INTEREST ON BORROWED CAPITAL -- SECTION 36(1)(iii)
This query is : Resolved
18 April 2011
MY CLIENT HAS EXPANDED HIS EXISTING BUSINESS DURING ASS. YEAR 2007-08 BY INSTALLING NEW PLANT AND MACHINERY FOR THE MANUFACTURE OF SAME EXISTING PRODUCTS AT THE SAME PREMISES BY AVAILING TERM LOAN FROM THE BANK.BUT THE PLANT AND MACHINERY WAS NOT PUT TO USE DURING THE SAME ASS. YEAR. THE CASE OF MY CLIENT WAS FINALISED U/S 143(3)NOW THE INCOME TAX DEPARTMENT, ON THE BAIS OF AUDIT OBJECTION, WANTS TO DISALLOW THE INTEREST ON TERM LOAN PAID FOR THE INSTALLATION OF PLANT AND MACHINERY PURCHASED BY BORROWED FUNDS. PLEASE ENLIGHTEN ME ON THE SAID SUBJECT HOW SHOULD I DEAL WITH THEM? ALSO PLEASE QUOTE ANY CASE LAW, IF ANY.
THANKS
(CA. AJAY BANSAL)
CELL: 9855652696
THANKS
(CA. AJAY BANSAL)
CELL: 9855652696
18 April 2011
Under such circumstance the A.O. might have issued notice u/s. 154 proposing to rectify the assessment order passed. You should give reply like this;
1. There is no primafacie mistake apparent from the face of record so as to invoke sec. 154 to correct the assessment order passed. No amendment/correction can be made in the assessment order on the basis of audit objection. The audit objection is for the purpose A.O. to take due care in future on such issues but not to make amendment/correction in the original order passed. All the facts and records were made available during the course of hearing. Case was discussed at length. The A.O. has correctly allowed the interest paid on such loans by considering the facts of the case.
2. Even if the asset was not put to use , it was purchased and lying within the factory for installation which is deemed use of plant and machinery. No deprection can be allowed untill and unless the machinery is put to use but there is no such bar in claiming the interest on loan.
Dear friend there are various case laws in which it was held that no rectification can be made on the basis of audit objections because no mistake came to the notice of A.O. but it was pointed out by the audit party in their report. It is now settled law that no addition can be made on the basis of objection raised by audit party. Even if department want to make any adition let them invoke order u/s. 263/264 of the income tax act. Nothing to worry you will succeed. Even if the interest is disallowed then prefer appeal you will certainly get the relief.
1. There is no primafacie mistake apparent from the face of record so as to invoke sec. 154 to correct the assessment order passed. No amendment/correction can be made in the assessment order on the basis of audit objection. The audit objection is for the purpose A.O. to take due care in future on such issues but not to make amendment/correction in the original order passed. All the facts and records were made available during the course of hearing. Case was discussed at length. The A.O. has correctly allowed the interest paid on such loans by considering the facts of the case.
2. Even if the asset was not put to use , it was purchased and lying within the factory for installation which is deemed use of plant and machinery. No deprection can be allowed untill and unless the machinery is put to use but there is no such bar in claiming the interest on loan.
Dear friend there are various case laws in which it was held that no rectification can be made on the basis of audit objections because no mistake came to the notice of A.O. but it was pointed out by the audit party in their report. It is now settled law that no addition can be made on the basis of objection raised by audit party. Even if department want to make any adition let them invoke order u/s. 263/264 of the income tax act. Nothing to worry you will succeed. Even if the interest is disallowed then prefer appeal you will certainly get the relief.
13 February 2012
Earlier it was decided in Core Health care case but after insertion of proviso w.e.f. 01.04.2004 the law has been changed and ITO is right in your case
Though i am submitting my analysis in this case.
The learned officer has disallowed the interest cost of Rs 16,87,06,911 using his own presumption the however the basis and presumption which he has taken was not justified as well as it is challengeable and it is without considering other available option. Further penalty u/s 271(1)( c ) was imposed. Though the case is very technical debatable and various case laws has been made on this and on the basis of that ground the learned officer can not imposed the penalty u/s 271 (1) ( c ) and with the plain reading of section 36(1)(iii) and Proviso of this section he can not allowed this.
Our submission to seeking relief against this order are categorized in following preference
Fact of the cases with reference to section 36(1)(iii)
1- Loan Taken in starting at Initial Stage as per Single Integrated Project
2. All the loan was sanctioned before start of commercial production
3. All the loan was sanctioned at a time initially
( See Loan Sanction Copy Attached Herewith )
4- No Extension and No loan taken for any extension of existing because all disbursement has been made initially
5- Interest paid for initial loan taken no loan taken further and no extension further
A : As per section 36(1)(iii) it is allowable expenditure as proviso is not applicable in our case
1. Analysis of Proviso of Section 36(1)(iii) & Proviso
2. Section Silent
3. Intention of law Behind the Proviso of Section 36(1)(iii)
4. Debate between 36(1)(iii) & Explanation 8 to S. 43(1)
5. Test of Proviso of Section 36(1)(iii) with the fact of the present case
B: Concept of Integrated Plant :Can integrated plant will constitute a plant and after starting of Commercial Production can any interest will be disallowed.
1. Judicial cases of Integrated Single Plant
2. FACT in our case about the Single Integrated Plant
C: Interest can be allowed u/s 37(1)
D: Unjust Presumption Approach
Analysis of Proviso of Section 36(1)(iii) & Proviso
(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28—
(iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :
[Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.]
Explanation.—Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause;
Analysis of Sections before 01.04.2004
Before insertion of Proviso w.e.f. 01.04.204 it was settled law by various court decision that any interest paid for business & profession can be claimed as a deduction.
Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC)
Jt. CIT v. United Phosphorus Ltd. [2008] 167 Taxman 261 (SC)
Analysis of Sections inserted w.e.f. 01.04.2004
1. Interest Paid
2. In respect of Capital Borrowed
3. Capital Borrowed For the Purposes of Business & Profession
4. Proviso-
a. Interest Paid
b. In respect of capital borrowed
c. Capital borrowed for acquisition of an asset
d. For Extension
e. Extension of Existing Business or Profession
f. Asset may be capitalized or not
g. for any period beginning from the date on which the capital was borrowed for acquisition of the asset
h. till the date on which such asset was first put to use
i. shall not be allowed as deduction
Now after insertion of proviso we check what is changes after this insertions and intention behind this insertion. Actually due to various cases and decision by the court government made this section in more clarification and wants to clarify all the doubts behind this. Actually government has not changed main character of section through proviso he tried to remove the ambiguity behind this. However proviso itself is in ambiguity and left lot of possibilities of different meaning.
This Proviso Says Following Line
Capital borrowed for acquisition of an asset
Proviso says amount borrowed for acquisition of an asset for extension of existing business or profession means it deals exclusively for acquisition of an asset for extension of existing business or profession and not deal with amount borrowed for business & profession generally or amount borrowed for first time at starting of business & profession or you may say it does not say about interest paid on capital borrowed for commence of a newly startup or this proviso does not deal with interest paid on capital borrowed for existing business it deal with extension of already existed business.
Asset
Section say capital borrowed for acquisition of an asset. But Asset is not defined in the Act itself neither in this section. This asset is Fixed Asset or Current Asset it is not defined elsewhere. However in section 2(11) Block of Asset is defined and in Section 2(14) “Capital Asset” defined but nowhere defined only “Asset”.
As far as deduction for interest is concerned the key consideration is borrowing for the purpose of business. Further thereto, in case of borrowing for acquisition of an asset for extension of business there is an additional requirement of user of such an asset, but there is no list of assets as in case of depreciation.
As 16 deals with Borrowing cost and it describe the qualifying asset and not only use asset. So here using the word asset means in general term all asset including current assets, investment & fixed assets.
Asset may be capitalized or not
Just like asset, capitalization is not defined in the act. In commercial language capitalization means that expense which is not treated as a revenue expenditure and shown in balance sheet. Here in proviso it is written that Asset may be capitalized or not and it shows that Act does not deal about the treatment in accounts of uses of capital borrowed. The Act main focus is capital borrowed for acquiring of an asset for extension of existing business and ACT does not care the accounting treatment or AS 16.
Acquisition of an asset for extension
Again section describe that this acquisition is for extension. This extension also is not defined in Income Tax Act. However in dictionary this word came from the word “Extend” and meaning of extend is-
• to stretch out; draw out to the full length
• to stretch, draw, or arrange in a given direction, or so as toreach a particular point, as a cord, wall, or line of troops.
• to stretch forth or hold out, as the arm or hand
• to place at full length, especially horizontally, as the body orlimbs.
• to increase the length or duration of; lengthen; prolong
As per dictionary meaning it come out that something stretch to be made to current position is called as a extension.
