TMI Blog1992 (10) TMI 11X X X X Extracts X X X X X X X X Extracts X X X X ..... commencement of production other than the expenditure relating to marketing was not part of cost of the plant, machinery and buildings ?" The questions referred in T. C. Nos. 167 and 168 of 1980 at the instance of the Department: "(i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the value of assets without deducting therefrom the liabilities should be taken for the purpose of capital computation under section 80J of the Income-tax Act and consequently in directing not to exclude the liabilities while computing the capital employed under section 80J of the Act ? (ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the capital computation under section 80J should be done by taking the value of the assets without excluding therefrom the liabilities not merely on the first or the last day of the accounting year but taking it on every day throughout the year as is done for the purpose of interest computation on a daily basis ? (iii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in hold ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e amount from the assessment ? (x) Whether, on the facts and in the circumstances of the case, the view taken by the Appellate Tribunal on the provisions of section 43A of the Act on the basis of which guidelines were laid down by the Appellate Tribunal for deciding the issue by the Income-tax Officer afresh is reasonable on facts and justified in law ?" The assessee, Messrs. Madras Fertilisers Limited, is a Government company established for setting up a fertilizer plant. It entered into an agreement with Chemical Construction Corporation of New York for the construction of a complete fertilizer plant on a turnkey basis. The assessee follows the financial year as its accounting year. The construction of the plant was completed and the same was handed over to the assessee on June 7, 1971, in the previous year relevant to the assessment year 1972-73, which is under consideration. Thereafter, trial runs were conducted. Ammonia was produced first on September 9, 1971. Urea was produced on October 19, 1971. NPK was produced on October 16, 1971. Thus production on commercial scale was commenced from November 1, 1971. Question No. 1 referred at the instance of the assessee relates ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m the Commercial Bank, New York, and Rs. 29,48,00,000 borrowed from the Government of India, applying rule 19A of the Income-tax Rules. On appeal, the Appellate Assistant Commissioner confirmed the order passed by the Income-tax Officer. On further appeal, the Tribunal, following an earlier order of its own on this point, held that, in computing the capital for the purpose of allowing relief under section 80J, the total value of the assets without deducting therefrom any amount by way of liabilities should be adopted. The Supreme Court in Lohia Machines Ltd. v. Union of India [1985] 152 ITR 308, held that rule 19A in so far as it excluded borrowed moneys and debts in computation of the capital employed, was not ultra vires section 80J. A new sub-section (1A) was added by the Finance (No. 2) Act, 1980, with retrospective effect from April 1, 1972. The position now is that amounts borrowed will have to be deducted in computing the capital employed for the purposes of section 80J. Therefore, the Tribunal was not correct in holding that, in computing the capital for the purpose of relief under section 80J, liabilities should not be deducted. Therefore, we answer this question referre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... March 31, 1970. Learned standing counsel appearing for the Department submitted as under: All these expenses were incurred during the years 1967-68, 1968-69 and 1969-70 and before March 31, 1970. For the purpose of income-tax, deduction can be permitted in respect of only those expenses and losses which are incurred in the relevant accounting year. Losses and expenses incurred before the commencement of that year, cannot be a subject of any allowance in that year. The assessee is following the mercantile system of accounting. These expenses cannot be allowed either under section 28 or under section 37 of the Income-tax Act, 1961. Further, it is capital expenditure, and, therefore, it cannot be allowed. On the other hand, learned counsel for the assessee submitted as under: Though these expenses were incurred over a period and the claimed expenditures related to the period prior to April 1, 1970, they were incurred only for the purpose of distributing fertilizers imported by the Government of India. The assessee was proposing to manufacture and sell in the market fertilizer of a particular variety. Therefore, unless advance action was taken to popularise the nature of the co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the Department relied upon a decision in the case of CIT v. Basant Rai Takhat Singh [1933] 1 ITR 197 (PC). According to the facts arising in that case, the assessee took a lease from a cantonment authority for a period of 30 years. Under the terms of the lease, he had to erect certain permanent buildings which were to become the property of the lessors on the determination of the lease. He erected the buildings and received rents from third persons to whom he had leased the buildings. In computing the tax payable by the assessee in respect of the rents so received, the assessee claimed that allowance should be made for the expenditure incurred by him in erecting the buildings. On these facts, the Judicial Committee of the Privy Council held that the assessee was not entitled to the deduction claimed inasmuch as