Delhi High Court Rules Interest Earned During Project Setup Can Be Income from Other Sources

(DELHI, INDIA) — The Delhi High Court held in 2026 that interest earned by VNG Automotive Pvt. Ltd. during its project setup phase was a capital receipt tied to the business’s establishment, not taxable under Income from Other Sources, even as it upheld the tax department’s reopening of the case on procedural grounds.

The ruling in VNG Automotive Pvt. Ltd. v. Assistant Commissioner of Income Tax revisits a recurring tax dispute for companies that raise money before commercial operations begin and temporarily place those funds in bank deposits. Judges drew the line between idle surplus funds parked to earn interest and funds placed in deposit while remaining bound to project obligations such as machinery purchases, factory construction and technical payments.

VNG Automotive had filed nil income returns for assessment years 1993-94 and 1994-95 and adjusted the interest it earned against project expenses. The company was incorporated to manufacture and export ecological brake-shoes and had entered into a technical know-how agreement with a Singapore company while also spending on land, raw material, tools, dies and advances for machinery.

That distinction has shaped Indian tax law for nearly three decades. Courts have treated pre-commencement interest one way when a company simply deposits unused money for a return, and another way when the deposit forms part of the process of setting up the plant or acquiring capital assets.

In Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT, decided in 1997, the Supreme Court held that interest earned on borrowed funds temporarily invested in short-term bank deposits before production began was taxable under Income from Other Sources. The company had argued that the interest should reduce pre-production expenses, but the court rejected that approach and treated the bank deposit as the source of the income.

Two later Supreme Court rulings narrowed the reach of that principle. In CIT v. Bokaro Steel Ltd. in 1999, the court held that receipts tied directly to the construction of a steel plant, including rent for workers’ accommodation, hire charges for plant and machinery, interest on advances to contractors, and royalty for stone taken from the company’s land, were capital receipts that reduced construction cost.

Then, in CIT v. Karnal Cooperative Sugar Mills Ltd. in 2000, the Supreme Court held that interest on money deposited with a bank to open a letter of credit for the purchase of machinery was not taxable income. The deposit was treated as part of the machinery acquisition process, not as an independent investment of spare money.

Against that backdrop, the Assessing Officer in the VNG Automotive case reopened the assessments and taxed the interest, relying on Tuticorin Alkali. The officer treated the money placed in the bank as surplus funds and said the interest had to be assessed separately under Income from Other Sources.

Commissioner of Income Tax (Appeals), or CIT(A), took the opposite view. CIT(A) held that the deposits were linked to committed obligations, including plant and machinery purchases, construction of factory premises and payment of technology fees, and therefore the interest arose incidentally during project setup.

The Income Tax Appellate Tribunal, or ITAT, then reversed CIT(A). It held that Bokaro Steel and Karnal Cooperative Sugar Mills did not apply and restored the tax treatment that classified the interest as separately taxable income.

The Delhi High Court disagreed with the tribunal on the merits. It said the real test was whether the funds were surplus funds invested to earn interest or were “inextricably linked” with setting up the project, a phrase that has come to define this line of cases.

On the facts before it, the court found that VNG Automotive’s funds were tied to project obligations and were not placed in deposit merely as spare money seeking a return. That brought the case closer to Bokaro Steel and Karnal Cooperative Sugar Mills than to Tuticorin Alkali, and the interest therefore had to be capitalized and adjusted against pre-operative expenses rather than taxed as revenue income.

The court’s reasoning leaves Tuticorin Alkali intact but confines it to the facts that produced it. If borrowed funds or invested funds sit idle and a company chooses to place them in a bank deposit to earn interest, the resulting income remains taxable. If the deposit exists because the project requires it, or because the funds remain earmarked for land, machinery, factory construction or technical know-how, the receipt can retain a capital character.

That practical distinction carries weight well beyond one manufacturer’s dispute. Companies, start-ups, infrastructure ventures, real estate developers, NRIs investing in Indian businesses and cross-border entrepreneurs often face a gap between raising money and deploying it. During that period, money may be held in deposits for a short time, and the tax treatment of the interest can change the reported cost of the project and the amount of taxable income.

The VNG Automotive ruling also turned on a separate procedural fight over reopening. The company argued that the reassessment amounted to a change of opinion, but the Delhi High Court held that the original processing had taken place under section 143(1), not through a scrutiny assessment under section 143(3).

That difference proved decisive. An intimation under section 143(1), the court held, is not an assessment order in which the Assessing Officer forms an opinion on the merits, so the tax department was not barred from reopening the matter on that ground. Revenue won on that procedural point, even though VNG Automotive won the substantive dispute over taxability.

The judgment offers a working map for future disputes. Interest on surplus or idle funds deposited to earn a return stays taxable under Income from Other Sources. Borrowed funds temporarily invested without a direct project requirement generally remain taxable under the Tuticorin Alkali rule. Deposits used for a letter of credit to buy machinery fall on the Karnal side of the line, while contractor-related receipts directly tied to construction fall under Bokaro Steel.

Cases in the middle will turn on proof of nexus. Courts have looked not just at accounting entries but at whether the funds were committed to land acquisition, plant purchases, factory works or technical obligations and whether the deposit was a temporary parking arrangement rather than an independent investment decision.

That places pressure on records created at the start of a project. Board approvals, project reports, machinery purchase agreements, land documents, technical know-how contracts, contractor arrangements, fund-flow statements, bank deposit records and book entries reducing pre-operative expenses can all help show whether the receipt arose from project-linked funds or from money left idle.

Revenue authorities, for their part, still retain a strong precedent where the money has no demonstrated tie to the project other than a later assertion that it would eventually be used there. The Delhi High Court did not say that all pre-commencement interest escapes tax. It said the tax result depends on the character of the deposit and the purpose the funds served when the interest accrued.

That leaves the VNG Automotive judgment as both a clarification and a warning. It clarifies that Delhi High Court judges will not apply Tuticorin Alkali mechanically where the record shows a direct project nexus. It also warns taxpayers that book treatment alone will not carry the case; the line between taxable interest and capital receipt still rests on whether the funds were truly surplus or remained bound to the project from the moment they were deposited.