Challapalli Sugar Ltd. versus the Commissioner of Income Tax… — Income Tax | Supreme Court (1975)

Challapalli Sugar Ltd. versus the Commissioner of Income Tax… — Income Tax | Supreme Court (1975)

What the court decided

AI extract

Outcome

Mixed result across the three appeals: Civil Appeal No. 1353 of 1970 (Challapalli Sugar) allowed, the Andhra Pradesh High Court's answer discharged and the reference question answered in the affirmative in favour of the assessee and against the revenue; Civil Appeals Nos. 1784 and 1785 of 1970 (filed by the Commissioner) dismissed; the assessees entitled to costs, with one hearing fee in Civil Appeals Nos. 1784 and 1785 of 1970.

Issue for consideration

Whether interest paid before the commencement of production on moneys borrowed for acquiring and installing machinery and plant represents an element of the 'actual cost' of the machinery and plant, so as to be capitalised for depreciation and development rebate under the Indian Income-tax Act, 1922. +1 more

Court's answer

Where 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 capitalised and added to the cost of the fixed assets created as a result of such expenditure, i.e. included in the 'actual cost' for depreciation and development rebate.

Ratio / Principle

The expression 'actual cost', not defined in the Act, must be construed in the sense which no commercial man would misunderstand, i.e. according to normal rules of accountancy; the accepted accountancy rule is that the cost of a fixed asset includes all expenditure necessary to bring it into existence and to put it in working condition, and this rule governs absent statutory definition or indication to the contrary.

Key takeaways

Clause (b) of sub-section (1) of section 208 of the Companies Act, 1956 gives statutory recognition to the principle of capitalising interest on share capital raised to defray construction/plant expenses; the same principle should hold good, with stronger reason, where interest is paid on money taken on loan for defraying such expenses.ratio¶122
The inevitable difference in the actual cost of a plant according as its machinery is acquired and installed with the assessee's own money or with borrowed money does not militate against capitalising pre-production interest in the case of borrowed moneys.ratio¶125
To attract section 5 of the Income-tax (Amendment) Act, 1972, what is necessary is that this Court should have held before 15 July 1972, on an appeal in respect of the assessment of the assessee for a particular assessment year, that wealth-tax paid by the assessee is deductible in computing the total income of that year; it is immaterial that the finding was recorded in other appeals heard together with the assessee's appeal, and that the assessee's appeal itself was not disposed of before that date.

Detailed headnote1 paragraphs

Supreme Court of India (Khanna J., for the Court; bench H. R. Khanna and A. C. Gupta, JJ.; 31 October 1974). (1) Actual cost / capitalisation of interest: 'Actual cost' under s.10(5), Indian Income-tax Act 1922, being undefined, must be construed by normal rules of accountancy — the cost of a fixed asset includes all expenditure necessary to bring it into existence and put it in working condition. Hence interest incurred before commencement of production on moneys borrowed to acquire and install machinery and plant can be capitalised and included in actual cost for depreciation and development rebate; s.208(1)(b), Companies Act 1956 gives statutory recognition to the principle, which applies a fortiori to interest on loan moneys; the resulting difference in actual cost between assets funded by owned and borrowed moneys is immaterial. The Andhra Pradesh High Court's contrary view was rejected and its judgment reversed; the Calcutta High Court's view was affirmed, and the Madras (L.G. Balakrishnan, [1974] 95 ITR 284) and Allahabad (I.K. Cotton, IT Ref. 234 of 1972) decisions approved. Corporation of Birmingham v. Barnes (19 TC 195) and India Cements ([1966] 60 ITR 52) were distinguished; Hinds v. Buenos Ayres Grand National Tramways ((1906) 2 Ch. 654) was relied upon. (2) Wealth-tax deductibility: Although the Income-tax (Amendment) Act 1972 (Act 41 of 1972), inserting s.40(a)(iia) of the 1961 Act and amending s.4, bars deduction of wealth-tax, the saving clause in s.5 applies where the Supreme Court held before 15 July 1972, on an appeal concerning the assessee's assessment for a particular year, that wealth-tax paid was deductible — even if that finding was recorded in connected appeals heard together and the assessee's appeal was disposed of later. The assessee in C.A. No. 1784 of 1970 is thus covered by s.5 (Indian Aluminium Constitution Bench decision of 29 March 1972), but only in respect of wealth-tax actually paid, not merely payable. Disposition: C.A. No. 1353 of 1970 allowed and the High Court's answer discharged; C.As. Nos. 1784 & 1785 of 1970 dismissed; costs to the assessees with one hearing fee in C.As. 1784-85.

538

CHALLAPALLI SUGAR LTD.

v.

THE COMMISSIONER OF INCOME TAX, A.P. HYDERABAD

October 31, 1974

[H. R. KHANNA AND A. C. GUPTA, JJ.]

B

.11ldia11 I11come·Tax Ac:t, 1922, Section 10, secs, 10(2), 10(2)(vl), 10(5) a11d .exp/a11atlon te1 sec. 10(5) a11d Sectio11 208(1) of Compa11ies Act, 1956 (A'.ct 1 .of 1956)-Payment of tax i11 respect of profits or gains-Interest paid li,efore commencement of produ,~tion on mo11ey borrowed for acquiri11g and lns1'1//i11g the machiner.y and plant, if coul<I be capitalised and i11c/uded 111 actual cost.

l11c01nc-rax Act, 1961, as amended by Income-Tax (Amendment) Act, 1972 (Act No. 41 of 1972) Sctions 10(2) (xv) and 40 (1ia)-Wealth•tax pai'd by .assessee on net wealth, whether deductible as business expendilui~ under sec. S uf Amending Act.

lo all the three appeals the case of the assessee is that the interest for the period before the com.men;ement of· production on money borrowed for the ·pur. pose of acquJ ring a.nd installing the machinery and plant should be included in the :actual cost of the plant and Ill! such capita.lised for the purpose. In Civil Al'J)ea1 No. 1784, the contention of the assessee is that the wealth-tax payable by the .nssessee is allowable aR n deduction. .Allowing Civil Appeal No. 1353. of 1970 and dismhsing Civil Appeals Nos. 1784 and 1785 of 1970.

