Holding

Interest earned on borrowed funds invested in short‑term deposits is taxable as income from other sources under Section 56 and cannot be set off against interest payable on the loans.

Summary

M/s Tuticorin Alkali Chemicals and Fertilizers Ltd., a newly incorporated heavy‑chemical manufacturer, raised term loans for setting up its plant and invested surplus funds in short‑term bank deposits before commercial production began. The company earned interest on these deposits and claimed that, under accepted accounting practice, the interest should be capitalised against pre‑production expenses (interest payable on the loans) and therefore not taxable. The Income Tax Officer rejected the claim, the Commissioner upheld the rejection, and the ITAT dismissed the appeal. The Supreme Court was asked whether such interest is chargeable to tax under "Income from other sources" or can be set off against the loan interest. The Court held that interest earned on borrowed funds is taxable income under Section 56 of the Income Tax Act and cannot be adjusted against the interest payable, as taxability is determined by statute, not accounting practice. Consequently, the company's claim was rejected and the reference was disposed in favour of the revenue.

Issues considered

Whether interest earned on borrowed funds invested in short‑term deposits before commencement of business is chargeable to tax under the head "Income from other sources".
Whether such interest income can be set off against or capitalised against the interest payable on the term loans used for pre‑production expenses.
Whether accounting practice can override the provisions of the Income Tax Act regarding taxability and deductions.

Legislation cited

Companies Acts. 208
Income Tax Act, 1961s. 10, s. 14, s. 4, s. 56, s. 57, s. 70, s. 71

Subjects

Income TaxInterest incomePre‑production expensesCapitalisationTaxabilityAccounting practiceIncome from other sourcesSet offBusiness commencement

Judgment

A M/S TUTICORIN ALKALI CHEMICALS AND
FERTILIZERS LTD., MADRAS
v.
COMMISSIONER OF INCOME TAX, MADRAS

JULY 8, 1997
B
[S.P. BHARUCHA, SUHAS C. SEN AND
M. JAGANNADHA RAO, JJ.]

C Income Tax, 1961-Sections 4, 56, 57-lncome from other sour-
ces-Taxability-Interest received by a Company from bank deposits and
loans-lncome derived from funds bo1Towed for setting up the factory of the
Company-Company had not yet commenced its business-Whether interest
derived by the assessee from bo1Towed funds, invested in short tenn deposits
would be chargeable to tax under the head 'l11co111e from other sources-Held,
D yes-It should not be adjusted against the interest payable on bo1Towed funds.
The petitioner company, incorporated for the purpose of
manufacturing heavy chemicals, had taken term loans from various banks
and financial institutions for setting up factories. That part of the
borrowed funds which was not imfnediately required by the Company was
E invested in short term deposits with banks. It had also given interest
bearing loans io its employees to purchase vehicles. The company claimed
that the interest income earned by the Company from the various loans
given by the Company and also from the bank deposits was not eligible to
tax as according to the accepted accounting Practice, interest and finance
F charges along with other pre-production expenses will have to be
capitalised, and that, therefore, the interest income should go to reduce
the pre- production expenses, which would ultimately be capitalised.

The Income Tax Officer rejected the assessee's claim. The
Company's appeal to the Income Tax Appellate Tribunal was dismissed.
G The question of law as fo 'whether, on the facts of 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
H from financial institutions, which would be capitalised after the
528
TIITICORIN ALKALI CHEMICALS & FERTILIZERS LTD. " C.LT. MADRAS 529

commencement of commercial production was referred to this Court. A
The Company argued that it had not commenced its business and
the income was derived from funds borrowed for setting up a factory and
therefore it should be adjusted against the interest payable on the
borrowed funds, as according to accounting practice the interest earned B
by the Company even before commencement of business from investing
borrowed capital will have to be set olf against interest pay.tble by the
Company on that borrowed capital.

