Income Tax Appellate Tribunal - Ahmedabad
Jt. Cit, Gnr, Sr vs Sardar Sarovar Narmada Nigam Ltd. on 31 August, 2004
Equivalent citations: [2005]93ITD321(AHD), (2005)93TTJ(AHD)965
ORDER
R.P. Garg, Vice President
1. These thirteen appeals and one cross-objection are against the orders of CIT(A,) for the Assessment Years 1989-90 to 2000-01. Since common grounds/ issues are raised in the appeal, they are being disposed off by this common order for the sake of convenience.
2. The Government of Gujarat has established the assessee Corporation as a wholly-owned Government Company under the provisions of the Companies Act, 1956 to take the execution of Sardar Sarovar Project - an inter-state multi-purpose project of four States viz. Madhya Pradesh, Maharashtra, Gujarat and Rajasthan with a terminal major dam on the river Narmada in Gujarat. The project is to create a concrete gravity dam of the height of 128 meters from the river-bed and reservoir with a live storage of 5800 million cubic meters (4.72 MAF) enveloping about 214 km. length of the Narmada valley and surface area of 37000 hectares. A 460 km main canal is to be constructed on the right bank from the reservoir upto Gujarat-Rajasthan Board. The main canal at the head has to have capacity of 1133 cumecs (40,000 cusecs) which is to be latest in the world and it is to taper down to about 71 cumecs (2500 cusecs) at Gujarat-Rajasthan Board. There are to be 35 branches off taking from the main canal. The distribution system net-work is to be at the length of about 75,000 kms. The supply of water is to be on volumetric basis by rotation to ensure equitable distribution. Further to ensure timely and reliable supply of irrigation water as also to prvent wasteful and excessive use of water, automatic remote control upto 300 cusecs and above capacity canal net-work and manual/semi-automatic control below 300 cusecs net work of canal was to PROVIDE.
3. the project is also to have the river-bed Power house, located underground on the right bank to accommodate six reversible Francis Type turbine units each of 200 MW capacity. The canal-head Power House, also on the right bank is to accommodate five units of conventional Kaplan Type each of 50 MW capacity. Further, to utilize the falls available at various locations along Narmada Main Canal and some of the Branch Canals it is envisaged to provide Micro-Hydel stations at these falls to generate electricity and feasibility reports for this purpose are being prepared through Gujarat Electricity Board in Gujarat, 17.92 lakhs hectares of lands in 12 districts, 62 talukas and 3393 villages (of which 75% is drought prone area) would come under irrigation every year and 75,000 hectares in the and areas of Banner and Jallore Districts of Rajasthan would also be benefited like-wise. Power generated capacity of 1450 MW was to be added. Besides these advantages, 4720 villages and 131 urban centres in Gujarat State to get a permanent solution as regards their drinking water supply needs. It is estimated to create an employment potential of 7 lakh workers daily during the construction period and 6 lakh workers daily during the post construction stage.
4. The dam and power house is proposed to be completed in 9 years with a planning to divert water for irrigation, upto Mahi River after 7 years on partial completion of the dam upto the height of RL 300 it. The distribution system is planned to be completed in 10/20 years. On completion of the project annual additional agricultural production was estimated to be Rs. 900 crores, power generation Rs. 400 crores and water supply Rs. 100 crores aggregating to about Rs. 1400 crores every year equivalent to Rs. 4 crores a day. The problem of domestic water supply to and areas of Saurashtra and Kachchh was also to be solved permanently.
5. The Government of Gujarat executed a put of the project and on being advised it decided the to form a Nigam and it passed a resolution vide the Government of Gujarat, Narmada Development Department's Resolution No. NMD/1073(86)/33(2)/H dated 21-3-1988, which reads as under:
"PREAMBLE:
With a view to execute the works of the Sardar Sarovar (Narmada) Project, the State Government has decided to set up a Public Limited Company namely the Sardar Sarovar Narmada Nigam Limited. The proposed Sardar Sarovar Narmada Nigam Limited will have its head office at Gandhinagar and its main objects would be to execute the works of the Sardar Sarovar (Narmada) Project.
RESOLUTION:
The Government is, therefore, pleased to set up the Sardar Sarovar Narmada Limited with its registered office at Gandhinagar with an authorized share capital of Rs. 2,000 crores to be divided into 2 crores shares of Rs. 1,000/- each. The entire capital will be scribed by the Government and accordingly the Nigam will be a wholly awned Government Company. The Company should be registered as Public Limited Company under the Companies Act, 1956...."
6. Thereafter, the assessee Corporation was incorporated under the Companies Act, 1956 on 24th March, 1988 and the Registrar of Companies, Gujarat issued Certificate of Incorporation. The assessee Corporation, thereafter, was granted Certificate for Commencement of Business by the ROC, Gujarat on 9th May, 1988. On formation of the assessee Corporation, the Government of Gujarat, Narmada Development Department vide Resolution No. MPC/1088/23/K, dated 31-3-1988 transferred en-bloc the entire staff and officers of the Circles and office other heads etc. working under the control of Narmada Development to the assessee Corporation. Further, the Government of Gujarat also transferred assets of Sardar Sarovar Narmada Project to assessee Corporation and to effect that transfer the Government of Gujarat also passed a G.R.No. COR-1488-H dated 27th October, 1988.
7. When the execution of the Project was transferred to the Corporation total works of Rs. 750 crores were under execution. During the year 1988-89 new tenders of the estimated cost of Rs. 352 crores were invited and during the current year 1989-90 further tenders of the estimated cost of Rs. 163.92 crores have been invited out and so on till the end of the accounting year 1999-2000.
8. That the estimated cost of the Project is Rs. 6406 crores as cleared by the Planning Commission in October, 1988 based on 1986-87 price level. The World Bank has agreed to provide aid of 450 million Dollars for the Project. Further Yen Credit of Rs. 150 crores under OECF will also be available for the Project. This external aid is to be received by the government of Gujarat through Government of India. About Rs. 1502 crores was expected as share from participating states i.e. Maharashtra, Madhya Pradesh and Rajasthan leving balance of about Rs. 4204 crores. The expenditure of about Rs. 750 crores has already been incurred on the Project. As per the compressed construction schedule of the Project of 10-12 years the above amount may escalate by 8% annual to Rs. 6000 crores. Considering the likely allocations from the Government of Gujarat and additional funds available due to the liberalized policy of the Government of India on external aid it is estimated that a net gap of only Rs. 1000 crores is to be there. This amount is planned to be raised through Deposits, Debentures, Bond, Kisan Vikas Patras and Non-Resident Indian Investments. It is expected that the servicing of the borrowed money is to be possible from the returns which is to start generating sometimes in 1993-94.
9. During the year 1988-89, the Government of Gujarat has made total share capital contribution of Rs. 650.10 crores of which Rs. 533.10 crores is in the form of assets transferred to the Corporation and the balance amount of Rs. 117 crores is received in cash. Against this, the Corporation has allotted equity shares of Rs. 563.50 crores. Further equity shares of Rs. 53.50 crores are allotted in April, 1989. The allotment of the equity shares against the balance amount of Rs. 33.10 crores is to be made on receipt of the report of the Committee appointed to give details regarding the categories of the assets transferred by the Government of Gujarat. Note No. 10 forming part of the accounts in the Annual Report 1988-89 incorporate the fact as under:
"(10). Government of Gujarat has transferred an operating branch of Mahi Canal to the Company vide Government letter No. EMT/1887/4387/2-G dated 19-3-1987 for Rotational Water Supply System of irrigation during the period. Income received by the Company from the operating branch is to be passed on to the Government of Gujarat."
10. No profit and loss account was prepared by the assessee in any of the years and in Note No. 7 forming part of the accounts in the Annual Report 1988-89 it is observed that "(a) No Profit and Loss Account for the period from 24th March, 1988 to 31st March, 1989 has been prepared as the Projects of the Company are under construction and the Company's operation of supply of water and power has not commenced by 31st March, 1989. (b) Most of the items classified under incidental expenditure during construction, according to the Company, are relating to the Project and it is therefore the intention of the Company to capitalize the same as and when commercial operations commence."
11. The position of the project executed and establishment of infra-structure continued upto and beyond the previous year relevant to the A.Y. 2000-2001. In the Directors' report for the year ended 31st March, 2000 observed in the "Highlight of the Project" as "The Sardar Sarovar (Narmada) Project being implemented by your Corporation is a unique multi-purpose project, participated by four states i.e. Gujarat, Madhya Pradesh, Maharashtra and Rajasthan. The project is the largest water resources development project in India and reportedly one of the three largest in the world. The length of the main concrete gravity dam is 1,210 meters and the height is 163 meters from the deepest foundation level. The gross storage capacity of the reservoir is 9,500 million cubic meters (7.70 MAF) and live storage capacity is 5,800 million cubic meters (4.72 MAF). The reservoir will be extending about 2.14 kms. Upstream covering a surface area of 370 sq.km. A 460 Kms. Long concrete lined main canal is being constructed on the right bank from the reservoir upto Rajasthan border having a capacity of 1,133 cumecs at the head and 71 cumecs at the tails i.e. at the Gujarat Rajasthan border. There will be 42 branches off-taking from the main."
12. The Directors' report further mention under head 'Dam and Appurtenant Works' as "Excavation and concrete works are two major components of the Main Dam works. Upto March, 2000 a total of 63.28 lacs cubic meteres excavation and 58.50 lacs cubic meters concrete works has been done, which constitute 98.88 & 85.78% respectively of the total work to be carried out." Similarly, under the head 'Hydro Power' it is mentioned that "9.85% open excavation and 91.55% underground excavation for the River Bed Power House have been completed. Of the two hydropower stations planned in the project the Canal Head Power House of 250 MW is completely read for commissioning. As soon as the dam height reaches 110M, it would start generating power. Imported turbo Generator sets from Japan are to be installed to River Bed Power House. Two unit have already reached the dam site and their installation is started and will be completed in May, 2003. As per planning, remaining sets will be installed from may, 2003 one by one at interval of four months."
13. Again under head "Narmada Main Canal" it is observed that "The construction of Narmada Main Canal (NMC) upto Mahi river crossing (i.e. reach 0 to 144 kms.) is in completion stage. Total 767.23 LCM earthwork (99.17% of revised qty.) 150.55 lsm lining (99.98% and 20.96 LCM structured concrete (97.66%) are completed upto March, 2000. The Narmada Main Canal works from 144 kms. To 264 kms. Reach (i.e. from Mahi river crossing to Saurashtra Branch Canal off-take) are in progress. Total 633.89 LCM excavation (96.35%, 12.19 LSM lining (95.28%) and 4.73 LCM (92.38%) structural concrete are completed upto March, 2000. The works of six major canal siphons on major rivers i.e. Shedhi, Saidak, Mohar, Watrak, Meshwo and Sarbarmati are in progress and on Khari is completed." While in the Report under head 'Distribution System' it is stated that "Phase-I-"Sardar Sarovar (Narmada) Project Command under Phase-I (i.e. area under NMC ch. 0 to 144 km) covers culturable command area of 4.47 lac Ha. Between the rivers Narmada & Mahi. The survey, investigation, planning, designing and estimating of distribution system upto 40 Ha. Block has been completed. The work of Distributories and some minors are nearly completed. Out of remaining works distributories & minors 41 works amounting to Rs. 262 crores have been awarded. For remaining works tenders are being invited." Phase-II-"The planning of distribution system in the C.C.A. of 3.85 lacs Ha. In Phase-II area is completed. In remaining area of 10 lac Ha. In Phase-II, the same is under progress. The work of above distribution system are yet to be taken up. The distribution of Shedhi Branch Canal (44,128 Ha. C.C.A.) is completed upto Minor level (except lining in minars). The sub-minors & field channels of the SSP will be constructed through Water Users' Association under farmers' Participatory Irrigation Management (PIM)."
14. Auditors' qualified the report and in reply to the Auditors' remark on accounts, (tem 4) the Board of Directors replied that "The Company is not a contractor. Therefore, Accounting Standard-7 is not applicable to the Company. No revenue has been generated during the year from the normal activities of the Company. Therefore, Accounting Standard-9 (Revenue Recognition) is also not applicable to the Company. All other Accounting Standards have been complied with to the extent they are applicable to the Company." The expenses and income are not carried to Profit & Loss account, but are shown in the Balance Sheet under the Head "Incidental Expenditure Pending Capitalisation". There are expenses minus income.
15. Pending project completion /construction, the money available with the assessee, out of capital contribution by the Govt. of Gujarat and also the borrowings, which could not be utilized for construction immediately, became surplus and was invested in short-term deposits with the banks and the assessee earned interest thereon in all these years.
16. The assessee did not file return of income presumably because it had not prepared any Profit & Loss Account as stated in note 7 to the Annual Accounts of the year 1998-99, its project being under construction and operations of supply of water and electricity had not commenced. It adjusted all the expenditure and income to work-in-progress account. Pursuant to the notice Under Section 148 the assessee filed return of income for the years under consideration, claiming the expenditure incurred by it as business expense, even though in the books of account, the expenditure was capitalized and carried and debited to work-in-progress. The assessee corporation/Nigam contended that it was incorporated with the sole purpose of construction of dam, canals and power houses and there is no provision to continue to operate once construction is complete and, therefore, the Nigam was carrying on the construction business, and therefore, the moment it had put first bricks for construction and started its first activity with regard to construction, it has commenced its business activity.
17. The AO did not accept this contention of the assessee. He held that had the intention of the Govt. of Gujarat was only to incorporate the assessee Corporation, with a view to merely construct dam, canal system etc. it would not have been registered as a Company under Section 25 of the Companies Act, 1956, because undoubtedly, the project is for promoting useful object for general public. The fact that the Government had contributed towards capital of the assessee Corporation and not advanced any loan etc. also goes to establish the fact that the Government did not see the Corporation as a contractor for the construction of Sardar Sarovar Dam. The AO narrated the main object of the assessee Corporation as under:
"To undertake "execution" of the Sardar Sarovar Project comprising a dam across the river Narmada in the Nandod Taluka of Bharuch district in the State of Gujarat; a canal system emanating from the reservoir called the Sardar Sarovar impounded by the construction of the said dam; power houses at the foot of the said dam and at the canal head and all other works incidental or ancillary to the said project in accordance with the direction of the Govt. of Gujarat. The works relating to dam and power houses shall be carried out under supervision of the Sardar Sarovar Construction Advisory Committee set up by the Central Govt. pursuant to the decision of the Narmada Water Disputes Tribunal. The directions that may be issued by the Narmada Control Authority and the Review Committee appointed by the Central Govt. pursuant to the decision of the Narmada Water Disputes Tribunal shall also be complied with by the company...."
and held that the above objects were quite ambiguous and not in compliance with other objects of the Articles of the Association. He referred to the decision of the Bengal & Assam Investors Ltd. 59 ITR 547(SC), wherein the Supreme Court held that the object of the any incorporating company as laid down in the Memorandum of Association are not conclusive of question whether the activities of the company amount to carrying on business and that question has to be decided independently. Similar were the observations of the Supreme Court in the case of Oriental Investment Co. 32 ITR 664(SC) holding that object clause in Memorandum of the Company is relevant, but no conclusive. He further held that it is necessary to see the overall circumstances to decide the ultimate object of the company. Accordingly to him the decisions or actions of the Board of Directors at the time of incorporation of the company and immediately thereafter would provide best indication about the ultimate objectives of the company and what they want to pursue rather than resolution and reports of the Board of Directors of a later period.
17.1 He then referred some of the extracts from the Directors report as under:
"It is accepted that servicing of the borrowed money will be possible from the returns which will start generating sometimes in 1993-94.
"Since the project is under construction stage no profit and loss account is drawn" (Page No. 12 of Annual Report for FY 88-89."
17.2 From the above the AO observed that "here generation of returns from Sardar Sarovar Project were envisaged by the Board of Directors of the Company. As per Corporate philosophy for the healthy functioning of a Corporate democracy, right of information to members of a company is necessary therefore a Directors' Report is given a statutory recognition. Section 217 of the Companies Act, 1956 prescribes the information which must be made available by the Board of Directors to a member. One such information, as per Sub-section (1) of Section 217 is in respect of state of the Company's affairs. A Director may incur liability to individual shareholders who acts in reliance upon a negligent or mis-statement made in the Directors' Report, penalty for failure to take reasonable steps to comply with provisions of Section 217(1) to (4) is prescribed in Sub-section (5) and (6). In the case of India Polyfibres Ltd. v. ACIT, 58 TTJ (All) 84 the ITAT even gone to the extent and held that an entry in the log-book (maintained on day to day basis) can not be relied on in preference to Director's Report."
