Income Tax Appellate Tribunal - Mumbai
Reliance Energy Ltd. (Formerly Known As ... vs The D.C.I.T., Special Range 30 on 21 December, 2005
Equivalent citations: [2006]103ITD223(MUM), [2007]290ITR344(MUM), (2007)106TTJ(MUM)367
ORDER
K.K. Boliya, Accountant Member
1. These two appeals, pertaining to the same assessee are disposed of, for the sake of convenience, by this common order as under:
Appeal No. 1314:
2. This appeal arises from the order dated 27.12.93 of CIT(A)-XII, Mumbai. The grounds No. 1 to 5 pertain to the same issue i.e., confirmation by the ld. CIT(A) of disallowance of Rs. 16,61,03,713/- being the amount appropriated by the assessee company towards the Reserve for the new power generation project at Dahanu. The ld. counsel, Shri P.J. Pardiwala, appearing for the assessee was fair enough to point out that this issue arose during the immediately preceding AY 90-91 and was decided against the assessee vide ITAT's order dated 20.10.97 in ITA No. 7839/Bom/93 (copy at pages 21 to 32 of the Paper Book). The ld. counsel, however, contended that in respect of the AY 90-91, the assessee mainly relied on the Bombay High Court decision in the case of Somaiya Orgeno Chemicals Ltd. (SOCL) v. CIT 216 ITR 291, before the Tribunal, and the Tribunal has also referred to this judgment in their order. It is submitted that while arriving at their conclusion, the Tribunal failed to consider the Jurisdictional High Court judgment. The Tribunal, in fact, drew support from certain Supreme Court decisions on this issue. The ld. counsel further submitted that the view adopted by the Bombay High Court in the case of SOCL has been confirmed by the Supreme Court in the case of CIT v. New Horizon Sugar Mills Pvt. Ltd. (NHSMPL) 269ITR 397. It is pointed out that on similar issue, the decision of the Madras High Court in the case of CIT v. New Horizon Sugar Mills Pvt. Ltd. 244 ITR 738 has been affirmed by the Supreme Court in the above case. The ld. counsel argued that, since the Supreme Court has endorsed the view adopted by the Bombay High Court, this issue requires reconsideration by the Tribunal.
3. Shri R.K. Rai, ld. CIT DR, opposed the arguments raised by the ld. counsel for the assessee and submitted that the Bombay High Court decision in the case of Somaiya Orgeno Chemicals Ltd. is not applicable to the peculiar facts of the assessee's case and therefore the Supreme Court decision in the case of New Horizon Sugar Mills Pvt. Ltd. does not make any difference. Accordingly, the CIT DR contended that the issue is squarely covered by the Tribunal's order for the AY 90-91 and therefore the same view must be followed in the present assessment year.
4. We have given our careful consideration to the rival submissions and have gone through the Tribunal's order for the AY 90-91 as also the cases relied upon by the ld. counsel for the assessee. First of all, the relevant facts may be recapitulated briefly. The assessee company is engaged in the business of distribution of electricity in the suburbs of Mumbai under a license from the Government of Maharashtra since the year 1926. The aforesaid license was renewed by the Government in the year 1986, with the condition that the assessee company shall set up its own facility for generation of electricity of 500 MW in the state of Maharashtra. It was the responsibility of the assessee company to raise the requisite resources for the above purpose. If this condition was not fulfilled, the license granted to the assessee company for distribution of electricity was liable to be cancelled. As a result of this direction from the Government of Maharashtra, the assessee company decided to set up power generation project at Dahanu, Maharashtra. Vide letter dated 28.7.89, the assessee company requested the Government of Maharashtra to allow it to appropriate a sum of Rs. 100 crores for financing the part of the cost of the proposed power generation project. The Government of Maharashtra sympathetically considered this request and the Secretary (Energy), Government of Maharashtra communicated to the assessee company the approval of the Government of Maharashtra for appropriation of a sum of Rs. 100 crores. A copy of this communication is at pages 13 and 14 of the Paper Book and the Paras 2 and 3 of this communication merit reproduction below:
Government considered your proposal and has decided to permit special appropriation under Para XVII(2)(c)(vi) of the Sixth Schedule to the Electricity (Supply) Act, 1948 to BSES Ltd. at the rate of 3 paise per unit (ppu) until such time BSES Ltd. collects Rs. 100 crores for its project of 500 MW Power Station at Dahanu in Thane District subject to the following condition:
That the BSES Ltd. will collect 3 ppu from its consumers only.
Permission for special appropriation to BSES Ltd. should also be subject to the following conditions:
i. BSES Ltd. should take full responsibility for any consequences in the event of such an action being challenged in the Court of Law and also to refund the amount collected if any Court were to pass such an order.
ii. BSES Ltd. should deduct from the capital base the amount so collected. In the event of take over of the undertaking, the amount collected by special appropriation by the BSES Ltd. will be deducted from the amount payable to the BSES Ltd.
