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TMI Blog2003 (3) TMI 91X X X X Extracts X X X X X X X X Extracts X X X X ..... akes of the character of purchase price and therefore not liable to deduction at source under section 195(1) of the Act? (4) Whether the Appellate Tribunal was right in law and on facts in allowing the deduction under sections 80HH and 80-I to the assessee holding that ship breaking activity gives rise to manufacture and production of altogether a new article or thing? In Tax Appeals Nos. 285, 286, 299 and 348 of 2002: (1) Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of the definition of the term "interest" under section 2(28A) of the Income-tax Act, 1961? (2) Whether the Appellate Tribunal was right in law and on the facts in deleting the disallowance under section 40(a)(i) of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195(1) of the Act? (3) Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes of the character of purchase price and therefore not liable to deduction at source under section 195(1) of the Act? In Tax Appeals Nos. 374, 375, 376, 377, 381 and 382 of 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... manufacturing and production of altogether a new article or thing? II. Brief facts: Tax Appeals Nos. 273 of 2002 and 196 of 2002 have been argued as the lead matters. This is because the main judgment of the Tribunal from which the first three questions of law raised in Tax Appeal No. 273 of 2002 arise has been followed by the Tribunal in other matters and the substantive judgment which has been rendered on the fourth question which is the sole question in Tax Appeal No. 196 of 2002 has been decided by the Tribunal in the order from which that appeal arises which has been followed by the Tribunal in other matters. Learned counsel for the appellant-Revenue have filed paper book in Tax Appeal No. 273 of 2002. Learned counsel for the respondents-assessees have also filed a common paper book in Tax Appeal No. 273 of 2002 and separate paper book Nos. 1 and 2 in Tax Appeal No. 348 of 2002, Tax Appeal No. 196 of 2002 and a compilation in Tax Appeal No. 196 of 2002. All learned counsel have argued all these appeals referring to the record of Tax Appeal No. 273 of 2002 and Tax Appeal No. 196 of 2002 and these paper books and have stated that all other appeals involve identical points sin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest paid outside India should not be disallowed in the course of assessment. After considering the submissions made by the assessee and the material on record, the Assessing Officer negatived the contention of the assessee that both the principal amount of the purchase price of the ship and the interest amount paid on the usance credit constituted the purchase price of the ship. It was held that the purchase price of the ship was separately mentioned in the MOA and that the usance interest amount which was also separately mentioned was not part of the purchase price. The officer held that any other view would be illogical because if the contention of the assessee is to be accepted, then it would lead to a situation where as soon as the delivery of the vessel was made, the seller would get the price of the vessel plus the usance interest of 180 days though the usance period would be counted only after the date of delivery. It was held that the purchase price of the vessel and the usance interest were two distinct items of payment. It was also held that the reliance by the assessee on the decision of the Andhra Pradesh High Court in CIT v. Visakhapatnam Port Trust [1983] 144 ITR 146 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payment of purchase consideration in respect of the two ships for the purpose of its business carried on in India. It was held that the Double Taxation Avoidance Agreement between the Government of India and the Government of U.K. and Singapore provided for taxation of interest income even in the country of the resident which in the present case was India and that interest income from debt claims of any kind could be so taxed in India. It was held that the amount of interest paid by the assessee to the non-resident concerns were liable to deduction of tax at source under section 195(1) of the Act and since the assessee had failed to deduct the amount of such tax, the Assessing Officer had correctly applied the provisions of section 40(a)(i) of the Act for disallowing the claim of interest of Rs. 42,52,767. The Commissioner of Income-tax (Appeals) noted that the assessee had debited the purchase price of the ships as was mentioned in the MOA in its books of account and the liability for the interest amount mentioned in the MOA had been separately claimed as revenue expenditure. It was also noted that the purchase consideration excluding interest had been disclosed to the customs au ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... did not incur any debt in the sense of raising any loan or advance so as to be indebted to the sellers, and that it was a pure and simple purchase transaction in terms of the L.C. for the total amount including interest. It was further held that, in the present case, the purchase price and interest payable were arising from the same source, i.e., the transaction entered into with the buyer for sale of ship and not from two different sources. On this basis, the Tribunal concluded that the interest amount though separately mentioned in the MOA and described as "interest" therein, partook of the character of the purchase price for the buyer and should be treated as purchase price. According to the Tribunal, its view point was strengthened from the provisions of the DTAA, under which as per the definition of the term "interest", each and every debt was not envisaged to be included in the term "debt claims" referred to in the definition of "interest". It was held that the expression "debt claims" will take colour from the associated terms used in the definition namely bonds, debentures, etc., and that the term "interest" under the DTAA was meant to be interest earned on Government secur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paid. It was also argued that there were ample safeguards in sections 195 and 197 to prevent double taxation and requisite order could be obtained determining whether tax was deductible on such payment, or certificate could be obtained allowing payment of interest to the non-resident without deduction of tax. It was submitted that the payment of the amount of purchase price and interest under the L.C. discharged the underlying debt in respect of the sale of the ship. Learned counsel, therefore, argued that since no deduction was made by the assessees as required by the provisions of section 195(1) nor any order or certificate obtained so as to justify the non-deduction, they were not entitled to deduct the interest amount while computing the income chargeable under the head "Profit and gains of business income" in view of the provisions of section 40(a) of the Act. It was also submitted that where in respect of any such sum tax has been paid or