Commissioner of Income Tax vs Kerala State Industrial Development Corporation Ltd. (No. 2)

K.A. Nayar, J.—At the instance of the Commissioner of Income Tax, Trivandrum, the Income Tax Appellate Tribunal, Cochin Bench, has referred the following questions to this court for decision :

"1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the statutory deduction u/s 36(1)(viii) of the Income Tax Act, 1961, has to be calculated on the total income before deduction of the amount allowable u/s 36(1)(viii) ? (assessment years 1975-76 and 1977-78).

Whether, on the facts and in circumstances of the case, the Tribunal was right in holding that the interest which had accrued to the asses-see on the balance amount due from Malabar Spinning and Weaving Mills Co. Ltd. was not includible in the income of the assessee ? (assessment years 1976-77 and 1977-78).

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the expenditure incurred by the assessee on investigation, research and feasibility study is a revenue expenditure to be allowed as a deduction ? (assessment years 1976-77 and 1977-78)."

The matter arises out of the Income Tax assessments on the respondent for the assessment years 1975-76, 1976-77 and 1977-78. The assessee, in all the cases, is the Kerala State Industrial Development Corporation Limited. The assessment for the assessment year 1975-76 was originally completed on December 28, 1977. The Income Tax Officer computed the deduction u/s 36(1)(viii) of the Income Tax Act on the total income before allowing the deduction u/s 36(1)(viii) itself. The said assessment was reopened by the Income Tax Officer on the ground that deduction should have been allowed only on the total income as reduced by the deduction u/s 36(1)(viii) of the Act. Reassessment was made accordingly. The Commissioner of Income Tax (Appeals) set aside the assessment. When the appeal came up for hearing before the Tribunal, the assessee relied upon the subsequent decision of the Patna High Court reported in Commissioner of Income Tax Vs. Bihar State Financial Corporation, , wherein it has been held that the statutory deduction u/s 36(1)(viii) should be calculated on the total income before deduction of the amount allowable u/s 36(1)(viii) itself. Following the said decision, the Tribunal upheld the order of the Commissioner of Income Tax (Appeals), though for different reasons. The first question extracted above related to this aspect for the years 1975-76 and 1977-78.

With regard to the assessment year 1976-77, the Income Tax Officer included in the income of the assessee a sum of Rs. 4,70,984 being the interest which accrued on the balance due to the assessee from Malabar Spinning and Weaving Mills Co. Ltd. Similarly, for the assessment year 1977-78, an addition of Rs. 6,57,260 was made by way of interest due to the assessee from the said company, namely, Malabar Spinning and Weaving Mills Co. Ltd, The Income Tax Officer rejected the contention of the assessee that the amount should not be treated as income as there is no chance of recovering the same. As regards the assessment year 1976-77, the addition was confirmed by the Commissioner of Income Tax (Appeals), but the addition was deleted by the Commissioner of Income Tax (Appeals) with regard to the assessment year 1977-78. On appeal, the Tribunal found that the assessee was fully justified in taking up the stand that there is no chance of recovering interest on the loans advanced by the assessee. On appreciation of the facts, the Tribunal further held that the interest amount is not includible in the income as it has not at all accrued as income. Question No. 2 referred to above related to this aspect for the assessment years 1976--77 and 1977-78.

For the assessment years 1976-77 and 1977-78, the assessee claimed deduction of sums of Rs. 3,02,067 and Rs. 3,32,603, respectively, as expenditure incurred on investigation, research and feasibility study. This was disallowed by the Income Tax Officer, but was allowed by the Commissioner of Income Tax (Appeals) following the decision of the Tribunal dated February 12, 1981, in the case of the same assessee relating to the assessment year 1975-76. The Tribunal confirmed the order of the Commissioner of Income Tax (Appeals). The third question referred to above related to this aspect for the years 1976-77 and 1977-78.

We heard counsel for the Revenue and the respondent.

It is agreed that the third question, namely, whether the Tribunal was right in holding that the expenditure incurred by the assessee on the investigation, research and feasibility study is a revenue expenditure, to be allowed as a deduction, is covered by our decision in Income Tax References Nos. 42 to 47 of 1982 and 104 of 1983, dated January 31, 1989, Commissioner of Income Tax Vs. Kerala State Industrial Development Corporation Ltd. (No. 1), ), wherein we held that the expenditure incurred in investigation, research and feasibility study is only revenue expenditure, to be allowed as a deduction. In the light of the said decision, we answer the third question in the affirmative, that is, in favour of the assessee and against the Revenue.

