K.C. Singhal, Judicial Member.

1. The only issue arising in this appeal is whether the assessee is entitled to exemption under section 10B in respect of interest income of Rs. 18,77,170 on fixed deposits.

2. Briefly stated the facts are that the assessee was engaged in the business of export and was eligible for exemption under section 10B being 100% Export Oriented Unit. In view of the same, the assessee declared NIL income after adjusting brought forward losses of the earlier years. In the course of assessment proceedings, it was noticed by the Assessing Officer that the total income declared by the assessee included the interest of Rs. 18,77,171 which was earned from FDRs with the Bank of Baroda, Sonepat. The assessee was asked to show-cause as to why such income should not be treated as Income from Other Sources.

3. The explanation of the assessee was as under :—

"Company had during the financial year 1996-97 had earned interest income of Rs. 27,02,538. The breakup of which has been submitted with your office vide separate letter of even date. With regard to interest income of Rs. 18,77,171 on FDRs deposited with Bank of Baroda, Sonepat, we wish to submit that this income is part of Business income, because the FDRs were given to bank in order to achieve the deposit target of the branch. This money was withdrawn from our PC/CC account maintained with the branch. Simultaneously, the company took loan against the FDR and utilized the money for its normal business activities. As you may appreciate that our company has substantial loan outstanding with the banks as on 31-3-1997 and company being a biggest customer of Bob, Sonepat branch had to keep harmonious relation with the branch manager and had contributed towards its target achievement by giving FDR deposits, though we had no surplus funds. And in order to keep our liquidity in place, immediately loan against FDR was taken. We are enclosing herewith a certificate from the bank, which clearly states that loan facilities sanctioned to the company and FDRs kept as security with the bank."

4. However, the Assessing Officer was not satisfied with the above explanation of the assessee in as much as he was of the view that these FDRs were purchased out of the surplus funds. Accordingly, he treated the said income as "Income from Other Sources". Consequently, the exemption was denied in respect of the interest income.

5. The matter was carried in appeal before the CIT(A) before whom it was submitted that the assessee company did not have any surplus funds during the year and the fixed deposits of Rs. 50 lakhs were made out of the common business funds. According to the assessee, these Fixed Deposits were made out of the Packing Credits of Rs. 1.25 crores and in support thereof, a copy of bank account was placed before him. The assessee also pleaded the justification for taking such loans in the context of its relationship with the banking institution. Alternatively, it was also pleaded that the interest paid on loan against the FDRs should be adjusted against the interest on FDR. However, the CIT(A) was not convinced with the submissions of the assessee and accordingly the order of the Assessing Officer was upheld by him. Aggrieved by the same, the assessee is in appeal before the Tribunal.

6. The ld. Counsel for the assessee has raised various contentions in order to assail the findings given by the CIT(A) and the Assessing Officer. Firstly, he has raised a legal contention to the effect that the interest income, irrespective of the head under which it is to be assessed, cannot be taxed in view of the language employed by the Legislature in section 10B under which exemption is claimed by the assessee. He drew our attention to point out that the Legislature used the expression "any profits and gains" in section 10B relevant to the year under consideration in comparison to the expression such profits and gains used in the amended section 10B effective from 1-4-2001. According to him the word ‘any’ would take within its ambit of all types of income and therefore the interest income would also exempt even assuming it is assessable under the head "Income from Other Sources". We are unable to accept such contention of the ld. Counsel of the assessee for two reasons. Firstly the Legislature has referred to the expression ‘profits and gains’ in comparison to the word ‘income’, which is of the widest amplitude. The word ‘income’ has been defined in clause 24 of section 2 which includes not only profits and gains but also various other income like dividend, perquisites, capital gains etc. etc. The business income is separately assessed under a specified head, "profits and gains of business or profession". In various sections under Chapter VI-A, the Legislature has used the words ‘profits and gains’, which also referred to the business income. Therefore, in view of the scheme of the Act, we are of the view that the expression any profits and gains would not include the income assessable under the head "Income from Other Sources". There is another reason for rejecting the contention of the ld. Counsel of the assessee. The expression any profits and gains is qualified by the words "derived by an assessee from a 100% Export Oriented Undertaking". The words derived from have not been defined for the purpose of section 10B like section 80HHC and therefore its meaning has to be considered in the restricted sense as interpreted by the Hon’ble Supreme Court in various judgments including Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84. [LQ/SC/1978/133] Therefore, only those profits and gains are to be exempted under section 10B which have direct and proximate relationship with the activities referable to Export Oriented Unit. Therefore, it cannot be said that income assessable under the head ‘Income from Other Sources’ can be exempted under section 10B. In view of the above discussion, the contention of the ld. Counsel for the assessee is hereby rejected.

