Court’s Decision
The Bombay High Court allowed the appeal filed by the assessee-company and set aside the Income Tax Appellate Tribunal’s (ITAT) order which had denied the adjustment of interest expenditure against interest income for the Assessment Year (AY) 1992–93. The Court held that the assessee’s business of letting out premises and financing had already commenced in AY 1992–93, and therefore the interest paid on borrowed funds could be set off against interest received on advances to sister concerns.
The Court emphasized:
“It would defeat the ends of justice if the Tribunal is permitted to take one view upon perusal of the material qua a particular year and record a diagonally opposite finding after perusing the same material in the subsequent year.”
Accordingly, the appeal was allowed in favour of the assessee.
Facts
The assessee-company was incorporated in February 1992 with the objective of constructing business centres and letting them on lease, alongside carrying on financing activities.
For AY 1992–93, the assessee borrowed ₹9.20 crores from Citibank against equitable mortgage and directors’ guarantees. Out of this loan, part was used for capital advances and furnishing, while the bulk was advanced to group companies at interest rates ranging between 21%–22.5%.
The assessee earned ₹14.66 lakhs as interest income and paid ₹13.37 lakhs as interest to Citibank. In its return, it claimed a set-off of interest expenditure against interest income. The Assessing Officer disallowed the claim, treating the income as “Income from Other Sources.”
The Commissioner of Income Tax (Appeals) [CIT(A)] allowed the set-off, holding that business had commenced and the transaction was a composite financing arrangement. However, the ITAT reversed this in 2003, restoring the Assessing Officer’s order.
The assessee challenged the ITAT order before the High Court under Section 260A of the Income Tax Act.
Issues
- Whether the assessee’s business of leasing and financing had commenced during AY 1992–93.
- Whether the interest paid on borrowed funds could be set off against interest earned from advances to sister concerns.
- Whether inconsistent treatment of identical transactions across successive years is legally permissible.
Petitioner’s Arguments
The assessee argued that its business had clearly commenced in AY 1992–93, as evidenced by:
- Borrowing substantial funds from Citibank for business purposes.
- Advancing funds to sister concerns and earning interest.
- Having clauses in its Memorandum of Association (MoA) permitting financing as a business object.
It relied on CIT v. Sarabhai Management Corporation Ltd. (1991) 192 ITR 151 (SC), where the Supreme Court held that acquiring, repairing, and preparing property for lease amounts to commencement of business.
It also referred to CIT v. Club Resorts Pvt. Ltd. (Madras HC, 2006), CIT v. E-Funds International India (Delhi HC, 2007), and CIT v. L.G. Electronics (Delhi HC, 2005), all of which held that expenditure incurred in preparatory stages qualifies as business expenditure.
Additionally, it invoked Radhasoami Satsang v. CIT (1992) 1 SCC 659, arguing that consistency across years is essential where facts remain unchanged.
Respondent’s Arguments
The Revenue contended that:
- The assessee was incorporated only in February 1992, and it was impossible to commence business before March 1992.
- Lending to sister concerns was a one-off transaction, not part of its principal business.
- Financing was not a main object under the MoA, and reliance on subsequent years’ assessments was irrelevant for AY 1992–93.
- It cited Tuticorin Alkali Chemicals v. CIT (1997) 227 ITR 172 (SC), where interest earned on temporary deposits of borrowed funds before commencement of business was taxed as “Other Sources.”
- It also relied on CIT v. Mimraj Manmal Ruia (1972) 84 ITR 673 (Bom) and CIT v. Jagmohandas J. Kapadia (1966) 61 ITR 663 (Bom), holding that unless expenditure is incurred for earning income, no set-off is permissible under Section 57(iii).
Analysis of the Law
The Court examined the distinction between “setting up” and “commencement” of business. It held that under the Income Tax Act, business need not wait until actual leasing begins; preparatory activities such as arranging finance, repairs, and furnishing are sufficient to establish commencement.
The Court stressed that the ITAT erred in relying on Ramaraju Surgical Cotton Mills (63 ITR 478, SC) decided under the Wealth Tax Act, since the meaning of “set up” differs under the Income Tax Act.
It applied the principle from Sarabhai Management Corporation Ltd. (supra) that business activities like acquisition and preparation of property form integral parts of business commencement.
Precedent Analysis
- Sarabhai Management Corporation Ltd. (SC) — Held that preparatory steps like repairs and installation before actual leasing amount to commencement of business.
- Club Resorts Pvt. Ltd. (Madras HC) — Expenditure during project development treated as business expenditure.
- E-Funds International India (Delhi HC) — Hiring staff and building infrastructure before earning revenue held sufficient for commencement.
- L.G. Electronics (Delhi HC) — Distinguished between “setting up” and “commencement”; preparatory acts included.
- Saurashtra Cement & Chemical Industries Ltd. (Guj HC) — Commencement includes initial extraction activity before final product sale.
- Tuticorin Alkali Chemicals (SC) — Distinguished as applicable only where borrowed funds were not used for business purposes.
- Radhasoami Satsang (SC) — Principle of consistency in assessment years applied; inconsistent ITAT rulings cannot stand.
Court’s Reasoning
The Court found ITAT’s conclusions perverse and inconsistent, as in AY 1993–94 and later years, identical transactions were treated as business activities, but for AY 1992–93 they were excluded.
It held that:
- Financing was part of the assessee’s business under its MoA.
- Lending to sister concerns in AY 1992–93 was not a “fortuitous” act but a legitimate business activity.
- Interest paid to Citibank was clearly for business purposes and must be adjusted against interest earned.
The Court reiterated:
“Business under the Income Tax Act commences not only when property is actually let out but when steps are initiated for making it fit for letting.”
Conclusion
The Bombay High Court set aside the ITAT’s order and restored the CIT(A)’s ruling allowing set-off of interest expenditure against interest income. The appeal was allowed in favour of the assessee, affirming that its business had commenced in AY 1992–93.
Implications
This judgment is critical for companies in real estate and finance sectors, as it clarifies that:
- Preparatory and financing activities constitute business commencement under the Income Tax Act.
- Interest on borrowed funds, if used for business purposes, is deductible against related income.
- Authorities must maintain consistency across assessment years where facts remain identical.
It narrows the scope of Tuticorin Alkali’s application and strengthens the jurisprudence on distinguishing business commencement from preparatory stages.
FAQs
Q1. Can interest paid on loans be set off against interest earned during construction or preparatory stages?
Yes. The Court held that borrowed funds used for business purposes, even before actual leasing, qualify for adjustment.
Q2. Does a company’s business commence only when revenue is earned?
No. Preparatory acts such as repairs, furnishing, financing, and leasing arrangements constitute commencement.
Q3. What happens if identical transactions are treated differently across years?
The Court held that inconsistency violates principles of justice and relied on Radhasoami Satsang to apply consistency across years.
