Issues relating to direct taxes are often confused when these are viewed and considered from accounting angles. For example, accounting practices treat different business activities in accordance with accounting standards, however, the problem arises where accounting standards or practices are at variance with the tax laws and give rise to many intricate questions.
One may ask the question whether or not an accrued interest from TDR can be adjusted by the assessee against the expenditure on capital work in progress, an important fact to be noted in this regard is that the company may have not commenced the business yet.
The fact is that there can be a difference of opinion between the viewpoint of accounting managers and revenue regarding the treatment of an accrued profit or income from placement of capital in the revenue yielding instruments. An accounts manager can argue that earned profit on these instruments can be computed towards expenditure of the project to decrease its costs.
As per law, the taxable income is to be determined under the provisions of Sections 9, 10 and 11 of the Income Tax Ordinance. Section 11 of the Ordinance provides heads of income including the income from other sources [see Section 11 (I) (e)] of the Ordinance], there may be difference of treatment regarding this income under accounting principles, yet the revenue has to rely on the provisions of tax law, therefore, for revenue, the income generated through profit earned on TDR would be treated as 'an income from other sources' and deduction from such income can be made only in respect of such expenditures which are not capital in nature and have been laid out or expended wholly and exclusively for the purpose of making or earning such income. There is no provision in the income tax law providing that interest income from other sources may in certain circumstances ceases to be taxable if it is applied in the expenditure of the project. And merely because the interest income has been appropriated or adjusted or treated as a reduction in barrowing cost does not cease its character to be an income liable to tax under the tax law since the application of income per se does not affect its taxability except for specific exception in the law.
Where a company had not commenced its business and its plant and building were under construction, and it earns profit by way of interest from bank deposits and it had been debited in the "capital work-in-progress account" such a proposition gives rise to the following questions:
(I). Whether the interest received by the assessee from the bank can be termed as income under the tax law;
(II). If it is income, whether any deduction is allowable there from; and
(III). Whether the said interest income is at all taxable since its application had reduced the cost of construction or it was utilised for the purpose of construction.
In order to appropriately answer such questions one should keep in mind that tax under the law is leviable on the total income of the previous year to be computed in accordance with the legal provisions. The inclusive definition of "income" as set out in the law takes within its sweep various profits and receipts. In the case of [Gopal Saran Narain Singh (Maharajkumar) v. CIT [1935] 3 ITR 237], it was held by the Privy Council that "anything which can properly be described as income is taxable under the Act unless expressly exempted".
Keeping in view the facts and the meaning of "income" as discussed here, it needs no further elaboration to conclude that the bank interest received in this case is "income from other sources" within the framework of income tax law since income is not chargeable under any other head of income specified in Sections 9-11 of the Ordinance. If that be so, the assessee will be entitled to deduction from this income only if the conditions laid down in the law are satisfied.
On a reading of the relevant provisions of the tax law there is no escape from taking the view that expenditure is allowable as deduction out of an "income from other sources" only if it is found that, in fact, (i) it has been expended wholly and exclusively for the purpose of making or earning such income; and (ii) It is not in the nature of capital expenditure.
Coming to the next facet of the question, it is to be seen whether application of the interest income or its mode of accounting can make it exempt. The fact is that there is no provision in the law providing therein that the income from other sources will cease to be taxable if it is applied in acquisition of capital assets. Therefore, merely because the interest income has been appropriated or adjusted towards construction of the plant or building, it does not cease to be income liable to tax.
In the case of [Challapalli Sugars Ltd v. CIT [1975] 98 ITR 167], it was held that interest paid on amounts borrowed by the assessee for the acquisition and installation of plant and machinery before the commencement of production forms part of the "actual cost" of the asset to the assessee and, as such, it is capital expenditure, and in such situation no tax exemption is available:
It may thus be stated that the taxability of a receipt under the tax law is not dependent on its accounting treatment.
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates Karachi)