S.M Jhunjhunuwala, J.:— By this reference made under section 256(1) of the Income-tax Act, 1961, the following question has been referred to this court for opinion at the instance of the Revenue:

“Whether, on the facts and in the circumstances of the case, the interest income of Rs. 3,14,366 and miscellaneous income of Rs. 2,742 are not taxable under section 56 of the Income-tax Act, 1961, under the head ‘Income from other sources’ for the assessment year 1977-78”

2. The assessee is a limited company incorporated for doing business as a manufacturer of ferro-manganese. The assessment year involved in this reference is 1977-78, the previous year of which was the year ended on June 30, 1976. During the assessment year under consideration, the assessee was engaged in the erection of a smelter for the purpose of manufacturing ferro-manganese. The commercial production had not started. The total expenses incurred during the year amount to Rs. 83,32,473. The assessee had realised a sum of Rs. 3,14,366 as interest on short-term deposits of the funds not immediately required by the assessee. At the same time, the assessee had paid a sum of Rs. 58,51,595 as interest on funds borrowed by it for the purpose of its business. During the year, the assessee had received a sum of Rs. 2,742 from the sale of empty gunny bags. Out of the total expenses of Rs. 83,32,473 incurred during the year, the assessee treated a sum of Rs. 1,04,190 as an item which could not be capitalised. Out of the balance amount of Rs. 82,28,283, the assessee deducted the two items of income, viz., interest and miscellaneous income, amounting in all to Rs. 3,17,108 and capitalised the balance of Rs. 79,11,172. Hence, the assessee adjusted the income earned by it during the period of construction against its other expenses and took the net amount as the expense of construction. The Income-tax Officer held that the said two items of income amounting to Rs. 3,17,108 were assessable as the income of the assessee under the head “Income from other sources”. The Income-tax Officer, accordingly, made the assessment and raised a demand on the assessee. The assessee appealed to the Commissioner of Income-tax (Appeals). The Commissioner of Income-tax (Appeals) agreed with the contention of the assessee and held that the said two items of income referred to above arose in the course of the business carried by the assessee and not out of any separate source of income. The Commissioner of Income-tax (Appeals) directed the Income-tax Officer not to assess the said two items of income amounting to Rs. 3,17,108 as “income from other sources” but accepted the adjustment as made by the assessee in its accounts. In the Departmental appeal filed before the Income-tax Appellate Tribunal, the Department contended that the Commissioner of Income-tax (Appeals) erred in his decision. The Tribunal noticed that the treatment given by the assessee to the said two items of income was in accordance with the principles laid down by the Institute of Chartered Accountants of India, which is a recognised authority on accounting principles, and upheld the decision of the Commissioner of Income-tax (Appeals). The appeal filed by the Department was dismissed. In these circumstances, the above question has been referred to this court at the instance of the Revenue.

3. The total income of an assessee (subject to statutory exemption) is chargeable under section 4(1) of the Income-tax Act, 1961 (for short, “the Act”). Section 14 of the Act enumerates the six heads under which the income of an assessee falls to be charged. It reads as under:

“14. Save as otherwise provided by this Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following heads of income:

A. Salaries.

B. Interest on securities.

C. Income from house property.

D. Profits and gains of business or profession.

E. Capital gains.

F. Income from other sources.”

4. In order to be chargeable, an income has to be brought under one of the aforesaid six heads. “Total income” has been defined in section 2(45) of the Act to mean “the total amount of income referred to in section 5, computed in the manner laid down in this Act”. Sections 15 to 59 of the Act lay down the rules for computing income for the purpose of chargeability to tax under the aforesaid six heads. The classification made by section 14 under the distinct heads of income is attributable to the source of income from which the respective income is derived. Therefore, the income derived from a distinct source falling under the specific head has to be computed for the purposes of taxation in the manner provided by the appropriate sections. Section 56 contains provisions about the residuary head, viz., “Income from other sources”, and it does not come into operation until the preceding five heads mentioned above and contained in section 14 are excluded. As per section 56, income of every kind which is not to be excluded from the total income under the Act shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income-tax under any of the heads specified in items ‘A’ to ‘E’ mentioned in section 14 of the Act. However, section 56 does not apply to income which is not includible in the total income of the assessee at all or to a receipt which cannot be considered as income of the assessee.