Disposing of the Reference, this Court
c
HELD: 1.1. Income attracts tax as soon as it accrues. The application
or destination of the income has nothing to do with its accrual or taxability.
If the capital is fruitfully utilised instead of keeping it idle the income thus
generated will be of revenue nature 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 D
the purpose of earning income that income will have to be taxed in accord-
ance with law. Income is something witjch flows from the property. Some-
thing 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 in-
come and is clearly taxable even though the interest amount is earned by E
utilising borrowed capital. The company, in this case, is at liberty to use the
interest income as it likes. It is under no obligation to utilise this interest
income to reduce its liability to pay interest to its creditors. It can re-invest
the interest income in land or share, it can purchase securities, it can buy
house property, it can also set up another line of business, it may even pay
'>
dividends out of this income to. its shareholders. There is no overriding title F
of anybody diverting the income at source to pay the amount to the creditors
of the company. [541-H; 542-A; 537-C-D]

1.2. It is well-settled that tax is attracted at the point when the
income is earned. Taxability of income is not dependent upon its
destination or the manner of its utilisation. It has to be seen whether at G
the point of accrual, the amount is of revenue nature. If so, the amount
will have to be taxed. 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 H
530 SUPREME COURT REPORTS [1997] SUPP. l S.C.R.

A with the provisions of the Act. When the question is whether a receipt of
money is taxable or whether certain deductions from that receipt are
permissible in law or not, the question has to be decided according to the
principles of law and not in accordance with accountancy practice.
Accounting practice cannot override Section 56 or any other provision of
B the Act. Therefore, 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'. It would
not go to reduce the interest payable by the assessee on the term loans
secured by the assessee from financial institutions, which be capitalised
after the commencement of commercial production. No adjustment can be
C allowed except in accordance with the principles of income Tax Act.
However desirable it may be from the point of view of equity, this
adjustment cannot be made unless the law specifically permits such
adjustment. [537-D; 538-B; 539-C-D; 533-B; 536-C; 537-A; C-D]

Commissioner of Income-Tax v. Seshasayee Paper and Boards Ltd.,
D 156 ITR 543 (Mad), approved.

CIT v. Nagarjuna Steels Ltd., 171 ITR 663(A.P); CIT v. Electrochem
Orissa Ltd., 211 ITR 552 (Orissa) and CIT v. Maharashtra Electrosmelt Ltd.
214 ITR 489 (Born) , overruled.
E Commissioner of Income Tax. Bengal v. Shaw Wallace & Co., (1932)
59 I.A 206; Kr.dar Narain Singh v. Commissioner of Income Tax, 6 I.T.R. 157
and B.S.C. Footwear Ltd. v. Ridgway Inspector of Taxes, (1972) 83 l.T.R.
269, referred to

F Pondicheny Railway Company Ltd. v. C.I.T., AIR (1931) P.C. 165,
relied on.

Challapalli Sugars Ltd. v. CIT (1975) 98 ITR 167, distinguished.

Hinds v. Buenos Ayres Grand National Tramways Co. Ltd., (1906) 2
G Ch. 654.
CIVIL APPELLATE JURISDICTION : Tax Reference Case Nos.
1 and 2 of 1992.

Arising out of I.TA No. 1244 (Mds)/86 & C.O. No. 116 (Mds)/87
H Assessment Years: 1982-83 and 1983-84 dated on 22.4.88 and 19.9.88.
TlTTICORIN ALKALI CHEMICALS& FERTILIZERS LTD. v. C.l.T. MADRAS [SEN, J.] 531

J. Ramamurthi and V. Balachandran for the Appellants. A

B.S. Ahuja for the Respondent.

The Judgment of the Court was delivered by

SEN, J. M/s. Tuticorin Alkali Chemicals and Fertilizers Limited B
formerly known as Tuticorin Alkali Limited was incorporated on 3.12.1971
for the purpose of, inter alia, manufacturing heavy chemicals such as
ammonium chloride and soda ash. The trial production of the factories of
the Company commenced on 30.6.1982. For the purpose of setting up of
the factories, the Company had taken term loans from various banks and C
financial institutions. That part of the borrowed funds which was not
immediately required by the Company was kept invested in short- term
deposits with banks. Such investments were specifically permitted by the
Memorandum and Articles of Association of the Company.

