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PETITIONER: COMMISSIONER OF INCOME-TAX BIHAR-II, PATNA

       Vs.

RESPONDENT: BOKARO STEEL LIMITED, BOKARO

DATE OF JUDGMENT:       18/12/1998

BENCH: SUJATA V. MANOHAR, & G.B.PATTANAIK.,

JUDGMENT:

--------

Mrs. Sujata V. Manohar, J. -------------------------

       Civil  Appeal  Nos.  2544-45  of  1988  pertain   to assessment  year  1972-73  while Civil Appeal Nos. 642-48 of 1989 pertain to assessment years  1965-66  to  1971-72.  The Income-tax  Appellate  Tribunal  had  referred the following questions to the High Court for determination under  Section 256(1) of the Income-tax Act, 1961:-

At the instance of the Revenue: ------------------------------         "Assessment year 1965-66:         ------------------------

               Whether,   on   the   facts   and   in   the         circumstances  of  the  case,   the   Tribunal   was         justified in law in holding that the hire charges of         Rs.  56 received by the assessee-company for letting         out the plant and machinery to the contractors  were         not taxable?

       Assessment year 1966-67:         -----------------------

       (1)   Whether, on the facts and in the circumstances         of  the  case,  the Tribunal was justified in law in         holding that the hire charges of Rs. 7,224  received         by the assessee-company for letting out of the plant         and machinery to the contractors were not taxable?

       (2) Whether, on the facts and in  the  circumstances         of  the  case, the Tribunal was justified in holding         that the royalty of Rs.  8,530/- received  from  the         contractor  was  not  taxable  as  it was of capital         nature and not revenue?

       Assessment year 1967-68:         -----------------------

       (1) Whether, on the facts and in  the  circumstances         of  the  case,  the Tribunal was justified in law in         holding that  the  hire  charges  of  Rs.     12,195         received  by the assessee-company for letting out of         contractors were not taxable?

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       (2)   Whether, on the facts and in the circumstances         of  the  case, the Tribunal was justified in holding         that the royalty of Rs.1,22,902  received  from  the         contractors  was  not  taxable  as it was capital in         nature and not revenue?

       Assessment year 1968-69:         -----------------------         (1) Whether, on the facts and in  the  circumstances         of  the  case,  the Tribunal was justified in law in         holding that  the  hire  charges  of  Rs.     17,913         received  by the assessee-company for letting out of         the plant and machinery to the contractors were  not         taxable?

       (2)   Whether, on the facts and in the circumstances         of the case, the Tribunal was justified  in  holding         that  the  royalty  of  Rs. 65,799 received from the         contractor was not taxable as it was of  capital  in         nature and not revenue?

       Assessment year 1969-70:         -----------------------

       (1) Whether, on the facts and in  the  circumstances         of  the  case,  the Tribunal was justified in law in         holding that  the  hire  charges  amounting  to  Rs.         46,342  received by the assessee-company for letting         out of the plant and machinery  to  the  contractors         were not taxable?

       (2)     Whether,   on   the   facts   and   in   the         circumstances   of   the   case,  the  Tribunal  was         justified in law in  holding  that  the  royalty  of         Rs.25,928  received  from  the  contractors  was not         taxable as it was of capital nature and not revenue?

       Assessment year 1970-71:         -----------------------

       (1)  Whether,  on the facts and in the circumstances         of the case, the Tribunal was justified  in  law  in         holding   that   the   interest   received   by  the         assessee-company  on  the  amount   of   Rs.7,50,502         advanced to the contractors was not taxable?

       (2)     Whether,   on   the   facts   and   in   the         circumstances   of   the   case,  the  Tribunal  was         justified in law in holding that the hire charges of         Rs.182 received by the assessee-company for  letting         out  the plant and machinery to the contractors were         not taxable?

       (3) Whether, on the facts and in  the  circumstances         of  the  case, the Tribunal was justified in holding         that  the  royalty  of   Rs.13,502   received   from         contractors  in  not  taxable  as  it  is of capital         nature and not revenue?

