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CASE NO.: Appeal (civil)  3952-3955 of 2002

PETITIONER: Deputy Commissioner of Income Tax,Ahmedabad

RESPONDENT: M/s. Core Health Care Ltd

DATE OF JUDGMENT: 08/02/2008

BENCH: S.H. Kapadia & B. Sudershan Reddy

JUDGMENT: J U D G M E N T

CIVIL APPEAL NOS.3952-3955 OF 2002 WITH Civil Appeal Nos. 8509-10 of 2002 Commissioner of Income Tax, Baroda                                                  \005 Appellant (s)                 versus M/s. Core Health Care Ltd.                      ... Respondent (s)

KAPADIA, J.

For the sake of convenience we state the facts occurring  in Civil Appeal Nos.3952-55 of 2002 \026 Dy. Commr. of Income  Tax, Ahmedabad v. M/s. Core Health Care Ltd.     

2.      These civil appeals are directed against judgment and  order dated 25.4.01 delivered by Gujarat High Court in Tax  Appeal Nos.449 and 450 of 2000 and in Civil Application  Nos.53 and 54 of 2001 whereby the Department’s appeals,  under Section 260A of the Income-tax Act, 1961, stood  dismissed.

3.      On 31.12.92 assessee filed its return of income for A.Y.  1992-93 declaring "nil" income.  Later on the assessee filed a  revised return on 6.8.93 declaring a loss of Rs.1,11,68,543/-.   Assessee-company is engaged in the business of  manufacturing and sale of intravenous solutions.  For the  assessment year under consideration assessee claimed  deduction towards expenses aggregating to Rs.2,12,05,459/-  which included interest on borrowings of Rs.1,56,76,000/-.   During the assessment year under consideration assessee had  installed new machinery.  The A.O. vide assessment order  dated 30.3.95 disallowed the amount of Rs.1,56,76,000/-  placing reliance on the judgment of this Court in Challapalli  Sugars Ltd. & Anr. v. Commissioner of Income-tax, A.P.  and Anr. \026 (1975) 98 ITR 167, inter alia, on the ground that  during the assessment year under consideration assessee had  installed new machinery on which production had not started.   On appeal, vide order dated 15.11.96, CIT (A) confirmed the  addition of interest amount on borrowings of Rs.1,56,76,000.   Therefore, both the authorities, namely, the A.O. and CIT (A)  added the said amount of Rs.1,56,76,000/- to the income of  the assessee.  The matter was carried in appeal by the  assessee.  Vide order dated 6.6.2000 the Tribunal held that  the Department was not justified in adding Rs.1,56,76,000/-  to the income of the assessee.  In other words, the Tribunal  held that the A.O. was not justified in making disallowance of

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Rs.1,56,76,000/- in respect of borrowings utilized for  purchase of machinery.  This decision was confirmed by the  High Court, hence these civil appeals are filed by the  Department.

4.      The following question of law has been placed before us  for determination: "Whether interest paid in respect of borrowings on  capital assets not put to use in the concerned  financial year can be permitted as allowable  deduction under Section 36(1)(iii) of the Income-tax  Act, 1961?"

5.      According to the Department, the assessee was not  entitled to treat the interest on borrowings as revenue  expenditure.  According to the Department, in view of  Explanation 8 to Section 43(1) of the Income-tax Act, 1961 (for  short, "1961 Act’) the assessee was not entitled to claim  deduction for interest on borrowings, particularly, when the  machines were not put to use during the assessment year  under consideration.  According to the Department, provisions  of Section 36(1)(iii) of the 1961 Act were required to be  harmoniously construed along with the provisions of  Explanation 8 to Section 43(1) regarding actual cost.   According to the Department provisions of Section 36(1)(iii)  being general in nature had to give way to the special  provisions contained in Explanation 8 of Section 43(1) of the  1961 Act.

6.      At the outset, we may clarify that before the High Court it  was not the case of the Department that a new business was  set up or commenced during the assessment year under  consideration.  It was undisputed before the High Court that  three additional machines were installed by the assessee  during the assessment year under consideration for the  production of intravenous injectibles.  It was not in dispute  that the assessee had borrowed moneys during the accounting  year commencing from 1.4.91 to 31.3.92.