5. Pursuant to the abovementioned developments, the assessee company, during the. previous year relevant to the AY 90-91 and also during the previous year relevant to the AY under appeal charged 3 paise per unit of electricity supplied to the consumer and the additional amount thus collected was transferred to the Special Appropriation Account created for financing the new project at Dahanu. The assessee claimed that the aforesaid income was not liable to the charge of income-tax as it was diverted by overriding title to special reserve fund for a special purpose as directed by the Government of Maharashtra. For the AY 90-91, the AO and the CIT(A) rejected the assessee's claim and the matter thus traveled before the Tribunal. Apart from the Bombay High Court decision in the case of SOCL (supra), the assessee also relied on the Bombay High Court decision in the case of Amalgamaged Electric Co. Ltd. (AECL) v. CIT 97 ITR 334. As a matter of fact, the Bombay High Court, in the case of Somaiya Orgeno Chemicals Ltd., has also referred to the earlier decision in the case of Amalgamaged Electric Co. Ltd. We find that while deciding this issue for the AY 91-92, the Tribunal has taken note of the facts and the ratio of the Bombay High Court in the case of Somaiya Orgeno Chemicals Ltd., which is apparent from the following discussion contained at Para 5 of the order:
Shri Dastur further argued that the mere fact that the assessee was the owner of the reserve fund did not mean that the same was its taxable income. In this connection, Shri Dastur placed strong reliance on the decision of the Hon'ble Bombay High Court in the case of SOCL (216 ITR 291) wherein their Lordships after considering the decision of the Bombay High Court in the case of CWT v. Bombay Suburban Electric Supply Ltd. (BSES Ltd.) 105 ITR 384, had held that the title to the fund was not conclusive in deciding whether the amount which was deposited in that fund constitutes a diversion of the amount deposited in that account at source or not. What was necessary was to see whether there was a diversion fat source and whether the assessee had lost domain and control over the amount so diverted. The assessee was under a statutory obligation to set aside Rs. 6 per kilo litre for the storage fund There was, therefore, a clear diversion at source of this amount In any event the assessee had lost domain over this amount of Rs. 6 per kilo litre. In the above case the assessee company became obliged under the statutory provision to set apart Rs. 6 per kilo litre out of its receipts for setting up of a storage tank under statutory order The High Court has held that the above amount was not part of taxable receipts. The fact that the assessee was the owner of the above fund did not make any difference. Relying strongly on the above decision, Shri Dastur has submitted that the lower authorities were not justified in treating the receipts in question as taxable receipts merely by holding that the assessee had ownership of the receipt. It was emphasized that domain over the fund was not with the assessee.
Thereafter, the Tribunal drew support from the following Supreme Court decisions:
i. Associated Power Company Ltd. (APCL) v. CIT 218 ITR 195 ii. Vellore Electric Corporation Ltd. (VECL) v. CIT 227 ITR 557.
The Tribunal felt that the issue before them was squarely covered by the aforesaid two decisions of the Apex Court. In this connection, a reference may be made to Para 6 of the order which is reproduced below:
We have given careful thought to the rival submissions. Their Lordships of Hon'ble Supreme Court in the case of APCL 218 ITR 195 and VECL 227 ITR 557 have examined the nature and character of certain reserves created under the Electricity (Supply) Act, 1948 and held them to be taxable. This was done after through examination of the provisions of Electricity (supply) Act, 1948 inclusive of the Sixth Schedule to the Act. The following extracts and discussion from the above said two decisions would show that those decisions are on all fours to the case on hand and have to be applied to the facts and circumstances of the case.
Thereafter, the Tribunal, at Paras 7 to 13 of the order, has considered the facts and analyzed the ratio of the abovementioned Supreme Court decisions. The Tribunal observed that in the case of APCL (supra), the assessee relied on the Kerala High Court decision in the case of Cochin State Power and Light Corporation 93 ITR 582 and the Bombay High Court decision in the case of AECL 97 ITR 334. The Department had relied on the contrary decision of the Madras High Court in the case of Vellore Electric Supply Corporation (VESC) v. CIT 109 ITR 454. The Tribunal noted that the Madras High Court decision in the case of VECL was approved by the Supreme Court whereas the Bombay High Court decision in the case of AECL was overruled. The Tribunal has extensively quoted from the Supreme Court decision to drive home the point that the facts of the assessee's case were similar to the facts of the cases decided by the Supreme Court. It may be appropriate here to reproduce below the head note of the Supreme Court decision in the case of APCL (supra):
Clause II of the Sixth Schedule to the Electricity (Supply) Act, 1948, requires the electricity company to create certain reserves if its clear profit exceeds a reasonable return. Monies standing to the credit of the contingencies reserve which are set apart to be utilized by the electricity company for the purposes set out in Clause V of the Sixth Schedule are to meet expenses or recoup loss of profits arising out of accidents, strikes or other circumstances which the electricity company could not have prevented; to meet expenses on replacement or renewal of plant or works; and for payment of compensation required by law for which no other provision has been made. These are all expenses which the electricity company has to incur. The reservation is made so that money is always available for meeting these expenses and the supply of electricity is not interrupted. For the same reason, payments out of the contingencies reserve can be made only with the State Government's approval. It is particularly noteworthy that the electricity company can make good from out of the contingencies reserve even a loss of profit arising out of strikes, accidents and other circumstances over which it has no control. There can be no doubt, in the circumstances, that the monies in the contingencies' reserve belong to the electricity company, and are not diverted away from it. It is the electricity company which has to invest the sums appropriated to the contingencies reserve. The investment would be in its name and it would be the owner thereof. The restriction that the investment can be made only in securities mentioned in the Indian Trusts Act makes no difference to this position. The fact that on the purchase of the undertaking the contingencies reserve has to be handed over to the purchaser and maintained as such is only to make explicit the obvious, for the reserve is for the purpose of the undertaking that is being transferred. There is nothing in the statute to suggest that the amount standing to its credit cannot be taken into consideration in arriving at the purchase price. For the purposes of sale to a State Board or Government, a different statute lays down how the price is to be fixed. The amount credited to the contingencies reserve is not diverted by reason of an overriding obligation or title and, in determining the business profits of the assessee, it must be taken into account.
