S.H Kapadia, J.— For the sake of convenience we state the facts occurring in Civil Appeals Nos. 3952-55 of 2002, Dy. CIT v. Core Health Care Ltd.
2. These civil appeals are directed against judgment and order dated 25-4-2001 delivered by the Gujarat High Court in Tax Appeals Nos. 449 and 450 of 2000 and in Civil Applications Nos. 53 and 54 of 2001 whereby the Department's appeals, under Section 260-A of the Income Tax Act, 1961, stood dismissed.
3. On 31-12-1992 the assessee filed its return of income for AY 1992-1993 declaring “nil” income. Later on the assessee filed a revised return on 6-8-1993 declaring a loss of Rs 1,11,68,543. The assessee Company is engaged in the business of manufacturing and sale of intravenous solutions. For the assessment year under consideration the assessee claimed deduction towards expenses aggregating to Rs 2,12,05,459 which included interest on borrowings of Rs 1,56,76,000. During the assessment year under consideration the assessee had installed new machinery. AO vide assessment order dated 30-3-1995 disallowed the amount of Rs 1,56,76,000 placing reliance on the judgment of this Court in Challapalli Sugar Ltd. v. CIT (1975) 3 SCC 572, (1975) 98 ITR 167 inter alia, on the ground that during the assessment year under consideration the assessee had installed new machinery on which production had not started. On appeal, vide order dated 15-11-1996, CIT (A) confirmed the addition of interest amount on borrowings of Rs 1,56,76,000. Therefore, both the authorities, namely, AO and CIT (A) added the said amount of Rs 1,56,76,000 to the income of the assessee. The matter was carried in appeal by the assessee. Vide order dated 6-6-2000 the Tribunal held that the Department was not justified in adding Rs 1,56,76,000 to the income of the assessee. In other words, the Tribunal held that AO was not justified in making disallowance of Rs 1,56,76,000 in respect of borrowings utilised for purchase of machinery. This decision was confirmed by the High Court, hence these civil appeals are filed by the Department.
4. The following question of law has been placed before us for determination:
“Whether interest paid in respect of borrowings on capital assets not put to use in the financial year concerned can be permitted as allowable deduction under Section 36(1)(iii) of the Income Tax Act, 1961?”
5. According to the Department, the assessee was not entitled to treat the interest on borrowings as revenue expenditure. According to the Department, in view of Explanation 8 to Section 43(1) of the Income Tax Act, 1961 (for short “the 1961 Act”) the assessee was not entitled to claim deduction for interest on borrowings, particularly, when the machines were not put to use during the assessment year under consideration. According to the Department, provisions of Section 36(1)(iii) of the 1961 Act were required to be harmoniously construed along with the provisions of Explanation 8 to Section 43(1) regarding actual cost. According to the Department provisions of Section 36(1)(iii) being general in nature had to give way to the special provisions contained in Explanation 8 of Section 43(1) of the 1961 Act.
6. At the outset, we may clarify that before the High Court it was not the case of the Department that a new business was set up or commenced during the assessment year under consideration. It was undisputed before the High Court that three additional machines were installed by the assessee during the assessment year under consideration for the production of intravenous injectibles. It was not in dispute that the assessee had borrowed monies during the accounting year commencing from 1-4-1991 to 31-3-1992.
7. We quote hereinbelow Section 36(1)(iii) and Explanation 8 to Section 43(1) of the 1961 Act which read as follows:
“36. Other deductions.—(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in Section 28—
(iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession:
Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.
Explanation.—Recurring subscriptions paid periodically by shareholders or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause;
43. Definitions of certain terms relevant to income from profits and gains of business or profession.—In Sections 28 to 41 and in this section, unless the context otherwise requires—
(1) ‘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 any other person or authority:
Provided that where the actual cost of an asset, being a motor car which is acquired by the assessee after the 31st day of March, 1967 but before the 1st day of March, 1975, and is used otherwise than in a business of running it on hire for tourists, exceeds twenty-five thousand rupees, the excess of the actual cost over such amount shall be ignored, and the actual cost thereof shall be taken to be twenty-five thousand rupees.
Explanation 8.—For the removal of doubts, it is hereby declared that where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use shall not be included, and shall be deemed never to have been included, in the actual cost of such asset.”