Question No. 1 related to deduction u/s 36(1)(viii) of the Income Tax Act. In calculating the total income for the purpose of deduction u/s 36(1)(viii), whether the deduction under the said Section has to be allowed is, in short, the question to be considered. The same question arose for consideration in respect of the same assessee for the year 1976-77 wherein we held that deduction should be allowed on the total income before the deduction of the amount allowable u/s 36(1)(viii) of the Act. In doing so, we followed the decisions of the Patna and Madhya Pradesh High Courts reported in Commissioner of Income Tax Vs. Bihar State Financial Corporation, , Commissioner of Income Tax Vs. Bihar State Financial Corporation, , Commissioner of Income Tax Vs. Bihar State Financial Corporation, and Commissioner of Income Tax Vs. M.P. Financial Corporation, . Learned counsel on behalf of the Revenue submitted that the said decision requires reconsideration in view of the decision reported in Cambay Electric Supply Industrial Co. Ltd. Vs. The Commissioner of Income Tax, Gujarat-II, Ahmedabad, . We have gone through the decision of the Supreme Court carefully and we do not think that our decision requires reconsideration in any manner.

The question that came up for consideration before the Supreme Court in the decision in Cambay Electric Supply Industrial Co. Ltd. Vs. The Commissioner of Income Tax, Gujarat-II, Ahmedabad, , is whether in computing the total income of the assessee carrying on the business of an industry specified u/s 80E of the Act for the purpose of the special deduction permissible thereunder, the balancing charge arising as a result of the sale of old machinery and buildings and unabsorbed depreciation and development rebate are to be taken into account. Section 80E as it stood then reads that in the case of a company to which the section applies, where the total income includes any profits and gains attributable to the business of generation or distribution of electricity, etc., there shall be allowed a deduction from such profits and gains of an amount equal to 8 per cent. in computing the total income of the company. The company in question was a company generating electricity and entitled to claim deduction at 8 per cent. of the total income. The question that arose for consideration is whether the profits u/s 41(2) and unabsorbed depreciation and development rebate can be considered as profits and gains attributable to the business. Their Lordships held that the word used is "attributable" and not "derived" and, therefore, the profits and gains u/s 41(2) as well as the unabsorbed depreciation and development rebate have to be taken into account. The observation emphasised on behalf of the Revenue is (at p. 91) :

"On reading Sub-section (1) it will become clear that three important steps are required to be taken before the special deduction permissible thereunder is allowed and the net total income exigible to tax is determined. First, compute the total income of the concerned assessee in accordance with the other provisions of the Act, i. e., in accordance with all the provisions except Section 80E ; secondly, ascertain what part of the total income so computed represents the profits and gains attributable to the business of the specified industry (here generation and distribution of electricity) ; and, thirdly, if there be profits and gains so attributable, deduct 8% thereof from such profits and gains and then arrive at the net total income exigible to tax."

