1. This appeal by the department is directed against the order dated 12-10-1981 passed by the Commissioner (Appeals).
2. The assessee is a private limited company. The assessment year is 1978-79. The previous year ended on 31-3-1978.
3. At the relevant time the assessee was engaged in the construction of three buildings. Under the method of accounting followed by the assessee and accepted by the department, the profits were offered for assessment when the construction of buildings and sale of flats comprised therein were completed. In the relevant accounting year, the construction of the buildings and sale of the flats had not been completed. Consequently, all the expenses incurred during the year were carried forward to the next year.
4. On the scrutiny of the profit and loss account, the ITO found that the assessee had credited, inter alia, following five amounts in the relevant accounting year:(i) Interest on sale deposits 20,000(ii) Interest on temporary loans from the surplus funds 14,686(iii) Interest on fixed deposits 1,200(iv) Other interest 2,877(v) Profit on sale of property 6,66,000 7,04,763 5. The ITO was of the opinion that the said amounts represented income which had no relationship with the business of the construction of buildings and sale thereof. According to him, those items related to income arising from source other than the business of construction carried on by the assessee. That income was, therefore, not liable to be computed along with business income of construction of buildings which income was offered on completion of construction. He, therefore, with the approval of the IAC, assessed the said income as income from other sources for the relevant year. He did not accept the explanation given by the assessee in letter dated 6-3-1981.
6. The Commissioner (Appeals), before whom the assessee went in appeal, relied on his own earlier order for the assessment years 1974-75 and 1975-76, wherein it had been held that earning of interest by the assessee was 'the fruit of its business activity of the construction of buildings and selling the same'. He further held that the interest was a trading receipt and could not be said to have arisen from other activity. Consequently, taxation thereof as income from other sources was not warranted either on principles af accountancy or under provisions of law. Following the said decision of his own, the Commissioner (Appeals) allowed the appeal and directed the ITO to consider those items as business receipts of the assessee while computing the business income in respect of completed projects in accordance with the system stated to have been regularly followed.
7. The department has now come in appeal before us and the ground raised is that the Commissioner (Appeals) had erred in holding that the said amount of Rs. 7,04,763 was to be treated as income from business and not income from other sources.
8. It may be mentioned at the outset that term 'interest' has been used in respect of first four items while the term 'profit on sale of property' is used in respect of the fifth item. We shall first concentrate on first four items, viz. (i) interest on sale deposits, (ii) interest on temporary loans, (iii) interest on fixed deposits, and (iv) other interest.
9. The facts found and not in controversy are as follows. The assessee received deposits in instalments from prospective purchasers while the work of construction was in progress. The deposits had to be made by certain dates by the prospective purchasers, under the agreements executed by them. If they failed to make deposits by stipulated dates, they had to pay interest for the period of default. The first item relates to interest of this nature received by the assessee.
10. The authorised capital of the assessee was small. But the amounts received as deposits were large. All the amounts were not required by the assessee to meet the cost of construction at one and the same time.
Hence, large portion of these deposits remained idle. The assessee, therefore, deposited them in current account or gave temporary loans so that the amounts could be received back at the time when they were needed to meet the cost of construction. In the process, the assessee earned interest. The interest of item Nos. (ii) and (iv) came under that category.
11. The assessee constructed buildings on the land which had been taken on lease from the State Government. The assessee had to give certain guarantee to the State Government. For that purpose the assessee had to keep certain amounts in fixed deposits. These fixed deposits in the process gave rise to income by way of interest. The interest on item No. (iii) above comes under this category.
12. The question is whether the interest income which was generated in the above process should be treated as business income as contended on behalf of the assessee and held by the Commissioner (Appeals) or it should be treated as income from other sources as held by the ITO. If it is held to be the business income arising in the course of the business of the assessee of the construction of the buildings, it would reduce the cost of the project and would enter into computation at the time of completion of the project. If it is held as income unconnected with the business of the construction of the buildings, it would not be business income and would be liable to be assessed as income from other sources in the year in which it accrued and not in the year in which the project was completed. So the controversy centres on this narrow point.