17.3. He thereafter reproduced note 7 as extracted above from the Schedule-I NOTES FORMING PART OF THE ACCOUNTS OF ANNUAL REPORT 1988-89 and observed that the above notes were prepared by the statutory auditors of the company and later on approved by its Board of Directors and members i.e. Government of Gujarat after having received report of the Comptroller & Auditor General of India. He then observed that two different statutory auditors, who hold the post of statutory auditors of the assessee company during the financial year(s) 1988-89 to 1991-92 prepared same/similar notes only. He further noted from the profit & loss accounts and balance sheets prepared for the F.Y. 88-89 to 91-92 that the investment in construction of dam etc. was not shown as closing stocks or under head current assets but shown under the head "Work in Progress" (Schedule "E" to the Balance sheet as at 31.3.1989)". He also mentioned that the assessee Corporation came out with a prospectus Under Section 58(a) of the Companies Act, 1956 for the purpose of "Public Issue of Secured Redeemable Non-Tax Exempt Deed Discount bonds of Rs. 3600/- each and 17.5% Secured Redeemable Non Tax Exempt Non-convertible bonds of Rs. 5,000/- each for cash together aggregating to Rs. 300 crores which opened on 1st November-1993. He observed that this prospectus was a public document and on the faith of it large number of depositors had invested their hard earned money with the assessee corporation; that the Companies Act, 1956 provides for penalty, if there is any mis-statement in the prospectus issued by the Company; and that this prospectus on its face mentioned under the head "Highlights" the main benefits of the projects as under:
* Irrigation facilities for 1.8 million hectares of land in Gujarat, 75,000 hectares in Rajasthan and 37500 hectares in Maharashtra.
* Drinking water in 8,215 villages and 135 urban Centres.
* Electric power generation with a capacity of 1,450 MW.
17.4. He also discussed the following relevant extracts of prospectus stating for REDEMPTION RESERVE; MEANS OF FINANCE and AUDITORS REPORT providing "The project of the SSNNL is under construction and no commercial activity has been commenced and in view of reliance on legal opinion of counsel and authoritative pronouncement the SSNNL has also approached Company Law Board for clarification, to exhibit revenue expenditure not allocable to specific project in a Schedule instead of preparing Profit & Loss Account as required under Section 211 of the Companies Act, 1956, pending said clarification from the Company Law Board, SSNNL has not prepared profit and loss account and has exhibited revenue expenditure not allocable to specific project in a separate schedule under heading "Incidental Expenditure pending capitalization". (Page No. 35 of Prospectus)."
17.5. He then reproduced the excerpts from the decision of the Madras High Court in the case of Coimbatore Spinning & Weaving Co. Ltd. 95 ITR 375 which read as under:
"The practice of exaggerating inflation of stocks in statements given to banks to get loan is not shown to exist or that it has been recognized in the commercial circles or by courts. Even assuming that such a practice exists the Tribunal is not expected to take judicial notice of such sub-standard morality on the part of the assessee so as to enable them to go back to their own sworn statements given to the banks as to the stocks held and hypothecated by them to the banks. In a case like this where the assessee is confronted with his own sworn statements which shown a different state of affair then the own shown in his own books of accounts, heavy burden lies on the assessee to prove that the books of account alone give the correct picture, and the sworn statements given to the banks were motivated."
17.6. He observed that on the same principles a heavy burden lies on the assessee Corporation that reports of Board of Directors, Auditor's reports and even their own submissions made by way of letter dt.28-12-89 and statements made "Prospectus" (as discussed above) were motivated in order to accept their contention that business has commenced. He further noted that the assessee corporation had failed to file Tax Audit Report as provided Under Section 44AB of the Act for the A.Y.1989-90. Had the assessee's business commenced, it would have had filed the Tax Audit Report in view of provisions of Section 44AB of the Income Tax Act, 1961. As the assessee corporation has been advised by the eminent firms of Chartered Accountants in respect of tax matters besides itself employing number of Chartered Accountants on its pay roll, it cannot be presumed that obligation regarding filing of Tax Audit Report had escaped its attention.
17.7. He then quoted from Memorandum & Articles of Association of the Company, which provide as under:
"Interest Out of Capital:
Where any shares are issued for the purpose of raising money to defray the expenses of construction of any work or building or the provision of any plant which cannot be made profitable for a lengthy period, the company may pay interest on so much of that share capital as is for the time being paid up, for the period at the rate and subject to the conditions and restrictions provided by Section 208 of the Act, and may charge the same to capital as part of the cost of the construction of the work or building or the provisions of the plant. (Page No. 20).
17.8. The AO questioned, as to how without having any objective in mind regarding commercial exploitation of the Sardar Sarovar Project, the company could have thought of paying interest on the capital to the Government of Gujarat. He therefore observed that the assessee corporation have had in its mind earning of profits and therefore only the provision regarding distribution of dividends found place in its Memorandum & Articles of Association.
17.9. He further noted that the assessee company resorted to borrowing from the market even at the interest rate of 17.5% per annum or more for the purpose of financing construction of Sardar Sarovar Project. No prudent businessman without keeping in mind the prospective return from the project, take risk to borrow funds at such a high rate of interest.
17.10. He found nothing in Memorandum & Articles of Association of the Company or in any of the notification or resolution issued by the Govt. of Gujarat that once the construction of Sardar Sarovar Project was completed, the assessee corporation would be wound up and canals & power houses would be transferred to Govt. of Gujarat. Therefore, he held that in all probabilities the intention of the Govt. of Gujarat is that the assessee Corporation should construct and own the above project.
17.11. He further noted from para-5 of the assessee corporation's letter dtd.28.12.89 (A copy of which is enclosed as Anx.B to this order) wherein the assessee corporation itself pleaded that unless and until the Dam is constructed, canals star functioning, power houses are set up and supply of water and electricity for irrigation etc. started the business of Corporation cannot be said to be set up and all expenditure till then would be capital expenditure.
17.12. On the basis of the above material, the AO held that intention of the Govt. of Gujarat to incorporate the Assessee Corporation and transfer the work of construction of Sardar Sarovar Project to the Assessee Corporation was to complete the project and to get it exploited commercially by the assessee, and therefore, business of the assessee would be commenced only when the water starts flowing from the canals and/or when the power houses start generating electricity. As both of them did not happen, during the previous year relevant to the assessment years under consideration, he held that the business of the Assessee Corporation is not commenced. The Assessing Officer further held that by obtaining Certificate for Commencement of business dated 9-5-88 cannot help the assessee, because it merely entitled the company to start borrowing money and entered into several other transactions and/or start its business and it does not mean that the business of the company commenced immediately on receipt thereof.
17.13. He also rejected contention of the assessee that the Corporation had already been set up as the main objective was to undertake the Sardar Sarovar Project comprising of dam, canals system, power houses and other work incidental to the said project, and therefore, all the expenses incurred should be allowed as deduction. He made references to the following four decisions relied upon by the assessee.
i) Sarabhai Management Corpn., 192 ITR 151 (SC)
ii) Prem Conductors Pvt. Ltd. 108 ITR 654 (Guj.)
iii) Saurashtra Cements & Chemicals Ltd., 91 ITR 170 (Guj.)
iv) Speciality Papers Ltd., 133 ITR 879 (Guj).
17.14. The AO, found in the above decisions that the assesses were basically manufactures (except in the case of Sarabhai Management Corpn. Ltd.) who had installed plant & machinery and the same were ready to put into use for the purpose of production. In case of Sarabhai Management Corpn. (supra) also he found that the assessee was engaged in the business of acquiring immovable property and letting them out on lease with all amenities etc. and in that way properties were ready for use. However, in the present case, the assessee was not able to complete the construction of dam, canal, power house etc. in order to supply water and electricity, and therefore, its business was held to have been not set up.
17.15. Looking to the fact that receipts in respect of interest from contractors, rent from employees, recovery from contractors, guest houses and other misc. receipts including hire charges for machinery were inextricably linked with the set up of the Sardar Sarovar Project he held that in view of decision of the Supreme Court in the case of Bokaro Steels Ltd., 236 ITR 315 (SC), would go to reduce the cost of project of the assessee corporation, and therefore, the assessee would be liable to pay interest earned from banks.
17.16. However in the opinion of AO, the income from interest was chargeable to tax, in view of the decision of the Supreme Court in the case of Tutikorin Alkali Chemicals & Fertilisers Ltd. 227 ITR 172(SC). Contention of the assessee regarding non-chargeability of the interest on the ground that interest from bank on Short Term Statutory Deposits and others as per statutory requirements under the Rule 3A of the Companies (Acceptance of Deposits) Rules 1975 and that the interest expenditure incurred by it exceeds the interest income as well as the claim of deduction under Section 57(iii) of the Act, was not accepted by the AO, as according to him, what Section 57(iii) provided is that in computation of income under the head "Income from Other Sources" in respect of expenditure (not being in the nature of capital expenditure) laid down or expended wholly or exclusively making or earning such income. Referring to the decision of the High Court of Gujarat in the case of Smt. Padmavati Jay Krishna 101 ITR 153, (approved by the Supreme Court in 166 ITR 176) he observed that the purpose and dominant objective of incurring the expenditure has to be the earning of the income, which is brought under tax under Section 57(iii), for such expenditure to be entitled to deduction. He then referred the decision of the Karnataka High Court in the case of CAP Steels Ltd, 162 ITR 533, where the claim of the interest on borrowings from interest received on deposits made out of such borrowed fund, was negatived by observing that the interest earned or income accrued to the assessee were chargeable to the tax irrespective of the fact that whether earning was on deposits made or out of money borrowed or out of its own capital. He then referred to the decision of Karnataka High Court in the case of Forest Plantation Corpn. Ltd. 156 ITR 275 and the decision of Special Bench of the Tribunal in the case National Thermal Power, 24 ITD and held that crucial tes t to be applied is whether the expenditure incurred was for wholly or exclusively for the purpose of earning income and/or whether the receipts were inextricably linked with the main object of the company viz. construction of dam, canals and power houses. He noticed that the deposits from others and application money were not procured with a view to earning income from interest, but with a view to finance the project undertaking by the assessee corporation. He held that the purpose of paying interest on the above deposits was to obtain resources for execution of the project and accrual of income by way of interest was only an incidental result. He, therefore, held that interest received by the assessee of Rs. 9,84,131/- in the A.Y. 1989-90 and similar receipts in subsequent years from the banks on short term deposits were liable to be tax, as income from other sources.
17.17. The assessee corporation has also raised a contention before the AO that its total income is exempt under Section 10(20A) of the Act, being an authority constituted in India for the development or improvement of cities, towns, villages etc. relying upon the decision of Gujarat Industrial Development Corporation Ltd., 227 ITR 414 (SC). The contention of the assessee was not found acceptable by the AO, because the assessee has failed to produce any evidence that it was an authority constituted in India for the said purposes. He observed that a Company incorporated under the provisions of the Companies Act, 1956, whether private or Section 617 Company viz. Government Company cannot claim to be an authority. He also observed that in Memorandum and Articles of the Association of the Company, there was nothing to do with satisfying the needs for housing accommodation for the purpose of planning, development and improvement of cities, towns and villages. He, therefore, held that case of the assessee does not fall within the ken of the Supreme Court's verdict in the case of Gujarat Industrial Development Corporation(supra).
18. The CIT(A) in the appeal against the order of the AO for the Asstt.Year 1989-90 accepted the claim of the assessee of having commenced its business by observing in paragraph-27 to 28, as under:
"27. ... ... However, the Assessing Officer had not looked into the Memorandum of Association spelling out aims and objects very carefully because in the aim & objects, itself lay the answer to this problem. In this connection, reference is made to Item No. of the main object to be pursued by the company. The above para begins with the word "to undertake "execution" of the Sardar Sarovar Project comprising a dam across the river Narmada in the Nandod Taluka of Bharuch District in the State of Gujarat, a canal system emanating from the reservoir called Sardar Sarovar impounded by the construction of the said dam, power houses at the foot of the said dam and at the canal head and all other works incidental or ancillary to the project in accordance with the direction of the Government of Gujarat. It is significant to note that the object of the corporation was not either to construct or to operate the Sardar Sarovar Project consisting of dam, canal system and power generating systems. It was to execute the such project, the word execute has been defined in the Concise Oxford Dictionary in Page-408 to mean "carry into effect", "Perform (a plan, duty, command, operation etc.) "carry out a design for (product of art or skill)". On the other hand the word construct has been defined to mean "make by fitting parts together or build". In other words, the object assigned to the appellant company was at large in its scope than the mere construction of dam, canals & power houses. This is further elaborate into member of objects which run into a many as 42 items. It is further seen from the records that the Gujarat Government had vide its resolution dtd. 21/3/88 decided to form a corporation for execution of the Sardar Sarovar Project. With that intention a public limited company was incorporated in the name and style of Sardar Sarovar Narmada Nigam Ltd. who received the commencement of business certificate from the Registrar of companies u/2.149 of the Companies Act on 9/5/88. The fact that the above project was already under execution under the supervision and control of Government of Gujarat stands proved not only by the resolution dtd.21/3/88, but also from the resolution dtd.31/8/88 No. NPC/108/23/K wherein entire staff engaged in the work of execution of Sardar Sarovar Project was transferred to the public limited company, i.e. appellant on deputation basis. These actions show very clearly that the work of construction or execution of Sardar Sarovar Project had already been started under the supervision and control of the Gujarat Government which was subsequently transferred to the appellant company. Not only the man power deployed on the above project was transferred as pointed out above, the government vide its resolution dtd.27/10/88 G.R.No. COR-1488-M transferred total assets worth Rs. 533.09 crores to the appellant company. This amount figures in the total work in progress at the end of year 1991-92. The total assets transferred by the Gujarat Government at Rs. 533.09 crores included assets of dam valued at 168.21 crores, assets of canal system worth Rs. 167.99 crores and assets of hydro power stations worth Rs. 117 crores. The transfer of work in progress or the assets worth Rs. 533.09 crores irresistibly lead to the conclusion that the work on the construction and execution of project had already begun much prior to the incorporation of appellant corporation. Therefore, when the appellant corporation received the man power and work in progress, it received from the Government of Gujarat an on-going project. Therefore, the business of the appellant corporation had in fact commenced right from the day when it had come into existence. The memorandum of association as it existed during the assessment year under appeal did not address to the question of operation and maintenance of the project including canal system and hydro electric generating system. This is also clear from the subsequent events which came to light in the 25th meeting of Board of Directors held on 10th June, 1991. In the above meeting, the Board of Directors considered the question that object clause did not provide for the maintenance and operation for the project. It was only in the meting held on 10th June, 1991 that it was decided that the Nigam should continue after the construction work was over and should carry on the activity of operation and maintenance of canal for water distribution, business of generation of hydro electricity and other such activities connected with it. It was also decided to amend the object clause of Memorandum of Association as contained in the Agenda item. Copy of the agenda item No. 25/27 contains proposed addition to the object clause which reads as under:-
"Other Objects:-
1. To undertake operation and maintenance of canals for water distribution to farmers, for optimizing use of land and water for promoting command area development of the Sardar Sarovar Project and for water distribution for domestic, municipal and industrial uses.
2. To undertake the business of generation of hydro electricity and also undertake the business of Electric Power Light Supply Company in all its branches and in particular to construct, lay down establish, fix, and carry out power stations, power generating plants, cables wires, lines etc. and to generate, accumulate, distribute and supply the electricity.
28. This aspect has not been looked into while concluding that the appellant company had not commenced its business. This was so probably due to the very nature of the project which is unique and one of its own kind in Asia. Neither the appellant corporation nor the Government of Gujarat had a clear idea of the stupendous task involved in the execution of the project. The project had a chequred history embedded with serious inter-state disputes, agitation by environmentalists and disputes involving periodical intervention of the Supreme Court. However, inspite of its complicated nature, the fact cannot be denied that the business of the project commenced right from the day when the construction or the execution of the scheme started. In its nature and facts the scheme is identical to Konkan Railway project undertaken by the Indian Railways under Konkan Railway Corporation Ltd. In that case similar dispute land come for adjudication before CIT(A)-III, New Delhi. After carefully considering the reasons discussed by Ld. CIT(A) in his order dtd.8/3/97 in Appeal No. 129/96-97 and the facts and circumstances of appellant's case, it is held that the business of the appellant company had commenced during the financial year as such. This ground is accordingly decided in favour of the assessee.
18.1 As regards treatment of interest of Rs. 9,84,131/-, he held that it was income from other source by observing in paragraph 31 under:
"31. The contention of the appellant has been carefully examined. The facts discussed in the assessment order have also been perused. The amount of Rs. 9,84,131/- has been earned by the appellant on the short term deposits with the banks. The above income has nothing to do with the assessee's business of execution of Sarkar Sarovar Project and its other ancillary activities. The very nature of the interest earned from the bank is liable to be taxed as appellant's income under the head income from other sources. This is also in conformity with the Supreme Court's decision in the case of Tuticorin Alkalies Chemicals & Fertilizers Ltd. v. CIT 227 ITR 172. In so far as the interest earned on short term deposits with the bank, the decision of Supreme Court in the case of CIT v. Bokaro Steels Ltd. does not interfere with its own finding in Tuticorin Alkalies Chemicals & Fertilisers Ltd. As a matter of fact the assessee in the case of CIT v. Bokaro Steels Ltd. had not filed any appeal from the finding which was given against it and their Lordship had observed that this question was concluded by a decision of Court in Tuticorin Alkalies Chemicals & Fertilisers Ltd. In other words, inspite of the decision of Bokaro Steels Ltd. the interest income earned by the assessee on short term deposit with the banks amounting to Rs. 9,84,131/- has to be taxed as income from other sources. The above findings of the Assessing Officer is accordingly upheld. This ground is dismissed."
