2025 (7) TMI 587 - AT - Income Tax

Addition on account of interest earned - assessee had kept FDRs in lien against Bank Guarantee for real estate project. Hence interest on FDRs have been deducted from the value of inventory (work in progress) claiming that it was capital in nature - AO and CIT(A) did not accept this proposition and the same was disallowed - HELD THAT - We find that facts of the present case are identical to that of NCML Varanasi Private Limited 2022 (11) TMI 1078 - ITAT DELHI as decided the issue in dispute in favour of the assessee as held interest income earned has a direct nexus with the business activity of the assessee. In that view of the matter the interest income earned by the assessee has to be treated as income from business and can be set off against the cost of construction. There is no doubt that the interest income pertained to the impugned assessment year and the concerned banks have deducted tax at source while crediting the interest income to the account of the assessee. We direct that this treatment of interest income as adjustment from work-in-progress is correct hence we set aside the orders of the authorities below and decide the issue in favour of the assessee. Disallowance of interest u/s 24(b) - CIT(A) observed that nexus between loan and purchase of house property was not established as the interest is on Loan Against Property and not loan for purchase of property hence he upheld the fining of the AO that the interest does not fall within the ambit of section 24(b) - assessee has filed a Paper Book consisting of Application under Rule 29 of ITAT Rule 1963 for production of additional evidence before us with Affidavit relating to detail showing source for repayment of loan to PNB - HELD THAT - We find considerable cogency in the contention of the Assessee for admission of additional evidences under Rule 29 of the ITAT Rules 1963. Therefore we deem it fit and proper to admit the aforesaid additional evidences filed by the assessee before us and in the interest of justice remit back the matter to the file of the AO with the directions to consider the aforesaid contention of the Ld. AR and decide the issue in dispute afresh. Assessee s appeal is party allowed for statistical purposes.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in the appeal are:

(a) Whether the addition made by the Assessing Officer (AO) and upheld by the Commissioner of Income Tax (Appeals) [CIT(A)] on account of interest earned by the assessee on fixed deposits (FDRs) given as lien against bank guarantees should be treated as business income or disallowed as income unrelated to business activity;

(b) Whether the disallowance of interest claimed as deduction under section 24(b) of the Income Tax Act, relating to interest paid on loans taken for acquiring or financing property, is justified, particularly when the loan is a loan against property and not directly for purchase of the property;

(c) Whether additional evidence filed by the assessee under Rule 29 of the ITAT Rules, 1963 relating to the utilization of loans and repayment details should be admitted for adjudicating the disallowance under section 24(b).

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Addition on account of interest earned on fixed deposits given as lien against bank guarantees

Relevant legal framework and precedents: The issue revolves around the tax treatment of interest income earned on FDRs kept as security against bank guarantees furnished for real estate projects. The assessee contended that such interest income is capital in nature and should be adjusted against the value of inventory (work-in-progress), thereby reducing the cost of construction. The AO and CIT(A) disagreed and treated the interest income as taxable business income, disallowing its adjustment against inventory.

The Tribunal relied on the precedent set by a Coordinate Bench in NCML Varanasi Private Limited vs. ITO and Ors., where it was held that fixed deposits kept as security for performance guarantees have a direct nexus with the business activity. The interest earned thereon is business income and can be set off against project expenses. The Hon'ble Jurisdictional High Court in CIT vs. Japyee DSC Ventures Ltd. also held that interest income earned on fixed deposits kept as security for performance guarantees is taxable as business income and can be set off against project expenses.

Court's interpretation and reasoning: The Tribunal observed that the facts of the present case are identical to those in the NCML Varanasi case. The fixed deposits were kept in lien against bank guarantees issued in favor of the Director General Town and Country Planning Haryana for real estate projects. Since the FDRs were directly connected to the business activity, the interest income earned had a direct nexus with the business and should be treated accordingly.

Key evidence and findings: The assessee maintained that the interest income was deducted from the value of inventory (work-in-progress) in its books of account, reflecting the capital nature of the income. The AO and CIT(A) rejected this approach, but the Tribunal found no reason to depart from the precedent where such interest income was held to be business income and allowable as adjustment against project expenses.

Application of law to facts: Following the Coordinate Bench decision and the High Court ruling, the Tribunal held that the interest income earned on FDRs kept as security for bank guarantees should be treated as business income and allowed to be adjusted against the cost of construction (work-in-progress). Hence, the addition made by the AO and upheld by CIT(A) was set aside.

