Commissioner Of Income-Tax, Kerala v. Travancore-Cochin Chemicals Ltd.

Gopalan Nambiyar, J.:— The Income-tax Appellate Tribunal, Cochin Bench, has stated the following question of law and referred the same for our opinion, namely:

“Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the expenditure of Rs. 53,49,374 was part of the actual cost of the plant and machinery to the assessee under section 43(1) of the Income-tax Act, 1961, for purposes of development rebate as claimed by the assessee?”

2. The assessee is a limited company engaged in the manufacture of caustic soda, and incorporated in 1951. It had an old 40 tonne plant for the purpose. A new 60 tonne caustic soda plant was acquired and installed by the company and commenced production from November 15, 1967. For the accounting year ending March 31, 1968 (assessment year 1968-69), the Income-tax Officer allowed depreciation on the full cost of the new machinery and plant as claimed by the assessee. But regarding development rebate, he noted that the actual cost of the plant, according to the assessee's claim, included a sum of Rs. 32,65,605 as interest on loans and other charges for the project up to November 15, 1967. We are not concerned with the rest of the items claimed. This amount was rejected by the officer as not forming part of the “actual cost” for the purpose of development rebate. Similarly, in respect of a rectifier plant forming part of plant and machinery the book-cost for installation was Rs. 25,99,861. This included proportionate interest charges on loans to the extent of Rs. 4,70,740. The Income-tax Officer disallowed this amount as not forming part of the “actual cost” to the assessee. On appeal, the Appellate Assistant Commissioner concurred in rejecting the claim for interest under these two heads. On further appeal, the Tribunal held that the assessee's claim for inclusion of interest as part of the actual cost to the assessee for the purpose of development rebate was valid, and upheld the same. The assessee's appeal was allowed. The question of law, noticed above, was formulated and sent up to this court for opinion.

3. Section 33 of the 1961 Act provides for development rebate and it is enough to notice broadly that the same is allowed at a certain per cent, of the “actual cost to the assessee”. Section 43(1) states that actual cost means the actual cost 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. section 43(1) of the Income-tax Act, 1961, defines “actual cost” as follows:

“‘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.”

4. Section 10(2)(vi) of the Indian Income-tax Act of 1922 is the precursor of this section. Sub-section (5) of the said section explains the meaning of certain expressions used in sub-section (2). The same contained an Explanation which laid down the meaning of the expression “actual cost”. Under the said Explanation the term means actual cost reduced by that portion which had been met by the Government or any public or local authority.

5. In the light of the above provisions, we have to decide the question whether, when an assessee erects a plant or machinery or building with borrowed capital, the interest paid on the loan or capital borrowed, is part of the “actual cost to the assessee” for erecting the same. There appears to be a conflict of judicial opinion on the point. In Birmingham Corporation's case [1935] 3 ITR Eng Cas 26, 30 the question arose under the English law regarding the allowable deduction on the cost of certain constructions. It was held that, on the terms of the English rule, this could be allowed at a certain rate of the “actual cost to the assessee”. Both the aspects of the expressions underlined*, namely, “actual cost” and “to the assessee” were elucidated by the House of Lords. Lord Atkin, who spoke for the House, observed:

“The word ‘actual’ itself gives me no assistance. It serves, as counsel suggested, to give emphasis to the word following. It is to be the cost, the whole cost, and nothing but the cost. It removes any question of estimate, and in cases where the plant has been purchased for a lump sum together with factory premises it may give rise to a difficult question of fact. The word ‘actual’ is used in the same emphatic sense in rule 3 in respect of actual wages, actual expenditure and actual loss. I do not read actual cost to mean anything more than cost accurately ascertained.

But it is said that the words ‘to the person’ in the phrase ‘actual cost to the person’ plainly indicate that the section is intending to confine the relief to an aggregate equal to the sum of money which the person has defrayed out of his own resources, the cost of the burden which has ultimately fallen upon him. I confess I do not think that this is the natural meaning of the words. What a man pays for construction or for the purchase of the work seems to me to be the cost to him; and that whether someone has given him the money to construct or purchase for himself; or before the event has promised to give him the money after he has paid for the work; or after the event has promised or given the money which recoups him what he has spent.”