Extension of Existing
Also in proviso the word used “of” means there should be extension and this extension should be of existing. Means this proviso does not deal
• on interest paid on capital borrowed for commence of a newly startup.
• or this proviso does not deal with interest paid on capital borrowed for existing business.
What is Existing
Again existing used in this section is not defined in the ACT so we have to go to the general commercial or dictionary meaning of the word “Exist”.
Exist Means
• to have real being whether material or spiritual
• to have being in a specified place or with respect to understood limitations or conditions
• to have life or the functions of vitality
Origin of EXIST
Latin exsistere to come into being, exist, from ex- + sistereto stand, stop; akin to Latin stare to stand — more at STAND
Here word used in commercial term exist means something physically present at particular point of time. And extension of existing means some thing added to this physically present business asset at particular point of time.
• Means some asset to be added to existing business
• and capital borrowed for this something new addition of existing business.
Or you may say for disallowance of interest paid on capital borrowed following condition to be satisfied,
• an existing business is required
• and the capital borrowed is only for extension of this existing business
• and not capital borrowed for other than existing business
• and not capital borrowed 1st time when no existing business was there
• And not capital borrowed for existing business only and not for its extensions.
• And not for capital borrowed for replacement of an asset in the course of an existing business is not affected and any interest incurred to finance such a replacement would qualify for deduction upfront without any restriction.
Existing Business Means
Existing business means business was already started and currently in existence.
And the operation related activities has been started.
Section Silent
Section is silent about capital borrowed first time for startup where more than one integrated plant was planned to be installed and only one part of plant is running and rest were not started just because of some more capital requirement. The all asset were bought at starting and thereafter neither new asset was added nor any new further extension was made and also nor any further capital was borrowed.
Intention of law Behind the Proviso of Section 36(1)(iii)
For tax purposes, interest is treated as an allowable business deduction as long as it is incurred in respect of capital borrowed and used for business. Courts have had several occasions to examine the allowability of interest, particularly in the context where such interest has been capitalised for the purpose of books of accounts.
Finance Bill 2003-04 seeks to address this issue by inserting a proviso to Section 36(1)(iii) of the Income-Tax Act (the Act), which reads thus:
"Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of new asset for extension of existing business or profession (whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction."
The purpose of the amendment has been spelt out in the memorandum explaining the provisions which states that "it is, therefore, proposed to provide that no deduction will be allowed in respect of interest paid, in respect of capital borrowed for acquisition of new asset for extension of existing business or profession (whether capitalised in the books of account or not) for the period beginning from the date on which the capital was borrowed for the acquisition of the asset till the date on which such asset was first put to use."
Proviso to 36(1)(iii) is only clarification of section and can not change the meaning of sections.
The logic behind provison is only to ensure that wherever interest is capitalised for books of accounts, it remains capitalised for the purpose of income-tax. This interest cannot be claimed as a deduction under Section 36(1)(iii) of the Act. One is not clear on the import of the expression "extension of existing business or profession... "
Extension is alien to income-tax parlance and cannot be defined in objective and exact terms. In today's business context, even acquisition of a machinery worth a few lakhs may tantamount to extension. The objective is to address issues of substantial expansion of business. If that was the intention, the concept of "extension of industrial undertaking", as mentioned and applicable for Section 35D of the Act dealing with amortisation and preliminary expenses, could have been transplanted in Section 36(1)(iii) of the Act. This would clearly establish that the proviso would apply to extension of industrial undertaking and not extension of business per se.
Also, the use of the expression "whether capitalised in the books of account or not" could raise host of controversies. Interest is capitalised in the books of accounts in the present regime in accordance with the principles laid down in Accounting Standard 16 on borrowing costs. The operative portion of the standard is as follows:
"Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this statement. Other borrowing costs should be recognised as an expense in the period in which they are incurred."
Borrowing costs are capitalised as part of the cost of a qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognised as an expense in the period in which they are incurred.
This mandatory standard has to be applied in respect of accounting periods commencing on or after April 1, 2000.
Also the AS 16, in paragraph 21 of Cessation of capitalization it said that Capitalisation of borrowing costs should cease when substantiallyall the activities necessary to prepare the qualifying asset for its intended use or sale are complete. While in Income Tax Act Capitalisation of borrowing costs should cease when Business will start. It means capitalization concept as per accounts and as per Act is not matching so no one can said that this is the concealment of Income or Inaccurate particular. Proviso it self hint that company may it capitalize or not.
Hence, once interest is capitalised for accounting purposes, the proviso could have simply stated that the treatment given for accounting purposes would apply for the purpose of tax computation also.
It is also not clear as to use of the expression "extension of profession" in the proviso. While extension of business is normal and part of business activity, one cannot visualise or understand how interest in such cases would be capitalised.
In sum, the amendment has been introduced to nullify judicial controversies on the subject and bring the much-needed alignment between books and income-tax in the matter of interest accounting.
On this subject, one may recall that Kelkar Committee suggestion to remove Section 36(1)(iii) in toto and advocating the allowability of interest under Section 37 of the Act.
Debate between 36(1)(iii) & Explanation 8 to S. 43(1)
A debate has emerged, independent of insertion of the said proviso in S. 36(1)(iii), in respect of the eligibility for claim of interest in cases where an asset is not put to use during the year. One view is that such interest shall be allowed once it is established that the borrowing is for the purposes of the existing business, while the other view, strongly relying on Explanation 8 to S. 43(1), holds that interest for the period up to the date of use is not allowable as deduction. The debate, though partly resolved by the said proviso in S. 36(1)(iii) to the extent of covering the cases of extension, continues to be relevant for cases not involving extension and also for cases for the period during which the said proviso is not applicable.
1.6 The Gujarat High Court held that interest for the period prior to the use of asset was allowable as deduction in case of an existing business and that Explanation 8 was not relevant for deciding the claim for deduction of interest. However the Calcutta High Court, relying on the said Explanation 8, held that interest for the period prior to the use of asset was not allowable as deduction.
Explanation 8 to section 43(1) is not relevant - Explanation 8 has been inserted in section 43(1) by Finance Act, 1986 with retrospective effect from 1-4-1974. It is important to note that the words ‘actual cost’ would mean the whole cost and not the estimate of cost. ‘Actual cost’ means nothing more than the cost accurately ascertained. The determination of actual cost in section 43(1) has relevancy in relation to section 32 (deprecia¬tion allowance), section 32A (investment allowance), section 33 (development rebate allowance) and section 41 (balancing charge). ‘Actual cost’ of an asset has no relevancy in relation to section 36(1)(iii). This reasoning flows from a bare reading of section 43(1). Section 43 defines certain terms rele¬vant to income from profits and gains of business and therefore, the said section commences with the words ‘In sections 28 to 41 and unless the context otherwise requires’ ‘actual cost’ shall mean the actual cost of the assets to the assessee, reducing by the that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. In other words, Explanation 8 applies only to those sections like sections 32, 32A, 33 and 41 which deal with concepts like depreciation. The concept of depreciation is not there in section 36(1)(iii). That is why the Legislature has used the words ‘unless the con¬text otherwise requires’. Hence, Explanation 8 has no relevancy to section 36(1)(iii). It has relevancy to the aforementioned enumerated sections - Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC)
Asset acquired out of borrowal need not have been used during relevant year and interest can be allowed unless this asset is not for extension of existing business.
Asset acquired out of borrowal need not have been used during relevant year - Where machinery was purchased out of borrowed amount for purpose of business and it was treated as business assets, merely because such machinery had not been actually used in business at the time when assessment was made, interest paid on amount borrowed could not be disallowed - CIT v. Associated Fibre & Rubber Industries (P.) Ltd. [1999] 102 Taxman 700 (SC)/CIT v. Insotex (P.) Ltd. [1984] 150 ITR 195 (Kar.)/Calico Dyeing & Printing Works v. CIT [1958] 34 ITR 265 (Bom.)/C.T. Desai v. CIT [1979] 120 ITR 240 (Kar.). See also Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC)/Jt. CIT v. United Phosphorus Ltd. [2008] 167 Taxman 261 (SC)
In view of Supreme Court’s judgment in case of Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206, it was to be held that interest paid in respect of borrowing for purchasing capital assets, which are not put to use in concerned financial year, can be permitted as an allowable deduction - Jt. CIT v. United Phosphorous Ltd. [2008] 167 Taxman 261 (SC).
Where machinery was purchased out of borrowed amount for purpose of business and it was treated as business assets merely because such machinery had not been actually used in business at time when assessment was made, interest paid on amount borrowed could not be disallowed - CIT v. Associated Fibre & Rubber Industries (P.) Ltd. [1999] 102 Taxman 700 (SC)/CIT v. Insotex (P.) Ltd. [1984] 150 ITR 195 (Kar.)/Calico Dyeing & Printing Works v. CIT [1958] 34 ITR 265 (Bom.)/C.T. Desai v. CIT [1979] 120 ITR 240 (Kar.).
