Case Law Companies Act Petitioner Challapalli Sugar Ltd Vs Respondent The Commissioner of Income Tax A P Hyderabad

Case Law Companies Act

Petitioner Challapalli Sugar Ltd Vs

Respondent The Commissioner of Income Tax Hyderabad




CITATION: 1975 AIR  97 1975 SCR  (2) 538 1975 SCC  (3) 572


ACT: Indian  Income-Tax  Act,  1922,  Section  10,  secs.  10(2), 10(2)(vi),  10(5) and explanation to sec. 10(5) and  Section 208(1) of Companies Act, 1956 (Act 1 ,of 1956-Payment of tax in   respect  of  profits  or  gains-Interest  paid   before commencement of production on money borrowed for-  acquiring and  installing  the  machinery  and  plant,  if  could   be capitalised and included in actual cost. Income-tax Act, 1961, as amended by Income-Tax (Amendment  ) Act   1972  (Act No. 41 of 1972) Sctions 10(2) (xv)  and  40 (iia)-  Wealth tax paid by assessee on net  wealth,  whether deductible as business expenditure under sec. 5 of  Amending Act.

HEADNOTE: In  all the three appeals the case of the assessee  is  that the  interest  for the .period before  the  commencement  of production  on money borrowed for the purpose  of  acquiring and installing the machinery and Plant should be included in the actual cost of the plant and as such capitalised for the purpose.   In Civil Appeal No. 1784, the contention  of  the assessee  is that the wealth-tax payable by the assessee  is allowable as a deduction.

Allowing Civil Appeal No. 1353 of 1970 and dismissing  Civil Appeals Nos. 1784 and 1785 of 1970. HELD  :  (i) So far as the first question is  concerned  the legal  position  for determining the actual  cost.  for  the purpose of development rebate is the same as for the purpose of   depreciation.   A  reading  of  the  provisions   sees. 10,10(2), 10(2)(vi), 10(5) and the explanation to sec. 10(5) will  disclose  that,  while  considering  the  question  of deduction on account of depreciation and development  rebate the  written  down  value  has to  be  taken  into  account. Written down value in its turn depends on the actual cost of the assets to the assessee.  As the expression “actual cost” has  not been defined in the Act, it should be construed  in the  sense which no commercial man would misunderstand.   It would   appear  that  the  accepted  accountancy  rule   for determining  the  cost  of fixed assets is  to  include  all expenditure  necessary to bring such assets  into  existence and  to  put them in working condition.  In  case  money  is borrowed by a newly started company which is in the  process of  constructing  and  erecting  its  plant.  the   interest incurred  before  the  commencement of  production  on  such borrowed  money can be capitalised and added to the cost  of the fixed assets which have been created as a result of such expenditure.   The  above  rule  of  accountancy  should  be adopted for determining the actual cost of the assets in the absence  of any statutory definition or other indication  to the contrary. [543B-D, E; 545F-H] Clause

(b) of  sub-section  (1)  of  section  208  of  the Companies  Act,  1956, gives statutory  recognition  to  the principle of capitalising the interest in case the  interest is   paid  on  money  raised  to  defray  expenses  of   the construction of any work or building or the provision of any plant in contingencies mentioned in that section even though such  money constitutes share capital.  The same  principle, should hold good if interest is paid on money not raised  by way  of share capital but taken on loan for the  purpose  of defraying  the expenses of the construction of any  work  or building  or the provision of any plant.  The reason  indeed would  be  stronger in case such interest is paid  on  money taken on loan for meeting the above expenses. [545H-546C] It  is  true  that for similar fixed  assets  there  can  be different  actual  costs.  The fact that there  would  be  a difference  in  the  actual cost of the plant  in  case  its machinery is acquired and installed with the assessee’s  own money or in case it is acquired and installed with  borrowed money  does not consequently militate against the  principle that interest paid in such circumstances can be  capitalised and  included  in the actual cost of  machinery  and  plant. [546F-G] 539

Hindus. v. Buenos Ayres Grand National Tramways Co. Limited, [1906]  2 Cl, D. 654, Corporation of Birmin gham  v.  Barnes (H.  M. Inspector of Taxes), 19 Tax Cases 195, India Cements Ltd. v. Commissioner of Income-Tax, Madras,[ 1966] 60 ITR 52 referred to. Commissioner of Income-Tax Madras v. L. G. Balakrishnan  and Bros.  (P)  Lid. [1974] 95 I.T.R. 284  and  Commissioner  of Income-tax  v.  J. K.  Cotton Spinning’   &  Weaving  Mills. Income-tax reference No. 234 of 1972 decided on My 13. 1974, by Allahabad High Court, approved.