"it is, therefore, quite apparent that the business of construction and operation of the railway line for which the appellant was established was already in existence at the beginning of the current previous year and further expenses were incurred on capital work in progress during the year under consideration. During the year, a small portion of the railway line already constructed had also become operational and there was passenger traffic receipts of Rs. 32,269/- which further shows that that the business of operation of railway line had also commenced during the year. Although the appellant had capitlalized the expenditure on construction of railway line as cost of the project, it is noticeable that capitalization is a matter of accounting which is not relevant for computing the assessable income under the I.T. Act. It is therefore held that the appellant's business of construction and operation of the railway line which commenced in the preceding years had continued during the current year. Accordingly, the business income is directed to be re-computed after allowing the admissible expenses including such expenses which have been capitalized during the year."
18.2. He however upheld the validity of reopening of assessment in the appeal for the first year and further rejected the claim of the assessee for exemption u/10 (20)/(20A) of the Act in all the years in appeals. In the appeal for the Asstt.Years 1990-91 onwards, the CIT(A), however, upheld the order of the AO and rejected all the contention of the assessee. He observed that the Assessing Officer has brought on record substantial evidences and fats which indicated that the activity of the appellant company was of pre-operative nature and the commencement of the business would start only when the appellant company starts exploitation of the project. He has also brought on record some important evidences which indicated that the exploitation of the project was definitely envisaged by the appellant Corporation. With regard to reliance placed on the appellant order in its own case for Asstt.Year 1989-90, he pointed out that the conclusion arrived at by the CIT(A)-IX was solely based on the decision of CIT(A)-III, New Delhi in the case of Konkan Railway Corporation Ltd. In that case in the relevant previous year, the project of Konkan Railway Corporation had become operational and the exploitation of the same had started inasmuch as there was passenger traffic receipt of Rs. 32,269/-. As the exploitation of the project had started, the CIT(A)-III, New Delhi was obviously justified in holding that the business of Konkan Railway Corporation had commenced during the previous year relevant to Asstt.Year 93-94. It is matter of record that the exploitation of the project by Konkan Railway Corporation started only in the period relevant to Asstt.Year 1993-94 wherein the passenger traffic receipts of Rs. 32,269/- were received and therefore there was an apparent contradiction in the observation of the CIT(A)-III, New Delhi when he mentioned that the business of construction and operation of the railway line had commenced in the preceding year. The facts in the appellant's case were however different inasmuch as the exploitation of the project had not yet started and there were admittedly no revenue receipts during the previous year by way of exploitation of the project. He therefore held that the decision of CIT(A) in the case of Konkan Railway Corporation could not be applied in the case of the appellant. He also rejected the claim of the appellant that its activity was similar to that of a Building Contractor as being apparently not in tune with the existing facts because the exploitation of the project was very much envisaged in the Directors' Report [refer para 4(iii)] and in the prospectus issued to the public while inviting subscriptions to the public issue of Secured Redeemable Deep Discount Bonds [refer para 4(v)] wherein it has been vividly made clear that revenue generation of the assessee corporation shall be from the exploitation of the project which was still under construction and pre-operative stage. The assessee Corporation had, at no point of time, indicated its intention to generate revenue by functioning as a contractor for construction of the project. There is no mention in the Memorandum and Articles of Association of the appellant Corporation which indicate that the project was to be sold or handed over back to the Government of Gujarat after the construction work. He observed:
"6.5 It is matter of record that the appellant Corporation came into existence to take over Sardar Sarovar Narmada project. All properties of the Sardar Sarovar Narmada project were transferred to the appellant Corporation when it came into existence. The value of the project at that stage was estimated to be Rs. 533.09 crores and this value of the project was treated as share capital contribution by the Government of Gujarat. The mega project under progress was in the process of building up capital assets which can be equated with construction of factory building and fabrication of plant and machinery in the case of a manufacturing company. This is further evidenced from the fact that the capital contribution by the Government of Gujarat was debited under the heads of major capital outlay, Rs. 415.73 crores was debited under the head, "4701 capital outlay on major and medium irrigation" and the balance Rs. 117.36 crores were debited under the head "4801 capital outlay on power projects.". It is thus obvious that the whole investment by the Government of Gujarat in the project which was till then owned by the Government of Gujarat and was known as Sardar Sarovar Narmada project was a capital investment for creating irrigation and hydro electric power generation infrastructure. No part of the investment till then was considered to be of revenue nature. It is therefore consequence that the revenue generation from this project was expected only when such irrigation and power generation infrastructure came into operation. The argument of the ld. counsel for the appellant that the activity of the appellant Corporation was similar to that of a building contractor is not tenable for the reason that the appellant Corporation was working for its own capital assets with the sole aim to carry forward the work in progress of Sardar Sarovar Narmada project. There is nothing on record that the appellant Corporation was functioning in the capacity of a contract for samebody else. There was no existence of any such contract. The thought propounded by the ld. counsel for the appellant that the appellant Corporation was engaged in the contract work for the Government of Gujarat is also not acceptable because neither there was any such agreement with the Government of Gujarat nor the assets of the projects were required to be transferred to the Government of Gujarat. The ownership of the project as such with all rights, liabilities and obligations of the Government of Gujarat was transferred to the appellant Corporation and in lieu thereof, the appellant Corporation had credited the Government of Gujarat with the share capital contribution of Rs. 533.09 crores. The Government of Gujarat continued to develop and control the project through the appellant Corporation. It is thus apparent that during the previous year, the appellant Corporation was still in the stage of developing the mega project and the stage of revenue generation from the same had yet not arrived. Besides the above, it can also be seen that the appellant Corporation had nowhere indicated that it was functioning in the capacity of a contractor to develop the project. This is for the simple that the appellant Corporation never prepared its accounts in a manner to give such projection. There are two accounting procedures followed by the contractors. In one method, estimated profit on conservative basis was estimated every year and was credited to the P&L A/c. In another method, the whole of the expenditure incurred during the year was credited to the work in progress and the profit was computed only on completion of the project. In the later case also, the transaction would rout through the P&L A/c. with no profit during the previous year. In the case of the appellant Corporation, however, no such P&L A/c. was prepared for the obvious reason that the appellant Corporation was not engaged in any contract work for anybody else. From the Memorandum of Association, it is apparent that the appellant Corporation was the owner of the capital work in progress and was entitled to exploit the project after the project reaches to a stage where revenue generation either through irrigation or power distribution or in any other way was possible.
18.3 He then referred to certain clauses of Memorandum of Association in this regard and observed in paragraph 6.6 of his order that: "From the above, it is obvious that the appellant Corporation, by no means, was functioning as a contractor for any other party, but the object and activities of the appellant Corporation extended to exploitation of the project for revenue generation after its completion. This line of argument of the ld. counsel for the appellant therefore is not acceptable and therefore as a consequence, it follows that during the previous year, the appellant Corporation was still in the process of acquisition and construction of capital assets and there was no commencement of business activity."
18.4. Looking to the extent of activities of the assessee Corporation as elaborated by the ld. counsel for the assessee and referred to in para-5 of his order he pointed out that the whole argument on this line only indicated the magnitude and the quantum of work in the mega project and further that the same was still under construction stage and was not completed. The work done by the appellant corporation during the previous year was, by all means, towards creating and bringing into existence a capital asset i.e. the creation of source aiming to yield income and till such asset comes into existence on completion of the project, it could not be said that business of the assessee Corporation had commenced. The whole activity of the appellant Corporation till the previous year only indicates the element of pride of the assessee Corporation of being owner of the project and it was a well settled position of law that the activities associated with the development of such an asset which is expected to generate income at a later stage for the appellant corporation could not be regarded as adventure in the nature of trade or an engagement of the appellant Corporation in any business activity. He observed that it is an admitted position of fact that there was no other party with whom the appellant could be said to have done any business as no branch of the project was yet in a position to generate revenue. He was therefore, of the view that the assessee Corporation was correct in not preparing any P&L Account with reference to the project work as the whole activity of the appellant Corporation was towards the capital work in progress which could not enable the appellant to compute any income or loss under the head "income from business and profession". Such presentation of the accounts by the appellant Corporation was also in tune with the provisions of Income-tax law as far as the commencement of business activity was concerned. In view of the discussion as above, he found that the Assessing Officer was fully justified in arriving at the conclusion that the business of the assessee Corporation was not set up during the previous year and that all activities till the previous year were towards the capital work in progress nor the business of the assessee Corporation had not commenced during the previous year. He agreed with the observation of the Assessing Officer that the business of the appellant would commence only when water starts flowing from the canals and/or when power houses start generating electricity.
19. The Revenue is in appeal in A Y 1989-90 and against that appeal the assessee filed cross objection and for all other years challenging the findings of the CIT(A) upholding the validity of the proceedings under Section 147 of the Act that the assessee is not entitled to deduction under Section 10(20A) of the Act and treating the income from interest as income from other sources and in holding that claim of interest is not allowable and that no appeal lies against charging of interest under Sections 234A, 234B. In AY 1999-2000 a also changed the levy of interest Under Section 234D of the Act.
20. In the appeal for AY 1989-90 the claim ins also raised by the assessee for deduction Under Section 10(33) in respect of dividend from Units but the same was not pressed.
21. The learned counsel of the assessee submitted that the assessee Corporation was incorporated on 24-3-1988 to take over the construction of on-going project and it had started working on the project, the moment it had taken over the same from the Gujarat Government. He therefore submitted that the Company had commenced its business from its inception. The assessee was given the project to construct the Sardar Sarovar Dam and infrastructure for providing electricity and that it was doing since 1989-90, the day of its inception/incorporation. The distribution of water and electricity was only incidental. He carried us through various documents evidencing the fact that it had been continuously engaged in fulfilling the object of the construction of dam from year to year. It was also granted Certificate of Commencement of business on 9-5-1988 itself. In any case, he submitted that the assessee Corporation had set up its business, if not commenced, and in that situation all the expenditure has to be allowed as revenue expenditure incurred for the purpose of carrying out its business so set up. He referred to various decisions to establish that it had set up the business. These decisions are: I) Western India Vegitable products Ltd. 26 ITR 151 (Bom); Sarabhai Management Corporation Ltd. 102 ITR 25 (Guj); which is uphold by the Supreme Court in 192 ITR 15 (SC); Prem Conductors Pvt. Ltd. 108 ITR 654 (Guj); Western India Seafood (P) Ltd. 199 ITR 777 (Guj); Hotel Alankar 133 ITR 866 (Guj); Saurastra Cement and Chemical Ltd. 91 ITR 170 (Guj); and the Tribunal's decision in case of Interlink Petrol Chem., 83 TTJ 274 (Ahd.). He invited our attention to the certificate under Section 10(23G) which is normally granted to an assessee on the ground that it was engaged in carrying on business within the meaning of Section 80-I(4) of the Act, read with explanation-c(ii) thereof. He further submitted that book entries are not relevant and decisive nor determinative of the legal effects of a transaction. He referred to the decision of Tuticorin Alkalies Chemicals & Fertilizers Ltd. [supra] and in the case of Kedarnath Jute Mills 82 ITR 363 (SC). The statutory deposits, in any case, he submitted are to be taken as business deposit and interest thereon be either as business income or be excluded from the cost of the project in view of the decision of Calcutta High Court in the case of L.N. Dalmia 207 ITR 88 (Cal) and even interest earned on fixed deposits also reduce the cost of the project in view of the decision of Supreme Court in the case of Bokaro Steels Ltd., 236 ITR 315. He also submitted that the assessee is a local authority and therefore exempt from taxation under Section 10(20)(20A) of the Act. In support of challenge to re-open the assessment year 1989-90 in cross objection, he submitted that the reopening was to assess the interest received from contractors and the same amount has not been ultimately assessed, therefore, the reopening of the assessment year is invalid and bad in law, in view of decision in the case of Bokaro Steel Limited 170 ITR 522 (Pat), and on appeal to Supreme Court 236 ITR 315(SC); Lakhmani Mewal Das 103 ITR 437-8(SC); and Simon Carves Ltd. 105 ITR 212-219 (SC). He also submitted that the motive was not to earn income, and in that connection referred to the decision of Bombay Tribunal in the case of Jindal Vijaynagar Steel Ltd. 87 ITD 630. In any case, he submitted that, interest paid on borrowings for making deposits, on which the assessee earned interest be allowed as deduction under Section 57 of the Act.
22. The learned Department Representatives, on other hand, submitted that there was neither commencement of the business nor it is a case of setting up of the business of the assessee, as the project undertaken by the assessee was not only for the construction but also to operate and earn income by making itself the supply of water and electricity. He referred to various documents referred to in the order of the AO i.e. Directors' Report, Profit & Loss Account and Balance Sheet, Prospectus, Income earning from the project and sharing water charges etc. which show that income earning was part of the project. Certificate of Incorporation and/or Certificate of Commencement of Business are not decisive test for the commencement of business, but only an authority to enter into business activity. The assessee is not doing construction for somebody else, as like of a contractor, but constructing a project as an owner for itself in order to earn income and therefore unless it is ready to give results or the income, it cannot be said to have been commenced or set up the business. He further submitted that most of the cases relied upon by the assessee are trading companies wherein first activity was held to be indicative of setting up or commencement of the business. He then referred to the decisions of the Tribunal in the case of Interlink Petroleum Ltd 83 TTJ 274 and the decision of Bombay High Court in the cease of Western India, (supra). He submitted that the cases of manufacturing are even to the extent that it trial run is not successful, it not amounts to setting up. Setting up a business according to him is a stage prior to commencement of actual production and expected results. Delhi Tribunal's case relied upon by the CIT(A) in the appeal for the A.Y.1989-90 is on different facts and was rightly distinguished by the earlier CIT(A) in Appeals for A.Yrs.1990-91 onwards. The expenses also can not be allowed according to him in view of Tuticorin Alkalies Chemicals & Fertilizers Ltd. [supra], as the expenses were not incurred for the purpose of earning or making income from interest but for utilizing the same in the project of construction.
23. We have perused the records and carefully considered the rival submissions of the parties. Government of Gujarat conceived the idea of establishing the project named, Sardar Sarovar Narmada Project. It was to construct the dam and canals with a view to supply water on volumetric basis on the rotational water supply system with automated regulation of the canals by means of computerized controls for optimizing the use of scarce water and minimizing danger of water logging and salinity in soil. The project would also provide irrigation to 18 lakhs hectares of land in Gujarat and 37,500 hectares of land in Maharashtra. It is also have underground excavation for the river bed power house to start generating power, when reaches height at 110 meter. Gujarat Government did not said work departmentally and on being advised, incorporated the assessee Corporation and transferred the work-in-progress etc. to the assessee on ownership basis. The Government of Gujarat is the main shareholder of the Company, as seen from the G.R. No. COR-1488-H dated 27th October, which reads as under:
"PREAMBLE:
The Government of Gujarat has set up a Governmental Company viz. Sardar Sarovar Narmada Nigam Limited to execute the works of the Sardar Sarovar Narmada Project.
2. The authorized share capital of the Nigam has been fixed at Rs. 2,000 crores (Rupees two thousand crores) divided into 1,00,00,000/- (One crore) equity shares of Rs. 1,000 (One thousand) each and 1,00,00,000/- (one crore) unclassified shares of Rs. 1,000 (One thousand).
3. This Nigam has been registered under the Companies Act, 1956 and is governed by its Memorandum of Association and Articles of Association. Clause 1 of the "main objects" (for which the company is established) of the Memorandum of Association of the Nigam provides, interalia, to undertake execution of the Sardar Sarovar Project. Article 4(d) of the Articles of Association of the Nigam provides that all rights, liabilities and obligations of the Government, which whether arising out of any contract or otherwise, were acquired or incurred by it in connection with the Sardar Sarovar Project and the matters connected therewith or for any of the objects and purposes referred to in the Memorandum of Association of the Nigam before the incorporation of the Nigam shall be deemed to have been acquired or incurred by the Nigam and shall be the rights, liabilities and obligations of the Nigam. In view of these the assets of Sardar Sarovar Project stand transferred to the Nigam. After careful consideration, Government is pleased to resolve as under:
RESOLUTION:-
4. Government is pleased to transfer the assets as stated in the enclosed Annexure-A, the aggregate value of which is tentatively fixed at Rs. 533.09 crores, to the Sardar Sarovar Narmada Nigam Limited. The valuation is tentative and will be finalized in due course. Government orders for finalization of the value of the assets transferred to the Nigam will be issued separately.
5. The estimated cost of the assets transferred to the Nigam (Rs. 533.09 crores) is to be treated as share capital contribution of the Government by debit to two Major Heads viz. "4701 Capital Outlay on Major and medium Irrigation - 80 General - 190 Investment in Public Sector and Other Undertakings - Share Capital Contribution to Sardar Sarovar Narmada Nigam Limited" with a sum of Rs. 415.73 crores and "4801 Capital Outlay on Power Projects - 01 Hydel Generation - 190 Investment in Public Sector and other Undertakings - Share Capital Contribution to Sardar Sarovar Narmada Nigam Limited with a sum of Rs. 117.36 crores totaling to Rs. 523.09 crores under Demand No. 65 of Narmada Development Department by Contra Credit to as Deduct-Receipts and recoveries on Capital Account under various sub-heads as shown in Annexure B of this G.R.
6. These orders are issued with the concurrence of the Finance Department dated 30-6-1988 on this department's file No. COR/1488/H. By order and in the name of the Government of Gujarat. ..."