7.      We quote hereinbelow Section 36(1)(iii) and Explanation 8  to Section 43(1) of the 1961 Act which read as follow: "OTHER DEDUCTIONS

36. (1) The deductions provided for in the following  clauses shall be allowed in respect of the matters  dealt with therein, in computing the income referred  to in Section 28 -                  (iii)   the amount of the interest paid in respect  of capital borrowed for the purposes of the business  or profession :                          Provided that any amount of the interest paid,  in respect of capital borrowed for acquisition of an  asset for extension of existing business or  profession (whether capitalised in the books of  account or not); for any period beginning from the  date on which the capital was borrowed for  acquisition of the asset till the date on which such  asset was first put to use, shall not be allowed as  deduction.                          Explanation : Recurring subscriptions paid  periodically by shareholders, or subscribers in  Mutual Benefit Societies which fulfill such

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conditions as may be prescribed, shall be deemed to  be capital borrowed within the meaning of this  clause;"

"Definitions of certain terms relevant to income  from profits and gains of business or profession.

43. In sections 28 to 41 and in this section, unless  the context otherwise requires \026

       (1)     "actual cost" means the actual cost of the  assets to the assessee, reduced by that portion of  the cost thereof, if any, as has been met directly or  indirectly by any other person or authority:

Provided that where the actual cost of an asset,  being a motor car which is acquired by the assessee  after the 31st day of March, 1967, but before the  1st day of March, 1975, and is used otherwise than  in a business of running it on hire for tourists,  exceeds twenty-five thousand rupees, the excess of  the actual cost over such amount shall be ignored,  and the actual cost thereof shall be taken to be  twenty-five thousand rupees.

Explanation 8: For the removal of doubts, it is  hereby declared that where any amount is paid or is  payable as interest in connection with the  acquisition of an asset, so much of such amount as  is relatable to any period after such asset is first put  to use shall not be included, and shall be deemed  never to have been included, in the actual cost of  such asset."

8.      Interest on moneys borrowed for the purposes of  business is a necessary item of expenditure in a business.  For  allowance of a claim for deduction of interest under the said  section, all that is necessary is that \026 firstly, the money, i.e.  capital, must have been borrowed by the assessee; secondly, it  must have been borrowed for the purpose of business; and,  thirdly, the assessee must have paid interest on the borrowed  amount [See: Calico Dyeing & Printing Works v. Commr. Of  Income-tax, Bombay City-II \026(1958) 34 ITR 265].  All that is  germane is : whether the borrowing was, or was not, for the  purpose of business.  The expression "for the purpose of  business" occurring in Section 36(1)(iii) indicates that once the  test of "for the purpose of business" is satisfied in respect of  the capital borrowed, the assessee would be entitled to  deduction under Section 36(1)(iii) of the 1961 Act.  This  provision makes no distinction between money borrowed to  acquire a capital asset or a revenue asset.  All that the section  requires is that the assessee must borrow capital and the  purpose of the borrowing must be for business which is  carried on by the assessee in the year of account.  What sub- section (iii) emphasizes is the user of the capital and not  the user of the asset which comes into existence as a  result of the borrowed capital unlike Section 37 which  expressly excludes an expense of a capital nature.  The  legislature has, therefore, made no distinction in Section  36(1)(iii) between "capital borrowed for a revenue purpose" and  "capital borrowed for a capital purpose".  An assessee is  entitled to claim interest paid on borrowed capital provided  that capital is used for business purpose irrespective of what

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may be the result of using the capital which the assessee has  borrowed.  Further, the words "actual cost" do not find place  in Section 36(1)(iii) of the 1961 Act which otherwise find place  in Sections 32, 32A etc of the 1961 Act. The expression "actual  cost" is defined in Section 43(1) of the 1961 Act which is  essentially a definition section which is subject to the context  to the contrary.

