order of the CIT(A).

On appeal before the high Court the court considered that the short and basic issue on which  questions of law are  raised, turn, is whether the interest income earned by the assessee as set out hereinabove would be assessable as "income from business" or as "income from other source".

Counsel of revenue  contended that the issue had been dealt with and settled by a judgment of the apex court in the case of Tuticorin Alkali Chemicals and Fertilisers Ltd. v. CIT [1977] 227 ITR 172. In that case, the assessee, prior to commencement of its business by way of trial production  on June 30, 1982, received interest of Rs. 2,92,440, from certain investments made out of  certain term loans received from various banks and financial institutions. The assessee  in its  return disclosed  Rs. 2,92,440 as income from other sources but later, realising its mistake, filed a revised return showing a business loss of Rs. 3,21,802/. In the revised return the company claimed that the interest income of Rs. 2,92,440 should go to reduce the pre-production expenses which would ultimately, be capitalised. During the accounting year ending June 30, 1982, similar interest income of Rs. 1,08,336 was received by the company. In its return for the assessment year 1983-84 the company again claimed that the interest income should go to reduce the pre-production expenses. On the aforesaid facts the apex court held that the company had surplus funds in its hands and in order to earn income out of the surplus funds, it had invested the amount for the purpose of earning interest and the interest thus earned would be of revenue nature and would have to be taxed accordingly. It was further held that the company could not claim any reliefs under section 70 or 71 since its business had not started and there could not be any computation of business income or loss incurred by the assessee. In such a situation, the expenditure incurred by the assessee could not be allowed, as a deduction nor could it be adjusted against any other income under any other head. Similarly, any income from a non business source could not be set off against the liability to pay interest on funds borrowed for the purpose of purchase of plant and machinery even before commencement of the business of the assessee.

Considering the facts of the case before the High Court it held as follows;

a.       the facts of the present case are completely different than the facts in the case of Tuticorin [1977] 227 ITR 172 (SC).

b.      In that case, the business of the assessee-company had not commenced and, therefore, the apex court held that there could be no income from business.

c.        the business of the assessee in that case was the manufacturing of heavy chemicals ( which was not commenced).

d.       In Tutiticoran the investment of loans received and the accruing of interest therefrom were not a part of the business of the assessee-company.

e.       In the present case, the fact situation is that the income admittedly arose out of a running business of the assessee-company ( as against in case of Tuticoran the business was not commenced) .

f.         Interest was earned out of such monies accruing from the business of the assessing-company and the same was also utilised for the purpose of business. This is not a case where the assessee did not have a running business during the assessment year.

g.        The advocate of assessee  relied upon a judgment in the ease of CIT v. Paramount Premium P. Ltd. reported in [1991] 190 ITR 259. The facts of Paramount were almost similar to the facts in present case.

h.        The assessee in that case had received deposits in instalments from prospective purchasers while the work of construction was in progress. If the purchasers failed to make deposits by stipulated dates, they were required to pay interest. Idle amounts were deposited with the bank or given on temporary loans until such time as they were required for construction. Thus, interest was earned on these amounts. In due course the assessee's appeal was considered by the Tribunal and the Tribunal recorded a finding that the entire interest sprang from the business activity of the assessee and did not arise out of any independent activity. This court held that the aforesaid interest was assessable as income from business and affirmed the correctness of the view of the Tribunal that the interest so earned was "Income from business".

i.          The law as laid down in CIT v. Paramount Premium P. Ltd. [1991] 190 ITR 259 (Bom) is squarely applicable to the facts of the present case.

j.          The advocate for the assessee also referred to  CIT v. Bokaro Steel Ltd. 2008 -TMI - 5705 - SUPREME Court. In that case, the assessee-company was in the business of manufacturing of steel. For the purpose of construction of the plant the company gave advances to its contractors and earned interest from such advances, which were adjusted against the charges payable to the contractors, thus utilising the interest amount to reduce the cost of construction. In such a fact situation, the apex court affirmed the finding of the High Court, that these were capital receipts and not income of the assessee from any independent source. The fact situation in that case was completely different than the fact situation in the present case. The assessee in the case before the Supreme Court was not in the business of construction. The interest receipts had been utilised towards creation of capital assets. The said judgment is not relevant for deciding the present matter.

k.      The advocate for the assessee also referred to  a more recent judgment  in the case of Shree Krishna Polyster Ltd. v. Deputy CIT reported in [2005] 274 ITR 21 (Bom). In that case, the assessee-company was engaged in the business of manufacturing of synthetic yarn. The assessee received surplus money in public issue of shares and the said money was invested in bank deposits for a period of 45 days. In their returns the assessee claimed that this interest was "business income",. The Tribunal found that the assessee was not in the business of money-lending and, therefore, the interest income could not be said to be business income. It treated the income as "Income from other sources". The fact situation in that case was also different from the fact situation in the present case. In that case, the assessee-company was not in the business of money-lending. In the present case, admittedly, the assessee-company was engaged in a construction business and had deposited money received in the course of such business with the bank, earning interest thereon.

l.          The court held that for the reasons aforesaid, there is no merit in the appeal as the questions of law as raised would not arise. Hence, the appeal dismissed.

Earlier published articles by  author :

The readers may refer to the following articles written by the author:

Earnings during construction period from temporarily idle project funds  (1995) 78Taxman 266- 270 (mag.) and

Earnings during construction period from temporarily idle project funds-II (2001) 117 Taxman 46-52 (mag.)

These articles were concerned with earnings of temporarily idle project funds and it was suggested that if the funds are invested in the course of implementation of projects, then earnings would go to reduce the cost of project and shall not be taxable as income from business or income from other sources. These views found approval in three judgments of the Supreme Court namely  CIT v. Bokaro Steel Ltd. 2008 -TMI - 5705 - SUPREME Court, CIT V Karnal Co-operative Sugar Mills Ltd 2008 -TMI - 5777 - SUPREME Court and CIT V Karnataka Power Corpn. Ltd (2000) 112 Taxman 629.

The deposits made out of trade advances are different from deposits made out of money raised by way of share capital or loans. However, when money is received in course of business, interest income would fall under the head income from business. In some situations, however such earnings can also go to reduce costs of execution of contract instead of a separate head of income liable to tax.  In such cases there can possibly a deferment of tax liability till the work is completed and revenue is realized. For example, when a builder receive advance money from customers, allow some discount in price to customer due to advance money received, and temporarily surplus money is invested, the earnings can definitely be called as recovery of part of cost of construction in progress or can be adjusted against  cash discount given to the  customers who made advance payments.      

Conclusions:

The fact that money is received in course of business and deposits are also made in the course of business are very important. Receipt of money from customers is different from receipt of money as share capital or borrowed funds fro execution of new projects. Existence of running business and business not yet in existence but in the process of being set up are also very important factors to decide as to what should be treatment of income from deployment of temporary idle funds.