the expenditure for erection of buildings was not incurred in the year in respect of which the income sought to be assessed arose, but occurred many years before. Another decision relied upon by learned standing counsel was that in A. Y. S. Parisutha Nadar v. CIT [1962] 46 ITR 1041 (Mad). In that case, this court held that section 10(2)(xv) of the Indian Income-tax Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incurred by the assessee-company from June 10, 1964, should be allowed as a deduction in determining its business profits under section 28 of the Income-tax Act, 1961. Yet another decision relied upon by learned counsel for the Department was that in Bhodilal Menghraj and Co. P. Ltd. v. CIT [1979] 119 ITR 968 (Bom). In that case, the Bombay High Court, following the decision in CIT v. Industrial Solvents and Chemicals Pvt. Ltd. [1979] 119 ITR 608 (Bom) the decision in Western India Vegetable Products Ltd. v. CIT [1954] 26 ITR 151 (Bom), the decision of the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. [1967] 63 ITR 478 and four decisions of the Gujarat High Court, viz., Sarabhai Sons Pvt. Ltd.'s case [1973] 90 ITR 318; CIT v. Saurashtra Cement and Chemical Industries Ltd. [1973] 91 ITR 170; Sarabhai Management Corporation Ltd. v. CIT [1976] 102 ITR 25 and Prem Conductors Pvt. Ltd.'s case [1977] 108 ITR 654, held that the assessee in that case cannot claim deduction of an expenditure of Rs. 92,400 as revenue expenditure till it could be regarded as having set up its business. Therefore, according to learned standing counsel for the Department, the expenditure incurr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion that, in the case of a single venture, the expenditure incurred by the assessee in respect of that venture during the prior years must be allowable while assessing the profits of that venture. But, according to the facts arising in the present case, the assessee is not doing a single venture. Another decision relied upon by learned counsel for the assessee was that in Addl. CIT v. Farasol Ltd. [1987] 163 ITR 364 (Raj). According to the facts arising in that case, the assessee, a foreign company, entered into a contract with the Oil and Natural Gas Commission. The formal contract was executed in February, 1964, and actual drilling operations were started in December, 1964. The assessee claimed the following expenses in assessment year 1966-67 for which it had been allowed to have the period from September 10, 1964, to December 31, 1965, as the previous year. On these facts, the following question was referred to the High Court for its opinion, viz., whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing the expenditure of Rs. 3,26,794 and Rs. 19,126 incurred before February 17, 1964, from the total income for the assessment year 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... utta High Court held as under (headnote): "In the instant case, the expenditure though made initially was not for the starting of the business. Reading the agreement as a whole it appeared that the aim and object of the expenditure was not to bring into existence any asset of enduring advantage or benefit for the assessee's business but to produce profits in the conduct of its business. The assessee had not acquired any capital asset under the agreement. Having regard to the facts and circumstances of the case and specially in the nature of the obligations undertaken by the agreement and the background of the other three agreements, the purpose of the expenditure was to get rid of the annual expenditure which was necessary to be incurred for carrying on business. The sum of Rs. 66,666 was allowable as revenue-expenditure for the assessment year 1973-74." According to the facts in that case, the expenditure claimed was not for the starting of the business. The business was a running concern. The expenditure incurred was spread over 20 years and the expenditure relating to the assessment year 1973-74 was claimed in that year. It is on these facts that the above said decision was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... different from the facts arising in the present case. Hence, the decision in Security Printers of India P. Ltd. v. CIT [1970] 78 ITR 766 (All) will also not be applicable to the facts of the present case. The next decision relied upon by learned counsel for the assessee was that in the case of CIT v. Saurashtra Cement and Chemical Industries Ltd. [1973] 91 ITR 170 (Guj). According to the facts arising in that case (headnote): "A company was formed in 1956 for the manufacture and sale of cement. As part of its business the assessee obtained a mining lease for quarrying limestone and started the mining operations in 1958. It claimed the expenditure incurred for the purpose of extracting limestone as also depreciation and development rebate for the machinery installed for that purpose for the assessment years 1960-61 and 1961-62." On these facts, the High Court held as under (headnote): "That the activities which constituted the business of the assessee were divisible into three categories, the first category consisted of the activity of extraction of limestone by quarrying the leased area of land. This activity was necessary for the purpose of acquiring the raw material to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aimed by way of deduction. The Tribunal held that the claim related to revenue expenditure but was not admissible in the year under consideration." On a reference, the High Court held as under: "The nature of the arrangement was such that it would not have been possible to assess the performance and take a final decision in the matter