13. It is well settled that the heads of income under Section 14 of the Income-tax Act, 1961 ('the Act') are mutually exclusive and that the income falling under each one of them should be computed under that head only. Certain decisions were cited by the parties on this point but the proposition is so well established that it is not necessary to notice them. It is also clear from Section 56 of the Act that income which is otherwise includible would come under the head 'Income from other sources' only if that income is not chargeable to income-tax under any of the heads specified in Section 14, items A to E. It follows that interest income in the present case would fall under the head 'Income from other sources' only if that income does not fall under the head 'D'-- Profits and gains of business or profession and not otherwise.
14. Now, the business with which we are concerned in this case is business of construction of flats in buildings and sale of these flats after completion of construction. Large deposits came in the hands of the assessee in the course of this business from the prospective purchasers. These large amounts were not immediately needed by the assessee to meet the cost of construction. They were needed at particular intervals. During the intervening periods the funds remained idle. Hence, they had to be deposited in bank or given as loans in such manner that the funds remained at beck and call. This was what was done by the assessee. Similarly, the assessee received interest from prospective purchasers who were late in making deposits. The interest was received in pursuance of the very agreements made with those purchasers. Some amounts had to be kept in fixed deposit in pursuance of requirement of the lease of the land on which construction was made.
15. Thus, all this interest income sprang from the business activity of the assessee. It did not arise out of any independent activity, i.e., an activity wholly unconnected with the business of construction. The interest had direct nexus with the business activity. The interest received was virtually a trading receipt and interest paid was a trading layout. In these circumstances there can be no doubt that the interest income was the business income of the assessee.
16. It is to be noted that the interest income has not arisen out of the idle capital of the assessee. It has arisen out of deposits received in the course of business. This aspect is important and cannot be overlooked.
17. It can hardly be gainsaid that the profits and gains of a business have to be arrived at not merely by considering the profits derived by an assessee on the sale of its stock-in-trade but also the profits earned by it as an integral part of its business activities and embedded in the various kinds of trading receipts which are ancillary or incidental to such business. Thus, it was held in R.B. Jodhamal Kuthiala v. CIT83 ITR 464 (Punj. & Har.) that the interest which a company receives in respect of refund of tax would be its business income.
18. On the same principle it was laid down in CIT v. Favre-Leuba & Co.
Ltd.  1 Taxman 419 (Bom.) that where a sole selling agent makes advances to its principal and earns interest therefrom, the interest would be assessable as business income where the advances are made in the course of business and with a view to assist the principal in its manufacturing activity particularly where advances are made not out of the idle funds but out of deposits received by it from its sub-distributors or out of overdrafts taken by it from the banks.
19. Reliance was placed by the department on the decision in CIT v.Industrial Solvents & Chemicals (P.) Ltd.  119 ITR 608 (Bom.).
The principle laid down therein is that business can be said to have been set up when reasonable quantity of end product is obtained.
Expenses preparatory to commencement of business was not allowable. On the basis of this decision, it was argued that since interest income had arisen prior to completion of construction, it was an income derived prior to commencement of business and as such the said income cannot be treated as business income. There is obvious fallacy in the argument. The business of construction of flats and sale thereof commences with the entering into agreement with prospective purchasers after acquisition of land. It does not commence only after completion of construction. Hence, income derived subsequent to agreements with prospective purchasers would be income of the business and would not be pre-busi-ness receipts.
20. Considering all the circumstances, we hold that interest income falling under items (i) to (iv) was income of the business of the assessee and was liable to be considered at the time of completion of project along with other income. It was not income from other sources liable to be assessed in the assessment year with which we are concerned. The directions given by the Commissioner (Appeals) so far as they pertain to these four items are upheld.21. We shall now deal with fifth item of Rs. 6,66,000. This amount represents, what has been described by the assessee as 'profit on sale of property'. The contention of the assessee is that this amount in substance is the interest earned on deposits while the contention of the department is that the said amount falls under a different category. We shall first analyse the transaction from which the above sum has been received.
