2003 (3) TMI 91 - HC - Income Tax

Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of the definition of the term interest under section 2(28A) of the Income-tax Act, 1961? - Whether the Appellate Tribunal was right in law and on the facts in deleting the disallowance under section 40(a)(i) of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195(1) of the Act? - Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes of the character of purchase price and therefore not liable to deduction at source under section 195(1) of the Act? - Whether the Appellate Tribunal was right in law and on facts in allowing the deduction under sections 80HH and 80-I to the assessee holding that ship breaking activity gives rise to manufacture and production of altogether a new article or thing? - Whether the Tribunal was right in holding that usance interest was not interest as envisaged in the Double Taxation Avoidance Agreements?

Issues Involved:
1. Whether the usance interest paid by the assessee apart from the purchase price of the ship falls within the scope of the definition of "interest" under section 2(28A) of the Income-tax Act, 1961.
2. Whether the Appellate Tribunal was correct in deleting the disallowance under section 40(a)(i) for the failure of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195(1).
3. Whether the Appellate Tribunal was correct in holding that usance interest partakes of the character of purchase price and therefore not liable to deduction at source under section 195(1).
4. Whether the Appellate Tribunal was correct in holding that usance interest is not interest as envisaged in the Double Taxation Avoidance Agreement (DTAA).
5. Whether the Appellate Tribunal was correct in allowing the deduction under sections 80HH and 80-I to the assessee, holding that ship breaking activity gives rise to manufacture and production of altogether a new article or thing.

Detailed Analysis:

1. Definition of "Interest" under Section 2(28A):
The court held that the usance interest paid by the assessee was not part of the purchase price of the ships but was "interest" within the meaning of section 2(28A) of the Income-tax Act, 1961. The definition of "interest" under section 2(28A) includes interest payable in any manner in respect of any moneys borrowed or debt incurred and includes any service fee or other charge in respect of the moneys borrowed or debt incurred. The court found that the purchase price and the usance interest were separately mentioned in the Memorandum of Agreement (MOA) and were treated as distinct items by both parties. The court also noted that the customs duty was paid only on the purchase price, excluding the usance interest, further supporting that the usance interest was not part of the purchase price.

2. Disallowance under Section 40(a)(i):
The court concluded that the assessees who did not deduct tax at source under section 195(1) on the usance interest payable outside India were not entitled to deduct the amounts of such usance interest in computing their income chargeable under the head "Profits and gains of business or profession." The court emphasized that the liability to deduct tax at source arises when the credit entry is made or when payment is made by any mode, whichever is earlier. The court rejected the argument that the payment made to the issuing bank in India absolved the assessees from the obligation to deduct tax at source.

3. Character of Usance Interest:
The court held that the usance interest partook of the character of interest and not of the purchase price. The MOA clearly separated the purchase price and the usance interest, and the interest was calculated on the purchase price for the period of credit. The court observed that the interest amount was treated separately in the accounts and customs duty was paid only on the purchase price. Therefore, the court concluded that the usance interest was interest payable on a debt incurred, i.e., the unpaid purchase price of the ship.

4. Usance Interest under DTAA:
The court held that usance interest is "interest" within the meaning of the article concerning taxation of interest in the relevant DTAAs. The DTAAs define "interest" as income from debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits. The court rejected the argument that the usance interest was part of the business profits and not interest. The court noted that the expression "debt claims of every kind" is broad and includes interest on deferred payment sales, even if not explicitly stated in the DTAA.

5. Ship Breaking Activity:
The court held that ship breaking activity is not an activity of manufacture or production of any article or thing for the purposes of availing of the benefit of deductions under sections 80HH and 80-I of the Income-tax Act, 1961. The court observed that ship breaking involves dismantling old ships and extracting existing materials, which does not result in the manufacture or production of new articles or things. The court emphasized that the benefit of sections 80HH and 80-I is intended for industrial undertakings engaged in the manufacture or production of new articles or things, not for activities like ship breaking that do not create new products.

Decision:
1. The usance interest paid by the assessees was not part of the purchase price of the ships and was interest under section 2(28A) of the Income-tax Act, 1961.
2. The assessees who did not deduct tax at source on the usance interest payable outside India are not entitled to deduct the amounts of such usance interest in computing their income.
3. The usance interest partook of the character of interest and not of the purchase price, and the assessees were liable to deduct income-tax thereon under section 195(1).
4. Usance interest is "interest" within the meaning of the article concerning taxation of interest in the relevant DTAAs.
5. Ship breaking activity is not an activity of manufacture or production of any article or thing for the purposes of sections 80HH and 80-I, and the assessees are not entitled to deductions under these sections.

The court set aside the impugned orders of the Tribunal to the extent they were challenged and allowed all the appeals with costs to be paid by the respondents assessees to the appellants, quantified at Rs. 10,000 for each appeal. The court rejected the prayer for a certificate of fitness for appeal to the Supreme Court and for staying the operation of the order.

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