deducted in any subsequent year under Chapter XVII-B, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid or deducted, as per the proviso to section 40(a). It was, therefore, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad to be agitated by the non-resident assessee at the time of his assessment. It was held that those persons who are bound under the Act to make deductions at the time of payment of any income, profits or gains are not concerned with the ultimate result of the assessment. (c) The decision of the Delhi High Court in J.K. Synthetics Ltd. v. Asst. CIT [1990] 185 ITR 540, which was rendered in the context of the provisions of sections 9(1)(v) and 195(2) of the said Act, was cited for the proposition that the interest payable to the foreign supplier of raw material was deemed by section 9(1)(v) to accrue or arise in India and the proviso to section 195(2) made section 195(2) inapplicable in such case. In that case, the petitioner had to remit interest to a foreign supplier of raw material which it claimed was exempt from tax in the provisions of section 10(15)(iv)(c) of the said Act. The petitioner applied for exemption from deduction of tax at source. That application came to be rejected and the petitioner challenged the order refusing exemption. It was held that the application for grant of a certificate of exemption from deduction of tax at source could not have been made under any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was part and parcel of the sale price. (f) The Supreme Court, in Kesoram Industries and Cotton Mills Ltd. v. CWT [1966] 59 ITR 767, while considering the definition of the word "debt" and noticing the judgments which were cited at the Bar, held that there was no conflict on the definition of the word "debt", and that all the decisions agreed that the meaning of the expression "debt" may take colour from the provisions of the concerned Act; it may have different shades of meaning. It was held that the definition of the word "debt" to the effect that a debt is a sum of money which is now payable or will become payable in future by reason of a present obligation; "debitum in praesenti solvendum in futuro" was unanimously accepted. The Supreme Court also held that in the expression "debt owed", the verb "owe" means "to be under an obligation to pay", and it does not really add to the meaning of the word "debt". (g) The decision of the High Court of Justice (King's Bench Division) in Hudson's Bay Co. v. Thew (Surveyor of Taxes) [1919] 7 TC 206 (KB), was cited to point out that, in a case where the company entered into an agreement with the purchaser unable to provide the whole purch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that character, and, it would be wrong to interfere with that established practice. It has to be remembered that a vendor of goods selling against the confirmed letter of credit is selling under the assurance that nothing will prevent him from receiving the price. That is of no mean advantage when goods manufactured in one country are being sold in another. (i) The decision of the House of Lords in Riches v. Westminster Bank Ltd. [1947] 15 ITR (Suppl.) 86, 89; [1947] AC 390 was cited to point out that, it was held therein that the essence of interest is that it is a debt. It is a payment which becomes due because the creditor has not had his money at the due date. The House of Lords negatived the contention that the sum in question could not be interest at all because interest implies a recurrence of periodical accretions, whereas the sum came to existence uno flatu by the judgment of the court and was fixed once for all, holding that, in truth, the sum represented the total of the periodic accretions of interest during the whole time in which payment of the debt was withheld. The sum awarded was the summation of the total of all the recurring interest items. Viscount Simon observ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion 40(a)(i) of the Income-tax Act inasmuch as the said provision provided that the interest shall not be a deductible item in the computation of total income if the tax payable has not been deducted at source under Chapter XVII-B of the Income-tax Act. (1) In W.J. Alan and Company Ltd. v. El Nasr Export and Import Co., a decision of the Court of Appeal, reported in [1972] I Lloyds Law Reports 313; [1972] 2 All ER 127, Lord Denning M.R. after analyzing the effect of a letter of credit, held that in the ordinary way, when the contract of sale stipulates for payment to be made by confirmed, irrevocable letter of credit then, when the letter of credit is issued and accepted by the seller, it operates as conditional payment of the price. It does not operate as absolute payment. It is analogous to the case where under a contract of sale, the buyer gives a bill of exchange or a cheque for the price. It is presumed to be given, not as absolute payment, nor as a collateral security, but as conditional payment. If the letter of credit is honoured by the bank, when the documents are presented to it, the debt is discharged. If it is not honoured, the debt is not discharged and the seller ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therefore, the assessee was under a duty to deduct income-tax and super-tax under the said provisions and was responsible for the tax. (q) The decision of the Supreme Court in Standard Triumph Motor Co. Ltd. v. CIT [1993] 201 ITR 391, which was rendered in the context of sections 5(2) and 145 of the said Act, was cited to point out that, where there was a collaboration agreement between a non-resident and an Indian company and the appellant was entitled to a royalty of 5 per cent. thereunder, on all sales effected by the Indian company, the royalty less the Indian tax had to be remitted to the appellant in pounds sterling, it was held that the credit entry of the royalty to the account of the appellant in the books of the Indian company amounted to receipt of the royalty by the appellant and it was accordingly taxable. It was held that it was immaterial when the appellant actually received it in the U.K. and the method of accounting adopted by the appellant was irrelevant, and, therefore, the order of remand made by the Tribunal was unnecessary. (r) The decision of the Supreme Court in Hyderabad Industries Ltd. v. Union of India [1995] ELT 641 was cited for the proposition that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o chips and powder was not a process of manufacture that brings about a new commodity. IV. Contentions and cases cited for the assessees: The two learned senior counsel and other counsel, who appeared for the assessees in all these appeals, contended that the assessees had not made any payment to the non-residents from whom the ships were purchased, because, in view of the independent contract between the assessees and their bankers for taking out irrevocable letters of credit, the assessees had made payment of the amounts to the bank in India and not to the non-residents. They were, therefore, not liable to deduct tax at source under section 195(1) of the Act. It was then