22. As already stated, the assessee had large amount at its disposal on account of deposits received from intending purchasers. Out of that amount the assessee paid Rs. 50,00,000 to Haribhai Estates (P.) Ltd. on 4-1-1977. The said company is under the same management as the assessee-company. The "said payment was made in pursuance of an agreement dated 4-1-1977. Under the said agreement the assessee agreed to purchase from the said company certain portions of the building, viz., 8th, 9th and 10th floors of Maker Towers 'E' admeasuring 44,400 sq. ft. The said building was under construction at that time. The price was fixed at Rs. 66,60,000 and Rs. 50,00,000 were accepted as part of the said price by way of earnest money. It was specifically mentioned in the agreement that balance of Rs. 16,60,000 would be paid by the assessee to the said company at the time of delivery of possession.
23. On the same day, i.e., on 4-1-1977, the said company wrote a letter to the assessee in which the terms of the said agreement were confirmed. Thereafter two further terms were mentioned. The first was that if the said company paid Rs. 50,00,000 to the assessee by 30-7-1977, the said agreement of sale would stand terminated and that at the time of termination the said company would pay Rs. 6,60,000 to the assessee as and by way of compensation on repurchase of the said offices and thereafter the right, title and interest of the assessee would come to an end. The second was that in case the said company failed to make the said payment, the assessee would have the right without making the balance payment of Rs. 16,60,000 to enter upon the aforesaid premises if completed or if incomplete the assessee would become absolute owners of the said premises as the period of condition of repurchase would be over.
24. The said company repaid to the assessee Rs. 50,00,000 on 30-7-1977 along with sum of Rs. 6,60,000 'as and by way of compensation on repurchase of the said offices'. It is this amount of Rs. 6,60,000 regarding which the controversy is before us.
25. The contention of the assessee is that the said amount of Rs. 6,60,000 had been earned by the assessee on the sum of Rs. 50,00,000 which had been received as deposits and as such the said amount represents its income in the business of construction of buildings.
Consequently, the said amount should be assessed as part of business income at the time of final assessment on completion of project. The said amount would reduce the overall cost of the project. The contention on behalf of the department is that the activity of purchase and sale of office premises in Maker Towers 'E' under agreement dated 4-1-1977 was an activity distinct from that of construction of building by the assessee. Consequently, any profit earned from former activity would not be part of the profits of the business of construction of buildings carried on by the assessee and said profits would be liable to be assessed separately in the year in which they arose.
26. We have considered the rival submissions and facts on record. We are unable to accept the contention that the income of Rs. 6,60,000 which had arisen under the said agreement dated 4-1-1977 was by way of interest. If the assessee intended to lend Rs. 50,00,000 to the said company on interest, nothing prevented the parties from drawing up an agreement of loan. It is said that simple agreement of loan was not drawn up because that might have resulted in the breach of certain obligations under provisions of the Companies Act, 1956. It is not necessary for us to consider that aspect. If an act cannot be done directly, it cannot be done indirectly. Besides, Rs. 6,66,000 could not be interest on Rs. 50,00,000 for period of less than seven months at normal rates of interest.
27. In CIT v. B.M. Kharwar  72 ITR 603 it has been laid down by the Supreme Court that taxing authorities are not entitled to ignore the legal character of the transaction which is the source of the receipt and proceed on what they regard as 'substance of the matter'.
Similarly, it is not open to the assessee to contend that terms of an agreement were not the same as were incorporated in the document and that in substance the agreement was different from what was incorporated in the document particularly nothing prevented the parties to incorporate the terms according their so-called real intention.
28. In the present case the documents indicate that the relationship that was created between the said company and the assessee was that of vendor and intending purchaser. It is true that the company had option to return the amount by 30-7-1977 along with compensation and terminate the agreement but there was no corresponding right in the assessee to terminate the same and demand the amount. What all the assessees could insist, on failure of the company to repay the amount, was delivery of possession of the premises and call upon the company to convey title.
This was, therefore, not a case of loan to the company. It was a transaction of purchase of certain premises coupled with liability to terminate the agreement if the amount was refunded with compensation.