(ii) In Travancore Titanium Product Ltd. v. Commissioner  of Income-Tax, Kerala [1966] 60 ITR 277, the Supreme Court held that the amount of Wealth Tax paid by an assessee on his net wealth  under  the  Wealth-Tax  Act  is  not  a  permissible deduction under sec. 10(2) (xv) of the Act in his income-tax assessment.   After  this  decision  when  the  matter   was considered  by a larger Bench consisting of five  Judges  in the  case  of Indian Almunium Co. Ltd.  v.  Commissioner  of Income-Tax,  West Bengal, Lk[ 1972) 84 ITR 735]  this  Court held  that  the WealthTax paid by the assessee which  was  a trading  company  on assets held by it for  the  purpose  of business  was  deductible  as  a  business  expenditure   in computing  the assessee’s income from business.   Subiequent to this decision, the Income-Tax Act, 1961 was amended first by  means of an Ordinance and later by means of the  Income- Tax (Amendment) Act, 1972 (Act No. 41 of 1972).  The  result of this amendment is that any sum paid on account of Wealth- Tax  cannot  be  deducted  in computing  the  income  of  an assessee  chargeable  under the head “Profits and  Gains  of business,  profession  or Vocation” or  “Income  from  other sources”.  The serving clause contained in section 5 of  the amending Act provided

“Where,  before  the 15th day  of        July,  1972 being   the  date        on  which  the   Income-tax (Amendment)  Ordinance, 1972 came into  force, the  Supreme  Court  has,        on:  an  appeal  in respect  of the assessment of an assessee        for any  particular  assessment  year,  held        that wealth-tax paid by the assessee is  deductible in  computing the total income of        that  year, then, nothing contained in sub-clause (iia) of clause (a) of section 40, or sub-section        (IA) of  section  58,        of  the  principal  Act,  as amended  by this Act, or, as the case may        be, section  4  of this Act, shall  apply  to        the assessment   of such   assessee   for   that particular year.” [549F-550F]

What is necessary to attract this section is that this Court should  have  held  before July 15, 1972  on  an  appeal  in respect  of an assessment of the assesse for any  particular assessment year that the wealth-tax paid by the assessee  is deductible in computing the total income of that year.  Once that is the effect of a decision given by this Court  before July 15, 1972 the fact that the judgment in which the  above finding  is  recorded is given in other appeals,  which  are heard  together along with the appeal of the  assessee,  and the  further fact that assessee’s appeal is not disposed  of before  July  15,  1972,  would not take  the  case  of  the assessee  out of the purview of section 5. The case  of  the assessee  in  Civil Appeal No. 1784 is covered by 5  of  the Amending Act. [5510-552A]

JUDGMENT: CIVIL  APPELLATE  JURISDICTION : Civil Appeal  No.  1353  of 1970. From the Judgment and order dated the 5th September, 1969 of the Andhra Pradesh High Court in Case No. 64 of 1965 and Civil Appeals Nos. 1784 & 1785 of 1970. From the Judgment & Order dated the 18th August, 1965 of the Calcutta High Court in I.T.R. No. 148 and 149 of 1961. N.A. Palkhivala, S. T. Desai and T. A. Ramachandran, for the appellant (in C.A. No. 1353 of 1970.) V.   S.  Desai, J. Ramamurthi and R.  N. Sachthey,  for  the appellant (in C.A. 1784-85.) V.   S.  Desai,  J.  Ramamurthi,  S.  P.  Nayar  and  R.  N. Sachthey, for the respondent (in C.A. 1353 of 1970.) 540 N..  A.  Palkhiwala,  S.  T. Desai, A.  K.  Varma,  Ravinder Narain, J.     B. Dadachanji, 0. C. Mathur, and K. J.  John, for the Interveners Nos. 1 and 3 (in C.A. No. 1784-85/70.) N.   A. Palkhiwala, Bhakta, J. B. Dadachan, Ravinder Narain, O.   C. Mathur, for Interveners Nos. 1 and 3 (in C.A.  1784- 85/70.)


D. N. Gupta for Intervener No. 2 (in C.A. 1784-85/70.) The Judgment of the Court was delivered by KHANNA,  J.-Appeal  No.  1353 of  1970   on  certificate  is directed  against the judgment of Andhra Pradesh High  Court whereby  the High Court answered the following  question  on reference  made  to  it under section 66(1)  of  the  Indian Income-tax  Act, 1922 (hereinafter referred to as  the  Act) against the assessee and in favour of the revenue “Whether         the   interest   payment   of   Rs. 2,38,614/represents  an element on the  actual cost  of        the  machinery, plant  etc.  to  the asseessee        and as such depreciation and  deve- lopment  rebate are admissible with reference to this amount also ?”

The  matter  relates  to the assessment  year  1959-60,  the corresponding  accounting year for which ended on  June  30, 1958.   The assessee is a public limited company engaged  in the  manufacture and sale of sugar.  The company  went  into production  on January 22, 1958.  The assessee  company  had borrowed  considerable  sum  of money  from  the  Industrial Finance  Corporation  of  India  for  the  installation   of machinery  and plant.  During the relevant year and for  the period  prior  to  the  commencement  of  its  business  the assessee  paid  Rs. 2,38,614 as interest.  The case  of  the assessee  is that the payment of interest added to the  cost of  machinery  and plant to the assessee and as  such  while calculating  depreciation  admissible to the  assessee,  the interest  paid should be treated as part of the cost of  the machinery and plant to the assessee. The  income)-tax  officer rejected the above  claim  of  the assessee  and held that the interest paid from year to  year was  an  admissible  item  of  revenue  expenditure  and  no depreciation  could be allowed on the capitalised amount  of the expenditure incurred on account of interest.  No part of the  above  amount,  according to  the  incometax  ,officer, should be taken as expenditure attributable to the  erection of the machinery or other assests.  The Appellate  Assistant Commissioner on appeal reversed the decision of the  income- tax  officer  on  this  aspect.   The  Appellate   Assistant Commissioner  held  that during the period  of  construction when  money was borrowed for the purpose of  purchasing  and installing  the machinery, the payment of interest  was  the “cost  of  maintaining the borrowal”, and as such  could  be included as part of the capital cost.  On further appeal the Income-tax  Appellate  Tribunal held that the  cost  to  the assessee must include all expenditure which it had to  incur for  acquiring and installing the asset.  The interest  paid or payable during the period of acquisition and installation could,  therefore, be considered as part of the cost to  the assessee. 541