HELD : (i) So far .as the first question is concero~d the legal position for -determining lhe actual cost .. for the purpose of development rebate is the same .as for the purpose of depreciation. A reading of the provisions secs. 10,10(2), 10{2)(vi), 10(5) and the explanation to sec. 10(5) will disclose that, while: coo· sideriog the question of deduction on account of depreciation and development rebate the wiitten down value has to be taken into account. Written down value in its tum depends on the actual cost of the assets to the assessee. As the. expres· sioo "actual cost" .has not been defined in the Act, it should be construed in the sense which ':no cpmmercial man would misunderstand. It would appear that the .ae<:epted accountani.:y rule for determining the cost of fixed assets is to iD.clude all expenditure necessary to bring such assets into existence and to put them in working condition. lo case money is borrowed by a newly started company which is in the process of constructing and erecting its plant. the interest i'ocurred before the. commencement of production on such borrowed money can be capitalise:d and added to the cost of (he fixed assets which have been created as a result of suoh expenditure. The above rule of accountancy should be adopted for deternlioing the actual c0st of the a:l'Sets in the absen:e of any staMory definition or other 'indication to' the contrary. [543B-D, E; 545F·HJ

Clause (b) of sub-s1~ction (1) of sec:t.ioo 208 of the Companies Act, 1956, gives statutory recognition to the principle of capitalising the interest in case the interest is paid on money_ raised to defray expenses of the construction of any work or building or the provision of any plant in contingencies mentioned in that ·section even though such money constitutes share capital. The same principle, should hold .sood if interest: is paid on money not raised by way of share 'capital but taken on ·loan for tlie purpose of defraying the expenses of the construction of any work or building or the provision of any plant. The reason indeed would 'be stronger in case such interest is paid on money taken on loan for meeting the above expenses. [54SH-546C]

It is true that for similar fixed assets there can be different actual costs. The fact that there would be a difference in the actual cost of the plant in case its machinery is acquired and installed with ihe assessee's own money or in case it is ·acquired and installed with borrowed money does not consequently militate against the princiole that interest oaid in such circumstances can be ~pitalised -and induded in the actual cost of machinery and plant. [546F·0]

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CHALLAPALLI SUGAR LTD, v, C.I.T. (Khanna, J,)

539

A [{111ds, v, .Buenos Ayres Grant/ National Tramways Co. Limided, [1906] 2 Cl., D. 654, Corporation of Blrmln;ham v. Barne8 (H. M. Inspector of Taxes), 1!> Tax Cases t95, India Cements Ltd, v. Comm/ss/011er of Income.tax; Madras, (1966] 60 !TR 52 referred 10.

Commissioner of lncome·Tax Madras v. L, G. Balakrishnan and Bros. (I') Ltd, [1974] 95 I.T.R .. 284 and Commissioner of Income-tax v. /. K. Cotton Sp/111t/11g & Weaving Miils. Income-tax reference No. 234 of 1972 decided on Muy 13, 1974, by Allahabad High Court, approved.

B (ii) In Tra1•t111core Titanium .Product Ltd. v. _Commissioner of /nG·ome-Tax, K<"rala_ [1966] 60 ITR 277, the Supreme Court held that the amount of Wealth· Tax paid by nn assessee on his net wealth under the Wealth-Tax Act is not .i permissible deduction under sec. 10(2) (xv) of the Act in his income-tax assess· ment. After this decision when the matter was considered by a larger Bench con· sisting of five Judges in the case of _Indian Aluminium Co. Ltd._ v. _Commissioner of Income-Tax, West Bengal,_ [(1972) 84ITR 735] this Court held that the Wealth. Tax paid by the assessee which was a trading company on assets held by it for the c purpose of business was deductible as a business expenditure in computing the as· sessee's income from business. Sub>eque.nt to this decision, the Income-Tax Act, 1961 was amended first by means of an Ordinance and later by means of the In· come-Tax (Amendment) Act, 1972 (Act No. 41 of 1972). The result of this amendme11t is that any sum paid on account of Wealth-Tax cannot be deducted in computing the income of an assessee chargeable under the head "Profits and Gains of business, profession or Vocation" or "Income from other sources". The saving clause contained in section 5 of the amending Act provided :-

"Where, before the 15th day of July, 1972 being the date on which the Income-tax (Amendment) Ordinance, 1972 came into force, the Supreme Court has, qit an appeal in respect of the assessment of an as· sessee for any particular assessment year, held that wealth-tax paid by the assessee is deductible in computing the total income of that year, then, nothing contained in sµb-clause (iia) of clause (a) of section 40, or sub-section (IA) of section 58, of the principal Act, as amended by this Act, or, as the case may be, section 4 of this Act, shall apply to the assessment of such assessee for that particular year." [549F-550F]

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What is necessary to attract this section is that this Court should have held before July 15, ·1972 on an appeal in respect of an assessment of the assessee for ·any particular assessment year that the wealth-tax paid by the a.ssessee is deductible in computing the total income ·of that year. Once that is the eff~ of a decision given by this Court before July 15, 1972 the fact that the judgment in which the above finding is recorded is given in other appeals, which are heard together along with the appeal of the assessee, and the further fact that assessee's appeal is not disposed of before July 15, 1972, would not take the case of the assessee out of F the purview of section 5. The case of the assessee in Civil Appeal No. 1784 is covered by se.:. 5 of the Amending Act. [551G·552A)

C!vIL APPELLATE JURISDICTION : Civil Appeal No. 1353 of 1970,

From the Judgment and order dated the 5th September, 1969 of the Andhra Pradejh High Court in Case No. 64 of 1965 and

G

Civil Appeals Nos. 1784 & 1785 of 1970.