However this is before the insertion of proviso but one thing is clear that when it is proved that the capital is not borrowed after business was exist then this proviso will not be applicable and decision of abovementioned cases can be applicable. Because in our present case the capital was not borrowed after the existing business was started. And at the time of capital borrowed no business was existed and all the capital was borrowed altogether and not with separate sanctioning of the loan.
Test of Proviso of Section 36(1)(iii) with the fact of the present case
We discuss here line by line our fact of the case and applicability of this section & proviso on our case. For test of allowability or disallowability each line of proviso to be tested.
Line 1 Interest Paid Yes No Issue
Line 2 In respect of capital borrowed Yes No Issue
Line 3 Capital borrowed for acquisition of an asset Yes Yes capital borrowed for acquision of an asset for a integrated plant wherein one raw material will be processed at different stage and in ultimate FG will be Tin Plate. Se the Production Flow Chart Attached of this Integrated Plant.
Line 4 Acquisition of an asset for extension Not for extension No further capital borrowed for extention, Capital borrowed for first project and no further project extension initiated.
Line 5 Extension of Existing Business or Profession No Extension of Existing 1-Capital borrowed is not for extention of existing, it was first time borrowed when project was started.
2- Also at the time of borrowing there was no any business was existed, while as per proviso at the time of capital borrowed existence of already a business is required.
Line 6 Asset may be capitalized or not No Issue It is not material in our case
As seen above that the some line of proviso is not applicable to our fact, so in our opinion learned officer has erred in law during disallow the interest.
For more clarification I want to elaborate the meaning & intention of legislature that reflects from plane reading of section and proviso.
Concept of Integrated Plant :Can integrated plant will constitute a plant and after starting of Commercial Production can any interest will be disallowed.
The disallowances made by the learned officer raise the following question-
1- Whether integrated plant will constitute a single plant or not
2- And after starting of production of final product can interest will be disallowed if some process related part of plant was not started and company uses readymade input instead of in house processed input.
Before discussing this we need to look in to relevant extract of following case of
HIGH COURT OF DELHI-CIT Vs Monnel Industries Ltd.ITA No. 450/2008 November 21, 2008
5.8 In determining whether two lines of businesses constitute the same business and to this end, whether nature of the two businesses has to be looked at, was a proposition, the Supreme Court rejected in the case of a Produce Exchange Corporation Ltd v. CIT: (1970) 77 ITR 739. In this case, the assessee carried on business in diverse commodities as also in stocks and shares. The issue was whether the losses suffered by the assessee in the sale of shares of Public Limited Company could be set off against profits from transactions in other commodities in the relevant year. In the said case the Supreme Court noted that the Calcutta High Court had followed the test laid down by it in Shree Ramesh Cotton Mills Ltd v. Commissioner of Income Tax: (1967) 64 ITR 317, wherein in determining whether the two lines of businesses constitute the same business, they had applied the yardstick, whether the nature of the two businesses was the same. The Supreme Court, however, reversed this view of the Calcutta High Court by holding as follows:-
“We need not consider whether the ultimate decision of the High Court in Shree Ramesh Cotton Mills Ltd’ s case on which reliance was placed is correct, but we are unable to agree with the High Court that the decisive test for determining whether the two lines of businesses constitute the same business is the nature of the two businesses.”
6. The aforesaid view taken by the Supreme Court was re-affirmed by it, in the case of B.R.Ltd v. V.P.Gupta, Commissioner of Income Tax, Bombay: (1978) 113 ITR 647. In B.R.Ltd (supra), the Supreme Court was called upon to decide whether unabsorbed losses suffered in the business of import of woolen fabrics could be set off from the profits earned in respect of export of cotton textiles . The Supreme Court in the said case, approved the ratio of the judgments of its own court in the case Prithvi Insurance (supra), and Produce Exchange (supra). In doing so it also noted the observations made in the decision of the Supreme Court in the case of Standard Refinery and Distillery Ltd v. Commissioner of Income Tax: (1971) 79 ITR 589 and finally concluded that, tests for ascertaining whether the two lines of businesses were the same business was not dependent on determination of the nature of goods dealt with. The decisive test according to the Supreme Court was the unity of control and not the nature of two lines of businesses. It further held that even though the fact that one business cannot be conveniently carried on after the closure of the other business may furnish a strong indication that the two businesses do not constitute the same business, but as already held in Prithvi Insurance (supra) no decisive inference can be drawn from the fact that after the closure of one business the other cannot be conveniently carried on.
6.1 Based on the aforesaid tests, let us examine the findings returned by Tribunal in coming to the conclusion that there is a unity of control and management, interlacing and dovetelling of finances. The Tribunal in the instant case found as a fact in paragraph 30-31 of the impugned judgment that there was a common Board of Directors controlling the ferro alloys plant, as well as, the sugar plant which, operated from the head office located at Delhi, funds for the two plants were common and hence, there was inter-mingling and interlacing of funds, as also the fact, that even though the two divisions were geographically located at different sites, marketing of the final products was carried out under the supervision and control of the same set of executives at the head office. Applying the tests discussed hereinabove to facts as determined by the Tribunal, we have no difficulty in holding that the sugar plant and the ferro alloys plant were in the same fold of business.
6.4 The Gujarat High Court, after analyzing the decision of the Bombay High Court in Calico Dyeing and Printing Works v. Commissioner of Income Tax: (1958) 34 ITR 265 and of the Supreme Court in India Cements Ltd v. Commissioner of Income Tax: (1966) 60 ITR 52 and in Challapalli Sugars Ltd v. Commissioner of Income Tax: (1975) 98 ITR 167, concluded as follows:-
“It is no doubt true that in the case of Challapalli Sugars Ltd the Supreme Court has unequivocally observed that interest paid on the borrowing utilised to bring into existence a fixed asset which has not gone into production goes to add to the cost of installation of that asset. But these observations have been made with reference to a situation wherein it was not possible to contend that the borrowing on which interest was paid was made for the purpose of any business. The company which had made the borrowing in that case had not yet started production, and hence had not commenced any business when it borrowed the amount in question. Therefore, it was not possible to say in that case that the borrowing was made” for the purposes of the business? to bring the case within the ambit of Section 10(2)(iii) of the Indian Income Tax Act, 1922 (which is equivalent to Section 36(1)(iii) of the Act of 1961). If the said borrowing was not “for the purpose of business” in as much as no business had come into existence, it must follow that it was made for the purpose of acquiring an asset which could be put to use for doing business, and hence interest paid on such borrowing would go to add to the cost of the assets so acquired.
“The question is, is this line of reasoning inconsistent with the view taken by the Bombay High Court in Calico Dyeing and Printing Works, or by the Supreme Court in India Cements Ltd”. On proper analysis the reasoning on which the view taken by the High Court of Bombay and the Supreme Court in the above-referred cases rests is as under:
Section 10(2)(iii) of the Act of 1922 allows deduction of interest on all borrowings which are made “for the purposes of business”. The expression “purposes of business” is comprehensive enough to cover expenditure of revenue nature as well as of capital nature because both the types of expenditures can be incurred for business purposes. Therefore, even if a borrowing is made for incurring an expenditure of capital nature, it remains the borrowing for a business purpose. If that is so, the requirements of Section 10(2)(iii) of the Act of 1922 are fully satisfied and interest paid on such borrowing is entitled to deduction as revenue expenditure. The High Court of Bombay has unequivocally stated in Callico Dyeing and Printing Works that in order to attract the provisions of Section 10(2)(iii) it does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all that the Section requires is that the assessee must borrow the capital for the purpose of his business. This dichotomy between the borrowing of a loan an actual application thereof in the purchase of a capital asset, seems to be on the ground that a mere transaction of borrowing does not, by itself, bring any new asset of enduring nature into existence, and that it is the transaction of the investment of the borrowed capital in the purchase of the new asset which brings that asset into existence. Since the transaction of borrowing is not the same as the transaction of investment, the Supreme Court has observed in India Cements Ltd vs Commissioner of Income Tax that, for considering whether payment of interest on a borrowing is revenue expenditure or not, the purpose for which the borrowing is made is irrelevant. Thus, the decisions of the Bombay High Court in Callico Dyeing and Printing Works and of the Supreme Court in India Cements Ltd were given with reference to the borrowings made for the purposes of running businesses, while the decision of the Supreme Court in Challapalli Sugars Ltd was given with reference to the borrowings which could not be treated as made for the purposes of business, as no business had yet been commenced. Thus, there is no incompatibility between these decisions. The Supreme Court itself had distinguished its earlier decision in India Cements Ltd in the following terms in Challapalli Sugars Ltd:
“This case too is of no assistance to the revenue. The appellant-company in that case at the time it raised the loan was a running concern. Unlike the assessees in the present appeals, the loan raised by the appellant-company in the cited case was not before the commencement of production but at a later stage. The question of including the interest paid on the loan before the commencement of business in the actual cost of plant did not arise in that case.”
