Calcutta High Court
Commissioner Of Income-Tax vs India Steamship Co. Ltd. on 16 January, 1992
Equivalent citations: [1992]196ITR917(CAL)
JUDGMENT Ajit K. Sengupta, J.
1. Pursuant to the decision of the Supreme Court, the following questions of law have been referred under Section 256(1) of the Income-tax Act, 1961, at the instance of the Revenue for the assessment year 1972-73 :
" 1. Whether, on the facts and in the circumstances of the case, the finding and/or conclusion of the Tribunal that the sum of Rs. 1,13,62,848 being the amount of interest payment made by the assessee for purchase of two vessels was spent for the purpose of acquisition of the assessee's business assets and as such the assessee is entitled to capitalise such interest on deferred liability are vitiated in law or are otherwise unreasonable and/or perverse ?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the interest payment on loan prior to delivery of the ships amounting to Rs. 7,55,746 and Rs. 8,54,383 and other expenses of Rs. 2,89,616 and Rs. 3,34,844 should be capitalised for the purpose of development rebate ?"
2.The facts of the case are that the assessee-company had been carrying on shipping business for a long time. During the year under reference, it purchased two ships, namely, Indian Venture and Indian Valour, The capital cost of these ships was shown by the assessee at Rs. 4,74,83,585 and Rs. 4,67,88,345, respectively, which included the following expenses :
Indian Venture Indian Valour (Rs.) (Rs.)
(a) Stage payments for cost of construction 3,87,43,843 3,83,10,092
(b) Cost of additional equipment 5,29,284 5,25,295
(c) Interest prior to delivery 8,54,383 7,55,746
(d) Interest on deferred liability 56,81,424 56,81,424
(e) Bank commission for deferred payment guarantee 13,39,807 12,26,172
(f) Other expenses, namely, travelling and hotel charges of seamen and staff 3,34,844 2,89,616 4,74,83,585 4,67,88,345
3. The assessee claimed development rebate on the entire cost of the two ships. The Income-tax Officer held that since this was an old business, interest on funds borrowed for the purchase of new ships and guarantee commission paid for obtaining the loans and other expenses were to be allowed as business expenses and not to be capitalised in view of the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT .
4. The Income-tax Officer further disallowed a sum of Rs. 88,709 in computing the total income of the assessee holding that house rent allowance, car allowance, personal allowance and holiday allowance constituted perquisities for the purpose of Section 40A(5)(ii) of the Income-tax Act, 1961.
5. In appeal, the Appellate Assistant Commissioner, after considering the submissions made before him as also going through the facts of the case, held that the assessee was not entitled to capitalise interest on deferred liability in the light of the decision of the Supreme Court in the case of Bombay Steam Navigation Co. (1953) Private Ltd. v. CIT [1965] 56 ITR 52.
6. The assessee came up in appeal before the Tribunal. The assessee's couns'el reiterated the same contentions as were advanced before the lower authorities. He urged that it was not the case of interest payment on simple borrowings as held by the lower authorities but was an expenditure relating to the acquisition of a business asset. It was urged that the cost of an asset included not only its actual price but also such incidental charges as sales tax, freight, insurance, transport, installation expenses and interest payment on the capital borrowed for acquisition of such asset. It was asserted that even Section 208 of the Companies Act, 1956, permitted the capitalisation of interest on borrowed capital. Relying on the decision of the Supreme Court in the case of Challapalli Sugars , the assessee's counsel urged that the accepted accountancy rule for determining the cost of a fixed asset was to include all expenditure necessary to bring such asset into existence and to put them in working condition. In case money was borrowed for those purposes, the interest payment on such borrowings could be capitalised and added to the cost of that asset. It was contended that the obligation for payment of interest was incurred for obtaining deferred payment terms under the contract for the purchase of the assessee's business assets without which the assessee could not earn its business income and that any expenditure for acquisition of an asset could not be regarded as a revenue expenditure. The assessee's counsel invited the attention of the Tribunal to the terms of the contract between the assessee and the German company as also the approval of the Government of India for construction of the two vessels on deferred payment terms subject to payment of interest at 5.5%. It was pointed out that the assessee also treated the interest payment as capital expenditure and claimed depreciation on this amount while filing its return of income. Reliance was placed on the decision of the Gujarat High Court in the case of CIT v. Tensile Steel Ltd. and it was claimed that, under similar circumstances, it was held that interest on deferred payment terms was to be capitalised and added to the cost of the asset for the purpose of depreciation and development rebate.
