Interest received on share capital money deposited with the bank cannot 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.

( 1 ) THIS reference under section 256 (1) of the Income-tax Act, 1961, raises the following question of law for our decision : "whether, on the facts and in the circumstances of the case, the sum of Rs. 18,913 being interest received by the assessee-company from bank deposits could not be brought to tax for the assessment year 1977-78 and whether the Income-tax Appellate Tribunal was justified in annulling the assessment ?" The relevant assessment year is 1977-78 for which the previous year ended on September 30, 1976. The respondent-company had not yet gone into production by then. For the purpose of construction and setting up of an industry, the respondent-company borrowed funds and had paid interest thereon to the tune of Rs. 2,40,554. The assessee had also earned interest on share capital monies received from the public which was kept in fixed deposit with the banks. At this stage, it is relevant to point out that no details are forthcoming from the record as to the periods of deposit and the purpose for which the share money was meant to be utilised or actually utilised. The respondent, in its return, originally accepted the interest receipt of Rs. 18,913 as its income. Later on, the respondent claimed that the said amount shall not be treated as income as it is liable to be deducted from the interest paid on term loans and the net interest arrived at, i. e. , Rs. 2,21,641, is to be capitalised. In other words, the contention of the assessee was that the interest received during the pre-production or construction period shall be reflected in the capital cost of the project and it should go to reducing the capital cost. This contention was not accepted by the Income-tax Officer who held that the interest received is not a capital receipt and that it is liable for taxation under the head "income from other sources". The Commissioner (Appeals) affirmed the order of the Income-tax Officer. On further appeal to the Appellate Tribunal, the Tribunal accepted the contention of the assessee and annulled the assessment. In recording its conclusion, the Tribunal relied on two Special Bench decisions. The first decision was rendered by the Special Bench of the Income tax Appellate Tribunal at Hyderabad in the case of Nagarjuna Steels Ltd. v. ITO [1983] 3 ITD 796. The view taken by the Special Bench was endorsed by this court in the case of CIT v. Nagarjuna Steels Ltd. [1988] 171 ITR 663. It must be noted that the said decision relates to receipt of interest on the deposit of borrowed funds. The Special Bench held that there was a direct nexus between the borrowed funds and the deposited funds and hence the receipt by way of interest can be set off against the interest paid to the bank and the balance amount could be capitalised. As already mentioned, this court affirmed the view taken by the Tribunal. The other decision followed by the Tribunal is that of the Special Bench at Madras in Arasan Aluminium Industries (P.) Ltd. v. First ITO [1982] 1 ITD 10, which is on all fours with the present case inasmuch as the eligibility to tax of the interest received from out of the paid up capital amount came up for consideration before the Special Bench. The Special Bench held that there was no distinction in principle between the interest received out of borrowed funds and the interest received out of share money. According to the Special Bench, the source of deposit - whether out of paid up capital or borrowed capital - is a distinction without difference. The Special Bench, therefore, followed the earlier Special Bench decision in the Nagarjuna Steels case [1983] 3 ITD 796 (Hyd ). However, it is to be noted that the decision of the Special Bench in Arasan Aluminium Industries case, [1982] 1 ITD 10 (Mad) must be deemed to have been disapproved by the Madras High Court (vide CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542), in which the reference was answered in favour of the Revenue. The Division Bench held that the interest ea

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