Income earned by Govt company on Unutilized Funds before commencement of operation is not Taxable : High Court

JUDGMENT

Mrs. S. Sujatha, J. – These appeals are filed by the Revenue under section 260-A of the Income-tax Act, 1961 (‘Act’ for short) challenging the common order dated 31-10-2014 passed in ITA Nos.1070 and 1071/Bang/2011 by the Income-tax Appellate Tribunal, Bangalore Bench ‘A’, Bangalore (‘Tribunal’ for short) relating to the assessment years 2007-08 and 2008-09.

2. These appeals were admitted to consider the following substantial questions of law:—

“1. Whether the Tribunal was correct in not following the settled law of the Hon’ble Apex Court in the case of Tuticorin Alkali Chemicals and Fertilizer Ltd., reported in 227 ITR 172 wherein it has been clearly held that if the capital of the company in fruitfully utilized instead of keeping it idle, the income generated will be of revenue nature and not accretion to capital.

2. Whether the Tribunal is correct in holding that the company is a nodal agency for the government to implement the infrastructure project relying on an indifferent decision in the case of KUIFDC without appreciating that the assessee company has been incorporated as a joint venture company between the Government of Karnataka and Government of India for providing transport facility and to earn income from sale of tickets and to earn income from sale of tickets to customers, thus profit motive is germane to the project as against the welfare of KUIDFC.”

3. The assessee is a company incorporated under the Companies Act, 1956 and is wholly owned undertaking of the Government of Karnataka. It was established with the approval of Government of India, for the implementation of a rail-based Mass rapid Transit System which was called as ‘Bangalore Metro Rail Project’ in five years in five stages. The cost of the project was to be financed by both the Union and the State Government. The assessee had received funds during the assessment year 2007-08 which were not immediately required for execution of the project and the same was invested in fixed deposit and mutual funds. As a result, interest and dividends were received as under:

4. The assessee offered only the income from Sl.Nos.1 to 3 and contended that the dividend income on mutual funds received from SBI and UTI were exempt under section 10(35) of the Act. Apart from this, the assessee also claimed short-term loss of Rs. 5,02,05,005/- arising out of redemption of units with mutual fund. However, a revised return was filed showing nil income sans claiming any loss from mutual funds.

5. The Assessing Officer rejecting the contention of the assessee brought the income of Rs. 10,30,48,755/- that was earned by the company through deposits to tax. Aggrieved by the said order, the assessee preferred an appeal before the CIT (Appeals) which came to be dismissed upholding the findings of the Assessing Officer. Being aggrieved by the same, the assessee preferred an appeal before the Tribunal. The Tribunal vide common order dated 31-10-2014 allowed the appeals of the assessee and reversed the order of CIT (Appeals). Being aggrieved by the said order of the Tribunal, the Revenue has preferred these appeals.

6. Learned counsel Sri. K.V. Aravind appearing for the Revenue argued that the Tribunal grossly erred in not following the settled principles of law enunciated by the Hon’ble Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172. Placing reliance on the said judgment, the learned counsel argued that if the capital of the company is fruitfully utilized instead of keeping it idle, the income generated will be of revenue nature and is liable to tax.

7. It was further argued that the Tribunal erred in holding the assessee as a nodal agency for the Government to implement the infrastructure project relying on an indifferent decisions in the case of CIT v. Karnataka Urban Infrastructure Development & Finance Corpn. [2009] 315 ITR 301 (Kar.) and CIT v. Karnataka Urban Infrastructure Development & Finance Corpn. [2006] 284 ITR 582 (Kar.) without appreciating that the assessee company has been incorporated as a joint venture company between the Government of Karnataka and Government of India for providing transport facility and to earn income from the sale of tickets to the customers, thus profit motive is germane to the project.

8. Learned Senior Counsel Sri. A. Shankar representing the respondent – assessee argued that the assessee is a Special Purpose Vehicle to the Government of Karnataka and is acting as a nodal agency for the implementation of a rail based Mass Rapid Transport System. The assessee was not carrying out any business on its own while implementing the scheme in question, in fact commercial operation commenced only on October, 20th 2011. In order to keep the unutilized money received for the purpose of the rail project, in accordance with the Government directive, the same was invested in fixed deposit and mutual funds. Thus, in computing the total income of the assessee, the interest earned on the deposits made out of unutilized funds cannot be treated as the income of the assessee as the same partakes the nature of a Capital receipt.

9. Learned Senior counsel submitted that the assessee has been set up wholly and exclusively for undertaking certain sub-sovereign functions on behalf of the Government of Karnataka and Government of India for the public utility project for setting up a local metro and therefore, is not permitted to engage in any business activities involving a profit motive. It is a pass-through entity in which the government funds are deployed for an ultimate use in setting up of an infrastructure project.

10. Placing reliance on the judgments of this Court in the case of KUIDFC,(supra) and CIT v. Karnataka State Agricultural Produce Processing & Export Corporation Ltd. [2015] 377 ITR 496 (Kar.), learned Senior counsel submitted that the Tribunal was justified in allowing the appeals. Learned Senior counsel made an endeavor to distinguish the judgment in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd.,(supra), in the facts and circumstances of the case.