7. On behalf of the Department, reliance was placed on the decision of the Supreme Court in the case of Bombay Steam Navigation Co. (1953) Private Ltd. [1965] 56 ITR 52 to show that, under similar circumstances, interest payment was considered to be revenue expenditure. It was urged that the interest payment on funds borrowed even for acquisition of an asset, by a continuing business, could not be said to be capital expenditure in view of the Supreme Court decision in the case of India Cements Ltd, v. CIT . According to the Department, the vessels were purchased by the assessee for extension of its existing business and as such the amount spent by it was not in the nature of capital expenditure. It was further contended that in Challapalli Sugars Ltd. and Tensile Steel Ltd. , the principle laid down by the Supreme Court in the case of Bombay Steam Navigation Co. (1953) Private Ltd. [1965] 56 ITR 52 had been overlooked.
8. The Tribunal, however, decided the issue in favour of the assessee following the principles laid down by the Allahabad High court in J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153 and the Gujarat High Court in Tensile Steel Ltd. [1976] 104 ITR 581. The Tribunal was of the view that the facility of deferred payment of the price was a part of the financial and technical collaboration agreements resulting in spreadover of the payment of actual price over a long period which, in turn, necessarily involved the question of payment of interest also. The Tribunal, therefore, held that the interest payments on deferred instalments of the purchase cost of two vessels were capital expenditure which should be added to the cost of the vessels for the purpose of depreciation and development rebate.
9. Before the Tribunal, the Department also came up in appeal. The first ground of the Department was that the Appellate Assistant Commissioner was wrong in directing the following expenditure as capital expenditure :
Indian Valour Indian Venture (Rs.) (Rs.)
(a) Interest on loan 7,55,746 8,54,383
(b) Other expenses, viz., travelling and hotel charges of seamen and staff 2,89,616 3,34,844
10. The assessee's case before the Income-tax Officer was that the aforesaid expenditure was incurred for the purpose of acquiring business assets and as such this should be added to the cost of those assets for the purpose of depreciation and development rebate. The Income-tax Officer, on the ground that the business of the assessee being an old one, held that the aforesaid expenses could be allowed as revenue expenditure, and rejected the contention of the assessee. In appeal, the Appellate Assistant Commissioner, following the decision of the Supreme Court in the case of Challapalli Sugars Ltd. , held that the aforesaid expenses should be capitalised as claimed by the assessee. Being aggrieved, the Department came up in appeal before the Tribunal. The Tribunal held that the Appellate Assistant Commissioner was justified in treating the aforesaid expenses as capital expenditure.
11. It has not been disputed before us that, having regard to the principles laid down by the Supreme Court in Challapalli Sugars Ltd. , interest paid on amounts borrowed and other related expenses in connection with the acquisition of ships before such ships were delivered to the assessee is includible in the actual cost of the ships acquired. We, therefore, answer the second question in this reference in the affirmative and in favour of the assessee.
12. We shall now turn to the first question. Mr. Bajoria, learned counsel appearing for the assessee, has contended that, although interest paid for periods after the commencement of the business cannot be capitalised, where interest is paid on balance of the purchase price of the ship, such interest is includible in the actual cost. Mr. Bajoria has very fairly submitted that, according to the principles of accountancy, he cannot claim the unpaid purchase price as a capital expenditure, but the intention of the Legislature as contained in Explanation 8 to Section 43(1) inserted by the Finance Act, 1986, is that the benefit of such capitalisation would be denied on and from the assessment year 1974-75. Accordingly, the assessment year in the present reference being 1972-73, the said Explanation will have no application. He, therefore, submits that the first question in this reference must be answered in favour of the assessee.
13. The short question, therefore, is whether interest on the balance of the purchase price of the ship on deferred payment basis is includible in the actual cost.