The Company had also deposited certain sums with the Tamil Nadu D
Electricity Board. It had also given interest-bearing loans to its employees
. to purchase vehicles. Upto the assessment Year 1980-81, interests earned
by the Company from the various loans given by· the Company and also
from the bank deposits were shown as income and was truced accordingly.

For the accounting year ending on 30.6.1981, (assessment year 1982-
E
83), the assessee received a total amount of interest of Rs. 2,92,440. In its
return of income filed on 22.6.1982, the Company disclosed the said sum
of Rs.2,92,440 as "Income from other sources". It also disclosed business
loss of Rs. 3,21,802. After setting off the interest income against business
loss, the Company claimed the benefit of carry forward of net loss of Rs. F
29,360.

The Company later on realised its mistake and on 26.12.1984, it filed
a revised return showing business loss of Rs. 3,21,802. It claimed that
according to the accepted accounting practice, interest and finance charges G
along with other pre-production expenses will have to be capitalised, and
that, therefore, the interest income of Rs. 2,92,440 should go to reduce the
pre- production expenses (including interest and finance charges), which
would ultimately be capitalised. In this connection, the Company high-
lighted the fact that during the previous year relevant to the assessment
year 1982-83, it had incurred a sum of Rs. 1,13,06,068 as and by way of H
532 SUPREME COURT REPORTS [1997] SUPP.1 S.C.R.

A interest and finance charges, which had to be capitalised along with other
pre-production expenses. In other words, according to the assessee,. the
interest income of Rs. 2,92,440 was not exigible to tl!J\.

The Income Tax Officer rejected the assessee's claim that the interest
income was not exigible to tax. The view of the Income Tax Officer was
B upheld by the· Commissioner of Income Tax appeals. The Company's
further appeal to the Income Tax Appellate Tribunal was dismissed.

We are also concerned in this case with the assessment year 1983-
84. During the previous year relevant to this assessment year, the assessee
C had received interest income of Rs. 1,08336. The assessee filed its return
in which .it claimed that the interest income of 1,08336 should go to reduce
the pre-production expenses including the interest and finance charges
which would ultimately be capitalised. This contention was once again
negatived by the income Tax Officer. The view of the income Tax Officer
was upheld by the Commissioner of Income Tax (Appeals) and the
D Tribunal. Two applications were made for referring questions of law arising
out of the order of the Tribunal as to the right of the Company to treat
the receipt of interest on capital account and adjust it against preliminary
expenditure incurred by the Company. The attention of the Tribunal was
drawn to two conflicting decisions on the point of law involved in this case.
E The view taken by the Madras High Court in the case of Commis-
sioner of Income-Tax v. Seshasayee Paper and Board Ltd., (156 ITR 543)
was that the interest earned by the assessee on investment of share capital
in call deposits even before production commenced could be assessed
separately under the head "Other Sources". The Andhra Pradesh High
F Court took a contrary view in the case of CIT v. Nagarjuna Steels Ltd., (171
ITR 663) where it was held that interest received on short-term deposits
by a company prior to commencement of production could not be treated
as revenue receipt. In view of the aforesaid conflict of decisions between
the Madras and Andhra Pradesh High Courts, the Tribunal has referred
G the following question of law to this Court for decision:

"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
H reduce the interest payable by the assessee on the term loans
TIJTICORJN ALKALI CHEMICALS& FERTILIZERS LTD. v. C.l.T. MADRAS [SEN, J.) 533

secured by the assessee from financial institutions, which would be A
. 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 B
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 our judgment neither of the two factors can affect taxability of the C
income earned by the Company. Under the Income Tax Act, 1961, the total
income of the company is chargeable to tax under Section 4. The total
income has to be computed in accordance with the provisions of the Act.
Section 14 lays down that for the purpose of computation, income of an
assessee has to be classified under six heads:
D
(a) Salaries.

