Commissioner Of Income-Tax, Gujarat Ii v. Alembic Glass Industries Ltd.

1. This reference arises out of the assessment of the respondent's income for the assessment years 1965-66 and 1966-67 and involves a question :-

"Whether the amounts spent by the assessee in payment of interest on the borrowings, on the establishment of a new undertaking at Bangalore, and other miscellaneous expenses and travelling relating to the setting up of the said undertaking at Bangalore, should be taken on the revenue account or on the capital account ?"

2. Following are the short facts leading to this reference. The respondent-assessee is a company manufacturing glass at Baroda, and is in existence even since the year 1947. During the accounting period relating to the years of assessment, the company incurred certain expenditure for establishing a new glass manufacturing unit known as "Whitefield Factory" at Bangalore. The said unit did not go into production during the two assessment years in question. The assessee, however, incurred expenses for the purpose of the Bangalore unit during the accounting period in question to the turn of Rs. 77,53,084 and Rs. 77,00,000 respectively. During the course of the assessment, the Income-tax Officer noticed that a part of these borrowings was used for the purpose of setting up the Bangalore unit and, therefore, he disallowed the payment of interest on such borrowings. According to the estimation of the Income-tax Officer the interest referable to the establishment of the Bangalore unit was to the tune of Rs. 50,000 for the assessment year 1965-66, and to the tune of Rs. 2,00,000 for the assessment year 1966-67. Since the Bangalore unit had not commenced the production, the Income-tax Officer disallowed this payment of interest as revenue expenditure. He further held that the Bangalore unit was not the branch of the assessee's factory at Baroda and was, therefore, a new business and since this new business had not started production during the accounting period in question, the payment of interest cannot be taken as revenue expenditure.

3. The company had incurred some miscellaneous expenditure and travelling expenditure during the accounting periods. The Income-tax Officer found that for the assessment year 1965-66 the miscellaneous expenditure to the tune of Rs. 5,427 was referable to the setting up of the Bangalore unit, and for the assessment year 1966-67, the miscellaneous expenditure to the tune of Rs. 18,676 was also referable to the establishment of the new unit at Bangalore. So far as the travelling expenditure is concerned, he found that for each of the assessment years, the expenditure of Rs. 4,000 was referable to the establishment of the new unit at Bangalore. This Bangalore expenditure was also disallowed as revenue expenditure, because the unit had not started production during the accounting period.

4. Being aggrieved by this decision of the Income-tax Officer the respondent-assessee approached the Appellate Assistant Commissioner who came to the conclusion that though the unit established at Bangalore was a new one, it did not become a new business undertaking and, therefore, the deductions claimed by the respondent-assessee ought to have been allowed by the Income-tax Officer. He, therefore, allowed all these deductions with the result that the revenue approached the Appellate Tribunal in appeal. The Appellate Tribunal found that the establishment of the new unit was not a new business of the respondent-assessee, though the unit was newly established. The Tribunal, therefore, agreed with the view taken by the appellate Assistant Commissioner and dismissed the appeal preferred by the revenue. Being aggrieved by this, the revenue has preferred this reference, in which the Tribunal has referred the following two questions for our opinion :

"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the Whitefield Factory at Bangalore did not constitute a separate undertaking but was only an establishment of a new unit of the existing factory at Baroda.

(2) Whether, on the facts and in the circumstances of the case, the interest, miscellaneous expenses, and travelling expenses incurred by the assessee referable to the Bangalore unit are wholly and exclusively for the purpose of the assessee's business ?"

5. After hearing the parties, we find that question No. 1 is not correctly framed. We, therefore, recast the first question as under :

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the Whitefield Factory at Bangalore did not constitute a new business but was the new establishment of a new unit of an existing business at Baroda ?"