The question reproduced above was then referred to the  High Court.    The  High  Court  held  that  where  a  plant   is constructed out of borrowed money, the interest on the  loan up to the date of the commencement of the business could not be capitalised or treated as part of the actual cost of  the plant. Similar question arises in civil appeals Nos. 1784 and  1785 of 1970 which have been filed by the Commissioner of Income- tax on certificate against the judgment of the Calcutta High Court whereby the High Court answered the following question in  reference under section 66(1) of the Act for  assessment years 1955-56 and 1959-60 against the revenue and in  favour of the assessee company : “Whether on the facts and in the circumstances of  the  the assessee was entitled  under        the provisions of sections 10(2)(vi), 10(2)(vi-a) and 10(2)(vi-b) and read With section 10(5) of the Indian Income tax Act to treat the sum  of Rs.  23,53,284  being the amount of  interest paid on monies borrowed at part of the  actual cost for the purpose of depreciation allowances and development rebate ?”

In  civil  appeal  No. 1784 of 1970, which  relates  to  the assessment  year 1959-60, the following additional  question was also answered by the High Court against the revenue  and in favour of the assessee “Whether  the  wealth-tax  payable   by   the assessee        under the provisions of the  Wealth- tak  Act of 1957 is allowable as a  deduction under section 10(1) or under section 10(2)(xv) of the Indian Income-tax Act?”

The  assessee  company in these two  appeals,  M/s  Standard Vacuum  Refining Co. of India Ltd. (now known  as  Hindustan Petroleum  Corporation  Ltd.), was incorporated on  July  5, 1952 and commenced its business in September 1954.  In  June 1953  it  borrowed rupees four crores on  debenture  at-the. rate  of Rs. 5 1/4 per cent interest from the  public.   The interest  was  to  run from June  1953.   The  above  amount together  with rupees twelve crores financed by the  company was  used  in  setting up a refinery  for  which  plant  and machinery  were imported from abroad.  The refinery  started work  on  September 1, 1954, from  which  date  depreciation began  to be calculated.  The assessee  company  capitalised all   the  expenses  during  the  period  of   construction, including the interest amounting to Rs. 23,53,284 which  had accrued  from  the  date of borrowing to the  date,  of  the commencement  of  the  business on the  aforesaid  loan  and claimed depreciation on full amount.  The income-tax officer did  not include interest on debentures in arriving  at  the figure of actual cost and as such rejected the claim of  the assessee   in   this  respect.   The   Appellate   Assistant Commissioner   agreed  with  the  Incometax  officer.    The Tribunal  on further appeal held that the assessee was  also entitled to depreciation on the capitalised interest of  Rs. 23,53,284 paid to the debenture holders. The  relevant facts so far as the second question  in  civil appeal  No. 1784 of 1970 is concerned were as follows.   Ile assessee, 542

company filed a return showing an income of rs.  1,52,88,497 for  the  assessment year 1959-60, the  relevant  accounting year  for which was the calendar year 1958.  In arriving  at the  above figure of the income, the assessee claimed a  sum of  Rs. 5,04,000 representing the provision  for  wealth-tax payable by it for the previous year relevant to the date  of valuation, viz., December 31, 1958.  The income-tax  officer held  that the provision for the payment of wealth  tax  did not  amount to expenditure laid out wholly  and  exclusively for the purposes of the business.  ‘The Appellate  Assistant Commissioner agreed with the income-tax officer.  On  second appeal  the  Appellate Tribunal held that the  above  amount could be allowed at the time when actual payment was made. The  High  Court, as already mentioned,  answered  both  the questions in favour of the assessee and against the revenue. This judgment would dispose of all the three civil appeals. In  appeal  before  us  Mr.  Palkhivala  on  behalf  of  the assessees in the three appeals has argued that interest  for the  period before the commencement of production  on  money borrowed  for  the purpose of acquiring and  installing  the machinery and plant should be included,  in the actual  cost of  the plant and as such capitalised for the,  purpose.  As against  that,  Mr.  Desai  on behalf  of  the  revenue  has supported theview taken by the Andhra Pradesh High  Court. After hearing the learned counsel for the parties, we are of the  opinion that the submission made by Mr.  Palkhivala  is well-founded.