14. As regards interest payable after the date of commencement of production, on instalments relating to assets purchased on deferred payment terms or on monies borrowed for the purpose of acquiring fixed assets, the Allahabad High Court in CIT v. J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153, the Gujarat High Court in CIT v. Tensile Steel Ltd. [1976] 104 ITR 581, the Bombay High Court in Ballarpur Paper and Straw Board Mills Ltd. v. CIT [1979] 118 ITR 613 and the Punjab and Haryana High Court in CIT v. Oswal Spinning and Weaving Mills Ltd. [1986] 160 ITR 426, have taken the view that interest payable on the unpaid purchase price which is deferred and payable in yearly instalments is an integral part of the price and the liability for such payment arises when the agreement for purchase is made. It is, therefore, contended that such interest will form part of the cost of the asset if the agreement for the purchase of the asset is executed before the commencement of production or before setting up the new unit. As a matter of fact, the decision in Tensile Steel Ltd. has been followed by the Bombay and Punjab High Courts. In Tensile Steel Ltd. a foreign collaboration agreement for providing financial collaboration, supply of plant and machinery and technical know-how was executed between the Indian company and the Japanese company. Under this agreement, the Indian company acquired plant and machinery on deferred payment terms. 20% of the price of the plant and machinery was paid at the time of signing the agreement and the balance of 80% of the price was to be paid in instalments over a period of five years. Interest at the rate of 6% per annum was payable on the outstanding amount after adjusting the instalments payable under deferred payment terms. In that case, the Tribunal reached the following conclusion (at page 589) :
"... We have gone through the entire material given in the paper book filed by counsel for the appellant and are fully satisfied that the interest has been shown to be a part and parcel of the actual cost of the machinery. No doubt the interest is contingent on the deferred payment of instalments but, on a perusal of the copy of the invoices furnished and the contract agreement and other papers, we find that the interest payment is a part and parcel of the cost of the machinery and it has been paid along with the principal amount till the final payment of instalment is made. Thus, the payment of interest being part of the cost of the machinery, it cannot be held that it is a revenue expenditure."
15. There, the Gujarat High Court observed that the interest was a part and parcel of the original price the payment of which was agreed to be spread over for a period of five years. On a construction of the agreements, the Gujarat High Court came to the conclusion that the entire arrangement was such that the payment of the principal as well as interest was for the purpose of acquiring plant and machinery and, consequently, of a capital nature.
16. The Gujarat High Court proceeded to hold as follows (at pages 594, 595) :
" The liability to pay interest was incurred under the agreements and it was to the effect that the interest at the rate of 6% was to be paid on the balance of the price the payment of which was agreed to be deferred over a period of five years. It was, therefore, urged on behalf of the Revenue that in any case the interest which has been paid after the assessee-company went into production cannot be allowed to be capitalised and it was pointed out to us that the first instalment of the balance of price of 1,40,400 was to be paid one year after the date of shipment, and accordingly the first instalment of the balance of the price as well as the interest at the rate of 6% thereon was to be paid on November 30, 1963. Each of the remaining subsequent instalments was to be paid thereafter after every six months. It was, therefore, urged that the payment of interest was for the period after the assessee-company went into production and, therefore, on the ratio of the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT , it is only the interest incurred before the commencement of the production which can be capitalised and added to the cost of the fixed assets. We must reject such a broad submission made on behalf of the Revenue, In Challapalli's case , Mr. Justice Khanna, speaking for the court, said that for the purpose of deduction on account of depreciation and development rebate one has to take into account the written down value ; and the actual cost, though not defined, should be construed in the sense which no commercial man would misunderstand. For that purpose, the court referred to the connotation of the said expression in accordance with the normal rules of accountancy prevailing in commerce and industry as well as to the provisions contained in Section 108 of the Companies Act, 1956. The court referred, inter alia, to the Statement on Auditing Practices issued by the Institute of Chartered Accountants of India (1974) from which paragraph 2.5 was reproduced. The material part of that paragraph so far as relevant for purposes of these references reads as under :
'... Cost includes all expenditure necessary to bring the assets into existence and to put them in working condition. By way of illustration the following may be mentioned :--. . .
(iv) Interest on borrowings to the extent specified in paragraph 2.22.' The Supreme Court thereafter set out paragraph 2.22. The relevant part of the said paragraph so far as material for these references is as under :
' The question often arises as to whether interest on borrowings can be capitalised and added to the fixed assets which have been created as a result of such expenditure. The accepted view seems to be that in the case of a newly started company which is in the process of constructing and erecting its plant, the interest incurred before production commences may be capitalised. " Interest incurred " means actual interest paid or payable in respect of borrowings which are used to finance capital expenditure . . . Interest on monies which are specifically borrowed for the purchase of a fixed asset may be capitalised prior to the asset coming into production, i.e., during the erection stage. However, once production starts, no interest on borrowings for the purchase of machinery (whether for replacement or renovation of existing plant) should be capitalised . . . '."
17. Ultimately, the Gujarat High Court held that, in the facts of that case, the obligation to pay interest under the agreements was incurred immediately when, according to the agreements, machinery and plant were supplied and transferred to the assessee-company. It was in the calendar year 1962 that the assessee-company debited the price of plant and machinery to the account of plant and machinery. The fact that the disbursement of that liability was spread over a period of five years would not make any difference. In that view of the matter, the Gujarat High Court approved the order of the Tribunal in treating the expenditure in question as capital expenditure.