6. The first question is whether the establishment of the new unit at Bangalore can be treated as a new or separate business of the assessee. This question does not present any difficulty in view of the decisions given by the Supreme Court in Commissioner Of Income Tax, Madras v. Prithvi Insurance Co. Ltd.. ([1967] 63 ITR 632 (SC)) and Produce Exchange Corporation Ltd. v. Commissioner of Income-tax ([1970] 77 ITR 739 (SC)). In Prithvi Insurance Co. ([1967] 63 ITR 632 (SC)), the test for determining whether two lines of businesses constitute the "same business" within the meaning of section 24 (2), at the relevant time, is stated as under :

A fairly adequate test for determining whether the two constitute the same business is furnished by what Rowlatt J. said in Scales v. George Thompson & Co. Ltd. ([1927] 13 TC 83, 89 (KB)) : 'Was there any inter-connection, any inter-lacing, any inter-dependence, any unity at all embracing those two businesses ?' That inter-connection, inter-lacing, inter-dependence and unity are furnished in this case by the existence of common management, common business organisation, common administration, common fund and a common place of business.

7. In the subsequent decision in the case of Produce Exchange Corporation Ltd. ([1970] 77 ITR 739 (SC)), the Supreme Court has approved of the above test and has further observed that it is not possible to agree with the proposition has the decisive test for determining whether the two lines of businesses constitute the same business, is the nature of the two businesses.

8. Now, applying the above test to the facts of the present case it cannot be disputed that the business organisation, administration and the fund of both the units of the assessee, namely, the unit at Baroda and the unit at Bangalore, are common. There is one company which controls the administration of both the units. It is one company which supplies the staff to both the units, and it is one company which manages the whole of the business organisation of both the units. The production of both units is considered the production of the assessee-company itself. It should be noted here that application for the proposed expansion of the establishment of the new unit at Bangalore was made by the assessee to the Under-Secretary to the Government of India on 8th December, 1959, wherein it was specifically mentioned that this new unit at Bangalore was for the manufacture of glass bottles and was nothing but the expansion of the existing business. In the application for licence, which was submitted by the assessee to the Government, it is specifically mentioned that the newly envisaged unit would be nothing but the expansion of the business carried on by the existing unit at Baroda. This correspondence has been produced and relied upon by the assessee during the course of the proceedings before the Tribunal and the taxing authorities below. A compilation of the same has been produced before us and the contents of this compilation clearly shows that the newly established unit at Bangalore is nothing but the extension and expansion of the existing business which the assessee-company was conducting at Baroda at the relevant time. Thus, there is complete inter-connection, inter-lacing and inter-dependence of both the units. Shri Kaji, who appeared on behalf of the revenue, contended that there is no common place of business, because the Bangalore unit is many miles away from Baroda. This contention is not acceptable because the head office of the assessee-company is at Baroda and it is the head office which controls the affairs of both the units and, therefore, it is not possible to say that there is no common place of business of both the units.

9. It was contended by the revenue that the real test for considering whether a particular unit is a separate business from the business of the other unit or not, is to see whether the closure of one unit would affect the other unit or not. Even applying this test we find that the closure of any of the two units would surely affect the working and the business of the remaining unit for the simple reason that a larger liability of the whole business would obviously have to be borne by the other unit on the closure of one unit.

10. Reliance was placed by Shri Kaji on the decision of the Supreme Court given in L. M. Chhabda & Sons v. Commissioner of Income-tax ([1967] 65 ITR 638 (SC)). The Supreme Court has therein observed that if the assessee carries on several distinct and independent businesses, and one of such businesses is closed before the previous year, he cannot claim allowance under section 10 of the Indian Income-tax Act of 1922, of an outgoing attributable to the business which is closed against the income of his other business in that year. It was further observed that there is no general principle that where an assessee carried on business ventures of the same character at different places it must be held as a matter of law that the ventures are parts of a single business : whether different ventures carried on by the assessee form part of the same business must depend on the facts and circumstances of each case, and it is for the assessee to establish that the different ventures constitute parts of the same business. In our opinion the facts of this case have no application to the facts of the case under our consideration, because in the case considered by the Supreme Court, the assessee owned two theatres at two different places. Each of these theatres had a separate and distinct business of its own, and closure of one could obviously not have affected the business of the other which was situated at a different place. This is not the case here, because it cannot be gain-said that the closure of either of the two units at Baroda or at Bangalore would have an obvious impact on the business carried on by the other unit.