(b) Interest on Securities.

(c) Income from house property.

( d) Profits and ga~ns of business or profession.
E

( e) Capital gains.

(f) Income from other sources.

By an amendment made in 1988 'interest on securities ' has been F
made chargeable to tax as business income when such interest forms part
of business profits and in all other cases under Section 56 (2) (i-d) as
income from other sources. The amendment made in 1988 has no relevance
for the purpose of this case. We shall take this Act as it stood at the
material time in the assessment year 1983-84.
G
The computation of income under each of the above six heads will
have to be made independently and separately. There are specific rules of
deduction and allowances under each head. No deduction or adjustment
on account of any expenditure can be can made except as provided by the
~. H
534 SUPREME COURT REPORTS [1997) SUPP. 1 S.C.R.
A The basic proposition that has to be borne in mind in this case is that
it is possible for a company to have six different sources of income, each
one of which will be chargeable to income tax. Profits and gains of business
or profession is only one of the heatls under which the company's income
is liable to be assessed to tax. If a company has not commenced business,
there cannot be any question .of assessment of its profits and gains of
B business. That does not mean that until and unless the company commen-
ces its business, its income from any other source will not be taxed. If the
company, even before it commences business, invests the surplus fund in
its hand for purchase of land or house property and later sells it at profit,

C
the gain made by the company will be assessable under the head 'Capital
gains'. Similarly, if a company purchases a rented house and gets rent, such
rent will be assessable to tax under Section 22 as income from House
-
property. Likewise, a company may have income from other sources. It may
buy shares and get dividends. Such dividends will be taxable under Section
56 of the Act. The Company may also, as in this case, keep the surplus
fund in short-term deposits in order to earn interest. Such interests will be
D chargeable under Section 56 of the Act.

The Company has chosen not to keep its surplus capital idle, but has
decided to invest it fruitfully. The fruits of such investment will clearly be
of revenue nature. This position in law was explained by Sir George
E Lowndes in the oft-quoted passage in the case of Commissioner of Income
Tax, Bengal v. Shaw Wallace & Co., (1932) 59 I.A. 206 :

"Income, their Lordships think, in this Act connotes a periodical

c
monetary return 'corning in'. with some sort of regularity or
expected regularity from definite sources. The source is not
F necessarily one which is expected to be continuously productive,
but it must be one whose object is the production of a definite
return, excluding anything in the nature of a mere windfall. This
income has been likened pictorially to the fruit of a tree, or the
crop of a field. It is essentially the produce of something which is
often loosely spoken of as 'capital'."
G
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 diffen::nce to
H this principle. If borrowed Capital is used for the purpose of earning
TUTICORIN ALKALI CHEMICALS & FERTILIZERS LTD. v. C.l.T. MADRAS [SEN, J.) 535

income that income will have to be taxed in accordance with law. Income A
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.
B
"
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 l.T.R. 157) that "anything which can properly be C
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 D
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 E
against interest assessable under Section 56. Section 57 of the Act sets out
iq ics 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.
F
If that be so, under which other provision of law can the assessee
claim deduction or set -off of his income from other source against interest
payable on the borrowed fund?

There are specific provisions in the Income Tax Act of setting off of G
loss from one source against income from another source under the same
head of income (Section 70), as well as setting off of loss from one head
against income from another (Section 71). In the facts of this case the
Company cannot claim any relief under any of these two Sections, since its
business had not started and there could not be any computation ·of
business income or loss incurred by the assessee in the relevant accounting H
536 SUPREME COURT REPORTS [1997] SUPP. lS.C.R.