The transaction was one of purchase and sale of premises from others and obviously this was not part of the business of the assessee which was to construct buildings and sell the flats comprised therein.
29. It is the profits and loss of the business of construction of buildings which are to be assessed on the completion of the project.
Any gains accruing to the assessee from activity unconnected with said business are not to be computed along with the said profits and loss of the business. Such gains would arise from a different source, viz., that of agreement to purchase certain immovable property and they would be liable to be assessed separately in the year in which they arise.
30. The interest income which has been discussed in the beginning is of different character from income by way of compensation with which we are at present dealing. It is true that the amounts which gave rise to both these incomes spring from the same source, viz., deposits received by the assessee from intending purchasers of the fiats under constructions. However, the activity which gave rise to these incomes are different. In the first case, the funds not required were temporarily lent on interest or deposited in banks. Thus, the amounts were at the beck and call and there was mere temporary use of those funds which resulted in the interest income. In the other case the funds have been diverted for investment in the purchase of immovable property and under the terms, there was no option but to purchase if the vendor was unable to pay. There was no right to get back the amount itself. Thus, it was altogether a different activity.
31. Supposing the funds had been invested in purchase of shares. Any income received by way of dividend would have been income from other sources and gains arising from sale of shares would have attracted provisions regarding capital gains. Such gains would not have been business income. Similar would be the case when the funds have been invested in purchase of immovable property.
32. On behalf of the assessee reliance is placed on decisions of the Tribunal in Arasan Aluminium Industries (P.) Ltd. v. First ITO  1 ITD 10 (Mad.) (SB) and in Nagarjuna Steels Ltd. v. ITO  3 ITD 796 (Hyd.) (SB). These decisions lay down that interest income during construction was business income. We have already held so in respect of interest income. These decisions do not deal with the question with which we are concerned at present. We have already pointed out that interest income is different in nature from income by way of compensation on purchase of property. Another decision of the Tribunal on which reliance was placed is in the assessee's own case for the assessment year 1974-75 in IT Appeal No. 602 (Bom.) of 1981, dated 7-6-1982. That order deals with the question whether reopening of the assessment under Section 147 of the Act was justified. It does not deal with the merits of the question with which we are at present concerned.
33. The ratio of the decisions of the Supreme Court in CEPT v. Lakshmi Silk Mills Ltd.  20 ITR 451, Karnani Properties Ltd. v. CIT  82 ITR 547 and Pandit Narain Dutt Chhimwal v. CIT  83 ITR 413. S.G. Mercantile Corporation (P.) Ltd. v. CIT  83 ITR 700 and Chowringhee Sales Bureau (P.) Ltd. v. CIT  87 ITR 542 on which the assessee relied is that income from exploitation of commercial assets would be business income whether the exploitation is done directly or through some other agency. What is important in such cases is to scan closely the facts and circumstances of the case and examine the intention and object of the assessee in giving on lease the commercial assets. If the intention is to exploit the commercial assets at some point of time and the lease is only a temporary phase forced on him by financial or other limitations, the income in the hands of the assessee would be business income. On the other hand, if the intention is to derive income on the basis of ownership and lease of assets, the income would be assessable under Section 56.
34. In the present case as already stated, there was no option for the assessee to call upon the company to repay the amount of Rs. 50,00,000.
It was only the option of the company to repay. If the company did not repay, the assessee had no option but to make the purchase absolute.
Thus, it cannot be said that amount was given as loan. The transaction was that of purchase of immovable property and the gains arising thereof would be income from other sources.
35. We, therefore, hold that amount of Rs. 6,66,000 under the head 'profit on sale of property' does not form part of the income of the business of construction of buildings and sale of flats comprised therein and as such the said amount was liable to be assessed as income from other sources in the relevant assessment year and the assessee would be entitled to only such deductions as are permissible under the Act for computation of income from other sources. We, therefore, set aside the order of the Commissioner (Appeals) in respect of this item and direct the ITO to assess the said amount in accordance with law.