during or at the close of the preceding assessment year. In fact, the terms of the agreement are such that the relative position could only be determined after the supply had been effected. In the facts of the case, therefore, the appropriate year in which the amount could be taken into account is the assessment year and the assessee had rightly claimed the deduction in this year and not the previous year. No cogent reason has been advanced by any of the authorities of the Revenue for rejecting the claim. On the facts of the case, we are led to hold that there is force in the assessee's stand that the amount became due for deduction during the year." In this case also, the assessee did not claim any expenditure incurred prior to the commencement of the business. The assessee-company was a running concern. The expenditure incurred in the year 196 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tute a single transaction. Therefore, the Tribunal was not correct in the present case in holding that the expenditures incurred during the years 1967-68, 1968-69 and 1969-70 prior to March 31, 1970, are allowable as deduction in the assessment year 1972-73. Learned counsel for the assessee contended that the expenditure incurred in the years 1967-68, 1968-69 and 1969-70 and prior to March 31, 1970, should be alternatively considered as capital expenditure added to the value of actual cost. The Supreme Court in the case of Challapalli Sugars Ltd., [1975] 98 ITR 167 held that any expenditure which is necessary to bring an asset in existence and to put it in working condition will go to inflate the actual cost of the assets. Applying this test, on an analysis of the expenditure incurred under this head, the income-tax authorities came to the conclusion that Rs. 35,55,769 cannot be said to be an expenditure which was necessary to bring any asset into existence and put any asset in working condition. Hence it was held that there is no question of adding this expenditure to the cost of the plant. On appeal, the Tribunal pointed out that, by their very nature promotional and publicity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the primary condition is that the assessee should have incurred an expenditure when the business is in existence. Learned standing counsel pointed out that the expenses in the present case are in the nature of advertisement and publicity and hence these expenses cannot be said to be an expenditure in connection with conducting a market survey or any other survey necessary for the business of the assessee. Learned standing counsel further submitted that, at the time when these expenditures were incurred, the business was not in existence. To elucidate the meaning of the word "survey", learned standing counsel relied upon various dictionaries. Therefore, according to learned standing counsel for the Department, the Tribunal was not correct in allowing the expenditure claimed under this head. On the other hand, learned counsel for the assessee submitted that the expenses relating to advertisement included signboards, advertisement in newspapers and magazines, etc., audio-visual advertisement expenditure and also subsidy to farmers which covers field extension programmes, expenditure on demonstration plots, farmer/dealer meetings and also soil test expenses and other expenses relatin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of sub-section (2)(a) of section 35D mentions about conducting a market survey or any other survey, necessary for the business of the assessee. The business of the assessee herein is manufacture of fertilizers and marketing the products. Considering the nature of the assessee's business, the Tribunal found that expenditure incurred under various heads as stated above are necessary for marketing the products. The word "survey" occurring in section 35D(2)(a)(iii) should be understood in the context of the nature of the business carried on by the assessee. There is no point in attributing the mere dictionary meaning to this word. It remains to be seen that the word "survey" does not mean a mere onlooking or overlooking of what happened, but would also include, attracting customers to a particular spot demonstrating to them the utility, value of the assessee's products and studying therefrom the business possibilities or determining the action necessary to extend the business. Hence, we are also of the view that no part of the expenditure claimed and allowed under the abovesaid heads can be considered as not connected with the conduct of a market survey or any other survey necessary fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ioner, on analysing the expenditure claimed under this head, in the light of the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 directed the Income-tax Officer (1) to include a sum of Rs. 4,04,96,240 being the cost of process materials used in the trial run in the actual cost of plant and machinery, (2) to include Rs. 56,31,696 incurred in connection with borrowals on account of debenture issue expenses, debenture trust fund and legal expenses in the actual cost of plant and machinery, (3) to allow 60 per cent. of the expenses on account of salaries, wages and rent as forming part of the actual cost, (4) not to capitalise welfare expenses, taxes, insurance, audit fees, directors' travelling expenses and publicity and promotional expenses, (5) to capitalise the repair expenses of Rs. 64,100 and (6) to allow 60 per cent. of the expenditure, in respect of New York office expenses, and 50 per cent. in respect of travelling and conveyance, postage and telegrams, audio and printing and stationery. Thus, out of establishment expenses