Sen, J.:— This reference arises out of the income-tax assessment of New Central Jute Mills Co. Ltd., the assessee, in the assessment year 1958-59, the relevant previous year being the one ended on the 31st March, 1948. On an application of the Commissioner of Income-tax (Central), Calcutta, under s. 66(1) of the Indian I.T Act, 1922, the Tribunal has referred for the opinion of this court the following questions as questions of law arising out of its order:

“1. Whether, on the facts and in the circumstances of the case, the sum of Rs. 1,46,875 spent on the purchase of loom hours was an allowable revenue expenditure under the Indian Income-tax Act, 1922?

2. Whether, on the facts and in the circumstances of the case, the sum of Rs. 7,79,117 (sic) paid to the U.P Government as interest on moneys borrowed from it was allowable as a deduction against the interest income of Rs. 1,75,471 earned from the Central Bank of India Ltd.?”

2. The first question appears to be covered by a decision of this court in Commissioner Of Income-Tax (Central), Calcutta v. Empire Jute Company Ltd., [1974] 97 ITR 581 (Cal). Following the same, we answer the said question in the negative and in favour of the revenue. The facts relating to the other question as has been found and/or admitted in the proceedings are shortly as follows

3. The assessee, at the material time, was setting up a heavy chemical plant at Varanasi and in the relevant assessment year the said plant was under erection. Earlier, in or about 1955, the assessee had successfully negotiated with the Government of Uttar Pradesh and had obtained a loan of Rs. 1.45 crores for the purpose of setting up the said plant. Amounts received under the said loan had been kept in deposit with the Central Bank of India pursuant to the terms thereof till transfer or utilization thereof for the stipulated purpose.

4. During the year in question, the assessee earned a sum of Rs. 1,75,471 as interest from the amount received under this loan and kept in deposit with the Central Bank of India Ltd. In the same year the assessee paid to the Government of Uttar Pradesh a sum of Rs. 9,54,588 as interest. The difference between the interest earned and interest paid, viz., Rs. 7,79,117, was claimed by the assessee to be a revenue expense. The ITO disallowed the claim on the ground that such expenses had nothing to do with the existing business of the assessee in jute and related to a separate unit, viz., the chemical plant, which was still under erection and that business had not started till then.

5. Being aggrieved, the assessee preferred an appeal to the AAC who found that this specifically earmarked loan has been actually utilized for the purchase of machinery. He held that the payment was in the nature of capital expenditure and had been rightly disallowed by the ITO.

6. The assessee preferred a further appeal to the Income-tax Appellate Tribunal. It was contended that though the money had been utilised for capital expenditure the same being for the purpose of business, the interest paid by the assessee should be allowed as a deduction. It was claimed, in the alternative, that the amount of interest paid should, in any event, be allowed against the receipt of Rs. 1,75,471 from the Central Bank of India Ltd.

7. It was contended on behalf of the revenue that the loan was for a new business and the assessee's claim for allowance against the interest earned did not arise as such interest was not separately taxed.

8. The Tribunal did not accept the assessee's contention that the interest paid was deductible as a revenue expenditure, but it held that the amount paid by way of interest had to be allowed as a deduction as against interest earned from the Central Bank of India Ltd. in terms of the loan, the assessee had to keep the money in deposit in the said bank segregated from its other business assets. The interest earned from the said amount would be income from other sources. By adopting a different method of assess ment the ITO could not defeat the assessee's claim. As the sum of Rs. 1,75,471 is assessable under the head “Other sources” under s. 12 of the Indian I.T Act, 1922, the interest paid to the Government of Uttar Pradesh for the amount borrowed had to be deducted against the interest received. The difference would represent a loss under the head “Other sources” which would be admissible for set-off against income arising from other heads in the relevant year.

9. Mr. B.L Pal, learned counsel for the revenue, has contended before us that facts admitted in the instant case were, inter alia, that the money was borrowed by the assessee for a new business unit in the process of construction and erection. Interest paid by the assessee to the Government of Uttar Pradesh on the money borrowed, therefore, fell into the category of expenditure incurred before the commencement of production in the said new unit. Mr. Pal submitted that, on the principles of accountancy, both the money borrowed and the expenditure incurred should be capitalised and added to the cost of the fixed asset. This was the law as laid down by the Supreme Court in the case of Chattapalli Sugars Ltd. v. CIT, [1975] 98 ITR 167.

10. The facts in that case were that the assessee, a public limited company, went into production of sugar on the 22nd January, 19551. In the assessment year 1959-60, the corresponding accounting year ending on the 30th June, 1958, the assessee had paid interest of over Rs. 2 lakhs to the Industrial Finance Corporation of India on moneys borrowed for installation of machinery and plant calculated up to the 22nd January, 1958. The assessee contended that such interest should be treated as part of the cost of the machinery and plant. The contention of the assessee having been rejected by the Uttar Pradesh High Court, there was an appeal to the Supreme Court. The Supreme Court observed as follows (p. 175):

“It would appear……that the accepted accountancy rule for deter mining 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 which is in the pro cess 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 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.”

11. Mr. Pal also drew our attention to a subsequent decision of the Gujarat High Court in CIT v. Alembic Glass Industries Ltd., [1976] 103 ITR 715, where the court stated the ratio in several decisions including those of the Supreme Court in India Cements Ltd., [1966] 60 ITR 52 (SC) and Challapalli Sugars Ltd., [1975] 98 ITR 167 (SC) as follows:

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

(b) 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.

(c) 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 purpose of which the capital is borrowed if deduction under s. 10(2)(iii) is to be allowed.

(d) 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 s. 10(2)(iii) of the Act of 1922 or s. 36(1)(iii) of the Act of 1961.

