There are three important decisions on this point. In the first case, the court discussed the principles of law and held that the acquisition has to be decided on the facts of each case according to the principles of law and not in accordance with accounting practices.

In the second and third cases, it was held that interest directly connected with acquisition of capital assets was a capital receipt which could not be taxed.

The first decision is in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd vs CIT (227 ITR 172). In this case, the Supreme Court held that the total income of a company is chargeable to tax under Section 4 of the Act. Section 14 lays down that, for the purpose of computation, income of an assessee has to be classified under six heads. It is possible for a company to have six different sources of income-tax. Profits and gains of business or profession is only one of the heads under which a company's income is liable to be assessed.

According to the court, if a company has not commenced business, there cannot be any question of aasessment of its profits and gains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. The company may keep the surplus funds in short-term deposits in order to earn interest. Such interest will be chargeable under Section 56.

However, the apex Court in CIT vs Bokaro Steel Ltd (236 ITR 315) held that in case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets created as a result of such expenditure. By the same reasoning, if the assessee receives any amount which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets. These are receipts of a capital nature and cannot be taxed as income.

The facts in this case were that the assessee was a corporation wholly owned by the government of India. It was incorporated in January, 1964 and was assessed in the status of a company. Its object was to construct and own an integral iron and steel works. During the assessment years 1965-66 to 1971-72, the work of construction of the company's factory and installation of the plant was in the process of completion. The company had not started any business during the assessment years in question.

During this period, the company had given to the contractors, quarters for the residence of the staff and workers employed by the contractors who had been engaged by the assessee for carrying out the work of construction. The assessee charged the contractors for the use of the quarters so given.

Secondly, during the assessment years in question, the assessess had entered into supplementary agreements with its contractors under which the assessee had made certain advances to the contractors to enable them to execute the large scale construction work smoothly. The assessee-company had charged interest. This interest was later adjusted against the dues of the contractors.

For the purpose of the construction work, the assessee had also given on hire certain plant and machinery to the contractors. Against the letting of plant and machinery, the assessee received from the contractors, income in the form of hire charges.

Further, the assessee-company allowed the contractors to use the stones lying on the assessee's land for construction work. The stones lying on the assessee-company's land were the capital assets of the assessee-company. The assessee charged the contractors a certain amount by way of royalty for excavation and use of these stones for construction work.

The Supreme Court held that the advances which the assessee made to the contractors to facilitate the construction activity of putting together a very large project was as much to ensure that the work of the contractors proceeded without any financial hitch as to help the contractors. The arrangements which were made between the assessee-company and the contractors pertaining to these receipts were intrinsically connected with the construction of its steel plant.

The receipts had been adjusted against the charges payable to the contractors and had gone to reduce the cost of construction. They had, therefore, been rightly held as capital receipts and not income of the assessee from any independent source.

The Supreme Court followed this decision in a subsequent case, CIT vs Karnal Cooperative Sugar Mills Ltd (243 ITR 2). In this case, the assessee had deposited money to open a letter of credit for the purchase of the machinery required for setting up its plant in terms of the assessee's agreement with the supplier. It was on the money so deposited that some interest had been earned. This was, therefore, not a case where any surplus share capital money which was lying idle had been deposited in the bank for the purpose of earning interest.

The deposit of money in the present case was directly linked with the purchase of plant and machinery. Hence, any income earned on such deposit was incidental to the acquisition of assets for the setting up of the plant and machinery.

The Supreme Court held that the ratio laid down by the court in Tuticorin Alkali Chemicals and Fertilizers Limited was not attracted. The more appropriate decision in the present case was in Bokaro Steel Ltd.

In sum and substance, an analysis of the three decisions would indicate that where monies are parked temporarily even during the pre-commencement period, the interest would be taxable as income under the head "income from other sources". However, if there is no such investment but interest is earned in the course of acquisition of capital assets, or where interest is earned on advances to contractors or suppliers of equipment, such interest would be inextricably linked with the capital asset. Hence, the receipt would be on capital account and cannot be brought to charge under any provision of the Income-tax Law.