9.      In the case of Commissioner of Income-tax v.  Associated Fibre and Rubber Industries (P) Ltd. \026 (1999)  236 ITR  471, the Division Bench of this Court held as  follows: "Even though the machinery has not been actually  used in the business at the time when the  assessment was made, the same has to be treated  as a business asset as it was purchased only for  business purposes.  In the circumstances, the  interest paid on the amount borrowed for purpose of  such machinery is certainly a deductible amount."

10.    As stated above, the Department contended before us  that the judgments of this Court, prior to insertion of  Explanation 8 in Section 43(1) of the 1961 Act, has no  application to the present case.  According to the Department,  Section 36(1)(iii) of the 1961 Act being general in nature has to  give way to special provisions contained in Explanation 8 to  Section 43(1) of the 1961 Act.  According to the Department,  in none of the earlier judgments this Court has considered the  true scope of Explanation 8 to Section 43(1) vis-‘-vis Section  36(1)(iii) of the 1961 Act.  We find no merit in this contention.   Section 43 groups together all provisions in the nature of  definitions or interpretations relevant to the computation of  income under the head "Profits and Gains of Business".   Section 43(1) defines "actual cost".  The definition of "actual  cost" has been amplified by excluding such portion of the cost  as is met directly or indirectly by any other person or  authority.  Explanation 8 has been inserted in Section 43(1) by  Finance Act, 1986 (23 of 1986), with retrospective effect from  1.4.74.  It is important to note that the word "actual cost"  would mean the whole cost and not the estimate of cost.   "Actual cost" means nothing more than the cost accurately  ascertained.  The determination of actual cost in Section 43(1)  has relevancy in relation to Section 32(depreciation allowance),  Section 32A(investment allowance), Section 33(development  rebate allowance), and Section 41(balancing charge).  "Actual  cost" of an asset has no relevancy in relation to Section  36(1)(iii) of the 1961 Act.  This reasoning flows from a bare  reading of Section 43(1).  Section 43 defines certain terms  relevant to income from profits and gains of business and,  therefore, the said section commences with the words "In  Sections 28 to 41 and unless the context otherwise requires"  "actual cost" shall mean the actual cost of the assets to the  assessee, reducing by that portion of the cost thereof, if any,  as has been met directly or indirectly by any other person or  authority.  In other words, Explanation 8 applies only to those  Sections like Sections 32, 32A, 33 and 41 which deal with  concepts like Depreciation.  The concept of Depreciation is not  there in Section 36(1)(iii).  That is why the legislature has used  the words "unless the context otherwise requires".  Hence,  Explanation 8 has no relevancy to Section 36(1)(iii).  It has  relevancy to the aforementioned enumerated sections.   Therefore, in our view Explanation 8 has no application to the  facts of the present case.

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11.     Before concluding on this point we may state that in this  batch of civil appeals we are concerned with the assessment  years 1992-93, 1993-94, 1995-96 and 1997-98.  A proviso has  since been inserted in Section 36(1)(iii) of the 1961 Act.  That  proviso has been inserted by Finance Act, 2003 w.e.f.  1.4.2004.  Hence, the said proviso will not apply to the facts of  the present case.  Further, in our view the said proviso would  operate prospectively.  In this connection it may be noted that  by the same Finance Act, 2003 insertions have been made by  way of proviso in Section 36(1)(viia) by the same Finance Act  which is also made with effect from 1.4.2004.  Same is the  position with regard to insertion of a sub-section after Section  90(2) and before the Explanation.  This insertion also operates  w.e.f. 1.4.04.  In short, the above amendments have been  made by Finance Act, 2003 and all the said amendments have  been made operational w.e.f. 1.4.04.  Therefore, the proviso  inserted in Section 36(1)(iii) has to be read as prospectively  and w.e.f. 1.4.04.  In this case, we are concerned with the law  as it existed prior to 1.4.2004.  As stated above, we are not  concerned with the interpretation or applicability of the said  proviso to Section 36(1)(iii) w.e.f. 1.4.04 in the present case.   