       (4)      Whether,  on   the   facts   and   in   the         circumstances   of   the   case,  the  Tribunal  was         justified  in  law   in    holding  miscellaneous of         Rs. 49 as not taxable?

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       Assessment year 1971-72:         -----------------------

       (1)      Whether,  on   the   facts   and   in   the         circumstances   of   the   case,  the  Tribunal  was         justified  in  law  in  holding  that  the  interest         received  by  the  assessee-company on the amount of         Rs.14,98,993 advanced  to  the  contractor  was  not         taxable?

       (2)  Whether,  on the facts and in the circumstances         of the case, the tribunal was justified  in  law  in         holding   that   the  hire  charges  of  Rs.3,68,442         received by the assessee-company for letting out the         plant and machinery  to  the  contractors  were  not         taxable?

       (3)      Whether,   on   the   facts   and   in  the         circumstances  of  the  case,   the   Tribunal   was         justified  in  holding  that the royalty of Rs.6,504         received from the contractors is not taxable  as  it         is capital in nature and not revenue?

       (4)       Whether,   on   the   facts   and  in  the         circumstances  of  the  case,   the   Tribunal   was         justified  in  law  in  holding  that  the  interest         received   amounting   to   Rs.7,39,332    by    the         assessee-company  on  the  amount  advanced  to M/s.         Hindustan Steel Ltd. is not taxable?"

       For  the  assessment  year  1972-73  a  consolidated reference was made at the instance of the revenue as well as the assessee and the following questions were referred:-

       "(1)  Whether  on the facts and in the circumstances         of the case, the receipts arising from  the  letting         out  of  the  quarters  to  the  outsiders,  such as         employees  of  the  contractors   engaged   in   the         construction  of  the  plant  can  be treated as the         income of the assessee and/or, in any event,  should         be  adjusted  against the cost of construction so as         to reduce such cost?

       (2)      Whether   on   the   facts   and   in   the         circumstances  of  the  case,  the receipts from the         letting out of the properties to outsiders, such  as         the  employees  of  the  contractors  engaged in the         construction of the plant  are  to  be  assessed  as         income   from  property  under  section  22  of  the         Income-tax Act, 1961, or the said income  should  be         assessed  under  section  28  of the Income-tax Act,         1961, as business income  or  in  any  event,  under         section  56  of  the Income-tax Act, 1961, as income         from other sources?

       (3) Whether on the facts and in the circumstances of         the case, the receipts arising from the letting  out         of  the quarters to the outsiders, such as employees         of the contractors engaged in  the  construction  of         the  plant  can  be  treated  as  the  income of the         assessee and/or, in any event,  should  be  adjusted         against  the  cost  of  construction so as to reduce         such cost?

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       (4) Whether on the facts and in the circumstances of         the case, the interest received  from  the  bank  on         short-term  deposits is liable to be assessed as the         income of  the  assessee  or  such  interest  should         reduce the cost of construction of the assessee and,         therefore,  would  not  constitute the income of the         assessee?

       The  assessee  is  a corporation wholly owned by the Government of India.  It was assessed in  the  status  of  a company.   The  assessee-company, M/s Bokaro Steel Ltd., was incorporated in January 1964.  Its object was  to  construct and  own  an  integral  iron  and  steel  works.  During the assessment  years   under   consideration,   the   work   of construction  of  the  company’s factory and installation of the plant was in the process of completion. The company  had not  started  any  business  during  the assessment years in question.

(1)     During this period the  company  had  given  to  the contractors  quarters  for  the  residence  of the staff and workers employed by the contractors who had been engaged  by the   assessee-respondent  for  carrying  out  the  work  of construction. The assessee charged the contractors  for  the use  of  the  quarters  so  given to the contractors for the residence  of  his  workmen  who   were   engaged   in   the construction activity of the assessee’s plant.

