MUMBAI, 15 SEPT, 2016: THE issue is - Whether the interest income earned by an assessee on investment of share investor's money is to be classified under 'income from other sources'. YES is the answer.

Facts of the case

The assessee company had embarked on major expansion and diversification programme for which it had obtained necessary industrial licence for manufacture of Sodium Tri Poly Phosphate (STPP). However, the industrial licence was conditional upon the assessee diluting foreign equity share holding in it. There was a condition attached to the industrial licence as per which the company should issue fresh shares to the Indian public to the exclusion of the foreign shareholders, to the extent of which will, after the proposed issue of bonus shares in the proportion of one new share to every six shares reduce the shareholding of the nonresident shareholders during the course of implementation of this project only. Consequent to the above, the assessee issued shares to the Indian Public in order to reduce the percentage of foreign share holding in it. Assessee had for the purpose of issuing shares to Indian Public incurred an expenditure of Rs.33.74 lakhs. In the assessment proceedings, assessee claimed that the expenses of Rs.33.74 lakhs on account of issue of additional shares to the Indian public were in the revenue field and sought deduction of the same while computing its income chargeable to tax. However, AO did not accepted the assessee's contention, holding that any expenditure for issue of additional share capital, would be in the capital field and thus not allowable for deduction as a revenue expenditure.

On appeal before CIT(A), the assessee urged that the entire expenses of Rs.33.74 lakhs should be allowed as it was an expense incurred with the object of carrying on its business to increase its profitability, in view of conditional licence granted to it. Alternatively, it was submitted that in any event, a sum of Rs.4.88 lakhs being the interest earned on the amounts received on issue of shares and deposited in the bank, subject to the allotment of shares, should be excluded while computing the total income. The CIT(A) allowed the appeal of the assessee by holding that the issue of shares for diluting the foreign share holding was issued as per the Government of India's directions and failure to do so would have resulted in stopping its expansion / diversification programme affecting its business. Thus, the expenses incurred on issue of shares to Indian public have to be allowed as a deduction while computing the total income. In the above view, the alternative submission urged for excluding the interest earned on the amounts received on allotment of shares, was not considered.

On further appeal before Tribunal, the assessee filed its cross-objection before the Tribunal on the issue of interest earned on the share application money till allotment of shares not to be included in computing its income. The Tribunal allowed the Revenue's Appeal by holding that raising additional capital, being in the capital field, cannot be allowed as a revenue expenditure. It placed reliance upon the decision of the Kerala High Court in Commissioner of Income Tax v/s. Common Wealth Trust Ltd. 167 ITR 365 wherein it is held that expenditure incurred for changing the capital structure of the company was capital in nature and not revenue. So far as the alternative contention raised by assessee in its cross-objection was concerned, the Tribunal held that the interest earned on share application money, had to be taxed as income from other sources. Accordingly, the cross-objection filed by assessee, was rejected.

Held that,

++ we find that SC in Kodak India Ltd. has held that expenses incurred in connection with issue of public shares to Indian public even when the issue of shares was done to comply with the directions of the RBI, would be an expenditure incurred in the capital field. The facts before the SC in Kodak India Ltd., were that Kodak had to increase its share capital amongst the Indian public as it had been directed by RBI to reduce the foreign shareholding, if it wanted to continue to do business in India. On the aforesaid facts, the Court held that the object of the Assessee therein was to increase share capital and at whose instance, it was done, was not material. In the present facts also, the issue of fresh shares, was to comply with the condition imposed by Government of India for obtaining a manufacturing licence. This licence would enable it to carry on business, and yet it would be in the capital field just as in the case of Kodak (I) Ltd. Thus, this issue is no longer resintegra before us and stands concluded against the assessee. However, assessee urges that the decision of SC in Kodak India Ltd., would not apply to the present facts as it relied upon its earlier decision in Punjab State Development Corporation. It is urged by assessee that if the principle laid down in Punjab State Development Corporation, is applied to the present facts, then the expenditure incurred on account of issue of shares would be a revenue expenditure. The SC in Punjab State Development Corporation was concerned with the issue whether the filing fees paid to the Registrar of Company for enhancement of capital by issue of shares is to be considered as a capital or revenue expenditure. The Court held that any expenditure directly related to expansion of the capital base of the company would be a capital expenditure although incidental benefit may be for running of its business and making of profit. Thus, in the aforesaid facts, the filing fee was held to be on capital account. Taking a cue from the words 'directly related' and 'incidental benefit' as used by SC, Mr. Pardiwalla, urges that in this case, the issue of share capital was primarily for doing business and increasing its profits. The change in capital structure was incidental. Thus, SC in Kodak India Ltd., on an identical fact situation applied the ratio of the Punjab State Development Corporation to conclude that it would apply to cover expenditure incurred for issue shares even if done to comply with the RBI directions for the purpose of carrying on business. Thus, the decision of SC in Kodak India Ltd. would apply to the facts of thepresent case and no fault can be found in view of the Tribunal. A direct decision of the SC in Kodak India Ltd. which was rendered on identical fact situation as arising in this case, would cover the controversy herein. In the above view, question (A) is answered in the affirmative i.e. in favour of the Revenue and against the assessee;