A year. In such a situation the expenditure incurred by the assessee for the
purpose of setting up its business cannot be allowed as deduction, nor can
it be adjusted against any other income under any other head. Similarly any .
income from a non-business source cannot be set off against the liability
to pay interest on funds borrowed for the purpose of purchase of plants
and machineries. even before commencement the business of the assessee.
B
It has b1::en argued that the source 'lrom which the Company has
earned interest is borrowed capital. The Company has to pay interest to
its creditors on the same borrowed capital . Having regard to the identity
of the fund on which interest is earned and interest is payable, the Com-
C pany should be allowed to set off its income against interest payable by it
on the same fund. We are of the view that no adjustment can be allowed
except in accordance with the provisions of the income Tax Act. However
desirable it may be from the point of view of equity, this adjustment cannot
be made unless the law specifically permits such adjustment.

D Next it has been argued that according to well-established account-
ancy practice the interest earned by the Company even before commence-
ment of business from investing borrowed capital will have to be set off
against interest payable by the Company on that borrowed capital. The
argument based on accountancy practice has liftle merit if such practice
cannot be justified by any provision of the statute or is contrary to it.
E
In the case of B.S.C. Footwear Ltd. v. Ridgway (Inspector of Taxes),
[1972] 83 I.T.R. 269, Russell, L.J. while rejecting an argument based on
well-settled accountancy practice pointed out that the Income Tax law does
not march step by step in the divergent footprints of the accountancy
profession.
F
The view of Russell, L.J. was upheld by the House of Lords on
appeal. It was observed by Lord Reid (83 l.T.R. 269, 283)

"Whatever merits there may be in the company's accountancy
methods for the purposes of its internal affairs I am not persuaded
G that Cross J. and the Court of Appeal were wrong in finding them
unacceptable for tax purposes."

In the case before us the Company had surplus funds in its hands.
In order to earn income out of the surplus funds, it invested the amount
H for the purpose of earning interest. The interest thus earned is clearly of
TUTICORIN ALKALI CHEMICALS & FERTILIZERS LID. v. C.1.T. MADRAS [SEN, J.) 537

revenue nature and will have to be truced accordingly. The accountants may A
have taken some other view but accountancy practice is not necessarily
good law. InB.S.C. Footwear's case, the House of Lords had no hesitation
in holding that the accounting practice for calculating its profit followed
by the assessee and accepted by revenue for 30 years could not be treated
as sanctioned by law. and was not acceptable for the purpose of B
computation of trucable income.

There is another aspect of this matter. The company, in this case, is
at liberty to use the interest income as it likes. It is under no obligation to
utilise this interest income to reduce its liability to pay interest to its
creditors. It can re-invest the interest income in land or share, it. can C
purchase securities, it can buy house property, it can also set up another
line of business, it may even pay dividends out of this income to its
shareholders. There is no overriding title of anybody diverting the income
at source to pay the amount to the creditors of the company. It is
well-settled that true is attracted at the point when the income is earned. D
Trucability of income is not dependent upon its. destination or the manner
of its utilisation. It has to be seen whether at .the point of accrual, the
amount is of revenue nature. If so, the amount will have to be truced.
Pondicheny Railway Company Ltd. v. C.I.T. AIR (1931) P.C. 165.

Our attention was drawn to two other decisions where the view of E
the Andhra pradesh High Court was followed. In the case of Commissioner
of Income-Tax v. Electrochem Orissa Ltd., 211 ITR 552, the Orissa High
Court preferred the view expressed by the High Court of Andhra Pradesh
to the view expressed by the Madras High Court in Seshasayee Paper and
Board Ltd.'s case on the ground that the Madras case was based on a F
finding of fact that there was no direct connection between th~ ~terest
' paid and the interest received. In our view it will not be right to read the
judgment in Seshasayee Paper and Board Ltd. 's case in that way. The
Court's finding in Seshasayee Paper and Board Ltd. 's case was that the
· interest earned by the assessee from the bank deposits had to be assessed G
under the head "Other sources". Consequently, the interest paid on the
borrowing for the purpose of purchase of plants and machineries could not
be allowed or adjusted against this income under Section 57(iii) nor were
such adjustment permissible under Sections 70 or 71 of the Act because
the business of the assessee had not commenced. The Madras high Court
categorically held : H
538 SUPREME COURT REPORTS [1997] SUPP.1 S.C.R.