The Tribunal also took note of the fact that the Madras High Court decision in the case of VESC (supra) was approved by the Supreme Court 227 ITR 557. The Supreme Court, in this case, followed the earlier decision in the case of APCL (supra). The Tribunal felt that the two Supreme Court decisions were squarely applicable to the facts of the assessee's case and therefore it was held that the income appropriated by the assessee company towards the new power project was chargeable to tax. The finding of the Tribunal may be reproduced below from Para 13 of the order:
The reserve in question is akin to reserve fund referred to and considered by their Lordships in the case of VECL (supra). Thus the funds are part of real profits of the electricity company. The fact that these funds were to be utilized on development of the company like setting up of plant would not affect the nature of the funds. Again, the fact that a reserve is created with the approval of the State Government for a specific purpose of setting up of a plant will not change the character of the receipt. The contingencies reserve and development reserve were also meant to be utilized under the statutory provision. The reason given by their Lordships for holding two reserves could be part of taxable income or equally applicable to the fund in question. There is no distinguishing feature to hold them as not taxable. In the light of the above discussion, we hold that Rs. 56,25,100/- appropriated towards the power project reserve is not deductible and is liable to be charged to tax.
From the discussions given above, it is abundantly clear that the issue is fully covered by the ITAT's order in assessee's own case for the AY 90-91 and the only question which requires consideration is as to whether the Supreme Court decision in the case of NHSMPL does in any way dilute the effect of the Tribunal's order. First of all, a reference may be made to the facts of the Bombay High Court decision in the case of SOCL (supra). In that case, the assessee carried on the business of manufacturing Rectified Spirit out of Molasses. The assessee transferred a sum of Rs. 43,633/- from the sale proceeds of Rectified Spirit to the Storage Fund for Molasses and Alcohol Account as required under the Ethyl Alcohol (Price Control) Amendment Order for the creation of Storage Facilities for Molasses and Alcohol. It was held by the Bombay High Court that this amount over which the assessee had lost its domain could not be considered as part of its real income or profit. In other words, the Bombay High Court was of the view that this was a case of diversion of income at source. It appears that similar view was taken in similar factual scenario by the Madras High Court in the case of CIT v. NHSMPL 244 ITR 738 and this decision was affirmed by the Supreme Court 269 ITR 397. The appeal filed by the Revenue was dismissed by the Supreme Court with the following short observation:
The civil appeals are dismissed in view of the order dated August 28, 2001 in the case of CIT v. Ambur Co-op. Sugar Mills Ltd. (C.A. No. 2499 of 1998) (2004) 269 ITR 398 (SC) (Appendix).
The order of the Supreme Court in the case of Ambur Co-op. Sugar Mills Ltd. (ACSML), forming part of the Appendix may also be reproduced below:
The civil appeals and special leave petition are not pressed by Mr. M.L. Verma, ld. counsel for the Revenue, for the reason that the special leave petition against the judgment followed by the High Court in the order under appeal was dismissed as also special leave petitions against the judgments of various High Courts taking a similar view. The civil appeals and special leave petition are dismissed.
Firstly, it may be mentioned that the facts which arose before the Bombay High Court in the case of SOCL as also the facts in the case of NHSMPL (supra) before the Madras High Court are materially different from the facts of the assessee's case. Further, it is notable that the case of Ambur Co-op. Sugar Mills Ltd. was decided by the Supreme Court on concession. It is also notable that the 1 Supreme Court decision in the case of APCL(supra) and VECL (supra) were never cited before the Supreme Court in the case of NHSMPL and therefore the Supreme Court had no occasion to consider the abovementioned two cases which have been held to be squarely applicable to the facts of the assessee's case by the Tribunal in assessee's own case for the immediately preceding AY. It is also notable that it was the assessee company who approached the Government of Maharashtra to permit it to appropriate the sum of Rs. 100 crores for the purpose of partly financing the power project at Dahanu. The Government of Maharashtra permitted the assessee company to levy additional charges on the consumer of 3 paise per unit of electricity for this purpose. The proposal, thus, originated from the assessee and the assessee was not directed under any law by the Government of Maharashtra to transfer a part of the income so as to create any overriding title. Considering the entire facts and circumstances as mentioned above, we are in respectful agreement with the view adopted by the Tribunal for the AY 90-91. Accordingly, on this issue, the order of the ld. CIT(A) is confirmed.
6. The grounds No. 6 to 8 pertain to only one issue i.e., confirmation by the ld. CIT(A) of disallowance of Rs. 4,28,53,308/- being the amount appropriated by the assessee company towards development reserve account. The ld. counsel appearing for the assessee was fair enough to concede that this issue is covered against the assessee by the Tribunal's order for the AY 90-91 referred to (supra). Accordingly, on this issue, the order of the ld. CIT(A) is confirmed.
7. The grounds No. 9 and 10 pertain to confirmation by the ld. CIT(A) of disallowance of Rs. 73,73,805/- being the amount appropriated by the assessee company towards debenture redemption fund. We have heard both the sides on this issue and have gone through the facts. In our view, the order of the ld. CIT(A) on this issue does not call for any interference. The debentures issued by the assessee are in the character of advance or loan taken by the assessee company for business purposes and income is transferred to reserve fund so as to enable the assessee to redeem such debentures. By no stretch of imagination can it be said that such income which is transferred to such reserve account is not chargeable to income tax. The reserve has been created by the assessee for repayment of loan. We, therefore, confirm the order of the ld. CIT(A) on this issue.