In view of this, we conclude that the decisions of the Bombay High Court in Callico Dyeing and Printing Works and of the Supreme Court in India Cements Ltd, hold the field with equal force, even after the decision in Challapalli Sugars Ltd.
7. The upshot of the aforesaid decisions as applied by the Tribunal in instant case is that:-
(i) a loan taken or capital borrowed is, by itself, not a capital asset, nor does it give an advantage of an enduring nature;
(ii) as long as a loan was taken or capital was borrowed for the purposes f business, the assessee is entitled to claim interest paid thereon as deduction under Section 36(1)(iii) of the Act;
(iii) interest may have to be capitalized after the borrowed capital or loan taken is utilized in bringing into existence an asset at the stage of commencement of business. In other words, after the assessee’s business had already commenced then the interest paid on capital borrowed or loan taken can be claimed as deduction under Section 36 (1)(iii) of the Act.
(iv) in coming to the conclusion whether the interest paid on capital borrowed or loan taken in setting up a new line of business ought to be capitalized or treated as revenue expenditure, the test as laid down by the Supreme Court in the case of Produce Exchange Corporation (supra) and Prithvi Insurance Company (supra) would be relevant and;
(v) lastly, as long as interest is paid on capital borrowed or loan taken in respect of new line of business which is in the same business fold for the purposes of ascertaining income under Section 28 of the Act, it can be claimed as a deduction under Section 36(1)(iii) of the Act.
8. In the instant case, the Tribunal has returned the finding that there is a unity of control and management, in respect of the ferro alloys plant as well as the sugar plant and there is also intermingling of funds and dove-tailing of businesses. In these circumstances it cannot be said that the respondent/assessee had not commenced its business and hence, interest would have to be capitalized in terms of the ratio of the judgment in the case of Challapalli Sugars Ltd (supra). If that is not so then, the only other conclusion that is possible on these facts, is that, the interest was paid by the respondent/assessee on borrowed capital for the purposes of business. That being the case, in our view, the Tribunal correctly allowed the financial charges i.e., interest paid to the extent of Rs 3,50,83,472/- as deduction under Section 36(1)(iii) of the Act.
COMMISSIONER OF INCOME TAX vs. TATA CHEMICALS LTD.
HIGH COURT OF BOMBAY
H.L. Gokhale & V.C. Daga, JJ. IT Appeal No. 31 of 2000 3rd April, 2002 (2002) 175 CTR (Bom) 443 : (2002)
256 ITR 395 (Bom) : (2002) 122 TAXMAN 643 (Bom)
Sections 36(1)(iii), 260A,
Asst. Year 1992-93
10. This order of the AO has been mechanically confirmed by the CIT(A), Mumbai. As against this, the Tribunal has culled out the propositions of law based on various judgments of the apex Court as well as of various High Courts in para 28 of its order. It has summarised propositions and determined the tests on the question of unity of business.
They are as follows :
(i) The nature of the two lines of business is not relevant.
(ii) The fact that one business can be conveniently closed down without affecting the other business is a strong indication that both the businesses are distinct and separate. But no decisive inference can be drawn from the fact.
(iii) The decisive test is the unity of control which is indicated by inter-lacing, inter-dependence and inter-connection between the businesses and the dovetailing of one into the other. Such interlacing, inter-dependence or inter-connection can be shown to exist by reason of a common management, common administration, common fund and the common place of business. The above propositions are culled out from the following judgments of the apex Court : (1)
Setabganj Sugar Mills Ltd. vs. CIT (1961) 41 ITR 272 (SC) : TC 54R.777; (2) CIT vs. Prithvi Insurance Co. Ltd.(1967) 63 ITR 632 (SC) : TC 45R.348;(3) Produce Exchange Corpn. Ltd. vs. CIT (1970) 77 ITR 739 (SC) : TC15R.357; (4) Standard Refinery & Distillery Ltd. vs. CIT (1971) 79 ITR 589 (SC) : TC 45R.498; (5) Hooghly Trust (P) Ltd. vs. CIT (1969) 73 ITR 685 (SC) : TC 45R.493; and (6) B.R. Ltd. vs. V.P. Gupta, CIT 1978 CTR(SC) 82 : (1978) 113 ITR 647 (SC) : TC 45R.362. The learned counsel appearing for the parties took us through the text of the various judgments referred to hereinabove and we are in complete agreement with the Tribunal that the above determined tests would be the correct approach to the questions with which we are concerned. The Tribunal while reaching to the conclusion has considered various factors such as administration of various units, flow of funds, unity of management, unity of the accounting set up as well as control coupled with various such
relevant factors. The Tribunal also found that the administration and management of funds of two units is common. The Tribunal has also recorded finding of fact that there was a functional integrity between the two units. It is in these circumstances that the deduction under the particular section was held allowable.
11. The Tribunal has come to the conclusion that the decisive test is the unity of control which is indicated by inter-lacing, inter-dependence and inter-connection between the businesses and dovetailing of one into the other. In the present case, it is quite clear that the amalgamation of the subsidiary was allowed by the High Court. Thereafter, it is for the management of the company to manage its affairs and the benefit which would be available for the borrowings done for a unit would certainly be claimable by the company as such. Sec. 36(1)(iii) which permits the amount of interest paid in respect of capital borrowed for the purposes of the business will have to include the borrowing for a unit of the company which is what the fertilizer unit at Babrala is. Considering the fact that finding is based on appreciation of evidence brought on record, we do not find that this question can be said to be a question of law warranting adjudication by this Court. In view of what is observed hereinabove, the questions of law raised in at (b) and (h) do not arise for our consideration. Question (f)
Based on the study of above case our view is that-
1- Integrated Plant can be a single plant under a single roof
2- After starting of final product as per design plant of plant plant can be understood as a started.
3- Merely on the basis of the some working capital problem some of the part of CWIP is not started production bur ready for production can not be understood as that whole CWIP is not ready for use.
4- When Plant designed as a Intergrated Plant in a starting, planning and execution for this establishment started simultaneously and during span of time some portion has started commercial production and some has not. And Capital borrowed in starting also and not after the first plant was ready. So if the capital borrowed altogether then it can not be termed as it was taken for extension of existing business because at the time of taken of capital borrowed no business was existed at all.
5- When the plant has started commercial production any interest attributable to this integrated plant should be expense out.
6- Learned officer has erred in law in making presumptive definition of CWIP as many of the asset which are in production are very interlinked and it is not possible to separated it from running portion of plant and idle portion of plant.So if he disallow treating them as a separate extension of existing business what treatment will be of running portion of plant which are already in run and closely interlinked with these portion.
FACT in our case about the Single Integrated Plant
The Company was planned to establish an integrated plant which produce following produce which will be ultimately be raw material for next product or can be sold as it is. This project was a long and integrated and company was applying to the bank for a Project term loan of Rs 325 Crores for whole project including HRC > CRFH > CRCA > TMBP > ETP Plant.
Company’s Project cost at the time of application to the bank was 498 crore out of this 498 crore Bank Loan requirement was 325 crore and this 325 crore was asked to the bank as per schedule of implementation.
All bank loan were requested and taken for an single integrated project, to be runned in a same factory shed under one roof, jointly connected to each other, under common control & supervision of same management and labor staff, no separate department for each sections, single accounting was followed and no any other segment was planned at the time of project formulation. And no further proposal place for any extension of project as no extension was planned by the company yet.
Unfortunately all the integrated plant was not installed due to some working capital problem and company has started commercial production of CRFH,HRPO & Tin Plate. Other machinery which were bought and installed for rest product was kept idle due to working capital problem and some installation issues.
The bank loan neither further requested not any extension of plant planned. The design prepared at the start was complete for this unit and no other unit was opened further.
This capital was borrowed only for this unit where in different plant was designed as a part of integrated plant for TIN PLATE products. No other unit is opened no new loan proposal was requested. All the asset and CWIP shown were bought out from this first loan requested of Rs 325 crores.
Why this unit will be treated as a single unit and no extension of this unit is required
1- Plant is integrated
2- Each output will be input of next output product
3- Proposal for whole project was submitted
4- Single Project Report Placed to the Bank
5- Single Proposal for Term Loan Placed to the bank
6- It is running in a same factory shed under one roof,
7- Jointly connected to each other
8- Under common control & supervision of same management and labor staff
9- No separate department for each sections,
10- Single accounting was followed
11- No any other segment was planned at the time of project formulation.
12- No further proposal place for any extension of project as no extension was planned by the company yet.