12. Mr. R.N Bajoria, learned counsel for the assessee, submitted on the other hand the alternative contention of the assessee, namely, that the interest earned from the amount deposited with the Central Bank of India’ was the assessee's income from other sources and in order to earn such income the assessee had incurred expenditure being interest paid to the Government of Uttar Pradesh and, therefore, the said expenditure should be allowed against the income earned and the loss ascertained should be set off against the income of the assessee arising from other heads. In support of his contention, Mr. Bajoria cited the following decisions:

(a) CIT v. Bihar Spinning and Weaving Mills Ltd., [1953] 24 ITR 108 (Cal). The assessee in this case was in the process of setting up its spinning and weaving mills and had not commenced tusiness though it had some income by way of interest. Being assessed under s. 12 of the Act of 1922, the assessee claimed deduction of a number of items of expenditure which were disallowed by the revenue authorities. On appeal, the Tribunal allowed deduction of Rs. 6,000 on estimate. On a reference, it was held by this court that the only deduction which the assessee could claim was the expenses actually incurred in earning and collecting the interest and not expenses unconnected with the earning of the same.

(b) Commissioner Of Income-Tax, Madras v. S. Devaraj.*, [1969] 73 ITR 1 (Mad). In this case, s. 12(2) of the Indian I.T Act, 1922, was construed by the Madras High Court and it was held that an expenditure need not be obligatory nor incurred with a view to directly or indirectly result in the earning of income. It would be sufficient if the expenditure was incurred voluntarily on the ground of commercial expediency in order to facilitate indirectly the earning of the income. There must be a connection direct or indirect between the expenditure incurred and income earned and a nexus between the character of the expenditure and the earning of income. If the expenditure is not for the purpose of earning or is unrelated to or unconnected with the activity of earning, such income will not be allowed as deduction.

(c) CIT v. H.H Maharani Shri Vijaykuverba Saheb of Morvi, [1975] 100 ITR 67 (Bom). The facts in this case were that a settlor died within two years of creating a trust in favour of his son. The trustees became liable to estate duty and as accountable persons paid over Rs. 8 lakhs on account of such duty by borrowing from a bank. Interest was paid on the loan for the three assessment years before it was repaid. The amounts paid as interest were claimed as deduction against income earned under the head “dividend” and “interest on securities”. The Bombay High Court held that the expenditure incurred in the form of interest paid was an expenditure incurred solely for the purpose of earning the dividend or interest and the assessee was entitled to deduction under s. 12(2). The test was whether the expenditure incurred had any direct or indirect connection with the earning of the income or maintaining or preserving the income at the old rate. The trustees having borrowed money for the purpose of preserving the existing income, sufficient nexus between the expenditure incurred and the income earned had been established for the deduction of the expenditure.

(d) Seth R. Dalmia v. CIT, [1977] 110 ITR 644 (SC). In this case, the assessee, an individual, agreed to buy a large number of shares from a bank by a certain date. It was also agreed that if the shares were not taken delivery of by the stipulated date, the dividends, rights, bonus, etc., thereon would be held by the bank for the benefit of the assessee who would be liable to pay interest at an agreed rate on the purchase price of the said shares from the stipulated date of delivery till such delivery was actually obtained. If the assessee failed to take delivery of the shares then at the end of three years from the stipulated date the bank would be at liberty to sell the shares undelivered till then and to hold the assessee liable for the difference. The assessee purchased a large number of shares by borrowing over Rs. 44 lakhs from the bank and in the assessment year 1953-54, the previous year ending 30th September, 1952, paid a sum of Rs. 2,04,744 as interest while earning a dividend of only Rs. 95,654. The Supreme Court found that:

(a) A genuine and bona fide contract had been entered into between the parties pursuant whereto the assessee had raised the loan and paid the interest thereon.

(b) By such acquisition the dividends, rights, bonus, etc., in respect of the said shares came to be held for the benefit of the assessee.

(c) Without the loan, the assessee would not have been entitled to the dividend.

13. The Supreme Court held that there was a direct nexus between the expenditure incurred by way of interest paid and the earning of the dividend and that the assessee had clearly established that the expenditure had been incurred solely and wholly for the purpose of earning such bonus and dividend. Accordingly, the assessee was entitled to deduction of the amount of interest.

14. It appears to us that, in the instant case, the purpose of the assessee in obtaining the loan was to defray the cost of the said chemical plant which was in the process of erection. Under the agreement, the amount received on the said loan had to be utilised for the said plant and in fact the money was spent on machinery for the plant. Till the amount was utilised for the stipulated purpose, the assessee had agreed to keep the same in deposit with the Central Bank of India. It was not a term of the agreement that the amount had to be kept in a deposit account which would earn interest in the interim period.

15. According to law as settled by the Supreme Court in Challapalli Sugars Ltd., [1975] 98 ITR 167, the interest paid to the Government of Uttar Pradesh had to be capitalised and added to the cost of the said plant which was being set up. That being so the same amount could not be treated differently in the accounts of the assessee and converted into a loss by deducting therefrom the interest paid to the Government of Uttar Pradesh.

16. The assessee no doubt has succeeded in establishing that there was some connection or nexus between the interest paid to the Government of Uttar Pradesh and the interest earned from the Central Bank of India, such nexus being that both the items of interest were either earned or paid on the said amount of loan but the assessee has failed to establish that it was its purpose or one of its purposes to utilise the amount received on loan for earning interest. It also cannot be said that the assessee has established that the expenditure was incurred solely and wholly for the purpose of earning interest from the Central Bank of India. For the reasons given above the question No. 2 is answered in the negative and in favour of the revenue. There will be no order as to costs.

C.K Banerji, J.:— I agree.