HC Rules Pre-Operational Interest as Capital, Not Income

VNG Automotive Pvt. Ltd. was set up in March 1992 to manufacture eco-friendly brake shoes. For this, it entered into a technical know-how agreement with a Singapore-based company and raised about Rs 72.69 lakhs as unsecured loans from its directors. These funds were used for business setup, paying technical fees, buying land, and making advance payments for machinery. Since some of the funds were not immediately required but were already earmarked for these expenses, the company parked them in bank deposits for a short time.

This earned interest of Rs. 1.33 lakh (AY 1993–94) and Rs. 2.37 lakh (AY 1994–95). The company adjusted this interest against project costs and declared nil income. However, the Assessing Officer reopened the case and treated this interest as “Income from Other Sources,” relying on the Tuticorin Alkali judgement. The CIT(A) ruled in favour of the company, but the ITAT reversed it, leading to the High Court appeal.

Main Issue: Whether interest earned on temporarily parked funds, which were meant for setting up the business, should be taxed as income or treated as part of the project cost.

HC’s Decision: The High Court ruled in favour of the company and set aside the ITAT’s order. It noted that the funds were not idle surplus but were tied to specific business purposes like machinery and technical payments. Relying on CIT v. Bokaro Steel Ltd., the Court held that the interest was directly linked to the setting up of the business. So, it should be treated as a capital receipt and adjusted against project cost. The Court also clarified that this case was different from Tuticorin Alkali, where surplus funds were invested just to earn income. Here, the deposits were incidental to the business setup. Hence, the interest was not taxable.

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