Flow of Integrated Plant
HRC > CRFH > CRCA > TMBP > ETP
Interest can be allowed u/s 37(1)
As per the plain reading of section 37(1) the following line is written-
37. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
For allowance of Expenditure under this section three major condition to be followed
1- Any expenditure (not being expenditure of the nature described in sections 30 to 36
It means if the item not falling under 30 to 36 and it is satisfying other below two condition then it can be allowed. Therefore in present case if learned officer does not considered this expenditure as per nature of interest defined in the section 36(1)(iii) it automatically comes to section 37(1) as section 37(1) is a residuary section and when it comes to this section we need to check other below two condition also. As per our case if learned officer does not allow this u/s 36(1)(iii) he should consider the applicability u/s 37(1) and simply he can not disallow without checking the applicability of section 37(1)
2- and not being in the nature of capital expenditure or personal expenses of the assessee)
The other condition in section 37(1) is this should not be capital expenditure or personal expenses. As per this present case this is the private limited company and there is not any personal expense of company so this part of section will not apply in present case. Also the section speaks about capital expenditure but the fact is that There is no definition of the expression ‘capital expenditure’ in the Act, and it must be construed in a business sense save insofar as there may be rules of construction applicable to it - Mohanlal Hargovind of Jubbulpore v. CIT [1949] 17 ITR 473 (PC).
The expression ‘capital expenditure’ is not defined in the Income-tax Act and the words ‘in the nature of capital expenditure’ occurring in section 37(1) make the meaning of the expression more elastic in its application to the facts of each case. The consistent view of the Court is that the expression is to be construed in a business sense save insofar as there may be rules of construction applicable to it.
3- laid out or expended wholly and exclusively for the purposes of the business or profession
As per the above line if above two condition satisfied the expenses incurred should be wholly and exclusively for the purposes of the business or profession. And as per present case the interest paid is wholly and exclusively for the purposes of the business or profession.
Therefore first condition is automatically satisfied if learned officer does not consider it in section 36(1)(iii) and in other hand this is not a capital expenditure strictly as it is not defined in the act and third it is wholly and exclusively for the purposes of the business or profession so either u/s 36(1)(iii) or u/s 37(1) it should be allowed.
Though i am submitting my analysis in this case.
The learned officer has disallowed the interest cost of Rs 16,87,06,911 using his own presumption the however the basis and presumption which he has taken was not justified as well as it is challengeable and it is without considering other available option. Further penalty u/s 271(1)( c ) was imposed. Though the case is very technical debatable and various case laws has been made on this and on the basis of that ground the learned officer can not imposed the penalty u/s 271 (1) ( c ) and with the plain reading of section 36(1)(iii) and Proviso of this section he can not allowed this.
Our submission to seeking relief against this order are categorized in following preference
Fact of the cases with reference to section 36(1)(iii)
1- Loan Taken in starting at Initial Stage as per Single Integrated Project
2. All the loan was sanctioned before start of commercial production
3. All the loan was sanctioned at a time initially
( See Loan Sanction Copy Attached Herewith )
4- No Extension and No loan taken for any extension of existing because all disbursement has been made initially
5- Interest paid for initial loan taken no loan taken further and no extension further
A : As per section 36(1)(iii) it is allowable expenditure as proviso is not applicable in our case
1. Analysis of Proviso of Section 36(1)(iii) & Proviso
2. Section Silent
3. Intention of law Behind the Proviso of Section 36(1)(iii)
4. Debate between 36(1)(iii) & Explanation 8 to S. 43(1)
5. Test of Proviso of Section 36(1)(iii) with the fact of the present case
B: Concept of Integrated Plant :Can integrated plant will constitute a plant and after starting of Commercial Production can any interest will be disallowed.
1. Judicial cases of Integrated Single Plant
2. FACT in our case about the Single Integrated Plant
C: Interest can be allowed u/s 37(1)
D: Unjust Presumption Approach
Analysis of Proviso of Section 36(1)(iii) & Proviso
(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28—
(iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :
[Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.]
Explanation.—Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause;
Analysis of Sections before 01.04.2004
Before insertion of Proviso w.e.f. 01.04.204 it was settled law by various court decision that any interest paid for business & profession can be claimed as a deduction.
Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC)
Jt. CIT v. United Phosphorus Ltd. [2008] 167 Taxman 261 (SC)
Analysis of Sections inserted w.e.f. 01.04.2004
1. Interest Paid
2. In respect of Capital Borrowed
3. Capital Borrowed For the Purposes of Business & Profession
4. Proviso-
a. Interest Paid
b. In respect of capital borrowed
c. Capital borrowed for acquisition of an asset
d. For Extension
e. Extension of Existing Business or Profession
f. Asset may be capitalized or not
g. for any period beginning from the date on which the capital was borrowed for acquisition of the asset
h. till the date on which such asset was first put to use
i. shall not be allowed as deduction
Now after insertion of proviso we check what is changes after this insertions and intention behind this insertion. Actually due to various cases and decision by the court government made this section in more clarification and wants to clarify all the doubts behind this. Actually government has not changed main character of section through proviso he tried to remove the ambiguity behind this. However proviso itself is in ambiguity and left lot of possibilities of different meaning.
This Proviso Says Following Line
Capital borrowed for acquisition of an asset
Proviso says amount borrowed for acquisition of an asset for extension of existing business or profession means it deals exclusively for acquisition of an asset for extension of existing business or profession and not deal with amount borrowed for business & profession generally or amount borrowed for first time at starting of business & profession or you may say it does not say about interest paid on capital borrowed for commence of a newly startup or this proviso does not deal with interest paid on capital borrowed for existing business it deal with extension of already existed business.
Asset
Section say capital borrowed for acquisition of an asset. But Asset is not defined in the Act itself neither in this section. This asset is Fixed Asset or Current Asset it is not defined elsewhere. However in section 2(11) Block of Asset is defined and in Section 2(14) “Capital Asset” defined but nowhere defined only “Asset”.
As far as deduction for interest is concerned the key consideration is borrowing for the purpose of business. Further thereto, in case of borrowing for acquisition of an asset for extension of business there is an additional requirement of user of such an asset, but there is no list of assets as in case of depreciation.
As 16 deals with Borrowing cost and it describe the qualifying asset and not only use asset. So here using the word asset means in general term all asset including current assets, investment & fixed assets.
Asset may be capitalized or not
Just like asset, capitalization is not defined in the act. In commercial language capitalization means that expense which is not treated as a revenue expenditure and shown in balance sheet. Here in proviso it is written that Asset may be capitalized or not and it shows that Act does not deal about the treatment in accounts of uses of capital borrowed. The Act main focus is capital borrowed for acquiring of an asset for extension of existing business and ACT does not care the accounting treatment or AS 16.
Acquisition of an asset for extension
Again section describe that this acquisition is for extension. This extension also is not defined in Income Tax Act. However in dictionary this word came from the word “Extend” and meaning of extend is-
• to stretch out; draw out to the full length
• to stretch, draw, or arrange in a given direction, or so as toreach a particular point, as a cord, wall, or line of troops.
• to stretch forth or hold out, as the arm or hand
• to place at full length, especially horizontally, as the body orlimbs.
• to increase the length or duration of; lengthen; prolong
As per dictionary meaning it come out that something stretch to be made to current position is called as a extension.
Extension of Existing
Also in proviso the word used “of” means there should be extension and this extension should be of existing. Means this proviso does not deal
• on interest paid on capital borrowed for commence of a newly startup.
• or this proviso does not deal with interest paid on capital borrowed for existing business.
What is Existing
Again existing used in this section is not defined in the ACT so we have to go to the general commercial or dictionary meaning of the word “Exist”.
Exist Means
• to have real being whether material or spiritual
• to have being in a specified place or with respect to understood limitations or conditions
• to have life or the functions of vitality
Origin of EXIST
Latin exsistere to come into being, exist, from ex- + sistereto stand, stop; akin to Latin stare to stand — more at STAND
Here word used in commercial term exist means something physically present at particular point of time. And extension of existing means some thing added to this physically present business asset at particular point of time.
• Means some asset to be added to existing business
• and capital borrowed for this something new addition of existing business.
Or you may say for disallowance of interest paid on capital borrowed following condition to be satisfied,
• an existing business is required
• and the capital borrowed is only for extension of this existing business
• and not capital borrowed for other than existing business
• and not capital borrowed 1st time when no existing business was there
• And not capital borrowed for existing business only and not for its extensions.
• And not for capital borrowed for replacement of an asset in the course of an existing business is not affected and any interest incurred to finance such a replacement would qualify for deduction upfront without any restriction.
Existing Business Means
Existing business means business was already started and currently in existence.
And the operation related activities has been started.
Section Silent
Section is silent about capital borrowed first time for startup where more than one integrated plant was planned to be installed and only one part of plant is running and rest were not started just because of some more capital requirement. The all asset were bought at starting and thereafter neither new asset was added nor any new further extension was made and also nor any further capital was borrowed.
Intention of law Behind the Proviso of Section 36(1)(iii)
For tax purposes, interest is treated as an allowable business deduction as long as it is incurred in respect of capital borrowed and used for business. Courts have had several occasions to examine the allowability of interest, particularly in the context where such interest has been capitalised for the purpose of books of accounts.