++ we find that this issue has been held in favour of the assessee by the decision of Gujarat HC in CIT v/s. Shree Rama Multi Tech Ltd. 214 Taxman 650, wherein an identical issue was raised. The Gujarat HC held that assessee was statutorily required to keep the share application money in a separate account, till the allotment of shares is completed. Therefore, interest earned on such separately kept amount was adjustable towards the expenditure incurred for raising share capital. This is so as the earning of interest was inextricably linked with the requirement to raise share capital. In support, reliance was placed upon the decisions of SC in Commissioner of Income Tax v/s. Bokaro Steel Ltd.2002-TIOL-161-SC-IT and Commissioner of Income Tax v/s. Karnal Cooperative Sugar Mills Ltd. 2002-TIOL-878-SC-IT. We are in respectful agreement with this decision of the Gujarat HC. The reliance placed by Gujarat High Court on Bokaro Steel Ltd. and Karnal Cooperative Sugar Mills Ltd. was apposite. In Bokaro Steel Ltd., SC held that during the construction of the steel plant, M/s. Bokaro had charged rent, hire charges and interest on advances from its contractors. The Revenue sought to tax the above as revenue receipts. The SC held the above income went to reduce the cost of construction and were capital receipts. In Karnal Cooperative Sugar Mills Ltd. the amount had been deposited in a bank to open a letter of credit for purchase of a machinery required for setting up a plant. The deposit so made to open the letter of credit earned interest. This interest is inextricably linked with the purchase of the machinery and such interest income has necessarily to be taken into account to reduce the cost of acquisition of asset, being income incidental to the purchase of the asset. In this case also, the share application money has been kept in the separate account as statutorily required till allotment of shares and any interest earned on the deposit of share application money is directly linked with the issue and allotment of fresh shares. Consequently, it cannot be brought to tax as income but has to be taken into account to reduce the expenditure incurred on issue of shares;

++ assessee's counsel very fairly brought to our notice a decision of a single Judge of the Karnataka HC in Southern Herbals Ltd. v/s. Settlement Commission and Anr. 261 ITR 681. In the above case, the Court, while dismissing a petition under Article 226 of the Constitution of India, upheld the order of the Settlement Commission that interest earned by an assessee on investment of share investor's money is to be classified under 'income from other sources' and not as 'business income'. It applied the principle laid down in the decision of SC in Tuticorin Alkali Chemicals and Fertilizers Ltd. v/s. Commissioner of Income Tax 2002-TIOL-489-SC-IT-LB, where interest was earned on loans taken before the commencement of business and such interest was held to be chargeable to tax. However, the Apex Court in Karnal Cooperative Sugar Mills Ltd. on identical facts, as arising herein, had occasion to consider both the decisions of the Apex Court in Bokaro Steel Ltd., and Tuticorin. On consideration on the fact situation, it held that the ratio of SC in Tuticorin would not apply to the present facts but the SC decision in Bokaro Steel Ltd. would apply. In any case, the Karnataka High Court's decision was rendered in the context of Article 226 of the Constitution of India and completely different considerations apply in writ petitions as opposed to Appeals/References. In the above view, question (B) as raised for our opinion is answered in the negative, i.e. in favour of the Assessee and against the Revenue.

(See 2016-TIOL-2135-HC-MUM-IT)