6. The observations of Lord Atkin are found quoted in most of the judgments on this part of the law. In Commissioner of Income-tax v. Poona Electric Supply Co. Ltd., a Division Bench of the Bombay High Court (Kania and Chagla JJ.) had to consider the question whether contributions received from the Government by the assessee, an electric supply company, were part of the capital cost of constructing the new supply line, or were trading receipts. It was held that they were capital receipts and not trading receipts, and, therefore, not assessable to tax in the hands of the assessee. It was further held that the contributions formed part of “the actual cost to the assessee” within the meaning of section 10(5) of the Indian Income-tax Act, 1922. Chagla J., who delivered the judgment of the court, noticed the English decision in Birmingham Corporation v. Barnes [1935] 3 ITR Eng Cas 26, and observed that the scheme of depreciation in the English Act is slightly different from that under our Act. It was held that the Government contribution could not be excluded from the actual cost to the assessee. In Habib Hussein v. Commissioner Of Income-Tax, Bombay City I. [1963] 48 ITR 859 Bom., a Division Bench of the Bombay High Court had to consider the extent of the depreciation allowance which could be claimed by the assessee in that case, in respect of a cinema theatre and several depreciable assets acquired or erected by it, for the purpose of carrying on its business of running the “Liberty Cinema”. The assessee, for starting its business, had entered into an agreement with the owner of the plot of land on 4th June, 1948. The owner agreed to help the assessee to prepare suitable plans for the cinema theatre and other buildings, obtained permission from the municipality for constructing an additional sixth floor, and procure the necessary finance to enable the assessee to complete the construction of a modern theatre and other buildings and process the matters at every stage. In consideration of the services and assistance rendered by the owner, the assessee agreed to give the owner a sum of Rs. 3,30,000 within a period of five years by 20 quarterly instalments of Rs. 16,500 each. The amount of Rs. 3,30,000 was debited by the assessee at the close of the accounting year, 31 st March, 1950. For the assessment years 1950-51, 1951-52 and 1952-53, the assessee claimed that the sums should be included in the actual cost of all depreciable assets for the purpose of determining the depreciation allowance under section 10(2)(v) of the Act. It was held by the Bombay High Court that the expenditure incurred in getting prepared suitable plans and designs for the construction of the cinema theatre and for getting various priorities and permits for scarce material, etc., were liable to be included in the “actual cost” of the depreciable assets to the assessee, and, therefore, such portion of the remuneration should be included in the cost of the depreciable assets. It was further observed that the services rendered by the owner for the acquisition and to enable the assessee to complete a modern cinema theatre could not be treated as connected with the acquisition of the depreciable assets.

7. The Calcutta High Court in Commissioner of Income-tax v. Standard Vacuum Refining Co. of India Ltd. had to consider whether interest on monies borrowed on debentures and utilised along with the other money by the assessee for setting up a refinery which started work in September, 1954, could be reckoned as “actual cost” to the assessee for the purpose of section 10(2)(vi), 10(2)(vi)(a), (b) and 10(5) of the Indian Income-tax Act, 1922. After an elaborate survey of the case law, it was observed:

“It is argued on behalf of the revenue that interest on paid up capital raised for the purpose of erecting a plant will be included in cost by an accountant according to the principles of accountancy, but such interest may not be an item of cost for income-tax purposes. We cannot accept this argument. The term ‘cost’ has not been defined in the Income-tax Act. There is nothing in that Act which says that interest can never form part of the cost of construction. That being the position, reference may be made to commercial practice to ascertain the meaning of cost as contemplated by section 10(5)(a) and the principles of accountancy are in accordance with ordinary commercial principles. If an accountant in consonance with the principles of accountancy regards interest as an element of cost and such interest is paid on share capital raised on debentures issued for obtaining a capital asset, he does so according to commercial principles. Therefore, in our opinion, in the instant case, if we apply the principles of accountancy and for the matter of that the ordinary commercial principles there is no reason for excluding the interest paid on the debenture issued till the plant is ready for production from the actual cost of construction.”

8. It was held that the interest had to be included in the actual cost of the assessee, for the purpose of reckoning the development rebate.

9. The Andhra Pradesh High Court in Commissioner of Income-tax v. Challappalli Sugars Ltd. had to consider the identical question whether interest paid on borrowed capital which is used for the acquisition of the machinery can be included in “actual cost” to the assessee under section 10(2)(vi) of the 1922 Act. The English decisions on the point, the Bombay decision in Habib Hussein's case and the Calcutta decision in Standard Vacuum Refining Co.'s case, were all noticed. Stress was laid on the disallowance in the Bombay case of the deduction claimed in respect of the commission amount which the assessee paid for procuring the capital which was spent for the construction of the theatre. It was ruled that interest cannot be regarded as part of the actual cost to the assessee. The court observed:

“It is true that if the statute is one passed, with reference to a particular trade, business or commerce, and words are used therein which everybody conversant with that trade, business or commerce knows and understands to have a particular meaning in it, then the words are to be construed as having that particular meaning which may differ from the ordinary or popular meaning. But section 10 is not legislated for any particular trade, business or commerce. It is a general legislation applicable to all those who get caught in its net. That apart, ‘actual cost’ does not appear to be a technical business, trade or commercial term used as such and is known and understood in the way in which it is now sought to mean. The above-said extract does not make any claim of that sort. Furthermore, in order that an alleged trade, business or commercial use of a term shall prevail, it must appear that such commercial meaning is the result of established usage in business, trade or commerce and that, at the time of the passage of the Act, such usage was definite, uniform and general and not particular, local or personal. No such case, in our view, is made out in this case. Moreover, we feel that the interpretation we have placed on the said term is more agreeable to the object and intention of the legislature.”