Treatment of competing arguments: The Revenue did not controvert the precedent relied upon by the assessee. The Tribunal found the assessee's submissions well-founded and consistent with judicial pronouncements.

Conclusion: The Tribunal allowed the appeal on this issue, directing that the interest income be treated as an adjustment from work-in-progress and not added to the income of the assessee.

Issue 2: Disallowance of interest claimed under section 24(b) on loan against property

Relevant legal framework and precedents: Section 24(b) of the Income Tax Act allows deduction of interest on borrowed capital used for acquisition, construction, repair, renewal or reconstruction of a house property. The issue was whether interest paid on a loan against property qualifies for deduction when the loan was not directly taken for purchase but used to repay an earlier loan that was taken for acquiring the property.

Court's interpretation and reasoning: The AO and CIT(A) disallowed the deduction on the ground that the nexus between the loan and the acquisition of the property was not established, as the loan was a loan against property and not a direct loan for purchase. The assessee filed an application under Rule 29 of the ITAT Rules, 1963 seeking admission of additional evidence to establish the source and utilization of loans, including ledger accounts and bank statements, to prove that the borrowed funds were ultimately used for acquiring the property free from lien.

Key evidence and findings: The additional evidence included detailed accounts showing the repayment of an earlier loan taken from PNB by utilizing the loan obtained from Reliance House Finance Ltd., which in turn replaced private lenders temporarily. The assessee contended that this chain of borrowing was bona fide and directly related to acquisition and freeing the property from encumbrances, thereby qualifying for deduction under section 24(b). The assessee also relied on prior assessment years where similar deductions were allowed.

Application of law to facts: The Tribunal found merit in the assessee's contention for admission of additional evidence, noting that the earlier counsel inadvertently failed to place these documents before the CIT(A). The Tribunal emphasized that the matter was yet to be heard on merits and that admitting the evidence would serve the interest of justice without causing prejudice to the Revenue. Consequently, the Tribunal admitted the additional evidence and remitted the matter to the AO for fresh consideration after giving the assessee an opportunity of being heard.

Treatment of competing arguments: The Revenue relied on the orders of the lower authorities for disallowance. The Tribunal, however, found the assessee's explanation and documentary evidence sufficiently cogent to warrant fresh adjudication.

Conclusion: The appeal was allowed in part by admitting the additional evidence and remitting the issue for fresh adjudication in accordance with law.

3. SIGNIFICANT HOLDINGS

Regarding the interest income on FDRs kept as security for bank guarantees, the Tribunal held:

"The fixed deposits kept with banks are in connection with the business activity of the assessee. That being the factual position emerging on record, the interest income earned has a direct nexus with the business activity of the assessee. In that view of the matter, the interest income earned by the assessee has to be treated as income from business and can be set off against the cost of construction."

Further citing the High Court decision:

"In case of CIT vs. Japyee DSC Ventures Ltd. the Hon'ble Jurisdictional High Court while considering identical nature of dispute has held that the interest income earned on fixed deposits kept as security for performance guarantee is taxable as business income and can be set off against project expenses."

On the disallowance of interest under section 24(b), the Tribunal emphasized the importance of considering all relevant evidence and held that:

"We find considerable cogency in the contention of the Assessee for admission of additional evidences under Rule 29 of the ITAT Rules, 1963. Therefore, we deem it fit and proper to admit the aforesaid additional evidences filed by the assessee before us, and in the interest of justice, remit back the matter to the file of the AO with the directions to consider the aforesaid contention of the Ld. AR and decide the issue in dispute, afresh, in accordance with law, after giving adequate opportunity of being heard to the assessee."

Core principles established include:

(i) Interest earned on fixed deposits kept as security for bank guarantees related to real estate projects is business income and can be adjusted against project expenses, reducing the cost of inventory (work-in-progress).

(ii) Deductions under section 24(b) require establishing a clear nexus between the borrowed funds and the acquisition or construction of the property; the Tribunal allows admission of additional evidence to establish this nexus and remits for fresh consideration.

Final determinations:

The Tribunal set aside the addition of interest income and allowed its adjustment against work-in-progress. On the issue of disallowance of interest under section 24(b), the Tribunal admitted additional evidence and remitted the matter to the AO for fresh adjudication, allowing the appeal partly for statistical purposes.