2010 (1) TMI 949 - HC - Income Tax

Revenue or capital expenditure - assessee has claimed the entire pre-operation expenditure in respect of new industrial unit that was being set up Held that - Entire expenditure incurred for setting up of new industrial unit, though under expansion scheme, for the manufacture of product, is capital in nature section 37 prohibits granting of any deduction which is of a capital nature Deduction of interest on term loan borrowed for acquisition of plant and machinery Held that - Interest on borrowed funds for the acquisition of capital asset is not allowable as revenue expenditure until the asset is put to use and accrued interest until the asset is put to use by the assessee will only form part of actual cost for the purpose of depreciation and other allowances allowable under the Act - it is for the officer to verify whether interest is capitalised along with cost of plant and machinery and fixed assets, and if so interest component of the claim allowed by the Tribunal for the year 1997-98 will stand disallowed

Summary

Issues:
1. Allowability of pre-operation expenditure as revenue expenditure for setting up a new industrial unit.
2. Deduction of interest on term loan borrowed for acquisition of plant and machinery.

Issue 1:
The High Court addressed the question of whether pre-operation expenditure incurred for setting up a new industrial unit by expanding production is allowable as revenue expenditure. The assessee, engaged in manufacturing rubber chemicals, set up a new factory for the same product during the assessment years 1996-97 and 1997-98. The Revenue argued that interest paid on borrowed funds for plant and machinery acquisition should be part of the actual cost for depreciation, not a deduction. The Court referred to statutory provisions like section 36(1)(iii) and section 37(1) to analyze the nature of the expenditure. It concluded that the entire expenditure for the new industrial unit, though under expansion, is capital in nature, not revenue, as it was not commissioned. The Court differentiated between revenue expenditure for existing business and capital investments for future operations.

Issue 2:
Regarding the deduction of interest on term loan borrowed for plant and machinery acquisition, the Court examined the Supreme Court's decision in Core Health Care Ltd. The Revenue contended that the decision did not apply as it involved setting up a factory, not just purchasing machinery. The Court highlighted the proviso to section 36(1)(iii), which disallows deduction of revenue expenditure on borrowed funds until the asset is in use. It clarified that interest on borrowed funds for acquiring capital assets is not deductible as revenue expenditure until the asset is operational. The Court noted that the amendment introducing the proviso was clarificatory and applied even before its enactment. Despite these findings, the Court upheld the Tribunal's decision, citing consistency with the Supreme Court's ruling and potential amortization benefits under section 35D for certain expenditure items.

In conclusion, the High Court dismissed the Revenue's appeals, emphasizing the distinction between revenue and capital expenditure and the specific provisions governing deductions and allowances under the Income Tax Act. The Court highlighted the importance of correctly categorizing expenses and ensuring compliance with statutory requirements for claiming deductions.