1. Identical question has been set forth before us for decision in this reference under Section 256(2) of the Income-tax Act 1961, and the appeal under Section 260A thereof. Therefore, both these cases were taken up together and have been addressed by learned counsel for the respective parties simultaneously. The assessee being one and the same and it related to only two different assessment years consecutively, we have taken up the matter together and propose to dispose of the same by one common judgment.

The question:

2. The questions that have been set forth in the reference are as follows :

"(1) Whether, on the facts and in the circumstances of the case, the amount of interest paid is allowable as a deduction under Section 57 of the said Act while computing the interest income assessed as income from other sources under Section 56 of the Act ?

(2) Whether, on the facts and in the circumstances of the case, the hon'ble Tribunal was justified in holding that there was no nexus between the interest expenditure incurred by the applicant and the interest income received by the applicant by investing the surplus amount out of borrowed fund when the said activity was clearly permissible under the memorandum and articles of association of the applicant ?

(3) Whether the interest expenditure incurred by the appellant is allowable as a deduction under Section 57 of the Income-tax Act, 1961, while computing the interest income sought to be assessed as 'income from other sources' under Section 56 as expenditure incurred for earning the income ?

(4) Whether having regard to the memorandum of association of the appellant and its certificates of incorporation and commencement of business, the transactions relating to borrowing and lending were business operations and the interest paid was allowable as an expenditure incurred for earning the interest income under Section 3(1)(iii) of the said Act ?"

3. Though a little varied expressions have been used in the appeal, these grounds do not make any distinction to obscure the identity of the grounds, which are one and the same.

Facts :

4. The assessee-company was incorporated as a limited company on June 15, 1987, under the Companies Act, 1956, with the main object of carrying on the business of manufacturing acrylic fibre. The objects of the memorandum of the company included borrowing and lending, viz., advancement of money and earning interest thereon. The assessee obtained a sum of Rs. 5.92 crores towards share application money from the promoters, which was shown under the head "Unsecured loans". It had also obtained a sum of Rs. 5 crores from financial institutions as "secured loan". The relevant assessment year in the reference is 1990-91. The assessment year 1991-92 is involved in the appeal. Admittedly, the assessee did not commence its business until these relevant assessment years and the project was under construction. There were certain surpluses in the hands of the assessee. These were kept in short-term deposit on which the assessee earned interest. It is on the interest on the short-term investment of the surplus funds that the question is being raised as to whether it would be an income from other sources or business income. The Assessing Officer, the Commissioner of Income-tax (Appeals) and the learned Tribunal held this income to be an income from other sources.

Whether the income is eligible for deduction under Section 36(1) or under Section 57(iii) :

5. Dr. Pal had argued that since the objects clause in the memorandum of association included borrowing and lending, viz., advancement of money, therefore, the interest earned on advancement of money is also to be treated as business, entitling him to claim the benefit of the interest paid on the borrowed sum under Section 36(1) as deduction. Alternatively, he claimed that if it cannot be a business income and if it is treated as income from other sources, then it would be eligible for deduction under Section 57(iii).

6. Admittedly, the assessee had not commenced its business till the relevant assessment year. The objects clause might include borrowing and lending, i.e., advancement of money, but such advancement of money must be in the course of its business. Admittedly, the business was not commenced. Therefore, even if any income was earned on this Surplus fund pursuant to this object of borrowing and lending, i.e., advancement of money, the same would not be a business income. That apart this investment was not made for business purpose ; inasmuch as the money was borrowed for the purpose of establishing or constructing a project with the object of carrying on business of manufacturing acrylic fibre. The capital was raised through floating of shares as well as borrowing from the financial institutions. They were not borrowed for the purpose of carrying on the business of lending, i.e., advancement of money. Therefore, there cannot be any commencing of business of lending, i.e., advancement of money out of the sum borrowed for the purpose of construction of the manufacturing unit.

7. Dr. Pal, however, has pointed out that the company had borrowed this amount for the purpose of construction of the project. Since the entire amount was not being utilised, therefore, for the interregnum period the unutilised surplus was invested in business expedience in short-term deposit for earning interest so as to provide a buffer for payment of interest on the idle surplus out of the amount borrowed.

