TMI Blog1978 (12) TMI 15X X X X Extracts X X X X X X X X Extracts X X X X ..... d into a loan agreement with the Chemical Bank New York Trust Company in December, 1966 for borrowing 23 million dollars to be drawn in convenient instalments and also borrowed from the Government of India rupee funds to the tune of Rs. 5.5 crores. A copy of the aforesaid agreement entered into between the Chemical Bank New York Trust Company and the assessee-company in December, 1966, has been annexed to the statement of the case submitted by the Tribunal. Section 1.03 of the said agreement is the clause authorising the execution and delivery of debentures up to 5,750,000 dollars as " A " series and up to 1,725,000 dollars as " B " series. The agreement required expending on the part of the company prior to the completion date not less than an amount in dollars equal to the aggregate principal amount of notes issued under the agreement for the purchase of goods and services of source and origin within the United States of America. Section 6.08 required the company to deposit the proceeds of the loans evidenced by the A Notes and the proceeds of the issuance and sale of the B Notes and any dollar proceeds of the issue of shares in the company in a special account to be maintained w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee's appeal observing that since the orders of the ITO got merged with the orders of the CIT, he would not be competent to pass any, order on appeal against such orders, of the ITO. The AAC happened to pass such an order because the Addl. CIT by that time had taken action under s. 263 of the I.T. Act, 1961, to revise the orders of the ITO for the assessment year 1969-70 and enhanced the assessment by a sum of Rs. 13,95,121 for the reason that allowance of proportionate interest and overhead expenses to the extent of 20% of the sums claimed as overhead expenses was erroneous and prejudicial to the interests of the revenue. He further held that the assessee would not be entitled to deduction under s. 57(iii) of the I.T. Act, 1961, since he was of the view that the payment of interest by the assessee to the lending bank had really no direct connection with the interest received and,therefore, the interest paid was in the nature of pre-production expenses and it related to the erection of the factory and purchase of capital goods and, consequently, it had no connection with the earning of interest income. Further, with regard to the first contention about the claim allowed, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e extent of the loans deposited, the claim of interest had to be limited. In its view, there was close nexus between earning of the interest and the payment of interest and, therefore, the interest paid by the assessee to the lending bank proportionate to the amount on which it earned interest had to be allowed under s. 57(iii) of the Act. With regard to the amount allowed to the extent of 5% by the Addl CIT, as against 20% allowed by the, ITO, the Tribunal held that 10% of the expenses could be said to be reasonable. It is this order of the Tribunal which has given rise to the two references before us. The department applied for under s. 256(1) of the I.T. Act, 1961, and obtained a reference of the following question for the opinion of this court, which is the subject-matter of T.C. No. 392/74 : " Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding and had valid material to hold that proportionate interest payments should be deducted from the interest on bank deposits under section 57(iii) ofthe Income-tax Act, 1961, and the taxable income from ' other sources ' determined for the assessment years 1969-70 and 1970-71 assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... counsel for the assessee was that during the two years in question, the assessee engaged in putting up the plant and that formed part of the carrying on of the business by the assessee and that, therefore, the interest income earned during the relevant years must be treated as business income. As we have pointed out already, the object of the assessee-company was to manufacture and market ammonia, urea and other complex fertilizers and this finds a place in the agreed statement of the case submitted to this court by the Tribunal. Equally admittedly the production of these had not been commenced till March 31, 1970. In such a context the question for consideration is, whether the interest received by the assessee from the bank can be said to be its business income at all. Setting up of a factory may be a preliminary step and it is an indispensable and essential step for the purpose of carrying on the business of manufacturing and marketing ammonia, urea and other complex fertilizers. But it cannot be said to be carrying on the business itself. Here again we asked the learned counsel for the assesee to substantiate the contention put forward by him with reference to any authority and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k Trust Company