THE COMMISSIONER OF INCOME TAX vs. M/S COCHIN SHIPYARD LTD

On facts suffice it to notice that the assessee is a ship building company, who inter-alia enters into contracts with foreign purchasers, for construction of sea going vessels. On such contracts being awarded, the assessee also purchases goods from abroad, for which import, the assessee opens letter of credits for which amounts are deposited as fixed deposits in the banks in which the letter of credits are opened. In pursuance of the contracts, the assessee also makes deposit of amounts in the banks, which is the condition of the contract for retention of margin money and as performance guarantee, till the contract is over. The interest income earned from the aforesaid deposits, the assessee claimed as income from profits and gains of business. The Department, however, was of the opinion that the interest income does not change its character merely because they are from the deposits which are by reason of a contract and the same can only be treated as income from other sources. On the question of whether depreciation can be set off against the income from other sources, there can be no dispute that it cannot be. What we are called upon to decide is only as to whether the interest income earned by the assessee from the specific activities above-mentioned could be termed as profits and gains of business and not income from other sources. The assessee relies on the decision in C.I.T. v. Govinda Choudhury and Sons, [1993] 203 ITR 881. 3. The Revenue relies on Tuticorin Alkali Chemicals and Fertilizers Ltd. v. C.I.T., [1997] 227 ITR 172, K.Ravindranathan Nair v. Deputy C.I.T., [2003] 262 ITR 669 and Pandian Chemicals Ltd. (supra).

Sri.P.K.Raveendranatha Menon, learned Senior Counsel, Government of India (Taxes) would point out from K.Ravindranathan Nair that in a similar case of deposits made for opening of letters of credit, the Court found that it cannot be said to be a profit derived from exports. The position herein is identical, insofar as the assessee having claimed deposits made for opening letters of credit in the name of the foreign buyers. The assessee also has made deposits in pursuance of the contracts, the interest income of which is not a contract receipt and can only be considered as an income from other sources. Reliance is placed on Pandian Chemicals Ltd. to argue that in the case of deposits made before the Electricity Board; though power was a necessary requirement for the business of manufacturing of the assessee, the Hon'ble Supreme Court found the deposits to be one step distanced from the business itself. The interest earned on such deposits were found to be income from other sources. The learned Senior Counsel would seek for the Tribunal's decision to be set aside.

Initially, we thought that the issue would be covered by K.Ravindranathan Nair. However, the learned Counsel appearing for the assessee, Sri.Raja Kannan, alertly points out that there is substantial difference between the facts and the law declared in K.Ravindranathan Nair and that with which we are concerned. In K.Ravindranathan Nair, the issue was one of deduction under Section 80HHC and whether the interest income received could be said to be profits derived from exports. Section 80HHC specifically granted deduction only to profits derived from exports. Here, the question would be as to the head under which the income has to be assessed.

We notice from Tuticorin Alkali Chemicals that the Hon'ble Supreme Court had specifically noticed the various heads of 'income', as it was existing then. As of now, the only amendment is insofar as the interest on securities having been deleted. The profits and gains of business or profession and income from other sources are two separate heads under which income tax can be assessed. Therein, the question considered was as to whether the interest income earned from borrowed funds before the commencement of business, parked in fixed deposits, can be termed to be business income. The Supreme Court held that it can only be income from other sources. Here it is otherwise as we will presently demonstrate. Here, the benefit to the assessee is insofar as the present income by way of interest when treated as part of profits and gains of business, then depreciation is permitted to be set off as against such income. If not, as we earlier noticed, the depreciation cannot be set off as against income from other sources.

As has been pointed out by Sri.Raja Kannan, K.Ravindranathan Nair is on a totally different footing. Therein, Section 80HHC provided a deduction of the profits derived by the assessee from the export of goods and merchandise dealt with by the assessee. The Court found that the expression 'derived from' has a limited import and should be understood as profit directly arising from the export of the goods and not incidental to the export. We, on a more studied scrutiny of the judgment, feel that the facts in the present case are quite distinguishable. Here, the deposits made for opening letter of credits is in pursuance of the contract and for effecting supplies from abroad for the purposes of executing the contract itself. Likewise, the margin money deposits and deposits ensuring performance guarantee are also specific terms of the contract. The income so earned from the deposits by way of interest is in pursuance of the business itself for the deposit being intrinsically connected with the contract entered into by the assessee and the foreign purchaser.

We also find a clear distinction in the dictum laid down in Pandian Chemicals Ltd. There again, the Hon'ble Supreme Court was concerned with the words “derived from” in Section 80HH. It is in this context that the Hon'ble Supreme Court found that the deposit required for supply of electricity, though the supply of power was an essential ingredient in the manufacturing process, was one step removed from the business of the company. The company is engaged in the business of manufacturing and sale and the profits earned from it alone can be said to be; as derived from the business of the company. We notice that the specific claim was of deduction available to industrial undertakings in a backward area. As far as the present case is concerned, we are adjudicating upon which head the 'income' could be assessed to tax; whether it can be under profits and gains of business or income from other sources. We agree with the learned Senior Counsel that the interest income, does not change its character as interest, but however, for the purposes of assessment, one has to look at; which head it would fall under.

We turn to Govinda Choudhury, wherein the Hon'ble Supreme Court was concerned with a similar issue. Therein, the assessee had an arbitration award, which also granted interest. The Department took a stand that the interest as awarded by the Arbitrator would be taxed as income from other sources. The Hon'ble Supreme Court held so: “This brings us to a consideration of the second question. The sum of Rs 2,77,692 was received by the assessee as interest on the amounts which were determined to be payable by the assessee in respect of certain contracts executed by the assessee and in regard to the payments under which there was a dispute between the two parties. The assessee is a contractor. His business is to enter into contracts. In the course of the execution of these contracts he has also to face disputes with the State Government and he has also to reckon with delays in payment of amounts that are due to him. If the amounts are not paid at the proper time and interest is awarded or paid for such delay, such interest is only an accretion to the assessee’s receipts from the contracts. It is obviously attributable and incidental to the business carried on by him. It would not be correct, as the Tribunal has held to say that this interest is totally dehors the contract business carried on by the assessee. It is well settled that interest can be assessed under the head ‘income from other sources’ only if it cannot be brought within one of the other specific heads of charge. We find it difficult to comprehend how the interest receipts by the assessee can be treated as receipts which flow to him dehors the business which is carried on by him. In our view, the interest payable to him certainly partakes of the same character as the receipts for the payment of which he was otherwise entitled under the contract and which payment has been delayed as a result of certain disputes between the parties. It cannot be separated from the other amounts granted to the assessee under the awards and treated as “income from other sources”. The second question is, therefore, answered in favour of the assessee and against the revenue.” (underlining by us for emphasis)

Respectfully following the aforesaid dictum, we are of the opinion that here also the deposits made are in pursuance of the contract and but for the contract, there was no warrant for making the deposits or earning income by way of interest. As we already stated, the deposit and the income generated by way of interest, are intrinsically connected with the contract, the business engaged in by the assessee. It can only be income derived from profits and gains of the business. We hence answer the first question in favour of the assessee and against the Revenue. The second question requires no answer at our hands for it being a settled position that there could be no depreciation claimed as against income from other sources. This will have no effect in the case of the assessee insofar as the first question being answered in their favour. The Appeal would stand rejected. No order as to costs. K.VINOD CHANDRAN JUDGE ASHOK MENON dkr JUDGE