Finance Bill 2003-04 seeks to address this issue by inserting a proviso to Section 36(1)(iii) of the Income-Tax Act (the Act), which reads thus:
"Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of new asset for extension of existing business or profession (whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction."
The purpose of the amendment has been spelt out in the memorandum explaining the provisions which states that "it is, therefore, proposed to provide that no deduction will be allowed in respect of interest paid, in respect of capital borrowed for acquisition of new asset for extension of existing business or profession (whether capitalised in the books of account or not) for the period beginning from the date on which the capital was borrowed for the acquisition of the asset till the date on which such asset was first put to use."
Proviso to 36(1)(iii) is only clarification of section and can not change the meaning of sections.
The logic behind provison is only to ensure that wherever interest is capitalised for books of accounts, it remains capitalised for the purpose of income-tax. This interest cannot be claimed as a deduction under Section 36(1)(iii) of the Act. One is not clear on the import of the expression "extension of existing business or profession... "
Extension is alien to income-tax parlance and cannot be defined in objective and exact terms. In today's business context, even acquisition of a machinery worth a few lakhs may tantamount to extension. The objective is to address issues of substantial expansion of business. If that was the intention, the concept of "extension of industrial undertaking", as mentioned and applicable for Section 35D of the Act dealing with amortisation and preliminary expenses, could have been transplanted in Section 36(1)(iii) of the Act. This would clearly establish that the proviso would apply to extension of industrial undertaking and not extension of business per se.
Also, the use of the expression "whether capitalised in the books of account or not" could raise host of controversies. Interest is capitalised in the books of accounts in the present regime in accordance with the principles laid down in Accounting Standard 16 on borrowing costs. The operative portion of the standard is as follows:
"Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this statement. Other borrowing costs should be recognised as an expense in the period in which they are incurred."
Borrowing costs are capitalised as part of the cost of a qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognised as an expense in the period in which they are incurred.
This mandatory standard has to be applied in respect of accounting periods commencing on or after April 1, 2000.
Also the AS 16, in paragraph 21 of Cessation of capitalization it said that Capitalisation of borrowing costs should cease when substantiallyall the activities necessary to prepare the qualifying asset for its intended use or sale are complete. While in Income Tax Act Capitalisation of borrowing costs should cease when Business will start. It means capitalization concept as per accounts and as per Act is not matching so no one can said that this is the concealment of Income or Inaccurate particular. Proviso it self hint that company may it capitalize or not.
Hence, once interest is capitalised for accounting purposes, the proviso could have simply stated that the treatment given for accounting purposes would apply for the purpose of tax computation also.
It is also not clear as to use of the expression "extension of profession" in the proviso. While extension of business is normal and part of business activity, one cannot visualise or understand how interest in such cases would be capitalised.
In sum, the amendment has been introduced to nullify judicial controversies on the subject and bring the much-needed alignment between books and income-tax in the matter of interest accounting.
On this subject, one may recall that Kelkar Committee suggestion to remove Section 36(1)(iii) in toto and advocating the allowability of interest under Section 37 of the Act.
Debate between 36(1)(iii) & Explanation 8 to S. 43(1)
A debate has emerged, independent of insertion of the said proviso in S. 36(1)(iii), in respect of the eligibility for claim of interest in cases where an asset is not put to use during the year. One view is that such interest shall be allowed once it is established that the borrowing is for the purposes of the existing business, while the other view, strongly relying on Explanation 8 to S. 43(1), holds that interest for the period up to the date of use is not allowable as deduction. The debate, though partly resolved by the said proviso in S. 36(1)(iii) to the extent of covering the cases of extension, continues to be relevant for cases not involving extension and also for cases for the period during which the said proviso is not applicable.
1.6 The Gujarat High Court held that interest for the period prior to the use of asset was allowable as deduction in case of an existing business and that Explanation 8 was not relevant for deciding the claim for deduction of interest. However the Calcutta High Court, relying on the said Explanation 8, held that interest for the period prior to the use of asset was not allowable as deduction.
Explanation 8 to section 43(1) is not relevant - Explanation 8 has been inserted in section 43(1) by Finance Act, 1986 with retrospective effect from 1-4-1974. It is important to note that the words ‘actual cost’ would mean the whole cost and not the estimate of cost. ‘Actual cost’ means nothing more than the cost accurately ascertained. The determination of actual cost in section 43(1) has relevancy in relation to section 32 (deprecia¬tion allowance), section 32A (investment allowance), section 33 (development rebate allowance) and section 41 (balancing charge). ‘Actual cost’ of an asset has no relevancy in relation to section 36(1)(iii). This reasoning flows from a bare reading of section 43(1). Section 43 defines certain terms rele¬vant to income from profits and gains of business and therefore, the said section commences with the words ‘In sections 28 to 41 and unless the context otherwise requires’ ‘actual cost’ shall mean the actual cost of the assets to the assessee, reducing by the that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. In other words, Explanation 8 applies only to those sections like sections 32, 32A, 33 and 41 which deal with concepts like depreciation. The concept of depreciation is not there in section 36(1)(iii). That is why the Legislature has used the words ‘unless the con¬text otherwise requires’. Hence, Explanation 8 has no relevancy to section 36(1)(iii). It has relevancy to the aforementioned enumerated sections - Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC)
Asset acquired out of borrowal need not have been used during relevant year and interest can be allowed unless this asset is not for extension of existing business.
Asset acquired out of borrowal need not have been used during relevant year - Where machinery was purchased out of borrowed amount for purpose of business and it was treated as business assets, merely because such machinery had not been actually used in business at the time when assessment was made, interest paid on amount borrowed could not be disallowed - CIT v. Associated Fibre & Rubber Industries (P.) Ltd. [1999] 102 Taxman 700 (SC)/CIT v. Insotex (P.) Ltd. [1984] 150 ITR 195 (Kar.)/Calico Dyeing & Printing Works v. CIT [1958] 34 ITR 265 (Bom.)/C.T. Desai v. CIT [1979] 120 ITR 240 (Kar.). See also Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC)/Jt. CIT v. United Phosphorus Ltd. [2008] 167 Taxman 261 (SC)
In view of Supreme Court’s judgment in case of Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206, it was to be held that interest paid in respect of borrowing for purchasing capital assets, which are not put to use in concerned financial year, can be permitted as an allowable deduction - Jt. CIT v. United Phosphorous Ltd. [2008] 167 Taxman 261 (SC).
Where machinery was purchased out of borrowed amount for purpose of business and it was treated as business assets merely because such machinery had not been actually used in business at time when assessment was made, interest paid on amount borrowed could not be disallowed - CIT v. Associated Fibre & Rubber Industries (P.) Ltd. [1999] 102 Taxman 700 (SC)/CIT v. Insotex (P.) Ltd. [1984] 150 ITR 195 (Kar.)/Calico Dyeing & Printing Works v. CIT [1958] 34 ITR 265 (Bom.)/C.T. Desai v. CIT [1979] 120 ITR 240 (Kar.).
However this is before the insertion of proviso but one thing is clear that when it is proved that the capital is not borrowed after business was exist then this proviso will not be applicable and decision of abovementioned cases can be applicable. Because in our present case the capital was not borrowed after the existing business was started. And at the time of capital borrowed no business was existed and all the capital was borrowed altogether and not with separate sanctioning of the loan.
Test of Proviso of Section 36(1)(iii) with the fact of the present case
We discuss here line by line our fact of the case and applicability of this section & proviso on our case. For test of allowability or disallowability each line of proviso to be tested.
Line 1 Interest Paid Yes No Issue
Line 2 In respect of capital borrowed Yes No Issue
Line 3 Capital borrowed for acquisition of an asset Yes Yes capital borrowed for acquision of an asset for a integrated plant wherein one raw material will be processed at different stage and in ultimate FG will be Tin Plate. Se the Production Flow Chart Attached of this Integrated Plant.
Line 4 Acquisition of an asset for extension Not for extension No further capital borrowed for extention, Capital borrowed for first project and no further project extension initiated.
Line 5 Extension of Existing Business or Profession No Extension of Existing 1-Capital borrowed is not for extention of existing, it was first time borrowed when project was started.
2- Also at the time of borrowing there was no any business was existed, while as per proviso at the time of capital borrowed existence of already a business is required.
Line 6 Asset may be capitalized or not No Issue It is not material in our case
As seen above that the some line of proviso is not applicable to our fact, so in our opinion learned officer has erred in law during disallow the interest.
For more clarification I want to elaborate the meaning & intention of legislature that reflects from plane reading of section and proviso.
Concept of Integrated Plant :Can integrated plant will constitute a plant and after starting of Commercial Production can any interest will be disallowed.
The disallowances made by the learned officer raise the following question-
1- Whether integrated plant will constitute a single plant or not
2- And after starting of production of final product can interest will be disallowed if some process related part of plant was not started and company uses readymade input instead of in house processed input.