in the special account with that bank itself formed part of the same transaction and the earning of interest by the assessee from the deposit in the special account was not an independent transaction and that the interest was adjusted against the interest payable by the assessee to the bank with the result the assessee happened to pay a reduced interest than what it would have paid otherwise. The same contention was repeated before us and we are unable to agree with that contention. We have already referred to section 2.04 of the agreement dealing with the payment of interest by the assessees to the bank, that is, semi-annually. On the other hand, with reference to the deposit to be made by the assessee in a special account with the bank under section 6.08, there is no provision with regard to the rate of interest payable as well as the periodicity of payment. The learned counsel for the assessee himself had to admit that the agreement itself did not fix the rate of interest or periodicity of payment with regard to such deposit. In such a context, it is impossible to accept the contention put forward by the learned counsel for the assessee that, under the terms o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incurred. On the facts to which we have drawn attention, it is clear that there is no direct nexus or connection between the payment of interest by the assessee on the loan which is received from the Chemical Bank New York Trust Company and the interest which it earned on the deposit made in the special account with the same bank. Our attention was drawn to a few decisions bearing on the scope and construction of s. 57(iii) of the I.T. Act, 1961, corresponding to s. 12(2) of the Indian I.T. Act, 1922. A Bench of this court had occasion to consider the scope of s. 12(2) of the Indian I.T. Act, 1922, in CIT v. S. Devaraj [1969] 73 ITR 1 (Mad). At page 3 of the report, this court stated : " It seems to us that the scope of section 12(2) presents not much difficulty, but its application to particular facts is a matter of nicety. Broadly speaking, income-tax is a charge not on gross receipts but on the net income. And so, allowance has been provided for in the Act, in the form of deduction, in the computation of the total income, or in the form of rebates. An examination of the provisions of the Income-tax Act, relating to such allowances, discloses that the expenditure or outgoing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2) of the Indian Income-tax Act, 1922, used the expression ' solely ', while section 57(iii) of the Income-tax Act, 1961, uses the expression ' wholly and exclusively '] " that is to say, if the purpose of the expenditure is a mixed one, it will take it outside the scope of section 12(2). The word ' solely ' has the same sense as the words ' wholly and exclusively ' in section 10(2)(xv). Further, by the use of the words ' for the purpose of ', it is obvious that there must be a nexus between the character of the expenditure and earning of income, profits or gains. If the expenditure is not for that purpose, or is unrelated to or unconnected with the activity of earning such income, profits or gains, it will not be allowed as a deduction. These requisites are no doubt more easily stated than applied to particular circumstances. " The Gujarat High Court had occasion to consider the scope of s. 57(iii) of the I.T. Act, 1961, in Smt. Padmavati Jaykrishna v. CIT [1975] 101 ITR 153. In that case, the assessee borrowed monies for the purpose of discharging tax liabilities which included investment in annuity deposit and claimed to deduct the interest payable on the loan from the interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncome within the meaning of sub-clause (iii) of section 57 of the Act or under the corresponding provisions of section 10(2)(xv) of the Indian Income-tax Act, 1922." However, Mr. Uttam Reddi, learned counsel for the assessee, relied on a decision of the Bombay High Court in Kevalchand Nemchand Mehta v. CIT [1968] 67 ITR 804. In that case Kevalchand withdrew from his account with a firm Kapurchand and Company a sum of Rs. 3,75,000 on 16th December, 1955, and on the same date he deposited the said amount with M/s. Kapurchand Ltd. in the name of his minor son to whom he gifted the said amount. With reference to the interest received in respect of the said deposit, Kevalchand claimed to deduct the interest payable by him on the amount of Rs. 3,75,000 borrowed for the purpose of making the gift to his minor son. The Tribunal rejected the claim, but when the matter was taken up to the High Court, the High Court allowed the claim. The Tribunal had stated in that case (p. 807) : " In our opinion, in deciding this point, we have only to look to the purpose of the borrowing by the assessee at the time when the borrowings were made. That purpose was simply to make the gift to his minor ch ..... X X X X Extracts X X X X X X X X Extracts X X X X
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