2006 (8) TMI 640 - HC - Income Tax

Issues Involved:
1. Whether the Tribunal was justified in deleting the addition of Rs. 1,97,290 on account of interest and Rs. 9,80,000 on account of upfront fees by ignoring Explanation 8 to section 43(1) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Deletion of Addition of Rs. 1,97,290 on Account of Interest and Rs. 9,80,000 on Account of Upfront Fees:

The assessee, engaged in the business of yarn, filed its return of income for the assessment year 1992-93, declaring a taxable income of Rs. 3,59,86,351. The return was processed under section 143(1)(a) of the Income-tax Act, 1961 (the Act) at a total income of Rs. 3,60,04,130. Subsequently, the assessee filed a revised return declaring a taxable income of Rs. 3,48,09,071, claiming additional deductions of Rs. 1,97,290 on account of interest and Rs. 9,80,000 on account of upfront fees under section 36(1)(iii) of the Act. These claims were made for loans raised to set up a new unit at Baddi (HP).

The Assessing Officer disallowed these deductions, stating that the loan was raised for setting up a new unit, which was yet to commence commercial production. According to Explanation 8 to section 43(1) of the Act, interest for the period prior to the asset being put to use could not be allowed as revenue expenditure.

On appeal, the CIT(A) accepted the assessee's plea, holding that the new unit at Baddi was part of the existing business and merely an expansion. The CIT(A) relied on the Gujarat High Court judgment in CIT v. Alembic Glass Industries Ltd. [1976] 103 ITR 715 and distinguished the judgment in CIT v. Oswal Spg. & Wvg. Mills Ltd. [1986] 160 ITR 426.

The Tribunal upheld the CIT(A)'s order, stating that the new unit at Baddi was an expansion of the existing business. The Tribunal noted that the new unit and the old unit had common management, control, and funds, indicating that the new unit was not a separate business. The Tribunal supported its decision by referring to the Supreme Court judgment in CIT v. Associated Fibre & Rubber Industries (P.) Ltd. 236 ITR 471, which allowed interest on borrowed funds for the installation of machinery as revenue expenditure.

Legal Provisions and Interpretation:

Section 36(1)(iii) of the Act allows deductions for interest paid on capital borrowed for business purposes. However, the proviso specifies that interest paid for the acquisition of an asset for the extension of an existing business, until the asset is put to use, shall not be allowed as a deduction.

Explanation 8 to section 43(1) clarifies that interest paid in connection with the acquisition of an asset, for any period after the asset is first put to use, shall not be included in the actual cost of the asset. The object of this amendment, as explained in the Finance Bill, 1986, was to ensure that interest paid after the asset is put to use does not form part of the asset's cost.

The court noted that the natural consequence of Explanation 8 would be that interest paid before the asset is put to use should be capitalized and added to the cost of the asset. This interpretation aligns with the Supreme Court judgment in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167, which held that interest incurred before the commencement of production should be capitalized as part of the actual cost of the asset.

Judicial Precedents:

The court referred to the judgment in Oswal Spg. & Wvg. Mills Ltd., which held that interest paid on the acquisition of machinery should be treated as part of the cost of the machinery. Similarly, the Calcutta High Court in JCT Ltd. v. Dy. CIT [2005] 276 ITR 115 held that interest paid on loans for the acquisition of new assets, even in cases of business expansion, should not be treated as revenue expenditure.

Conclusion:

Given the earlier judgment in Oswal Spg. & Wvg. Mills Ltd. and the recent judgment in JCT Ltd., the court concluded that the question raised in the present appeal required consideration by a Larger Bench. The court directed that the papers be placed before the Hon'ble Acting Chief Justice for constituting a Larger Bench to hear the matter.

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