23.1. A close reading of the GR, it clearly shows that the assessee Corporation took over the project with all the assets, rights and liabilities of the project and on transfer they stood vested in it. The assessee Corporation, thus, becomes owner of the dams by acquiring the project for a price. In other words, the dams, power houses etc. would be belonging to the assessee Corporation and thenceforth whatever was to be done was on its own account and it was not in the account of Govt. of Gujarat or other three States viz. Madhya Pradesh, Rajasthan and Maharashtra. The dams or the power houses are to be constructed not as a price of art or an archeological monument and are with a view to and enable supply of water and electricity. They are in the nature of infrastructure and usufruct is the supply and regulation of water and generation of electricity to be supplied and distributed to cater the need of four States on volumetric basis and on rotational water supply system. The project is therefore, not only for construction of the dam, but also to provide infrastructure for supply of water and electricity in four States. It is more evident from the following various documents referred to, during the course of hearing. These are:
i) Annual Report for the A.Y. 1989-90. Note No. 7 forming part of the accounts in the Annual Report 1988-89 which reads as under:
"(7)(a) No Profit and Loss Account for the period from 24th March, 1988 to 31st March, 1989 has been prepared as the Projects of the Company are under Construction and the Company's operation of supply of water and power has not commenced by 31st March, 1989.
(b) Most of the items classified under incidental expenditure during construction, according to the Company, are relating to the Project and it is therefore the intention of the Company to capitalize the same as and when commercial operations commence."
ii) Annual Accounts for the year 1999-2000 where Auditors' qualified the accounts by stating in item No. 4 to Schedule-K as: 'In our opinion the "Statement of Incidental Expenditure pending capitalization" and Balance Sheet have not been drawn in accordance with the Accounting standards referred to in Sub-section (3c) of Section 211 of the Companies Act, 1956 to the extent they are applicable to the Company." In reply to the Auditor's remark on accounts, (item 4) the Board of Directors replied that "The Company is not a contractor. Therefore, Accounting Standard-7 is not applicable to the Company. No revenue has been generated during the year from the normal activities of the Company. Therefore, Accounting Standard-9 (Revenue Recognition) is also not applicable to the Company. All other Accounting Standards have been complied with to the extent they are applicable to the Company." The expenses and income are not carried to Profit & Loss account, but are shown in the Balance Sheet under the Head "Incidental Expenditure Pending Capitalisation". These are expenses minus income.
iii) Notes forming part of the accounts in Schedule-K, Clauses-7 and 10 for the year 1999-2000 again incorporate the facts as under:
"7. During the course of execution of the Sardar Sarovar Project, the Company has earned income by way of interest, dividend, rent and miscellaneous income which has been reduced from the incidental expenditure pending capitalization. Income tax Department has considered interest income earned on short term deposit etc. as income liable to tax under the head "Income from other Sources" and raised total tax demand of Rs. 29,04,98,844/- which includes interest of Rs. 16,7527,923 for the assessment year 1989-90 to 1994-95 and 1997-98. The Company had preferred Appeals before the Commissioner of Income Tax (Appeals) and the same has passed an order in November, 2000 for the Asst. Year 1989-1990 accepting the appeal of the Company that business of the Company has commenced since inception. The Company is also advised that the business of the company has commenced and as the expenditure for exceeds the income in all those years, there would not be positive income and hence no tax provision is made for the demand raised."
"10. Since the Project of the Company is under execution, no profit and loss account for the year has been prepared. In absence of revenue (except income form other sources) and thereby profits, no provision is considered in the accounts in respect of Redemption Reserve/Sinking Fund or Deep Discounting and Non-Convertible Bonds/Debentures issued by the Company from time to time. However, to provide adequate comfort to the investors, a Tripartite agreement has been entered into between the Company, the Trustees and the GOG, in which the Government has agreed to disburse the shortfall in repayment of the principal and interest on bonds and debentures."
iv) Objects clause of Memorandum of Association containing following clauses:
(a) Object Clause 3(A)(1):
"To undertake execution of the Sardar Sarovar Project comprising a dam across the river Narmada in the Nadod Taluka of Bharuch district in the State of Gujarat, a canal system emanating from the reservoir called the Sardar Sarovar impounded by the construction of the said dam; power houses at the foot of the said dam and at the canal head and all other works incidental or ancillary to the said project in accordance with the direction of the Government of Gujarat."
(b) Object Clause 3(A)(9):
"To promote schemes to facilitate navigation in the Narmada river"
(c) Object Clause 3(A)(10):
"To promote Schemes for irrigation and water supply in the State for utilization of water from the Sardar Sarovar."
(d) Object Clause 3(A)(21):
"To alter, manage, develop, exchange, lease, mortgage, underlet, sell, give I gifts or otherwise dispose of, improve or deal with the land, property, assets and rights and resources and undertaking of the company or any part thereof for such consideration of the company may thing fit and in particular for shares, stocks, debentures, or securities of any other company having objects altogether or in part similar to those of this company".
(e) Objet Clause 3(A)(26):
"To sell, improve, manage, develop, exchange, lease, mortgage, dispose of, turn to account or otherwise deal with all or any part of the property and rights of the company".
(f) Object Clause 3(A)(29):
"To let out on lease or on hire all or any of the property of the company either immovable or movable."
v). A reading of Prospectus is worth noting. It reads as under:
(a) REDEMPTION RESERVE:
It is unlikely that the company would be creating a redemption reserve for the Bonds because it is envisaged that profit would not be adequate for the purpose. However, the company feels that the Tripartite Agreement entered into between the Trustees, the company and the government of Gujarat as described elsewhere in this prospectus, would ensure adequate comfort to the investors regarding timely payment of interest and principal with regard to the Bonds. (Page 15 of prospectus).
(b) MEANS OF FINANCE:
(Rs. in crore) Funds already raised 2597.63 Funds to be raised 6402.37
--------
Total 9000.00 * The project cost does not include interest on market borrowings estimated at Rs. 1686 crores upto the year of the completion of the project. It is estimated that this would be funded through budgetary support from Gujarat Govt. and through Water and Electricity charges is shown in the fund flow statement given below:
Estimated funds flow statement (only relevant extract) (Rs. In crores) Upto-91 91-92 92-93 93-94 94-95 95-96
-------------------------------------
Water Charges 5 13
Elec. Charges 17
96-97 97-98 98-99 99-2000 Total
-------------------------------------
Water Charges 26 53 80 108 285
Elect. Charges 66 69 67 65 284
(Page 21 of the prospectus)
"Assumptions underlying the funds flow statement:"
2- Water would be available for irrigation, municipal and industrial purpose.
Based on 75% dependability, Gujarat's share would be 9 MAFt of which water for irrigation would be 7.94 MAFt and rest 1.06 MAFt the company would be billing for the quantity of the water released at the head of regular.
3- Revenue will start accruing gradually from 94-95 onwards and peak would be achieved later. The entire revenue would not be available for servicing and repayment of principal loans. 1/3rd of the amount is being kept apart for maintenance-operations, leaving the balance of 2/3 of SSNNL to meet its obligations., It may be mentioned here that the rates adopted here are conservative basis and there is every valid reason for upward revision by the Government. A Cabinet sub-committee is reported to be seized of this matter.
4- Revenue from Hydel generation (Gujarat share-16%) has been taken as per Techno Economic appraisal of the Power project of Sardar Sarovar Project by the Central Electricity Authority, Govt. of India (Page No. 22 of the prospectus).
(c) AUDITORS REPORT "A. Profit & Loss"
The project of the SSNNL is under construction and no commercial activity has been commenced and in view of reliance on legal opinion of counsel and authoritative pronouncement the SSNNL has also approached Company Law Board for clarification, to exhibit revenue expenditure not allocable to specific project in a Schedule instead of preparing Profit & Loss Account as required under Section 211 of the Companies Act, 1956, pending said clarification from the Company Law Board, SSNNL has not prepared profit and loss account and has exhibited revenue expenditure not allocable to specific project in a separate schedule under heading "Incidental Expenditure pending capitalization" (Page No. 35 of Prospectus)
v) Assessee's letter dated 28-12-1989 filed in the proceedings for AY 1989-90 wherein assessee corporation had pleaded that unless and until the dam was constructed, canals start functioning, power houses were set up and supply of water and electricity for irrigation etc. stated, the business of the corporation could not be said to be set up and till than the entire expenditure would be capital expenditure. Similarly, Assessee's letter dated 26-12-90 filed in the proceedings for AY 1990-91 wherein assessee Corporation again pleaded that unless and until the Dam was constructed, canal start functioning, power houses, etc. and supply of water and electricity for irrigation, etc. started, the business of the Corporation could not be said to be set up and all expenditure till then would be capital expenditure.
23.2. From above, it is obvious that the assessee Corporation is to engage itself in all other work incidental or ancillary to the project. It is obvious that the ultimate aim of the project is to develop irrigation system and a network of hydro electric power generation for consequential exploitation and such exploitation was incidental (i.e. liable to happen as a consequence) to the above project which would ultimately lead to generation of revenue. It is obvious that the schemes to facilitate navigation would generate revenue and that the scheme to be promoted by the assessee Corporation for irrigation and water supply would lead to revenue generation it is further apparent that the assessee Corporation is required to manage, develop and sell, assets, rights and resources generated from the project which would yield ultimate revenue to the assessee Corporation. The assessee Corporation is the owner of the project being developed and would be entitled to generate revenue by selling the rights of irrigation facilities and electricity, etc. which would lead to generation of revenue. The clauses also enables the assessee Corporation to generate revenue by letting out its rights in various parts of the project (i.e. to earn revenue from exploitation of the resources of the project). From the above it seems clear that the Project includes the provision of infrastructure and operation and exploitation thereof for supply and distribution of water and electricity i.e. not only to construct the dams but to exploit the same.
23.3. Now the question is that when the assessee corporation can be said to have set up or commenced its business. The assessee is not engaged in any business of construction of dams or power-house for others. It has to construct the dam for own self so as to regulate and supply of water and electricity. Constructed portion of the project is not its stock in trade but capital asset. Where the construction is part of stock in trade it might be said that it started its business activity the moment it put in the first brick to continue the taken over project. In case of construction of capital asset or infrastructure it could not be said to have or commenced the business. It is normally when it is ready to provide or produce the (SIC). The assessee Corporation being engaged in constructing infrastructure, the dam, in this case, cannot be said to have set up its business or it had commenced business. At best it can be said that it had taken steps to provide the infrastructure. It is only when the infrastructure is ready to exploit, it can be said to be started and/or set up its business or commenced its business. Let us examine the cases relied upon by the parties on these issues.
23.4 In the case of Western India Vegetable Products Ltd. [supra] the assessee company was incorporated on 29th December, 1945 with the object of running an oil mill. It obtained Certificate of Commencement of business on 20th April, 1946. The assessee company purchased ground nut oil mill, in working conditions on 1 st November, 1946. The Income-tax Officer held that the business of the assessee company was started on 1st November, 1946. The Appellate Assistant Commissioner held that it started business when the Certificate of Commencement of business was received on 20th April, 1946 and the Tribunal on the contrary held that it had started its business activity on 1st September, 1946, the date on which it purchased certain raw-material. The matter was carried to High Court by the assessee and the High Court held that the assessee commenced business only on 1st September, 1946, when it purchased the mill. Their Lordship observed that there is a clear distinction between a person commencing a business and a person setting up a business for the purpose of Indian Tax Act, and therefore, the "setting up of a business" and not the "commencement of a business" is to be considered. It is only after the business is set up that the previous year of that business commences and expenses incurred prior to the set up of the business would not be permissible as deductions. When the business is established and ready to commence business, then it can be said the business is set up, but before it is ready to commence business, it is not set up. However, all the expenses incurred between the setting up of the business and commencement of the business would be permissible deduction. As regards the date of 1-9-1946, it held that the Tribunal has come to the conclusion even on an interpretation more favourable to the assessee than the one it was which giving to the expression setting up. There Lordship also refrained from going into sufficiency of reasons for fixing the date as 1-9-1946 and reframed the question as: "Whether there was evidence before the Tribunal to hold that the assessee company set up its business as from 1st of September, 1946" and answered the question in affirmative. It should be noted that this reference was by the assessee and not by the Revenue. Therefore, setting up the business on any date after 1-9-1946 could not have been gone into by the High Court. As matter of principle, however, it is held that when a business is established and is ready to commence business, then it can be said that business has been set up, but before it is ready to commence business, it is not set up.
23.5 In the case of Sarabhai Management Corporation Ltd. [supra], wherein assessee company's main object was to acquire immovable property and to give it out either on leave and licence or on lease as residential or in the alternative, business accommodation, with all appurtenant amenities including the amenities of storage, watch and ward facilities, canteens, refreshment rooms etc. It purchased a bungalow together with the appurtenant compound on 28-3-1964 and thereafter building repairs, rewiring, installation of lift etc. were carried on by the company for the purpose of converting the residential accommodation to business and storage accommodation and to render the premises more serviceable to its prospective licensees or lessees. It claimed that it was in a position to offer services to licensees on and from October, 1964 to March 1965 and claimed expenditure as business expenditure. The Assessing Officer, the AAC as well as the Tribunal held that the company could not be said to have been ready to commence business prior to May, 1965, the date on which it gave on leave and licence part of the said building, and certainly not before 1-10-1964. On reference to High Court held that though the company actually let out on leave and licence a portion of the building with effect from 1-5-1965, the earlier and preceding part of its activities were also business activities to ensure that everything was for the use of occupier and therefore the assessee company could be said to have commenced its business activity on that date and all the expenses incurred by the assessee between 1-10-1964 to 31-3-1965 could be said to have been incurred by the assessee as business expenditure. In this context, their Lordship observed that the business activity could be said to be in three broad categories, viz. (1) the business was to acquire either by purchase or by any other manner immovable property so that the property can be ultimately given out either on leave and licence basis or on lease to others together with the appurtenant services, (2) business activity was to put these buildings and accommodation and lands and gardens into proper shape and set up the appurtenant services so that ultimately the property can be given out on leave and licence basis and (3) activity was to actually give out accommodation on leave and licence basis. The second activity viz. putting the building, accommodation and land and gardens into proper shape and set up the appurtenant services so that ultimately the property could be given on leave and licence basis, held by the High Court, said to have been commenced business. In the present case, the time is under consideration and cannot be said to have been set up in such condition that it ultimately could be utilized for the purpose for which it is being constructed.
23.6 In the case of Prem Conductors Pvt. Ltd. [supra], considering the earlier decision in the case of Saurashtra Cement and Chemical Industries [supra], the Court held that where the business of the assessee consists of different categories and where the activity was stated earlier than the actual commencement of the production, which could be said to have ben an essential part of the business activity, the company can be said to have been set up its business from the date when the one of the categories of the business is started and it is not necessary that all the categories of the business must start either simultaneously or that the last stage must start before it can be said that the business was set up. Test to be applied is as to when a business would regard a business being commenced and the approach must be from a common sense point of view. In this case, the assessee company was incorporated in November, 1963 with the object of manufacturing aluminium and copper conductors. The assessee claimed expenditure from the period 4-11-1963 to 31-12-1964 as business expenditure. The ITO, however, came to the conclusion that the company has started its business during the year, as it only started production of conductors on June 27 and for the period from January 1, 1965 to June 26, 1965, the claim of expenditure, was disallowed. The matter was carried to the High Court and the High Court held that Articles 3 provides the take over by the assessee company in another company and by a Resolution of Board of Directors of the company dated 6-4-1964 the assessee company acquired business of other company viz. Prem Industrial Corpn. Since selling of the goods manufactured by the company is a part of the business activity, it could be said that assessee company commenced its business and its business was set up when it started securing orders against further production - one business activity may precede the other. What is required to be seen is whether one of the essential activities for carrying on the business of the assessee company as a whole was or was not commenced. In this case, High Court held that the company had commenced it s business activity by securing orders first and going to production later on. In view of this particular special feature of this case, viz. business activity of securing orders had practically started since the very date of incorporation of the company, it is obvious that the business activity of the assessee company started from the date of its incorporation and not from the date of production of aluminum conductors was commenced.
23.7 In the case of Western India Seafood (P.) Ltd. the assessee claimed the processing of marine products to have been started on the basis that it had taken the processing premises from the Government in August, 1970 on annual rental basis and the contracted with fishermen for supplying fish in June, 1970. However, the actual business was carried out in October 1970, after the monsoon seas, when the fish and other marine products could be caught from the sea. Expenditure incurred prior to July 31, 1970 were claimed as business expenditure, which was disallowed by the AO, after making some adjustment. The Commissioner of Income-Tax (appeals) came to the conclusion that business was set up in August 15, 1970 and therefore held that the assessee is entitled to deduction of the expenditure. The Revenue appeal was dismissed by the following decision of the Gujarat High Court in the case of Prem Conductors Pvt. Ltd. (supra). On reference, the High Court uphold the view of the Tribunal by observing that at least from August 15, 1970, when the assessee acquired a godown where the processing of marine products could start when fish became available after the monsoon, it can be said that it had set up of business of processing marine products. Actual arrival of fish later on would not postpone the setting up of such business. Their Lordship observed that when a business is established and ready to commence the business then it can be said of that business that it is set up. The word "ready to commence" would not necessarily mean that all the integrated activities are fully carried out and/or wholly completed. Requirement is also complied with a given case where an assessee had undertaken the first of the kind of integrated activities of which the business is overall comprised of. It is not necessary that all the categories of its business activities must start either simultaneously or that the last stage must start before it can be said that the business was set up. The test to be applied is as to when a business would regard a business as being commenced and the approach must be from a common sense point of view. It is also observed that the question whether a business has been set up or not is always a question of fact which has to be decided on facts and in circumstances of each case. In this case, the acquisition of godown where the processing of marine products started was held to first activity in the process of setting up of the business, as on that date, the assessee is in a position to commence business and because of the arrival fish later on would not postpone the setting up of business, wherein in the present case, the assessee's project was under construction which was not in a position to be said, to be ready to commence business, and therefore, it cannot be said to have set up of the business.
