PCIT Vs International Coal Ventures Pvt. Ltd.: Delhi HC on whether pre‑operative interest is taxable or capital receipt

Background of the dispute

The Delhi High Court in PCIT Vs International Coal Ventures Pvt. Ltd. dealt with a recurring issue in income tax jurisprudence: when interest is earned on funds during the pre‑commencement stage of business, should it be taxed as “income from other sources” under Section 56 of the Income Tax Act 1961, or should it be treated as a capital receipt to be adjusted against the cost of setting up the business or acquiring a capital asset?

The appeal was filed by the Revenue under Section 260A challenging an order of the Income Tax Appellate Tribunal (ITAT) dated 06.04.2018 for Assessment Year (AY) 2012‑13, whereby the ITAT had allowed the assessee’s appeal and deleted the addition made by the Assessing Officer (AO).

The core controversy:

  • Whether interest earned on funds parked in short‑term fixed deposits before the commencement of business, where such funds were specifically mobilized for acquisition of a coal mine (a capital asset), can be taxed as “income from other sources” under Section 56, or
  • Whether such interest is a capital receipt that must be adjusted against Capital Work-in-Progress (CWIP) and thus not taxable as revenue income.

Facts and corporate structure

Incorporation and business objective

The assessee, International Coal Ventures Pvt. Ltd., was incorporated under the Companies Act 1956 on 20.05.2009 as a special purpose vehicle (SPV) and joint venture company of the following public sector undertakings:

  • Steel Authority of India Limited (SAIL)
  • Coal India Limited (CIL)
  • Rashtriya Ispat Nigam Limited (RINL)
  • National Mining Development Corporation Limited (NMDC)
  • National Thermal Power Corporation Limited (NTPC)

The principal object of the assessee was to secure a steady and reliable supply of coal for its promoter entities by acquiring coal resources abroad, including overseas coal mines.

Funding pattern and inflows

During the period relevant to AY 2012‑13:

  • Equity contributions and related inflows included:
    • Rs. 2.00 Crores from SAIL
    • Rs. 1.00 Crore from RINL
    • Rs. 1.00 Crore from NMDC
    • An advance of Rs. 156 Crores from RINL
    • Reimbursement of expenses from various promoters:
      • 21,81,28,800/- from SAIL
      • 223,92,296/- from RINL
      • 224,58,199/- from CIL

Separately, the assessee’s share capital, from incorporation till the subsequent financial years, was built up as follows (as stated and not disputed before the Court):

  1. At incorporation, the promoters subscribed to 7,00,000 equity shares of Rs. 10 each aggregating to 270,00,000/-.
  2. By 31.03.2010 (first year of existence), additional share application money of 297,50,000/- had been received.
  3. In FY 2010‑11 relevant to AY 2011‑12, share capital increased to 29.80 Crores with the following pattern:
    • 22.80 Crores — SAIL
    • 21.40 Crores — RINL
    • Rs. 1.40 Crores — NMDC
    • 22.80 Crores — CIL
    • Rs. 1.40 Crores — NTPC

Call money and fixed deposits

As part of the process of acquiring a coal mine overseas, the project had reached an advanced negotiation stage. Anticipating the need to make payments for acquisition, the assessee called up funds from its promoters.

On 29.06.2011, the assessee received 2157 Crores from RINL as call money:

  • Rs. 1.00 Crore was treated as share application money
  • The balance was recorded as borrowing and placed in fixed deposits with a bank

During the previous year relevant to AY 2012‑13:

  • Fixed deposits generated interest income of 211,45,19,580/-
  • The assessee incurred 24,48,78,068/- towards day‑to‑day expenses and project‑related activities, all treated as pre‑operative expenditure

In the preceding year (AY 2011‑12), the assessee had:

  • Earned interest of 211,45,92,550/- from fixed deposits made out of RINL’s funds
  • Paid interest of Rs. 11,14,73,651/-
  • Earned interest of Rs. 12,67,065/- on share capital funds, which it directly reduced from pre‑operative expenditure, thereby bringing down CWIP to 24,36,11,003/- at year‑end

The amounts received from RINL were kept in fixed deposits only temporarily, pending finalization of the mine acquisition transaction.

Aborted acquisition and refund of funds

Although the assessee was at an advanced stage for acquiring an overseas coal mine, the proposed transaction ultimately failed and was abandoned. This had several consequences:

  • Other promoters did not further infuse funds as earlier contemplated.
  • The assessee did not immediately return the 156 Crores received from RINL, initially keeping it in fixed deposits in the hope that another acquisition opportunity might arise.
  • Eventually, when it was clear the targeted coal mine would not be acquired, the assessee refunded Rs. 156 Crores to RINL.
  • Since interest had accrued to the assessee on these funds while they were parked in deposits, the assessee decided to pay interest to RINL as well.

RINL confirmed that it had treated the interest received from the assessee as its own income and paid tax on that income.

Assessment proceedings and appellate journey

Assessment by AO

For AY 2012‑13, the assessee filed its return declaring NIL income.

During the assessment, the AO noted:

  • Interest earned on funds received from promoters: 211,45,92,550/-
  • Interest paid to promoters: 211,14,73,651/-