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TMI Blog2008 (1) TMI 26X X X X Extracts X X X X X X X X Extracts X X X X ..... r the assessment year 1992-93: "(i) Whether on the facts and the circumstances of the case, the Hon'ble Income tax Appellate Tribunal was justified in deleting the addition of Rs. 1,97,290/- on account of interest and Rs. 9,80,000/- on account of upfront fees by ignoring Explanation 8 to Section 43(1)?" The assessee, who is engaged in the business of yarn, filed its return of income for the year in question on 30.12.1992, declaring its taxable income at Rs. 3,59,86,351/. The return was processed under Section 143 (1)(a) of the Income Tax Act, 1961 (for short 'the Act') on 6.1.1992 at a total income of Rs. 3,60,04,130/-. The assessee thereafter filed revised return on 6.8.1993 declaring a taxable income of Rs. 3,48,09,071/-. In the computation of income filed along with revised return, the assessee claimed additional deduction on account of Rs. 1,97,290/- and Rs. 9,80,000/-on account of interest under Section 36(1) (iii) of the Act and upfront fees, respectively. This claim was made on account of loans raised for set up of a new unit at Baddi (HP). In the revised return a detail note was given at Serial No. 9 that the assessee has set up a new unit, for the purpose of which, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... machinery and plant of old unit has been mortgaged to finance the new unit. The factual finding recorded by the learned Commissioner of Income-tax (Appeals) could not be challenged before us with reference to any material on record. The contention advanced on behalf of the Revenue that the learned Commissioner of Income-tax (Appeals) did not examine relevant question of common funds and common management and control, is not correct. As noted earlier, the plea on the above line was raised before the Assessing Officer and was not refuted in the assessment order. The Commissioner of Income-tax (Appeals) also examined the question is depth and decided the issue in favour of the assessee after elaborate discussion. We do not find any error in the approach of learned Commissioner of Income-tax (Appeals). The view taken in the impugned order is not only supported by the decision referred to by the learned Commissioner of Income-tax (Appeals) but is also supported by fourteen decision given in the paper Books of the assessee, the latest in line, being the decision of Hon'ble Supreme Court in the case of CIT Vs. Associated Fibre Rubber Industries (P) Ltd., 236 ITR 471. As it is a cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ew unit being set up at Baddi (HP) had not yet come into commercial production. The question for consideration in the present case is as to whether interest paid on borrowed capital for setting up of a new unit till such time it comes into commercial production, is deductible as the revenue expenditure under Section 36 (1)(iii) of the Act while computing the income of the assessee or to be treated as capital expenditure to be added to the cost of asset. Section 43 of the Act defines certain terms relevant to determine the income from business or profession. Subsection (1) thereof provides the definition of actual cost of an asset. Explanation 8 to Section 43(1) of the Act was added by the Finance Act, 1986 w.e.f. 1.4.1974. The object of the said amendment as contained in the Finance Bill, 1986 as it appeared in [1986] 158 ITR (St.) 88 is as under: "Under the existing provisions of clause (1) of that section, 'actual cost' means the actual cost of the asset to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. The proposed amendment seeks to clarify that any amount paid or payable as int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d such rule of accountancy should be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary. A perusal of Explanation 8 to Section 43(1) of the Act, referred to above, clearly shows that the same is nothing but reiteration of the principles laid down in M/s Challapalli Sugars' case (supra). The expression does not make any distinction whether the asset is acquired by the assessee for setting up of an entirely new business or in the process of expansion of its existing business or industry. It merely provides for determination of actual cost of asset on a date when the asset first is put to use. Unless an asset, which is being acquired, starts generating income, it cannot be said that the same is being used for the purpose of business. Once it is established that interest paid after asset is put to use is not to be included in the actual cost on asset. There would be no alternate but to hold that the interest paid before the asset was first put to use would be included in the actual cost thereof and has to be treated as capital expenditure and not revenue in nature. In Oswal Spinning's case ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... composite business of jewellery and cinema. The facts of the case are quite different with the facts of the present case. Keeping in view the earlier judgment of this Court in Commissioner of Income Tax v. Oswal Spinning and Weaving Mills Ltd. (supra) and also the recent judgment of Calcutta High Court in JCT Ltd. v. Deputy Commissioner of Income-tax and another (supra), addition of proviso in Section 36(1)(iii) of the Act, in our view, the question raised in the present appeal is required to be heard by a larger Bench. Accordingly, we direct that the papers be placed before Hon'ble the Acting Chief Justice for constituting a larger Bench". 2. The facts of the case in detail and relevant provisions of the Act have already been referred to in the reference order of Division Bench, and the same are not being repeated. 