11. Taking, therefore, all these facts and circumstances into consideration, we have no hesitation in concluding that the Tribunal was justified in law in holding that the new factory at Bangalore did not constitute a new business but was only an establishment of a new unit of the existing business at Baroda. Therefore, our answer to the first question, which is reframed by us, is in the affirmative.

12. Now, coming to the second question, the first contentious point is as regards the proportionate interest for both the accounting periods referable to that part of the borrowing, which is ascribed to the establishment of the new unit at Bangalore. Here, the contention of the revenue is that since during the assessment periods, the unit at Bangalore had not started production the payment of interest on the borrowing which was utilised for the purpose of establishing that new unit should go towards the cost of the new unit and, therefore, on the principle accepted by the Supreme Court in Challapalli Sugars Ltd. v. Commissioner of Income-tax ([1975] 98 ITR 167 (SC)), this interest item should be considered as capital expenditure and not as a revenue expenditure. As against this, the contention of the assessee is that the decision given by the Supreme Court in Challapalli Sugars Ltd. ([1975] 98 ITR 167 (SC)), has no application to the facts of the present case, because the borrowings were made by the assessee when this business was already going on and since according to section 36(1)(iii), amount of interest paid in respect of capital borrowed for the purpose of business is allowable deduction, the disputed amounts of interest should be treated as revenue expenditure. For this proposition, the assessee has placed reliance upon the decision given by the Supreme Court in India Cements Ltd. v. Commissioner Of Income Tax, Madras.. ([1966] 60 ITR 52 (SC)) and the Bombay decision in Calico Dyeing and Printing Works v. Commissioner of Income-tax ([1958] 34 ITR 265, 270 (Bom)).

13. We shall first analyse the facts of the Bombay case because these facts are found to be quite apposite to the facts of the present case. In the Bombay case the assessee-firm which carried on business of bleaching, dyeing and printing cloth, borrowed money in the year of account in order to expand its business, purchase land and erect additional plant and machinery and paid interest on borrowed capital. In this assessment to income-tax in the relevant assessment year the claim of the assessee to deduction of interest so paid under section 10(2)(iii) of the Indian Income-tax Act, 1922, was rejected on the ground that the plant and machinery were not used for business in the year of account. The High Court held that the assessee was entitled to deduction claimed even though the plant and machinery were not used in the year of account. While coming to this conclusion, the High Court observed that where the assessee claims deduction of interest paid on capital borrowed under section 10(2)(iii) of the Indian Income-tax Act, 1922, all that the assessee has to show is that the capital which was borrowed was used for the purpose of the business of the assessee in the relevant year of account. The High Court further observed that it did not matter that the capital was borrowed in order to acquire a revenue asset or a capital asset. Following are the pertinent observations which are made in that judgment :

"Before we look at the authorities, it would perhaps be best to turn to the section itself, and the deduction which is permissible under section 10(2)(iii) is 'in respect of capital borrowed for the purposes of the business, profession or vocation, the amount of the interest paid'. Now it will be noticed that the sub-section makes no distinction between capital borrowed in order to acquire a revenue asset and capital borrowed to acquire a capital asset. All that the section requires is that the assessee must borrow the capital and the purpose of the borrowing must be for the business which is carried on by the assessee in the year of account. The capital must be borrowed for the purpose of no other business except the business which is being assessed. Now, when we look at the other sub-clauses of section 10(2), it is clear that the underlying idea of these sub-clauses is that the particular deduction claimed must be in relation to the business which is referred to in sub-section (1) of section 10, that is, the business in respect of which tax is payable by an assessee ..... We are prepared to agree with Mr. Joshi that, looking to the whole scheme of sub-section (2), the capital which is borrowed must be used in the year of account. If the capital is used in the year of account and the use is for the purpose of the business, then it is immaterial whether the user of capital actually yields profit or not. What sub-clause (ii) emphasises is the user of the capital and not the user of the asset which comes into existence as a result of the borrowed capital ..... Unlike section 10(2)(xv) which expressly excludes an expense of a capital nature, the legislature has made no distinction in section 10(2)(iii) between capital borrowed for a revenue purpose and a capital purpose. An assessee is entitled to claim interest paid on borrowed capital provided it is for the purpose of the business irrespective of what may be the result of using the capital which he has borrowed."

