The Judgment of the Court was delivered by

D.K Seth, J.:— The question:

2. This appeal, under section 260-A of Income Tax Act arising out of the order dated 18th January, 1999 passed by the Income Tax Appellate Tribunal, A Bench, Calcutta in ITA No. 1422.Cal/1993 in respect of assessment year 1989–1990, was admitted on the following ground:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the interest on borrowed capital to the extent it was invested in immovable properties in question was not allowable as business expenditure under sections 36(1)(iii) and 37(1) of the Income Tax Act, 1961, and whether the finding of the Tribunal is perverse?”

Appellant's submission:

3. The learned counsel for the appellant contended that the Tribunal's finding was perverse having regard to the facts and circumstances of the case. He pointed out the perversity, leading us through the materials placed before this court. The immovable property was purchased for the purpose of business of the assessee who had already commenced the business. The interest paid on the borrowed capital for acquiring the immovable property, as an asset of the assessee, is a revenue expenditure. The business in real estate had commenced as soon the property was purchased and taken delivery of. It continues and steps into the second stage as soon construction started. Therefore, the interest paid on the borrowed capital is admissible to be deducted under section 36 sub-section (1) clause (iii) of the Income Tax Act, 1961. The rejection of the account on the ground that it was shown as advance against immovable property is immaterial. The assessee has its right to maintain his account in its own system. It is the nature and character of the account that has to be looked into for the purpose of imposing tax liability under the Act. The finding of the Tribunal is not a finding of fact but an inference drawn on the basis of the fact found. As such, it is a question of law as has been formulated. Though the assessee was carrying on business in shares and other materials, the memorandum of association included in its main object business in real estate. Therefore, the appeal should be allowed on the ground on which it is admitted and the order of the Tribunal should be set aside. The learned counsel for the appellant has relied on the decisions in Addl CIT, A.P v. Akkamba Textiles Ltd. . 1979 117 ITR 294 AP., Sivakami Mills Ltd. v. Commissioner Of Income-Tax, Madras. . 1979 120 ITR 211 Mad.., Addl. Commissioner Of Income-Tax, A.P v. Akkamba Textiles Ltd. . 1997 227 ITR 464 SC., Commissioner Of Income-Tax v. Rajeeva Lochan Kanoria. . 1994 208 ITR 616 Cal.., CIT Gujarat-I v. Saurashtra Cement and Chemical Industries Ltd. . 1973 91 ITR 170 Guj.., Sarabhai Management Corporation Ltd. v. CIT, Gujarat . 1976 102 ITR 25 Guj.., CIT v. Sarabhai Management Corporation Ltd. . 1991 192 ITR 151 SC., Cit, Kerala v. Associated Fibre & Rubber Industries (P) Ltd. . 1999 236 ITR 471 SC., Investment Ltd. v. Commissioner of Income Tax, Calcutta . 1970 77 ITR 533 SC., Sutlej Cotton Mills Ltd. v. CIT, WB . 1979 116 ITR 1 SC., CIT v. Berger Paints (India) Ltd. (No. 2), Mehta Parikh and Co. v. CIT, Bombay, Edwards (H.M Inspector of Taxes) v. Bairstow and Harrison.

Respondents contention:

4. The learned counsel for the respondent, on the other hand, contends that there is nothing to indicate in the profit and loss account that this property was a stock-in-trade. It was shown in the balance sheet as an advance against immovable property. Therefore, this cannot be a revenue expenditure. The learned counsel for the respondent further contended that the business has not commenced since there is nothing to indicate in the balance sheet that any business was in progress in respect of the same. He had also pointed out from the memorandum of association that the business in real estate was never carried on. It was only the business in shares that was being carried on. There is nothing in the report of the company or anywhere else that the assessee was carrying on business in real estate. The learned counsel for the respondent had further contended that this is a question of fact and no question of law is involved. He distinguished the decisions cited by the learned counsel for the appellant, and contended that these decisions do not help the appellant. He cited decisions in Challapalli Sugars Ltd. v. CIT, A.P, Commissioner Of Income-Tax v. India Steamship Co. Ltd., Dey's Medical Stores Manufacturing Pvt. Ltd. v. Commissioner of Income Tax, and Ritz Continental Hotels Ltd. v. Commissioner of Income Tax, Central II, Calcutta, in order to support his contention.