A "In this case, admittedly, the borrowing has not been made
exclusively and solely for the purpose of earning interest in which
case alone it should be taken as an income which should be
deducted from the interest receipts."

An assessee-company may have raised its capital by issue of shares
B or debentures or by borrowing. nut 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.
c
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
D 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
E 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
F sources" did not arise.
,.
It is difficult to follow this reasoning. If a person borrows money for
business purpose but utilises that money to earn interest, however
temporarily, the interest so generated will be his income. This income can
be utilised by the assessee whichever way he likes. He may or may not
G discharge his liability to pay interest with this income. Merely because it
was utilised to repay the interest on the loan taken by the assessee, it did
not cease to be his income. The interest earned by the assessee could have
been used for many other purposes. If the assessee purchased a house or
distributed dividend or paid salary of its employees with the money
H received as interest, will the interest amount be treated as not his income?
TUTICORIN ALKALI CHEMICALS & FERTILIZERS LTD. v. C.LT. MADRAS [SEN, J.] 539

This is not a case of diversion of income by overriding title. The assessee A
was· entirely at liberty to deal with the interest amount as he liked. The
application of the income for payment of interest could not affect its
taxability in any way.

The second reason given by the High Court was that the Institute of
Chartered Accountants of India was a recognised authority on accounting B
principles. This fact has been recognised by this Court in the case of
Challapalli Sugars Ltd. v. CIT, (1975) 98 ITR 167. Therefore, its view has
_to be respected.

It is true that this Court has very often referred to accounting C
practice for ascertainment of profit made by a company or value of the
assets of a company. But when the question is whether a receipt of money
is taxable or not or whether certain deductions from that receipt are
permissible in law or not, the question has to be decided according to the
principles of law and not in accordance with accountancy practice.
Accounting practice cannot override Section 56 or any other provision of D
the Act. As was pointed out by Lord Russell in the case of B.S. C. Footwear
Ltd., the Income Tax law does not march step by step in the footprints of
the accountancy profession.

The question in Challapalli Sugar Ltd. 's case was about computation E
of depreciation and development rebate unaer the Indian Income Tax Act,
1922. In order to calculate depreciation and development rebate it was
necessary to find out 'the actual cost' of the plant and machinery purchased
by the Company. This Court held that 'cost' is a word of wider connotation
than 'price'. There was a difference between the price of a machinery and
its cost. This Court thereafter pointed out that the expression "actual cost" F
had not been defined in the Act. It was, therefore, necessary to find out
the commercial sense of the phrase. Khanna, J. (as his Lordship then was)
observed:

"As the expression "actual cost" has not been defined, it should, G
in our opinion, be construed in the sense which no commercial
man would misunderstand. For this purpose it would be necessary
to ascertain the connotation of the above expression in accordance
with the normal rules of accountancy prevailing in commerce and
industry. The accepted accountancy rule for determining cost of
fixed assets is to include all expenditure necessary to bring such H
540 SUPREME COURT REPORTS [1997] SUPP. 1 S.C.R.

A assets into existence and to put them in working condition. In case
money is borrowed by a newly started company which is in the
process of constructing and erecting its plant, the interest incurred
before the commencement of production on such borrowed money
can be capitalised and added to the cost of the fixed assets created
as a result of such expenditure."
B
This Court also took note of the provisions of the Companies Act
and in particular Section 208 (l)(b). It observed :

