Court Rules: Interest Income Linked to Business is Business Income, Not Other Sources

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Case Name:

Commissioner of Income Tax vs V.S. Dempo & Co. Pvt. Ltd.(High Court of Bombay)

Tax Appeal No. 58 of 2007

Date: 20th July 2019

Key Takeaways:

1. Interest income directly related to business activities is classified as business income.

2. Consistency in tax treatment should be maintained unless there's a significant change in circumstances.

3. The court emphasized the importance of examining the nexus between income and business activities.

Issue: 

Should the interest income earned by V.S. Dempo & Co. Pvt. Ltd. be classified as business income or income from other sources?

Facts:

1. V.S. Dempo & Co. Pvt. Ltd. had been earning interest income for many years.

2. This income was consistently treated as business income in previous years.

3. The company used surplus funds for short-term deposits, providing security for loans, and opening Letters of Credit.

4. In the assessment year 1991-92, the Assessing Officer changed the classification to income from other sources.

5. The case went through various stages of appeal before reaching the High Court.

Arguments:

Appellant (Revenue):

- The interest income should be classified as income from other sources.

- The change in classification was justified based on the nature of the income.

Respondent (Assessee):

- The interest income has a direct nexus with business activities.

- The company's Memorandum and Articles of Association permit lending and depositing money as part of business activities.

- There was no substantial change in circumstances to justify altering the previous tax treatment.

Key Legal Precedents:

1. ACG Associated Capsules Pvt. Ltd. v/s. The Commissioner of Income Tax: This case was cited to support the assessee's position on the treatment of certain types of income under Section 80HHC of the Income Tax Act.

2. Commissioner of Income Tax, Goa vs. V.S. Dempo & Co. Ltd.: This previous case involving the same assessee established that interest income with a direct nexus to business activities should be treated as business income.

3. Radhasoami Satsang case: This Supreme Court decision was referenced to emphasize the importance of consistency in tax treatment unless there's a material change justifying a different view.

Judgement:

The High Court ruled in favor of the assessee (V.S. Dempo & Co. Pvt. Ltd.), concluding that:

1. The interest income earned by the assessee has a direct nexus with its business activity.

2. The funds were invested for business purposes such as availing short-term loans or opening Letters of Credit.

3. The interest income should be treated as "business income" due to its direct or proximate relationship with the main business activity.

4. The court emphasized that only if surplus money is completely removed from the business and has no connection to business activities can it be treated as non-business income or income from other sources.

The court answered most of the substantial questions of law in favor of the assessee and against the Revenue, with one exception (question IV) which was answered in favor of the Revenue but did not affect the overall outcome due to factual findings.

FAQs:

1. Q: What determines whether interest income is classified as business income?

  A: The key factor is whether the interest income has a direct nexus or proximate relationship with the company's main business activities.

2. Q: Can the tax department change the classification of income from previous years?

  A: While it's possible, the court emphasized the importance of consistency unless there's a substantial change in circumstances.

3. Q: What role does a company's Memorandum and Articles of Association play in such cases?

  A: It can be crucial in determining whether certain activities, like lending or depositing money, are part of the company's permitted business activities.

4. Q: How does this judgment impact other businesses?

  A: It provides guidance for companies earning interest income, emphasizing the importance of demonstrating a clear connection between such income and core business activities.

5. Q: What should businesses do to ensure their interest income is treated as business income?

  A: They should maintain clear records showing how the funds generating interest are used in connection with their business activities and ensure consistency in their approach.

Heard Ms. Linhares for the Appellant and Mr. Mihir Naniwadekar, with Ms. Vinita Palyekar for the Respondent.

2. By an order dated 12th October, 2007, this Appeal was admitted on the following substantial questions of law :

“ (I) Whether in the facts and in the circumstances of the case, the ITAT has erred while referring the issue to the file of A.O., to exclude 90 % of `net' interest income excess of interest received or paid provided there is direct nexus between interest earned and paid after establishing the fact that all the interest income except the interest on income tax is forming part of the profits of the business and not income from other sources ?