The Act only says that before giving deduction u/s 80E, the profits and gains are to be computed in the manner indicated therein. But it clearly says "in accordance with all provisions except Section 80E". The charge is on the profits and gains of business as mentioned in Section 28 of the Act. Income Tax has to be charged under the head "Profits and gains" and the income chargeable under profits and gains will have to be computed as mentioned in Section 29 and, therefore, the computation should be in accordance with the provisions contained in sections 30 to 43A. In computing the total income, the balancing charge as mentioned in Section 41(2), the carry forward depreciation as mentioned in Section 32(2) and carry forward development rebate as mentioned in Section 32(2), if applicable as in the case referred to in Cambay Electric Supply Industrial Co. Ltd. Vs. The Commissioner of Income Tax, Gujarat-II, Ahmedabad, , will also have to be taken into account. Apart from that, all deductions mentioned u/s 36 also have to be taken into account. But, one such deduction is mentioned in Section 36(1)(viii). That sub-section says that in respect of any special reserve created by a financial corporation which is engaged in providing long-term finance for industrial or agricultural development in India, an amount not exceeding 10 per cent. of the total income, before making any deduction under Chapter VI-A carried to such reserve account, will also have to be allowed. Therefore, necessarily, to compute 10 per cent. of the total income for allowing deduction under Clause (viii) of Sub-section (1) of Section 36 of the Act, the total income has to be computed before allowing the deduction mentioned in Section 36(1)(viii). We do not find anything in the decision reported in Cambay Electric Supply Industrial Co. Ltd. Vs. The Commissioner of Income Tax, Gujarat-II, Ahmedabad, militating against such conclusion. On the other hand, it supports the conclusion. In that case, for the purpose of Section 80E, the total income has to be computed in accordance with all provisions except Section 80E and, therefore, in computing the total income for the purpose of Section 36(1)(viii), the total income has to be computed in accordance with the provisions of sections 30 to 43A except Section 36(1)(viii). As already stated, the question that came up for consideration in the decision in Cambay Electric Supply Industrial Co. Ltd. Vs. The Commissioner of Income Tax, Gujarat-II, Ahmedabad, is whether the balancing charge arising out of the sale of machinery and buildings can be considered as profits and gains attributable to the business in question and similarly whether the carry forward depreciation and carry forward development rebate can also be considered as attributable to the business. The Supreme Court held that on a true construction of the provision, the balancing charge will have to be taken into account before computing the deduction of 8 per cent. contemplated by Section 80E(1) of the Act and, similarly, items of unabsorbed depreciation and unabsorbed development rebate will have to be deducted before arriving at the figure that will become exigible to tax as contemplated u/s 80E(1). Therefore, we do not think that the decision in Income Tax Reference No. 125 of 1984 requires reconsideration. After the judgment in Income Tax Reference No. 125 of 1984, dated June 19, 1989, Kerala State Industrial Development Corporation Ltd. Vs. Commissioner of Income Tax, , another decision, namely, Commissioner of Income Tax Vs. M.P. Audyogik Vikas Nigam Ltd. (No. 1), , came to oar notice wherein the High Court of Madhya Pradesh once again took the same view and held that the deduction u/s 36(1)(viii) has to be calculated on the basis of the total income computed before allowing the deduction u/s 36(1)(viii).

We, therefore, hold that the statutory deduction u/s 36(1)(viii) of the Act is to be calculated on the total income before making deduction of the amount allowable u/s 36(1)(viii). Hence, we answer the first question also in the affirmative, that is, in favour of the assessee and against the revenue.

The second question relates to the interest due to the assessee from Malabar Spinning and Weaving Mills Company Limited during the assessment years 1976-77 and 1977-78. On appraisal of the facts relating to the loan, the nature of the recovery in the earlier years and the financial position of Malabar Spinning and Weaving Mills Company Limited, the Tribunal found that the assessee was fully justified in taking up the stand that there is absolutely no chance of the assessee recovering any interest from the mills on the loans advanced by the assessee. The Tribunal also took note of the fact that the mills have been ordered to be wound up by the High Court of Kerala and that it has been declared as a relief undertaking u/s 3(1) of the Kerala Relief Undertakings (Special Provisions) Act, 1961. The Tribunal, clearly found that the assessee will not be able to recover from the mills even the full amount of the secured loans and that nothing may be available with regard to the unsecured loans and, therefore, the Tribunal concluded that there is no chance of the assessee recovering any interest on the loans advanced to the mills. The assessee also had not charged any interest on the loans in the accounts for the relevant accounting period. In the balance-sheet also, it is stated that interest has not been taken into consideration as it will not be possible to recover the same. Considering all these aspects, the Tribunal held that the interest amount cannot be included in the income. In the decision reported in State Bank of Travancore Vs. Commissioner of Income Tax, Kerala, , their Lordships observed that it is the income which has really accrued or arisen to the assessee that is taxable. Whether the income has really accrued or arisen to the assessee must be judged in the light of the reality of the situation. The concept of real income would apply where there has been a surrender of income which, in theory, may have accrued but, in the reality of the situation, no income had resulted because the income did not really accrue. It is also stated that the conduct of the parties in treating the income in a particular manner is material evidence of the fact whether income has accrued or not. The concept of real income is certainly applicable in judging whether there has been any income or not.

Adverting to all the circumstances of the case, the Tribunal found that there was no income by way of interest accrued and, in that view of the matter, the Tribunal held that the interest amount cannot be included in the income. We are, therefore, of the opinion that the Tribunal was right in holding that the interest which had accrued to the assessee on the balance amount due from Malabar Spinning and Weaving Mills Company Limited was not includible in the income of the assessee for the assessment years 1976-77 and 1977-78. We, therefore, answer question No. 2 also in the affirmative, that is, in favour of the assessee and against the Revenue.

In the light of the above finding, all the three questions referred to us are answered in the affirmative, that is, in favour of the assessee and against the Revenue.

A copy of this judgment under the seal of the High Court and the signature of the Registrar shall be forwarded to the Income Tax Appellate Tribunal, Cochin Bench.