2022 (2) TMI 915 - AT - Income Tax

Disallowance of interest expenses u/s. 36(1)(iii) - disallowance of financial cost attributable to capital work in progress and project work in progress - Admittedly, the assessee has huge borrowings from banks and financial institutions and when the loan was not taken for any specific purpose of acquiring of asset or execution of any project, then interest need not be capitalized to the work in progress account - HELD THAT - We do not subscribe to the arguments taken by assessee for simple reason that when the assessee is debiting all direct and indirect expenses to project work in progress account, then it ought to have capitalized interest attributable to said project work in progress, when there was no revenue generation from said project. We further noted that as per principles of matching concept of accounting, specific cost relatable to income revenue segment needs to be capitalized, including interest if any, incurred on said project. In this case, it was claim of the assessee that although it has paid huge interest on borrowings from banks and financial institutions, but said loans have not taken for any specific purpose. At the same time, the assessee is also unable to explain with necessary evidence to prove that loans taken from banks and financial institutions are not for any specific purpose of acquisition of any asset or execution of project. Therefore, we are of the considered view that the issue needs to go back to file of AO to ascertain correct facts with regard to nature of loan taken by the assessee and purpose for which such loans were taken. In case, the assessee has taken any loan for specific purpose of acquisition of asset or execution of project, then interest attributable to said purpose needs to be capitalized to work in progress account. Hence, we set aside the issue to file of the AO and direct to re-examine claim of the assessee in accordance with law - Assessee appeal allowed for statistical purposes.

Summary

Issues Involved:
1. Disallowance of finance cost attributable to Capital Work in Progress (CWIP) and Project Work in Progress (PWIP).
2. Consistency of the assessee's accounting method with Accounting Standard AS-16.

Issue-wise Detailed Analysis:

1. Disallowance of Finance Cost Attributable to CWIP and PWIP:
The assessee, engaged in manufacturing, installation, commissioning, and maintenance of windmills, filed returns showing losses. The Assessing Officer (AO) noticed significant borrowings and interest expenses but found that the assessee did not allocate interest costs to CWIP and PWIP. The AO disallowed ?19,08,81,851/- of interest expenses under section 36(1)(iii) of the Income Tax Act, 1961, arguing that these should be capitalized as they relate to CWIP and PWIP.

The CIT(A) upheld the AO's decision, referencing judicial precedents such as the Supreme Court's decision in Challapalli Sugars Ltd. Vs. CIT, which mandates capitalizing all expenditures necessary to bring assets into existence. The CIT(A) concluded that the principle of capitalizing interest costs related to asset acquisition or project execution is consistent with the matching principle in accounting.

2. Consistency of the Assessee's Accounting Method with AS-16:
The assessee contended that its method of accounting, which charges interest on general borrowings to the Profit & Loss account and capitalizes interest on specific borrowings, aligns with Accounting Standard AS-16. The assessee argued that since the loans were not for specific purposes, the interest should not be capitalized.

The Tribunal found the assessee's argument unconvincing, noting that when direct and indirect expenses are debited to PWIP, interest attributable to these projects should also be capitalized, especially when no revenue is generated from these projects. The Tribunal emphasized the need to adhere to the matching principle, which requires capitalizing specific costs related to income revenue segments, including interest on projects.

The Tribunal directed the AO to re-examine the nature and purpose of the loans. If loans were taken for specific purposes, the interest should be capitalized to the work in progress account. The Tribunal set aside the issue to the AO for further examination in accordance with the law.

Conclusion:
The Tribunal allowed the appeals for both assessment years 2013-14 and 2014-15 for statistical purposes, directing the AO to re-examine the nature of the loans and the necessity of capitalizing the interest costs in line with the matching principle and judicial precedents. The order was pronounced in open court on 9th February 2022.