Before dealing with the contentions advanced, we may set out therelevant provisions. Section 10 inter alia provides for the  payment  of tax in respect of profits or gains  of  any business by an assessee.Sub-section  (2)  of  that  section provides that such profits or gains shall be computed  after making the allowances specified therein. Clause (vi) of that sub-section deals with deductions on account of depreciation and provides inter alia that deductions would be permissible in  respect of depreciation of machinery or plant  used  for the  purpose  of  business and being  the  property  of  the assessee, of a sumequivalent  to  such percentage  on  the written  down value thereof as may in any case or  class  of cases be prescribed. “Written downvalue”  has been  defined in sub-section (5) of section 10 in the caseof       assets acquired  in  the  previous year, the  actual  cost  to  the assessee, and in the case of assets acquired in the previous year, the actualcost   to   the   assessee,   less   all depreciation actually allowed to  him under this Act or  any Act repealed thereby, orunder executive orders issued  when the Indian Income-tax Act,1886   was   in   force.   The definition is subject to provisos, but we are not  concerned with  them.  The explanation which has been  added  to  sub- section (5) reads as under


“Explation For the purpose of this  subsection the expression ‘actual cost’ means the  actual cost of the assetsto  the assessee  reduced by that portion of the cost thereof,if any, as has   been  met  directly   or  indirectly   by Governments 543 or  by any public or local authority, and  any allowance        in  respect  of  any   depreciation carried  forward  under  clause  (b)  of the proviso to- clause (vi) of sub-section (2) shall  be deemed to be depreciation  ‘actually allowed’.”

It has not been disputed that so far as the question  before us  is  concerned  the legal position  for  determining  the actual  cost  for the purpose of development rebate  is  the same as for the purpose of depreciation. It  would appear from the above that while  considering  the question  of  deduction  on  account  of  depreciation   and development rebate, we have to take into account the written down value.  Written down value in its turn depends upon the actual  cost of the assets to the assessee.  The  expression “actual  cost”  has  not been defined in the  Act,  and  the question which engages our attention is whether the interest paid  before  the commencement of production on  the  amount borrowed  for the acquisition and installation of the  plant and  machinery  can be considered to be part of  the  actual cost of the assets to the assessee.  So far as the  interest after  the commencement of production in respect of  capital borrowed for the purposes of business is concerned, the same can  be  deducted under clause (iii) of  subsection  (2)  of section 10 of the Act.

In  finding the answer to the question mentioned  above,  we have  to  bear  in mind that it arises  in  the  context  of profits or gains of business and the permissible  deductions on  account of depreciation and development rebate  relating to  the  machinery  and  plant  of  the  assessee.   As  the expression “actual cost” has not been defined, it should, in our  opinion, be construed in the sense which no  commercial man  would  misunderstand.   For this purpose  it  would  be necessary  to  ascertain  the  connotation  of  the   above, expression   in   accordance  with  the  normal   rules   of accountancy  prevailing in commerce and industry.  The  word “cost”,  as  observed on page 424 of Simon’s Taxes  B  Third Edition,  is  not synonymous with “price”.  Other  items  of expenditure,  such  for  instance as  freight  or  warehouse charges or insurance, must in certain cases be added to  the price. The  matter has been dealt with in  Accountancy  by Pickles  1955  Ed.on  page 944 under the  head  “Payment  of interest on Construction Capital”as under:


“In   the        ordinary  course  of   affairs   no dividends may be paid unless  such  dividends are   paid  out  of  profits  :  interest on debentures   (being  a  charge  is,   however, payable  whether profits are earned  or  not). Where company raises share, capital and out of the  proceeds  defrays  the  expenses  of        the construction  of  any works  or  buildings  or provision        of  plant  which  cannot  be   made profitable for a lengthened period the company may  pay  interest on so much  of  that  share capital  as is paid up for the period and   may charge  to  capital  the sum paid  by  way  of interest,  provided  that  the   re strictions  imposed  under section 65  of        the Companies, s Act, 1948 are complied with,” 4-L319Sup.Cl/75 544 It is further observed “The  interest so paid is ‘capitalised’,        that is to say it is treated as part of the cost of construction being added thereto (similarly to legal   expenses        of  acquiring  Property   or brokers’ charges on purchasing investments).” In  Spicer & Pegler’s Practical Auditing 11th Edition it  is observed  on pages 190-191 under the head “Interest  Payable Out of Capital During Construction” “Interest  on debentures issued for a  similar purpose  can be charged to capital during   the period of construction (Hinds v. Buenos  Ayres Grand National Tramways Co. Ltd. (1906) 2        Ch. 654).” In Higher Book-Keeping, & Accounts by Cropper Morris & Fison Seventh Edition, it is-observed as under “Capital   expenditure over a long period  must perforce        involve the question of interest  as an   additional  cost.   If  the         work   were undertaken  by  an independent  contractor  he would,  of course take,interest  into  account when preparing the  estimates on which to base his tender. The final cost cost of construction work is’ made up of’ thecost of machinery, materials, labour, supervision, and  establishment charges, plus        interest  on the  capital  employed  which,  but  for         its employment  in that way, would be invested  in good  securities, paying a reasonable rate  of interest.”