23.8. In the case of Hotel Alankar [supra], the assessee firm was formed in July, 1967 for carrying on business of a boarding and lodging house. A building at the disposal of the firm was put up by one of the partners of the firm as his capital by allowing use of the first, second, third and forth floors of the buildings for the purposes of the business. Expenses were incurred for installing lights, making the building more ventilated etc and the hotel was formerly inaugurated in February, 1968. The AO disallowed the expenditure by stating that the business was commenced only from February, 1979 and the expenditure had been incurred prior to the commencement of business which was not allowable as deduction. On reference, High Court held that the hotel business necessarily compromised of variegated activities commencing from the stage of acquisition of a proper and suitable building, making it more suitable and convenient for the hotel business, purchasing linen, cutlery, furniture etc. appointing the staff as managers, cooks etc. and ultimately reaching the stage of receiving customers. It would be dehors the commercial sense to assert that it was only when one reached the stage of receiving customers that one could be said to have set up a hotel business. The list of repairs which had been provided before the Tribunal, the court observed, indicated that there were no major structural changes except installation of lifts, making the building more ventilated etc. which were held to be revenue in nature. Here also the Court observed that when a business is established and is ready to commence business then it can be said of that business that it is set up. The word "ready to commence" would not necessarily mean that all the integrated activities are fully carried out and/or wholly completed, the requirement is also complied with in a given case where an assessee has undertaking the first of the kind of integrated activities of which the business is overall comprised of. In this case also the acquisition of building was held to be first step towards setting up of the business and the building was ready for use for hotel business except requiring installation of lights, making building more ventilated which were held to be expenditure of revenue nature. This case is also no help to the assessee as the building was completed for running hotel business. As against this the on going project of construction of dam, in the present case, was not ready for use and exploitation.
23.9. In the case of Saurashtra Cement and Chemical Industries Ltd. [supra] the assessee company was formed in 1956 for the manufacturing and sale of cement and as part of its business the assessee obtained a mining lease for quarrying limestone and started the mining operations in 1958. The expenditure incurred for the purpose of extracting limestone as also depreciation and development rebate for the machinery installed for that purpose for the assessment years, claimed for the purpose as revenue expenditure. In this case, High Court observed that business of the assessee was divisible into three categories, viz. first category consisted of the activity of extraction of limestone by quarrying the leased area of land and this activity was necessary for the purpose of quarrying raw-material to be used for manufacturing of cement, second category comprised of the activity of manufacture of cement by use of the plant and machinery, set up for that purpose, and third category combined together constituted the business of the assessee. It was observed that the activity of quarrying the leased area of land and extracting limestone, as such, an activity in the course of carrying on the business as to the manufacture and of cement and sale of manufactured cement and this activity came first in point of time and laid the foundation for the second activity and the second activity when completed laid the foundation for the third activity and therefore the assessee commenced its business when it started of extracting of limestone. This case also is of no help to the assessee as the first activity is towards setting up of the business viz. quarry of leased area and extracting of limestone from it had already been started by the assessee. In the present case except venturing into construction of dam, nothing has been started by the assessee and the dam being capital assets, cannot be said to be is activity carrying on business of the assets.
23.10. In the case of Tuticorin Alkali Chemicals and Fertilizers Ltd., (supra) the assessee company was incorporated on 3-12-1971 for the purpose of, interalia, manufacturing heavy chemicals such as ammonium chloride and soda ash. The trial production of the company was commenced on 3-6-1982. For the purpose of setting up of the factories, the company had taken term loans from various banks and financial institutions and that part of the borrowed funds which was not immediately required by the company was kept invested in short term deposits with the bank. Such investments were specifically permitted by the memorandum and articles of association of the company. It had deposited certain sum of money with the Tamil Nadu Electricity Board and also given interest bearing loans to its employees to purchase vehicles. Upto the assessment year 1980-81, interest earned by the company from the various loans given by the company and also from the bank deposits was shown as income and was taxed accordingly. For the A.Y. 1982-83, however, the assessee disclosed the receipt of interest as "income from other sources" and also disclosed loss of Rs. 3,21,802/- and after setting off the interest income against the business loss, it claimed benefit of carry forwarded of net loss of Rs. 29,360/-. In the assessment proceedings, the assessee claimed the entire amount of Rs. 3,21,802 as business loss and the interest and financial charges along with other pre-production expenses were claimed as capital expenses, reducing the interest income of Rs. 2,92,440/- from the amount to be capitalized. The ITO rejected the claim of the assessee that interest was not eligible to tax. The matter went upto Supreme Court. One of the finding of their Lordship was that the expenditure would have been deductible as incurred for the purpose of business if the assessee's business had commenced. But that is not the case here. The Supreme Court observed that if a company has not commenced business, there cannot be any question of assessment of its profits and gains of business.
23.11 In the case of Interlink Petroleum Ltd. v. DCIT 83-TTJ (Ahd) 274 the Tribunal summarized the principles of law emerging from various judgments from the both sides as under:-
"a) There is a clear distinction between a person commencing business and a person setting up of the business. There may be an interval between setting up of business and the commencement of the business.
b) When a business is established and is ready to commence, then it would be said that the business is set up.
(c) The expenses incurred during the intervening period between setting up of the business and the commencement of the business would be permissible deductions. However, expenses incurred during the preparatory stage prior to setting up of business would not qualify for deduction.
(d) The assessee can be said to have set up its business from the date when one of the essential categories of its business activities is started and it is not necessary that all categories of its business activities must start either simultaneously or that the last stage must start before it can be said that the business was set up.
(e) The question as to when business can be said to have been set up and commenced will depend on facts and surrounding circumstances of each case. The test to be applied is as to when a businessman would regard a business as being set up and/or commenced and the approach must be from a common-sense point of view."
23.12 In the case of CIT v. Sarabhai Sons P Ltd. 90-ITR-318 (Guj), the Gujrat High Court noting the Supreme Court decision in the case of CWT v. Ramaraju Sugical Cotton Mills Ltd. Discussed the issue as under:-
"Now, the question as to when a business can be said to be set up is no longer a matter of doubt or debate. It is concluded by a decision of the Supreme Court in CWT v. Ramaraju Sugical Cotton Mills Ltd. We shall presently refer to that decision but before we do so, it is necessary to refer to one other decision and that is the decision of the Bombay High Court in Western Indian Vegetable Products case. The Bombay High Court pointed out in this case that there is a clear distinction between a person commencing a business and a person setting up a business and for the purpose of Section 2(11) which was the section of the Indian IT Act, 1922, corresponding to Section 3(1)(d) of the IT Act, 1961, what is required to be considered is the setting up of a business and not the commencement of a business. It is only when a business is established and is ready to commence business that it can be said of that business that it is set up. Before it is ready to commence business, it is not set up. This view taken by the Bombay High Court was approved by the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. There the question was whether a new spinning unit started by the assessee was set up after the commencement of the WT Act, 1957, so as to qualify the assessee of reexemption Under Section 5(10)(xxi) of that Act. The licence for establishing the new spinning unit was obtained by the assessee from Government of India in August, 1955; the assessee had placed orders for purchase of necessary spinning machinery and plant in January and February, 1956, and the construction of factory buildings had started in March, 1956, and was in progress on 1st April, 1957, when the WT Act, 1957 came into force. The construction of factory buildings was completed by December, 1957, and the erection of spinning machinery and plant in factory buildings was completed in several stages commencing from June, 1957, and a licence from the Inspector of Factories for working the factory was obtained in June, 1958. The question arose before the Supreme Court on these facts as to when the new spinning unit could be said to have been set up by the assessee; whether it was before 1st April, 1957, or after. The Supreme Court speaking through Bhargave, J Pointed out:
"Thereafter, the High Court referred to a decision of the Bombay High Court in Western India Vegetable Products Ltd v. CIT and, on its basis, concluded that the proper meaning to be assigned to the expression "set up" in Section 54(1)(xxi) would be "ready to commence business". We are unable to agree with the learned counsel for the Commissioner that, in arriving at this view, the High Court committed any error. A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. It is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organization that it can be said that the unit has been set up."
The Supreme Court accordingly held that the new spinning plant was set up after 1st April, 1957, since it was long after that date that it could be said to be ready to discharge the function for which it was set up. These observations of the Supreme Court lay down the test which must be applied for the purpose of determining when a business can be said to be set up. If this test is applied to the facts found by the Tribunal - which facts we have already enumerated while stating the facts giving rise to the reference - it is clear that the new business stated by the assessee was not set up until July, 1966. The new business which was sought to be established by the assessee was a business of manufacturing scientific instruments and communication equipment and it could not be said to be ready to discharge the function for which it was being established, namely, manufacture of scientific instruments and communication equipment, until the machinery necessary for the purpose of manufacture was installed. It is only when the machinery was installed that the business could be said to be put into such a shape that it could start functioning as a manufacturing organization. It was not sufficient that the assessee obtained the land on lease from the Gujarat Industrial Development Manager or placed orders for purchase of raw materials and stores or ordered out the necessary machinery and equipment. These were merely operations for the setting up of the business. The business could be set up only as a culmination of these operations when all that was necessary for the setting up of the business was done. The new business in the present case could not, therefore, be said to be set up by the assessee until July, 1966, when the machinery was installed and the factory was ready to commence business."
23.13 We agree with the contention of the assessee that accounting entries by themselves would not be decisive of the legal effects of a transaction in view of the two decisions of the Supreme Court. In the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. (supra), it is observed that principle of accountancy do not over-ride the provisions of taxing statute and in this connection their Lordships observed that ".....It is true that this court has very often referred to accounting practice for ascertainment of profit made by a company or value of the assets of a company. But when the question is whether a receipt of money is taxable or not or whether certain deductions from that receipt are permissible in law or not, the question has to be decided according to the principles of law and not in accordance with the accountancy practice. Accountancy practice cannot override Section 56 or any other provision of the Act. As pointed by Lrd Russell in the case of B.S.C. Footwear Ltd., (1970) 77 ITR, 860 (CA), the income-tax law does not march step by step in the footprints of the accountancy profession."
24.14. Similar were the observations of the Hon'ble Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd., wherein for the sales-tax liability, the assessee has made no provision in its books of account with regard to the payment of that amount and claimed the same as allowable deduction. The claim was rejected by the AO on two grounds viz. (1) (1) that the assessee had contested the sales tax liability in appeals and (ii) the assessee had made no provision in its books of account. The Supreme Court allowed deduction by observing that the assessee had followed mercantile system of accounting and the liability which had accrued and arisen in the relevant previous year and that the liability did not ceased to be liability because the assessee had taken proceedings before the higher authorities for getting it reduced or wiped out so long as the contention of the assessee did not prevail. It was further observed that the fact that the assessee failed to debit the liability in its books of accounts, did not debar it from claiming the same as deduction and in that connection it was observed that "whether assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take on his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter."
23.15 No doubt it is true that these two decisions say that the accounting entries would not be decisive, but in this case it is not only the accounting entries but even the provisions of law are contrary to the claim of the assessee. The assessee has not commenced/set up its business and therefore any expenditure before setting up/commencement of business cannot be allowed as deduction. The project of the assessee was under construction in all the previous years and the construction has not been to such an extent as to enable one to say that it was ready to commence its business or that it had set up its business.
23.16 The Certificate of Incorporation as a Company and/or Certificate of Commencement of Business in 1998, do not establish anything except the fact that the assessee can operate as a company or it is authorized or permitted to commence the business. Whether the company has commenced its business or not depends upon the activities it carries on and not on what it can do or authorized to do. It had engaged in activities during these years only in construction of dams, which is the infrastructure with which it has to conduct its business on completion. No doubt, it is true that it had completed a major part of the mega project, but it has not completed the dams to such an extent that it can be exploited for starting supply of water and/or electricity nor it can be said to have set up the business or commenced its business.
23.17 The objects clause contained in the Articles and Memorandum of Association and also an authority of what assessee can do, but here also it does not establish that the assessee corporation was doing or had started its business, in light of the decision of the Supreme Court in the case of Bengal & Assam Investors Ltd. [supra] and Oriental Investment Co. [supra] wherein it was observed that the object clause is a relevant consideration but not conclusive. It is a matter of fact that whether it had actually commenced its business or had set up the same and that is to be determined by the activity it is engaged in. Mere engagement in construction of the dam by itself is not an activity of business or reaching a stage immediately prior to the commencement and setting up of the business to be carried out, when the construction is complete and reach a stage to be exploited.
23.18 In Delhi case, the business activity has already started. In that case in the relevant previous year relevant to A.Y. 93-94, the project of Konkan Railway Corporation had become operational and the exploitation of the same had started inasmuch as there was passenger traffic receipt of Rs. 32,269/-. The business of Konkan Railway Corporation had thus commenced during the previous year. Therefore, there was nothing wrong in the observation of the CIT(A)-III, New Delhi when he mentioned that the business of construction and operation of the railway line had commenced in the preceding year. The fats in the appellant's case are however different inasmuch the ongoing project of construction of the dam was not complete and the exploitation of the project had not yet started and there were admittedly no revenue receipt during the previous year by way of exploitation of the project. We therefore held that the decision of CIT(A) in the case of Konkan Railway Corporation could not be applied in the case of the appellant and he subsequent CIT(A) is therefore right in distinguishing the same and holding that the Konkan Railway decision has no application to the facts of this case.
23.19 Equating the case of the assessee to that of a contractor is not valid (and also not claimed int eh proceedings before us), as the construction was not being done as a contractor for somebody else and the partly constructed dam was taken over as the capital assets of the assessee and the further construction to be constructed would be on its own account to make it fit to exploit commercially. Govt. of Gujarat has transferred the projet and ownership of the project-the on-going project of the dam, to the assessee on receipt of consideration paid/payable by the assessee and the assessee became the owner of the dam right from the date of its acquisition itself, which is capital assets.
23.20 Reference of provision of Section 10(23G) read with Section 80-I is not relevant. This Section 10(23G), as it stood at the relevant time, provides for deduction of any income by way of dividends, interest or long-term capital gains of an infrastructure capital fund or an infrastructure capital company from investments mae by way of shares or long-term finance in any enterprise carrying on the business of developing, maintaining and operating any infrastructure facility. Explanation a) to this section provide for the purposes of this clause, "infrastructure capital company" to mean such company as has made investments by way of acquiring shares or providing long-term finance to an enterprise carrying on the business of developing maintaining and operating infrastructure facility and Explanation b) to this section provide for the purposes of this clause) "infrastructure capital fund" to mean such fund operating under a trust deed, registered under the provisions of the Registration Act, 1908 (16 of 1908), established to raise monies by the trustees for investment by way of acquiring shares or providing long-term finance to an enterprise carrying on the business of developing, maintaining and operating infrastructure facility, the case of the assessee does not fall in either. Explanation c) might be applicable to the case of the assessee and it provide that an "infrastructure facility" means- i) a road, highway, bridge, airport, port, rail system or any other public facility of a similar nature as may be notified by the Board in this behalf in the Official Gazette which fulfills the conditions specified in Sub-section (4A) of Section 80-IA; (ii) a water supply project, irrigation project, sanitation and sewerage system which fulfils the conditions specified in Sub-section (4A) of Section 80-IA; (iii) a project for generation or generation and distribution of electricity or any other form of power where such project starts generating power on or after 1st day of April, 1993; (iv) a project for providing telecommunication services on or after the 1st day of April, 1995; (d) "long-term finance" shall have the meaning assigned to it in Clause (viii) of Sub-section (1) of Section 36. Clause ii) and iii) are the clauses which could apply to the assessee. Section 80IA[(4A) prescribed such enterprises to be any enterprise carrying on the business of developing, maintaining and operating any infrastructure facility which fulfils all the following conditions, namely: i) the enterprise is owned by a company registered in India or by a consortium of such companies; ii) the enterprise has entered into an agreement with the Central Government or a State Government or a local authority or any other statutory body for developing, maintaining and operating a new infrastructure facility subject to the condition that such infrastructure facility shall be transferred to the Central Government, State Government, local authority or such other statutory body, as the case may be, within the period stipulated in the agreement; (iii) the enterprise starts operating and maintaining the infrastructure facility on or after the 1st day of April, 1995.] 23.21 A certificate was granted to the assessee Under Section 10(23G) on 11-2-1999 and from that assessee wants that it is to deemed to have started its business at least from A Y 1998-1999, 1999-2000 and 2000-2001 for which years the certificate is given to it. We do not find any force in this argument of the assessee as well because what Section 80IA grants deduction for is the profit derived from the Industrial Undertaking and since its undertaking is not ready to be exploited for the purpose for which it is constructing the Dam it cannot be said to be servicing profit from the undertaking. It had not started operating and maintaining the infrastructure facility on or after the 1st day of April, 1995 and until the end of previous years relevant to the impugned Assessment years.
