TMI Blog1992 (1) TMI 89X X X X Extracts X X X X X X X X Extracts X X X X ..... 5,746 and Rs. 8,54,383 and other expenses of Rs. 2,89,616 and Rs. 3,34,844 should be capitalised for the purpose of development rebate ? " The facts of the case are that the assessee-company had been carrying on shipping business for a long time. During the year under reference, it purchased two ships, namely, Indian Venture and Indian Valour. The capital cost of these ships was shown by the assessee at Rs. 4,74,83,585 and Rs. 4,67,88,345, respectively, which included the following expenses : Indian Indian Venture Valour (Rs.) (Rs.) (a) Stage payments for cost of construction 3,87,43,843 3,83,10,092 (b) Cost of additional equipment 5,29,284 5,25,295 (c) Interest prior to delivery 8,54,383 7,55,746 (d) Interest on deferred liability 56,81,424 56,81,424 (e) Bank commission for deferred payment guarantee 13,39,807 12,26,172 (f) Other expenses, namely, travelling and hotel charges of seamen and staff 3,34,844 2,89,616 --------------------- --------------------- 4,74,83,585 4,67,88,345 --------------------- --------------------- The assessee claimed development rebate on the entire cost of the two ships. The Income-tax Officer held that since this was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come and that any expenditure for acquisition of an asset could not be regarded as a revenue expenditure. The assessee's counsel invited the attention of the Tribunal to the terms of the contract between the assessee and the German company as also the approval of the Government of India for construction of the two vessels on deferred payment terms subject to payment of interest at 5.5%. It was pointed out that the assessee also treated the interest payment as capital expenditure and claimed depreciation on this amount while filing its return of income. Reliance was placed on the decision of the Gujarat High Court in the case of CIT v. Tensile Steel Ltd. [1976] 104 ITR 581 and it was claimed that, under similar circumstances, it was held that interest on deferred payment terms was to be capitalised and added to the cost of the asset for the purpose of depreciation and development rebate. On behalf of the Department, reliance was placed on the decision of the Supreme Court in the case of Bombay Steam Navigation Co. (1953) Private Ltd. [1965] 56 ITR 52 to show that, under similar circumstances, interest payment was considered to be revenue expenditure. It was urged that the interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Appellate Assistant Commissioner, following the decision of the Supreme Court in the case of Challapalli Sugars Ltd. [1975] 98 ITR 167, held that the aforesaid expenses should be capitalised as claimed by the assessee. Being aggrieved, the Department came up in appeal before the Tribunal. The Tribunal held that the Appellate Assistant Commissioner was justified in treating the aforesaid expenses as capital expenditure. It has not been disputed before us that, having regard to the principles laid down by the Supreme Court in Challapalli Sugars Ltd. [1975] 98 ITR 167, interest paid on amounts borrowed and other related expenses in connection with the acquisition of ships before such ships were delivered to the assessee is includible in the actual cost of the ships acquired. We, therefore, answer the second question in this reference in the affirmative and in favour of the assessee. We shall now turn to the first question. Mr. Bajoria, learned counsel appearing for the assessee, has contended that, although interest paid for periods after the commencement of the business cannot be capitalised, where interest is paid on balance of the purchase price of the ship, such interest is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the balance of 80% of the price was to be paid in instalments over a period of five years. Interest at the rate of 6% per annum was payable on the outstanding amount after adjusting the instalments payable under deferred payment terms. In that case, the Tribunal reached the following conclusion (at page 589) : " . . . We have gone through the entire material given in the paper book filed by counsel for the appellant and are fully satisfied that the interest has been shown to be a part and parcel of the actual cost of the machinery. No doubt the interest is contingent on the deferred payment of instalments but, on a perusal of the copy of the invoices furnished and the contract agreement and other papers, we find that the interest payment is a part and parcel of the cost of the machinery and it has been paid along with the principal amount till the final payment of instalment is made. Thus, the payment of interest being part of the cost of the machinery, it cannot be held that it is a revenue expenditure." There, the Gujarat High Court observed that the interest was a par and parcel of the original price the payment of which was agreed to be spread over for a period of five ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as reproduced. The material part of that paragraph so far as relevant for purposes of these references reads as under: '...Cost includes all expenditure necessary to bring the assets into existence and to put them in working condition. By way of illustration the following may be