Appellant's reply:

5. The learned counsel for the appellant, however, in reply contended that the four decisions cited by the learned counsel for the respondent has no manner of application in the present case. The decision in Commissioner Of Income-Tax v. India Steamship Co. Ltd. (supra) is distinguishable on facts. He had also pointed out from the balance sheet that the interest paid on the borrowed capital has been shown in the balance sheet as against capitals and assets. It is an expenditure and, as such, could not be shown in the profit and loss account. There is no scope of showing business-wise account, as contended by the learned counsel for the respondent. The learned counsel for the appellant further contended that Company's Act does not provide for inclusion of such statement in any of the statement or report of the company. Therefore, the contention of the learned counsel for the respondents should not be given much importance.

The principle:

6. Whether the deduction under section 36(1)(iii) is available or not is dependent on the question whether the capital borrowed is for the purpose of the business of the assessee. If it is found that the capital was borrowed for the purpose of the business of the assessee, the interest payable thereon, is admissible under the said section. It is immaterial whether the same is in the nature of capital expenditure or revenue expenditure. If the expenditure is a business expenditure relates to any of the stage of the business activity carried on by the assessee, whether isolated transaction or not, is admissible for deduction under the said section. A business commences with the activities undertaken even at the preparatory stage for setting up of the business. Acquisition of immovable property for being used in the business by borrowed capital entitles the assessee to claim benefit of the section on the interest paid thereon, even if the asset acquired is not utilized for the purpose of business in the relevant previous year. The finding arrived at drawing an inference on the proved facts is a question of law within the scope of examination under section 260-A where the decision of the authority seems to be perverse either on account of misconception of law or misreading of the facts in the matter of drawing inferences from admitted facts.

7. Whether the amount is a capital expenditure or a revenue expenditure is immaterial if it is a stock-in-trade even though it is immovable property for being built upon. Business commences on the first step for commencement of the business if undertaken. In the business of real estate, there are three stages; one is the acquisition of land and other is the process of construction of building and the third is the actual distribution or sale of the building. Similarly, in other business also there are three stages. Here at the first stage, it has been acquired and works were in progress. Respondent's counsel contended that there is nothing to indicate that the works were in progress. It is not necessary to show that the work is in progress. It is the nature of the expenses that would determine the character in whatever manner it might be shown in the accounts of the assessee. In this case the question was at the second stage and as such the business shall be deemed to have been commenced.

8. The meaning of the expression ‘business’ has been disputed by the learned counsel for the respondent. In our view, ‘business’ is an adventure or undertaking to gain profit out of the transaction. Even if it is one transaction, still then it is an adventure and a business. If someone starts a business and then leaves it after one transaction, even then it would be a business. As such a sporadic action cannot be singled out to discard that it is not part of the business. Therefore, the contention of the learned counsel for the respondent cannot be accepted. In order to support the contention, we may beneficially refer to the decision in Edwards (H.M Inspector of Taxes) v. Bairstow and Harrison.

The facts:

9. In this case the assessee had purchased two immovable properties being land at Gurgaon, Haryana and a flat at Shibpur, Howrah. The memorandum of association in its object clause 5 (page 25 of the Paper Book) provides for undertaking of business in real estate. The property was purchased in the earlier year. Interest on the borrowed capital was allowed under section 36(1)(iii) in the earlier year. It was claimed in the previous year. This has since been disallowed. According to the memorandum of association, one of the main objects of the company was to carry on business in real estate. This is so provided in paragraph 5 of the memorandum of association (page 25 of the Paper Book). This has commenced on the acquisition of the land or the flat. It is not necessary to show that it is intended for sale or otherwise. The fact remains that by 1994, the house constructed on the land and the flat were sold and shown in the return for the relevant year. This was shown as profit from business. Be that as it may, it is not necessary to prove how it was dealt with at this stage of assessment. In the decision in Associated Fibre and Rubber Industries (P) Ltd., (supra), it was held that where the machinery acquired through borrowed capital had not been actually used in the business at the time when the assessment was made, even then the same are to be treated as business assets having been purchased for the purpose of business only. Therefore, the interest paid on the amount borrowed for the purchase of such machinery is an amount deductible, once the other ingredients are fulfilled. It is shown in the balance sheet under the capital and asset heading as an asset but not a stock-in-trade. The description in the books of accounts would be immaterial. If it is a stock in trade, in that event, the amounts invested would be a revenue expenditure and not a capital expenditure.