argued that the amount in question though described as interest in the MOA was not "interest" within the meaning of section 2(28A) of the said Act, or within the meaning of the definition of "interest" in the article concerning taxation of interest in the Double Taxation Avoidance Agreements. It was argued that the amount though described as interest was, in fact, part of the purchase price of the ship, because, it was payable with the purchase price at the end of the usance period of 180 days. It was submitted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y was charged on the purchase price of the ship and not on the interest amount considering the later to be part of the price would not be conclusive for holding that the interest amount was not a part of the purchase price. Learned counsel have also contended that ship breaking was an activity of manufacture or production of new articles or things because the raw material that was ship was converted into totally different articles mainly steel plates. In support of their contentions, the learned counsel for the assessees relied upon the following decisions (a) The decision of the Supreme Court in Federal Bank Ltd. v. V.M. Jog Engineering Ltd. [2001] 106 Comp Cas 267, was cited for the proposition that the contract of the bank guarantee or the letter of credit is independent of the main contract between the seller and the buyer. This is also clear from articles 3 and 4 of the Uniform Commercial Practice of Documentary Credits (1983). In case of an irrevocable bank guarantee or letter of credit, the buyer cannot obtain injunction against the banker on the ground that there was a breach of the contract by the seller. On the basis of this decision, it was argued that since as per the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uires a right to receive the income, the income can be said to have accrued to him, though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody. Unless and until there is created in favour of the assessee a debt due by somebody, it cannot be said that he has acquired a right to receive the income or that income has accrued to him. The matter related to managing agency commission which was at an annual payment calculated upon the annual net profit of the company, and was to be due to the managing agents yearly on the March 31, in each and every year. In that context, the Supreme Court held that the amount of such commission did not become a debt owing by the company to the managing agents until March 31, in each and every year and was to be paid immediately after the annual accounts of the company have been passed by the shareholders. It was held that the managing agency agreement was an entire and indivisible contract stipulating a payment of remuneration or commission per year and enjoined upon the managing agents the duty and obligation of rendering the ser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income, will apply if interest is payable, under the terms of an agreement, expressed or implied and the court or the arbitrator gives effect to the terms of the agreement and awards interest which has been agreed to be paid. (h) The decision of the Supreme Court in Kedarnath Jute Manufacturing Co. Ltd. v. CIT [1971] 82 ITR 363; [1971] 28 STC 672, was cited for the pro position that, whether the assessee is entitled to a particular deduction or not will depend on the provisions of law relating thereto and not on the view which the assessee might take of his rights; nor can the existence or absence of entries in his books of account be decisive or conclusive in the matter. (i) In the decision of the Court of Appeal, in Charge Card Services Ltd., In re [1988] 3 All ER 702, which was rendered in the context of payments in respect of sale of goods by credit card transaction, it was held that there was no general principle of law that, whenever a method of payment was adopted which involved a risk of non-payment by a third party, there was a presumption that the acceptance of payment through the third party was conditional on the third party making the payment, and that, if he fails t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , nor was it a case in which there was an actual advance of money. (l) The decision in Vijaya Bank Ltd. v. Addl. CIT [1991] 187 ITR 541 (SC) was cited to point out that, in a case where the assessee purchased securities at a price determined with reference to their actual value as well as the interest accrued thereon till the date of purchase, the entire price paid for them would be in the nature of a capital outlay and no part of it can be set off as an expenditure against the income by way of interest received on the securities. It was contended before the Supreme Court that the price paid for the securities was determined with reference to their actual value as well as the interest which had accrued on them till the date of purchase. But the fact was, whatever was the consideration which prompted the assessee to purchase the securities, the price paid for them was in the nature of a capital outlay and no part of it could be set off as expenditure against the income accruing on those securities. It was held that subsequently when the securities yielded income by way of interest, such income attracted section 18 of the said Act. The court held that a claim for deduction can be su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eing contended that the price received by the company on sale of the stock included this interest. The court found that the stock was sold for a sum for principal and accrued and accruing interest; and it was not true to say in fact that in the purchase price there was necessarily to be found a sum as purchase money of the accrued interest exactly equivalent to the amount of interest which had accrued. It was therefore held that the company was not assessable in respect of the interest accrued at the date of the sale of the stock and the appeal was dismissed. (p) In the decision of the High Court of Justice (King's Bench Division) reported in Simpson v. Executors of Bonner Maurice and Executor of Edward Kay [1929] 14 TC 580 (CA), the question involved was whether compensation under the Peace Treaty computed on the basis of interest was income. It was held that the income in question arose when received by the banks and that the compensation was not income for income-tax purposes. Lord Hanworth M. R. held that the way to estimate compensation or damages-the sensible way no doubt-would be by calculating a sum in terms of what interest it would have earned. That had been done but the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion to treat the balance of sale consideration as paid off in full and no novation to treat the balance of consideration as a loan, the amount received by the seller cannot be regarded as interest on money lent. It was a matter where a German company tendered contract for the supply of the equipment and an agreement was entered into between the German company and the port trust whereby the German company under took to supply the equipment and to delegate