7. The next contention of the ld. Counsel for the assessee is that the interest income accruing on FDRs could not be assessed as "Income from Other Sources" in as much as these Fixed Deposits were not purchased out of the surplus funds. It was maintained by him that all these FDRs were made out of the borrowed funds i.e., against the Packing Credit Limit sanctioned by the Bank and in order to have the liquidity of the funds, the assessee had to take loans against the security of such FDRs. This fact itself shows that there were no surplus funds with the assessee and consequently lower authorities wrongly held that the interest income was assessable under the head "Income from Other Sources". On the other hand, the ld. DR had strongly relied on the orders of the lower authorities.

8. After hearing both the parties at length, we are in agreement with the submissions of the ld. Counsel for the assessee on this aspect of the matter. We have gone through the order of the Assessing Officer and we do not find any reference to any material on the basis of which it could be said that such FDRs were made out of surplus funds. The submissions of the assessee before him that these FDRs were made out of the Packing Credit Limit have not been controverted by the Assessing Officer. The finding of the Assessing Officer in this regard is not based on any material or evidence on record. The CIT(A) has also not given any reason for upholding the finding of the Assessing Officer that FDRs were made out of surplus funds. Accordingly, we are of the view that interest income could not be assessed under the head "Income from Other Sources". Considering the fact that these FDRs were made out of Packing Credit Limit and the fact that the loans were taken against the security of these FDRs in order to maintain the liquidity, we are of the view that such interest income was attributable to the business activity of the assessee and, therefore, assessable as business income.

9. The next contention of the assessee’s counsel is that if interest income is held to be assessable as business income then assessee is entitled to exemption under section 10B in respect of such income. In support of this contention, he relied on the judgment of Bombay High Court in the case of CIT v. Punit Commercial Ltd. [2000] 245 ITR 550. [LQ/BomHC/2000/765] Alternatively it has been contended that if it is to be taxed then net interest income should be taxed. He drew our attention to page 25 of the paper book to point out that assessee had paid interest of Rs. 18,26,851 on loans taken against such FDRs and therefore, it was pleaded that the same has to be allowed as set off against such interest income. The ld. DR has relied on the order of the CIT(A).

10. In our view the main contention of the assessee’s counsel cannot be accepted. The exemption under section 10B is allowable only in respect of profits and gains derived by the assessee from 100 per cent Export Oriented Unit and not in respect of each and every item of income assessable as business income. The Legislature was well aware of the distinction between the scope of words ‘derived from’ and ‘attributable to’. It had used both the expressions wherever it was considered necessary. Further, where the Legislature wanted to give larger meaning to the expression ‘derived from’ it has defined such expression. Reference can be made to the provisions of section 80HHC where in sub-section (1) the deduction is allowable in respect of the profits derived from exports while in sub-section (3), profits derived from export has been defined by enlarging its natural meaning. According to this sub-section, such profits would amount to profits and gains computed under the head "profits and gains of business or profession". But there is no such definition for the purpose of section 10B. Therefore, the expression ‘derived from’ in section 10B shall have to be construed in the restricted sense as held by the Hon’ble Supreme Court in the case of Cambay Electric Supply Co. Ltd. (supra). According to the Apex Court, such profits would refer to the income arising from the immediate source and not indirect source. It is in this sense, the meaning of the words "derived from" has to be construed for the purpose of section 10B.