mentioned:-.... (iv) Interest on borrowings to the extent specified in paragraph 2.22. ' The Supreme Court thereafter set out paragraph 2.22. The relevant part of the said paragraph so far as material for these references is as under : 'The question often arises as to whether interest on borrowings can be capitalised and added to the fixed assets which have been created as a result of such expenditure. The accepted view seems to be that in the case of a newly started company which is in the process of constructing and erecting its plant, the interest incurred before production commences may be capitalised. " Interest incurred " means actual interest paid or payable in respect of borrowings which are used to finance capital expenditure ... Interest on monies which are specifically borrowed for the purchase of a fixed asset may be capitalised prior to the asset coming into production, i.e., during the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d pay the sale price in ten equal instalments along with interest to the vendor-companies. The first instalment of the principal amount and the interest was to be paid in each case within six months after the final shipment of the plant and machinery, etc., and the remaining instalments were to be paid as specified in the respective agreements. There, the Tribunal held that the interest on the unpaid price of the plant and machinery on deferred payment basis did not form a part of the actual cost of the assets to the assessee within the meaning of section 43 of the Income-tax Act, 1961, and that the same was allowable as revenue expenditure. After considering the judgment of the Gujarat High Court in Tensile Steel Ltd. [1976] 104 ITR 581, the Bombay High Court held as follows (at page 622): " As in the case before the Gujarat High Court, in the present case, so far as the new unit that was set up by the assessee was concerned, it could not be worked unless the assessee acquired the assets. As the price to be paid to the foreign vendor was spread over a period of sixty months, it meant that facility of deferred payment of price was granted by the foreign supplier. Such facility ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [1982] 135 ITR 736 (Cal), one of the questions was whether development rebate was allowable on the sum representing interest on deferred payment for machinery. No argument was advanced in that case and it proceeded on the concession of the learned advocate for the Revenue. The relevant part of the judgment is as follows (at page 740) : " Mr. B. L. Pal, learned advocate for the Revenue, is candid enough to concede that the last question, i.e., question No. 3, is covered by the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 and the decision of the Tribunal is right on that point. As he does not press this question and in view of the decision of the Supreme Court, we answer question No. 3 in the affirmative and in favour of the assessee." As indicated earlier, in Tensile Steel Ltd. [1976] 104 ITR 581 (Guj) the Gujarat High Court quoted with approval relevant extracts from the Statement on Auditing Practices issued by the Institute of Chartered Accountants of India in 1974. The Gujarat High Court quoted paragraph 2.22 of the above statement. According to the Gujarat High Court, the Statement of Auditing Practices explained that " inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that interest payable on unpaid purchase price of the asset is revenue expenditure and is allowable as deduction while computing business, income of the relevant year under the Income-tax Act. On September 16, 1979, the Research Committee of the Institute of Chartered Accountants of India issued a Statement on " Treatment of Interest on Deferred Payments ". In that statement, the Research Committee considered the precise question with which we are concerned vis-a-vis the shipping companies. The relevant extracts are as follows : " 1. Some companies have taken the view that interest payable on unpaid price of plant and machinery for which deferred payment facilities have been obtained forms part of the cost of the relevant asset. Some shipping companies have taken the view that the liability for interest on deferred payment terms offered by the suppliers is incurred when the ship is acquired. Such liability can be treated as deferred revenue expenditure as it does not result in any enhancement in the capacity of the ship but is incurred for the benefit to be derived during the entire period of life of the ship. In other words, according to their view, this is a revenue expendit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct of fixed assets purchased on deferred payment terms can be treated as " Deferred Revenue Expenditure ". This treatment has been suggested by some of the shipping companies. This question arises when a shipping company acquires a ship and pays, say, 20% of the price to the suppliers and undertakes to pay the balance of 80% of the price to them in ten yearly instalments with interest at the stipulated rate. The interest payable in each year is worked out on the balance outstanding after adjustment of instalments payable by the company on stipulated dates. The accounting treatment suggested is that the company works out the total interest