Interest received on short-term deposits during the construction period of a factory is taxable under section 56 of the Income-tax Act, 1961, and cannot be reduced from the interest payments while capitalising the various expenditure on capital account.

1. - On the request of the Revenue, the following two questions of law arising out of the order of the Income-tax Appellate Tribunal, Jaipur, dated May 7, 1985, have been referred under section 256(1) of the Act in respect of the assessment year 1979-80 :

" 1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that interest received of Rs. 2,58,089 on short-term deposits with banks was not taxable under section 56 of the Income-tax Act, 1961 ?

2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that interest received of Rs. 2,58,089 on short-term deposits with banks was to be reduced from the interest payments while capitalising the various expenditure to capital account ?"

2. The facts of the case are that the assessee is a limited company and was incorporated on October 27, 1976. The certificate of commencement of business was issued by the Registrar of Companies on January 19, 1977, and the company was granted the consent by the Controller of Capital Issues on July 27, 1978. The prospectus for the raising of capital from the public was issued on November 18, 1977. The loans were obtained from the financial institutions as well as from other parties for the purchase of capital equipment and for setting up the business of the company, which was manufacturing cement. The company has paid interest on all its borrowings. Besides the loan, the company has also received the application money for issue of share certificates and the application money so received was deposited with the bank as short-term deposit besides part of the borrowings. On such deposit, the company earned an interest of Rs. 2,58,089. On the other hand, the amount of interest paid by the company on its borrowings was Rs. 14,32,072. The amount of Rs. 2,58,089 was deducted from the interest paid and the balance amount of interest was treated as part of the capital cost of the building, plant and machinery, etc. The submission of the assessee was that since construction activities were going on, all the expenditure and receipt of money go either to increase the cost of the capital assets or reduce them and as such the interest received should be adjusted from the interest paid. The Income- tax Officer held that the interest income earned by the assessee on deposits with the bank has nothing to do with the construction activities and as such is taxable income from other sources under section 56. The contention of the assessee that the interest amount paid should be set off against the income earned, was also negatived by the Income-tax Officer on the ground that section 57 of the Act permits the deduction only of such expenditure which has been incurred by the assessee in earning the interest. Since the borrowings by the company were for the purpose of construction and has no relation with the earnings of interest with the deposit, the Income-tax Officer was of the view that the interest paid cannot be deducted under section 57. However, a sum of Rs. 10,000 was allowed which was considered as relatable to the earning of the income of interest as there were certain administrative expenses incurred by the company.

3. The appeal before the Commissioner of Income-tax (Appeals) was rejected and the order of the assessing authority was confirmed. In the second appeal, before the Income-tax Appellate Tribunal, again the contention was raised that till the construction is complete, the entire activities of the company are centred on construction alone and, therefore, the interest paid or received goes to increase the cost of capital assets or reduce it and, therefore, that cannot be taxed as income "from other sources".

4. The submission of Mr. Bapna, on behalf of the Revenue, is that the deduction which has been provided under section 57 could alone be allowed in respect of an income which is "from other sources". Since the payment of interest in respect