an engineer to supervise its installation under clause 10(a) of the contract. The purchase price for the equipment was payable in German currency in Germany. Part of it was payable on conclusion of the contract and the balance was payable in 20 semiannual instalments. For the credit remaining after payment of each of the instalments, interest was to be paid by the port trust at 6 per cent. per annum. The port trust paid the instalments in German currency in Germany. The Income-tax Officer held that the port trust should have deducted tax at source on the interest under section 195(2) of the Act. When the matter reached the Tribunal, the assessee for the first time raised the question whether the tax was deductible in view of the I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... instalments along with interest on the instalment of purchase money, the agreement though it vested the property agreed to be sold in the purchaser, does not have the effect of converting the price due into a loan. The intrinsic nature of the money due to the vendor is as unpaid purchase money and not as debt. It was observed that the parties may however agree to convert the unpaid purchase money as a debt, referring to Radha Kissen Chamria v. Keshardeo Chamria, AIR 1957 SC 743. (s) The decision of this court in CIT v. Saurashtra Cement and Chemical Industries Ltd. [1975] 101 ITR 502 was cited to point out that the court, in the context of the provisions of section 9(1)(i) of the Income-tax Act, held that since most of the elements of the contract were found to be densely grouped with the other country which was Italy where the non-resident company was carrying on its business of supplying plant and machinery and the debt which the assessee-company owed to the non-resident company was not an asset held by the non-resident company in India, the interest which was payable in respect of the debt was not income arising from or through any asset held by the non-resident company in Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecomes due because the creditor has not had his money at the due date. It may be recorded either as representing the profit he might have made if he had the use of the money, or, conversely, the loss he suffered because he had not that use. The court observed that the general idea is that he is entitled to compensation for the deprivation; the money due to the creditor was not paid, or, in other words, was withheld from him by the debtor after the time when payment should have been made, in breach of his legal rights, and interest was a compensation whether the compensation was liquidated under an agreement or statute. (u) The decision of the High Court in CIT v. Smt. Asrafi Devi Rajgharia [1983] 142 ITR 380 (Cal) was cited to point out that the court accepted the contention on behalf of the assessee that none was entitled to payment of interest unless the amount on which the interest was claimed was quantified and was payable to him. (v) In the decision of the Supreme Court in K.S. Krishna Rao v. CIT [1990] 181 ITR 408, which was rendered in the context of the provisions of section 28 of the Land Acquisition Act, in which the court followed its earlier decision in Rama Bai v. CI ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thus credited are not realised but having accrued are treated as received though in fact there is nothing more than an accrual or arising of the profits at that stage. They are book profits. Receipt being not the sole test of chargeability and profits and gains that have accrued or arisen or are deemed to have accrued or arisen are also liable to be charged for income-tax, the assessibility of these profits which are thus credited in the books of account arises not because they are received but because they have accrued or arisen. (x) The decision of this court in Meteor Satellite Ltd. v. ITO [1980] 121 ITR 311 was cited to point out that, while rejecting the preliminary objection against the maintainability of the petition in view of the alternative remedies available to the petitioner under the Act, the court held that in order to facilitate the remittance of the amount of the first two instalments payable to the collaborator in sterling, the petitioner was entitled, if it were right in law, to have a tax clearance certificate from the Income-tax Officer. It could not, in view of the terms of the agreement, wait for the long process of having the matter assessed and then tested ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deduction under section 10(2)(iii) of the Act. (z) In CIT v. Cooper Engineering Ltd. [1968] 68 ITR 457 (Bom), the court, in the context of the provisions of sections 4(1) and 18(3B) of the Indian Income-tax Act, 1922, held that unless any payment of interest is such that the interest is chargeable under the Act, the liability upon the person responsible for paying such interest to deduct the tax at source is not there. The court found upon the facts that the amount of interest payable to Tata Ltd., London, was not an amount chargeable under the Act. It was, therefore, held that there was no obligation upon the assessee to deduct tax on the amount of interest at source. The court held that the words "chargeable under the provisions of this Act" in section 18(3B) apply to "interest" as well as "any other sum" and consequently a person paying interest to a non-resident is not liable to deduct tax on the said interest if it is payable to the non-resident in respect of the money payable to him for service rendered without the taxable territories, which, under section 4(1) of the Act of 1922, was not chargeable to tax under the Act. (z-1) The decision of the Kerala High Court in Unite ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion Avoidance Agreement between India and the U.K. was cited for the proposition that in case of inconsistency between the terms of the Double Taxation Avoidance Agreement and the taxation statute, the Agreement alone would prevail. (z-4) The decision of the Calcutta High Court in Czechoslovak Ocean Shipping International joint Stock Co. v. ITO [1971] 81 ITR 162, while considering the provisions of section 195(2) of the said Act, held that the said provision pre-supposes that the person responsible for making the payment to the non-resident is in no doubt that tax is payable in respect of some part of the amount to be remitted to a non-resident, but is not sure what should be the portion so taxable or the amount of tax to be deducted. He can then make an application to the Income-tax Officer for determining the amount. It was held that it is only when these conditions were satisfied and an application is made to the Income-tax Officer that the question of making an order under section 195(2) will arise. Where the Income-tax Officer is only approached for a certificate that no tax was due in respect of freight charges for goods unloaded at an Indian port as such a certificate was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the commercial world as other than the ship and therefore, the assessees should be entitled to claim deductions