8. Interest on monies borrowed for the purposes of business is a necessary item of expenditure in a business. For allowance of a claim for deduction of interest under the said section, all that is necessary is that — firstly, the money i.e capital, must have been borrowed by the assessee; secondly, it must have been borrowed for the purpose of business; and, thirdly, the assessee must have paid interest on the borrowed amount (see Calico Dyeing & Printing Works v. CIT (1958) 34 ITR 265 (Bom)). All that is germane is: whether the borrowing was, or was not, for the purpose of business.
9. The expression “for the purpose of business” occurring in Section 36(1)(iii) indicates that once the test of “for the purpose of business” is satisfied in respect of the capital borrowed, the assessee would be entitled to deduction under Section 36(1)(iii) of the 1961 Act. This provision makes no distinction between money borrowed to acquire a capital asset or a revenue asset. All that the section requires is that the assessee must borrow capital and the purpose of the borrowing must be for business which is carried on by the assessee in the year of account. What sub-section (iii) 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 37 which expressly excludes an expense of a capital nature. The legislature has, therefore, made no distinction in Section 36(1)(iii) between “capital borrowed for a revenue purpose” and “capital borrowed for a capital purpose”. An assessee is entitled to claim interest paid on borrowed capital provided that capital is used for business purpose irrespective of what may be the result of using the capital which the assessee has borrowed. Further, the words “actual cost” do not find place in Section 36(1)(iii) of the 1961 Act which otherwise find place in Sections 32, 32-A, etc. of the 1961 Act. The expression “actual cost” is defined in Section 43(1) of the 1961 Act which is essentially a definition section which is subject to the context to the contrary.
10. In CIT v. Associated Fibre and Rubber Industries (P) Ltd. (1999) 2 SCC 309, (1999) 236 ITR 471 the Division Bench of this Court held as follows:
“4. … Even though the machinery has not been actually used in the business at the time when the assessment was made, the same has been treated as a business asset and it was purchased only for the purposes of the business. In the circumstances, the interest paid on the amount borrowed for purchase of such machinery is certainly a deductible amount.”
11. As stated above, the Department contended before us that the judgments of this Court, prior to insertion of Explanation 8 in Section 43(1) of the 1961 Act, have no application to the present case. According to the Department, Section 36(1)(iii) of the 1961 Act being general in nature has to give way to special provisions contained in Explanation 8 to Section 43(1) of the 1961 Act. According to the Department, in none of the earlier judgments this Court has considered the true scope of Explanation 8 to Section 43(1) vis-à-vis Section 36(1)(iii) of the 1961 Act. We find no merit in this contention.
12. Section 43 groups together all provisions in the nature of definitions or interpretations relevant to the computation of income under the head “Profits and gains of business”. Section 43(1) defines “actual cost”. The definition of “actual cost” has been amplified by excluding such portion of the cost as is met directly or indirectly by any other person or authority. Explanation 8 has been inserted in Section 43(1) by the Finance Act, 1986 (23 of 1986), with retrospective effect from 1-4-1974. It is important to note that the words “actual cost” would mean the whole cost and not the estimate of cost. “Actual cost” means nothing more than the cost accurately ascertained. The determination of actual cost in Section 43(1) has relevancy in relation to Section 32 (depreciation allowance), Section 32-A (investment allowance), Section 33 (development rebate allowance) and Section 41 (balancing charge).
13. “Actual cost” of an asset has no relevancy in relation to Section 36(1)(iii) of the 1961 Act. This reasoning flows from a bare reading of Section 43(1). Section 43 defines certain terms relevant to income from profits and gains of business and, therefore, the said section commences with the words “In Sections 28 to 41 and in this section, unless the context otherwise requires” “actual cost” shall mean the actual cost of the assets to the assessee, reducing by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. In other words, Explanation 8 applies only to those sections like Sections 32, 32-A, 33 and 41 which deal with concepts like depreciation. The concept of depreciation is not there in Section 36(1)(iii). That is why the legislature has used the words “unless the context otherwise requires”. Hence, Explanation 8 has no relevancy to Section 36(1)(iii). It has relevancy to the aforementioned enumerated sections. Therefore, in our view Explanation 8 has no application to the facts of the present case.