which would become payable during the deferred period of 10 years. If the company estimates the life of the ship at 20 years, the total interest payable during the deferred period is divided into 20 equal instalments. The interest paid or payable in each year, according to the deferred payment terms agreed upon at the time of acquiring the ship, is debited to 'Interest to builders account' and out of this, a fixed amount equal to 1/20th of the total interest, worked out at the beginning is charged to the profit and loss account of each year during ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st payable every year during the deferred period is not a proper charge against the revenue of the respective year only. (e) The method adopted by some of the shipping companies has not been objected to by the Shipping Development Fund Committee. (f) With the phenomenal project costs, with debt equity ratio in the range of 9 : 1 to 4 : 1, expanding but competitive and lower ROI consumer market, shy capital market, the old treatment of interest will lead to absurd situations. Moreover, it is not in consonance with or in compliance with the 'matching principle'. 14. No precedents or legal decisions in support of the method suggested in para 12 above are available at present. On the other hand, the decision of the Supreme Court in the case of Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 supports the view that interest payable on unpaid price of an asset is a revenue expenditure and is fully deductible for the purpose of computing income under the Incometax Act. Our law courts have recognised the accounting principles for the purpose of determining the income for tax purposes and the principle enunciated in the above decision is based on generally accepted a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the actual cost of the asset for the purpose of allowing depreciation and development rebate. But then Mr. Bajoria, learned counsel, contends that since the Legislature intended that the benefit of such capitalisation would be denied only from the assessment year 1974-75, even though the method adopted is contrary to the accountancy principles, such benefit cannot be denied for the assessment year in question. It is, therefore, necessary to consider the scope and effect of the amendment. By section 9 of the Finance Act, 1986, a new Explanation being Explanation 8 was added to section 43(1). Section 9 of the Finance Act, 1986, provides as follows : "In section 43 of the Income-tax Act, in clause (1), after Explanation 7, the following Explanation shall be inserted and shall be deemed to have been inserted with effect from the first day of April, 1974, namely : 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inclusion of interest in the actual cost of the asset for the purposes of claiming depreciation, investment allowance, etc., under the Income-tax Act. It is an accepted accounting principle that where an asset is acquired out of borrowed funds, the interest paid or payable on such funds constitutes the cost of borrowing and not the cost of the asset acquired with those funds. It is for this reason that as per the clear guidelines issued by the Institute of Chartered Accountants of India, the interest on moneys which are specifically borrowed for the purchase of a fixed asset may be capitalised only relating to the period prior to the asset coming into production, i.e., relating to the erection stage of the asset. However, once the production starts, no interest on borrowings for the purchase of such assets should be capitalised. In spite of these clear guidelines, as also the consistent view of the Department in this matter, some taxpayers had adopted a contrary stance and had capitalised such interest. The first decision in favour of this stance had been rendered on May 13, 1974, in the case of CIT v. J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153 (All). This de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndered in May 13, 1974, we do not find any logic or reason or rationale behind making the Explanation effective from April 1, 1974. We are, therefore, of the view that this Explanation being clarificatory in nature and which intends to clear up any doubt or ambiguity must be deemed to be always in existence. It explains the meaning and intendment of the Act. It is no doubt true that, ordinarily, a statute, and particularly when the same has been made applicable with effect from a particular date should be construed prospectively and not retrospectively. But this principle will not be applicable in a case where the provision construed is merely explanatory, clarificatory or declaratory. It cannot be disputed that the object of the Explanation is to explain the meaning and intendment of the Act itself. In the present case, having regard to the fact that the method adopted by the assessees in capitalising the interest was not proper and contrary to the established accountancy principles, it must be held that the Explanation has been added as and by way of an interpretation clause. The object, as we have said, is to suppress the mischief of getting the benefit of capitalising the i ..... X X X X Extracts X X X X X X X X Extracts X X X X
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