8. The grounds No. 11 to 14 pertain to confirmation by the ld. CIT(A) of disallowance of interest of Rs. 23,31,473/- paid by the assessee on borrowed funds used for the new power generation project at Dahanu. In respect of these grounds, the authorized representative of the assessee have filed a letter dated 21.11.2001, stating that the assessee made a claim for deduction of net interest after deducting the interest received of Rs. 8,99,216/- from the gross interest paid of Rs. 32,30,681/-. It is further stated that subsequently the AO passed an order Under Section 143 read with Section 263 bringing to the charge of tax the aforesaid amount of interest earned by the assessee. Therefore, it is submitted that interest deductible Under Section 36(1)(iii) would be gross interest of Rs. 32,30,681/-. Accordingly, the original grounds of appeal on this issue are sought to be revised and substituted by the following grounds:
That the entire interest amounting to Rs. 32,30,681/- being the interest paid by the assessee on monies borrowed for its generation project at Dahanu be allowed as a deduction Section 36(1)(iii) of the Act instead of the net interest amounting to Rs. 23,31,473/- as claimed by the assessee.
That inasmuch as the assessee having paid interest amounting to Rs. 32,30,681/- on its borrowing for the Dahanu project and having received interest income of Rs. 8,99,216/- on investment of surplus funds not immediately required for the Dahanu project, it had claimed the net interest liability of Rs. 23,31,473/- in its return of income as a deduction Under Section 36(1)(iii). However, in view of the fact that the DCIT, Special Range 30, Mumbai, vide his order Under Section 143(3), 133(3) read with Section 263 dated 31.12.96 had brought to tax the said sum of Rs. 8,99,216/- as income from other sources, the entire interest paid by the assessee amounting to Rs. 32,30,681/- ought to be allowed as a deduction Under Section 36(1)(iii) of the Act.
At the time of hearing, the ld. counsel appearing for the assessee submitted that the revised grounds on this issue should be admitted and decided on merits. The ld. CIT DR opposed this submission and contended that such revised grounds did not arise from the orders of the Revenue authorities. The assessee had claimed deduction of interest of only Rs. 23,31,473/-, being the net interest paid and therefore now the claim that deduction should be allowed at Rs. 32,30,681/- cannot be accepted.
9. After considering the rival submissions on the technicality of admitting the revised grounds of appeal, in our view, these revised grounds directly flow from the original grounds of appeal and are inextricably connected with the relevant issue. There is no dispute that the assessee incurred liability for payment of total interest of Rs. 32,30,681/-. A part of the borrowed funds which were not immediately required for investment in the Dahanu project were temporarily parked by the assessee in term deposits and the assessee earned gross interest of Rs. 8,99,216/-. The net interest was claimed by the assessee as deductible Under Section 36(1)(iii) of the Act. This claim was rejected by the Revenue authorities. Thereafter, the Commissioner of Income-tax, while exercising his powers Under Section 263 of the IT Act, set aside the assessment order on the ground that the order was erroneous and prejudicial to the interests of the Revenue as the AO failed to bring to the charge of tax the interest income of Rs. 8,99,216/-. Pursuant to the setting aside, the AO has brought to the charge of tax the aforesaid interest income. Apparently, the assessee claimed deduction for the net interest of Rs. 23,31,473/- after deducting the interest income and therefore if the interest income is separately brought to the charge of tax, whatever treatment is required to be given to the interest payment, it has to be the gross amount of Rs. 32,30,681/-. We, therefore, feel that for the purposes of substantial justice, the revised grounds of appeal must be admitted.
10. Shri Pardiwala, the ld. counsel for the assessee submitted that the Revenue authorities were not justified in holding that the interest paid by the assessee must be capitalized as such expenditure was in connection with setting up of new business which was yet not commenced. It is submitted that the assessee was hitherto engaged in the business of distribution of electricity and as directed by the Government of Maharasthra, the assessee had to set up a power generation project at Dahanu. It is submitted that generation of electricity is closely connected with the business of distribution of electricity and therefore it cannot be said that the assessee set up a new line of business. The ld. counsel submitted that similar question arose before the Tribunal for the AY 90-91 with regard to the expenditure of Rs. 1,72,200/- incurred by the assessee in connection with the electricity generation project at Dahanu. It is contended that the Tribunal recorded a finding that this was not a new business activity. The ld. counsel invited our attention to Paras 14 to 16 of the Tribunal's order, which are reproduced below:
The other issue raised in the grounds of appeal pertains to disallowance of Rs. 1,72,200/-incurred by the assessee in defending certain writ petitions filed against the assessee seeking to prevent the establishment of the generation project at Dahanu. The assessee claimed that the above expenditure was directly relatable to the assessee's business and was incurred to protect the existing business. The ld. CIT(A) while upholding the disallowance held that the assessee was engaged in the business of distribution of electricity and generation/production of power was entirely a different business. He held that the expenditure in question was pre-operative expenditure of the power project and could not be allowed. Accordingly, the disallowance of the expenditure was upheld.
In further appeal before us, Shri Dastur, the ld. counsel for the assessee, has submitted that the legal expenses were incurred to preserve the establishment. The licence to distribute electricity was extended on the condition that power plant to generate electricity would be set up and in case of failure the licence was to be cancelled. In these circumstances, no new business was set up by the assessee as supply and distribution of power was an integrated business. Further, the plant was being set up with the approval of the Government. Shri Dastur relied on the decision of the Bombay High Court in the case of All India Reported Ltd. v. CIT 49 ITR 196 and also on the decision of the Supreme Court in the case of CIT v. Birla Cotton Spinning & Weaving Mills Ltd. 82 ITR 166. Shri Dastur further submitted that setting up of plant cannot be said to be a new business as it had common funds and common management etc. The ld. DR has opposed to these submissions.
After considering the rival submissions, we are of the view that setting up of a plant for generation of power was a condition of the licence and as per that condition the assessee was allowed to distribute the electricity. In other words, setting up of a plant was an integral part of licence to carry on distribution of power. Without licence and without fulfilling the condition imposed thereon, the assessee could not carry on generation of power. Thus, setting up of a plant was necessary for the day-to-day running of assessee's business. The non-setting of plant would have adversely affected the assessee's continuance of business. Thus, the expenditure in question was incurred wholly and exclusively for purposes of the assessee's business and was deductible. Accordingly, we direct that the expenditure should be allowed to the assessee.