under the said provisions. The court held that the input of the ship breaking industry, namely, ship, covered by Chapter 89, is used to manufacture its output, namely, metal scrap covered by Chapters 72 to 81 of the Customs and Central Excise Tariff Act. It was held that in the course of breaking activity, the ship loses its identity and results in production of the items ferrous metals and nonferrous metals as well as non-metallic material enumerated in the judgment. (z-8) The decision in CIT v. Ashwinkumar Gordhanbhai and Bros. Pvt. Ltd. [1995] 212 ITR 614 (Guj), which was rendered in the context of section 104(4) of the Act, was cited for the proposition that the activities of the assessee in cutting tobacco leaves into small leaves or pieces and after removing the dust and unwanted stems of the tobacco leaves, selling them to bidi manufacturers, involved "processing" of goods. (z-9) The decision of the Supreme Court in Ujagar Prints v. Union of India [1989] 179 ITR 317 was cited for the proposition that the processes of bleaching, dyeing, printing, sizing, shrink ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "manufacture" takes in bringing into existence new goods by a process which may or may not amount to manufacture. It also takes in all the by-products, intermediate products and residual products which emerge in the course of manufacture of goods. The Supreme Court held that the principle of adopting a liberal interpretation which advances the purpose and object of beneficial provisions cannot be carried to the extent of doing violence to the plain and simple language used in the enactment. (z-14) The decision of the Bombay High Court in CIT v. Sterling Foods (Goa) [1995] 213 ITR 851 was referred to for pointing out that the court held that the word "production" has a wider connotation than the word "manufacture". The court followed the decision of the Supreme Court in N. C. Budharaja and Co.'s case [1993] 204 ITR 412, and observed that three expressions "production", "manufacture" and "produce" used in various taxing statutes are not interchangeable expressions. It will be seen that the court held on the merits that by subjecting prawns to processing for the purpose of export, they do not lose their original character and no new commodity or article emerges as a result of such p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under the notification issued under section 12 of the Act. (z-19) In Shree Balaji Mineral Grinding Industries v. State of Madhya Pradesh [2000] 117 STC 117, the Madhya Pradesh High Court held that making of marble powder by manufacturing process was an activity covered within the special definition of "manufacture" given in section 20) of the Madhya Pradesh General Sales Tax Act, 1958. (z-20) In Asst. CTO v. Girrota Silica Udyog [1994] 93 STC 280, the Rajasthan High Court held that in view of the findings of the Tribunal that the mineral was excavated from the mine in the form of lumps, that red or yellow colour on the sides of the lumps was removed and then they were ground, that the mineral was thereafter screened and graded etc., the assessees were rightly considered to be manufacturers. (z-21) In Deputy CST v. Coco Fibres [1991] 80 STC 249 (SC), where green coconut husk was soaked in saltish water for days together and after decomposition, it was subjected to beating by mechanical or manual process, the coconut fibre produced in the process was a distinct commodity known in commercial parlance. It was held that the respondent, a registered dealer was converting coconut husk ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... interest expenditure can be claimed only when the deduction of tax at source is made in respect thereof. Section 9 of the Act enumerates the income which shall be deemed to accrue or arise in India. Clause (v)(b) of sub-section (1) of section 9, which came to be inserted with retrospective effect from April 1, 1982, by the Taxation Laws (Amendment) Act, 1984 laid down that the income by way of interest payable by a person who is a resident shall be deemed to accrue or arise in India, except where the interest is payable in respect of any debt incurred or moneys borrowed and used, for the purposes of a business or profession carried on by such person outside India. Therefore, in all cases, where the income by way of interest payable by a resident does not relate to carrying on business outside India or earning of income from outside India, such income payable by way of interest would be deemed to accrue or arise in India. In other words, wherever income by way of interest may be payable by the resident, it shall be deemed to accrue or arise in India, that is the source of such income will be from India even if it is payable outside India, and this is the deeming fiction adopted to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esident is kept apart for the time-being and the amount specified as interest in the MOA is treated as interest payable under the contract by the resident-assessee to the non-resident in respect of deferred payment of price, such interest payable to the non-resident would be income deemed to have accrued or arisen to the non-resident in India under section 9(1)(v)(b) and would be chargeable to income-tax under section 4(1) read with section 5(2) of the Act. If that be so, income-tax thereon would be deductible at source under section 195(1) of the Act which, inter alia, provides that any person responsible for paying to such non-resident any interest chargeable under the provisions of the Act (not being income chargeable under the head "Salaries"), shall, at the time of credit of such income to the account of the payee or at the time of payment in cash or by the issue of a cheque or draft or by any other mode, which ever is earlier, deduct income-tax thereon at the rates in force. Under the MOA, the assessee was responsible for paying to the seller non resident, the amounts specified therein for the purchase of the ship for demolition purposes. The assessee was responsible for pay ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of income-tax thereon, subject to regular assessment and by the deduction of income-tax, the rights of the parties are not, in any manner, adversely affected. The rights of the payee or recipient are fully safeguarded under sections 195(2), 195(3) and 197 of the Act. The effect of the deeming fiction that the income by way of interest payable by a person who is resident would be that the income deemed to accrue or arise in India, as envisaged by clause (v)(b) of section 9(1), will be treated to be arising in India irrespective of its being paid anywhere outside India. Simply by virtue of its becoming payable by the resident, the interest income of the type covered by clause (v)(b) of section 9(1) will be deemed to be accruing or arising in India, even if it is actually received by the non-resident outside India. If it is permissible for a non-resident receiving such interest income from a resident of India to contend that he has actually been disbursed the amount outside India and, therefore, such