10. It was pointed out that wherever the legislature wanted interest accrued to be reckoned it had expressly provided as such in the 1961 Act, as in section 24. Earlier, the Division Bench had expressed thus:

“We do not find any valid and compelling reason to hold that where a plant is constructed out of borrowed moneys, interest paid on the loan up to the date of commencement of the business can be capitalised and treated as part of the actual cost of the plant. In our view, it would not be correct to treat the interest paid on the borrowed capital on par with the services rendered or supervision made by technicians to select and erect the machinery and expenses incurred in that behalf. Because, while interest is paid not on the acquisition of the asset but on borrowed capital and the fact that the borrowed money has gone into the acquisition of the plant may be a factor but is certainly not directly or intimately connected with the acqusition of the asset itself. The interest paid, therefore, is on the capital which he obtained by borrowing and has little to do with the actual cost to the assessee of the machinery which is his asset. It must be remembered that the source of capital is hardly relevant. What is relevant and pertinent is what actual cost the assessee has incurred in acquiring and erecting the machinery. We are, therefore, clear in our view that when sections 10(2)(vi) and 10(5) speak of original and actual cost of machinery to the assessee, it only means the amount expended or laid out by the assessee in acquiring and installing machinery. The interest paid on the borrowed capital, which went into the acquisition of an asset, cannot, in our opinion, form part of the actual cost of the asset.”

11. The Calcutta decision in Standard Vacuum Refining Co.'s case was dissented from. In Commissioner of Income-tax v. Fort Gloster Industries Ltd., the Calcutta High Court again considered the position, and followed its previous ruling in the Standard Vacuum Refining Co.'s case. No reference is to be found made to the Andhra Pradesh High Court's decision in the Challappalli Sugar's case. The Delhi High Court in The Commissioner Of Income-Tax, Delhi…Petitioner v. Smt. Mithlesh Kumari… [1973] 92 ITR 9 Delhi. has also taken the view that interest on borrowed capital is part of the actual cost to the assessee for the purpose of claiming development rebate. It is unfortunate that the Andhra Pradesh High Court decision was not referred to either by the Calcutta High Court in its later judgment or by the Delhi High Court. The Madras High Court in Commissioner of Income-tax v. L.G Balakrishnan and Bros. (P.) Ltd. [1974] 95 ITR 284 Mad. noticed the Calcutta and also the Andhra Pradesh decisions, and preferred to follow the Calcutta view.

12. Attention was called to the ruling of a Division Bench of this court in Commissioner Of Income-Tax…Applicant;* v. Cochin Electric Company Ltd.…. [1965] 57 ITR 82 Ker.. That was concerned with the only question whether the assessee, an electric supply company, was entitled to the allowance of depreciation in respect of that portion of the service line towards the construction of which the consumer had contributed amounts. It was held that it was. In so holding, this court referred to the judgment of Lord Atkin in Birmingham Corporation's case [1935] 3 ITR Eng. Cas 26. This court's decision does not touch the particular aspect that we have to consider in this case.

13. We prefer the view taken by the Calcutta and Delhi High Courts. We are of the opinion that interest paid on borrowed capital, till the building, plant or machinery is erected or constructed, is part of the actual cost to the assessee within the meaning of section 33 read with section 43 of the Income-tax Act, 1961. This seems to us to be in accordance with both popular and commercial conceptions. Once it is recognised that a building, plant or machinery can be constructed or erected with borrowed capital, if the question be put: “How much did it actually cost you to build the house or to erect the plant or machinery?” we think that the answer should include the interest on borrowed capital, til] the date of construction, or erection as the actual cost to the assessee. If actual cost would include interest on borrowed capital, one might well ask—as has been debated in some of the decisions noticed—whether interest should not enter into the reckoning of development rebate, till the liquidation of the debt, and not till the completion of the construction or erection. But decisions seem to limit it to the date of commencement of business, or completion of the building, plant or machinery. This aspect does not strictly arise for decision. But we may indicate that one reason for limiting the interest only up to the time of completion of the building, plant or machinery is, as pointed out by the Calcutta High Court in Standard Vacuum Refining Co.'s case that interest paid after the plant is installed, cannot form part of the cost of installing or establishing the plant. We also venture to think that after the completion of the building or plant or machinery, there comes into existence an income-yielding asset, which might off-set the interest to be paid on the capital borrowed to bring it into existence. However, we need not express our final or concluded view on this aspect.

14. We may also notice the observations of Warrington J. in Hinds v. Buenos Ayres Grand National Tramways Company Ltd.. The question there considered was whether the company was justified in charging interest on debenture stock to the capital account as part of the cost of conversion of its undertaking to a system of electric traction, or must charge it to revenue account. The following observations appear pertinent:

“They have to pay interest on that 10,000.1 during the period that construction is taking place. In my opinion that asset which they are so constructing cost them not only the 10,000.1, but the 10,000.1. plus the amount of interest during that period of construction; and that is what they are out of pocket during the construction of that 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 the 10,000 1 but the 10,000.1. and the interest on it during the period of construction.”

15. We would answer the question referred in the affirmative, viz., in favour of the assessee, and against the department. The assessee is entitled to the costs of the reference.

16. A copy of this judgment will be forwarded to the Tribunal as required by law.

17. Question answered in the affirmative.