23.22 From the aforesaid the following principals therefore can safely be culled out:
"a) There is a clear distinction between commencement of a business and a setting up of the business. There may be an interval between setting up of business and the commencement of the business.
b) The question as to when business can be said to have been set up and commenced will depend on facts and surrounding circumstances of each case and not on the accounting treatment in the books of accounts of the assessee though that may be an indication of the legal position. The test to be applied is as to when a businessman would regard a business as being set up and/or commenced and the approach must be from a common-sense point of view.
c) A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. It is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organization that it can be said that the unit has been set up.
(d) The assessee can be said to have set up its business from the date when one of the essential categories of its business activities is started and it is not necessary that all categories of its business activities must start either simultaneously or that the last stage must start before it can be said that the business was set up.
(e) Expenses incurred during the preparatory stage prior to setting up of business would not qualify for deduction. However, the expenses incurred during the intervening period between setting up of the business and the commencement of the business would be permissible deductions however long, the intervening period that may be.
24. As regards the alternate claim of the assessee that interest expenditure pertained to the borrowings which were idle and have been utilized in making temporary fixed deposits for earning the interest income be allowed in any case. The condition of the learned counsel of the assessee that the interest paid on borrowed money, which have been utilized for the purpose of earning interest is an expenditure specifically mentioned in and claimed under Section 57 of the Act. The contention of the learned DR, on the other hand, is that interest was on the borrowings raised for the purpose of construction of the project and, therefore, even if they have been utilised for earning interest, deduction would not be allowable to the assessee in view of the aforesaid decision in the case of Tuticorin Alkali Chemicals. In this case it is held that:
i) Interest income is always of revenue nature unless it is received by way of damages or compensation. If a person borrows money for business purposes but utilises that money to earn interest, however, temporarily, the interest so generated will be his income.
ii) The fact that, the company had to pay interest on the borrowed money, cannot be ground for exemption of interest earned by the company by utilising the borrowed funds as its income. It cannot claim any adjustment against the interest income under Section 56. The expenditure to be allowable under Section 57 would be the expenditure as set out in Clause (i) to (iii) thereof. The court observed that it is not the case of the assessee that interest payable by it on the term loan is liable as deduction under Section 57 of the Act.
24.1 The Supreme Court then examined the possibility of deduction or set off of his income from other sources against interest payable on the borrowed funds and observed"
"There are specific provisions in the IT Act for setting off loss from one source against income from another source under the same head of income (Section 70), as well as setting off loss from one head against income from another (Section 71). In the facts of this case the company cannot claim any relief under either of these two sections, since its business had not started and there could not be any computation of business income or loss incurred by the assessee in the relevant accounting year. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under any other head. Similarly, any income from a non business source cannot be set off against the liability to pay interest on funds borrowed for the purpose of purchase of plant and machinery even before commencement of the business of the assessee." (underlined by us) "It has been argued that the source from which the company has earned interest is borrowed capital. The company has to pay interest to its creditors on the same borrowed capital. Having regard to the identity of the fund on which interest is earned and interest is payable, the company should be allowed to set off its income against interest payable by it on the same fund. We are of the view that no adjustment can be allowed except in accordance with the provisions of the IT Act. However desirable it may be from the point of view of equity, this adjustment cannot be made unless the law specifically permits such adjustment."
Our attention was drawn to two other decisions where the view of the Andhra Pradesh High Court was followed. In the case of CIT v. Electrochem Orissa Ltd (1951) 211 ITR 552, the Orissa High Court preferred the view expressed by the High Court of Andhra Pradesh to the view expressed by the Madras High Court in Seshasayee Paper and Boards Ltd's case (1985) 156 ITR 542 on the ground that the Madras case was based on a finding of fact that there was no direct connection between the interest paid and the interest received. In our view, it will not be right to read the judgment in Seshasayee Paper and Board Ltd.'s case (1985) 156 ITR 542 (Mad) in that way. The Court's finding in Seshasayee Paper and Board Ltd.'s case (1985) 156 ITR 543 (Mad) was that the interest earned by the assessee from the bank deposits had to be assessed under the head "Other sources". Consequently, the interest paid on the borrowings for the purpose of purchase of plant and machinery could not be allowed or adjusted against this income under Section 57(iii) nor were such adjustments permissible under Section 70 or 71 of the Act because the business of the assessee had not commenced. The Madras High Court (see (1985) 156 ITR 542) categorically held:
"In this case, admittedly, the borrowing has not been made exclusively and solely for the purpose of earning interest in which case alone it should be taken as an income which should be deducted from the interest receipts"
An assessee company may have raised its capital by issue of shares or debentures or by borrowing. But when that capital or a portion of it was utilized for whatever reason, even for a short period, to earn interest, that interest must be treated as revenue receipt and will have to be taxed accordingly. Any set off or deduction of any expenditure can only be made in accordance with the provisions of the Act."
..........
..........
"In the premises, we are of the view that the Madras High Court came to the correct decision in the case of CIT v. Shesharayee Paper and Board Ltd. (1985) 156 ITR 542. The contrary views expressed in the cases of CIT v. Nagarjuna Steels Ltd. (1988) 171 ITR 663 (AP); CIT v. Electrochem Orissa Ltd. (1985) 211 ITR 552 (Orissa) and CIT v. Maharashtra Electrosmelt Ltd. (1995) 214 ITR 489 (Bom) are erroneous."
24.2. The assessee, the ld. Counsel submits, is not claiming any adjustment of that expenditure under Section 56 nor set off Under Section 70 nor 71 of the Act, but it claims a deduction under Section 57 of the interest on the borrowed money, which has been utilized for the purpose of earning interest income, and as such, interest would be allowable as deduction in view of the decision of Supreme Court in case of Rajendra Prasad Moody, 115 ITR 569 (SC). The Supreme Court, in the case of Tuticorin Alkali Chemicals, though specifically observed that there was no claim by the assessee for its allowability under Section 57 of the Act, but at the same time it held that such interest could have been deductible while computing the business income but that was not the case of the assessee, and the claim of adjustment was denied under Section 56, 70 and 71 of the Act. In our opinion, therefore, interest which pertains to the borrowings made not for the purposes of making deposits in the bank but made for the purposes of constructing the project which is under completion, eventhough which have been utilized for making short term deposit for earning interest cannot be allowed as deduction as the same could not be said to have been incurred for making or earning income from interest within the meaning of Section 57 of the Act. Let us have a look to some other decisions on the issue.
24.3 In the case of Smt Padmavati Jaykrishna v. CIT 101-ITR-153 (Guj), the court held that "In order to earn the deduction from "income from other sources" contemplated by Section 57(iii) of the IT Act, 1961, the assessee has to prove two things, namely, (1) that the expenses in question were incurred for the purpose of earning the income sought to be taxed, and (1) that such expenditure was incurred wholly and exclusively" for the said purpose; that "the legislature has made similar provision for deduction of the expenditure incurred for the purpose of business or profession in Section 37. But the expression "for the purpose of business or profession" has wider implications than the expression "for the purpose of making or earning income" used in Section 57(iii). The purpose contemplated by Section 57(iii) is more specific in character inasmuch as it points to a precise and specific object of making or earning income. Motive with which the expenditure is incurred is irrelevant under this section; that "the other requirement of Section 57(iii) is that the expenditure should be incurred "wholly and exclusively" for the purpose of earning income. If the purpose of earning income is coup-led with some other extraneous purpose it will not be possible to say that the deduction under Section 57(iii) is earned by the assessee." The assessee in this case sought to deduct interest on amounts borrowed for payment of income tax, wealth tax and annuity deposit under Section 57(iii) on the ground that if she had not borrowed the money she would have had to liquidate her shareholdings and thus would have lost one of her sources of income and in any case the annuity deposit would earn interest; and the order of the court is:
"Held, that it could not be said that the result of the borrowing was saving of dividend income from shares because by borrowing loans the assessee had saved her income not only from one source, namely, the shareholding but from all other sources as well from shares was an incidental result of borrowing loans and that incident did not supply any evidence of "purpose". Even if it were conceded that the assessee was required to take loans with a view to save her investment in shares it could not be said that the interest in question was expenditure incurred "wholly and exclusively" for the purpose of earning income from investments. The immediate purpose of taking the loan on interest was to pay taxes, etc. It could be that the other purpose was to save one of her sources of income but this would show that the purpose was a dual one and would not be a covered by Section 57(iii). At the relevant time it was obligatory to make annuity deposit and the earning of interest through such deposit was merely incidental. The interest on the borrowed amount was, therefore, not deductible under Section 57(iii)."
24.4. In this case the High Court has also noted the decision of the Supreme Court in the case of Seth R Dalmia v. CIT 110-ITR-644 (SC). Further in this case heavy reliance is placed on the decision of the Gujarat High Court in the case of Virmati Ramkrisna v. CIT 131-ITR-659 which is Appendix to this order and the principles culled out from the decided cases were summarized at page 672 of the report as under:-
"On an analysis of the statutory language and principles laid down in the decided cases referred to above, the following propositions clearly emerge:
(i) in order to decide whether an expenditure is a permissible deduction under Section 57(iii) the nature of the expenditure must be examined;
(ii) the expenditure must not be in the nature of capital expenditure or personal expenses of the assessee;
(iii) the expenditure must have been laid out or expended wholly and exclusively for the purpose of making or earning "income from other sources";
(vi) the purpose of making or earning such income must be the sole purpose for which the expenditure must have been incurred, that is to say, the expenditure should not have been incurred for such purpose as also for another purpose, or for a mixed purpose;
(v) the distinction between purpose and motive must always be borne in mind in this connection, for, what is relevant is the manifest and immediate purpose and not the motive or personal consideration weighting in the mind of the assessee in incurring the expenditure;
(vi) if the assessee has no option except to incur the expenditure in order to make the earning of the income possible, such as when he has to incur legal expenses for preserving and maintaining the sources of income, then, undoubtedly, such expenditure would be an allowable deduction; however, where the assessee has an option and the option which he exercises has no connection with the making or earning of the income and the option depends upon personal consideration or motives of the assessee, the expenditure incurred in consequence of the exercises of such option cannot be treated as an allowable deduction;
(vii) it is not necessary, however, that the expenditure incurred must have been obligatory; it is enough to show that the money was expended not of necessity and with a view to an immediate benefit to the assessee but voluntarily and on the ground of commercial expediency and in order indirectly to facilitate the making or earning of income;
(viii) if, therefore, it is found on application of principles of ordinary commercial trading that there is some connection, direct or indirect, but no remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction;
(ix) it would not, however, suffice to establish merely that the expenditure was incurred in order indirectly to facilitate the carrying on the activity which is the source of the income; the nexus must necessarily be between the expenditure incurred and the income earned;
(x) it is not necessary to show that the expenditure was a profitable one or that in fact income was earned;
(xi) the test is not whether the assessee benefited thereby or whether it was a prudent expenditure which resulted in ultimate gain to the assessee but whether it was incurred legitimately and bona fide for making or earning the income;
(xii) the question whether the expenditure was laid out or expended for making or earning the income must be decided on the facts of each case, the final conclusion being one of law."
24.5. The Supreme Court affirming this decision in 166-ITR-176(SC) observed that the High Court was right in holding that meeting the liability for income tax and wealth tax was a personal one and the dominant purpose for paying Annuity Deposit was not to earn income but to meet the statutory liability of making the deposit. It was also observed that unless the loan is incurred for meeting a liability connected with the source itself, it would ordinarily be difficult to entertain the claim for deduction of interest paid thereon under Section 57(ii).
24.6. In the later decision in the same case of Padmavati Jaykrishna 131-ITR-653, before the Gujarat High Court the assessee claimed deduction of interest deficit of Rs. 33,516 which was paid to H K Estate in respect of borrowings made by the assessee not only in the past but also during the current year. The withdrawals were utilized partly for investment in shares, etc. and partly for meeting personal liabilities like payment of income tax, annuity deposit and household expenses. The ITO noted that out of the opening balance, a part was for current withdrawals made for investment purpose. He therefore allocated the interest claimed in the proportion of withdrawals for investment purpose and withdrawals for meeting personal liabilities like payment of income tax, annuity deposit and household expenses. That order of the AO was upheld by the Tribunal and on reference by the Gujarat High Court.
24.7 In the case of CIT v. Kasturbhai Lalbhai and Anr. 70-ITR-267 (Guj), the assesses were Directors in a company of which another company was the management agent. There was some mismanagement and change in the Directors of that another company. There were differences between the assesses and the other directors. The assessee therefore sent out two circulars to the shareholders pointing out the mismanagement and also collected proxies for a meeting requisitioned in the meantime. Before the said meeting could be held, the differences were settled and ultimately the first assessee was elected Chairman of the Board. The assesses jointly spent about Rs. 33,299 for sending out the circulars. The claim was disallowed by the ITO but the Tribunal allowed the claim of the assessee. On reference : the High Court held -
"(i) as the assessee had incurred the expenditure in issuing the circulars on the ground of commercial expediency in order to indirectly facilitate the earning of the director's fees, the expenditure relating thereto was an expenditure incurred solely for earning the director's fees and hence was allowable under Section 12(2).
(ii) the expenditure incurred in collecting the proxies from the shareholders cannot be regarded as an expenditure, even indirectly, connected with the earning of the director's fees and, hence was not allowable under Section 12(2).
24.8. The Court held that "What Section 12(2) says in so many terms is that the expenditure must be incurred for the purpose of earning the income and, therefore, there must be some connection or nexus between the expenditure incurred and the income earned. The connection may not be direct : even an indirect connection would be sufficient. But the expenditure in order to be admissible under Section 12(2) must be incurred directly or indirectly to facilitate the earning of the income, for then only we can say that the expenditure is incurred for the purpose of earning the income."
24.9 In the case of Seth R Dalmia v. CIT 110-ITR-644 (SC) the assessee has agreed to purchase a large number of shares from a bank and he had to take delivery of the shares after paying the purchase price. The assessee did not take delivery of the shares by that date, the dividends, rights, bonuses etc. declared after that date were to be held by the bank for his benefit, and the assessee was to pay interest on the purchase price from April 1, 1948 till the actual date of delivery of the shares. The assessee claimed payment of interest against dividend income which was disallowed by the AO and the disallowance was upheld by the Tribunal and also by the High Court on reference. On appeal, the Supreme Court allowed the claim of the assessee by observing as under :-
"Held - (i) on the facts, that, even if there was no transfer of equitable title in the shares to the appellant, the interest of Rs. 2,04,744 was really paid by the appellant for the purpose of earning income, viz., dividends, bonuses, etc., which were held by the bank for his benefit, that it could not be said to be expenditure of a capital nature or of the nature of personal expenses, and that, therefore, the essential ingredients of Section 12(2) of the Act were satisfied and the interest was allowable as a permissible deduction under Section 12(2);"
24.10. In the case of Additional CIT v. Madras Fertilizers Ltd. 122-ITR-139 (Mad), the assessee claimed deduction of the amount of interest paid by it on its borrowings which were made to meet the cost of construction of its plant. The interest was earned on the deposits required to be made pursuant to the loan agreement in a Special account to be maintained with the bank until all the funds deposited therein have been applied by the company in connection with the project. The assessee claimed loss of Rs. 20,35,408/- to be carried as business loss and by claiming the total interest of Rs. 35,53,829/- as deduction. The A O was of the view that the total claim was not allowable because the company was still under construction and therefore the borrowings were used for capital construction and not for the business purposes. The AO worked out the interest paid for the same period for which interest has been received at Rs. 2,67,735/- and adding therein the interest on the rupee capital, he determined the interest at Rs. 3,26,759/- and deducting other expenses as claimed and allowed in the preceding year at Rs. 1,07,368/- he fixed the final net income at Rs. 2,19,394/-. The matter was carried in appeal claiming the entire interest amount. The AAC however dismissed the appeal as the order of the AO got merged with the order of the CIT Under Section 263. The CIT in order Under Section 263 by observing that allowance of proportionate interest was erroneous and prejudicial to the interest of the revenue, held that the assessee was not entitled to deduction Under Section 57(iii) because he was of the view that the payment of interest by the assessee to the lending bank had really no direct connection with the interest received and, therefore, the interest paid was in the nature of pre-production expenses and it related to the erection of the factory and purchase of capital goods and, consequently, it had no connection with the earning of interest income. The assessee took the matter in appeal to the Tribunal both against the order of the AAC as well as CIT Under Section 263. The Tribunal held that the assessee's claim could be combined to the extent of loan drawn and deposited Under Section 57(iii). However it rejected the contention of the assessee that the interest paid should be allowed on the footing that even the act of borrowing and depositing was in the course of the business. While dealing with the claim made Under Section 57(iii) the Tribunal found that there was no dispute that all the borrowed funds had not been deposited to earn interest, and, therefore, it was of the view that only to the extent of the loans deposited, the claim of interest had to be limited. It held that there was close nexus between earning of the interest and the payment of interest and, therefore, the interest aid by the assessee to the lending bank proportionate to the amount on which it earned interest had to be allowed Under Section 57(iii) of the Act. The matter traveled and On reference the High Court held -
1. that the interest received by the assessee on its deposits in the special account constituted its income;
2. that though setting up of a factory may be a preliminary and essential step for the purpose of carrying on the business of the assessee, it cannot be said to be carrying on the business itself;
3. that as the borrowing was for putting up the plant and investment in the special account was only till the money was utilized for the said purpose or purchasing capital goods, the borrowing itself was not for the purpose of depositing the money and earning interest and hence the interest paid could not have any direct connection with the receipt of the interest;
4. that the interest paid by the assessee to the bank cannot be said to be an expenditure laid out or expended wholly and exclusively for the purpose of earning interest from the deposit the assessee had made in the special account, and the assessee was not entitled to deduction of the interest paid on its borrowings from the interest received on the deposits under Section 57(iii)."