It is contended that the issue is squarely covered by the finding of the Tribunal for the immediately preceding AY. The ld. counsel also relied on the Gujarat High Court decision in the case of DCIT v. Core Health Care Ltd. (CHCL) 251 ITR 61. The head note of this judgment containing the ratio and the facts of the case may be reproduced below.
Section 36(1)(iii) of the Income-tax Act, 1961, is absolutely clear. It provides that the amount of interest paid in respect of capital borrowed for the purposes of the business shall be allowed in computing the income referred to in Section 28 of the Act. It is the settled legal position that interest paid/payable has to be in respect of capital borrowed for the purposes of business; the section nowhere stipulates that such borrowing has to be only on revenue account. The only requirement is that the interest must have been incurred for the purpose of capital borrowings made for the purpose of business. There is an inherent indication in the Act that any expenditure which is in the nature of capital expenditure would not be allowable as a deduction while computing the income chargeable under the head 'Profits and gains of business or profession' as laid down in Section 37 of the Act ; but in the same section the portion in parentheses lays down that such expenditure has to be not being expenditure of the nature described in Sections 30 to 36'. Therefore, there is a specific provision dealing with interest paid/payable in respect of the borrowings incurred for the purposes of business and hence the general provision viz. Section 37 of the Act cannot come into play. Therefore, whether the interest is paid for a borrowing which is utilized for acquisition of a capital asset or which is utilized for a revenue purpose loses its distinction. The view that interest which is capitalized, after the commencement of the business but before an asset is first put to use cannot be allowed as a revenue deduction Under Section 36(1)(iii) of the Act is against the plain language of the provisions of the Act. Where the Legislature wanted to restrict allowance/deduction to a particular type of expenditure a specific provision has been incorporated in the Act, as for example, the provisions of Sections 37 and 35D.
The scope of Section 36(1)(iii) and Explanation 8 to Section 43(1) are different. They operate in separate fields and though both are relatable to computing income Section 28 yet the nature of deductions are entirely distinct from each other. The concept and the meaning of 'actual cost' which is the definition laid down in Section 43(1) of the Act is for a limited purpose, viz. at a point of time when deduction is to be granted for the purpose of wear and tear (section 32) or an incentive for the purpose of setting up a specified industry (sections 32A and 33). The term 'actual cost' is applicable only in relation to an asset as against the phrase 'capital borrowed' used in Clause (iii) of Section 36(1) of the Act. The term 'capital borrowed' in the said provision is of a much wider import than the phrase 'actual cost'. Explanation 8 only lays down that where an amount is paid/payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use, shall not be included in the actual cost of such asset. The scope and ambit of this Explanation on a plain reading is restricted to a situation where after the asset is first put to use the interest which is paid/payable would never form a part of the actual cost. The Explanation nowhere provides that interest pertaining to a period prior to an asset being first put to use will not be allowed as a deduction Under Section 36(1)(iii). Explanation 8 was inserted to counteract tax avoidance by way of claiming depreciation, investment allowance, etc., on a larger amount of actual cost. Neither in the notes on clauses nor in the memorandum explaining the provisions in the Finance Bill, 1986, is there any indication that in a converse situation interest has to be capitalized and further that such interest cannot be claimed as deduction Under Section 36(1)(iii). In fact, there is no mention about the deductibility or otherwise Under Section 36(1)(iii). Section 36(1)(iii) does not make any distinction between the borrowing utilized to acquire a capital asset. or otherwise. In fact, the phrase used in the said provision is 'capital borrowed'. Therefore, the distinction about the interest having been capitalized or not loses its significance, inasmuch as if the capital is borrowed for the purposes of business, the interest is allowable as a deductible item of expenditure Under Section 36(1)(iii) while computing the income Section 28 of the Act. There is no other prescription in the provisions.
The assessee company was principally engaged in the business of manufacturing intravenous injections of two types-large volumes parenteral i.e., LVP and sterile water for injection (small volumes parenteral) i.e., SVP. The commercial production had commenced in February, 1988 and the manufacturing capacity had been generally increased from time to time. During the financial year ended on March 13, 1992, the company installed three more machines (in addition to the existing three machines) for the production of LVP and SVP resulting in substantial increase in the capacity of the manufactured products. The assessee claimed deduction of Rs. 1,56,76,000/- being interest paid towards borrowings made for the purpose of acquiring the new machinery. The AO and the CIT(A) rejected the claim. The Tribunal, however, allowed the deduction. On further appeal:
Held, that the Tribunal was justified in allowing as deduction Under Section 36(1)(iii), interest on borrowing made for acquisition of the capital assets, though pertaining to the period prior to the commencement of production.
11. The ld. CIT DR, Shri Rai, strongly supported the orders of the Revenue authorities on this issue and contended that an entirely new line of business was set up by the assessee. The assessee was never engaged in the generation of electricity and it was doing the business of merely distributing of electricity. A new project was set up at Dahanu for generation of electricity, which cannot be said to be expansion or extension of the same business. It is submitted that the Dahanu project was still under construction during the previous year relevant to the AY under appeal and therefore any expenditure which is referable to this project has to be treated as capital expenditure as the business of generation of electricity had not been commenced. The ld. CIT DR relied on the leading Supreme Court decision in the case of Challapalli Sugars Ltd. (CSL) 98 ITR 167 and invited our attention to the ratio of this case, which is reproduced below from the head note:
Interest paid before the commencement of production on amounts borrowed by the assessee for the acquisition and installation of plant and machinery forms part of the actual cost' of the assets to the assessee within the meaning of the expression in Section 10(5) of the Indian Income-tax Act, 1922, and the assessee will be entitled to depreciation allowances and development rebate with reference to such interest also.