14. These observations show that when for the purpose of a running business an assessee borrows some amount then it is immaterial for the purpose of section 10(2)(iii) of the Act of 1922 to consider whether the borrowed amount was invested for the purpose of obtaining an asset of enduring nature or was spent for revenue. The facts of the present case are exactly similar to the facts of the Bombay case, because here also the assessee's business was a going concern at Baroda and what the assessee has done is to expand its business by establishing a new separate unit at Bangalore. Thereafter, whatever borrowing was made by the assessee for the purpose of establishing a separate unit at Bangalore, the interest paid on such borrowing would, on the ratio of the above judgment of the Bombay High Court be covered by the provisions of section 10(2)(iii) for the simple reason that the said borrowing was for the purpose of the business which the assessee carried on, as section 36(1)(iii) of the Act 1961, with which we are concerned in this reference is equivalent to section 10(2)(iii) of the Act of 1922.

15. We find that practically the same view is taken by the Supreme Court in India Cements Ltd. v. Commissioner Of Income Tax, Madras.. ([1966] 60 ITR 52 (SC)). Therein the facts were that the assessee had obtained a loan of Rs. 40,00,000 from the Industrial Finance Corporation of India secured by a charge on its fixed assets. The reported judgment shows that a part of this loan was utilised in repaying the loans taken from other parties. The assessee had, in connection with this loan, spent the amount of Rs. 84,633 towards stamp duty, registration fees, lawyers fees, etc., and claimed this amount as business expenditure. The Income-tax Officer disallowed the claim of the assessee and considered the expenditure as capital expenditure. Ultimately, the matter went to the High Court and the High Court held that an amount of Rs. 2,00,000 out of the borrowed amount was spent for the purpose of capital nature in order to bring into existence capital assets. The High Court, therefore, concluded that the expenditure in question was not of revenue nature. The Supreme Court considered a number of cases and overruled many decisions which had taken a view that the expenditure of this type was of capital nature. Speaking about the question whether borrowing of this type can be treated as the asset or advantage of an enduring nature, the Supreme Court, while discussing the decision given by the Calcutta High Court in Sri Annapurna Cotton Mills Ltd. v. Commissioner of Income-tax ([1964] 54 ITR 592 (Cal)), observed as under ([1966] 60 ITR 52, 62, 63 (SC)) :

"But we are unable to agree that a loan obtained can be treated as an asset or advantage for the enduring benefit of the business of the assessee. A loan is a liability and has to be repaid and, in our opinion, it is erroneous to consider a liability as an asset or an advantage within the test laid down by Viscount Cave and approved and applied by this court in many cases."

16. The Supreme Court has summarised this test in the following words ([1966] 60 ITR 52, 62, 63 (SC)) :

"To summarise this part of the case, we are of the opinion that : (a) the loan obtained is not an asset or an advantage of an enduring nature; (b) that the expenditure was made for securing the use of money for a certain period; and (c) that it is irrelevant to consider the object with which the loan was obtained. Consequently, in the circumstances of the case, the expenditure was revenue expenditure within the meaning of section 10(2)(xv)."

17. This decision of the Supreme Court makes it clear that where for the purpose of a running business a borrowing is made, then the loan obtained by the said borrowing is not to be considered as an advantage of an enduring nature and that the consideration of the object with which the loan was obtained is irrelevant. If that be so, in this case also it can be said that even if the disputed borrowings were made by the respondent-assessee with the object of establishing a new industrial unit at Bangalore, the interest paid by it on those borrowings cannot be treated as the capital expenditure if it is found that the borrowings in question were for the purpose of its running business. Now, it cannot be disputed that the borrowings were for the purpose of business which the assessee was already running at Baroda, when it decided to establish a new industrial unit at Bangalore, because, though the unit at Bangalore was to be newly established, it was merely the expansion of the existing business, which was carried on by the assessee at Baroda.