3. It is relevant to add here that proviso to Section 36(1)(iii) was added vide Finance Act, 2003 and the explanation 8 to Section 43(1) was added by Finance Act, 1986 w.e.f. April 1, 1974. The notes on clauses for addition of proviso to Section 36(1)(iii) and objects and reasons for amendment of Section 43(1), as reported in (2003) 260 ITR 13 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m to accept accounting practices, with a view to counteracting tax avoidance through this method and placing the matter beyond doubt, the Bill seeks to provide that any amount paid or payable as interest in connection with the acquisition of an asset and relatable to a period after the asset is first put to use shall not form part and shall be deemed never to have formed part of the actual cost of the asset. This amendment will take effect retrospectively from 1st April, 1974, and will, accordingly, apply in relation to the assessment year 1974-75 and subsequent years" (sic). 4. The proposed amendment seeks to clarify that any amount paid or payable as interest in connection with acquisition of an asset and relatable to a period after the asset is first put to use shall not form part and shall be deemed never to have been formed part of the actual cost of the asset. 5. In the above factual matrix, the following substantial question of law is required to be considered by this Court in the present appeal:-"Whether on the facts and the circumstances of the case, the Hon'ble Income tax Appellate Tribunal was justified in deleting the addition of Rs.1,97,290/- on account of ; ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nces of the case the interest paid by the assessee on the loan raised for acquisition of new assets upto the date of its coming into production, was to be capitalized and cannot be claimed as revenue expenditure. He relied upon judgment of Hon'ble the Supreme Court in Challapalli Sugar Limited's case (supra) and this Court in Oswal Spinning's case (supra). 9. On the other hand, Sh. Syali, learned senior counsel appearing for the assessee submitted that the appeal does not raise any substantial question of law for the reason that concurrent findings of fact recorded by CIT(A) and the Tribunal have not been challenged by claiming any issue on perversity thereof. The appeal to this Court under Section 260 A of the Act, which is akin to Section 100 CPC, would lie only on a substantial question of law and once the same is not there, the appeal itself would not be competent. For the purpose, reliance is placed on Mahalingappa v. C.M. Savitha (2005) 6 SCC 441, Rajeshwari v. Poran Indoria (2005) 7 SCC 60, State of Bombay (now Gujarat ) v. Jagmohandas (1966) 60 ITR 206 (SC), and Ishwar Dass Jain AIR 2000 SC 426. 10. On merits, it is submitt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... after insertion of explanation 8 to Section 43 retrospectively, w.e.f. April 1, 1974. Reference has been made to para 18.2 of circular of the CBDT bearing No.461 dated July 9, 1986, which reads as under:-"It is an accepted accounting principle that where an asset is acquired out of borrowed funds, the interest paid or payable on such funds constitutes the cost of borrowing and not the cost of asset acquired with those funds. It is for this reason that as per the clear guidelines issued by the Institute of Chartered Accountants of India, the interest on moneys which are specifically borrowed for the purchase of a fixed asset may be capitalized only relating to the period prior to the asset coming into production, i.e., relating to the erecting state of the asset. However, once the production starts, no interest on borrowings for the purchase of such assets should be capitalized. In spite of these clear guidelines, as also the consistent view of the Department in this matter, some taxpayers had adopted a contrary stance and had capitalized such interest". 13. Relying on above circular of the Board, the submission is that only object of the amendment was to restrict the claim of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fect that the provisions of Sections 36 and 43 of the Act are to be read in isolation, we do not find any merit in the same. It is noticed that both Section 36 and 43 of the Act form part of the same Chapter, rather the same sub-part thereof dealing with profits and gains of business or profession. Section 43 of the Act contains definitions of certain terms relevant to the determination of income from profits and gains from business or profession. One of the definition in Section 43(1) is of the term "actual cost of the asset". The dispute in the present case is as to whether the interest paid by the assessee on the loans raised for acquisition of new asset, before the same was first put to use, is to be added towards the cost of the asset or the same is to be granted as a revenue expenditure for the reason that the assessee was already in business. Meaning thereby that in case the claim made by the assessee is accepted and the interest so suffered by the assessee is allowed as a revenue expenditure the same will not be added towards the cost of the asset. Whereas in case the claim of the revenue is accepted, the same would result in addition of the component of interest on the bor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid by it on the capital borrowed for the purpose of setting up of new unit is to be treated as capital borrowed for the purpose of business or profession, the same would result in distortion of the actual profits earned by the assessee in the business already being carried on by it. The new unit set up with the borrowed capital, the interest whereon is sought to be claimed as revenue expenditure, had not yet started contributing to the business carried on by the assessee. It is only when an asset is first put to use and commercial production starts then it starts generating income and it would be in the fitness of things in case the interest on the capital borrowed for the purpose of acquisition of that asset is allowed as a revenue expenditure only when such asset starts yielding income and not for any period prior thereto. For the period prior thereto the same has to be capitalised. 