11. The Hon’ble Supreme Court had to construe the meaning of the words "derived from" in the case of CIT v. Sterling Foods [1999] 237 ITR 5791. In that case, the assessee had received import entitlements against the exports made by it, which were sold by it in the year under consideration. The question arose whether profits on the sale of import entitlements could be considered as profits derived from Industrial Undertaking in the backward areas under section 80HH. The Apex Court held that immediate source was import entitlements and not the exports effected by the Undertaking and therefore assessee was not entitled to deduction under section 80HH. This makes it clear that even though the import entitlements were connected with the exports of the industrial undertaking yet it was held that the profits on sale of import entitlements could not be considered as profits derived from industrial undertaking as there was no direct nexus.

12. Recently the Apex Court again considered this issue in the case of Pandian Chemicals Ltd. v. CIT [2003] 262 ITR 278.2 In that case, the assessee had to make certain deposits with the Electricity Board for getting electric connection for running of industrial unit. The assessee earned interest on such deposits and claimed deduction under section 80HH in respect of such interest. The Apex Court held that such interest income could not be said to be derived from industrial undertaking.

13. The above analysis shows that all business income of an undertaking do not fall within the ambit of profits derived from an undertaking. Therefore, in our opinion, if an income accrues to the assessee directly from the main activity of the undertaking, then only such income can be said to be profits derived from such undertaking. However, where income accrues from an activity which is incidental to main activity then such income would fall within the expression ‘attributable to’ which is of wide amplitude. For example, if interest income is received on delayed payments from the persons to whom the goods are sold, it would directly relate to the main activity of the undertaking and consequently would fall within the scope of the words ‘derived from’ but where the interest is received from other transactions which are independent and not connected with the main activity but are incidental to such activity then such interest income would fall within the expression ‘attributable to’ and not within the expression ‘derived from’.

14. In the present case, the fixed deposits were made with the banks to facilitate them to achieve their target of fixed deposits. This was done only to maintain good relationship with its bankers. There was not even any compulsion for making such deposits. Though the facts of the case indicate that such income was assessable as business income but it cannot be said that such income directly arose from the main activity of export business. Hence such income cannot be said to be derived from 100 per cent Export Undertaking.

15. Further, we are in agreement in principle with the alternate contention of assessee’s counsel that if any interest is paid for earning such income then only net income has to be excluded from the total business income. Before us, the ld. Counsel of the assessee pleaded for setting off of the interest paid on loans taken against security of FDRs. We are not able to accept such submissions of the assessee’s counsel in view of the Supreme Court judgment in the case of Gopinathan where the Apex Court held on similar arguments that interest paid on loans against FDRs could not be set off against interest income on FDR as there was no direct nexus between these two items of interest.

16. However, we cannot close our eyes to the actual facts available from record. The explanation of the assessee shows that FDRs were made from Packing Credit Account. If this fact is correct, then interest paid on such borrowings would have direct nexus with interest earned on FDRs. However, it is to be kept in mind that so many times interest free funds are put by the assessee in such overdraft account in addition to the profits of the business. The Tribunal has been holding consistently that where interest free advances are made out of overdraft account then interest paid to bank is disallowed under section 36(i)(ii) only where there is direct nexus between the interest bearing borrowed funds and interest free advances and not otherwise. On the same reasonings, set off of interest paid would be allowed if there is a direct nexus between interest bearing borrowed funds and the FDRs made by the assessee. Therefore, if it is proved on record that interest free funds are deposited in the overdraft account and out of that any FDR is made then no set off is allowable. On the contrary if it is proved that interest bearing funds were utilized for making fixed deposits then interest paid to bank would have to be allowed as set off against interest on FDRs. In the present case, no such exercise is made by any authority. Therefore, in our opinion, interest of justice would be met if the matter is restored to the file of the Assessing Officer for limited purpose of verifying the above fact. Accordingly, the order of the CIT(A) is set aside and the matter is restored to the file of the Assessing Officer for fresh adjudication in the light of guidance provided by us.

17. In the result, the appeal of the assessee is allowed for statistical purposes.