5. The assessee, in the assessment year under consideration, had credited a sum of Rs. 3,14,366 as interest on call deposits with banks and a sum of Rs. 2,742 as “miscellaneous income”. It appears that during the year, the assessee had borrowed huge amounts for the purpose of its business on which heavy interest aggregating to Rs. 50,61,594 was paid. In order to reduce this burden on account of heavy interest payments, the amounts of loans not immediately required by the assessee were kept in call deposits with the banks. In the facts of the case, it appears that the whole arrangement of obtaining the finance and its temporary utilisation formed one composite transaction and, as such, the interest received by the assessee on account of temporary utilisation of the loans cannot be considered in isolation but has to be viewed in the context of the heavy interest which the assessee had to pay. The net result of the amount received by the assessee on account of temporary utilisation of the loans by keeping the same in call deposits with the banks was to reduce the liability of the assessee on amounts borrowed for the purposes of business of the assessee. After setting off or adjusting the sum of Rs. 3,14,366 received by the assessee by way of interest on account of temporary utilisation of the loans by keeping the same in call deposits with the banks against the amount of interest which the assessee had to pay on the amounts borrowed during the assessment year under consideration, it became evident that the assessee did not derive any income by temporary utilisation of the loans as aforesaid 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 sources” did not arise.

6. The Institute of Chartered Accountants of India is a recognised authority on accounting principles. This fact has been recognised by the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT, [1975] 98 ITR 167. The following extract from “A Study on Expenditure during Construction Period” published by the Institute of Chartered Accountants of India supports the case of the assessee:

“8.1 It is possible that a new project may earn some income from miscellaneous sources during its construction or pre-production period. Such income may be earned by way of share transfer fees or by way of interest from the temporary investment of surplus funds prior to their utilisation for capital or other expenditure.

8.2 Where a particular item of miscellaneous income can be directly related to a particular item of expenditure, it is suggested that it should be set off against the expenditure, and the net amount of the expenditure should be treated in the appropriate manner, depending upon its nature, in accordance with the various principles suggested above. For example, income from share transfer fees may be set off against the various corporate expenses incurred during the construction or pre-production period and income, if any, from lending transport vehicles to outsiders may be set off against the expenditure incurred in operating and maintaining these vehicles. Similarly, interest income earned during the construction period may be offset against interest expenses incurred during this period.”

7. Mr. Jetley, learned counsel appearing for the Revenue, in support of his submission that the said amounts of Rs. 3,14,366 and Rs. 2,742 aggregating to Rs. 3,17,108 ought to be considered as income derived by the assessee from “Other sources” has placed reliance on the judgments of the various High Courts including the judgment of the Andhra Pradesh High Court in the case of CIT v. Derco Cooling Coils Ltd., [1992] 198 ITR 375. In that case, the Andhra Pradesh High Court has held that the very idea of set off connotes that there is a nexus or correlation between the item of receipt and the expenditure. It is further held that it is not permissible to set off an item of interest from out of an item of expenditure unrelated to the former or incurred in a different connection. In that case, in the previous year relevant to the assessment year 1977-78, the assessee-company had not yet gone into production. For the purpose of setting up the industry, the assessee had borrowed funds and paid interest of Rs. 2,40,554. The assessee had also earned interest of Rs. 18,913 on share capital monies received from the public which were kept in fixed deposits with banks. The assessee claimed that the interest income of Rs. 18,913 should be deducted from the interest of Rs. 2,40,554 paid on term loans. The Income-tax Officer held that the receipt of Rs. 18,913 was taxable as “income from other sources”. The Tribunal accepted the claim of the assessee. On a reference, the Andhra Pradesh High Court held (headnote):

“…. that the amount of expenditure out of which the interest received was sought to be deducted related to term loans used for construction and setting up of the plant. The receipt in question arose out of share capital deposited with the bank which might or might not be utilised for the purpose of setting up of the plant. Section 57(iii) was also not applicable because the provision envisages that deduction of expenditure (not being capital expenditure) could be claimed only if it is expended wholly and exclusively for the purpose of making or earning the income from other sources. The amount of Rs. 18,913 was assessable as income from other sources.”