18. It is thus evident that the facts of the present case are completely covered by the above referred two decisions, one of the Bombay High Court, and the other of the Supreme Court.

19. The question which still remains to be considered is whether, in spite of the above referred two decisions, any difference in the legal situation is made by the recent decision of the Supreme Court in Challapalli Sugars Ltd. v. Commissioner of Income-tax ([1975] 98 ITR 167 (SC)). In order to understand the ratio of the decision in Challapalli Sugars Ltd.'s case ([1975] 98 ITR 167 (SC)), and with a view to see how far the said ratio is in harmony with the ratio of the above referred decision of the Supreme Court in India Cements Ltd.'s case ([1966] 60 ITR 52 (SC)), it would be necessary to state shortly the facts relating to that decision. There the assessee was a public limited company engaged in the manufacture and sale of sugar. The company went into production on January 22, 1958. It had borrowed considerable sums of moneys from the Industrial Finance Corporation of India for the installation of machinery and plant. During the accounting period, the company paid Rs. 2,38,614 as interest and claimed that the said payment should be treated as part of the cost of the machinery and plant installed by it, and the depreciation should be calculated accordingly. The Income-tax Officer rejected this claim of the company and held that the interest paid by the company from year to year was revenue expenditure. The matter eventually went to the Andhra Pradesh High Court which held that where a plant is constructed out of borrowed money, the interest on loan up to the date of the commencement of the business could not be capitalised or treated as part of the actual cost of the plant. The Supreme Court rejected this view of the High Court on consideration of the question as to what was the "actual cost" for the purpose of determining "written down value" of a plant. The Supreme Court considered the principles of accountancy and held that the cost of fixed assets should include all expenditure necessary to bring such assets into existence and to put them in working condition and, therefore, in case money is borrowed by 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 fixed assets which have been created as a result of such expenditure.

20. Relying upon this decision, Shri Kaji contended on behalf of the revenue that the new plant installed by the assessee in our case had not gone into production in the accounting period and hence the interest paid on the borrowings made for the purpose of the installation of that plant would go to argument the cost of the plant so installed, and should, therefore, be treated as capital expenditure. He also submitted that whatever be the previous position in law regarding the interest paid on borrowings, the said position is changed in view of the decision given by the Supreme Court in Challapalli Sugars Ltd.'s case ([1975] 98 ITR 167 (SC)).

21. It is no doubt true that in the case of Challapalli Sugars Ltd. ([1975] 98 ITR 167 (SC)) the Supreme Court has unequivocally observed that interest paid on the borrowing utilised to bring into existence a fixed asset which has not gone into production goes to add to the cost of installation of that asset. But these observations have been made with reference to a situation wherein it was not possible to contend that the borrowing on which interest was paid was made for the purpose of any business. The company which had made the borrowing in that case had not yet started production, and hence had not commenced any business when it borrowed the amount in question. Therefore, it was not possible to say in that case that the borrowing was made "for the purposes of the business" to bring the case within the ambit of section 10(2)(iii) of the Indian Income-tax Act, 1922 (which is equivalent to section 36(1)(iii) of the Act of 1961). If the said borrowing was not "for the purpose of business" inasmuch as no business had come into existence, it must follow that it was made for the purpose of acquiring an asset which could be put to use for doing business, and hence interest paid on such borrowing would go to add to the cost of the assets so acquired.

