36 (1)(iii)
This query is : Resolved
09 February 2009
in case a business is existing And asset is purchased for expansion of existing business… as per proviso no deduction shall be allowed in respect of any amount of interest paid , In respect of capital borrowed for acquisition of a new asset for expansion of the business ( whether capitalized in books or not) and where such amount of interest paid is for the period beginning from the date on which the capital was borrowed for for acquisition till the date on which such asset is first put into use………..
Plzzz clrify this section n tell me y interest cannot be allowed when an asset is purchased for expansion,……………
Plzzz clrify this section n tell me y interest cannot be allowed when an asset is purchased for expansion,……………
21 March 2012
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.
(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.
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