18. The reasoning of the Gujarat High Court was that the obligation of payment of interest was incurred for obtaining deferred payment terms under the contract of purchase of machinery and plant. In other words, it was for acquisition of assets without which the assessee-company could not commence its business. The facility of deferred payment of price granted by the foreign supplier was a part of the financial and technical collaboration agreements resulting in spreadover of the payment of the actual price over a long period which in turn necessarily involved the payment of interest also. The assessee was maintaining its accounts on the mercantile basis and, when it debited the price of plant and machinery, the interest was also incurred. The fact that part of the interest was paid after the assessee-company went into production was immaterial.
19. Our attention has also been drawn to a decision of the Bombay High Court in Ballarpur Paper and Straw Board Mills Ltd. v. CIT [1979] 118 ITR 613. In that case, with a view to expand the business and increase its daily capacity, the assessee entered into two agreements with M/s. Klonee-Collin, Gmbh, Dortmund, West Germany, and M/s. Empacel, Paris, France, on May 11, 1960, and May 16, 1960, for the purchase of new plant, machinery and equipment from them. Under the terms of the agreement, the assessee had to pay DM 1,67,91,350 to M/s. Klonee-Collin Gmbh and 5,77,612 to M/s. Empacel Company, as price of the plant and machinery, etc. It was agreed that the assessee would pay the sale price in ten equal instalments along with interest to the vendor-companies. The first instalment of the principal amount and the interest was to be paid in each case within six months after the final shipment of the plant and machinery, etc., and the remaining instalments were to be paid as specified in the respective agreements. There, the Tribunal held that the interest on the unpaid price of the plant and machinery on deferred payment basis did not form a part of the actual cost of the assets to the assessee within the meaning of Section 43 of the Income-tax Act, 1961, and that the same was allowable as revenue expenditure.
20. After considering the judgment of the Gujarat High Court in Tensile Steel Ltd. [1976] 104 ITR 581, the Bombay High Court held as follows (at page 622) :
" As in the case before the Gujarat High Court, in the present case, so far as the new unit that was set up by the assessee was concerned, it could not be worked unless the assessee acquired the assets. As the price to be paid to the foreign vendor was spread over a period of sixty months, it meant that facility of deferred payment of price was granted by the foreign supplier. Such facility necessarily involved the question of payment of interest. In such a case, the interest paid formed part of the actual cost that was to be paid to the foreign suppliers for supply of machinery."
21. The Bombay High Court agreed with the view taken by the Allahabad High Court in CIT v. J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153. In that case also, interest paid to the foreign suppliers for machinery on deferred payment terms was treated as forming part of the actual cost of the assets for the purpose of claiming depreciation and development rebate. Such was the view taken having regard to the well-recognised commercial and accountancy principles. Thus, in the opinion of the Bombay High Court, not only the amount paid by way of guarantee commission and stamp charges formed part of the actual cost of plant and machinery, but also the interest paid on the unpaid balance of consideration of the plant and machinery by reason of deferred payment basis also formed part of the actual cost of the assets to the assessee.
22. Our attention has been drawn to a decision of the Punjab and Haryana High Court in CIT v. Oswal Spinning and Weaving Mills Ltd. [1986] 160 ITR 426. In that case, the assessee which carried on the business of spinning and weaving woollen yarn purchased machinery on deferred term basis from a foreign country for starting a new unit. The payment for the machinery was to be made in equal yearly instalments spread over a period of 10 years and, while paying the instalments, interest due on the balance price had to be included. The assessee claimed that the amount of interest paid should be included in the cost of machinery and that it was entitled to depreciation and development rebate on the said amount. The Income-tax Officer rejected the claim of the assessee while the Tribunal accepted the claim. On a reference, the Punjab and Haryana High Court, following the decisions in Challapalli Sugars Ltd. , Tensile Steel Ltd. , Ballarpur Paper and Straw Board Mills Ltd. [1979] 118 ITR 613 (Bom) and CIT v. New Central Jute Mills , held that the interest paid on the purchase of machinery was part of the cost of machinery and that the assessee was entitled to depreciation and development rebate on the said cost.
23. At this stage, we must point out that in New Central Jute Mills , one of the questions was whether development rebate was allowable on the sum representing interest on deferred payment for machinery. No argument was advanced in that case and it proceeded on the concession of the learned advocate for the Revenue. The relevant part of the judgment is as follows (at page 740) :
" Mr. B. L. Pal, learned advocate for the Revenue, is candid enough to concede that the last question, i.e., question No. 3, is covered by the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT and the decision of the Tribunal is right on that point. As he does not press this question and in view of the decision of the Supreme Court, we answer question No. 3 in the affirmative and in favour of the assessee."