As the expression 'actual cost' has not been defined, it should be construed in the sense which no commercial man would misunderstand. For this purpose it would be necessary to ascertain the connotation of the expression in accordance with the normal rules of accountancy prevailing in commerce and industry. The accepted accountancy rule for determining cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalized and added to the cost of the fixed assets created as a result of such expenditure.
Shri Rai also drew support from the Bombay High Court decision in the case of CIT v. Vora Exclusive Tools Pvt. Ltd. (VETPL) 186 ITR 533, wherein also, following the Supreme Court decision in the case of Challapalli Sugars Ltd. (supra), similar view was taken. The ld. CIT DR also relied on the Kerala High Court decision in the case of CIT v. K. Ravindranathan Nair (KRN) 152 ITR 139, wherein, it was held that the expenditure is allowable only if it is in respect of business carried on in the previous year. In this case, the issue involved was whether different ventures of the assessee can be said to constitute a single business. The ld. CIT DR also submitted that the interest income earned by the assessee on short-term deposit is independently chargeable to income tax and for this proposition he relied on the Supreme Court decision in the case of CIT v. Autokost 248 ITR 110. In this case, the Supreme Court followed the earlier decision in the case of Tutikorin Alkalies, Chemicals & Fertilizers 227 ITR 172 and reversed the Kerala High Court decision (229 ITR 789). The ratio of this case, reproduced from the Headnote, is as under:
From the decision of the Kerala High Court (229 ITR 789) holding that where the assessee kept the moneys borrowed from the Industrial Development Bank of India for purchase of plant and machinery in short-term deposits in banks and used it in bill discounting until payment for the plant and machinery, the interest earned on the deposits was not taxable in the hands of the assessee as income from other sources but would go to reduce the actual cost of the plant and machinery, the Department took an appeal to the Supreme Court. The Supreme Court reversed the decision of the High Court holding that the interest was taxable in the hands of the assessee.
12. The ld. counsel for the assessee, in his rejoinder, submitted that the facts in the case of Vora Exclusive Tools Pvt. Ltd. were entirely different. In that case, the question related to the expenditure incurred during pre-production period, whereas in the case of the assessee company, it was already in this line of business. The ld. counsel also brought to our notice that the Kerala High Court decision in the case of K. Ravindranathan Nair (supra) has been reversed by the Supreme Court (247 ITR 178). The ld. counsel further relied on the following Bombay High Court decisions i. CIT v. Kothari Auto Parts Manufacturers Pvt. Ltd. (KAPMPL) 109 ITR 333 ii. Additional CIT v. Anyline Dye Stuffs Pharmaceuticals Pvt. Ltd. 138 ITR 843 The facts and ratio of the case of Kothari Auto Parts Manufacturers Pvt. Ltd. is reproduced below from the head note:
Clause 10 of the memorandum of association of the assessee company registered in January, 1959, permitted the company to buy, sell, import, export, manufacture, manipulate, treat, prepare and deal in merchandise, products, substances, commodities, articles, and the things of all kinds and Clause 26 permitted the company to manufacture and deal in all such stock-in-trade, goods, chattels, etc. The company went into production in 1960. For the period ended on 31.12.59, there was a net deficit of Rs. 30,159 in the purchase and sale of auto parts and this was returned as the loss for the accounting year January 19, 1959 to December 31, 1959. The ITO held that the said loss was not due to the business activities of the company and computed the total income at nil. On appeal, the Appellate Assistant Commissioner upheld the order of the ITO. On further appeal, the Tribunal held that, since the company had commenced business, it was entitled to deduct all expenses which would ordinarily be regarded as on revenue account, even if some of the expenses did not relate to the particular business activity carried on in the accounting year and allowed the claim of the assessee in full, except to the extent of Rs. 3,000 for which full details were not available.
Held, that the Tribunal's approach and conclusion were substantially unexceptionable. The Tribunal had found that business activities had actually commenced in the accounting year and there was no dispute that the interest and the bulk of the other expenses were incurred for the business of buying and selling spare parts. All the business activities of the assessee during the accounting year could be regarded as only relating to the same business. The memorandum of association of the company empowered the company to manufacture the items in which it was permitted to deal in, viz., merchandise, products, substances, commodities, articles, and the things of all kinds, and the business was essentially of the same type, the two activities being two separate stages of the same business. Therefore, the Tribunal was justified in allowing the sum of Rs. 27,159/- as business expenses during the accounting year January 19, 1959 to December 31, 1959.
In the case of Anyline Dye Stuffs Pharmaceuticals Pvt. Ltd., the assessee company was manufacturing dye stuffs and it set up a new industrial undertaking for manufacturing of dyes (intermediates) required for the manufacture of dye stuffs which were hitherto purchased by the assessee in the market. The assessee company purchased land for factory building, which was under construction, and machinery which was under installation during the relevant year. The assessee claimed deduction of Rs. 21,177/- being interest paid on capital borrowed for the new project. The project had not gone into production during the relevant year. The Bombay High Court held that it cannot be said that the assessee's project for manufacture of dyes (intermediates) was a separate and entirely new undertaking unconnected with its existing business. It was, therefore, held that the interest was allowable.