12.     In the case of Challapalli Sugars Ltd. (supra) this Court  observed that interest paid on the borrowing utilized to bring  into existence a fixed asset which has not gone into  production, goes to add to the cost of installation of that asset.     It was further observed that if the said borrowing was not "for  the purpose of business" inasmuch as no business had come  into existence, it must follow that it was made for the purpose  of acquiring an asset which could be put to use for doing  business, and hence interest paid on such borrowing would go  to add to the cost of the assets so acquired.   

13.     In our view the above observations have to be confined to  the facts in the case of Challapalli Sugars Ltd. (supra).  It was  a case where the company had not yet started production  when it borrowed the amount in question.  The more  appropriate decision applicable to the present case would be  the judgment of this court in the case of India Cements Ltd.  v. Commissioner of Income-tax, Madras \026 (1966) 60 ITR 52  in which it has been observed that, for considering whether  payment of interest on borrowing is revenue expenditure or  not, the purpose for which the borrowing is made is irrelevant.   In our view, Section 36(1)(iii) of the 1961 Act has to be read on  its own terms.  It is a Code by itself.  Section 36(1)(iii) is  attracted when the assessee borrows the capital for the  purpose of his business.  It does not matter whether the  capital is borrowed in order to acquire a revenue asset or a  capital asset, because of that the section requires is that the  assessee must borrow the capital for the purpose of his  business.  This dichotomy between the borrowing of a loan  and actual application thereof in the purchase of a capital  asset, seems to proceed on the basis that a mere transaction  of borrowing does not, by itself bring any new asset of  enduring nature into existence, and that it is the transaction  of investment of the borrowed capital in the purchase of a new  asset which brings that asset into existence.  The transaction  of borrowing is not the same as the transaction of investment.   If this dichotomy is kept in mind it becomes clear that the  transaction of borrowing attracts the provisions of Section  36(1)(iii).  Thus, the decision of the Bombay High Court in  Calico Dyeing & Printing Works (supra) and the judgment of  the Supreme Court India Cements Ltd. (supra) have been  given with reference to the borrowings made for the purposes  of a running business, while the decision of the Supreme

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Court in Challapalli Sugars Ltd. (supra) was given with  reference to the borrowings which could not be treated as  made for the purposes of business as no business had  commenced in that case.  Therefore, there is no inconsistency  between the above decisions.         

CONCLUSIONS  14.     For the above reasons, we hold that A.O. was not  justified in making disallowance of Rs.1,56,76,000/- in  respect of borrowings utilized for purchase of machines.   Accordingly, the above question is answered in favour of the  assessee and against the Department.   

15.     Apart from the above question under Section 36(1)(iii),  the present civil appeals are filed by the Department against  the decision of the High Court whereby the High Court has  dismissed Civil Application Nos.53 and 54 of 2001 filed by the  Department.  It may be noted that during the pendency of Tax  Appeal Nos.449 and 450 of 2000, the Department had moved  the above two civil applications for amendment of its Memo of  Appeal raising substantial questions of law, namely \026  (a)     whether advertisement expenses incurred by the  assessee to create a brand image with enduring  benefit are allowable as revenue expenditure;  (b)     whether the Tribunal had erred in granting  deduction under Section 35D regarding short-term  loan, in view of Explanation to Section 35D(3) which  refers only to long-term borrowings;  (c)     whether the Tribunal had erred in directing  deduction under Section 80-HH and 80-I on the  miscellaneous income of Rs.26,64,113 being income  on sale of empty containers?     

16.     Although the Department had moved the said Civil  Application Nos.53 and 54 of 2001 during the pendency of Tax  Appeal Nos.449 and 450 of 2000 well within limitation the  High Court without answering the above three questions  summarily rejected Civil Application Nos.53 and 54 of 2001.   We are of the view that the High Court had erred in dismissing  the above two civil applications for amendment of the Memo of  Appeal in Tax Appeal Nos.449 and 450 of 2000.  In our view  the above three questions are substantial questions of law  and, therefore, the High Court ought to have decided those  questions.

17.     Accordingly, we remit the above three questions to the  High Court for fresh consideration by it in accordance with  law.  Accordingly, Civil Appeal Nos.3952-55 of 2002 and Civil  Appeal Nos.8509-8510 of 2002 filed by the Department are  partly allowed with no order as to costs.