The Income Tax Appellate Tribunal (ITAT), Chandigarh Bench, has held that interest earned on unspent government grants parked in fixed deposits cannot be treated as an independent source of income for determining eligibility under Section 10(23C)(iiiab) of the Income Tax Act.

The bench of  Laliet Kumar (Judicial Member) and Manoj Kumar Aggarwal (Accountant Member) has ruled that the interest retains the same character as the original grants and directed the Income Tax Department to grant exemption to the educational society. 

The appellant/assessee is an educational society established for setting up and running an engineering college at Bilaspur, Himachal Pradesh, for the Assessment Year 2019-20.

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The case arose after the Assessing Officer (AO) reopened the assessment under Section 147 and denied the exemption available under Section 10(23C)(iiiab). Consequently, the AO assessed the society’s receipts of approximately ₹9.88 crore as business income after holding that the institution did not satisfy the requirement of being “wholly or substantially financed by the Government.” 

The educational institution had received Rs. 5 crore as Government grant, and Rs. 5 crore from NTPC for establishing the engineering college.

Since the college building was still under construction during the relevant year, the grants remained unutilized and were temporarily invested in fixed deposits. Interest accrued on these deposits.

The Assessing Officer included this interest income while calculating the institution’s total receipts of about ₹10.02 crore. Since the Government grant constituted only 49.89% of the total receipts, the AO concluded that the institution failed the requirement under Rule 2BBB, which requires Government financing to exceed 50% of total receipts for claiming exemption under Section 10(23C)(iiiab). Accordingly, the exemption was denied and the surplus was assessed as taxable business income. 

The society argued that it existed solely for educational purposes and not for profit.

It submitted that the State Government allotted land for establishing the engineering college. Funding for construction was provided by the Government along with NTPC and NHPC. During the relevant year, no educational activity had commenced because construction was still underway. The interest earned on fixed deposits represented merely an accretion to the unspent grants and was required to be utilized for the same project. Such interest could not be regarded as an independent source of income. 

The society also pointed out that in the immediately preceding assessment year, although proceedings had been reopened on similar grounds, its returned income had ultimately been accepted. 

After examining the financial statements and the nature of receipts, the ITAT observed that the institution had no independent source of income apart from Government grants and contributions received for establishing the engineering college.

The Tribunal noted that the college had not yet commenced operations. The only receipts apart from Government grants were interest earned on temporarily parked grant money. Such interest was incidental to the grants themselves. The interest retained the same colour and character as the original Government grants and could not be treated as a separate income source.

According to the Tribunal, once the interest was regarded as part of the grant itself, the institution was clearly substantially financed by the Government within the meaning of Rule 2BBB and therefore fulfilled the conditions prescribed under Section 10(23C)(iiiab). 

Allowing the appeal, the Chandigarh Bench directed the Assessing Officer to grant exemption under Section 10(23C)(iiiab) and accept the society’s returned income.

Since the quantum addition was deleted, the Tribunal also held that the consequential penalty proceedings under Section 270A could not survive and accordingly deleted the penalty as well. 

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