24. As indicated earlier, in Tensile Steel Ltd. the Gujarat High Court quoted with approval relevant extracts from the Statement on Auditing Practices issued by the Institute of Chartered Accountants of India in 1974. The Gujarat High Court quoted paragraph 2.22 of the above statement. According to the Gujarat High Court, the Statement of Auditing Practices explained that " interest incurred " means actual interest paid or payable in respect of the borrowings which are used to finance capital expenditure. It may be that the disbursement of interest might have taken place in future, but the obligation to pay interest was already incurred. It appears to us that the Gujarat High Court did not fully appreciate the accounting principles as laid down by the Institute. The expression " interest incurred " used in the Statement of Auditing Practices has to be construed in the context in which it is used. Interest on monies borrowed is a charge for using the amount belonging to the lender. The liability for payment of yearly interest arises from year to year on the outstanding amount. Therefore, merely because the agreement for purchase of the assets provides for payment of yearly interest on the unpaid purchase price, it cannot be said that the liability for total amount of interest is " incurred " when the agreement is executed. Where interest is payable for the use of funds for distinct periods, the liability for payment is incurred only during such period and not before the commencement of such period. At best, on entering into a contract for purchase of an asset under deferred payment terms carrying an obligation to pay interest during the period of deferment, there is a future commitment which is conditional on the continuance of the use of the finance during that period. In this context, one can draw an analogy from a contract of service under which a person is appointed for a period of, say, five years on a particular remuneration payable every month. In such a case, it cannot be said that the liability for payment of total remuneration for five years is incurred when the contract is entered into. The liability arises from month to month when services are rendered by the employee.
25. In this context, it would be relevant to note the decision of the Supreme Court of India in the case of Bombay Steam Navigation Co. (1953) P. ltd. v. CIT [1965] 56 ITR 52. In that case, the assessee-company purchased certain steamers, launches, boats, etc., for a consideration of Rs. 80 lakhs. Part of this consideration was paid by way of issue of equity shares to the vendors and the balance of the purchase price was treated as a loan from the vendor. The Income-tax Department treated the interest payment as a capital expenditure. The Supreme Court has held that interest payable on unpaid purchase price of the asset is revenue expenditure and is allowable as deduction while computing business income of the relevant year under the Income-tax Act.
26. On September 16, 1979, the Research Committee of the Institute of Chartered Accountants of India issued a Statement on " Treatment of Interest on Deferred Payments ". In that statement, the Research Committee considered the precise question with which we are concerned vis-a-vis the shipping companies. The relevant extracts are as follows :
" 1. Some companies have taken the view that interest payable on unpaid price of plant and machinery for which deferred payment facilities have been obtained forms part of the cost of the relevant asset. Some shipping companies have taken the view that the liability for interest on deferred payment terms offered by the suppliers is incurred when the ship is acquired. Such liability can be treated as deferred revenue expenditure as it does not result in any enhancement in the capacity of the ship but is incurred for the benefit to be derived during the entire period of life of the ship. In other words, according to their view, this is a revenue expenditure incurred for enduring benefit during the lifetime of the ship and can, therefore, be charged to revenue every year by spreading it equally over the life of the ship. The Research Committee of the Institute had considered the question of accounting treatment to be given to interest payable on deferred payment in the past and clarified the position in its publications. This note is being issued in order to clarify the position after taking into consideration some of the recent tax decisions and the views expressed on behalf of some of the shipping companies."
27. After considering the decisions of the Gujarat High Court (Tensile Steel Ltd. [1976] 104 ITR 581), the Allahabad High Court (J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153) and the Bombay High Court (Baliarpur Paper and Straw Board Mills Ltd. [1979] 118 ITR 613) and the decision of the Supreme Court in Bombay Steam Navigation Co. (1953) P. Ltd. [1965] 56 ITR 52), it is observed as follows :
" 11. In the light of the above discussion, the Research Committee would like to reiterate its view that interest payable for the period after commencement of production in respect of assets purchased on deferred credit basis should not be capitalised. If, however, any company decides to capitalise the total amount of interest which is likely to be payable over the period during which the deferred credit is allowed on the basis of the decisions of the High Courts referred to in para 6 above, the fact that interest has been so capitalised and the amount of the interest capitalised should be indicated by way of a note in the balance-sheet of the company in the year in which such capitalisation has been made and in each of the subsequent years as long as the asset continues to appear in the balance-sheet. It will also be necessary for the auditor to make a reference to this note in his report to the members. In such a case, depreciation should be provided in the accounts on the total cost, including the interest so capitalised. Once the total interest for the period during which the deferred credit is to run is treated by the company as part of the cost of the asset, the question of charging the interest payable as revenue expenditure against the income of each year will not arise.