24.11 In the case of CIT v. New Central Jute Mills Co. Ltd. 118-ITR-1005 (Cal) the assessee company was setting up a heavy Chemical plant and, in the AY 1958-59, the plant was under erection. Earlier in 1955, the assessee had obtained from the Govt. a loan for the purpose of setting up the plant. The amounts received under the loan had been kept in deposit with a bank pursuant to the terms thereof till transfer or utilization for the stipulated purpose. The assessee earned interest in the meantime and also paid interest to the Govt. on loan taken. The difference between interest earned and paid was claimed by the assessee as revenue expenditure. The AO disallowed the claim on the ground that the expenditure had nothing to do with the existing business of the assessee in jute and related to a separate unit which was still under erection and that business had not started till then. The AAC found that the specifically earmarked loan had been utilized for the purchase of machinery and that the payment was in the nature of capital expenditure and had been rightly disallowed by the ITO. The Tribunal held that the amount paid by way of interest should be allowed as a deduction as against interest earned from the bank in terms of the loan, that as the assessee had to keep the money in deposit in the bank segregated from its other business assets, the interest earned from the amount would be income from other sources, that by adopting a different method of assessment the ITO could not defeat the assessee's claim, that the interest paid to the Govt. on the amount borrowed had to be deducted against the interest received and that the difference represented a loss under the head "other sources" which was admissible for set off against income arising from the other head. On reference : the High Court held that:-
i) The purpose of the assessee in obtaining the loan was to defray the cost of the chemical plant which was in the process of erection. Under the agreement, the amount received on the loan had to be utilized for the plant and the money was spent on machinery for the plant. Till the amount was used for the stipulated purpose, the assessee had agreed to keep the same in deposit with the bank. It was not a term of the agreement that the amount had to be kept in a deposit account which would earn interest in the interim period;
ii) The interest paid to the Govt. had to be capitalized and added to the cost of the plant which was being set up and the same amount could not be treated differently in the accounts of the assessee : Challapalli Sugas Ltd. v. CIT (1975)98 ITR 167 (Supreme Court) applied.
iii) Though the assessee had succeeded in establishing that there was some connection or nexus between the interest paid to the Govt. and the interest earned from the bank, the nexus being that both the items of interest were either earned or paid on the amount of loan, yet the assessee had failed to establish that it was its purpose or one of its purposes to utilize the amount received on loan for earning interest. Further, the assessee had not established that the expenditure was incurred solely and wholly for the purpose of earning interest from the bank. Therefore the sum paid to the Govt. as interest on moneys borrowed from it was not allowable as a deduction against the interest earned from the bank.
24.12 In the case of Karnataka Forest Plantations Corporation Ltd v. CIT 156-ITR-275 (Kar) the assessee borrowed large amounts from the Govt. of Karnataka and banks for purpose of its business and the amounts that were not immediately required for carrying on its business operations were invested in banks in current account and short term deposits. Interest from such deposits were assessed as income from other sources. The assessee claimed that it was entitled to deduction on the amount borrowed, but the claim was disallowed. On a Writ Petition the High Court held that the borrowings had been made for the purpose of business and borrowings were not made to make investment sand earn interest from them. The borrowed amounts kept in short term deposits undoubtedly yielded interest. The interest income from such deposits was from such deposits only and was incidental to and was the result of the same. The interest income was totally independent of the borrowings. Interest payable on such borrowings was, therefore, not deductible Under Section 57(iii). In that connection the Court referred to its earlier decision in the case of Traco Cable Company Ltd. v. CIT 72-ITR-503. The Court however suggested to the Government to examine the feasibility of granting relief by amending the Act, by observing as under:-
"An examination of the fact situations and the liability imposed by the Act shows that the liability imposed against the petitioner was somewhat odd and even unjust which is accentuated when one notices that no relief is granted on the heavy interest paid to its bankers. Earlier, I have also found that the law as it stands does not permit the authorities or this court to grant relief to the petitioner. Both the eminent counsel with their rich experience in income tax law practice are unable to find a way out to help the petitioner as the Act stands at present. In my humble view, a way out had to be found to grant relief to the petitioner and others in similar circumstances. But, how that should be done is for Government and Parliament to decide. In order to enable the Government to examine this aspect and initiate necessary remedial measures, I consider it proper to forward a copy of this order to the Government.
24.13 This judgment of the High Court is dated 11th July, 1985 and no remedial action has been made or thought fit by the Government so far. Similarly when the similar matter came reached the Supreme Court in the case Tuticorin (supra) it had to remark "It has been argued that the source from which the company has earned interest is borrowed capital. The company has to pay interest to its creditors on the same borrowed capital. Having regard to the identity of the fund on which interest is earned and interest is payable, the company should be allowed to set off its income against interest payable by it on the same fund. We are of the view that no adjustment can be allowed except in accordance with the provisions of the IT Act. However desirable it may be from the point of view of equity, this adjustment cannot be made unless the law specifically permits such adjustment."
24.14. In the case of Vijaya Laxmi Sugar Mills Ltd. v. CIT 191-ITR-641, the Supreme Court at page 646, in connection with allowability of expenditure Under Section 57(iii) observed as under:-
"The next submission of learned counsel for the assessee was that, in the course of effecting the winding up of the assessee company, the liquidator has been incurring expenses such as salaries, legal fees, travelling expenses and other liquidation expenses and that these expenses are allowable as deduction from income earned by way of interest from fixed deposits in the relevant year. In computing the income chargeable under the head "Income from other sources", Section 57(iii) provides that deduction is to be made in respect of expenditure laid out or expended wholly and exclusively for the purpose of making or earning such income. The question for consideration therefore, is whether the expenses of the type incurred by the liquidator in this case can be said to have been incurred solely for the purpose of carning the interest income. It is true that the connection between the expenditure and the earning of income need not be direct and it may be indirect. But, since the expenditure must have been incurred for the purpose of earning that income, there should be some nexus between the expenditure and the earning of the income. There is not even some sort of evidence to show that the expenses incurred by the liquidator were to facilitate the earning of or at least for protecting the income. The interest accrues sui generic. The interest is payable by the bank whether it is claimed or not and whether there is any establishment or not. Normally, there was no necessity for spending anything separately for earning the interest. However, we may hasten to add that, if any expenditure was incurred like commission for collection or such similar expenditures which may be considered as spent solely for the purpose of earning that income, the position may be different. But that was not so in this case. It could not also be said that the expenditure incurred was to preserve or acquire the asset. Nor could it be said that the expenses were incurred for the purpose of maintenance of the source. The requirement under Section 57(iii) that the expenditure should have been incurred "for the purpose of making or earning such income" shows that the object of spending or the end or aim or the intention of such spending was for earning the interest income. There could be no doubt that the expenditure incurred by the liquidator in this case can, by no stretch of imagination, be said to have been incurred with the object or for the purpose of earning the interest income. The Tribunal was, therefore, right in holding that he expenses claimed are not related to the interest income and were not deductible expenditure under Section 57(iii)."
24.15. In the case of Sarabhai (P) Ltd. v. CIT 201-ITR-464 (Guj), after considering the decision in the case of Kasturbhai Lalbhai (Supra), Smt Virmati Ramkrishna v. CIT (supra), decisions of the Supreme Court in the case of Rajendra Prasad Moody 115-ITR-519, Seth R Dalmia (supra) and the second decision of the Gujarat High Court in the case of Padmavati Jaykrishna (supra), the High Court held as under:-
"Now, if we turn to the facts of this case, what is required to be noted is that the shares of SOML were held by the assessee along with two other groups of shareholders, viz. Kasturbhai group and Patel group. The assessee held 11,264 shares, Kasturbhai group held 24,975 shares and the Patel group held 12,737 shares. The assessee was also the managing agent of SOML. It was agreed amongst the shareholders that the assessee should purchase all the shares in order to improve the business of SOML by holding 100% shares of SOML, which would have enabled it to implement the expansion projects. Thus, the shares which were purchased by the assessee were not for the purpose of earning income, though that can be regarded as the ultimate motive. The shares were purchased by the assessee with a clear purpose or object of getting 100% control over SOML. If the purpose was to earn income only, of even if that was the dominant purpose, it would not have sold the shares again to KPPL as, by that time, it had already acquired more than 90% shares, and that would have satisfied its objets of earning more income by possessing more shares. The reason why the assessee sold the shares was that it was not able to get 100% control by purchasing all the remaining shares. Thus, from the nature of the transaction, it becomes apparent that the expenditure which was incurred by the assessee was to for the purpose of earning income, but for the purpose of getting full control over SOML. Thus, applying the test as laid down in Kasturbhai Lalbhai's case (1968) 70 ITR 267 (Guj) and Smt Virmati Ramkrishna's case (1981) 131 ITR 659 (Guj) to the facts of this case, it becomes clear that the dominant purpose for which expenditure was incurred was not to earn income. At the highest, it was a mixed purpose. For the reason, it will have to be held that the expenditure incurred in that behalf fell outside the purview of Section 57(iii) of the Act.
24.16. Interest earned on short term deposits is an income in view of decision in the case of Tuticorin Alkalies Chemicals & Fertilizers Ltd. [supra] and is chargeable to tax Under Section 56 of the Act as income from other sources and as such the said amount of interest cannot be reduced from the cost of construction on the strength of the decision in the case of Bokaro Steel Ltd, [supra] as this case itself had made a distinction between interest receipts and other receipts. In the case of Bokaro Steel Ltd. the assessee was incorporated in January, 1964 with an object to construct and own an integral iron and steel work. During the assessment year 1965-66 to 1971-72, the work of construction of the company and installation of the plant was in the process of completion. The company had not started any business during the assessment years in question. Further, during the period the company had given to the contractors, quarters for the residence for the staff and workers employed by the contractors who had been engaged by the assessee for carrying out the work of construction and the assessee charged the contractors for the use of quarters so given. Secondly, during the assessment year in question, the assessee had entered into supplementary agreement, under which the assessee had made certain advances to the contractors to enable them to execute the large scale construction work smoothly. The assessee company had charged interest and this interest was later adjusted against the dues of the contractors. Thirdly, for the purpose of construction of work, the assessee had given on hire certain plant and machinery to the contractors and earned income in the form of hire charges. Fourthly, the assessee company allowed the contractors to use stones lying on the assessee's land for construction work, which was capital assets of the assessee company. The assessee charged the contractor certain amount by way of royalty for excavation and use of these stones for construction work. Fifthly, the assessee had during the assessment year 1971-72 shown in its accounts as income from interest a certain sum said to have been accrued to the assessee from H for eight locomotives supplied by the assessee company to H, which entry was subsequently reversed because eight new locomotive were supplied by H to the assessee. The Tribunal found that item No. 1 to 4 received by the assessee had gone to reduce the cost of construction and these were in the nature of capital receipts which could be set off against the capital expenditure. This view was uphold by the High Court and on appeal to the Supreme Court view of the High Court on first-three were uphold by stating (i) rent charged by the assessee to the contractors for housing workers and staff employed by the contractor for the construction work of the assessee including certain amenities granted to the staff by the assessee, (ii) hire charges charged for the plant and machinery which were given to the contractors for use in their construction work of the assessee and (iii) interest from advances made to the contractor by the assessee for the purpose of facilitating construction work and activities of the assessee in connection with all these receipts were directly connected with or incidental to the work of construction of its plant undertaken by the assessee. It further held that with regard to the received by the assess for stone excavated from the land, which had been allowed to the utilized by the contractors for excavating stones to be used for construction of the assessee, and the cost of plant to the extent of such royalty received was reduced for the assessee and therefore the royalty received was a capital receipts. As regards the interest income, it was observed that entry which was made initially, was reversed in the next year because in fact the nature of transaction was changed and the assessee did not receive any real income. With regard to the decision of Tuticorin [supra] the court observed that the assessee company had invested in short term deposit, the surplus fund, which was not immediately required and earned interest. It has been held in this case the receipt of interest amount comes under the head "income from other sources." The assessee has not filed any appeal from the findings, which has gone against it. In any case the question now concluded by the decision of Tuticorin case. This case therefore makes a clear distinction between interest earned on utilization of borrowed money and other misc. income and held that issue of interest earned is covered by decision in the case Tuticorin [supra].
24.17. Assessee gave the following note on claim of deduction Under Section 57(iii) in respect of interest expenditure for earning interest income.
"1. Bai Bhuriben Lallubhai v. CIT - 29 ITR 543 (Bom) In this case the borrowings were made by the assessee for the purpose of meeting household expenses, purchasing jewellery and meeting advance tax payment. The Bombay High Court reversed the decision of the Tribunal and held against the assessee observing that expenditure must be incurred in order to earn income. In the given case, the borrowings were made for not earning any income, however, to make payment for household expenses, purchase of jewellery and payment of advance-tax.
The above case is clearly not applicable and distinguishable on the facts. In the appellant's case admittedly there is nexus between the expenditure incurred and the income earned. Appellant had furnished details of investment with the evident that the same were made from the borrowed money and therefore, the case is not applicable. On the contrary the observation made by Hon'ble C.J. Chhagla at page 547 that:
"..... an order to decide whether a deduction is permissible under Sub-section (2), we have to examine the nature of the expenditure. The purpose for which the expenditure is incurred must be in order to earn the income. The expenditure may be incurred for any commercial purpose. The connection between the expenditure and the earning of the income may not be direct. However, indirect the connection may be, there must be a connection or a nexus between the expenditure incurred and the income earned."
Thus, it is clearly held that there must be a nexus between the expenditure and income which is proved beyond the doubt and therefore, the ratio laid down support the case of the appellant.
2. Smt. Virmati Ramkrishna v. CIT - 131 ITR 659 (Guj) In this case the assessee has income from dividend and interest on annuity deposit. It had claimed expenditure Under Section 57 (iii) for Rs. 44,397/- being amount of interest on outstanding loan of Rs. 8,53,118/- and Rs. 1,900/- being fees paid to Income-tax Practitioner. The ITO observed that the part of the loan was taken for personal expenses and tax liability and therefore, made disallowance out of claim of interest for Rs. 6,105/-. He also disallowed Rs. 1,900/- on the ground that expenditure of that nature could not be said to have been incurred wholly and exclusively for the purpose of making or earning dividend income and also on the ground that fees for income-tax practitioner for earlier years could not be said to be expenditure of the year. The Gujarat High Court laid down various propositions and applying the same, decided against the assessee. Appellant invite attention to proposition No. (viii) which reads as under:
"(viii) if, therefore, it is found on application of the principles of ordinary commercial trading that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction;"
In the appellant's case, there is direct nexus between the expenditure incurred and income earned. Complete details showing nexus between borrowings and investment has been furnished for assessment years 1989-90 and 2000-01.
It may be noted that in the case cited, the partial disallowance (Rs. 6105 out of Rs. 44,397) was made for interest on the ground that the loan was borrowed to meet personal expenses and tax liability. In the present case, there is no dispute that borrowed funds are used to earn income. Therefore, the facts are distinguishable. On the contrary proposition laid down by Hon'able court supports the case of the appellant.
3. CIT v. Seshasayee Paper and Boards Limited 156 ITR 542 (Madras) In this case assessing officer has disallowed the interest earned on investment of share capital in the call money deposits. While interest earned on investments of borrowed funds were not disallowed at all by the Income Tax Officer himself and therefore, the same is not the same is not the issue before the High Court. Relevant extract from the judgment (Pg. 544) is reproduced hereunder:
"The income tax officer held that the interest earned by the assessee on investment of borrowed money on call deposits was not liable to tax as the interest received was less than the interest paid. However, he took the view that as regards interest earned on call deposits of share capital, the same was liable to tax under the head "Other Sources"."
The following question was raised before the High Court:
"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law in holding that the interest earned by the assessee on investment of share capital in call deposits could not be assessed separately under the head 'Other Sources' for the assessment year 1962-63?"
On the above question Honourable High Court held that interest earned by the assessee on investment of share capital in Call Deposits could be assessed under the head "Other Sources". Thus the Tribunal judgment in so far it related to the interest received on investment of borrowed funds was accepted by the department and was not subject matter of dispute before the High Court.
In the case of Tutikorin Alkalies 227 ITR 172 Hon'able Supreme Court approved the above decision of the Madras H.C. It must please be appreciated that the only issue raised for consideration was in respect of set off of interest on borrowings against the interest earned on investments of share capital which is non interest bearing fund. To the extent of nexus of investments of borrowed funds for earning income, the officer himself allowed the claim.
Further, it is clearly stated in the case of Tutikorin Alkalies (Supra) that it is not the case of appellant company that the expenditure is allowable Under Section 57(iii) of the I.T. Act. In the present case admittedly investment is made from the borrowed funds only and direct nexus is also established between the borrowings and the investments and the specific claim is made as regards allowance of deduction of interest expenditure Under Section 57(iii) of the I.T. Act. Therefore, in the fats of the appellant's case the above decision supports the contention and in any event issue raised is not at all relevant.