of Rs. 32,67,309, miscellaneous expenses of Rs. 28,37,128 were not considered for working out the actual cos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w materials, travelling, etc., should not be allocated to plant and machinery. According to learned standing counsel, there was no justification for allocating a good portion of the salary, etc., towards the cost of machinery. Learned standing counsel submitted that many items of expenditure which are irrelevant either to the cost of construction or to the erection of the plant were directed to be added towards the actual costs. On the other hand, learned counsel for the assessee submitted as under: All the expenditures were incurred for the purpose of business. During the pre-production period, all the activities were centered around putting up the plant and bringing it up to the working condition. Expenses for manufacture, production or sale have been separated by the assessee itself. The plant went into production on November 1, 1971. The contract was on turnkey basis and the investment came to about Rs. 46 crores. The marketing operations also started in 1967 itself. The assessee spent nearly Rs. 98 lakhs for this. The assessee was carrying on only two activities during this period, viz., putting up the plant and marketing. The expenses relating to marketing had been separate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urt in the case of CIT v. L. G. Balakrishnan and Bros. (P.) Ltd. [1974] 95 ITR 284 and the decision of the Allahabad High Court in the case of CIT v. J. K. Cotton Spinning and Weaving Mills Ltd. [1975] 98 ITR 153 were approved. Thus, it must be borne in mind that all expenses necessary for putting up the plant into production stage are part of the cost of construction. Where the expenses had been incurred prior to the plant of the company going into production, but were leading up to the stage of production, it was held they were necessarily required to be incurred by the assessee for putting its plant into production and notwithstanding that they represented the aggregate amount of expenses incurred under different heads for the period prior to the commencement of the production, they must be treated as part of the actual cost of the plant and machinery to the assessee (Shree Vallabh Glass Works Ltd. v. CIT [1981] 127 ITR 37 (Guj)) actual cost of a particular asset is a question of fact which has to be determined on the evidence of the materials produced before or available to the income-tax authorities. The assessee in the instant case pointed out that the plant went into pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... achinery. In fact, the Tribunal, following the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 and other decisions, held that "the actual cost for the purpose of depreciation and development rebate in the present case has to be found by applying the above principles to the figures before us." Therefore, question No. (ii) as framed and suggested by the assessee does not arise out of the order of the Tribunal. Accordingly, we are not answering the same. Question No. (vi) referred at the instance of the Department relates to capitalisation of expenses incurred in respect of raw materials, materials and supplies, fuel, water, power used in the trial run, the expenses incurred by way of debenture issue, debenture trust fee and legal expenses and also a sum of Rs. 64,103 included in miscellaneous expenses. A sum of Rs. 4,04,96,240 was incurred in respect of raw materials and supplies, fuel, water, power, etc., used in the trial runs. This was required to be capitalised for the purpose of allowance of development rebate and depreciation. The trial run forms part of the erection of the plant and machinery. It is not sufficient only to const ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as part of the actual cost of the plant for purposes of computing depreciation and development rebate." In the case of CIT v. New Central Jute Mills [1982] 135 ITR 736 (Cal), it was held that (headnote): "Expenses incurred for staff training, insurance and power and fuel for installing plant and machinery form part of the actual cost of the machinery and depreciation and development rebate is admissible on such actual cost under sections 33 and 34 of the Income-tax Act, 1961." In the case of Shree Vallabh Glass Works Ltd. v. CIT [1981] 127 ITR 37, the Gujarat High Court held that (headnote): "All expenditure necessary to bring assets into existence and to put those assets in working condition is part of the actual cost of the assets to the assessee and it is in the light of that actual cost that the question of depreciation has to be considered by the income-tax authorities." In the case of CIT v. Saurashtra Cement and Chemical Industries Ltd. [1981] 127 ITR 47, the Gujarat High Court held that: "The Tribunal was correct in law in holding that Rs. 9,000 being the expenditure on cement factory lighting and Rs. 11,000 being electrical expenses on test and trial runs for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e New York office expenses and 50 per cent. of the travelling and conveyance, postage and telegrams, audio base and printing and stationery. The items under salaries, wages and rent, as pointed out above, would go both towards erection, etc., of the plant and machinery and also for the other working of the company. While the Income-tax Officer rejected the assessee's claim in respect of these items in its entirety, the Appellate Assistant Commissioner allowed a portion of the same for capitalisation. The Tribunal directed that, out of Rs. 1,87,35,399 being the establishment charge, 75 per