From the Judgment & Order dated the 18th August, 1965 of the Calcutta High Court in I.T.R. No. 148 and 149 of 1961. N.A. Palkhivala, S. T. Desai and T. A. Ramachandran, for the appellant (in C.A. No. 1353 of 1970.)

V. S. Desai, ]. Ramamurthi and R. N. Sachthey, for the appellant H (in C.A. 1784-85.) V. S. Desai, J. Ramamurthi, S. P. Nayar and R. N. Sachthey, for the respondent (in C.A. 1353 of 1970.)

p 975 J 2 s.c.R.

SUl'REME COURT REPORTS

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A

N. A. P<llkhiwa/a, S. T. Des<li, A. K. Varma, Ral'inder Narain, J. B. Dculachanji, 0. C. Mathur, and K. J. John, for the Tntc.rvcners Nos. 1 and 3 (in C.A. No. 1784 .. 85 /70.)

N. A. Pa/khiwalo, Bhakta, J. B. Dadachan;i, R<lviiuler /VL1rai11, 0. C. Mathur, for lntervencrs Nos. 1 and 3 (in C.A. 1784-8Sj70.)

D. N. Gupta ~or Intervener No. 2 (in C.A. 1784·85170.)

B

The Judgment of the Court was delivered by

KHANNA J.-Appeal No. 1353 of 1970 on certificalc is directed ag<1inst the j~dgment of Andhra Pradesh High Court whereby the High Court answered the following question on reference made to it under section 66(1) of the Indian Income-tax Act, 1922 (hereinafter referred to ~s the Act) against the am:ssee and in favour of the revenue :

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"Whether the interest payment of Rs. 2,38,614/represents an element on the actual cost of the machinery, plant etc. to the asseessee and as such depreciation and development rebat() arc admissible with reference to this amount also ?"

The matter relates to the asS()SSment year 1959-60, the corresponding accounting year for which ended on June 30, 1958. The assessee is a public limited company engaged in the manufacture and sale of sugar. The company went into production on January 22, 1958. The assessee company ha.cl borrowed considerable sum of money from 'the Industrial Finance Corporation of India for th1~ instal· lation of machinery and plant. During the relevant year and for the period prior to the commencement of its business the assessee paid Rs. 2,38,614 as interest. The case of the assessee is that the payment of interest added to the cost of machinery and plant to the :assessee and as such while calculating depreciation admissible to the assessee, the inter1~t paid should be treated. as part of the cost of the machinery · and plant to the a:ssessee.

The income-tax officer rejected the above claim of the assessee and held that the interest paid from year to year was an admissible item of :revenue expenditure and no depreciation could be allowed · on the . capitalised amount of the expenditure incurred on account of interest. No part of the above amount, according to the inc1::1me-tax officer, should be taken as expenditure attributable to the ereition of the machinery or other nssets. The Appellate Assistant Commissioner -0n appeal reversed the decision of the income-tax officer on this aspect. The Appdlate Assistant Commissioner held that during the period <?f constrction. when money. was borrowed for the purpose of pur~~as111g and. ms!31Img the machmery, the payment of inte!·est was the cost of mamtammg the borrowal" and as such could be i.nc!udr.d as part of the capital cost. On further appeal the Income-tax Appellate Tribunal held that the cost to the assessee must include all expenditure which it had to incur for acquiring and installing the asset., The !nterest paid or payable during the period of acquisition and mstallahon could, therefore, be considered as part of the cost to the assessee.

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CHALLAPALLI SUGAR LTD. v. c.I.T. (Khanna, /.)

541

A The question reproduced above was then referred to the High Court. The High Court held that where a plant is constructed out of borrowed money, the interest on the loan up to the date of the cominencement of the business could not be capitalised or treated as part of the actual cost of the plant .

. Similar question arises in civil appeals Nos. 1784 and 1785 of B 1970 which have been filed by the Commissioner of Income-tax on certificate against the judgment of the Calcutta High Court whereby the High Court answered the following question in reference under section 66(1) of the Act for assessment years 1955-56 and 1959-60 against the revenue and in favour of the assessee company :

"Whether qn ·the facts and in the circumstances of the c 1:ase, the assessee. was entitled under the provisions of sections 10(2) (vD, 1Q(2}(vi-a) and 10(2)(vi-b) and read with section 10 ( 5) of the Indian Income tax Act to treat the sum of Rs. 23,53,284 being the amount of interest paid on nionies borrowed at part of the actual cost for the purpose of depreciation allowances and development rebate ?"

D In civil appeal No. 1784 of 1970, which relates to the assessment year 1959~60, the following additional question was also answered by the High Court against the revenue and in favour of the assessee :

E

' "Whether the wealth-tax payable by the assessee under . the provisions of the Wealth-tax Act of 1957 is allowable as a deduction under section 10(1) or under section 10(2)(xv) of the Indian Income-tax Act?"

The assessee company in these two appeals, M/s Standiltd Vacuum Refining Co. of India Ltd. (now known as Hindustan Petroleum Corporation Ltd.), was incorporated on July 5, 1952 and commenced its business in September 1954. In June 1953 it borrowed rupees four crores on debenture at th~ rate of Rs. St per cent. interest from the public. The interest was to run from June 1953. The ·above F amount together with rupees twelve crores financed by the company was used .in setting up a refinery for which plant and machinery were imported from abroad. The refinery started work on September 1, 1954, from which date depreciation began to be calculated. The assessee company capitalised all the expenses during the period of construction, including the interest amounting to Rs. 23,53,284 which had accrued from the date of borrowing to the date of the commenceG ment.of the business on the aforesaid loan and claimed depreciation on full amount. The income-tax officer did not include interes• on debentures in arriving at the figure of actual cost and as such rejected the claim of the assessee in this . respect.' The Appellate Assistant Commissioner agreed with the Income-tax officer. The Tribunal on further appeal held that the assessee was also entitled to depreciation H on the capitalised interest of Rs .. 23,53,284 paid to the debentore holders.