8. At the very outset, in his usual fairness, Dr. Pal has pointed out that his argument is confined only to the interest earned on the amount invested out of the funds borrowed from the financial institutions. So far as the interest earned on the surplus funds out of the amount received towards the share application money, the same is completely different and distinct and on that the benefit of Section 57(iii) or that of Section 36(1) thereon cannot be conceived of. Therefore, there was no reference in the appeal against that part of the interest, which was earned on the investment of the surplus out of the share application money. Both the reference and the appeal are confined only to that part of the investment, which was made out of the unutilised surplus funds received from the financial institutions.

9. Thus, once it is held to be income from other sources coming under Section 56 of the Act, the only benefit of the assessee could derive is under section 57(iii). clause (iii) of section 57 makes it clear that any expenditure, not being in the nature of capital expenditure, laid out or expended wholly and exclusively for the purpose of making or earning the income, is deductible in the process of computation of the income chargeable under the head "Income from other sources". Dr. Pal stressed on the expression used in clause (iii). It is only those expenditures, which are laid out or expended for earning the income and that too wholly and exclusively for such purpose would be eligible for deduction.

10. In the present case, the borrowing was made for the purpose of construction of the project and instead of retaining the amount, the unutilised part was invested in short-term deposits. Whether it was invested or not, on the borrowing the assessee was bound to pay interest and the assessee was at liberty to capitalise the amount of interest paid on the borrowed capital so long the business does not commence. The interest was otherwise payable on the borrowing whether invested or not. This amount was borrowed not for the purpose of investment of money in order to earn the income. Therefore, it cannot be said that the interest paid on the borrowed capital was laid out or expended wholly and exclusively for earning such income. The expression is clear and unambiguous. The expenditure must be incurred wholly and exclusively for the purpose of earning such income in the course of its business. In this case, it cannot be so said. The money was borrowed for the purpose of construction of the project. The interest paid thereon was not an expenditure laid out or expended wholly and exclusively for the purpose of earning the interest out of such deposit; on the other hand, this was laid out or expended out of the borrowed capital for the purpose of construction of the project eligible to be capitalised.

11. The borrowing was made not for the purpose of enabling the assessee to carry on its business of lending. Therefore, the investment of unutilised surplus at the hands of the assessee for the time being out of the capital borrowed for the purpose of the project cannot be said to be a part of the assessce's business which was, admittedly, yet to commence. And, as such, the interest paid thereon cannot be said to have been laid out or expended wholly and exclusively for the purpose of the business of earning interest. Thus, it does not qualify under Section 36(1) for being eligible for deduction under that head.

12. An income can be charged to tax only under a particular head. Unless the income qualifies under a particular head, it cannot be charged under that particular head. If the income cannot be charged in any particular head provided in Section 14 of the Income-tax Act, the income cannot at all be charged. If the income can be charged under a particular head, then it is to be charged under that head alone, not otherwise. We had occasion to so hold in the decisions in CIT v. General Industrial Society Ltd. and East India Electric Supply and Traction Co. Ltd. v. CIT .

13. In this case the income was identified as "income from other sources". Therefore, it has to be taxed only under the provisions of that head and deductions would not be available until the amount for which deduction is claimed becomes eligible for deduction under the provisions of the said head. Income from other sources under Section 56 is computed under Section 57 where the eligibility for deduction is specified in no uncertain terms in clause (iii), which, in our view, does not qualify the amount of interest paid on the borrowed capital for acquiring the asset before it was first put to use as an eligible deduction thereunder.

Section 57(iii): The principle : The precedents :

14. This question had cropped up in the decision in Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT . In the said case, the unutilised capital was invested in short-term deposit. However, in that case, no claim was laid under Section 57(iii). In the said decision, it was held by the apex court that the source of income would not detract from the revenue character of the receipt and the question of adjustment would depend upon the provisions of the Act. In fact, interest paid on the borrowed capital would have been deductible as incurred for the purpose of business but the assessee's business was not commenced. Therefore, the assessee would be entitled to capitalise the interest so payable. But the assessee could not claim adjustment of this expenditure against interest assessable under Section 56. However, the assessee did not claim deduction under Section 57. In these circumstances, this decision proceeded to hold that this amount was not adjustable under Section 70 or 71 since its business had not started.