cent. of salaries, wages and rent aggregating to Rs. 79,44,069 should be added to the cost of assets for allowing depreciation and development rebate. Out of the total amount of Rs. 77,74,728 being the miscellaneous expenses, made up of contract labour, staff training and recruitment expenses, the Tribunal upheld the Appellate Assistant Commissioner's order in allowing capitalisation of Rs. 64,103 and 60 per cent. of the New York office expenses and 50 per cent. of travelling and conveyance, postage and telegrams, audio base and printing and stationery. The assessee erected the factory on a turn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lowed. Other insurance expenses, either after erection or when the machinery was in a stationery position in the site, would not go to add to actual costs. In the case of CIT v. Binny and Co. [1986] 159 ITR 303, this court held that the Tribunal was correct in estimating the capital expenditure to be added to the cost of machinery for the purpose of grant of depreciation allowance. In CIT v. Borosil Glass Works Ltd. [1986] 161 ITR 286 (Bom) and in CIT v. Tata Chemicals Ltd. [1986] 162 ITR 556 (Bom), it was held that travelling expenses to inspect and place orders, correspondence and postage, insurance premium on plant and erection, technical personnel's remuneration, travelling expenses in connection with design and preliminary engineering work for installation, would form part of the actual cost of the machinery and the building. In CIT v. J. M. A. Industries Ltd. [1981] 129 ITR 373, the Delhi High Court held that expenditure incurred by way of salaries and wages to technical staff and travelling form part of the actual cost of plant and machinery. In the case of CIT v. New Central Jute Mills [1982] 135 ITR 736 (Cal), it was held that expenses incurred for insurance for installi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er arrangement. On the facts, it was shown that what had taken place was a mere barter transaction. Since there was no sale, Rs. 8,66,000 cannot be considered as sale consideration. Hence the Tribunal was correct in upholding the order passed by the Appellate Assistant Commissioner in dealing with this amount of Rs. 8,66,000. Thus, we answer question No. (ix) referred to us at the instance of the Department in the affirmative and against the Department. Question No. (x) referred at the instance of the Department relates to the guidelines given by the Tribunal in the matter of regulating the deduction under section 43A of the Act. From the cost of plant and machinery arrived at at Rs. 91,69,77,796, the Income-tax Officer deducted a sum of Rs. 48,29,717 applying the provisions of section 43A of the Act and accepted the balance, for the grant of depreciation. The sum of Rs. 48,29,717 is credited in the account called exchange fluctuation benefit. On appeal, the Appellate Assistant Commissioner held that section 43A will be applicable to the facts of this case and the Income-tax Officer was correct in adjusting the amount of Rs. 48,29,717 in the cost of plant and machinery. Accordi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty has to be adjusted in the cost of the plant and machinery. Learned counsel for the assessee submitted as under: The company was set up in 1966. The contract for construction of the plant was given to the contractor in 1967. The trial runs were conducted in September, 1971. The production commenced on a commercial scale from November 1, 1971. On September 13, 1977, the U. S. dollar was devalued reducing its value from Rs. 7.50 per dollar to Rs. 7.279. The bank balance and the U. S. dollar liabilities having been affected by the change in exchange rates, the beneficial difference arrived at at Rs. 42,30,316 was credited to the exchange fluctuation reserve account. This represented the net result of a gain of Rs. 48,29,717 and a loss of Rs. 5,99,401 on account of variation in exchange rate. The assessee acquired the assets from more than one source, viz., equity, dollar amounts and interest realisation. Therefore, it is not correct to state as to how much of the U. S. dollar allocations or outstanding would relate to the value of the assets unpaid. Though the assessee owed amounts to the Chemical Bank from whom money had been drawn for the purchase of machinery, the machinery was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctual cost has anything to do with the cost of the asset in question being capitalised or not (CIT v. Tata Hydro Electric Power Supply Co. Ltd. [1986] 159 ITR 28 (Bom)). Sub-section (2) of section 43A specifically rules out the application of the section for the purpose of development rebate. In the present case, the actual amount of Rs. 42,30,316 credited to the exchange fluctuation reserve account, is the net result of a gain of Rs. 48,29,717 arising from the devaluation of the U. S. dollar on December 13, 1971, and a loss of Rs. 5,99,401 on account of variation in the exchange rate. The three conditions required by section 43A are satisfied in the present case. The assessee has purchased the machinery abroad. For this purpose, loans have been taken from Chemical Bank, New York. The loan in foreign currency is specifically intended to some extent for the purpose of acquiring an asset in respect of which depreciation is claimed. There was devaluation of the dollar in December, 1971. Hence, there is fluctuation in the rate of exchange on that date. The rate of exchange as on date of purchase of the machinery and the rate as on November 1, 1971, are not known. It is also not known ..... X X X X Extracts X X X X X X X X Extracts X X X X
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