13. We have given a careful consideration to the rival submissions and have also gone through the Tribunal's order for the AY 90-91 First of all, it must be mentioned that almost similar issue arose before the Tribunal for the immediately preceding AY. During that year, the assessee company incurred an expenditure of Rs. 1,72,200/- in connection with the new electricity generation project at Dahanu. The assessee claimed that the expenditure was relatable to the assessee's business. It was held by the Tribunal that the expenditure was an allowable expenditure The claim of the assessee that setting up of the power generation project at Dahanu was an integral part of the existing business of distribution of electricity is also substantiated by the Bombay High Court in the cases of Kothari Auto Parts Manufacturers Pvt. Ltd. and Anyline Dye Stuffs Pharmaceuticals Pvt. Ltd. (supra). The assessee's claim for deduction of interest is also supported by the Gujarat High Court decision in the case of CHCL (supra), wherein the Supreme Court decision in the case of CSL (supra) was duly considered. The cases relied upon by the ld. CIT DR pertain to setting up of entirely new line of business activity and pertain to pre-production expenses. In the present case, the assessee was already engaged in the business of distribution of electricity and on the direction issued by the Government of Maharashtra, the assessee was required to set up power generation project, which was a condition even for carrying on the existing business of the assessee. In these circumstances, we hold that the expenditure on payment of interest is deductible Under Section 36(1)(iii). We accordingly direct the AO to allow deduction in respect of interest payment of Rs. 32,30,681/-. However, the interest income of Rs. 8,99,216/- earned by the assessee on investment of surplus funds in short-term deposits will be clearly chargeable to tax in view of the binding Supreme Court decision in the case of CIT v. Autokost Ltd. (supra).
14. The grounds No. 17 to 19 pertain to the confirmation by the ld CIT(A) of addition of Rs. 8,43,432/- made by the AO on account of the gains on fluctuation of the rate of foreign exchange. The relevant facts are that the assessee company had a wholly owned subsidiary company in Saudi Arabia known as Bombay Suburban Saudi Arabia Ltd. In acquiring the shares of this company, the assessee company invested 6,00,000 Saudi Riyals in January, 1986. The aforesaid subsidiary company went into liquidation in the month of December 1995 and on transfer of the shares held by the assessee company, it received 5,59,319 Saudi Riyals. The assessee company thus suffered a loss of 40,681/- Saudi Riyals (equivalent to Rs. 1,95,509/-). This was claimed as capital loss and was allowed by the AO as such. Subsequently, during the previous year relevant to the AY 91-92, the amount received by the assessee and comprising of 5,59,319 Saudi Riyals was repatriated to India and on account of change in the rate of exchange during the intervening period, the assessee earned a profit of Rs. 8,43,432/-, which was credited to the profit & loss account. At Para 14 of his order, the AO has stated that the sum of Rs. 8,43,432/- was deducted from the computation of total income for separate consideration, but while computing the income under the head 'capital gains', the said amount was not taken into account. The AO, therefore, added the impugned sum to the assessee's total income.
15. When the matter came up before the ld. CIT(A), he was of the view that two separate and distinct transactions had taken place. First transaction was transfer of shares by the subsidiary company for 5,59,319 Saudi Riyals on which the assessee suffered loss equivalent to Rs. 1,95,509/-. Second transaction was repatriation of the said amount to India wherein the assessee earned profit of Rs. 8,43,432/-. The ld. CIT(A) referred to the provisions of Section 43A and confirmed the addition.
16. The ld. counsel appearing for the assessee contended that the sum of Rs. 8,43,432/- has been held by the Revenue authorities to be in the nature of capital gains and therefore the same can be brought to the charge of tax only under that head. It is submitted that for this purpose, Rule 115 of the IT Rules is relevant. Sub-rule (1) of Rule 115 reads as under:
The rate of exchange for the calculation of the value in rupees of any income accruing or arising or deemed to accrue or arise to the assessee in foreign currency or received or deemed to be received by him or on his behalf in foreign currency shall be the telegraphic transfer buying rate of such currency as on the specified date.
The ld. counsel pointed out that the phrase 'specified date' has been defined under Sub-rule (2) and Clause (f) of Sub-rule (2), which is reproduced below, is relevant for the issue under appeal:
(f) In respect of income chargeable under the head 'capital gains', the last day of the month immediately preceding the month in which the capital asset is transferred.
Strongly relying on the aforesaid provisions of Rule 115, the ld. counsel contended that it is mandatory to adopt the exchange rates as prevailing on the last date of the month immediately preceding the month in which the capital asset is transferred. It is argued that on this basis the assessee has not been benefited by any gains. It is submitted that the date of repatriation of the amount to India is not relevant for determining the income chargeable under the head 'capital gains'. The ld. CIT DR supported the orders of the Revenue authorities on this issue.
17. We have given a careful consideration to the arguments raised before us on this issue vis-a-vis the relevant facts. It may be mentioned that the assessee company had relied before the ld. CIT(A) on the Supreme Court decision in the case of Sutlej Cotton Mills Ltd. (SCML) v. CIT 116 ITR 1, wherein the Supreme Court held that if the foreign currency is held as capital, any gain arising on remittance to India would be on capital account. The ld. CIT(A) held that the Supreme Court decision will not apply. Since the decision of the Supreme Court has already been referred to in the order of the ld. CIT(A), it would be appropriate to reproduce below the relevant part of the ratio of this case from the head note:
Where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by him, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.
It has been held by the Supreme Court that ordinarily the profit on conversion of foreign currency into another currency, will be in the nature of trading profits if the foreign currency is held by the assessee on revenue account. However, if the foreign currency is held as capital asset or as fixed capital, such profit would be of capital nature. In the present case, in our view, the profit earned by the assessee on repatriation of the foreign currency has no connection whatsoever with the capital gain, which arose to the assessee on transfer of shares of the subsidiary. We agree with the view of the CIT(A) that repatriation of foreign currency to India is an event which is separate and distinct from the event of transfer of shares of the subsidiary company Rule 115(2)(f) is relevant only for determination of income chargeable under the head capital gains. Under the head capital gains, the loss of Rs. 1,95,509/- has been determined and accepted by the AO. This loss has been presumably determined in accordance with the requirements of the aforesaid Clause (f). With this, process of determination of income or loss under the head 'capital gains' has come to an end. The assessee received sale consideration comprising of 5,59,319 Saudi Riyals. This amount, thereafter, formed part of the assessee's working capital and was retained abroad and was not immediately repatriated. On the date of repatriation, the exchange rate had undergone change in assessee's favour and therefore on repatriation, the assessee earned profit of Rs. 8,43,432/-. In our view, this profit is clearly on revenue account and cannot be said to be a capital receipt. We, therefore, confirm the order of the ld. CIT(A) on this issue.