8. In the case of Derco Cooling Coils Ltd., [1992] 198 ITR 375, the Andhra Pradesh High Court has referred to its earlier judgment in the case of CIT v. Nagarjuna Steels Ltd., [1988] 171 ITR 663 and though it accepted the ratio of Nagarjuna Steels Ltd.'s case, [1988] 171 ITR 663 as correct, it distinguished it from the facts in the case of Derco Cooling Coils Ltd., [1992] 198 ITR 375 (AP). The facts in the case of Nagarjuna Steels Ltd., [1988] 171 ITR 663 (AP) have been similar to the facts in the present case. In the case of Nagarjuna Steels Ltd., [1988] 171 ITR 663 (AP), the assessee, after having been incorporated, was engaged in setting up the plant. During the accounting year relevant to the assessment year concerned herein, it was still at the stage of construction. It had borrowed certain funds for setting up the plant. A part of the funds which were not immediately required was kept in deposit upon which some interest was earned. On the amounts borrowed by it, it was paying interest at a much larger figure. It, therefore, sought to deduct the interest earned by it from out of the interest paid by it and capitalised the balance interest paid. The Income-tax Officer, however, did not agree with this method. He treated the interest earned in a sum of Rs. 15,092 as “income from other sources” and held that no amount is deductible therefrom as none was expended wholly and exclusively for earning the said interest amount. In short, he treated the said amount as income of the said year, refusing to allow it to be deducted from the interest paid by the assessee during the relevant assessment year. On appeal, the Commissioner (Appeals) affirmed the order of the Income-tax Officer. On further appeal, however, the Tribunal took a different view. Relying upon the notes prepared by the Institute of Chartered Accountants of India on “A study on expenditure during construction period”, the Tribunal held that the proper method to be adopted in such cases is not to treat the said interest amount of Rs. 15,092 as income from other sources, but to treat the same, as also the interest paid by the assessee on the loans obtained by it, as one single account. The court, on a reference, held that where the object of the assessee was to do business and in the course of setting up a plant, since all the borrowed money was not needed at once, it keeps surplus funds in short-term deposits, the interest earned on such short-term deposits should be set off against the interest paid by the assessee on the loans obtained by it and the balance of the interest amount should be capitalised. It is further held that the interest received on such short-term deposits is not assessable as a revenue receipt.

9. In the case of Derco Cooling Coils Ltd., [1992] 198 ITR 375 (AP), the Andhra Pradesh High Court took a different view, since the amount received by way of interest was received on share capital amount which could not be set off against the interest payment made by the assessee during the same accounting year in respect of a different source of money, viz., borrowed loan amount. In that case, the interest was earned on an amount unrelated to the amount for which the interest was paid by the assessee.

10. In the instant case, during the assessment year under consideration, the assessee was engaged in the erection of a smelter for the purpose of manufacturing ferro-manganese. The commercial production had not yet started. The total expenditure incurred by the assessee during the year amounted to Rs. 83,32,473. Out of which, the assessee capitalised the balance amount of Rs. 79,11,173 as aforesaid. The interest paid on large borrowings by the assessee and interest earned on temporary call deposits with the banks during the assessment year under consideration were interconnected and had nexus forming part of one composite transaction. In this view of the matter, since the facts in the various judgments relied upon by Mr. Jetley, including in the case of Derco Cooling Coils Ltd., [1992] 198 ITR 375 (AP) being different, the same have no applicability to the facts in the present case. In the case of Godavari Sugar Mills Ltd. (No. 2) v. CIT, [1991] 191 ITR 359 (Bom) on which also reliance has been placed by Mr. Jetley, the Tribunal had held interest to be income from other sources on the grounds: (i) that the interest paid by the assessee oa borrowings was allowed as business expenditure and, therefore, those borrowings must have been used by the assessee for the purpose of its business; (ii) it inferred from the said fact that the monies available for advancing loans, thus had or could have their sources in the assessee's own reserves and surpluses from the profits; and (iii) that the advances were mostly to the assessee's subsidiary companies and its allied concerns. On the facts of the case, this court held that the assessee had not placed any material before the Departmental authorities or the Tribunal to show that the monies on which the interest in dispute was earned were advanced in the course of the assessee's business and that the Tribunal was justified in its conclusion and the income by way of interest received on loans and advances was taxable as income from other sources. The said decision has also no applicability to the facts of the present case. The ratio of the judgment in the case of Nagarjuna Steels Ltd., [1988] 171 ITR 663 (AP) squarely applies to the facts in the present case.

11. The receipt of Rs. 2,742 by the assessee during the year by way of sale of empty gunny bags could not be considered as a profit on sale thereof. Since it was not a revenue receipt, the said amount could not have been considered as income derived by the assessee from other sources. In the result, we answer the question in the affirmative, that is, in favour of the assessee and against the Revenue.

12. In the facts of the case, there shall be no order as to costs.