(2) Secondly, during the assessment years  in  question  the assessee  had entered into supplementary agreements with its contractors  under  which  the  assessee  had  made  certain advances  to  the  contractors to enable them to execute the large scale construction work smoothly.   The  assessee  had agreed  to  advance  these  advances  to  the contractors on payment of interest.  The contractors thus did not  have  to raise funds    from    outside    agencies.        For   the assessee-company, this arrangement primarily  meant  payment in  advance  of  the  amounts  of the contractors’ bills for which the asseessee-company  had  charged  interest.    This interest   was  later  adjusted  against  the  dues  of  the contractors.

(3)   For the purpose of the construction work the  assessee had  given  on  hire  certain  plant  and  machinery  to the contractors. Against the letting of plant and machinery  the assessee received from the contractors income in the form of hire   charges.   It   was   not   the   business   of   the assessee-company to let out plant and machinery  to  others. The  assessee-company  permitted  its  use  only  to its own contractors  for  the  construction   work   done   by   the contractors for the assessee-company. The Tribunal has found that  the assessee-company charged hire charges for such use of plant and machinery in order to cover the maintenance and wear and tear of the plant and machinery  belonging  to  the assessee.

(4) The assessee-company allowed the contractors to use  the stones  lying  on the assessee’s land for construction work. The stones lying on the assessee’s company’s land  were  the capital assets   of  the  assessee-company.    The  assessee charged the contractor a certain amount by  way  of  royalty for  excavation  and  use  of  these stones for construction work.

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(5) The assessee had, during  the  assessment  year  1971-72 shown  in its accounts as income from interest a certain sum said to have been accrued to the assessee from M/s Hindustan Steel  Limited  for  eight  locomotives  supplied   by   the assessee-company to   M/s  Hindustan  Steel  Limited.    The assessee-company, however, reversed this entry in  the  next year  because  eight  new  locomotives  were supplied by M/s Hindustan Steel Limited to  the  assessee  and  no  interest income actually accrued to the assessee.

       We  have to consider whether the amounts received by the assessee under these five heads can be treated as income of the assessee for the  relevant  assessment  years.    The Tribunal  has  held that all these amounts (under items 1 to 4) received by the assessee have gone to reduce the cost  of construction.   These  are in the nature of capital receipts which  can  be  set  off  against  the  capital  expenditure incurred  by  the  assessee  during  the relevant assessment years.  This view has been upheld  by  the  High  Court  and hence the department has come by way of the present appeals.

       During      these      assessment     years,     the respondent-assessee had invested the amounts borrowed by  it for   the  construction  work  which  were  not  immediately required, in short-term deposits and earned  interest.    It has  been  held  in  these  proceedings  that the receipt of interest amounts  to  income  of  the  assessee  from  other sources.   The  assessee  has not filed any appeal from this finding which is given  against  it.    In  any  case,  this question  is  now  concluded  by a decision of this Court in Tuticorin Alkali  Chemicals  and  Fertilizers   Ltd.      v. Commissioner of Income-tax ( [1997] 227 ITR 172).  Hence, we are not called upon to examine that issue.

       We  will  take the first three heads under which the assessee has received certain amounts.  These are, the  rent charged  by  the  assessee  to  its  contractors for housing workers  and  staff  employed  by  the  contractor  for  the construction   work   of   the  assessee  including  certain amenities granted to the staff by the assessee.    Secondly, hire  charges for plant and machinery which was given to the contractors by the assessee for the purpose of  facilitating the work of construction.  The activities of the assessee in connection  with  all  these  three  receipts  are  directly connected with or are incidental to the work of construction of its plant undertaken by the assessee.  Broadly  speaking, these  pertain to the arrangements made by the assessee with its contractors pertaining to the work of construction.   To facilitate   the   work  of  the  contractor,  the  assessee permitted the contractor to use the premises of the assessee for  housing  its  staff  and   workers   engaged   in   the construction activity  of  the  assessee’s  plant.  This was clearly to facilitate the work of construction.    Had  this facility  not been provided by the assessee, the contractors would have had to make their own arrangements and this would have been reflected in the charges of  the  contractors  for the construction  work.   Instead, the assessee had provided these facilities.  The same is true of the hire charges  for plant  and  machinery which was given by the assessee to the contractor for  the  assessee’s  construction  work.     The receipts  in  this  connection  also  go  to  compensate the assessee for the wear  and  tear  on  the  machinery.    The advances  which  the  assessee  made  to  the  contractor to facilitate the construction activity of putting  together  a very  large  project  was as much to ensure that the work of