22. Such is the line of reasoning which can be spelt out from the decision of the Supreme Court in Challapalli Sugars Ltd.'s case ([1975] 98 ITR 167 (SC)). The question is, is this line of reasoning inconsistent with the view taken by the Bombay High Court in Calico Dyeing and Printing Works ([1958] 34 ITR 265 (Bom)), or by the Supreme Court in India Cements Ltd. ([1966] 60 ITR 52 (SC)) ? On proper analysis the reasoning on which the view taken by the High Court of Bombay and the Supreme Court in the above referred cases rests is as under :

section 10(2)(iii) of the Act of 1922 allows deduction of interest on all borrowings which are made "for the purposes of business". The expression "purposes of business" is comprehensive enough to cover expenditure of revenue nature as well as of capital nature because both the types of expenditures can be incurred for business purposes. Therefore, even if a borrowing is made for incurring an expenditure of capital nature, it remains the borrowing for a business purpose. If that is so, the requirements of section 10(2)(iii) of the Act of 1922 are fully satisfied and interest paid on such borrowing is entitled to deduction as revenue expenditure. The High Court of Bombay has unequivocally stated in Calico Dyeing and Printing Works ([1958] 34 ITR 265 (Bom)) that in order to attract the provisions of section 10(2)(iii) it does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all that the section requires is that the assessee must borrow the capital for the purpose of his business. This dichotomy between the borrowing of a loan and actual application thereof in the purchase of a capital asset, seems to be on the ground that a mere transaction of borrowing does not, by itself, bring any new asset of enduring nature into existence, and that it is the transaction of the investment of the borrowed capital in the purchase of the new asset which brings that asset into existence. Sine the transaction of borrowing is not the same as the transaction of investment, the Supreme Court has observed in India Cements Ltd. v. Commissioner Of Income Tax, Madras.. ([1966] 60 ITR 52 (SC)) that, for considering whether payment of interest on a borrowing is revenue expenditure or not, the purpose for which the borrowing is made is irrelevant. Thus, the decisions of the Bombay High Court in Calico Dyeing & Printing Works ([1958] 34 ITR 265 (Bom) and of the Supreme Court in India Cements Ltd. ([1966] 60 ITR 52 (SC)) were given with reference to the borrowings made for the purposes of running businesses, while the decision of the Supreme Court in Challapalli Sugars Ltd. ([1975] 98 ITR 167, 178 (SC)) was given with reference to the borrowings which could not be treated as made for the purposes of business, as no business had yet been commenced. Thus, there is no incompatibility between these decisions. The Supreme Court itself has distinguished its earlier decision in India Cements Ltd. ([1966] 60 ITR 52 (SC)) in the following terms in Challapalli Sugars Ltd. ([1975] 98 ITR 167, 178 (SC)) :

"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 present 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 of including the interest paid on the loan before the commencement of business in the actual cost of the plant did not arise in that case."

23. In view of this, we conclude that the decisions of the Bombay High Court in Calico Dyeing & Printing Works ([1958] 34 ITR 265 (Bom)) and of the Supreme Court in India Cements Ltd. ([1966] 60 ITR 52 (SC)), hold the field with equal force, even after the decision in Challapalli Sugars Ltd. ([1975] 98 ITR 167, 178 (SC)). We can state the ratio of all these three decisions as under :

(1) Where a borrowing is made for the purposes of a business, the interest paid on such a borrowing becomes eligible to deduction contemplated by section 10(2)(iii) of the Act of 1922 or section 36(1)(iii) of the Act of 1961.

(2) This would be so, even if the capital is invested in order to acquire a revenue asset or a capital asset, because the act of borrowing capital is distinct from the act of investment of that capital to acquire an asset.

(3) However, the business for which an asset of enduring nature is purchased with the borrowed capital should not be separate or distinct from the business for the purposes of which the capital is borrowed if deduction under section 10(2)(iii) is to be allowed.

(4) If there is no existing business with reference to which the capital is borrowed and the borrowed capital is invested to purchase a new asset of enduring nature, then the interest paid on such borrowing till the asset so purchased goes into production, increases the cost of the installation of the said asset, and hence should be treated as capital expenditure not covered by section 10(2)(iii) of the Act of 1922 or section 36(1)(iii) of the Act of 1961.

24. In view of this we find on question No. 2 that in this case the amounts of interest are allowable as revenue expenses.