interest income did not accrue or arise in India, the provisions of section 9(1)(v)(b) will become wholly redundant. Such income is deemed to accrue or arise in India wherever it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the payment was to be made by irrevocable letter of credit. The letter of credit issued complied with the conditions laid down in the MOA. The MOA did not specifically provide that mere issue of credit shall be absolute and final payment. Acceptance by the seller of a commercial credit constituting absolute payment which would debar him from his ordinary right to pursue the buyer if the seller did not receive payment under the credit has to be expressed in clear terms in the absence of which the seller's rights against the buyer are not exhausted by the issue of credit. The purpose of the system of confirmed irrevocable documentary credits developed in the international trade is "to give to the seller an assured right to be paid before he parts with control of the goods" (see Lord Diplock's Speech in United City Merchants (Investments) Ltd. and Glass Fibres and Equipment Ltd. v. Royal Bank of Canada, Vitrorefuerzos SA and Banco Continental SA [1982] 2 Lloyd's Report 1 (HL); [1982] 2 All ER 720 (HL). Thus, in the absence of a specific "absolute payment" clause when the letter of credit is issued and accepted by the seller, it operates as a conditional payment of the price (Lord Denn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... equirement of consideration. Dean Roscoe Pound in his Jurisprudence, Volume III, in Chapter 14, places fifteen such exceptions under four different heads. Under heading IV. Intention to be bound in a business transaction at page 212, in the context of the letters of credit, points out that the letters of credit though not upon consideration are given effect when acted on, on the theory of estoppel or sometimes on a theory of consideration moving from a third person and the attitude of the courts not to interfere with them having regard to the norms adopted by the substantive institution of law merchant, in the following terms: "Letters of credit not under seal and not upon consideration are given effect when acted on. Sometimes this is done on a theory of estoppel, sometimes on a theory of consideration moving from a third person, and sometimes on a theory of an independent transaction of the law merchant requiring no consideration except between the immediate parties. As has been well said, 'Throughout the cases we may note the courts feeling, more or less subconsciously, that we have here a substantive institution of the law merchant, which ought to be sustained on its own basis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the instructions of the applicant" (the assessee-buyer in the present case), do so "for the account and at the risk of such applicant", and banks assume no liability or responsibility should the instructions they transmit not be carried out, even if they have themselves taken the initiative in the choice of such other banks. By article 18(d) of the U.C.P., it is made clear that the applicant-customer (the assessee-buyer in the present case), shall be bound by and liable to indemnify the banker against all obligations and responsibility imposed by foreign laws and usages. Even under the Uniform Rules for Collection (ICC No. 322), the customer entrusting the operation of collection (which means handling by banks, on instructions received, of documents as defined in the definition clause which includes commercial documents), is the "principal" under whose instructions the remitting bank to whom the principal has entrusted the operation of collection, will utilize the collecting bank "for giving effect to the instructions of the principal" (i.e., the customer) as provided in article 3, and, "banks utilizing the service of other banks for the purpose of giving effect to the instructio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the issuing banker when the letter of credit was delivered and therefore, there was no duty on the part of the buyer to make deduction at source of the tax under section 195(1) of the said Act is, therefore, misconceived and unwarranted. Then comes the contention that if the sum paid by release of the letter of credit to the non-resident is to be deemed to be income accrued or arisen to him in India, then it was not in fact "interest" and was part of the price of the ship purchased and therefore, no tax was required to be deducted from such amount under section 195(1) by the buyer. The argument runs thus: The amount of usance interest though described as interest in the MOA was not interest as contemplated by section 2(28A) of the Act. The price of the goods would consist of costs of material, labour costs, costs of finance and profit. Though the price would be the sum total of these items, payment made for the goods is not payment towards any of the components that go in to the fixation of the price. It is submitted that the MOA itself recognizes interest as a part of the purchase price by making the whole amount payable thereunder, including the so called interest, at the en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rom the date of the NOR. The invoices and drafts of the original price and the interest amount were to be separately prepared and were in fact separately prepared. The commercial invoice certified the details of the vessel and its purchase price at US $ 30,69,016.51 as per the MOA dated July 14, 1994. It will also be seen that, admittedly, the buyers paid customs duty on the purchase price of the ship excluding the interest amount. Thus, not only the invoices of the purchase price of the ship and the interest amount were to be separately prepared, the customs duty which was payable for the buyers account as per clause (21) of the MOA was paid on the purchase price of the ship excluding interest. The intention of the parties to the contract was, thus, clear and the price of the ship was considered to be separate as certified in the invoice, which reflected its price agreed in the MOA, and, the buyer in lieu of the credit facility of 180 days from the date of the NOR was required to pay interest at the rate stipulated in the MOA and worked out thereunder for which a separate invoice was prepared. It is also significant to note that the price of the ship was separately calculated on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vered to the buyer. If before delivery the vessel became "total constructive loss", the contract was to be considered as null and void and the letter of credit to be immediately released to the buyers as per clause (14) of the MOA. These stipulations show that the purchase price became payable on the delivery being effected as per the NOR when the risk passed to the buyer. Under section 20 of the U.K. Sale of Goods Act, 1979 (similar to section 26 of the Indian Act), the property in the ship was transferred to the buyer, prima facie with the passing of the risk. The definition of "interest" in section 2(28A) of the Act was inserted with effect from June 1, 