12. The next question which arises for consideration is whether interest payable after commencement of production in respect of fixed assets purchased on deferred payment terms can be treated as " Deferred Revenue Expenditure ". This treatment has been suggested by some of the shipping companies. This question arises when a shipping company acquires a ship and pays, say, 20% of the price to the suppliers and undertakes to pay the balance of 80% of the price to them in ten yearly instalments with interest at the stipulated rate. The interest payable in each year is worked out on the balance outstanding after adjustment of instalments payable by the company on stipulated dates. The accounting treatment suggested is that the company works out the total interest which would become payable during the deferred period of 10 years. If the company estimates the life of the ship at 20 years, the total interest payable during the deferred period is divided into 20 equal instalments. The interest paid or payable in each year, according to the deferred payment terms agreed upon at the time of acquiring the ship, is debited to ' Interest to builders account ' and out of this, a fixed amount equal to l/20th of the total interest, worked out at the beginning is charged to the profit and loss account of each year during the life of the ship. The balance amount standing to the debit of this account at the end of each year is carried over and shown in the balance-sheet under the heading ' Miscellaneous expenditure '. While computing business income under the provision of the Income-tax Act, the entire amount of interest payable under the deferred payment terms in the relevant year and debited to 'Interest to builders account' is claimed as revenue expenditure. No provision for deferred taxation liability is made in the accounts in respect of the difference between the amounts of interest claimed as a deduction for tax purposes and the amount of interest charged in the profit and loss account of the relevant year. Similar treatment is advocated for interest payable on long-term loans taken for the purpose of financing purchase of a ship.
13. Some of the shipping companies which have adopted the above method of accounting claim that this method is more appropriate, logical and is more in compliance with the principle of ' matching '. According to their view, the profits determined by charging interest in this manner and the financial position presented by the balance-sheet in the above manner give a 'true and fair' picture of the state of affairs of the company. The main reasons given in support of their view are as under :
(a) The interest liability is incurred for acquisition of a ship, i.e., creating a capacity and making it equally available to all the years involved in the whole life.
(b) The interest liability incurred in acquiring the ship does not add to its capacity. Nor does it represent any exchange value in the present value terms and hence is not the cost of the asset but is revenue expenditure incurred whose benefit is for the whole life and so has to be spread over the whole life on parity of deferred revenue expenditure which is a generally accepted principle.
(c) Spreading it over only on deferred period and that too on a reducing scale brings distortion in yearly results but spreading it over equally over the whole life brings in equity and is in consonance with the principle of matching as equal earning capacity is made available to each of the 20 years by incurring this expenditure.
(d) This interest is not for use of finances employed for generating the yearly revenue but is for making the capacity available to generate the revenue. Hence, the interest payable every year during the deferred period is not a proper charge against the revenue of the respective year only.
(e) The method adopted by some of the shipping companies has not been objected to by the Shipping Development Fund Committee.
(f) With the phenomenal project costs, with debt equity ratio in the range of 9 : 1 to 4 : 1, expanding but competitive and lower ROI consumer market, shy capital market, the old treatment of interest will lead to absurd situations. Moreover, it is not in consonance with or in compliance with the 'matching principle'.
14. No precedents or legal decisions in support of the method suggested in para 12 above are available at present. On the other hand, the decision of the Supreme Court in the case of Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 1TR 52 supports the view that interest payable on unpaid price of an asset is a revenue expenditure and is fully deductible for the purpose of computing income under the Income-tax Act. Our law courts have recognised the accounting principles for the purpose of determining the income for tax purposes and the principle enunciated in the above decision is based on generally accepted accounting principle."