"Clause (b) of sub-section (1) of that section provides that in case
c interest is paid on share capital issued for the purpose of raising
money to defray the expenses of constructing any work or building
or the provision of any plant in contingencies mentioned in that
section, the sum so paid by way of interest may be charged to
capital as part of the cost of construction of the work or building
or the provision of the plant. The above provision thus gives
D statutory recognition to the principle of capitalising the interest in
case the interest is paid on money raised to defray expenses of the
construction of any work or building or the provision of any plant
in contingencies mentioned in that section even though such money
constitutes share capital. The same principle, in our opinion,
should hold good if interest is paid on money not raised by way of
E
share capital but takerr:on loan for the purpose of defraying the
expenses of the construction of any work or building or the
provision of any plant. The reason indeed would be stronger in
case such interest is paid on money taken on loan for meeting the
above expenses."
F
This Court also relied on an English case in support of,this conclusion in
Hinds v. Buenos Ayres Grand National Tramways Co. Ltd., [1906] 2 Ch. 654.
In Hinds' case dealing with the question of capitalisation of interest paid
on loans taken to install electric traction for tram lines, it was held by
G Warrington J.:

"Now, what is it that the company are really proposing to do? They
are creating a capital asset by means of which they will hereafter
earn, or they hope to earn, profits for the company. They are not
simply employing contractors to find the money and do the work.
H They are finding the money themselves, and they find the money
TUTICORIN ALKALI CHEMICALS & FERTILIZERS LTD. v. C.l.T. MADRAS [SEN, J.] 541

by borrowing it. What does each mile of line cost them under these A
circumstances -what is that they expend in construction each mile
of line, taking the amount of the borrowed money expended on
that line to be £10,000, that being the company's estimate? The
money is borrowed for that particular purpose - the £10,000. They
have to pay interest on that £10,000 during the period that B
construction is taking place: In my opinion that asset which they
are so constructing costs them not only the £10,000 but the £10,000
plus the amount of interest during the period of construction; and
that is what they are out of pocket during the construction of that
mile of line. Now, it seems to me that the company are entitled -
I do not say that they are bound to do it - if they think fit to charge C
in their accounts as the cost of that mile of line not only £10,000,
but the £10,000 and the interest on it during the period of
construction."

In other words, it was held that cost of construction will be the amount D
actually spent and also the interest payable on the amount borrowed during
"the period of construction.

The judgment in Challapalli's case goes to show that the Court was
not in any way departing from legal principles because of any opinion
expressed by the Institute of Chartered Accountants. The phrase 'actual E
cost' was not defined in the Act. Therefore, it had to be understood in the
commercial parlance. To find that out the normal rule of accountancy
prevalent in commercial and industrial circles was noted. According to the
Institute of Chartered Accountants, actual cost will also include interest
paid on borrowed money for the purchase of the assets. Khanna, J. F
however, did not stop there. He pointed out that the principle of
capitalising interest was to be found in Section 208 of the Companies Act
itself and was also consistent with the view of the English Courts.

But this is an entirely different case. Whether a particular receipt is G
of the nature of income and falls within the charge of Section 4 of the
Income-Tax Act is a question of law which has to be deCided by the Court
on the basis of the provisions of the Act and the interpretation of the term
'income' given in a large number of decisions of the High Courts, the privy
Council and also this Court. It is well-settled that income attracts tax as
soon as it accrues. The application or destination of the income has nothing H
542 SUPREME COURT REPORTS [1997] SUPP. 1 S.C.R.

A to do with its accrual or taxability. It is also well-settled that interest income
is always of a revenue nature unless it is received by way of damages or
compensation.

In the premises, we are of the view that the Madras High Court came
to a correct decision in the case of Commissioner of Income-Tax v.
B Seshasayee Paper And Boards Ltd., (156 ITR 543). The contrary views
expressed in the cases of CIT v. Nagarjuna Steels Ltd., Commissioner of
Income-Tax v. Electrochem Orissa Ltd. and Commissioner of In.come- Tax
v. Maharashtra Electrosmelt Ltd. are erroneous.

We are of the view that the Tribunal has come to a correct decision.
C The question referred by the Tribunal is in two parts. The first part of the
question is answered in the affirmative and in favour of the revenue. The
second part of the question is answered in the negative and in favour of
the revenue.

D The References are-disposed of accordingly. There will be no order
as to costs.

R.A. References disposed of.