2018 (8) TMI 50 - AT - Income Tax

Disallowance of interest expenditure u/s 36(1)(iii) - borrowed funds utilized for installation of captive power plant which has not been put to use during the assessment years in question - Held that - The condition that borrowing must have been made for the purpose of business being carried on by the assessee in the previous year is implicit or inbuilt in Section 36(1)(iii) of the Act itself. The captive power plant was intended for pharmaceutical business as per the consistent stand of the assessee since inception. There is no rebuttal on this account. It is a matter of record that the assessee has entered into Sale & Lease Back Agreement of captive power plant with the lenders with a view to reduce financial costs. Notwithstanding, the assessee throughout is engaged in the business of pharmaceutical and therefore, interest incurred on power plant incidental to pharma unit is allowable deduction on revenue account. The power plant ultimately taken back on lease is nothing but the expansion/incidence of existing business. Thus, dis-investment and gaining control over the asset by way of lease would not, in our view, change the character of claim. Thus, we do not find any infirmity in the order of the CIT(A) in adjudicating the issue in favour of the assessee. We also take note of significant plea raised on behalf of the assessee that the assessee executed sale & lease back equipment lease agreement with Industrial Development Bank of India on 26.09.1996 relevant to AY 1997-98. We thus also find merit in the alternative plea raised in this regard that where the equipment was sold and company is not the owner of the asset at all, the interest on subsisting loans/borrowing cannot be attributed any longer to the assets so divested. While the power generation asset has been sold, the subsisting loans/borrowings has remained and continued in the books of accounts and used for the purpose of existing and ongoing business of the assessee company in revenue account. Thus, interest on loan amount presently used in ongoing pharma business is allowable otherwise also. - Decided against revenue

Issues Involved:
1. Allowability of interest expenditure under section 36(1)(iii) of the Income Tax Act, 1961.
2. Classification of interest expenditure as revenue or capital in nature.
3. Applicability of Explanation 8 to Section 43(1) of the Income Tax Act.
4. Impact of the proviso to Section 36(1)(iii) inserted by Finance Act 2003.
5. Implications of the intention to divest the captive power plant on the allowability of interest expenditure.

Issue-wise Detailed Analysis:

1. Allowability of Interest Expenditure under Section 36(1)(iii):
The core issue was whether the interest expenditure incurred by the assessee for the installation of a captive power plant qualifies for deduction under section 36(1)(iii). The assessee argued that the borrowed funds were for business purposes, specifically for backward integration to reduce power costs for its pharmaceutical business. The Tribunal upheld the CIT(A)’s decision, which allowed the interest expenditure as a revenue expense, emphasizing that the borrowed capital was for the purpose of business, fulfilling the conditions of section 36(1)(iii).

2. Classification of Interest Expenditure as Revenue or Capital:
The Assessing Officer (AO) disallowed the interest expenditure, treating it as capital expenditure because the power plant was not operational and was marked for disinvestment. However, the CIT(A) and the Tribunal found that the interest expenditure was for the expansion of the existing business and should be treated as revenue expenditure. The Tribunal noted that the power plant was intended to reduce operational costs and was part of the same business line.

3. Applicability of Explanation 8 to Section 43(1):
The AO invoked Explanation 8 to Section 43(1) to justify capitalizing the interest expenditure. However, the Tribunal, referencing the Supreme Court's decision in the assessee’s own case, clarified that Explanation 8 to Section 43(1) is not relevant to Section 36(1)(iii). The Tribunal emphasized that the interest on borrowed capital for business purposes is deductible, irrespective of whether the capital is used for acquiring a capital or revenue asset.

4. Impact of the Proviso to Section 36(1)(iii) Inserted by Finance Act 2003:
The Tribunal discussed the proviso to Section 36(1)(iii), which mandates capitalization of interest for assets not put to use, effective from 01.04.2004. Since the assessment years in question were prior to this amendment, the Tribunal concluded that the proviso does not apply retrospectively. Thus, the interest expenditure was allowable as per the law applicable during the relevant assessment years.

5. Implications of the Intention to Divest the Captive Power Plant:
The AO contended that the intention to divest the power plant negated the claim of the interest being for business purposes. The Tribunal, however, found that the initial purpose of setting up the plant was for the business's operational efficiency. The subsequent decision to divest due to financial difficulties did not alter the nature of the expenditure. Moreover, the Tribunal noted that the power plant was sold and leased back, indicating its continued use for business purposes.

Conclusion:
The Tribunal upheld the CIT(A)’s order, allowing the interest expenditure as a revenue expense under section 36(1)(iii). It dismissed the Revenue's appeals, reiterating that the interest on borrowed funds for the captive power plant was for business purposes and thus deductible, irrespective of the plant's operational status or the subsequent intention to divest. The Tribunal emphasized the distinction between the borrowing of capital and its application, aligning with the Supreme Court's interpretation in the assessee’s own case.

← Previous Next →