The relevant facts so far as the second question in civil appeal No. 1784 of 1970 is concerned were as follows. The assessee-

[1975] 2 S.C.R.

SUPREME COURT REPORTS

542

company filed a retirn showing an income of Rs. 1,52,88,497 for the assessment year 1959-60, the relevant accounting year for which was the calendar year 1958. In arriving at the above figure o:f the income the assessee claimed a sum of Rs. 5,04,000 representiJ1g the provisin for wealth-tax payable by it for the previous year re:levant to the date of valuation, viz., Dec:ember 31, 19~8. The income-tax officer held that the provision for the payment of wealtID-tax .. did not amount to expenditure laid out wholly and exclusively for the purposes of the business. The Appellate Assistant Commissioner agreed with the income-tax officer. On second appeal the Appellate Tribunal held that the above amount could be allowed at the time when actual payment was. made.

The High Court, as already mentioned, answered both the. questions in favour of the assessee and against the revenue.

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This judgment would dispose of all the three civil appeals.

In appeal before us Mr. Palkhivala on behalf of the assessees in the three appeals has argued that in,terest for the period befor,~ the commencement of producti.on on money borrowed .for the purpose of acquiring and . installing the machinery and plant should be included in the actual cost of the plant and as such capitalised for the purpose. As against that, Mr. Desai on behalf of the revenue has supported the view taken by the Andhra Pradesh High Court. After' hearing the lr.arned c()unsel for the parties, we are of the opinion that the submiSEsion made by Mr. Palkhivala is well-founded.

Before dealing with the contentions advanced, we may set out the relevant provisions. Section 1@ inter . alia provides for the payment of tax in respect of profits or gains of any business by an assessee. Sub-sectiQ!l ( 2) of that section provides that such pr0fits or gains shall be computed after making the allowances specified therein. Clause (vi) of that sub-section deals with deductions on account of depreciation and provides inter alia that deductions would be permissi;, ble in respect of depreciation of machinery or plant used for the purpose of business and being the property of the assessee, of a sum equivalent to such percentage on the written down value thereof as may in any case or class of cases be prescribed. "Written down value" has been defined in sub-section (5) of section 10 in the case of assets acquired in the previous year, the actual cost to the assessec, and in the case of assets acquired in the previous year. ·the actual cost to the assessee, less all depreciation actually allowed to him under this Act or any Act repealed · thereby, or under executive orders issued when the Indian lncome--tax Act, 1886 was in for~e. The definition is sub.iect to provisos, but we are not concerned with them. The explanation which has been added to sub-section (5) reads as under :

"Explanation.--For the purpose of this sub·section the expression 'actual cost' means the actual cost of the assets to the assessee reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by Government

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CHALLAPALLI SUGAil LTD. v. C.I.T. (Khanna, 1.)

543

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er by any public or local authority, and any allowance in respect of any depreciation carried forward under clause (b) of the proviso to clause (vi) of sub-section (2) shall be deemed to be depreciation 'actually allowed'."

It has not been disputed that so far . as the question before us is concerned the legal position for determining the actual cost for the B purpose .of development rebate is the same as for the purpose of depreciation.

It would . appear from the above that while considering the question of deduction on account of depreciation and development rebate, we have to take into account the written down value. Written down value in its turn depends upon the actual cost c of the assets to the assessee. The expression "actual cost" has not been defined in the Act, and the question which engages our attention is whether the interest paid before the commencement of production on the amount borrowed for the acquisition and installation of the plant and machinery can be considered to be part of the actual cost of the _ assets to the assessee. So far as the interest after the comme.ncement of produetion in respect of capital borrowed for the purposes of busiD ness is crincerned, the same can be deducted under clause (iii) of subsection (2) of section 10 of the Act.

In finding the answer to the question mentioned above, we have to bear in mind that it arises ii1''the .context of profits or gains of business and the permissible deductions on account of depreciation anq developm~nt rebate relating to the machinery and plant of the E assessee. As the expression "actual cost" has not been defined, it · should, in our opinion, be construed in the sense which no commercial man would misunderstand. For this purwse it would be necessary . to ascertain the connotation of the above expression in accordance with the normal :rules of accountancy prevailing in commerce and industry. The word "cost", as observed on · page 424 of Simon's Taxes B Third Edition, is not synonymous with "price". Other items F of expenditure, such for instance as freight or warehouse charges or insurance, must in certain cases be added to the price. The matter has been dealt with in Accountancy by Pickles 1955 Ed. on page 944 under the head "Payment of interest on Construction Capital" as under: ·

"In the ordinary course of affairs no dividends may be

G paid unless such dividends are paid out of profits : interest o.n debentures (being a ch11rge is, however, payable whether profits are earned or not). Where company raises share. eapital and out of the proceeds defrays the expenses of the construction of any works or buildings or provision of plant which cannot be made profitable for a lengthened period the company may pay interest on so much of that share capital

H as is paid up for the period and may charge 1o capital the swm paid by way of interest, provided that the restrictions

complied imoosed under with. " · section 65 of the Companies - · Act ' 1948 are

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(1975] 2 S.C.ll.

SUPREME COURT REPORTS

544

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It is further observed :

"The interest so paid is 'capitalised', that is to say, it is treated as part of the cost of constrc.tion being added theret (similarly to legal expenses of acqumng property or brokers charges <)n purchasing investments)."

In Spicer & Pegler's Practical Auditing 11th Edition it is obscr~ed on pages 190-{ 91 under the head "Interest Payable Out of Capital B During Construction"

"Interest on debentures issued for a similar purpose can be charged to capital during the period of construction (Hinds v. Buenos Ayres Grand National Tramways Co. Ltd. (1906) 2 Ch. 654)."

