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"Whether, on the facts and in the circumstances of the case, interest derived by the assessee from the borrowed funds which were invested in short term deposits with banks would be chargeable to tax under the head 'Income from other sources' or would go to reduce the interest payable by the assessee on the term loans secured by the assessee from financial institutions, which would be capitalised after the commencement of commercial production?"

The facts of this case are not in dispute. In usual course, interests received by the Company from bank deposits and loans would be taxable as income under the head 'income from other sources' under Section 56 of the Income Tax Act. It is argued on behalf of the Company that it had not yet commenced its business and in any event the income was derived from funds borrowed for setting up the factory of the company and should be adjusted against the interest payable on the borrowed funds.

In other words, if the capital of a Company is fruitfully utilised instead of keeping it idle the income thus generated will be of revenue and not accretion of capital. Whether the Company raised the capital by issue of shares or debentures or by borrowing will not make any difference to this principle. If borrowed Capital is used for the purpose of earning income that income will have to be taxed in accordance with law. Income is something which flows from the property. Something received in place of the property will be capital receipt. The amount of interest received by the Company flows from its investments and is its income and is clearly taxable even though the interest amount is earned by utilising borrowed capital.

It is true that the Company will have to pay interest on the money borrowed by it. But that cannot be a ground for exemption of interest earned by the Company by utilizing the borrowed funds as its income. It was rightly pointed out in the case of Kedar Narain Singh v. Commissioner of Income Tax, (6 I.T.R. 157) that "anything which can properly be described as income is taxable under the Act unless expressly exempted". The interest earned by the assessee is clearly its income and unless it can be shown that any provision like Section 10 has exempted it from tax, it will be taxable. The fact that the source of income was borrowed money does not detract anything from the revenue character of the receipt. The question of adjustment of interest payable by the Company against the interest earned by it will depend upon the provisions of the Act. The expenditure would have been deductible as incurred for the purpose of business if the assessee's business had commenced. But that is not the case here. The assessee may be entitled to capitalise the interest payable by it. But what the assessee cannot claim is adjustment of this expenditure against interest assessable under Section 56. Section 57 of the Act sets out in its clauses (i) to (iii) the expenditures which are allowable as deduction from income assessable under Section 56. It is not the case of the assessee that the interest payable by it on term loans are allowable as deduction under Section 57 of the Act.

An assessee-company may have raised its capital by issue of shares or debentures or by borrowing. But when that capital or a portion of it was utilised for whatever reason, even for a short period, to earn interest that interest must be treated as revenue receipt and will have to be taxed accordingly. Any set off or deduction of any expenditure can only be made in accordance with the provisions of the Act.

The other case is a decision of the Bombay High Court in Commissioner of Income-Tax v. Maharashtra Electrosmelt Ltd. 214 ITR 489. In that case the assessee, before commercial production had started, had realised a sum of Rs. 3,14,356 as interest on short-term deposit. At the same time, the assessee had paid a sum of Rs. 58,51,505 as interest on funds borrowed by it for the purpose of its business. The assessee after deducting the receipt of interest from the amount of interest paid by it capitalised the balance amount. The High Court was of the view that the background of raising of the fund by borrowing and temporary utilisation of a portion of that fund by keeping the same in call deposits with the banks went to show that the interest was earned for the purpose of reducing the liability of the assessee. The High Court came to the conclusion that it was evident that the assessee did not derive any income by temporary utilisation of the loans and since no income was derived by the assessee, the question of assessing the sum of Rs. 3,14,366 in the hands of the assessee as "income from other sources" did not arise.