The High Court of Delhi has ruled that interest earned on funds inextricably linked to the setting up of a project, and earmarked for committed obligations such as the purchase of plant and machinery, cannot be taxed as “Income from Other Sources.” The Division Bench, comprising Justice V. Kameswar Rao and Justice Vinod Kumar, held that such interest should instead be capitalized to reduce the cost of the project.
Background of the Case
The appellant, VNG Automotive P. Ltd, was incorporated in March 1992 for the manufacture and export of ecological brake-shoes. For the Assessment Years (AY) 1993-94 and 1994-95, the company filed “nil” returns, adjusting interest earned on bank deposits against its project expenses.
The company had entered into a technical know-how agreement with a Singapore-based entity, committing to a total payment of USD 2,50,000. To facilitate this and other project requirements, including the purchase of land and machinery, the company raised loans from its directors. Funds not immediately required for these payments were placed in bank deposits, yielding interest of Rs. 1,33,151 and Rs. 2,37,770 for the respective years.
The Assessing Officer (AO) reopened the assessments under Section 148 of the Income Tax Act, 1961, treating the interest as “income from other sources” based on the Supreme Court’s ruling in Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT. While the Commissioner of Income-tax (Appeals) [CIT(A)] ruled in favor of the assessee, the Income Tax Appellate Tribunal (ITAT) reversed that decision, leading to the present appeals.
Arguments of the Parties
The appellant’s counsel, Mr. Satyen Sethi, argued that the funds were not “surplus” but were arranged specifically for committed project obligations. He contended that the interest was “inextricably linked” to the setting up of the plant, citing the Supreme Court’s judgment in CIT v. Bokaro Steel Ltd. and the Delhi High Court’s own precedent in Indian Oil Panipat Power Consortium Ltd. v. ITO.
Conversely, Mr. Abhishek Maratha, Senior Standing Counsel for the Revenue, argued that since the business had not commenced, any interest earned prior to operations must be taxed as income. He further contended that the ITAT was correct in its application of the Tuticorin Alkali ruling and raised a procedural objection regarding the admission of “additional evidence” by the CIT(A).
Court’s Analysis and Observations
The Court addressed two substantial questions of law: the validity of the ITAT’s decision to uphold the reassessment and whether the reversal of the CIT(A)’s finding on the nature of the interest was justified.
On the jurisdictional issue, the Court upheld the ITAT’s power to decide the validity of the reassessment even if the Revenue had not specifically appealed that finding, noting that the ITAT “possesses ample power to decide any issue that goes to the root of the subject matter before it.”
On the merits, the Court distinguished between “surplus funds” and “earmarked funds.” It observed:
“We find that the funds in the present case were not lying as surplus but the same were earmarked to facilitate the balance payment for plant and machinery etc. for which advances were made by the assessee.”
The Court relied heavily on CIT v. Bokaro Steel Ltd., which held that receipts intrinsically connected with the construction of a plant are capital receipts. The Bench noted:
“The test… is that if funds have been borrowed for setting up of a plant and if the funds are ‘surplus’ and then by virtue of that circumstance they are invested in fixed deposits the income earned in the form of interest will be taxable under the head ‘income from other sources’. On the other hand… if income is earned… on funds which are otherwise ‘inextricably linked’ to the setting up of the plant, such income is required to be capitalized to be set off against pre-operative expenses.”
The Court found that the appellant had already initiated payments for technical know-how, land, and machinery, and the remaining deposits were necessary to meet upcoming installments.
Decision
The High Court set aside the ITAT’s order regarding the taxation of interest income. While it answered the jurisdictional question in favor of the Revenue (confirming the ITAT’s right to uphold reassessment), it answered the substantive question regarding the nature of the income in favor of the appellant.
The Court concluded that the funds were inextricably linked to the setting up of the business and thus covered by the Bokaro Steel Ltd. ratio rather than the Tuticorin Alkali precedent.
Case Details
Case Title: VNG Automotive P. Ltd v. Asstt. Commissioner of Income Tax
Case No.: ITA 795/2004 & ITA 796/2004
Bench: Justice V. Kameswar Rao and Justice Vinod Kumar
Date: April 10, 2026