In Higher Book-Keeping & Accounts by Cropper Morris & Fi.son Seventh Edition, it is observed as under :

"Capital expenditure over. a long period must perforce involve the question of interest as an additional cost. If the work were undertaken by an independent contractor he would, of course, take interest into account when preparing the estimates on which to base his tender. The final cost of D construction work is made up of the cost of machinery, materials, labour, supervision, _and establishment charges, plus interest on the capital employed which, but for its employment in that way, would be invested in good securities, paying a reasonable rate of interest."

Section 208 of the Companies Act, 1956 (Act 1 of 1956) deals with payment of interest on share capital in certain contingencies. Suh· E section ( 1) of that section reads as under:

"(1) Where any shares in a company are issued for the purpose of raising money to defray the expenses of the cons>truction of any work or building, or the provision of any plant, which cannot be made profitable far a lengthy period, the company may-·

(a) pay interest 011 so much of that share capital as is F for the time being paid up, for the period and subject to the conditions a11d restrictions mentioned in subsections (2) to (7); and ( b) charge the sum so paid by way of interest, to capital as part of the cost of construction of the work or building 04 the provision of the plant." G Exerise of. P?Wer uder sub-section ( 1) is, however, subject to certm restnctl()ns "Yh1ch have been enumerated in the remaining sul>· sec!Jons of the sction, one of :-Vhich requires that no such paymeni~ shall be made without the previous sanction of the Central Govern .. ment. Jn Statement on Auditing Practices issued by the Institute of Chartered Accountants of India (1974) it is observed in paragrapi'-. 2 . 5 as under : ' H . '.'2. 5 Fixed As~cts should be valued at cost and depreciation should be wntten off on a proper and consistent basis.

CHALLAPALLI SUGAR LTD. v. C.I.T. (Khanna, /.)

545

A Cost includes all expenditure neci:ssary ~ brin~ . the assets into existence and to put them m wrokin~ condition. By way of illustration the following may be mentioned :-

. (i) Legal charges and stamp duties in the case of land,

(ii) Architect's fees in the case of buildings,

B

(iii) Wages, salaries and installation expenses in the case of ma~hinery, and

(iv) Interest on borrowings to the extent specified in paragraph 2.22"

Relevant part of paragraph 2 . 22 reads as under :

''2.22 The question often arises as to whether inrest c on borrowings can be capitalised and added to the fixed assets which have been created as a result of such expendir ture. The accepted view seems to be that in the case of a newly started company which is in the process of constructing and erecting its plt, the interest incurred before production commences may be capitalised. 'Interest incurred' means a~tual interest paid or payable in respect of borrow0 ings which are used· to finance capital expenditure. In no circumstances, should imputed interest be capitalised, such as interest on equity or preference capital at a notional rate. Interest on capital during construction paid in accordance with the provisions of section 208 of the Companies Act, 1956, may, however, be capitalised as permitted by that section. Interest on monies which are specifically borrowed E for the purchase of a fixed asset may be capitalised prior. to the asset coming into pro4uction, i.e. during the erection stage. However, once production starts, no interest on borrowings for the purchase of machinery (whether for re>placement or renovation of existing plant) should be capitafised ............. "

F It would ·appear from the above that the accepted accountancy rule for determining the 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 whlch is in the process of constructing and erecting its plant, the interest incurred· before the commencement· of . production on such borrowed money can be capitalised and added to the cost of G the fixed assets which have been created as a result of such expenditure. The above rule of accountancy should, in our view, be adopted for determining the actual cost of the assets in the absence of any statutory. definition or other indication to the contrary.

We have already referred to section 208 of the Companies Act which makes provision for payment of interest on share capital in H certa!n contingencies. Clause (b) of sub-section (1) of that section provides that in case interest is paid on share capital issued for the purpose of raisiJ?g . money to defr~Y. the expenses of constructing any work or bu1ldmg or the prov1Ston of any plant in contingencies

[1975) 2 S.C.R.

SUPREME COURT REPORTS

546

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mentioned in that section, the sum so paid by way .of interest may be charged to capital as part of the cost of construction of. t!ie work or building or the provision of the plant, The aoe. proVJs1n thus gives statutory recognition to the principle. of cap1tal1smg the mter1st in case the interest is paid on money raised to defray expenses of the construction! of any ;Nork or building or the provisipn of any plant in contingencies.ment1011ed in that section even though suh money constitutes share capital. Uie same principle, in our opimon, should hold good if interest is paid on money not raise.ct by. way of share capital but take on loan for the purv.os~ of defraymg t~~ expem1es of the construction of any work or buildmg or the prov1s1011 of any plant. The reason indeed would be stronger in case such in;terest is paid on money taken on loan for meeting the above expenses.

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Mr. Desai has argued that if the interest paid on loan incurred for the purpose of acquisi1ion and installing the machinery of a plant is to be taken into accourtt in considedng the actual cost of the plant, the result would be that the actual cost would be higher if the machinery for the plant is acquired and installed with borrowed money compared to the cost of such plant in case the money spent for the acquisition and installation of the above machinery is that which belongs to th~ assessee. This undoubtedly is so but it is inevitable and should not detract from the conclusion at which we have arrivf:d. Let us take the case of an archite-ct constructing his house. In ca.se the architect engages another architect tp prepare the plait for his house and to supervise its construction and pays remuneration to tl11at other archited for this purpose, the amount so paid to the other architect shall have to be taken into account in arriving at the figure of actual cost of the house. In case, however, the architect constructing the house himself prepares the plan of the hous_e and supervises its construction, he. would naturally be not paying any remuneration to himself for the aforesaid work. The result would . be that in the latter event the actual c:ost of the house wotil.d be less compared to the cost of the house in the ·former event even though the house in all other respects is identi.cal. It would, therefore follow that for similar fixed assets there can be differt1t actual cos. The fact that there. would. be a ifference i_n the actuI cost of the plant in case ~ts machmery 1s acqmred and _ mstalled w:ith the assessee's o'\Vn money or in case it is. ~cquired .and installed with ?orrowed money does not consequently militate agamst the answer which we propose to give to the question referred in the three appeals.