15. This was sought to be distinguished by Dr. Pal that in this case the question of adjustment is not claimed, at the same time, the impact of Section 57(iii) was not involved in the said decision and that there was no such finding that the said decision is distinguishable. May be, the Supreme Court was not called upon to decide the impact of Section 57(iii) in respect of the interest earned vis-a-vis the interest paid. But the question is dependent on the fact whether the assessee had commenced its business. So long the business is not commenced, the interest paid cannot be treated as a revenue expenditure, but to be included in the actual cost for being capitalised as capital expenditure, and, therefore, it could not have been treated to be an expenditure incurred within the meaning of Section 57(iii). The character of the interest paid on the borrowed capital has been crystallised in the said decision in Tuticorin Alkali Chemicals and Fertilizers Ltd. . It was said that even if it may be desirable on the point of equity but even then until the law qualifies it for being eligible, the benefit cannot be available.

16. The taxability of income is not dependent upon its destination or the manner of its utilisation. It has to be seen at the point of accrual. It is not necessary that there should be a direct connection between the interest paid and the interest received for the purpose of claiming benefit under Section 57(iii). But still it has to be seen whether this amount has been laid out or expended wholly and exclusively for the purpose of earning the income. Unless this test is satisfied the benefit under Section 57(iii) cannot be available.

17. However, while dealing with CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542, the decision of the Madras High Court was not correctly understood by the Orissa High Court in CIT v. Electrochem Orissa Ltd. [1995] 211 ITR 552, as would appear from the decision in Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT [1997] 227 ITR 192, in which the Supreme Court had read the decision in Seshasayee Paper and Boards Ltd. correctly. In Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT [1997] 227 ITR 192, the apex court held that interest earned by the assessee from the bank deposits had to be assessed under the head "Other sources" and consequently the interest paid on the borrowings for the purpose of purchase of plant and machinery could not be allowed or adjusted against this income under Section 57(iii) nor were such adjustments permissible under Section 70 or 71 of the Act because the business of the assessee had not commenced. The Madras High Court had categorically held that 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. This decision was held to have laid down the law correctly by the apex court in Tuticorin Alkali Chemicals and Fertilizers Ltd. [1997] 227 ITR 172 and contrary views expressed in CIT v. Nagarjuna Steels Ltd. ; CIT v. Electrochem Orissa Ltd. [1995] 211 ITR 552 (Orissa) and CIT v. Maharashtra Electrosmelt Ltd. [1995] 214 ITR 489 (Bom) were held to be erroneous.

18. The decision in Tuticorin Alkali Chemicals and Fertilizers Ltd. was reiterated and followed in CIT v. Dr. V.P. Gopinathan and South India Shipping Corporation Ltd. v. CIT and was also followed by the apex court in CIT v. Autokast Ltd. [2001] 248 ITR 110 (SC). In the Madras case, it was held that the interest paid on overdraft obtained for the purpose of business could not be deducted from the interest earned on monies kept in fixed deposits ; as such the income derived by way of interest on fixed deposits was to be taxed under the head "Income from other sources" since the interest paid on the overdraft did not quality for deduction under Section 57(iii).

19. In CIT v. Bokaro Steel Ltd. [1999] 236 ITR 315, the apex court had also dealt with this similar question at page 321 wherein it was observed that during these assessment years the respondent-assessee had invested the amounts borrowed by it for the construction work which were not immediately required in short-term deposits and earned interest. It was held in these proceedings that the receipt of interest amounts to income of the assessee from other sources. The assessee had not filed any appeal from this finding, which was given against it. In any case, this question is now concluded by the decision of the apex court in Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT [1997] 227 ITR 172. In CIT v. Bokaro Steel Ltd. also an identical question arose in the case of investment of unutilised part of borrowed capital meant for construction of the project in a situation where the business of the assessee involved in the said case had not commenced. Thus, it appears that the proposition as advanced by Mr. Agarwal seems to be the settled proposition as has been held in those decisions.

20. Dr. Pal, however, sought to distinguish these decisions relying on the decisions in Seth R. Dalmia v. CIT ; CIT v. Rajendra Prasad Moody and Eastern Investments Ltd. v. CIT .

21. In Eastern Investments Ltd. the principle was laid down as to how the deduction under Section 12(2) of the 1922 Act would be available. The provisions of Section 12(2) of the 1922 Act correspond to those of Section 57(iii) of the 1961 Act as was held in Tuticorin Alkali Chemicals and Fertilizers Ltd. . But the distinguishing feature as has been pointed out in this case was that no business had commenced and the interest paid on the borrowed capital was not laid out or expended for the purpose of earning the said income as found earlier. The decision in Eastern Investments Ltd. would not help us in view of the distinguishing feature. The other two decisions cited by Dr. Pal had followed the decision in Eastern Investment's Ltd. . There is no doubt about the proposition laid down therein. But in the facts and circumstances of the case, as distinguished in respect of Eastern Investments Ltd. , this decision is also of no help for the purpose of answering the present question.