11. Further, the Government Order dated 25-3-2008 has been placed on record to substantiate the stance taken by the assessee before the authorities as well as the Tribunal that it is at the direction of the Government of Karnataka, the unutilized funds of the project were invested in the fixed deposit and mutual funds and the same cannot partake the character of revenue income.

12. We have carefully considered the rival submissions of the learned counsel appearing for the parties and perused the material on record.

13. In Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), the facts were that M/s. Tuticorin Alkali Chemicals and Fertilizers Ltd., which was incorporated on 3-12-1971 for the purpose of, inter alia, manufacturing heavy chemicals such as ammonium chloride and soda ash, begun its production during June, 1982. The term loans taken from various banks and financial institutions for the purpose of setting up the factories, which was not immediately required by the company, were kept invested in short-term deposits with banks, which was specifically permitted by the Memorandum and Articles of Association of the Company. Interest earned by the company from the various loans given by the company and also from the bank deposits which were considered by the departmental authorities as income and brought to tax was the subject matter of the tax reference case before the Hon’ble Apex Court. The following question of law was referred to the Court for the decision:—

“Whether, on the facts and in the circumstances of the case, interest derived by the assessee from the borrowed funds which were invested in short-term deposits with banks would be chargeable to tax under the head “Income from other sources” or would go to reduce the interest payable by the assessee on the term loans secured by the assessee from financial institutions, which would be capitalised after the commencement of commercial production.”

In that context, it was held thus:

“4. The basic proposition that has to be borne in mind in this case is that it is possible for a company to have six different sources of income, each one of which will be chargeable to income tax. Profits and gains of business or profession is only one of the heads under which the company’s income is liable to be assessed to tax. If a company has not commenced business, there cannot be any question of assessment of its profits and gains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. If the company, even before it commences business, invests the surplus fund in its hand for purchase of land or house property and later sells it at profit, the gain made by the company will be assessable under the head ‘Capital gains’. Similarly, if a company purchases a rented house and gets rent, such rent will be assessable to tax under s. 22 as income from house property. Likewise, a company may have income from other sources. It may buy shares and get dividends. Such dividends will be taxable under s. 56 of the Act. The company may also, as in this case, keep the surplus fund in short-term deposits in order to earn interest. Such interests will be chargeable under s. 56 of the Act.”

14. The co-ordinate bench of this Court in the case of KUIDFC (supra), has held thus:—

‘An identical question had come up for consideration before a Division Bench of this Court in (CIT v. Karnataka Urban Infrastructure Development and Finance Corporation [2006] 284 ITR 582), I.T.A. No. 2418 of 2005 between the same parties, decided on February 21, 2006. The said judgment has been placed for consideration before us and we have gone through it. Essentially, the Tribunal has also placed reliance on the said judgment and accordingly held in favour of the assessee.

We have no doubt in our mind that the said judgment squarely covers the issue involved in this appeal. It has been held by the Division Bench of this Court in the aforesaid judgment in the relevant paragraph as under (page 584):

“The material on record shows that the very purpose of constitution of the assessee was to act as a nodal agency for implementation of the mega city scheme worked out by the Planning Commission. Both the Central and the State Governments are expected to provide requisite finances for implementation of the said project. The funds from the Central and State Governments will flow directly to the specialised institutions/nodal agencies as grant and the nodal agency will constitute a revolving fund with the help of Central and State shares out of which finance could be provided to various agencies such as water, sewerage boards, municipal corporations, etc. The objective is to create and maintain a fund for the development of infrastructural assets on a continuing basis and, therefore, the assessee is a nodal agency formed/created by the Government of Karnataka as per the guidelines; there is no profit motive as the entire fund entrusted and the interest accrued therefrom on deposits in bank though in the name of the assessee has to be applied only for the purpose of welfare of the nation/States as provided in the guidelines ; the whole of the fund belongs to the State Exchequer and the assessee has to channelise them to the objects of the Centrally sponsored scheme of infra-structural development for the mega city of Bangalore. Funds of one wing of the Government are distributed to the other wing of the Government for public purpose as per the guidelines issued. The monies so received, till they are utilised, are parked in a bank. The finding recorded by the Tribunal clearly shows that the entire money in question is received for implementation of the scheme which is for a public purpose and the said scheme is implemented as per the guidelines of the Central Government and, therefore, the assessee is only acting as a nodal agency of the Central Government for implementation of these projects. It is not the case of the Revenue that the assessee was carrying on any business or activities of its own while implementing the scheme in question. The unutilised money, during which the project could not be fully implemented, is deposited in a bank to earn interest. That interest earned is also again utilised for the implementation of the mega city scheme which is also permitted under the scheme. Therefore, in computing the total income of the assessee for any previous year the interest accrued on the bank deposits cannot be treated as an income of the assessee as the interest is earned out of the money given by the Government of India for the purpose of implementation of the mega city scheme.