10. The Tribunal had proceeded on the basis that the business has not commenced and that it is the capital expense that was shown as advance against the immovable property. Therefore, it cannot be a borrowed capital entitling the assessee to the benefit of section 36(1)(iii) in respect of the interest paid thereon.

Revenue or Capital expenditure: Immaterial:

11. In Bombay Steam Navigation Co. (1953) Pvt. Ltd. v. CIT, Bombay, where it was held that the expression “profits or gains” includes revenue outgoing and capital outgoings. Interest paid in respect of capital borrowed is admissible for deduction under section 10(2)(iii) of the Income Tax Act, 1922, which is pari materia similar to section 36(1)(iii) of the 1961 Act. In State of Madras v. G.J Coelho, it was held that payment of interest in respect of capital borrowed for acquiring assets to carry on business must be regarded as revenue expenditure in commercial practice and should not be termed as capital expenditure. The interest paid need not, however, borrow the character of a revenue outgoings to be admissible as allowance under clause (iii) of section 36(1), but the interest must be paid in respect of capital borrowed. In Addl. CIT, A.P v. Akkamba Textiles Ltd., it was held that the question whether a particular expenditure is revenue expenditure incurred for the purpose of business must be viewed in the larger context of business necessity or expediency. The transaction of acquisition of assets closely related to the commencement and carrying on of business by an assessee is admissible for deduction. The SLP against this decision was dismissed by the Apex Court (1997) 227 ITR 464 (SC).

12. In Challapalli Sugars Ltd. v. CIT, A.P, it was held that the interest paid before the commencement of production, an amount borrowed by the assessee for the acquisition and installation of plant and machinery forms part of the actual cost of the assets to the assessee within the meaning of expression in section 10(5) of the 1922 Act entitling the assessee to depreciation allowances and development rebate with reference to such interest also. In Sivakami Mills Ltd. v. Commissioner Of Income-Tax, Madras., it was held that purchase of machinery by the assessee for the purpose of business is allowable as revenue expenditure. In Rajeeva Lochan Kanoria, (supra) it was held that the enquiry that is to be made is whether the payment of interest was in respect of the capital borrowed for the purpose of assessee's business. The amount borrowed may be utilized for the purpose of acquisition of stock-in-trade or for the purpose of acquisition of capital assets. So long the money is utilized for business purposes, the interest is allowable as deduction. It is well settled that business expenditure is not confined to expenses incurred on revenue account. Capital expenditure may not be allowed as a deduction under section 37 because the section specifically bars any deduction of expenditure of capital nature. But section 36 is differently worded. There is no bar in section 36(1)(iii) to allowance of interest paid in respect of capital borrowed, which has been utilized for purchase of capital assets. The position of law in this regard was explained in India Cements Ltd. v. CIT, and State of Madras v. G.J Coelho.

Commencement of business:

13. In CIT Gujarat-I v. Saurashtra Cement and Chemical Industries Ltd., it was held that business connotes a continuous course of activities, which go to make up the business need not be started simultaneously in order that the business may commence. The business would commence when the activity which is first in point of time and which must necessarily precede all other activities is started. A business activity consists of three stages: the first stage relates to the activity necessary for the purpose of acquiring the raw material and establishment of plant and machinery and the second activity comprise of the processing and manufacturing by using the raw material and the plants and machinery set up for the purpose and the third category consisted of the marketing thereof. The first in point of time lays the foundation for the second activity and the second activity when completed lays the foundation for the third activity. Therefore, the expenditure incurred for carrying on any of these activities including the first activity are also deductible in computing the profits and gains of the assessee for the relevant year when the activity is undertaken. In Sarabhai Management Corporation Ltd. v. CIT, the Gujarat High Court took the same view and held that the business commences with the first activity for acquiring by purchase or otherwise, immovable property. There may be an interval between the setting up of the business and the commencement of the business. All expenses incurred during that interval are also permissible for deduction. In CIT v. Sarabhai Management Corporation Ltd., the decision of the Gujarat High Court was affirmed and went a step ahead that even the activities at a preparatory stage is also admissible.