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the contractors proceeded without any financial  hitches  as to help  the  contractors.  The arrangements which were made between the assessee-company and the contractors  pertaining to   these   three   receipts  are  arrangements  which  are intrinsically connected with the construction of  its  steel plant.   The receipts have been adjusted against the charges payable to the contractors and have gone to reduce the  cost of construction.  They have, therefore, been rightly held as capital  receipts  and  not  income of the assessee from any independent source.

       In the case of Addl.   Commissioner  of  Income-tax, New Delhi V.  Indian Drugs and Pharmaceuticals ltd.  ([1983] 141  ITR  134), the Delhi High Court considered a case where the work of construction of the factory of the assessee  was in progress and production had not commenced.  receipts from sale  of tender forms and supply of water and electricity to the contractors engaged in construction as also receipts  on account  of  sale  of stones, boulders, grass and trees were held to be receipts not from independent  sources  but  were considered  as  inextricably  linked  with  the  process  of setting up of business.  These were directly related to  the capital structure of business and were held to be capital in nature.   We  agree  with  this view taken by the Delhi High Court.

       The appellant, however, relied upon the decision  of this  Court  in  Tuticorin  Alkali Chemicals and Fertilizers Ltd.  v.  Commissioner of Income-tax  (supra).    That  case dealt with the question whether investment of borrowed funds prior  to  commencement of business, resulting in earning of interest by  the  assessee  would  amount  to  the  assessee earning any  income.    This  Court  held  that  if a person borrows money for business purposes, but utilizes that money to earn  interest,  however  temporarily,  the  interest  so generated will  be  his income.  This income can be utilized by the assessee whichever way he likes.  Merely  because  he utilized  it  to re-pay the interest on the loan taken, will not make the interest income as  a  capital  receipt.    The department   relied  upon  the  observations  made  in  that judgment (at page 179) to the effect that  it  the  company, even  before it commences business, invests surplus funds in its hands for purchase of land or house property  and  later sells  it  at  profit,  the gain made by the company will be assessable under the head "capital gains".  Similarly, if  a company purchases rented house and gets rent, such rent will be  assessable  to tax under Section 22 as income from house property.  Likewise, the company may have income from  other sources.   The  company  may also, as in that case, keep the surplus funds  in  short-term  deposits  in  order  to  earn interest.  Such interest will be chargeable under Section 56 of the  Income-tax Act.  This Court also emphasised the fact that the company was not bound to utilize  the  interest  so earned  to  adjust  it against the interest paid on borrowed capital.  The company was free to use  this  income  in  any manner it   liked.     However,  while  interest  earned  by investing borrowed capital  in  short-term  deposits  is  an independent   source   of  income  not  connected  with  the construction  activities  or  business  activities  of   the assessee,  the same cannot be said in the present case where the utilisation of various assets of  the  company  and  the payments  received  for such utilisation are directly linked with the activity of setting  up  the  steel  plant  of  the assessee.   These  receipts are inextricably linked with the setting up of the capital structure of the assessee-company.