Whether advancing money and earning interest is an object and the business commenced with the advancement of the money:

22. Now turning to the question as to whether the object of advancing money would be relevant for the purpose, Mr. Agarwal had relied upon Thiagarajar Charities v. Addl. CIT [1997] 225 ITR 1010. The apex court in that decision relying upon an English decision had held as follows (page 1022) :

" 'It drew a distinction between the objects in a memorandum of association and the powers taken in the memorandum of association to carryout those objects. Reliance had been placed on a decision of the Court of Appeal in North of England Zoological Society v. Chester Rural District Council [1959] 3 ALL ER 116 (CA) which in turn referred to a decision of the House of Lords in Cotman v. Brougham. [1918] AC 514 (HL). Lord Wrenbury expressed the view in Cotman v. Brougham that there may be included in the objects what are not real objects of the company but are enabling powers to achieve the objects of the company. A passage from the judgment of Lord Wrenbury at page 522 may be extracted :

"The objects of the company and the powers of the company to be exercised in effecting the objects are different things. Powers are not required to be, and ought not to be, specified in the memorandum. The Act intended that the company, if it be a trading company, should by its memorandum define the trade, not that it should specify the various acts, which it should be within the power of the company to do in carrying on the trade. The Third Schedule of the Act contains model forms of memoranda of association. These ought to be followed. Section 118, Sub-section (1), enacts that those forms "or forms as near thereto as circumstances admit" shall be used in all matters to which those forms refer.

There has grown up a pernicious practice of registering memoranda of association which, under the clause relating to objects, contain paragraph after paragraph not specifying or delimiting the proposed trade or purpose, but confusing power with purpose and indicating every class of act which the Corporation is to have power to do. The practice is not one of recent growth. It was in active operation when I was a junior at the Bar. After a vain struggle I had to yield to it, contrary to my own convictions. It has arrived now at a point at which the fact is that the function of the memorandum is taken to be, not to specify, not to disclose, but to bury beneath a mass of words the real object or objects of the company with the intent that every conceivable form of activity shall be found included somewhere within its terms."

The paragraphs relied on by counsel on behalf of the Revenue can be treated as powers distinct from the primary objects of the company and they are meant to enable the real purposes being achieved. The memorandum in question is one wherein there has been a mingling of real objects with powers. The real objects disclose charitable purposes and the powers taken are merely to carry out the objects.

[See also : Pennigton's Company Law (Sixth edition), page 13 ; Palmer's Company Law (Twenty-fifth edition), volumn I, paragraph 2.606, wherein the law has been discussed in detail]'."

23. Dr. Pal, however, pointed out that this decision will not apply in this case since the objects clause in the memorandum and articles of the company clearly mentioned the advancement of money as an object of the business therein. But the fact remains that the assessee had not commenced its business. In the process of constructing the project for establishing a project if the unutilised part of the fund is invested and interest is earned, the same would not be an income from a business yet to commence. Utilisation of unutilised funds cannot be said to be a part of the business for which the fund was borrowed. Therefore, this decision stares on the face.

Conclusion:

24. We need not dilate on this question because of the distinction we have already made, namely, until the business commences the interest paid on the borrowed capital for acquiring asset is includible in the actual cost within the meaning of Explanation 8 to Section 43(1) and it would not be a business expenditure till the asset is first put to use and until the business commences the interest received on investment of unutilised funds will not be a business income, when such interest, until the business commences, is in the nature of capital expenditure and is eligible for being capitalised. The purpose of the borrowing was for the purpose of construction of the project and the interest would have been paid even if it would not have been invested. Therefore, this interest could not be said to have been laid out or expended for the purpose of earning the income particularly when the interest paid is eligible for being capitalised, the expenditure that has been incurred being in the nature of capital expenditure, and as such it would not come within the purview of Section 57(iii).

Order In the circumstances, the reference and the appeal fail and are hereby dismissed. No costs.

Xerox certified copy of this judgment be made available to the parties, if applied for, on usual terms.

R.N. Sinha, J.

25. I agree.