28. The Research Committee concluded as follows :
" 22. After careful consideration of all the aspects discussed above, the Research Committee is of the view that there is no reason to deviate from its existing recommendation about accounting treatment for interest payable on deferred credit basis or to make an exception in the case of shipping companies. As clarified in this note, interest payable during the period of construction or installation of fixed assets can be capitalised. However, interest payable on fixed assets purchased on a deferred credit basis or on monies borrowed for acquisition of assets should not be capitalised after such assets are put to use. If such interest is treated as part of the cost of the asset on the basis of tax decision referred to in para 6, adequate disclosure of this fact should be made as explained in para 11 above. As discussed in this note, interest payable in respect of the asset purchased on deferred payment terms cannot be treated as 'deferred revenue expenditure' after commencement of production. "
29. The Council also issued the following guideline :
" The Council further reiterates that in cases where interest has been so capitalised and the amount involved is material, it will be necessary for the auditor to qualify his report accordingly. An example of the qualification is given below :
' Interest payable on borrowings related to the acquisition of fixed assets has been capitalised for the periods during which the assets were in use for commercial production. This is contrary to the accounting practice recommended by the Institute of Chartered Accountants of India. Consequently, the profit (after charging depreciation and provision for taxation) of the company has been overstated by Rs......, the fixed assets have been overstated by Rs. ...... and reserves and surplus have been overstated by Rs. ..... as compared to the position which would have prevailed if the recommended practice had been followed '."
30. In the premises, the method followed by the assessee in capitalising the interest on deferred payment made for acquisition of the ships is contrary to the established accountancy principles and as such cannot be permitted. In other words, the interest on deferred payment will be allowed every year as revenue expenditure and not as capital expenditure. Such interest payment cannot be added to the actual cost of the asset for the purpose of allowing depreciation and development rebate. But then Mr. Bajoria, learned counsel, contends that since the Legislature intended that the benefit of such capitalisation would be denied only from the assessment year 1974-75, even though the method adopted is contrary to the accountancy principles, such benefit cannot be denied for the assessment year in question. It is, therefore, necessary to consider the scope and effect of the amendment.
31. By Section 9 of the Finance Act, 1986, a new Explanation being Explanation 8 was added to Section 43(1). Section 9 of the Finance Act, 1986, provides as follows (See [1986] 159 ITR (St.) 17, 27) :
" In Section 43 of the Income-tax Act, in Clause (1), after Explanation 7, the following Explanation shall be inserted and shall be deemed to have been inserted with effect from the first day of April, 1974, namely :--
Explanation 8.--For the removal of doubts, it is hereby declared that where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use shall not be included, and shall be deemed never to have been included, in the actual cost of such asset. "
32. We may refer to the Notes on Clauses to the Finance Bill, 1986 ; it provides the relevant notes which are as follows (see [1986] 158 ITR (St.) 88) :
Clause 9 seeks to insert a new Explanation 8 to Clause (1) of Section 43 of the Income-tax Act relating to the definition of actual cost.
33. Under the existing provisions of Clause (1) of that section, ' actual cost ' means the actual cost of the asset to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. The proposed amendment seeks to clarify that any amount paid or payable as interest in connection with the acquisition of an asset and relatable to a period after the asset is first put to use shall not form part and shall be deemed never to have formed part of the actual cost of the asset.
34. This amendment will take effect retrospectively from 1st April, 1974, and will, accordingly, apply in relation to the assessment year 1974-75 and subsequent years."
35. This Explanation declares that the new Explanation 8 to Section 43(1) which has been inserted by the Finance Act, 1986, will have retrospective effect from April 1, 1974. It declares, for the removal of doubts, that where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use is not to be included, as it is to be deemed never to have been included, in the actual cost of such asset.
36. The scope and effect of the newly inserted Explanation 8 have been elaborated in the following portion of the departmental Circular No. 461, dated July 9, 1986, as under (See [1986] 161 ITR (St.) 17, 30) :
" (ix) Modification in the definition of 'actual cost' for the purposes of depreciation, investment allowance, etc.--18.1. Under the existing provisions of Section 43(1) of the Income-tax Act, 'actual cost' means the actual cost of the assets to the assessee reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. It was found that certain taxpayers supported by some court decisions had resorted to a major change in accounting practice by capitalising the interest paid or payable in connection with acquisition of an asset relatable to the period after such asset is first put to use. This capitalisation implies inclusion of interest in the actual cost of the asset for the purposes of claiming depreciation, investment allowance, etc., under the Income-tax Act.