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They must, therefore, be viewed as capital receipts going to reduce the cost of construction.  In the case of Challapalli Sugars Ltd.  v.  Commissioner of Income-tax, A.P.    ([1975] 98  ITR  167),  this  Court  examined  the  question whether interest paid before the commencement  of  production  by  a company   on   amounts  borrowed  for  the  acquisition  and installation of plant and machinery would form a part of the actual cost of the asset to the assessee within the  meaning of that expression in Section 10(5) of the Indian Income-tax Act,  1922  and  whether  the  assessee  will be entitled to depreciation  allowances   and   development   rebate   with reference to  such  interest  also.  The Court held that the accepted accountancy rule for  determining  cost  off  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 of  such  borrowed money can be capitalised and added to the cost of the  fixed  assets  created  as  a  result  of  such expenditure.   By  the  same  reasoning if the assessee such expenditure.  By the same reasoning if the assessee receives any amounts which are inextricably linked with  the  process of setting up its plant and machinery, such receipts will go to reduce  the  cost of its assets.  These are receipts of a capital nature and cannot be taxed as income.

       The same reasoning would apply to  royalty  received by the  assessee  company for stone etc.  excavated from the assessee company’s land.  The land had been  allowed  to  be utilized  by  the  contractors for the purpose of excavating stones to be used in the  construction  work  of  assessee’s steel plant.    The  cost of the plant to the extent of such royalty received, is  reduced  for  the  assessee.    It  is therefore, rightly taken as a capital receipt.

       In the assessment year  1971-72,  the  assessee  had shown  in  its  books  of accounts a sum of Rs.7,39,232/- as income from interest received from  M/s.    Hindustan  Steel Ltd.    for   the   eight   locomotives   supplied   by  the assessee-company to them.  The  entry  in  this  regard  was reversed in  the  next year since M/s.  Hindustan Steel ltd. had   replaced   the   eight   locomotives   lent   by   the assessee-company to  it  by  new ones.  The entire nature of the transaction was changed between the parties.  There  was a  resolution of the assessee-company in this regard and the income from interest did not result at all as  the  original agreement ceased  to  be  operative ab initio.  The entry in the books which was made was  about  a  hypothetical  income which  did not materialise and the entry was reversed in the next year.  Both the Tribunal as well as the High Court have held that  since  this  entry  reflected  only  hypothetical income, it could not be brought to tax as income.  Only real income can be brought to tax.

       In support of this finding, the assessee  has  drawn our  attention  to  a  decision  of  this  Court  in  Godhra Electricity Co.  Ltd.    v.    Commissioner  of   Income-tax ([1997]  225  ITR 746) where the Court, inter alia, examined the case system and the mercantile system of  accounting  in the context  of  hypothetical  income.    The computation of income is made in accordance with the method  of  accounting regularly employed  by  the  assessee.  It may be either the case system where entries are made on the  basis  of  actual receipts and actual outgoings or disbursements; or it may be

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the  mercantile  system  where  entries  are made on accrual basis, that is to say,  accrual  of  the  right  to  receive payment and the accrual of the liability to disburse or pay. However,  in  both  cases unless there is real income, there cannot be any income-tax.  Considering the facts before  it, the  Court  said  that  although  the  assessee-company  was following the mercantile system of accounting and  had  made entries  in  the  books  regarding  enhanced charges for the supply of electricity made to its consumers, no real  income had  accrued  to  the  assessee-company  in respect of those enhanced charges in view of the fact  that  soon  after  the assessee-company decided to enhance the rate, representative suits  were filed by the consumers which were decreed by the court and ultimately, after various proceedings  which  took place,  the  assessee-company  was  not  able to realise the enhanced charges.  The Court held that no  real  income  had accrued to assessee-company and hence the entries in respect of  enhanced  charges did not reflect the real income of the assessee and could not be brought to tax by  the  Income-tax Officer.

       In  the  present  case  also  the  entry  which  was initially made  as  interest  was  reversed  the  next  year because  in  fact  the nature of the transaction was changed and the assessee did not receive any real income.  The  High Court  has,  therefore,  rightly  held  this  entry  as  not reflecting the real income of the  assessee  and  hence  not exigible to income-tax.

       In  the  premise,  the  appeals are dismissed. There will, however, be no order as to costs.