E

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G

In the cuse of Hinds v. Buel1(Js Ayres Grand National Tramways Col1!pay, Limited(')_ a tramway company, for the purpose of co'ti.vrting its undertaking to a system of electric traction, issued convel.".sion debenture stock. The directors passed resolutions that the i:iterest on this stock should be treated a.s part of the cost of constru·::bon, and chargeable to capital account during the cons'ruction of the work~. 'The mell1;o;andum nd artices of _association of the company contamed no prov1s1ons relating to this sub1ect. It was held that thei~

H

(I) [1906] 2 Ch. D. 654.

CHALLAPALLI SUGAR LTD. v. C.l.T. (Khanna, J.)

547

A was no general rule of law. which compelled companies to charge to revenue account interest on money borrowed for the purpose of constructing works, or prohibited them from charging it, during construction, to capital account. It was furt4er h~ld that i? the absence of any provision to the contrary the company was at liberty to charge the interest in question to capital account. Dealing with the question of costs for the purpose of construction -and the question whether the B interest paid on money borrowed for such construction could be capitalised, Warrington J. observed :

"Now, what is it that the company ar,e really proposing

to do ? They are creating a capital asset by means of which they will hereafter earn, or they hope to earn, profits for the company. They are not simply employing contractors to

c find the money and do the work. They are finding the money themselves, and they find the money by borrowing it. What does each mile of line cost them under \these circutnstanceswhat is it that they expend in constructing each mile of line, taking the amount of the borrowed money expended on that line to be £s 10,000, that being the company's estimate? The money is borrowed for that particular purpose-the

D £s 10,000. They have to pay interest on that £s 10,000 during the period that construction is taking place. In my opinion that asset which they are so constructing costs them not only the £s 10,000, but the £s 10,000 plus the an1ount of interest during the period of construction; and that _is what they are out of pocket during the construction of that

E mile of line. Now, it seems to me that the company are entitled-I do not say that they are bound to do it-if they think fit to charge in their accounts as the cost of that mile/ of line not only £s 10,000, but the £s 10,000 and the interest on it during the p-ei:iod of construction."

Mr. Desai has referred to the decision of the House of Lords in

the case of Corporation of Birmingham v. Barnes (H. M. Inspector of Taxes).(¹ ) The appellant corporation in this case entered into aa agreement with a company to lay a tramway track and establish a tramway service to the compiµiy's works. By virtue of the work having been comp!eted and J_he service established by a certain date, the corporation received from the company in accordance with the terms of the agreement, a specified sum. The corporation also spent considerable. sums of money on the renewal of their tramway tracks and

G received in that connection grants from the Unemployment Grants Committee. These grants were made under certain conditions to local authorities to assist them in carrying out at once approved schemes of public utility on which a substantial number of unemployed persons could be engaged. It was he)d that the payment by the company and the grant from the Unemployment Grants Committee

H should not be taken . into account in ascertaining the actual costs to the corpor~tlon of the tramway track in question for the purpose of computmg the allowance due to the corporation for (I) 19 Tax Cases 195.

[1975) 2 S.C.R.

SUPREME COURT REPORTS

548

A

wear and tear of such tracks. Lord Atkin observed in the above case:

"What a man paysforconstruction orfrthe purchase
ofa works1:emstometobethe cost tohlDl;and . that
whether someone hasgivenhimthemoneytoconsuctor
purchaseforhimself,or before the eventhaspromised to
givehimthemoney.afterhe.has paidforthe "'.ork, orater
theeventhaspronused orgiventhemoneywhichrecoups
him what he has spent. In the present case the Corporation
paid thewholeofthe cost of the tramways outoftheir funds
unlessthefirsthalfofthe Dunlop contributionwasso
applied : astowhich thereisno evidence, norisit mater-
ial."

B

c

The above observations were made in the context whether money contributed by another party can be taken into account in considet'ing the cost of construction. No such ques¹ ion arises in .the present ca~e. On the contrary, what we are concerned with here· is whether interest paid on money borrowed for the acquisition and installation of the machinery of a plant accruing before the commencement of production can be taken into account in considering the actual cost of the plant Such a question did not arise in the above mentioned case before the House of Lords.

,

D

Another case to which reference has been made on behalf of the revenue is India Cements Ltd. v. Commissioner of Income-tax Madras.('). The appellant company in that case obtained a loan E of Rs. 40 lakhs from the Industrial Finance Corporation by creating a charge on its fixed assets. In connection therewith the company spent a siµn of Rs. 84,633 towards stamp duty, registration fees, lawyer's fee and claimed this amount as business expenditure. It was held that the amount spent was not in the nature of capital expenditure and was laid Olllt or expended wholly and exclusively for the purpose of the: assessee's business and was therefore allowable as F a deduction under section 2(xv) of the Act. The act of borrowing money, it. was observed, was incidental to the carrying on of business and the loan obtained was not an asset or an advantage of enduring nature. This Court accordingly held that the amount of Rs. 84,633 was an allowable expenditure. This case too is of no assistance to the revenue. The appellant company in that case at the time it raised the loan was a running concern. Unlike the assessees in the G p;esent appeals, the loan raised by the appellant company in the cited case was not before the commencement of production but at a later stage. The question cf inludin~ the interest paid on loan b~fore the. co1;11mencement ol busmess m the actual cost of the plant dtd not anse m that case. • It may be mentioned that as against the view taken by the H Andhra Pradesh High Court in the judgment which is the subject (I) [ 1966] 60 I.T.R. 52.

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CHALLAPALLI SUGAR LTD. v. c.LT; (Khanna, I.)