It is an accepted accounting principle that where an asset is acquired out of borrowed funds, the interest paid or payable on such funds constitutes the cost of borrowing and not the cost of the asset acquired with those funds. It is for this reason that as per the clear guidelines issued by the Institute of Chartered Accountants of India, the interest on moneys which are specifically borrowed for the purchase of a fixed asset may be capitalised only relating to the period prior to the asset coming into production, i.e., relating to the erection stage of the asset. However, once the production starts, no interest on borrowings for the purchase of such assets should be capitalised. In spite of these clear guidelines, as also the consistent view of the Department in this matter, some taxpayers had adopted a contrary stance and had capitalised such interest. The first decision in favour of this stance had been rendered on May 13, 1974, in the case of CIT v. J. K. Cotton Spinning and Weaving Mills Ltd, . This decision as well as the subsequent decisions were contrary to the legislative intent. Hence, in order to enable the Government to collect the tax legitimately due to it for the earlier years, a clarificatory amendment to this provision has been made retrospectively from April 1, 1974, and will, accordingly, apply in relation to the assessment year 1974-75 and subsequent years. "
37. The Explanation is a part of the main section and it clears the ambiguity, if any, in the main section. The Explanation cannot be read in isolation. The intention of adding the Explanation is that if anything is not clear in the main section, it shall be made clear by adding the Explanation. As indicated earlier, the Explanation 8 has been added in Section 43(1) of the Act. We have already extracted the Explanation and the reasons for insertion of the said Explanation. It is evident that the Explanation intends to clarify the position in law as regards the capitalisation of interest paid in connection with the acquisition of an asset after it has been put to use. We do not find any rhyme or reason in the declaration that the Explanation will come into force from April 1, 1974. Obviously that is due to the fact that the judgment in J. K. Cotton Spinning and Weaving Mills Ltd. was rendered on May 13, 1974, and, accordingly, it was made effective from April 1, 1974. There is no logic behind the retroactive effect being given to the amendment from the assessment year 1974-75 when, admittedly, the treatment of interest is contrary to the established accountancy principles. The Explanation makes the clarification whereby what was implicit was made explicit. It cannot be that such Explanation will be effective only from a particular assessment year. The Explanation in itself does not, however, make any such provision. It says that, where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period, after such asset is first put to use shall not be included, and shall be deemed never to have been included, in the actual cost of such asset. This clearly indicates that the intention of the Legislature is not to apply this Explanation from a particular assessment year. Although the judgment of the Allahabad High Court in J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153 was rendered in May 13, 1974, we do not find any logic or reason or rationale behind making the Explanation effective from April 1, 1974. We are, therefore, of the view that this Explanation being clarificatory in nature and which intends to clear up any doubt or ambiguity must be deemed to be always in existence. It explains the meaning and intend-ment of the Act.
38. It is no doubt true that, ordinarily, a statute, and particularly when the same has been made applicable with effect from a particular date should be construed prospectively and not retrospectively. But this principle will not be applicable in a case where the provision construed is merely explanatory, clarificatory or declaratory. It cannot be disputed that the object of the Explanation is to explain the meaning and intendment of the Act itself.
39. In the present case, having regard to the fact that the method adopted by the assessees in capitalising the interest was not proper and contrary to the established accountancy principles, it must be held that the Explanation has been added as and by way of an interpretation clause. The object, as we have said, is to suppress the mischief of getting the benefit of capitalising the interest in connection with the acquisition of an asset which will be allowable as a revenue expenditure. The assessee is not, therefore, denied any relief ; the assessee is allowed such deduction as is admissible in accordance with the established commercial and accountancy principles. The Explanation added to Section 43(1) supplies an omission and is intended to remove the illegality. What was illegal at the very inception must be held to be illegal throughout ; there cannot be any line of demarcation. The Explanation only indicates that the Legislature, for want of prescience of a fact-situation like this, left a gap in the law. It left its intent unsaid for not having anticipated a controversy of this type. The Explanation thus fills up a void. What now appears as the Explanation was latent in the mind of the Legislature. It only dawned on the Legislature finding such a controversy arising in 1974 that the inadequacy of articulation of its intent needed to be removed by the insertion of the Explanation to make patent what was latent. Given that the Explanation is retrospective in effect from the assessment year 1974-75, can we turn away from the fact that what was unsaid for 1974-75 was not so even earlier? The fact is that if the law was not articulate to afford an answer precisely, requiring an Explanation, that position is equally true even earlier before the assessment year 1974-75. It is nobody's case that the dilemma for want of manifestation of the legislative intent started only in 1974-75 and not earlier or that the position before 1974-75 is any different, not needing the same Explanation. If the same Explanation can resolve the difficulty for the inadequacy of the written law, there is no impediment to taking aid from it even in settling the question arising before the assessment year 1974-75.
40. For the reasons aforesaid, we answer the first question in the negative and against the assessee.
41. There will be no order as to costs.
Shyamal Kumar Sen, J.
42. I agree.