(II) Whether the findings of the ITAT while restoring the issue of interest income to the file of the A.O. to exclude 90 % of `net' interest income is valid in law ?

(III) Whether in the facts and in the circumstances of the case, the ITAT is right in law in taking into account the interest on bank deposits', interest on intercorporate deposits', `interest on debentures', and interest from sister concerns' and `other interest' is forming the part of the head “Profits and gains of business or profession”?

(IV) Whether the findings of the ITAT that the receipts on account of `professional services' and proceeds from electronic data processing' are not income falling within the exclusionary provisions of clause (baa) of Explanation to section 80HHC, is right in law ?

(V) Whether the findings of the ITAT, that 90 % of the net income from receipts on account of stevedoring agency business' and travel agency business' are falling within the exclusive provision of clause (baa) of explanation to section 80HHC, is right in law ?

(VI) Whether in facts and circumstances of the case, the ITAT has erred in applying the provision of Section 172 in holding that section 40(a)(i), is not applicable, particularly when section 172 concerned with levy and recovery of tax in a case of any ship, as against section 195 r/w 40(a) (i) of the IT Act, refers to non-resident Assessee as in the present case ?

(VII) Whether the findings of the ITAT, that only 90 % of net' income from the `transfer of vessel' and barge freight', has to be excluded, for the purpose of computing profits of the business under clause (baa) of Explanation to section 80HHC, is right in law ?

(VIII) Whether the findings of the ITAT that, only 90 % of the `net' income from the `lease hire charges' received by the Assessee apart from depreciation has to be excluded for the purpose of computing profits of the business under clause (baa) of Explanation to Section 80HHC, is right in law ?

3. From a perusal of the aforesaid substantial questions of law, it is apparent that the substantial questions (I), (II), (V), (VII) and (VIII) relate to the issue, namely, whether the finding of the ITAT that only 90% of the 'net income' from the transfer of the vessel and barge freight has to be excluded for the purpose of computing the profits of the business under clause (baa) of Explanation to Section 80HHC is right or not. The learned Counsel for the parties agree that these substantial questions of law be taken up for consideration together. Both the learned Counsel have further agreed and jointly submit that this issue stands covered by the Judgment of the Apex Court in the case of ACG Associated Capsules Pvt. Ltd. v/s. The Commissioner of Income Tax in favour of the Respondent-Assessee and against the Revenue. In fact, following the decision in ACG Associated Capsules Pvt. Ltd. (supra), we have, by our order dated 29th April, 2015, disposed of Tax Appeal No.61/2007 which also involved the same issue. Therefore, the substantial questions of law at (I), (II), (V), (VII) and (VIII) are answered against the Revenue and in favour of the Respondent-Assessee.

4. In so far as the substantial question of law at (III) is concerned, again there is no serious dispute that even this question stands answered in favour of the Assessee and against the Revenue in the decision of a Division Bench of this Court in the case of Commissioner of Income Tax, Goa vs. V.S. Dempo & Co. Ltd. In paragraphs 14 and 15, this is what the Division Bench of this Court has observed, incidentally in the case of the very same Assessee:

“14. Thus, after taking into consideration the settled legal position as enumerated from the aforesaid citations and as stated earlier, in the present case also as per the own findings of the Assessing Officer, the Assessee is utilizing deposits for giving security to the banks and opening Letters of Credit etc. As per the records, investing surplus funds in the call money market or short term deposit in favour of the banks for providing security for obtaining short term loans or as a deposit towards LC opening is one of the business activities of the Assessee and this had come for the scrutiny of the Tribunal for the Assessment Years 1967-68 to 1972- 1973 and it was held in favour of the Assessee that the interest income accrued therefrom is a business income. The record is very clear that there is no material to demonstrate the substantial change in the said view for years which were followed thereafter. It was after substantial consistent following of the said view, it appears that the Assessing Officer took a distinct and separate view thereby treating the interest income as income from other sources in the year 1991-92 and thereafter. The department has not established in any case that the said interest has been spent for any other purpose except the business purpose. The important aspect which is to be considered here is that the Respondent/Assessee is earning this interest income for last many years and it was always treated as business income. In view of the ratio laid down by the Supreme Court in the case of Radhasoami Satsang ( supra ) and by applying the said rule of consistency, we hold that, in the absence of any material change justifying the Department/Assessing Officer to take a different view from that taken in earlier proceedings, the question of the exemption of Respondent/Assessee should not have been reopened.