Section 208 of the Companies Act, 1956 (Act 1 of 1956) deals with  payment  of  interest  on  share  capital  in  certain contingencies.   Subsection  (1) of that  section  reads  as under: “(1)  Where  any  shares in a company  are  issued  for  the purpose of raising money to defray the expenses of the cons- truction  of any work or building. or the provision  of  any plant, which cannot be made profitable for a lengthy period, the’ company may- (a)   pay.  interest  so much  of        that  share capital as is for the time being paid up,        for the  period and subject to the conditions        and restrictions  mentioned in subsections (2)  to (7); and (b)   charge  the        sum  so  paid  by  way   of interest,        to capital as part of the cost  of- construction  of the work or building  or        the Provision of the plant.” Exercise of power under sub-section (1) is, however  subject to  certain restrictions which have been enumerated  in  the remaining subsections of the section, one of which  requires that  no  such payment shall be made  without  the  previous sanction  of  the  Central Government.  ,  In  Statement  on Auditing  Practices  issued by the  Institute  of  Chartered Accountants of India (1974) it is observed in paragraph 2. 5 as under : “2.5

Fixed Assets should be valued at cost and depreciation should be written off on a proper and consistent basis. 545 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 (i)   Legal  charges and stamp duties  in the case of land, (ii)Architect’s fees in the case of buildings, (iii)Wages,    salaries and    installation expenses in the case of machinery, and (iv)  Interest  on  borrowings to the  extent specified in paragraph 2.22” Relevant part of paragraph 2.22 reads as under “2.22 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. In no circumstances,  should  imputed  interest  be capitalised,  such  as interest on  equity  or preference   capital  at  a   notional   rate. Interest  on capital during construction  paid in  accordance with the provisions of  section 208 of the Companies Act, 1956, may,  however, be  capitalised as permitted by that  section. 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  erection  stage. However,  once production starts, no  interest on  borrowings for the purchase  of  machinery (whether        for  replacement  or  renovation  of existing plant) should be capi- talised. ”

It would appear from the above that the accepted accountancy rule for determining the cost of fixed assets is to  include all   expenditure  necessary  to  bring  such  assets   into existence  and  to put them in working condition.   In  case money  is borrowed by a newly started ‘company which  is  in the  process  of constructing and erecting  its  plant,  the interest  incurred before the commencement of production  on such borrowed money can be capitalised and added to the cost of  the fixed assets which have been created as a result  of such expenditure.  The above rule of accountancy should,  in our view, be adopted for determining the actual cost of  the assets  in the absence of any statutory definition or  other indication to the contrary.

We have already referred to section 208 of the Companies Act which  makes  provision  for payment of  interest  on  Share capital  in  ,certain  contingencies.  Clause  (b)  of  sub- section  (1) of that section provides that in case  interest is  paid on share capital issued for the purpose of  raising money  to  defray the expenses of constructing any  work  or building or the provision of any plant in contingencies 546

mentioned  in  that  section,  the sum so  paid  by  way  of interest  may be charged to capital as part of ‘the cost  of construction of the work or building or the provision of the plant.    The   above  provision   thus   ,gives   statutory recognition to the principle of capitalising the interest in case the interest is paid on money raised to defray expenses of the construction of any work or building or the provision of  any  plant. in contingencies mentioned in  that  section even though such money constitutes share capital.  The  same principle,  in our opinion, should hold good if interest  is paid  on money not raised by way of share capital but  taken on  loan  for the purpose of defraying the expenses  of  the construction of any work or building or the provision of any plant.   The reason indeed would be stronger in  case,  such interest  is  paid on money taken on loan  for  meeting  the above expenses. Mr.  Desai  has  argued that if the interest  paid  on  loan incurred  for the purpose of acquisition and installing  the machinery  of  a  plant  is to  be  taken  into  account  in considering  the actual cost of the plant, the result  would be that the actual cost would be higher if the machinery for the  plant  is acquired and installed  with  borrowed  money compared  to the cost of such plant in case the money  spent for the acquisition and installation of the above  machinery is that which belongs to the assessee.  This undoubtedly  is so  but  it is inevitable and should not  detract  from  the conclusion  at which we have arrived.  Let us take the  case of  an  architect  constructing  his  house.   In  case  the architect engages another architect to prepare the plan  for his  house  and  to  supervise  its  construction  and  pays remuneration  to that other architect for this purpose,  the amount so paid to the other architect shall have to be taken into account in arriving at the figure of actual cost of the house.   In  case, however, the architect  constructing  the house himself prepares the plan of the house and  supervises its  construction,  he  would naturally be  not  paying  any remuneration  to himself for the aforesaid work  The  result would  be  that in the latter event the actual cost  of  the house would be less compared to the cost of the house in the former event even though the house in all other respects  is identical.   It  would therefore, follow  that  for  similar fixed assets there can be different ‘actual costs.  The fact that  there would be a difference in the actual cost of  the plant  in case its machinery is acquired and installed  with the  assessee’s  own  money or in case it  is  acquired  and installed with borrowed money does not consequently militate against the answer which we propose to give to the  question referred in the three appeals.