18. The issue as to whether the interest component on the capital borrowed for acquisition of the asset upto the date it is first put to use is to be added towards the cost of the asset or allowed as a revenue expenditure was considered by Hon'ble the Supreme Court in Challapalli Sugar Limited' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Rs. 23,53,284 being the amount of interest paid on monies borrowed as part of the actual cost for the purposes of depreciation allowances and development rebate?" In appeal before us Mr. Palkhivala, on behalf of the assesses in the three appeals, has argued that interest for the period before the commencement of production on money borrowed for the purpose of acquiring and installing the machinery and plant should be included in the actual cost of the plant and as such capitalized for the purpose. As against that, Mr. Desai, on behalf of the revenue, has supported the view taken by the Andhra Pradesh High Court. After hearing the learned counsel for the parties, we are of the opinion that the submission made by Mr. Palkhivala is well founded". "It would appear from the above that, while considering the question of deduction on account of depreciation and development rebate, we have to take into account the written down value. Written down value in its turn depends upon the actual cost of the assets to the assessee. The expression "actual cost" has not been defined in the Act, and the question which engages our attention is whether the interest paid before the commencement o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... page 190-191, under the head "Interest Payable Out of Capital During Construction" : "Interest on debentures issued for a similar purpose can be charged to capital during the period of construction ( Hinds v. Buenos Ayres Grand National Tramways Co. Ltd. )" In Higher Book-keeping Accounts by Cropper Morris Fison, seventh edition, it is observed as under: "Capital expenditure over a long period must perforce involve the question of interest as an additional cost. If the work were undertaken by an independent contractor he would, of course, take interest into account when preparing the estimates on which to base his tender. The final cost of construction work is made up of the cost of the machinery, materials, labour, supervision and establishment charges, plus interest on the capital employed which, but for its employment in that way, would be invested in good securities paying a reasonable rate of interest." Section 208 of the Companies Act, 1956 (1 of 1956), deals with the payment of interest on share capital in certain contingencies. Sub-section (1) of that section reads as under:-"(1) Where any shares in a company are issued for the purpose of raising money to defr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the purchase of a fixed asset may be capitalized prior to the asset coming into production, i.e., during the erection stage. However, once production starts, no interest on borrowings for the purchase of machinery (whether for replacement or renovation of existing plant) should be capitalized…" It would appear from the above that the accepted accountancy rule for determining the cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before commencement of production on such borrowed money can be capitalized and added to the cost of the fixed assets which have been created as a result of such expenditure. The above rule of accountancy should, in our view, be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary." 19. In Sivakami Mills' case (supra), Madras High Court quoted with approval a passage from the publication of the Institute of Chartered Accountants of India in the follo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company which commenced production from November 15, 1967. Though initially the Assessing Officer did not allow development rebate to the assessee by adding the interest in the cost of building. However, the Tribunal finally accepted the claim. On a reference sought by the revenue against the order of the Tribunal the question was answered in favour of the assessee by holding that the assessee was entitled to add the interest component incurred on the loans raised for setting up of plant, building and machinery. The following observations by the Full Bench would be relevant:- "We prefer the view taken by the Calcutta and Delhi High Courts. We are of the opinion that interest paid on borrowed capital, till the building, plant or machinery is erected or constructed, is part of the actual cost to the assessee within the meaning of Section 33 read with Section 43 of the Income-tax Act, 1961. This seems to us to be in accordance with both popular and commercial conceptions. Once it is recognized that a building, plant or machinery can be constructed or erected with borrowed capital, if the question be put : "How much did it actually cost you to build the house or to erect the plant o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... will not depict its true picture. This is in conformity with law and the accounting principles. 23. Now we may deal with the effect of addition of proviso of Section 36(1)(iii) added vide Finance Act 2003. The import of addition of proviso to Section 36(1)(iii) is that the interest paid on the capital borrowed for the purpose of acquisition of an asset till the date such an asset is first put to use shall not be allowed as deduction. This is borne out as a converse proposition vide explanation 8 to Section 43(1) and a combined reading of Section 36(1)(iii) and Section 43(1) shows that the same is in consonance with the law laid down by Hon'ble the Supreme Court in Challapalli Sugar Limited's case (supra), wherein it is provided that any amount of interest paid on the capital borrowed for the purpose of acquisition of the asset upto the date it is first put to use is to be added towards the cost of the asset. Though proviso to Section 36(1)(iii) was added vide Finance Act, 2003 but in our opinion the same is merely clarificatory as it has made explicit what was already implicit. 24. A reading of memorandum explaining the amendment to Section 43(1) of the Act by way of i ..... 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