Interest on Borrowed Capital

The assessee-company was engaged in the business of manufacture and sale of intravenous solutions. For the A.Y. 1992-93, the assessee claimed deduction towards expenses aggregating to Rs.2,12,05,459 which included interest on borrowings of Rs.1,56,76,000 utilised for purchase of machinery. During the assessment year under consideration the assessee had installed new machinery. The assessing Officer disallowed the amount of Rs.1,56,76,000 placing reliance on the judgment of the Supreme Court in Challapalli Sugar Ltd. v. CIT, (1975) 98 ITR 167, inter alia, on the ground that during the assessment year under consideration the assessee had installed new machinery on which production had not started. On appeal, the Commissioner of Income-tax (Appeals) confirmed the addition of interest amount on borrowings of Rs.1,56,76,000. The matter was carried in appeal by the assessee. The Tribunal held that the Department was not justified in adding Rs.1,56,76,000 in the income of the assessee. This decision was confirmed by the High Court. On appeal by the Department, the Supreme Court noted that before the High Court it was not the case of the Department that a new business was set up or commenced during the assessment year under consideration. It was undisputed before the High Court that three additional machines were installed by the assessee during the assessment year under consideration for the production of intravenous injectibles. The Supreme Court upon reading the provisions of S. 36(1)(iii) held that interest on moneys borrowed for the purposes of business is a necessary item of expenditure in a business. For allowance of a claim for deduction of interest under the said section, all that is necessary is that, firstly, the money i.e., capital, must have been borrowed by the assessee; secondly, it must have been borrowed for the purpose of business; and, thirdly, the assessee must have paid interest on the borrowed amount. All that is germane is : whether the borrowing was, or was not, for the purpose of business. The expression ‘for the purpose of business’ occurring in S. 36(1)(iii) indicates that once the test of ‘for the purpose of business’ is satisfied in respect of the capital borrowed, the assessee would be entitled to deduction u/s. 36(1)(iii). This provision makes no distinction between money borrowed to acquire a capital asset or a revenue asset. All that the Section requires is that the assessee must borrow capital and the purpose of the borrowing must be for business which is carried on by the assessee in the year of account. What clause (iii) emphasises is the user of the capital and not the user of the asset which comes into existence as a result of the borrowed capital unlike S. 37 which expressly excludes an expenses of a capital nature. The Legislature has, therefore, made no distinction in S. 36(1)(iii) between ‘capital borrowed for a revenue purpose’ and ‘capital borrowed for a capital purpose’. An assessee is entitled to claim interest paid on borrowed capital, provided that capital is used for business purpose, irrespective of what may be the result of using the capital which the assessee has borrowed. Further, the words ‘actual cost’ do not find place in S. 36(1)(iii) of the 1961 Act. The expression ‘actual cost’ is defined in S. 32, S. 32A, etc. of the 1961 Act which is essentially a definition section which is subject to the context to the contrary. S. 43(1) defines ‘actual cost’. The definition of ‘actual cost’ has been amplified by excluding such portion of the cost as is met directly or indirectly by any other person or authority. Explanation 8 has been inserted in S. 43(1) by Finance Act, 1986 (23 of 1986), with retrospective effect from April 1, 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 S. 43(1) has relevance in relation to S. 32 (depreciation allowance), S. 32A (investment allowance), S. 33 (development rebate allowance), and S. 41 (balancing charge). The ‘actual cost’ of an asset has no relevance in relation to S. 36(1)(iii) of the 1961 Act. The Supreme Court however observed that in the present appeal it was concerned with the A.Ys. 1992-93, 1993-94, 1995-96 and 1997-98. The Supreme Court noted that a proviso has been inserted in S. 36(1)(iii) of the 1961 Act, which denies deductions of interest for the period beginning from the date on which the capital was borrowed for acquisition of asset till the date on which the asset was first put to use. The Supreme Court held that proviso has been inserted by the Finance Act, 2003, with effect from April 1, 2004. Hence, the said proviso will not apply to the facts of the present case. The Supreme Court therefore held that the said proviso would operate prospectively. The Supreme Court held that the Assessing Officer was not justified in making disallowance of Rs.1,56,76,000 in respect of borrowings utilised for purchase of machines. Note : The said decision was followed in the following cases : 1. Jt. CIT v. United Phosphorous Ltd., (2008) 299 ITR 9 (SC) 2. ACIT v. Arvind Polycot Ltd., (2008) 299 ITR 12 (SC) 3. Dy. CIT v. Gujarat Alkalies & Chemicals Ltd., (2008) 299 ITR 85(SC) In United Phosphorus Ltd.’s case there was another question regarding option in law to claim partial depreciation in respect of any block of assets. The matter was remanded back to the High Court. In Arvind Polycol’s case there were other two questions (i) Re : Deduction of premium payable on redemption of debenture on pro-rata basis, and (ii) Re : Deduction of expenditure on foreign tour expenses for acquisition of machinery. The first question was decided following the decision in Madras Industrial Corporation Ltd., (1997) 225 ITR 802 (SC) and the second question was concluded on the concurrent finding of fact that the visit was by technical personnel. In Gujarat Alkali’s case also, there was another question regarding allowance of deduction of ‘commitment charges’. The Supreme Court held it to be deductible u/s.37 following its decision in Addl. CIT v. Akkamamba Textiles Ltd., (1997) 227 ITR 464 and CIT v. Sivakami Mills Ltd., (1997) 227 ITR 465.