The nature of transaction, not the description, is material:

14. A tax payer is free to employ, for the purpose of his trade, his own method of keeping accounts. It was so held in Investment Ltd. v. Commissioner of Income Tax, Calcutta. The entires made by an assessee in his books of accounts are not determinative. What is necessary to be considered is the nature of the transaction. It was so held in the decision in Sutlej Cotton Mills Ltd. v. CIT, W.B It is now a settled law that if according to the revenue laws the assessee is entitled to treat a sum as a revenue expenditure, then the legal right of the assessee is not self-estopped by the treatment given by the assessee to it in its books of account. This ratio was propounded in CIT v. Berger Paints (India) Ltd. (No. 2).

Drawing of inference: Question of law:

15. It is contended that the question involved is a question of fact. In fact in order to appreciate the situation, it is necessary to find out the fact. Now after the facts are found, it is the inference that has to be drawn for the purpose of giving the benefit of section 36(1)(iii) or to treat the same as the particular component or factor of the business for the purpose of computing the income of the assessee on the basis of the return submitted. Therefore, by reason of drawing of inference, a particular item of expenditure may be treated differently. This drawing of inference is a question of law. In Mehta Parikh and Co. v. CIT, Bombay, it was observed that the facts proved or admitted may provide evidence to support further conclusions to be deduced from them, which conclusions may themselves be conclusions of fact and such inferences from facts proved or admitted could be matters of law. In Edwards (H.M Inspector of Taxes) v. Bairstow and Harrison, it was held that whatever test is adopted that is whether the finding that the transaction was not an adventure in the nature of trade is to be regarded as a pure finding of fact or as the determination of a question of law or of mixed law and fact. Whether the finding is perverse or that the authority has misdirected itself in law by a misunderstanding of the statutory language or otherwise, the determination cannot stand. The misdirection may appear upon the face of the determination. It is only to be examined whether it is an adventure towards trade and business and nothing else. Even if the adventure was an isolated transaction, still then it is part of the trade or business. Therefore, the contention that the question referred to is not a question of law as contended by the learned counsel for the respondent cannot be sustained.

Decisions cited by the respondents:

16. The learned counsel for the respondent relied upon Challapalli Sugars Ltd. v. CIT, A.P But this decision as discussed hereinbefore does not help him having regard to the facts and the circumstances of the case. He next relied upon Ritz Continental Hotels Ltd. v. Commissioner of Income Tax, Central II, Calcutta, in order to contend that interest paid on capital prior to the commencement of business would not be admissible. But the said decision is distinguishable on facts. In the said case the interest was payable on a sum spent by LIC with effect from 1st August, 1960 on a borrowed capital even before 18th May, 1961, the date the assessee company was incorporated. Therefore, this decision does not help him. He next relied on Dey's Medical Stores Manufacturing Pvt. Ltd. v. Commissioner of Income Tax. the facts of this case are also distinguishable. In this case the expenditure was spent on a new project, which was distinct and separate from the existing business. Therefore, the capital borrowed for a different business cannot be included in the existing business. Though, the same can be claimed in respect of the new project, if it was an assessee.

17. He had also relied on Commissioner Of Income-Tax v. India Steamship Co. Ltd. This case was related to grant of development rebate in respect whereof it was held that the interest paid before the ships were delivered includible in actual cost and interest payable after delivery of ships cannot be capitalized for the purpose of development rebate. A principle, which is completely different than that we are now considering.

Conclusion:

18. On facts as discussed above, we find that the order of the learned Tribunal suffers from perversity. Inasmuch as, no reasonable person could have drawn an inference on the facts that this is not the case, which could be covered under section 36(1)(iii). Therefore, in view of the decision in Cit, Kerala v. Associated Fibre & Rubber Industries (P) Ltd. (supra), the interest paid on the borrowed capital is liable for deduction under section 36(1)(iii) of the 1961 Act.

Order:

19. In the circumstances, we allow this appeal and set aside the order of the learned Tribunal. The first part of the question is answered in the negative in favour of the assessee and the second part is answered in affirmative in favour of the assessee.

20. The appeal is, thus, allowed. No costs.

21. All parties are to act on a signed xerox copy of this dictated order on the usual undertaking.

22. R.N Sinha, J.:— I agree.