In the case of Hinds v. Buenos Ayres Grand National Tramways Company,  Limited(1) a trarnway company, for the purpose  of converting its undertaking to a system of electric traction, issued  conversion  debenture stock.  The  directors  passed resolutions  that  the  interest on  this  stock  should  be treated as part of the cost of construction, and  chargeable to  capital  account during the construction of  the  works. The  memorandum and articles of association of  the  company contained  no provisions relating to this subject.   It  was held that there (1)  [1906] 2 Ch.  D. 654. 547

was  no  general rule of law which  compelled  companies  to charge to revenue account interest on money borrowed for the purpose  of  constructing  works, or  prohibited  them  from charging  it, during construction, to capital  account.   It was  further he-Id that in the absence of any  provision  to the  contrary  the  company was at  liberty  to  charge  the interest  in question to capital account.  Dealing with  the question  of costs for the, purpose of construction and  the question  whether  the interest paid on money  borrowed  for such  construction  could  be capitalised,  Warrington   J. observed : “Now,  what is it that the company are  really proposing to do ? They are creating a  capital asset  by means of which they  will  hereafter earn,  or they hope to earn, profits  for the company. They  are  not  simply   employing contractors to find the money and do the work. They  are        finding the money  themselves,  and they  find  the money by borrowing  it. What does  each mile of line cost them under  these circumstanceswhat        is it that they  expend  in constructing  each  mile of line, taking  the amount of the borrowed money expended on that line  to be pond s 1 0,000,  that  being  the company’s estimate?  The money is borrowed for that particular purpose-the pond 10,000. They have  to  pay  interest on  that  pond  10,000 during the period that construction is  taking place.   In my opinion that asset        which  they are so constructing costs them not only the Es 10,000,  but the Es 10,000 plus the amount  of interest        during the period  of  construction; and that is what they are out of pocket during the  construction of that mile of line. Now, it seems to me that the company are entitled-I do  not  say that they are bound to  do  it-if they think fit to charge in their accounts  as the cost of that mile of line not only  pond-s 10,000, but the Es 10,000 and the interest  on it during the period of construction.”

Mr. Desai has referred to the decision of the House of Lords in  the case of Corporation of Birmingham v. Barnes (H.   M. Inspector  of Taxes).(1) The appellant corporation  in  this case  entered  into  an agreement with a company  to  lay  a tramway  track  and  establish  a  tramway  service  to  the company’s  works.   By  virtue  of  the  work  having   been completed and-the service established by a certain date, the corporation received from the company in accordance with the terms  of the agreement, a specified sum.   The  corporation also  spent  considerable sums of money on  the  renewal  of their tramway tracks and received in that connection  grants from  the Unemployment Grants Committee.  These grants  were made under certain conditions to local authorities to assist them  ‘in  carrying out at once approved schemes  of  public utility on which a substantial number of unemployed  persons could  be  engaged.   It was held that the  payment  by  the company and the grant from the Unemployment Grants Committee should not be, taken into account in ascertaining the actual Costs  to the corporation of the tramway track  in  question for  the  purpose  of computing the  allowance  due  to  the corporation for (1)  19 Tax Cases 195. 548 wear  and tear of such tracks.  Lord Atkin observed  in  the above case :

“What  a man pays for construction or for the purchase of a work seems to me to be the cost to him; and that whether someone has given him the   money  to  construct  or  purchase for himself, or before the event has promised  to give  him the money after he has paid for the work, or after the event has promsed or  given the money which recoups him what he has spent. In the present case, the Corporation paid the whole of the cost of the tramways out of their funds  unless  the first half  of the  Dunlop contribution  was so applied :  as  to  which there is no evidence, nor is it material.” The  above  observations were made in  the  context  whether money contributed by another party can be taken into account in  considering the cost of construction. No such  question arises  in the present case.  On the contrary, what  we  are concerned  with  here  is whether  interest  paid  on  money borrowed  for  the  acquisition  and  installation  of   the machinery  of  a plant accruing before the  commencement  of production  can  be, taken into account in  considering  the actual cost of the plant.  Such a question did not arise  in the above mentioned case before the House of Lords. Another  case to which reference has been made on behalf  of the revenue is India Cements Ltd. v. Commissioner of Income- tax Madras.(1). The appellant company in that case  obtained a  loan  of  Rs.  40  lakhs  from  the  Industrial   Finance Corporation  by creating a charge on its fixed  assets.   In connection  therewith the company spent a sum of Rs.  84,633 towards  stamp  duty, registration fees,  lawyer’s  fee  and claimed  this amount as business expenditure.  It  was  held that  the  amount spent was not in the  nature,  of  capital expenditure  and  was  laid  out  or  expended  wholly   and exclusively  for the purpose of the assessee’s business  and was  therefore allowable as a deduction under section  2(xv) of  the Act.  The act of borrowing money, it  was  observed, was  incidental to the carrying on of business and the  loan obtained  was  not  an asset or  an  advantage  of  enduring nature.  This Court accordingly held that the amount of  Rs. 84,633 was an allowable expenditure.  This case too is of no assistance  to the revenue.  The appellant company  in  that case  at the time it raised the loan was a running  concern. Unlike the assessees in the present appeals, the loan raised by  the appellant company in the cited case was  not  before the  commencement of production but at a later  stage.   The question of including the interest paid on loan before  the commencement of business in the actual  cost  of the plant did not arise in that case. It may be mentioned that as against the view taken by the Andhra  Pradesh  High  Court in the judgment  which  is  the subject (1) [1966] 60 I.T.R. 52. 549

