1.75     Query

Treatment of net interest income of a company from bank deposits

prior to their utilization in the construction activities of the company.

The query relates to item 8-2 on page 10 of the Institute’s Publication, ‘Study on Expenditure During Construction Period’, regarding income during the construction or pre- production period. It is suggested therein that where a particular item of miscellaneous income can be directly related to a particular item of expenditure, the income should be set off against that expenditure, and the net amount of expenditure should be treated in the appropriate manner in the accounts. It is observed in the last sentence of the same paragraph that interest income earned during the construction period may be offset against interest expenses incurred during this period. However it has not been clarified as to what should be done when such interest income during construction period exceeds the interest payments and this results in a net income.  It is presumed that the following treatment could be possible:

 Treat the net interest income as a capital receipt and capitalise the same thereby reducing the total cost incurred during construction or pre-production period. This follows the principle that when the income is less than the expenditure, the income should be adjusted against the expenditure and only the net expenditure should be capitalised. In other words, both the expenditure as well as the income during construction period should be capitalised and not be treated as revenue items.

We would request you to give us your considered opinion on the above point and clarify whether the treatment as has been explained above could be adopted.

In one of our client’s business, (a Private Limited Company) there is an excess of interest received from bank deposits prior to their utilisation in the construction activities of the plant. The income-tax authorities proposed to tax such receipts as income from other sources. However, we have taken a stand that it should be capitalised and not treated as taxable income. The matter is now before the Appellate Tribunal at Madras. In a similar case in Bihar Alloy Steel Ltd. Vs. C.I.T – reported in December 1978 issue of Taxman, an identical question has been considered and decided in favour of the assessee.  In that case, the Counsel of the assessee relied on the suggestions contained in the above mentioned publication of the Institute and since it has been held by the Supreme Court and various High Courts that regarding points involving accounting principles, the practice enunciated by the accounting body viz. the Institute of Chartered Accountants of Indian could be followed and adopted.

 While representing our case, the same points were stressed but the learned members of the Tribunal felt that the Institute’s publication is not very clear on the above point and only a case where there is net expenditure after considering the income has been dealt with. As such they have asked to get the confirmation of the treatment of surplus of interest income over interest payment, which could be followed in deciding the case.

We would request you to give us your considered opinion on the above points and clarify whether the treatment as has been   explained is acceptable.

                                                  Opinion                                                                           September 16, 1981

It appears that the entire interest income under reference has arisen during the period of construction prior to the commencement of production and that the net credit remains in the interest account after setting off all interest costs incurred during that period.

On a consideration of the issues involved, the Committees is of the opinion that the net income, that is to say the interest income as reduced by expenses relating to earning of interest income, if any, of the company during the period of construction, prior to commencement of production may be deducted in arriving at the final cost of the project, provided that as should generally be the case, such net interest income is not significant relative to the total cost of the project.  In that event such treatment will not impair the presentation   of a true and fair view of the cost of the project.

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