Before discussing this we need to look in to relevant extract of following case of
HIGH COURT OF DELHI-CIT Vs Monnel Industries Ltd.ITA No. 450/2008 November 21, 2008
5.8 In determining whether two lines of businesses constitute the same business and to this end, whether nature of the two businesses has to be looked at, was a proposition, the Supreme Court rejected in the case of a Produce Exchange Corporation Ltd v. CIT: (1970) 77 ITR 739. In this case, the assessee carried on business in diverse commodities as also in stocks and shares. The issue was whether the losses suffered by the assessee in the sale of shares of Public Limited Company could be set off against profits from transactions in other commodities in the relevant year. In the said case the Supreme Court noted that the Calcutta High Court had followed the test laid down by it in Shree Ramesh Cotton Mills Ltd v. Commissioner of Income Tax: (1967) 64 ITR 317, wherein in determining whether the two lines of businesses constitute the same business, they had applied the yardstick, whether the nature of the two businesses was the same. The Supreme Court, however, reversed this view of the Calcutta High Court by holding as follows:-
“We need not consider whether the ultimate decision of the High Court in Shree Ramesh Cotton Mills Ltd’ s case on which reliance was placed is correct, but we are unable to agree with the High Court that the decisive test for determining whether the two lines of businesses constitute the same business is the nature of the two businesses.”
6. The aforesaid view taken by the Supreme Court was re-affirmed by it, in the case of B.R.Ltd v. V.P.Gupta, Commissioner of Income Tax, Bombay: (1978) 113 ITR 647. In B.R.Ltd (supra), the Supreme Court was called upon to decide whether unabsorbed losses suffered in the business of import of woolen fabrics could be set off from the profits earned in respect of export of cotton textiles . The Supreme Court in the said case, approved the ratio of the judgments of its own court in the case Prithvi Insurance (supra), and Produce Exchange (supra). In doing so it also noted the observations made in the decision of the Supreme Court in the case of Standard Refinery and Distillery Ltd v. Commissioner of Income Tax: (1971) 79 ITR 589 and finally concluded that, tests for ascertaining whether the two lines of businesses were the same business was not dependent on determination of the nature of goods dealt with. The decisive test according to the Supreme Court was the unity of control and not the nature of two lines of businesses. It further held that even though the fact that one business cannot be conveniently carried on after the closure of the other business may furnish a strong indication that the two businesses do not constitute the same business, but as already held in Prithvi Insurance (supra) no decisive inference can be drawn from the fact that after the closure of one business the other cannot be conveniently carried on.
6.1 Based on the aforesaid tests, let us examine the findings returned by Tribunal in coming to the conclusion that there is a unity of control and management, interlacing and dovetelling of finances. The Tribunal in the instant case found as a fact in paragraph 30-31 of the impugned judgment that there was a common Board of Directors controlling the ferro alloys plant, as well as, the sugar plant which, operated from the head office located at Delhi, funds for the two plants were common and hence, there was inter-mingling and interlacing of funds, as also the fact, that even though the two divisions were geographically located at different sites, marketing of the final products was carried out under the supervision and control of the same set of executives at the head office. Applying the tests discussed hereinabove to facts as determined by the Tribunal, we have no difficulty in holding that the sugar plant and the ferro alloys plant were in the same fold of business.
6.4 The Gujarat High Court, after analyzing the decision of the Bombay High Court in Calico Dyeing and Printing Works v. Commissioner of Income Tax: (1958) 34 ITR 265 and of the Supreme Court in India Cements Ltd v. Commissioner of Income Tax: (1966) 60 ITR 52 and in Challapalli Sugars Ltd v. Commissioner of Income Tax: (1975) 98 ITR 167, concluded as follows:-
“It is no doubt true that in the case of Challapalli Sugars Ltd the Supreme Court has unequivocally observed that interest paid on the borrowing utilised to bring into existence a fixed asset which has not gone into production goes to add to the cost of installation of that asset. But these observations have been made with reference to a situation wherein it was not possible to contend that the borrowing on which interest was paid was made for the purpose of any business. The company which had made the borrowing in that case had not yet started production, and hence had not commenced any business when it borrowed the amount in question. Therefore, it was not possible to say in that case that the borrowing was made” for the purposes of the business? to bring the case within the ambit of Section 10(2)(iii) of the Indian Income Tax Act, 1922 (which is equivalent to Section 36(1)(iii) of the Act of 1961). If the said borrowing was not “for the purpose of business” in as much as no business had come into existence, it must follow that it was made for the purpose of acquiring an asset which could be put to use for doing business, and hence interest paid on such borrowing would go to add to the cost of the assets so acquired.
“The question is, is this line of reasoning inconsistent with the view taken by the Bombay High Court in Calico Dyeing and Printing Works, or by the Supreme Court in India Cements Ltd”. On proper analysis the reasoning on which the view taken by the High Court of Bombay and the Supreme Court in the above-referred cases rests is as under:
Section 10(2)(iii) of the Act of 1922 allows deduction of interest on all borrowings which are made “for the purposes of business”. The expression “purposes of business” is comprehensive enough to cover expenditure of revenue nature as well as of capital nature because both the types of expenditures can be incurred for business purposes. Therefore, even if a borrowing is made for incurring an expenditure of capital nature, it remains the borrowing for a business purpose. If that is so, the requirements of Section 10(2)(iii) of the Act of 1922 are fully satisfied and interest paid on such borrowing is entitled to deduction as revenue expenditure. The High Court of Bombay has unequivocally stated in Callico Dyeing and Printing Works that in order to attract the provisions of Section 10(2)(iii) it does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all that the Section requires is that the assessee must borrow the capital for the purpose of his business. This dichotomy between the borrowing of a loan an actual application thereof in the purchase of a capital asset, seems to be on the ground that a mere transaction of borrowing does not, by itself, bring any new asset of enduring nature into existence, and that it is the transaction of the investment of the borrowed capital in the purchase of the new asset which brings that asset into existence. Since the transaction of borrowing is not the same as the transaction of investment, the Supreme Court has observed in India Cements Ltd vs Commissioner of Income Tax that, for considering whether payment of interest on a borrowing is revenue expenditure or not, the purpose for which the borrowing is made is irrelevant. Thus, the decisions of the Bombay High Court in Callico Dyeing and Printing Works and of the Supreme Court in India Cements Ltd were given with reference to the borrowings made for the purposes of running businesses, while the decision of the Supreme Court in Challapalli Sugars Ltd was given with reference to the borrowings which could not be treated as made for the purposes of business, as no business had yet been commenced. Thus, there is no incompatibility between these decisions. The Supreme Court itself had distinguished its earlier decision in India Cements Ltd in the following terms in Challapalli Sugars Ltd:
“This case too is of no assistance to the revenue. The appellant-company in that case at the time it raised the loan was a running concern. Unlike the assessees in the present appeals, the loan raised by the appellant-company in the cited case was not before the commencement of production but at a later stage. The question of including the interest paid on the loan before the commencement of business in the actual cost of plant did not arise in that case.”
In view of this, we conclude that the decisions of the Bombay High Court in Callico Dyeing and Printing Works and of the Supreme Court in India Cements Ltd, hold the field with equal force, even after the decision in Challapalli Sugars Ltd.
7. The upshot of the aforesaid decisions as applied by the Tribunal in instant case is that:-
(i) a loan taken or capital borrowed is, by itself, not a capital asset, nor does it give an advantage of an enduring nature;
(ii) as long as a loan was taken or capital was borrowed for the purposes f business, the assessee is entitled to claim interest paid thereon as deduction under Section 36(1)(iii) of the Act;
(iii) interest may have to be capitalized after the borrowed capital or loan taken is utilized in bringing into existence an asset at the stage of commencement of business. In other words, after the assessee’s business had already commenced then the interest paid on capital borrowed or loan taken can be claimed as deduction under Section 36 (1)(iii) of the Act.
(iv) in coming to the conclusion whether the interest paid on capital borrowed or loan taken in setting up a new line of business ought to be capitalized or treated as revenue expenditure, the test as laid down by the Supreme Court in the case of Produce Exchange Corporation (supra) and Prithvi Insurance Company (supra) would be relevant and;
(v) lastly, as long as interest is paid on capital borrowed or loan taken in respect of new line of business which is in the same business fold for the purposes of ascertaining income under Section 28 of the Act, it can be claimed as a deduction under Section 36(1)(iii) of the Act.
8. In the instant case, the Tribunal has returned the finding that there is a unity of control and management, in respect of the ferro alloys plant as well as the sugar plant and there is also intermingling of funds and dove-tailing of businesses. In these circumstances it cannot be said that the respondent/assessee had not commenced its business and hence, interest would have to be capitalized in terms of the ratio of the judgment in the case of Challapalli Sugars Ltd (supra). If that is not so then, the only other conclusion that is possible on these facts, is that, the interest was paid by the respondent/assessee on borrowed capital for the purposes of business. That being the case, in our view, the Tribunal correctly allowed the financial charges i.e., interest paid to the extent of Rs 3,50,83,472/- as deduction under Section 36(1)(iii) of the Act.