4. Smt. Padmavati Jaykrishna v. CIT 101 ITR 153 (Guj) Approved by Supreme Court reported in 166 ITR 716 (SC) In this case the assessee derived income from source in form of interest and dividend and claimed deduction of interest of Rs. 26,986/- on interest on loan of Rs. 5,05,055/-. The Income-tax Officer rejected the claim only in respect of interest on withdrawals on the ground the same cannot be said to be expenditure for earning of income. Gujarat High Court upheld the order of the A.O. The relevant observation reads as under:
"Held, that it could not be said that the result of the borrowing was saving of dividend income from shares because by borrowing loans the assessee had saved her income not only from one source, namely, the shareholding but from all other sources as well from which she must be receiving income. Saving of income from shares was an incidental result of borrowing loans and that incident did not supply any evidence of "purpose".Even if it were conceded that the assessee was required to take loans with a view to save her investment in shares it could not be said that the interest in question was expenditure incurred "wholly and exclusively" for the purpose of earning income from investments. The immediate purpose of taking the loan on interest was to pay taxes, etc. It could be that the other purpose was to save one of her sources of income but this would show that the purpose was a dual one and would not be covered by Section 57 (iii). At the relevant time it was obligatory to make annuity deposit and the earning of interest through such deposit was merely incidental. The interest on the borrowed amount was, therefore, not deductible under Section 57(iii)."
The facts are totally distinguishable as it is not the case that the expenditure in form of interest is made not to earn any income.
Further, in the said case on page 163 Hon'ble Court referred to Supreme Court decision in the case of CIT v. Malayalam Plantations Ltd., wherein Court has held against the assessee that expenditure cannot be allowed to be deducted Under Section 57 (iii) so long as nexus between the expenditure and the income sought to be taxed is not established. In the present case, there is complete nexus between the borrowings and the investment and therefore, the ratio laid down by the Supreme Court in the case of Malayalam Plantation Ltd. (Supra) support the case of the assessee.
Appellant also refer to observation made by Hon'ble Supreme Court in the case of Tutikorin Alkalies Chemicals v. CIT reported in 227 ITR 172 wherein Hon'ble Court observed that "it is not the case of the assessee that interest payable by it on term loan as allowable as deduction Under Section 57 of the Act". Thus, the court has not examined applicability of Section 57(iii), which is not the case in the present case. The appellant has specifically made a claim of expenditure in form of interest and other expenditure Under Section 57(iii) and the claim ought to have been allowed particularly when the nexus between borrowings and investment has been established.
5. Sarabhai Sons. Private Limited v. CIT (201 ITR 464) (Guj) The facts of case are totally different. In this case the basic objective of investment was to acquire 100% control over the company while in the given case there is no such issue of acquiring control and therefore, the facts are totally distinguishable and hence the judgment cannot be applied to the appellant's case.
There are decisions of the Court wherein view is taken that such interest expenditure cannot be allowed to be set off against the interest income. Attention is invited to following judgments:
1. Commissioner of Income Tax (Central) Calcutta v. New Central Jute Mills Co. Limited (118 ITR 1005) (Cal.)
2. Addl. CIT v. Madras Fertilisers Limited (122 ITR 139) (Mad) However, appellant submits that as explained above, Gujarat High Court has laid down various propositions in the case of Virmati Ramkrishna v. CIT 131 ITR 659 and as stated in proposition No. (viii) that on application of the principles of ordinary commercial trading, if it is found that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction, which proposition is fulfilled. This being the jurisdictional High Court decision and therefore, is binding in the State of Gujarat. Applying the same in the fact that there is direct nexus between the borrowings and investments made, the interest expenditure should be allowed as deduction Under Section 57(iii) of the I.T. Act."
24.18 It is true that in case of Bai Bhuriben Lallabhai (supra) the borrowings for meeting household expenses, jewellery and meeting the advance tax liabilities was not allowed as deduction Under Section 12(2) by Bombay High Court because of absence of nexus between the purpose of expenditure & earning of income, which it may even be indirect. In Virmati Ramkrishnan (supra) interest relatable to payment of personal expenses and tax liability was the issue and the Court held that it is not allowable in absence of nexus of expenditure and earning of income. These cases were not of interest having nexus. In the case of Sheshareyaee the interest earned on deposit of call money was not assessed by the AO because the payment of interest on receipt of call money was more and the question was stated to be for set off for other interest against interest on share capital. It was a case of set off of interest paid by the assessee and the interest earned which was denied. The Supreme Court however held it be wrong reading of the judgment by stating. In our view, it will not be right to read the judgment in Seshasayee Paper and Board Ltd.'s case (1985) 156 ITR 542 (Mad) in that way. The Court's finding in Seshasayee Paper and Board Ltd.'s case (1985) 156 ITR 543 (Mad) was that the interest earned by the assessee from the bank deposits had to be assessed under the head "Other sources". Consequently, the interest paid on the borrowings for the purpose of purchase of plant and machinery could not be allowed or adjusted against this income under Section 57(iii) nor were such adjustments permissible under Section 70 or 71 of the Act because the business of the assessee had not commenced. The Madras High Court (see (1985) 156 ITR 542) categorically held:
"In this case, admittedly, the borrowing has not been made exclusively and solely for the purpose of earning interest in which case alone it should be taken as an income which should be deducted from the interest receipts"
An assessee company may have raised its capital by issue of shares or debentures or by borrowing. But when that capital or a portion of it was utilized for whatever reason, even for a short period, to earn interest, that interest must be treated as revenue recept and will have to be taxed accordingly. Any set off or deduction of any expenditure can only be made in accordance with the provisions of the Act."
24.19 In the case of Padmavati's case, however, one of the purpose for borrowing was to invest in Annuity Deposit giving earning by way of interest to the assessee and having direct nexus thereto, but even then disallowance was made by observing that borrowings were for discharging personal obligation to make Annuity Deposit and not to earn interest. There was a clear nexus between borrowing and interest but not interest paid and earning of income which was held to be incidental. The Supreme Court approved this view. Similarly in the case of Sarabhai there was a nexus in borrowing and investment in purchase of shares but the interest was disallowed because the purpose to acquire shares was not to each dividend but acquisition of control over the company. We find that New Central Jute Mills Co. Limited (Cal.) and Madras Fertilisers Limited (Madras) are direct decisions where borrowings for the construction of the factory or plant and machinery were used for making deposit and the interest paid on such borrowings was disallowed because the interest was paid on borrowings made for construction of factory and erection of plant.
24.20 Analysing the statutory language and principles laid down in the decided cases referred to above, the following propositions clearly emerge which should be considered for allowing interest Under Section 57 of the Act:
(i) the expenditure must not be in the nature of capital expenditure or personal expenses of the assessee;
(ii) the expenditure must have been laid out or expended wholly and exclusively for the purpose of making or earning "income from other sources";
(iii) the purpose of making or earning such income must be the sold purpose for which the expenditure must have been incurred, namely, the expenditure should not have been incurred for such purpose as also for another purpose, or for a mixed purpose;
(iv) the distinction between purpose and motive must always be borne in mind and what is relevant is the manifest and immediate purpose and not the motive or personal consideration weighing in the mind of the assessee in incurring the expenditure;
(v) the connection between the expenditure and the earning of income need not be direct and it may be indirect. But, the expenditure that must have been incurred for the purpose of earning that income, should have some nexus between the expenditure and the earning of the income. If there is not even some sort of evidence to show that the expenses incurred by the assessee were to facilitate the earning of or at least for protecting the income it cannot be an allowable deduction.
(vi) The interest accrues suit generic. The interest is payable by the bank whether it is claimed or not and whether there is any establishment or not. Normally, there is no necessity for spending anything separately for earning the interest. However, if any expenditure was incurred like commission for collection or such similar expenditures which may be considered as spent solely for the purpose of earning that income, the position may be different.
(vii) The requirement under Section 57(iii) that the expenditure should have been incurred "for the purpose of making or earning such income" shows that the object of spending or the end or aim or the intention of such spending was for earning the interest income.
(ix) it would not, however, suffice to establish merely that the expenditure was incurred in order indirectly to facilitate the carrying on the activity which is the source of the income; the nexus must necessarily be between the expenditure incurred and the income earned;
(x) it is not necessary to show that the expenditure was a profitable one or that in fact income was earned;
24.21 In view of the above and applying these tests, in our opinion, the expenditure of interest paid on borrowings raised by the assessee for the purpose of construction of the dam would not be allowable deduction while computing the income from interest under the head "other sources".
25. The ground regarding claim under Section 10(20)/(20A) claiming local authority is not valid. The assessee is not a local authority, and therefore, it cannot be granted exemption.
26. The reopening though for escapement of interest from contracts not assessed ultimately, cannot be said to be bad in law because the assessee had not filed return at all. In the case of L.N. Dalmia, the assessee borrowed money for acquiring share in company named Punalur Paper Mills Ltd. [hereinafter referred to as the "PPM"] and had paid interest thereon. The assessee floated another company named Laxminiwas and Co. (Export) P. Ltd. [hereinafter referred to as the "LNE"] and sold aforesaid shares of PPM to this newly floated company, till then it was not incorporated,but the transaction was ratified on its incorporation. The AO also held that the LNE was dummy of the assessee and the transactions of the sale of shares was unreal and sham and disallowed the loss on transfer of these shares. The AO held that that loss on account of sale of shares cannot be allowed as the acquisition of shares by the assessee was on capital account. As regards interest paid he held that interest can also not be allowed as deduction under the head "Income from other sources" because no income from the other sources had accrued. He further held that interest can be added to the cost of the said shares. The Tribunal and Appellate Asstt. Commissioner uphold the findings of the AO and on reference to the High Court it is held that the assessee was holding the shares as his investment portfolio for controlling interest and therefore it could not be but a capital loss, which formed a cushion against the future gain and capable of set off against the capital gain. It further observed that the though the paper loss, it had far-reaching effect on the tax liability. As regard interest, the Court observed that it is well settled that an allowance for deduction can be upheld on the ground other than that on which it was allowed by the Tribunal. The sum on account of interest was he allowable as deduction under the head "other sources", relying upon the observations stated in the decision, as appeared at page No. 103 of the ITR 207, which is as under:
"The last issue that arose in the case is whether the interest paid on the borrowed money for acquisition of the said shares could be added to its cost of acquisition for computation of capital loss. On this issue, the appellate authorities answered it in the affirmative. The interest was paid allegedly on the moneys borrowed for the acquisition of the shareholding by the assessee. The interest was not claimed as capital investment and no claim was made for the capitalization of the same. The Assessing held that the assessee did not earn anything from the shares purchased out of the borrowed amount. As there was no income from the shares held by him, the interest could not be allowed. The appellate authorities held that this interest was incurred in respect of borrowed funds utilized for the purpose of acquisition of shares and such interest would be considered as a capital investment and directed accordingly to capitalize the same and after the sale, the capitalization would increase the amount of loss to that extent. The Tribunal affirmed this decision. In coming to this decision, reliance has been placed in the case of CIT v. Mithlesh Kumari (1973) 92 ITR 9 (Delhi), holding that interest paid on borrowed capital is to be allowed as capital expenditure. In this case, the Delhi High Court considered the interest as part of the capital investment where the facts were that the interest was paid on money borrowed for purchase of and open plot of land which constituted part of the actual cost. The facts before us are different from the facts in the case cited. There the plot of land was for a building purpose and it was not intended for using as income-earning investment while the investment in shares in the case before us are investments made with a view to earning dividend. In the Delhi High Court case in CIT v. Mithlesh Kumari [1973] 92 ITR 9, the interest paid on borrowed amount for the acquisition of such plot of land, therefore, constituted part of the cost of acquisition. The investment in shares is quite different from that and we do not actually known how the interest paid for the borrowed amount has been claimed and treated in earlier years. Moreover, it has been submitted on behalf of the assessee that the assessee is entitled to submit before this court that the said deduction should be allowed under the head "Other sources" though against the decision of the Tribunal that such interest was to be capitalized being part of cost of acquisition of shares has not been appealed against. It is well settled that an allowance for deduction can be upheld on a ground other than that on which it was allowed by the Tribunal. We, accordingly, hold that the interest in question in the present case cannot be part of the cost of production. It is allowable against the income from the investment in question and it can be considered to be set off against the income from other sources. In the circumstances, this issue is answered saying that the said sum on account of interest is allowable as deduction under the head "Other sources".
26.1. In the case of Lakhmani Mewal Das, original assessment was made on the assessee after allowing deduction of a sum of Rs. 10,494 towards interest to certain creditors and thereafter a notice under Section 148 of the Act was issued to reopening of the assessment. In his reply to the Commissioner for re-opening of the assessment under Section 147(a) two reasons were mentioned viz. (i) M.K., who was shown to be one of the creditors of the respondent had since confessed that he was doing only name-lending and (ii) N.M., D.K.N., B.S. and others whose names too were mentioned in the list of the creditors of the assessee were known name-lenders. High Court held that pre-conditions for the exercise of jurisdiction under Section 147 were not fulfilled. The decision of the High court was uphold by the Supreme Court by observing that there was nothing to show that the confession of M.K. related to a loan to the assessee, much less to the loan which was shown to have been advanced by that persons to the assessee, in the first ground the live link or close nexus which should be there between the material before the ITO and the belief which was to form was missing or in any event too tenuous to provide legally sound basis for reopening the assessment. As regard second reason, it was observed that it could not have led to the formation of the belief that the income of the assessee had escaped assessment because of his failure or omission to disclose fully and truly all the material facts. In the present case, it is true that assessment was re-opened by incorporating the reasons that interest claimed by the assessee was not allowable deduction, but the facts remains that the assessee has not filed return of income and it was found that it had assessable income and therefore the challenge to the proceedings under Section 147 can not have any substance.
26.2. In the case of Simon Carves Ltd. [supra] the course observed that an order made by the AO at the time of the original assessment was a legally correct order and was not vitiated by any error and the absence of any error does not justify the inference that this was not a case of income escaping assessment. That there is necessarily an element of error in case of income escaping assessment mentioned in Section 147(b) of the Act of 1961, such error resulting in income escaping assessment becomes manifest in the light of information coming subsequently into the possession of the Income-tax Officer, where as in the present case, the order making the original assessment was a legally correct and was not vitiated by any error, the case would not be within the mischief of Section 147(b) of the Act. Their Lordships observed that the ITO ordering reassessment does not sit as a court of appeal over the ITO making the original assessment. Nor it is open to the ITO ordering reassessment to substitute his own opinion regarding the method of computing the income for that of the ITO who made the original assessment, especially when the method of computation adopted at the time of original assessment was permissible in law and the facts is that the adoption of a different method of computation would have resulted in higher yield of tax would not in such a case justify the reopening of the assessment. This is case where there were two different methods available to the AO and both were permissible in law and one of which was adopted by the AO in completing the assessment. In that context the Supreme Court held that it was not permissible for subsequent officer to say that first assessment was wrong because at the time when it was made, it was made within the permissible method available to the assessee. There is no such situation prevailing in this case and therefore, this decision is no help to the assessee.
26.3. In the case of Jindal Vijaynagar Steel Ltd. [supra], the main object of the assessee company was to set up iron and steel making facilities and continuous casting and hot and cold rolling mill plants for producing all kinds of metals both ferrous and non-ferrous including steel etc. The assessee earned an income of Rs. 11.07 crores from its incidental activities of lending, investment etc. The assessee earned an income of Rs. 11.07 crores from its incidental activities of lending, investment etc. The assessee having not commenced its production in steel, the AO treated the entire income as income from other sources and also declined to allow expenditure incurred thereon. The matter came to the Tribunal and the Tribunal held that when the assessee was authorized to carry on several business, it is sufficient to hold that it has commenced its business; that the assessee company had engaged itself in systematic and continuous activity of lending, granting loans and advances, bills discounting purchase and sale of securities etc. all have turnover of several hundred cores, which could not be said to be incidental activity only or an activity not carried out as business of company and therefore the income earned from the aforesaid activities was to be computed under the head "profit and gain of the business". No such case has been made out in the case of the assessee. It was observed that there was only averment of the intention of the assessee to carry this activity as business activity. Adverting to the allowability of the expenditure, the treatment given by the assessee in its books of account or the entry passed or the manner in which it was debited were all irrelevant in deciding the question of allowability of the expenditure. The expenses incurred in corporate treasury were found to have direct nexus with the activity of the assessee, whereas, the expenditure incurred in steel plant at Bellary and registered office at Bangalore were required to be capitalized as the same was incurred towards the project under implementation. This decision in a way goes against the assessee, in so far as the contention of carrying on the business of the project under implementation is concerned. There also the assessee's project of construction of dam was under consideration and therefore there is no other business which was started by the assessee, which could lay foundation stone of the assessee having commenced its business or any activity thereof.
27. In appeal for AY 1998-99 the claim regarding non inclusion Under Section 10(33) on dividend income from UTI is not pressed. It is accordingly dismissed.
28. In appeal for AY 1999-2000 interest on excess refund Under Section 234D is claimed to be chargeable the refund was granted to the assessee on 13-2-02 whereas Section 234D was inserted w.e.f. 1-6-2003. It is not the date on which the refund was originally granted. What we have to see is date when the excess grant of refund was found/determined. That was on 29-9-03 and this is the date happened to be after the date 1-6-03 with effect from which Section 234D was given effect to and when it had already come on the statute book. The claim of the assessee has therefore no force and is accordingly rejected.
29. In the result Revenue's appeal is allowed and all the appeals filed by the assessee are dismissed.