14. Before concluding on this point we may state that in this batch of civil appeals we are concerned with Assessment Years 1992-1993, 1993-1994, 1995-1996 and 1997-1998. A proviso has since been inserted in Section 36(1)(iii) of the 1961 Act. That proviso has been inserted by the Finance Act, 2003 w.e.f 1-4-2004. Hence, the said proviso will not apply to the facts of the present case. Further, in our view the said proviso would operate prospectively. In this connection it may be noted that by the same Finance Act, 2003 insertions have been made by way of proviso in Section 36(1)(vii-a) by the same Finance Act which is also made with effect from 1-4-2004. Same is the position with regard to insertion of a sub-section after Section 90(2) and before the Explanation. This insertion also operates w.e.f 1-4-2004. In short, the above amendments have been made by the Finance Act, 2003 and all the said amendments have been made operational w.e.f 1-4-2004. Therefore, the proviso inserted in Section 36(1)(iii) has to be read as prospectively and w.e.f 1-4-2004. In this case, we are concerned with the law as it existed prior to 1-4-2004. As stated above, we are not concerned with the interpretation or applicability of the said proviso to Section 36(1)(iii) w.e.f 1-4-2004 in the present case.
15. In Challapalli Sugar Ltd. (1975) 3 SCC 572, (1975) 98 ITR 167 this Court 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. It was further observed that 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.
16. In our view the above observations have to be confined to the facts in Challapalli Sugar Ltd. (1975) 3 SCC 572, (1975) 98 ITR 167 It was a case where the company had not yet started production when it borrowed the amount in question. The more appropriate decision applicable to the present case would be the judgment of this Court in India Cements Ltd. v. CIT (1966) 60 ITR 52 (SC) in which it has been observed that, for considering whether payment of interest on borrowing is revenue expenditure or not, the purpose for which the borrowing is made is irrelevant. In our view, Section 36(1)(iii) of the 1961 Act has to be read on its own terms. It is a code by itself. Section 36(1)(iii) is attracted when the assessee borrows the capital for the purpose of his business. It does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because of that what 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 proceed on the basis 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 investment of the borrowed capital in the purchase of a new asset which brings that asset into existence. The transaction of borrowing is not the same as the transaction of investment. If this dichotomy is kept in mind it becomes clear that the transaction of borrowing attracts the provisions of Section 36(1)(iii). Thus, the decision of the Bombay High Court in Calico Dyeing & Printing Works (1958) 34 ITR 265 (Bom) and the judgment of the Supreme Court in India Cements Ltd. (1966) 60 ITR 52 (SC) have been given with reference to the borrowings made for the purposes of a running business, while the decision of the Supreme Court in Challapalli Sugar Ltd. (1975) 3 SCC 572, (1975) 98 ITR 167 was given with reference to the borrowings which could not be treated as made for the purposes of business as no business had commenced in that case. Therefore, there is no inconsistency between the above decisions.
Conclusions
17. For the above reasons, we hold that AO was not justified in making disallowance of Rs 1,56,76,000 in respect of borrowings utilised for purchase of machines. Accordingly, the above question is answered in favour of the assessee and against the Department.
18. Apart from the above question under Section 36(1)(iii), the present civil appeals are filed by the Department against the decision of the High Court whereby the High Court has dismissed Civil Applications Nos. 53 and 54 of 2001 filed by the Department. It may be noted that during the pendency of Tax Appeals Nos. 449 and 450 of 2000, the Department had moved the above two civil applications for amendment of its memo of appeal raising substantial questions of law, namely—
(a) whether advertisement expenses incurred by the assessee to create a brand image with enduring benefit are allowable as revenue expenditure;
(b) whether the Tribunal had erred in granting deduction under Section 35-D regarding short-term loan, in view of Explanation to Section 35-D(3) which refers only to long-term borrowings;
(c) whether the Tribunal had erred in directing deduction under Sections 80-HH and 80-I on the miscellaneous income of Rs 26,64,113 being income on sale of empty containers?
19. Although the Department had moved the said Civil Applications Nos. 53 and 54 of 2001 during the pendency of Tax Appeals Nos. 449 and 450 of 2000 well within limitation the High Court without answering the above three questions summarily rejected Civil Applications Nos. 53 and 54 of 2001. We are of the view that the High Court had erred in dismissing the above two civil applications for amendment of the memo of appeal in Tax Appeals Nos. 449 and 450 of 2000. In our view the above three questions are substantial questions of law and, therefore, the High Court ought to have decided those questions.
20. Accordingly, we remit the above three questions to the High Court for fresh consideration by it in accordance with law. Accordingly, Civil Appeals Nos. 3952-55 of 2002 and Civil Appeals Nos. 8509-10 of 2002 filed by the Department are partly allowed with no order as to costs.