COMMISSIONER OF INCOME TAX vs. TATA CHEMICALS LTD.
HIGH COURT OF BOMBAY
H.L. Gokhale & V.C. Daga, JJ. IT Appeal No. 31 of 2000 3rd April, 2002 (2002) 175 CTR (Bom) 443 : (2002)
256 ITR 395 (Bom) : (2002) 122 TAXMAN 643 (Bom)
Sections 36(1)(iii), 260A,
Asst. Year 1992-93
10. This order of the AO has been mechanically confirmed by the CIT(A), Mumbai. As against this, the Tribunal has culled out the propositions of law based on various judgments of the apex Court as well as of various High Courts in para 28 of its order. It has summarised propositions and determined the tests on the question of unity of business.
They are as follows :
(i) The nature of the two lines of business is not relevant.
(ii) The fact that one business can be conveniently closed down without affecting the other business is a strong indication that both the businesses are distinct and separate. But no decisive inference can be drawn from the fact.
(iii) The decisive test is the unity of control which is indicated by inter-lacing, inter-dependence and inter-connection between the businesses and the dovetailing of one into the other. Such interlacing, inter-dependence or inter-connection can be shown to exist by reason of a common management, common administration, common fund and the common place of business. The above propositions are culled out from the following judgments of the apex Court : (1)
Setabganj Sugar Mills Ltd. vs. CIT (1961) 41 ITR 272 (SC) : TC 54R.777; (2) CIT vs. Prithvi Insurance Co. Ltd.(1967) 63 ITR 632 (SC) : TC 45R.348;(3) Produce Exchange Corpn. Ltd. vs. CIT (1970) 77 ITR 739 (SC) : TC15R.357; (4) Standard Refinery & Distillery Ltd. vs. CIT (1971) 79 ITR 589 (SC) : TC 45R.498; (5) Hooghly Trust (P) Ltd. vs. CIT (1969) 73 ITR 685 (SC) : TC 45R.493; and (6) B.R. Ltd. vs. V.P. Gupta, CIT 1978 CTR(SC) 82 : (1978) 113 ITR 647 (SC) : TC 45R.362. The learned counsel appearing for the parties took us through the text of the various judgments referred to hereinabove and we are in complete agreement with the Tribunal that the above determined tests would be the correct approach to the questions with which we are concerned. The Tribunal while reaching to the conclusion has considered various factors such as administration of various units, flow of funds, unity of management, unity of the accounting set up as well as control coupled with various such
relevant factors. The Tribunal also found that the administration and management of funds of two units is common. The Tribunal has also recorded finding of fact that there was a functional integrity between the two units. It is in these circumstances that the deduction under the particular section was held allowable.
11. The Tribunal has come to the conclusion that the decisive test is the unity of control which is indicated by inter-lacing, inter-dependence and inter-connection between the businesses and dovetailing of one into the other. In the present case, it is quite clear that the amalgamation of the subsidiary was allowed by the High Court. Thereafter, it is for the management of the company to manage its affairs and the benefit which would be available for the borrowings done for a unit would certainly be claimable by the company as such. Sec. 36(1)(iii) which permits the amount of interest paid in respect of capital borrowed for the purposes of the business will have to include the borrowing for a unit of the company which is what the fertilizer unit at Babrala is. Considering the fact that finding is based on appreciation of evidence brought on record, we do not find that this question can be said to be a question of law warranting adjudication by this Court. In view of what is observed hereinabove, the questions of law raised in at (b) and (h) do not arise for our consideration. Question (f)
Based on the study of above case our view is that-
1- Integrated Plant can be a single plant under a single roof
2- After starting of final product as per design plant of plant plant can be understood as a started.
3- Merely on the basis of the some working capital problem some of the part of CWIP is not started production bur ready for production can not be understood as that whole CWIP is not ready for use.
4- When Plant designed as a Intergrated Plant in a starting, planning and execution for this establishment started simultaneously and during span of time some portion has started commercial production and some has not. And Capital borrowed in starting also and not after the first plant was ready. So if the capital borrowed altogether then it can not be termed as it was taken for extension of existing business because at the time of taken of capital borrowed no business was existed at all.
5- When the plant has started commercial production any interest attributable to this integrated plant should be expense out.
6- Learned officer has erred in law in making presumptive definition of CWIP as many of the asset which are in production are very interlinked and it is not possible to separated it from running portion of plant and idle portion of plant.So if he disallow treating them as a separate extension of existing business what treatment will be of running portion of plant which are already in run and closely interlinked with these portion.
FACT in our case about the Single Integrated Plant
The Company was planned to establish an integrated plant which produce following produce which will be ultimately be raw material for next product or can be sold as it is. This project was a long and integrated and company was applying to the bank for a Project term loan of Rs 325 Crores for whole project including HRC > CRFH > CRCA > TMBP > ETP Plant.
Company’s Project cost at the time of application to the bank was 498 crore out of this 498 crore Bank Loan requirement was 325 crore and this 325 crore was asked to the bank as per schedule of implementation.
All bank loan were requested and taken for an single integrated project, to be runned in a same factory shed under one roof, jointly connected to each other, under common control & supervision of same management and labor staff, no separate department for each sections, single accounting was followed and no any other segment was planned at the time of project formulation. And no further proposal place for any extension of project as no extension was planned by the company yet.
Unfortunately all the integrated plant was not installed due to some working capital problem and company has started commercial production of CRFH,HRPO & Tin Plate. Other machinery which were bought and installed for rest product was kept idle due to working capital problem and some installation issues.
The bank loan neither further requested not any extension of plant planned. The design prepared at the start was complete for this unit and no other unit was opened further.
This capital was borrowed only for this unit where in different plant was designed as a part of integrated plant for TIN PLATE products. No other unit is opened no new loan proposal was requested. All the asset and CWIP shown were bought out from this first loan requested of Rs 325 crores.
Why this unit will be treated as a single unit and no extension of this unit is required
1- Plant is integrated
2- Each output will be input of next output product
3- Proposal for whole project was submitted
4- Single Project Report Placed to the Bank
5- Single Proposal for Term Loan Placed to the bank
6- It is running in a same factory shed under one roof,
7- Jointly connected to each other
8- Under common control & supervision of same management and labor staff
9- No separate department for each sections,
10- Single accounting was followed
11- No any other segment was planned at the time of project formulation.
12- No further proposal place for any extension of project as no extension was planned by the company yet.
Flow of Integrated Plant
HRC > CRFH > CRCA > TMBP > ETP
Interest can be allowed u/s 37(1)
As per the plain reading of section 37(1) the following line is written-
37. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
For allowance of Expenditure under this section three major condition to be followed
1- Any expenditure (not being expenditure of the nature described in sections 30 to 36
It means if the item not falling under 30 to 36 and it is satisfying other below two condition then it can be allowed. Therefore in present case if learned officer does not considered this expenditure as per nature of interest defined in the section 36(1)(iii) it automatically comes to section 37(1) as section 37(1) is a residuary section and when it comes to this section we need to check other below two condition also. As per our case if learned officer does not allow this u/s 36(1)(iii) he should consider the applicability u/s 37(1) and simply he can not disallow without checking the applicability of section 37(1)
2- and not being in the nature of capital expenditure or personal expenses of the assessee)
The other condition in section 37(1) is this should not be capital expenditure or personal expenses. As per this present case this is the private limited company and there is not any personal expense of company so this part of section will not apply in present case. Also the section speaks about capital expenditure but the fact is that There is no definition of the expression ‘capital expenditure’ in the Act, and it must be construed in a business sense save insofar as there may be rules of construction applicable to it - Mohanlal Hargovind of Jubbulpore v. CIT [1949] 17 ITR 473 (PC).
The expression ‘capital expenditure’ is not defined in the Income-tax Act and the words ‘in the nature of capital expenditure’ occurring in section 37(1) make the meaning of the expression more elastic in its application to the facts of each case. The consistent view of the Court is that the expression is to be construed in a business sense save insofar as there may be rules of construction applicable to it.
3- laid out or expended wholly and exclusively for the purposes of the business or profession
As per the above line if above two condition satisfied the expenses incurred should be wholly and exclusively for the purposes of the business or profession. And as per present case the interest paid is wholly and exclusively for the purposes of the business or profession.
Therefore first condition is automatically satisfied if learned officer does not consider it in section 36(1)(iii) and in other hand this is not a capital expenditure strictly as it is not defined in the act and third it is wholly and exclusively for the purposes of the business or profession so either u/s 36(1)(iii) or u/s 37(1) it should be allowed.
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