54.9

matter of the apj>eal, three other High <;:ourts have taken the contrary view and have ·held that interest paid in such circumstances can be · capitalised and included in the actual cost of the machinery and plant. The deeision of the Calcutta High Court in which the contrary view bas been taken is the subject matter of appeal before us. The view of Calcut~ High Court. has been followed by the Madras High Court and the Allahabad High Court. The. decision of the Madras High Court B is in the case of Commissianer of Income..tax Madras v. L. G. Balakrislman and Bros. (P) Ltd.,(t) while that of the Allahabad High Court is in the case of Commissioner of Income-tax v. /. K. Cotton . Spinning & Wvg. Mills(² ). After giving the matter our consideration, we are unable to subscribe to the view taken by the Andhra Pradesh High Court. The correct view. in the matter, in our opinion, has been taken oy the Calcutta High Court and we afiairm the same.

c

We may now advert to the second question in civil appeal No, 1784 on the point whether the wealth-tax payable by the assessee is Wlowable as a deduction. The High Court, as already mentioned, answered the second question in favour of the assessee. Subsequent to the judgment of the High Court this Court in the case of Travancore Titanium Product Ltd. v. Commissioner of Income-tax D · Kera/a(⁸ ) held that th.e amount of wealth tax paid by an assessee on his net wealth under the Wealth-tax Act is not a permissib'.e dedu~ i'tion under section: 10(2)<xv) of tl).e Act in .his income-tax assessment. This Court in that context observed that wealth-tax is imposed. on the owner of assets and not ort any commercial activity. The fact that in certain special cases the quantum of the liability of a company to wealth-tax is related to the profits earned would not E alter the character of the tax. It remains a tax charged upon the net wealth and it is not made a tax related to or incidental to the carrying on of business.

After the above decision, the matter was considered by a larger Bench consisting of five Judges in the case. of Indian Aluminium Co. Ltd. v, Commissioner of Income-tax West Bengal(4). This Court held F that the wealth-tax paid by the assessee which was a trading company on assets held by it for the purpose of business was deductible as a busines.s expenditure in computing the assessee's income from business. Sikri, C.J. speaking for four of the Judges observed 'that when a person has a dual capacity of a trader-cum owner, and he pays tax in respect of property which is used. for the -purpose of trade, the payment must be taken: to be in the capacity of a trader according G to ordinary commercial principles. ·

Subsequent to the above decision in the case of Indian Aluminium Co, (supr~) the lnc<?mtax Act, 1961 was amended first by means of \Ill ordinance and lar by means of the Income-tax (Amendment) Act, 1972 (Act No. 41 of 1972). By section 2 of the amending Act sub clause (iia) was inserted and was deemed always to have been

H

(1) [1974) 9S I.T.R. 284, (2) Income-tax reference No. 234 of 1972 decided on May 13, 1974. (3) [1966) 60 I.T,R. 277. (4) [1972) 84 I.T.R. 73S.

L1975] 2 s..R

suPREME couRT REPORTS

550

inserted in clause (a) ,~f section 40 of the Income-tax Act 1961 as under:

A

"(iia) any sum paid on accoun.t of wealth-tax."

An explanation was adde:d to the above sub-clause, but it is not necessary to reproduce th<i same. Section 40 of the Indian Income-t~x Act, 1961 spec.ifies the amounts which shall not ~? deducted .m computing the mcome charge:o.ble under the eads Profits or ga;ns of business or profession". According to section 4 of the amending Act, nothing contained in the Indian Income-tax .Act, 1922. shall be deemed to authorise, or shall be deemed ever to have authonsed, any deduction in the computation of the income of any assessee chargeable under the head "Profits and gains of business, profession or vocatin" or "Income from other sources" for the assessment year commencmg on the 1st day of April, 1957 or any subsequent assessment year, of any sum paid on accotmt of wealth-tax.

In viiw of the above provisions, it is plain that any sum paid on account of wealth-tax cannot be deducted in computing the income of an assessee chargeable under the head "Profits and gains of business, profession or vocation'' or "Income from other sources". There is, however, a saving clause contained in section 5 of the amending Act and it reads as under :

"Where, before the 15th day of July, 1972 being the date on which the Income tax (Amendment) Ordinance, 1972 came into for~~. the Supreme Court has, on an appeal in respect of the assessment of an assessee for any particular assessment year, held that wealth-tax paid by the assessee is deductible in computing the total income of that year, then, nothing contained in subclause (iia) of ctaus1~ (a) of section 40, or sub-section (lA) of section 58, of the principal Act, as amended by this Act, or, as the case may be, section 4 of this Act, shall apply to the assessment of such assessee for that particular year."

Mr. Palkhivala submits that the case of the assessee in respect f the second question in civil appeal No. 1784 is covred by seation 5 of the amending Act reproduced above.

. To appreciate the above submission, we may observe that civil appeals Nos. 1784 and 1785 of 1970 along with civil appeals Nos. 1694 and 1730 of Indian Aluminium Co. and civil appeal No. 1831 of .1970 of Standard Vacuum Oil Co. were argued before the Constit~~on Bench on February 1, 1972. The Court reserved judgments in CIVIi appeals No. 1694 and .. 1730 of Indian Aluminium Co. and civil appeal No. 1831 of Standard Vacuum Oil Co. As an additional question relating to the inclusion of interest in the calculation of the actual cost arose in civil appeals Nos. 1784 and 1785 of 1970 the C:cmrt after hel!l'ing some arguments on that point in these apPeals dn:ected ~hat they ?e ~e'.1fd by a Division Bench after the pronouncement ~f 1udgment m CIVll appeals No. 1694, 1730 and 1831. Judgments m those three appeals, i.e. two appeals of Indian .Aluminium

B

c

D

E

F

G

H

CHALLAPALLI SUGAR LTD. v. c.I.T. (Khanna, J.) 5 51

J

A Co. and one of Stndard Vacuum Oil Co. were pronounced '.on March 29 1972. The decision in the appeals in the case of Indian Aluminium Co. is reported, as already mentio11ed, in <1972)84 ITR ?35, while that in the case of Standard Vacuum Oil Co. is reported in (1972 86 ITR 1.

