2020 (9) TMI 237 - AT - Income Tax

Disallowance of interest expenditure - As per AO interest attributable to bring the inventory to its present location and condition should be included in the cost of inventory - AO computed interest attributable to the inventory by adopting prime lending rate of 12.75% determined by the State Bank of India - CIT(A) deleted the disallowance - HELD THAT - There is no dispute with regard to the fact that the inventories held by the assessee are current assets and hence the requirement of capitalising the interest does not arise, as per the proviso to section 36(1)(iii) of the Act mandates capitalization of interest only in respect of capital assets purchased out of borrowed funds. We also notice that the method of valuation adopted by the assessee also gets support from Accounting Standard 2 issued by ICAI. A.R. also submitted that the newly introduced ICDS though applicable in the subsequent year also supports the methodology adopted by the assessee. Decision rendered by the Ld. CIT(A) is in consonance with the decision rendered by the coordinate bench in the case of JSR Constructions 2016 (7) TMI 943 - ITAT BANGALORE we do not find any infirmity in the decision rendered by Ld. CIT(A) on this issue. - Decided against revenue.

Summary

Issues Involved:
1. Disallowance of interest expenditure by the Assessing Officer (A.O.).
2. Attribution of interest expenses to inventory valuation.
3. Applicability of Section 36(1)(iii) of the Income Tax Act.
4. Compliance with Accounting Standard (AS) 2 and Income Computation and Disclosure Standard (ICDS) for inventory valuation.
5. Precedents and judicial decisions relevant to the case.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Expenditure by the A.O.:
The primary issue in this case is the disallowance of interest expenditure amounting to ?1.53 crores by the A.O. The A.O. observed that the assessee did not have surplus funds equivalent to its inventory value and hence concluded that the loan funds were used for purchasing the inventory. Consequently, the A.O. determined that the interest expenditure should have been capitalized as part of the inventory cost, leading to the disallowance.

2. Attribution of Interest Expenses to Inventory Valuation:
The A.O. argued that the interest attributable to bringing the inventory to its present location and condition should be included in the inventory cost. This was computed based on the prime lending rate of 12.75% determined by the State Bank of India. The Ld. CIT(A) deleted this disallowance, stating that interest costs attributed to loans for financing normal trading activities are period costs and should be charged to the profit and loss account, not capitalized into inventory.

3. Applicability of Section 36(1)(iii) of the Income Tax Act:
The appellant argued that Section 36(1)(iii) allows for the deduction of interest paid on capital borrowed for business purposes, except when used for acquiring a capital asset. Since the loan was utilized for working capital, the interest should not be capitalized. The Ld. CIT(A) agreed, emphasizing that the proviso to Section 36(1)(iii) mandates capitalization of interest only for capital assets, not current assets like inventory.

4. Compliance with AS 2 and ICDS for Inventory Valuation:
The appellant relied on AS 2, which states that interest and borrowing costs are usually not included in the cost of inventories. This standard was supported by the Income Computation and Disclosure Standard (ICDS) II, which also excludes borrowing costs from inventory valuation. The Ld. CIT(A) noted that the appellant's method of inventory valuation was in line with AS 2 and ICDS, thus justifying the exclusion of interest costs from inventory valuation.

5. Precedents and Judicial Decisions:
The appellant cited the decision of the Bangalore ITAT in the case of JSR Constructions (P) Ltd, where it was held that interest costs related to loans for normal trading activities should be charged to the profit and loss account and not included in inventory costs. The Ld. CIT(A) found this precedent relevant and applicable, further supporting the appellant's position.

Conclusion:
The Tribunal upheld the decision of the Ld. CIT(A), agreeing that the interest expenditure should not be capitalized into inventory costs. The Tribunal emphasized that the inventories held by the assessee are current assets and not capital assets, and thus the capitalization of interest does not apply as per Section 36(1)(iii). The Tribunal also acknowledged that the appellant's method of inventory valuation complied with AS 2 and ICDS, and the judicial precedent in the case of JSR Constructions (P) Ltd was appropriately applied. Consequently, the appeal filed by the revenue was dismissed.