Appeal No. 4961:
18. This appeal has been filed by the assessee against the order dated 9.3.95 of Commissioner of Income-tax, BC-VI, Bombay, passed Section 263 of the IT Act. The relevant facts pertaining to this appeal have already been briefly stated while deciding similar issue in the assessee's appeal bearing ITA No. 1314. To recapitulate, the assessee incurred an expenditure of Rs. 32,30,681/- on payment of interest on borrowings used for the new electricity generation project at Dahanu. The assessee also received interest of Rs. 8,99,216/- on short-term deposits of surplus fund. The net interest income of Rs. 23,31,473/- was claimed by the assessee as deduction Under Section 36(1)(vii), which was disallowed by the AO. The ld. CIT, on perusal of the record, was of the view that the interest of Rs. 8,99,216/- should have been separately brought to the charge of tax by the AO and therefore on that ground, he issued show-cause notice Under Section 263 to the assessee. After hearing the assessee's representative, the assessment was set aside with appropriate direction to the AO for completing fresh assessment in the light of the CIT's order Under Section 263.
19. The main plank of the arguments of Shri Pardiwala, the ld. counsel for the assessee, is that this issue was duly considered by the AO and was also the subject matter of appeal before the CIT(A). Therefore, the AO's order on this issue merged with the order of the ld. CIT(A) with the result that the ld. CIT has no jurisdiction to invoke his powers Under Section 263 of the Act. Leading us through the chronology of events, it is pointed out that the return of income was filed by the assessee on 31.12.91 and assessment was made by the AO Under Section 143(3) on 21.3.93. The assessee claimed deduction of net interest, which was disallowed by the AO after due consideration. The net interest income was derived after deducting interest income from the gross interest payable by the assessee. This issue was the subject matter of appeal before the ld. CIT(A), who, vide his order dated 27.12.93, confirmed the order of the AO. Thereafter, the ld. CIT(A) has set aside the order Under Section 263 on 9.3.95. It is contended that on this issue, the AO's order fully merged with the order of the ld. CIT(A).
20. The ld. CIT DR submitted that the specific issue regarding bringing to the charge of tax the interest income of Rs. 8,99,216/- was not subject matter of appeal before the CIT(A). Therefore, the CIT has rightly invoked his jurisdiction Under Section 263. The ld. CIT DR also submitted that the AO did not apply his mind to this important issue which rendered his order erroneous and prejudicial to the interests of the Revenue. For this proposition, he relied on the Supreme Court decision in the case of Malabar Industrial Co. Ltd. (MICL) v. CIT 243 ITR 83 and IT AT, Mumbai Bench decision in the case of Bharat Mines & Engineering Co. v. DCIT 229 ITR (AT) 60. The ld. CIT DR also contended that even if the issue is debatable, the CIT can invoke his jurisdiction Under Section 263 and for this proposition, he relied on the Gujarat High Court decision in the case of CIT v. M.M. Khambhatwala 198 ITR 144.
21. We have considered the rival submissions and have gone through the facts. We feel that in view of our finding on the merits of this issue in appeal No. 1314, the present appeal is only of academic interest. We have already held that the gross interest liability is allowable Under Section 36(1)(iii) and the interest income earned by the assessee has to be brought to the charge of tax separately under the head 'income from other sources'. However, since the arguments on merits of the CIT's order have been submitted before us, it would be appropriate to record our finding on the merits of this order. First of all, it may be mentioned that the net interest income of Rs. 23,31,473/- in respect of which deduction was claimed by the assessee has been derived only from the two relevant figures being gross interest income of Rs. 32,30,681/- and interest income of Rs. 8,99,216/-. Thus, when the assessee claimed deduction of the net amount only, effectively, it means that the income of Rs. 8,99,216/- has been brought to the charge of tax. In any case, the AO examined this issue and rejected the assessee's claim. The assessee filed an appeal and the CIT(A) decided the issue against the assessee. In our view, the order of the AO on this issue has fully merged with the order of the ld. CIT(A) and therefore we hold that the Commissioner of Income-tax has no jurisdiction to invoke his powers Under Section 263 of the IT Act. Further, the AO's order cannot be said to be erroneous or prejudicial to the interests of the Revenue, even having regard to the cases relied upon by the ld. CIT DR. In the leading case of Malabar Industries Co. Ltd., the Supreme Court has categorically held that every loss of revenue as a consequence of an order of the AO cannot be treated as prejudicial to the interests of the Revenue. For example, when an ITO adopted one of the courses permissible under law and it has resulted into loss of revenue or where two views are possible and the ITO has taken one view with which the Commissioner does not agree, it cannot be treated as an erroneous order prejudicial to the interests of the Revenue, unless the view taken by the ITO is unsustainable under law. Considering the entire facts and circumstances and in view of the fact that the issue already Stands decided in the other quantum appeal referred to above, the order of the ld. CIT which is under appeal is hereby quashed.
22. In the result, while assessee's appeal in ITA No. 1314 is partly allowed, appeal in ITA No. 4961 is allowed.
Order pronounced on 21.12.2005