1976, by the Finance Act, 1976. "Interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized. The meaning of the word "interest" is, thus, very wide and would include interest on unpaid purchase price payable in any manner which would include payable by means of irrevo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erm in a contract to which the Act applies that any qualifying debt created by the contract carries simple interest. Such statutory interest shall be treated, for the purpose of any rule of law or enactment relating to interest on debts, in the same way as interest carried under an expressed contractual term. That Act applies to a contract of sale of goods and section 3 thereof provides that a debt created by virtue of an obligation under such contract to pay the whole or any part of the contract price is a "qualifying debt" for the purposes of the Act. Even under article 78 of the United Nations Conventions on Contracts for the International Sale of Goods Act, 1980 (CISG), if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it without prejudice to any claim for damages recoverable under article 74 thereof. Under article 53 of that Convention, the buyer must pay the price for the goods and take delivery of them as required by the contract and the said convention. By article 54, it is provided that the buyer's obligation to pay the price includes taking such steps and complying with such formalities as may be required und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest rate. Accounting Standard 9 issued by the Institute of Chartered Accountants of India of "revenue recognition" relating to transactions involving sale of goods as contained in paragraphs 10 and 11 read as under: "10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreason able to expect ultimate collection, revenue recognition should be postponed. 11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled: (i) the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and (ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods...." Interest revenu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tstanding unpaid purchase price of the goods, is not a debt. All that the Supreme Court has said is that the vendor-vendee relationship is not metamorphosed into creditor and debtor, meaning thereby, that it is not totally transformed into a creditor and debtor relationship. This only means that their rights and liabilities as vendor and vendee continue to exist even after the debt becomes outstanding. That is why, it was held that the vendor could not say that he is under no further obligation to the purchaser and that the purchaser must pay the price of the goods debited to him as a debt arising out of the book entry. The Supreme Court, while explaining the mercantile system of accounting held that it brings into credit, what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure amount for which a legal liability has been incurred before it is actually disbursed. Distinguishing Keshav Mills Ltd.'s case [1953] 23 ITR 230 (SC), the Supreme Court in Standard Triumph Motor Co. Ltd. v. CIT [1993] 201 ITR 391, held that the credit entry to the account of the non-resident assessee in the books of account of the Indian company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Contracting State, the tax so charged shall not exceed: (a) 10 per cent. of the gross amount of the interest if such interest is paid on a loan granted by a bank carrying on a bona fide banking business or by a similar financial institution (including an insurance company); (b) 15 per cent. of the gross amount of the interest in all other cases. 3. The term 'interest' as used in this article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits; and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this article....." The DTAAs follow the pattern of the Organization of Economic Co-operation and Development (OECD) Model Convention. The Model Convention has been used by the covenanting States as a basic document of reference while entering into such bilateral treaties. Such double taxation avoidance treaties are international agreements. Section 90 of the said Act enables the Centr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the buyer will be considered as an interest paid to the seller. Article 11(2) of the Model Convention lays down nothing about the mode of taxation in the State of source. This article does not deal with procedural aspects of tax collection. It therefore leaves that State free to apply its own laws and, in particular, to levy tax either by deduction at source or by individual assessment. Referring to the definition of "interest" in para. 3 of article 11 of the Model Convention, which is the definition adopted in the DTAAs between India on the one side and the U.K. and Singapore and other countries on the other, the OECD Commentary in para. 11C.21 records that the definition of "interest" is, in principle, exhaustive and covers practically all the kinds of income which are regarded as interest in the various domestic laws and that the formula employed offers greater security from the legal point of view and ensures that Conventions would be unaffected by future changes in any countries in domestic law." The expression "debt claims of every kind" cannot, therefore, be whittled down to mere debt claim in the form of loans. The addition of the words "including interest on deferred p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the case of the German company was that it had no "permanent establishment" in India and therefore, since section 9(1)(i) of the said Act was subject to the DTAA, it was not taxable in India, but in the other contracting State. The assessments in that case related to the years prior to the introduction of section 9(1)(v) in the Act with effect from June 1, 1976, under which by a deeming fiction interest, such as usance interest payable by a resident, would be deemed to accrue and arise in India. Therefore, the said decision of the Andhra Pradesh High Court cannot assist the assessees. It will be noticed that article VIII concerning taxation on interest in the DTAA with Germany existing at that time was worded differently from the article concerning taxation of interest of the revised Model Convention 77 and the DTAAs relevant to the present cases followed that Model Convention which included the expression "debt claim of every kind" in the article concerning taxation of interest which expression was absent in the said article VIII of the agreement with Germany. The decision of the Andhra Pradesh High Court was, therefore, rendered in a different context. We are, however, for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... molition and the ship was dismantled. The Bombay High Court, however, distinguished its earlier judgment on the ground that the ship was in that case condemned and unserviceable. The Tribunal relied upon the above judgment of the Bombay High Court, observing that since the ships were new and in good working condition because they remained afloat, it followed the said decision. New ships are