matter of the appeal, three other High Courts have taken the contrary  view  and have-field that interest  paid  in  such circumstances can be capitalised and included in the  actual cost  of  the  machinery and plant.   The  decision  of  the Calcutta  High  Court in which the contrary  view  has  been taken  is the subject matter of appeal before us.  The  view of Calcutta High Court has been followed by the Madras  High Court  and  the Allahabad High Court.  The decision  of  the Madras  High  Court  is  in  the  case  of  Commissioner  of  Madras  v.  L. G. Balakrishnan  and  Bros.  (P) Ltd.,(1)  while that of the Allahabad High Court is  in  the case of Commissioner of Income-tax v. J. K. Colton  Spinning &  WVg.  MilIs (2). After giving the matter  our  considera- tion,  we are unable to subscribe to the view taken  by  the Andhra  Pradesh  High.   Court.  The  correct  view  in  the matter, in our opinion, has been taken by the Calcutta  High Court and we affairm the same.


We may now advert to the second question in civil appeal No. 1784  on  the point whether the wealth-tax  payable  by  the assessee  is allowable as a deduction.  The High  Court,  as already mentioned, answered the second question in favour of the assessee.  Subsequent to the judgment of the High  Court this  Court in the case of Travancore Titanium Product  Ltd. v. Commissioner of Income-tax Kerala(3) held that the amount of  wealth tax paid by an assessee on his net  wealth  under the  Wealth-tax  Act is not a  permissible  deduction  under section  10(2)(xv) of the Act in his income-tax  assessment. This  Court  in  that context observed  that  wealth-tax  is imposed  on  the owner of assets and not on  any  commercial activity.   The  fact  that in  certain  special  cases  the quantum  of  the  liability of a company  to  wealth-tax  is related to the profits earned would not alter the  character of  the tax.  It remains a tax charged upon the  net  wealth and  it  is not made a tax related to or incidental  to  the carrying on of business.


After  the  above decision, the matter was considered  by  a larger Bench consisting of five Judges in the case of Indian Aluminium  Co.  Ltd.  v.  Commissioner  of  income-tax  West Bengal(4).  This Court held that the wealth-tax paid by- the assessee  which was a trading company on assets held  by  it for  the  purpose of business was deductible as  a  business expenditure  in computing the assessee’s income  from  busi- ness.  Sikri, C.J. speaking for four of the Judges  observed that  when  a  person has a dual capacity  of  a  trader-cum owner, and he pays tax in respect of property which is  used for  the purpose of trade, the payment must be taken to  be, in the capacity of a trader according to ordinary commercial principles. Subsequent  to  the  above decision in the  case  of  Indian Aluminium  Co. (supra) the Income-tax Act, 1961 was  amended first  by  means of an ordinance and later by means  of  the Income-tax  (Amendment) Act, 1972 (Act No. 41 of 1972).   By section 2 of the amending Act such clause (iia) was inserted and wits deemed always to have been (1)  [1974] 95 I.T.R. 284. (2)  Income-tax reference No. 234 of 1972 decided on May 13, 1974. (4) [1972] 84 I.T.R. 735. (3) [1966] 60 I.T.R. 277. 550


inserted  in clause (a) of section 40 of the Income-tax  Act 1961 as under : “(iia) any sum paid on account of wealth-tax.” An explanation was added to the above sub-clause, but it  is not  necessary to reproduce the,, same.  Section 40  of  the Indian  Income-tax  Act, 1961 specifies  the  amounts  which shall  not  be deducted in computing the  income  chargeable under   the   heads  “Profits  or  gains  of   business   or profession”.   According to section 4 of the  amending  Act, nothing  contained in the Indian Income-tax Act, 1922  shall be  deemed  to authorise, or shall be deemed  ever  to  have authorised,  any deduction in the computation of the  income of any assessee chargeable under the head “Profits and gains of  business, profession or vocation” or “Income from  other sources”  for the assessment year commencing on the 1st  day of April, 1957 or any subsequent assessment year, of any sum paid on account of wealth-tax. In  view of the above provisions, it is plain that  any  sum paid  on  account  of  wealth-tax  cannot  be  deducted   in computing  the  income of an assessee chargeable  under  the head “Profits and gains of business, profession or vocation” or “Income from other sources”.  There is, however, a saving clause  contained  in section 5 of the amending Act  and  it reads as under :