Therefore, we do not find any error in the conclusion reached by the Tribunal that there was no income earned by way of interest by the assessee and setting aside the order of the Assessing Officer which is affirmed by the first appellate authority. The finding given by the Tribunal is purely a question of fact. We do not find any substantial question of law involved in this appeal and, therefore, this appeal is liable to be dismissed at the stage of admission itself.”

In the light of the aforesaid findings recorded by the Division Bench of this Court, we are of the considered opinion that there is no merit or substance in this appeal. No substantial question of law arises to be answered by this Court. Thus, the appeal is hereby dismissed.’

15. In the case of Karnataka State Agricultural Produce Processing & Export Corporation Ltd., (supra), the co-ordinate bench of this Court (where one of us the Hon’ble SSJ was a member) following the judgments in the case of KUIDFC Tuticorin Alkali Chemicals & Fertilizers Ltd., (supra), as well as Bongaigaon Refinery & Petrochemicals Ltd., v. CIT [2001]251 ITR 329 (SC) and CIT v. Bokaro Steel Ltd. [1999]  236 ITR 315 (SC), has held thus :—

‘In the light of the judgments referred to above, we have examined the case on hand. It is clear that the assessee has received the grant of Rs. 10 crores from the Government of Karnataka for a particular project i.e., for improvement of infrastructure and to promote export of horticultural produce. Before the said grant was utilized for the specific purpose it was parked in fixed deposits and the interest was earned and by the subsequent additional evidence produced by the assessee before the Tribunal, it is further made clear that the State Government has categorically specified that any interest earned on those grants originally granted has to be considered as an additional grant and not an income of the assessee-Company.

As explained by the Apex Court, in Bongaigaon Refinary and Petrochemicals Ltd. case, (supra), in Tuticorin’s case, the investment in deposits was made by the Company during its formative period by investments and in Bokaro Steels Ltd., case (supra) the inextricable link between the interest earned and the set up of the plant was established. Thus, in the present case we are of the view that this is not an investment made subsequent to the setting up of the project but this is the unutilized income parked in fixed deposits for a temporary period and inextricable link for the interest earned on the grants and the original grant made by the State Government to set up a project is established as in Bokaro Steel case.

Thus we are of the view that the facts and circumstances of the present case is squarely covered by Bokaro Steel Ltd.,(supra) and it is not the case of the Revenue that the said interest earned on these fixed deposits was utilized by the Company for any other purpose other than the purpose for which the grants were made by the State Government. Even if we peruse the preamble to the Government Order dated January 23, 2007, by which the grant of Rs. 10 crores is made by the Government of Karnataka it is clear that “in view of the National Horticultural Machine Programme implemented in Karnataka and major thrust given by the State Government for the development of horticultural sector, there is unlimited potentiality for export of horticultural produce, but the main constraint is lack of post harvest infrastructures viz., procurement centres, grading, washing, waxing, packing units, refrigerated transport, pre-cooling and cold storages, intermediate cold storages, processing units and export house. In order to harness the potentiality and to increase exports. Further KAPPEC has proposed to create these infrastructure facilities in various parts of State in a phased manner and efforts will also be made to rope in funds from Government of India under the relevant scheme from different agencies”. The object of the scheme is to facilitate the farmers and to promote export of horticultural produce.

Hence, the very purpose of granting Rs. 10 crores to the assessee was to act as a nodal agency for implementation of the scheme. There is no profit motive as the entire fund entrusted and the interest accrued therefrom from deposits has to be utilised only for the purpose of the scheme originally granted. The whole of the fund belongs to the State exchequer and the assessee has to channelise them to achieve the objects of centrally sponsored scheme of infrastructural development as specified in the Government Order. Hence, interest on all these fixed deposits are considered to be capitalized and not revenue receipts to treat it as an income. The Tribunal considering these aspects and more particularly, following the judgment of this Court in KUIDC case has held that the interest earned on these grants is not an income, which we do not find fault with.’

16. As could be seen from the Government Order dated 25-3-2008 now placed on record, it is ex-facie apparent that the unutilized funds of the project, before the commencement of the functional operation of the project, was invested by the assessee in fixed deposits and mutual funds as per the directions of the Government. It is apt to refer to the said Government Order, the relevant portion of which reads thus:—

“The income generated out of earlier release of State Government to BMRCL before the commencement of BMRCL project would have to be converted into State’s equity towards the project and therefore cannot be counted as income of BMRCL. Further release as equity would be made to BMRCL only after adjusting this income.”

17. In the light of the judgments referred to above vis-à-vis the Government Order dated 25-3-2008, it is clear that the income generated out of earlier release of State Government for its project would have to be converted into State’s equity towards the project and the same cannot be counted as income of BMRCL. Thus, there is no profit motive as the entire fund entrusted and the interest accrued therefrom has to be utilized only for the purpose of scheme. Thus, it has to be capitalized and cannot be considered as revenue receipts.

18. For the reasons aforesaid, we confirm the order impugned passed by the Tribunal answering the substantial questions of law in favour of the assessee and against the Revenue.

In the result, the appeals stand dismissed.