not meant for demolition or breaking. It is after the operative and useful life of the ship is over that they are scheduled to be sold for demolition. The procedure for demolition of a ship is not just a private affair and involves permission of the authorities under the law to transfer them for demolition. Merely because the ship is able to sail on its own up to the shore where it is to be demolished, it cannot be said that such ship which is sold for demolition is a new ship. Remaining afloat is not a sure test for a ship to be called new, because, a condemned ship is not always a sunk ship. An old ship sold for demolition that manages to remain afloat cannot be said to be a new ship. The distinction made on that count is a distinction attempted without any real difference between the old shi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the deduction under section 80HH is meant to encourage establishment of new industrial undertakings in backward areas when such industrial undertaking "has begun or begins to manufacture or produce articles" and in the context of the fact that section 80-I is designed to encourage industrial undertakings to manufacture or produce "any article or thing, not being an article or thing specified in the list in the Eleventh Schedule". The Eleventh Schedule enumerates articles such as steel furniture, office machines and apparatus, gramophones, toilet preparations, etc., and things like aerated waters with blended concentrations, confectionary or chocolates. The excluded items give an idea of what is meant by the Legislature when it refers to "articles and things" in section 80-I(2) of the Act. If the contention of the deceased is tested in the context of an article of steel furniture, such as, steel table which would fall in the list of the excluded items in the Eleventh Schedule, the result would be that the benefit of section 80-I will not be available while making a new steel table, but will be claimed when that steel table is dismantled and cut into scrap, on a specious plea th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ient States, fact finding mission to the Indian Ship Breaking Yards in Alang and Bombay in October 1998" Authors Dipl.-Ing, Judit Kanthak, Andreas Berrstorff, published by Green Peace e.v. Hamburg, Germany). The Regulations of the Gujarat Maritime Board under the Gujarat Maritime Board Act, 1981, are regulations made for safety and welfare of workers as a measure of precautions during the cutting operations in the ship breaking yards and reliance on them does not advance the case of the assessees on the aspect of manufacture or production. In fact, ship breaking activities are defined in regulation 2(viii) as, all activities from beaching, cutting and other activities till dismantling of the ship, and the despatch of the dismantled materials from the ship breaking yard and not as any manufacture or production activity. The MOAs in the present matters clearly indicate that the old ships were purchased by the assessees for demolition purpose. The registration of the ships was cancelled and the deletion certificate showing cancellation of registration was to be forwarded to the buyers as undertaken in para. 3(viii) of the MOA dated July 14,1994, of "Global Hope" and part 3(vii) of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rical navigation equipments nylon and steel ropes shackles, pulley blocks, tarpaulin, paint and lubricant tins, machinery spares etc. are removed. * Some of the winches, masts and derricks which are useful to manipulate cutting operations are removed. * The ship hull is cut vertically into 3 to 10 ton blocks by oxygen-LPG torches. The hull cutting area is first cleaned manually by wire brushes and chippers before cutting. If the plates are rivetted, as in some ships aged more than 30 years, rivets are removed by gas-cutting orches or hammer and chisels. These blocks including those knocked down on to the beach are removed to the shore by winches. * Auxilliary equipment of the prime mover machinery like diesel generator sets, boilers, air compressors, pumps, valves, etc., are dismantled and removed. * The main engine is dismantled in parts head, main block, piston, crankshaft and base. Bigger chunks of the engine are removed only when the engine room is exposed after cutting bulkheads of the hull. * Bunker oil that cannot be pumped out in the beginning and that is stored under cargoholds is removed simultaneously with the engine dismantling. * The propeller is cut from its sha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ponents or raw materials an article or thing and not just removing an existing article or cutting it. The Supreme Court in Indian Poultry v. CIT [2001] 250 ITR 664, held, in the context of section 80-I, that it was not possible to conclude that the dressing of poultry is tantamount to manufacture. In CIT v. Gem India Manufacturing Co. [2001] 249 ITR 307, the Supreme Court held in the context of section 80-I, that there can be little difficulty in holding that the raw and uncut diamond is subjected to process of cutting and polishing which yields the polished diamond, but that is not to say that the polished diamond is a new article or thing which is the result of manufacture or production. In CIT v. Venkateswara Hatcheries (P.) Ltd. [1999] 237 ITR 174, the Supreme Court, in the context of sections 80HH, 80HHA, 80-I and 80J, held that the business of the assessee who was having poultry farms and running a hatchery where eggs were hatched on a large scale by adopting latest scientific and technological methods was not an industrial undertaking nor was it engaged in the business of producing "articles or things" and therefore, the assessee was not entitled to deductions under the said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngs. We hold that the assessees are not entitled to claim deductions under sections 80HH and 80-l'of the Act and that the Tribunal committed an error in upholding such deductions. VI. Decision: For the foregoing reasons, we decide the above questions of law formulated in these appeals as under: (1) The usance interest paid by the assessees was not any part of the purchase price of the ships and was interest within the meaning of the definition of the term "interest" under section 2(28A) of the Income-tax Act, 1961. (2) The assessees who did not deduct tax at source under section 195(1) of the Income-tax Act, 1961, on the usance interest payable outside India and on which tax had not been paid, are not entitled to deduct the amounts of such usance interest in computing their income chargeable under the head "Profits and gains of business of profession". The Tribunal was, therefore, wrong in deleting the disallowance under section 40(a)(i) of the Act for failure on the part of the assessees to deduct tax at source, from usance interest paid to the non-residents, under section 195(1) of the Act. (3) The assessees being responsible for paying to the non-residents usance interest w ..... X X X X Extracts X X X X X X X X Extracts X X X X
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