“Where,  before  the 15th day  of July,  1972 being  the  date on  which  the  Income   tax (Amendment)  Ordinance, 1972 came into  force, the Supreme Court has, on an appeal in respect of  the  assessment  of an  assessee  for any particular assessment year, held that  wealth- tax  paid        by the assessee  is  deductible  in computing the total income of that year, then, nothing contained in subclause (iia) of clause (a)  of  section 40, or  sub-section  (IA)  of section  58, of the principal Act, as  amended by this Act, or, as the case may be, section 4 of this Act, shall apply to the assessment  of such assessee for that particular year.” Mr.  Palkhivala  submits that the case of  the  assessee  in respect  of the second question in civil appeal No. 1784  is covered by section 5 of the amending Act reproduced above. To  appreciate  the above submission, we  may  observe  that civil  appeals Nos. 1784 and 1785 of 1970 along  with  civil appeals Nos. 1694 and 1730 of Indian Aluminium Co. and civil appeal  No.  1831 of 1970 of Standard Vacuum  Oil  Co.  were argued  before the Constitution Bench on February  1,  1972. The  Court reserved judgments in civil appeals No. 1694  and 1730  of Indian Aluminium CO. and civil appeal No.  1831  of standard  Vacuum Oil Co. As an additional question  relating to  the  inclusion  of interest in the  calculation  of  the actual  cost  arose in civil appeals Nos. 1784 and  1785  of 1970,  the Court after hearing some arguments on that  point in  these appeals directed that they be heard by a  Division Bench  after the pronouncement of judgment in civil  appeals No.  1694, 1730 and 1831. Judgments in those three  appeals, i.e. two appeals of Indian Aluminium 551

Co. and one of Standard Vacuum Oil Co. were pronounced on March 29, 1972.  The decision in the appeals in the case  of Indian  Aluminium Co. is reported, as already mentioned,  in (1972)84 ITR 735, while that in the case of Standard  Vacuum Oil Co. is reported in (1972) ’86 ITR 1. The submission made by Mr. Palkhivala is that even though no final  order was pronounced in civil appeal No. 1784  before July 15, 1972, the effect of the judgment in the other three civil  appeals  Nos. 1694, 1730 and 1831, which  were  heard along with civil appeal No. 1784 on the point as to  whether the  wealth-tax  paid  by the  assessee  was  a  permissible deduction, was that this Court held that the same was to  be the  decision  on that point in civil appeal No.  1784.   As against  that, Mr. Desai contends that there was no  finding by this Court before July 15, 1972 in civil appeal No.  1784 that  the wealthtax paid by the assessee was  deductible  in computing the total income of the assessee.

There  is,  in our opinion, force in the submission  of  Mr. Palkhivala.  As stated above, arguments were heard  together on  February 1, 1972 in civil appeals Nos. 1784, 1694,  1730 and  1831 on the question as to whether the wealth-tax  paid by  the assessee was a permissible deduction  under  section 10(2) (xv) of the Indian Income-tax Act.  On the  conclusion of  the  arguments on that point, this Court found  that  an additional  question arose in civil appeal No. 1784  on  the point as to whether the interest payable on loan was part of the actual cost of the assets.  The Constitution Bench after hearing  arguments on this additional point for  some,  time directed that civil appeal No. 1784 along with the connected civil  appeal  1785 should be posted for  hearing  before  a Division  Bench  after pronouncement of  judgment  in  civil appeals  Nos. 1694, 1730 and 1831.  The effect of the  above order  which  was  made on February 1,  1972  was  that  the decision  in civil appeals Nos. 1694, 1730 and 1831  on  the point as to whether the wealth-tax paid by the assessee  was a  permissible  deduction, was also to be  the  decision  in civil   appeal  No.  1784.   After  the  judgments  of   the Constitution Bench in civil appeals Nos. 1694, 1730 and 1831 on March 29, 1972 the question as to whether the  wealth-tax paid  by  the  assessee was a  permissible  deduction  under section  10(2)(xv) of the Act no longer remained subject  of controversy in civil appeal No. 1784 as the decision on that point  in the three appeals was also to govern the  decision in  appeal No. 1784.  It is no doubt true that civil  appeal No.  1784 was not disposed of before July 15, 1972 but  that fact  would  not prevent the case of the  assessee  in  that appeal  ‘being  covered by section 5 of. the  amending  Act. What is necessary to attract that section is that this Court should  have  held  before July 15, 1972  on  an  appeal  in respect of an assessment of the assessee for any  particular assessment year that the wealth-tax paid by the assessee  is deductible  in computing the total income of that  at  year. Once  that is the effect of a decision given by  this  Court fore  July 15, 1972 the fact that the judgment in which  the above  finding is recorded is given in other appeals,  which are heard together along with the appeal of the assessee and the  further fact that assessee’s appeal is not disposed  of before July 15, 1972 552

would  not take the case of the assessee out of the  purview of section 5. We would, therefore, hold that the case of the assessee in civil appeal No. 1784 is covered by section 5 of the amending Act. We, however, make it clear that the benefit of section 5  of the  amending  Act so far as the second  question  in  civil appeal  No.  1784 is concerned would be  available  only  in respect of wealth-tax paid and not merely payable. In the light of the above, we dismiss civil appeals No. 1784 and  1785 of 1970.  We accept civil appeal No. 1353 of  1970 and discharge the answer given by the High Court.  We answer the  aforesaid question in the affirmative in favour of  the assessee and against the revenue.  The assessees  shall  be entitled to the costs of these appeals.  One hearing fee  in civil appeals No. 1-784 and 1785 of 1970. C.  As.  Nos. 1784 & 1785/70 dismissed V.M.K. C.A.  No.  135 3/70 allowed. 553

Leave a Comment