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 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

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

Interpretation of statutes : Rule of purposive interpretation.

FACTS

The assessee, who 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 revenue’s appeal, the assessee contended that the appeal did not raise any substantial question of law for the reason that concurrent findings of fact recorded by the Commissioner (Appeals) and the Tribunal had not been challenged by claiming any issue on perversity thereof ; Explanation 8 to section 43(1) cannot restrict the scope of section 36(1)(iii) as section 43 merely contains definitions, which are limited for grant of depreciation and investment allowance.

HELD

There was no merit in the objection raised by the assessee to the effect that appeal did not raise any substantial question of law in the absence of challenge to the concurrent findings recorded by the Commissioner (Appeals) and the Tribunal. In the instant, the issue sought to be raised by the revenue was that whenever a new asset is created, may be in the form of expansion of the existing activity, the same has to be dealt with independently for the purpose of determination of its actual cost. The component of interest on the loans raised for the purchase of the asset is to be dealt with considering the same separately. The interest upto the date the asset is first put to use is to be added towards the cost of the asset and thereafter the same is to be claimed as revenue expenditure. The loan in the instant case was not raised for the purpose of running the business for its day to day requirements, rather the same was raised for the purpose of creating substantial additional assets by creating new capacity at a new location. [Para 15]

As far as the contention of the assessee to the effect that the provisions of sections 36 and 43 were to be read in isolation, was concerned, there was no merit in the same. It is noticed that 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 upto the date the asset was first put to use to the cost of the asset, accordingly, 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]

As far as the issue on merits was concerned, the object of the Act is to charge tax on the income earned by an assessee by carrying on his business. The figure so arrived at should not be distorted by any factor. section 28 provides for charging of income-tax on the profits and gains of business or profession carried on by the assessee under the head ‘profits and gains of business or profession’. The business or profession is carried out by an assessee with certain set up. The business would certainly mean the commercial activity being carried on by the assessee. While computing the income under the head ‘profits and gains of business or profession" certain deductions have been provided on account of expenses incurred by the assessee for earning such income and certain special deductions for promoting the industrial activities. Section 36 provides for certain deductions while computing the income assessable under section 28 under the head income from profits and gains of business or profession’. 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 case the plea raised by the assessee to the effect that the interest paid by it on the capital borrowed for the purpose of setting up of new unit was to be treated as capital borrowed for the purpose of business or profession, the same would result in distortion of the actual profits earned by the assessee in the business already being carried on by it. 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 set of facts was just the converse. In the instant case the dispute was regarding the interest so paid/payable for the period before the asset is first put to use. The answer to even said issue also implicit in the definition if it is to be given its full meaning. Accordingly, it is clear that the interest so paid prior to the date the asset is first put to use is to be added towards the cost of asset. [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 upto 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]

A reading of memorandum explaining the amendment to section 43(1) by way of insertion of Explanation 8 thereto clearly shows that the same was carried out with the object to curb tax avoidance by the assessees by adding the interest paid on the capital borrowed for acquisition of the asset even after the asset had been put to use. [Para 24]

On perusal of Explanation 8 to section 43(1) it is clear that no distinction in the cases where the new business was being set up and where the expansion of existing business was being carried out is carved out as it merely talks about payment of interest in connection with the acquisition of an asset. The business of the assessee in the instant case admittedly was to manufacture yarn and not setting up of plant and machinery to manufacture yarn. [Para 25]

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