15. The Respondent/Assessee has utilized the surplus money for making investments in the bank deposits or call money market or inter-corporate deposits and it always retained its character as business assets. In our opinion the interest income earned by the Assessee has direct nexus with its business activity, as the said amounts were invested by the Respondent/Assessee for availing short term loans or for taking out LC opening.

The object clauses of the Memorandum and Articles of Association particularly clauses (55) and (82) permit the company to lend, advance or deposit money as part of the business activity and the Assessee company carries out money market which is one of its business activities.

Therefore, it can be safely said that the interest income earned by the Respondent/ Assessee is an earning out of its business activity only, as it has direct nexus with the said amount of business activity. The interest received by the Respondent/Assessee is having direct or proximate relationship with their main business activity and as such, the same has to be treated as "business income". As stated earlier, the money of the company was used for making investment in the bank deposits or call money market or inter-corporate deposits with the objective for availing short term loans or for keeping deposits for the purpose of LC's and said money had always retained its character as business assets. In our opinion, the surplus money, unless and until it is pulled out totally from the business and having absolutely no nexus with the amount or ancillary business activity and thereby the same is deposited with the bank only and solely with a view of earning interest by keeping the said funds idle, then it can be treated as non- business income or income from the other sources.”

5. In so far as the substantial question of law at (IV) is concerned, Ms. Linhares, learned Standing Counsel for the Revenue points out that the question of law has, in fact, been answered in favour of the Revenue in the case of Sesa Goa Ltd. vs. The Commissioner of Income Tax

6. Mr. Mihir Naniwadekar, learned Counsel for the 3 Tax Appeal No. 53 of 2006 dated 7th May, 2015.

Respondent, however, points out that in the present case, the ITAT has recorded, as a matter of fact, that the net rates are either negative or nil. He, in fact, refers to paragraph 12 of the order of the ITAT in which it is seen that as against proceeds of 5,31,741/- from ₹ Electronic Data Processing, the expenditure is to the tune of ₹ 9,65,195/-. Similarly, as against the proceeds from Professional Services Rendered to the tune of 33,69,863/-, the expenditure is of the same amount. Mr. Naniwadekar, therefore, submits that even if this substantial question of law were to be answered in favour of the Revenue and against the Assessee, the same would make no difference in so far as the ultimate conclusion recorded by the ITAT is concerned.

7. Upon examining the records, we are inclined to accept the submission made by Mr. Naniwadekar. Accordingly, we hold that the substantial question of law at (IV) is, in fact, required to be answered in favour of the Revenue and against the Assessee. However, despite this, there is no reason to disturb the order made by the ITAT in view of the factual findings which have been recorded therein. We are satisfied that even after answering the substantial question of law at (IV) in favour of the Revenue, on facts, there is no case made out to interfere with the order of the ITAT, on this aspect.

8. Finally, in so far as the substantial question of law at (VI) is concerned, again, there is no dispute that the issue stands covered by the ruling of the Full Bench of this Court in the case of The Commissioner of Income Tax vs. V.S. Dempo & Co. Pvt. Ltd.

This substantial question of law is, therefore, to be answered in favour of the Assessee and against the Revenue.

9. In the result, we answer the substantial questions of law at (I), (II), (III), (V), (VI), (VII) and (VIII) against the Revenue and in favour of the Assessee. Further, we answer the substantial question of law at (IV) in favour of the Revenue and against the Assessee. However, we clarify that notwithstanding the position that we are answering the substantial question at (IV) in favour of the Revenue, there is no case made out to interfere with the order of the ITAT taking into consideration the factual findings as aforesaid which are recorded therein.

10. Consequently, this Appeal is disposed of in the aforesaid terms. There shall be no order as to costs.

Nutan D. Sardessai, J. M.S. Sonak, J.