HIGH COURT OF PUNJAB AND HARYANA (FULL BENCH)

Commissioner of Income-tax, Ludhiana

v.

Vardhman Polytex Ltd.

Adarsh Kumar Goel, M.M. Kumar and Rajesh Bindal, JJ.

IT Appeal No. 1 of 2003

January 21, 2008

Section 43(1) of the Income-tax Act, 1961 - Actual Cost - Assessment year 1992-93 - Whether it is not right to say that provisions of sections 36 and 43 are to be read in isolation - Held, yes - Whether in terms of Explanation 8 to section 43(1), interest on capital borrowed for acquisition of an asset for period before asset is first put to use is to be added towards its actual cost and for period thereafter it is not permitted to be added towards its actual cost - Held, yes - Whether language of section 43(1), Explanation 8, makes out no distinction in acquisition of an asset when a new business is being set up or when expansion is being carried out - Held yes

Section 36(1)(iii), read with section 43(1), of the Income-tax Act, 1961 - Interest on borrowed capital - Assessment year 1992-93 - Whether interest paid on capital borrowed for purpose of acquisition of an asset can be allowed as revenue expenditure only when such asset is first put to use and starts yielding income and not for any period prior thereto - Held, yes - Whether proviso to section 36(1)(iii) added by the Finance Act, 2003, is merely clarificatory as it has made explicit what was already implicit - Held, yes

Interpretation of statutes : Rule of purposive interpretation.

FACTS

The assessee, which was already engaged in business of yarn, started setting up of a new unit for which it incurred expenditure on interest on loans. It filed its return of income for the assessment year 1992-93 claiming deduction on account of interest under section 36(1)(iii), contending that the new unit had not yet come into commercial production and the same was nothing but expansion of its earlier business under the same management and administration. The Assessing Officer relying upon Explanation 8 to section 43(1) and keeping in view, the admitted facts that the loan was raised for setting up a new unit for creating a capital asset which was yet to come into production held that the interest for the period prior to that could not be allowed as revenue expenditure. On appeal, the Commissioner (Appeals) allowed the assessee’s claim. On appeal, the Tribunal upheld the order of the Commissioner (Appeals).

On account of different views expressed by Punjab and Haryana High Court in CIT v. Oswal Spinning and Weaving Mills Ltd. [1986] 160 ITR 426 and CIT v. Punjab Alkalis and Chemicals Ltd. [2006] 30 Indian Taxation Reports 247, the case was referred to larger bench.

HELD

It is not right to say that provisions of sections 36 and 43 are to be read in isolation. Both sections 36 and 43 form part of the same Chapter, rather the same sub-part thereof dealing with profits and gains of business or profession. In case the claim made by the assessee was accepted and the interest so suffered by the assessee was allowed as a revenue expenditure, the same would not be added towards the cost of the asset. Whereas in case the claim of the revenue was accepted, the same would result in addition of the component of interest on the borrowed capital up to the date the asset was first put to use to the cost of the asset. Thus, section 43 cannot be left aside and the claim of the assessee could not be considered merely by reading one provision of the Act and ignoring the other. The entire scheme of the Act is to be seen and all the provisions of the Act are to be read in conjunction with each other to achieve the object. [Para 16]

Clause (iii) of section 36 (1) provides for deduction of the amount of interest paid in respect of capital borrowed for the purpose of business or profession. This, will not bring within its fold the capital borrowed for the purpose of setting up of a new unit, may be in the same line, as the same would not amount to borrowing capital for the purpose of business or profession but for setting up of a plant, which is not the business of the assessee, rather it is the manufacturing activity. In the instant case the new unit set up with the borrowed capital, the interest whereon was sought to be claimed as revenue expenditure, had not yet started contributing to the business carried on by the assessee. It is only when an asset is first put to use and commercial production starts then it starts generating income and it would be in the fitness of things in case the interest on the capital borrowed for the purpose of acquisition of that asset is allowed as a revenue expenditure only when such asset starts yielding income and not for any period prior thereto. For the period prior thereto the same has to be capitalised. [Para 17]

It is evident from the memorandum explaining the amendment to section 43 (1) made in 1986 that the issue as regards the capitalization of interest paid before the asset is first put to use stood already settled and was being followed by the assessees. The necessity to carry out amendment arose for the reason that in some judgments it was opined that interest even after the date the asset is first put to use is also to be capitalized. Amendment was carried out in section 43(1) by adding Explanation 8 thereto vide Finance Act, 1986 with retrospective effect from 1-4-1974. The true import of Explanation 8 is that any amount paid or payable as interest in connection with an ‘asset’ which is relatable to the period after such asset is first put to use shall not be included in the actual cost of asset. The position in the instant case was just the converse. In the instant case the dispute was regarding the interest so paid/payable for the period before the asset was first put to use. The answer to even said issue was also implicit in the definition if it was to be given its full meaning. Accordingly, it was clear that the interest so paid prior to the date the asset was first put to use was to be added towards the cost of asset and for that purpose reliance could well be placed on the enunciation of law by Supreme Court in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167. [Para 18]

A purposive interpretation is required to be given to section 43(1), Explanation 8 and it is clear that interest on the capital borrowed for acquisition of an asset for the period before the asset is first put to use is to be added towards its actual cost and for the period thereafter it is not permitted to be added towards its actual cost. The language of section 43(1), Explanation 8 does not in any manner makes out a distinction in the acquisition of an asset when a new business is being set up or when the expansion is being carried out. In fact, the addition of proviso to section 36(1)(iii) is nothing else but clarifying the same underlined object in the scheme of the Act providing for the manner in which such an interest on the capital borrowed is to be dealt with. [Para 21]

Even a conjoint reading of section 36(1)(iii) as existing prior to the proviso inserted vide Finance Act, 2003 thereto and section 43(1), Explanation 8 clearly shows that any interest paid on the capital borrowed for the acquisition of an asset cannot be allowed as a revenue expenditure. The capital might have been borrowed by an assessee for the purpose of business. However, once it is admitted that a part thereof was used by the assessee for the purpose of acquisition of an asset, which is not in the form of replacement or modernization the interest component thereon up to the date it is first put to use has to be dealt with in terms of provisions of section 43(1), Explanation 8 as otherwise cost of the asset shown in the balance sheet will not depict its true picture. This is in conformity with law and the accounting principles. [Para 22]

The import of addition of proviso to section 36(1)(iii) vide Finance Act, 2003 is that the interest paid on the capital borrowed for the purpose of acquisition of an asset till the date such an asset is first put to use shall not be allowed as deduction. Though proviso to section 36(1)(iii) was added vide Finance Act, 2003 but the same is merely clarificatory as it has made explicit what was already implicit. [Para 23]

Thus, the Tribunal was not justified in deleting the addition on account of interest by ignoring Explanation 8 to section 43(1).