The submission made by Mr. Palkhivala is that even though no

B final order was pronounced in civil appeal No. 1784 before July 15, 1972 the effect of the judgment in the other three civil ap?.eals Nos. 1694; 1730 and 1831, which were heard along with civil appeal No. 1784 on the point as to whether the wealth-tax paid by the assessee was a permissible deduction, was that this Court held that the same was to be the decision on that point in civil appeal No. 1784. As against that, Mr. Desai contends that there was no finding by this

c Court before July 15, 1972 in civil appeal No. 1784 that the wealthtax paid by the· assessee was deductible in computing the total income of the assessee ..

There is, in our opillion, force in the submission of Mr. Palkhivala.

As stated above, arguments were heard together on February 1, 1972 in civil appeals Nos. 1784, 1694, 1730 and 1831 on the question as

D to whether the wealth-tax !'aid by the assessee was a permissible deduction under section 10(2) (xv) of the Indian Income-tax Act. On the conclusion 'of the arguments on that point, this Court found that an additional question arose in civil appeal No. 1784 on the point as to whether the. interest payable on loan was part of the actual cost of the assets. The Constirution Bench after hearing arguments . on this additional point for some time directed that civil appeal No. 1784

E along with the connected civil appeal 1785 should be posted for hearing before a Division Bench after pronouncement of judgments in civil appeals Nos. 1694, 1730 and 1831. The effect of the above order which was made on February 1, 1972 was that the decision in civil appeals Nos. 1694, 1730 and 1831 on the point as to whether the wealth-tax paid by the assessee was a permissible deduction, was also to be the decision in civil appeal No. 1784. After the judgments

F of the Constitution Bench in civil appeals Nos . .1694, 1730 and 1831 on March 29, 1972 the question as to whether the wealth-tax paid by the assessee was a permissible deduction under section 10(2)(xv) of the Act no longer remained subject of controversy in civil appeal No. 1784 as the decision on that point in the three appeals was also to govern the decision in appeal No. 1784. It is no doubt true that civil appeal No. 1784 was not disposed of

G before July 15, 1972 but that fact would not prevent the case of the assessee in that appeal being covered by section 5 of'. the amending Act. What is necessary to attract that section is that this Court should have held before July 15, 1972 on an appeal in respect of an assessment of the .assessee for any particular assessment year that the ealth-tax paid by the assessee is deductible in computing the total mme of that year. Once that is the effect of a decision given by

H this Court before July 15, 1972 the fact that the judgment in which the above finding is r~orded is given in other appeals, which are heard together along with the appeal of the assessee, and the further fact that assessee's appeal is not disposed of before July 15. 1972

[1975] 2 S.C,R.

552

SUPREME COURT REPORTS

would not take the case of the asses~ put of the purview of seCt-· tion 5. We would, therefore, hold that the case of the assessee in civil appeal No. 1784 is covered by section 5.of the amending Act.

We, however, make it cle3ll' that the benefit of section 5 of the amending Act so far as the second question in civil appeal No. 1784 is concerned would bo. ava1ilable only in respect of wealth-tax paid and not merely payable.

In the light of the atbove, we dismiss civil appeals No. 1784 and 1785 of 1970. We oo:ept civil appeal No. 1353 of 1970 and discharge the answer given by the High Court. We answer the aforesaid question in the affirmative in favour of. the assessee and against the revenue. The assessees shall be entitled to the costs of these appeals. One hearing fee in ciVil a'ppeals No. 1784 and 1785 of 1970.

C.As. Nos. 1784 & 1785/70 dismissed. . C.A. No. 1353/70 a!lowed.

V.M.K.

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Procedural history

How this case reached the court

AI extract

Order under challenge
Judgment and order dated 5 September 1969 of the Andhra Pradesh High Court in Case No. 64 of 1965, answering the reference question under section 66(1) of the Indian Income-tax Act, 1922 against the assessee and in favour of the revenue; challenged in Civil Appeal No. 1353 of 1970.¶30
Andhra Pradesh High Court · 5 September 1969
Prior proceeding
For assessment year 1959-60 (accounting year ended 30 June 1958): the income-tax officer rejected Challapalli Sugar's claim to capitalise pre-production interest of Rs. 2,38,614; the Appellate Assistant Commissioner reversed, holding interest during construction was cost of maintaining the borrowal; the Tribunal held cost includes all expenditure for acquiring and installing the asset, including interest paid or payable during that period.¶48
Prior proceeding
On reference, the Andhra Pradesh High Court held that interest on borrowed money up to the commencement of business could not be capitalised or treated as part of the actual cost of the plant.¶56
Prior proceeding
Calcutta High Court, by judgments dated 18 August 1965 in I.T.R. Nos. 148 and 149 of 1961 (references for assessment years 1955-56 and 1959-60), answered the capitalisation question in favour of the assessee company; the Commissioner of Income-tax appealed on certificate in C.As. Nos. 1784 & 1785 of 1970.¶33
Prior proceeding
In the Standard Vacuum Refining appeals, the income-tax officer declined to include interest on debentures in the actual cost and rejected the depreciation claim on the capitalised interest of Rs. 23,53,284; the Appellate Assistant Commissioner agreed; the Tribunal allowed depreciation on the capitalised interest.¶62
Prior proceeding
On the wealth-tax question (C.A. No. 1784, AY 1959-60): the income-tax officer held the Rs. 5,04,000 provision for wealth-tax was not expenditure wholly and exclusively for the business; the Appellate Assistant Commissioner agreed; the Appellate Tribunal held the amount could be allowed when actually paid; the High Court answered the question in favour of the assessee.¶67
Prior proceeding
On 1 February 1972 the Constitution Bench heard C.As. Nos. 1784, 1785, 1694, 1730 and 1831 together on the wealth-tax point, reserved judgment in Nos. 1694, 1730 and 1831, and directed Nos. 1784-85 to a Division Bench after pronouncement of those judgments; judgments therein were pronounced on 29 March 1972.¶176