Commissioner of Income Tax vs S.S. Narayanan

S.M. Ali Mohamed, J.—As per the order of this Court in TCP No. 505 of 1977 under s. 256(2) of the IT Act, 1961 (hereinafter referred

to as ""the Act""), this Court directed the Tribunal to draw up a statement of the case and refer the question of law. Accordingly, the following

question is referred to this Court :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in allowing the deduction of a sum of Rs. 9,148.50 representing

interest paid to the Government of Tamil Nadu for allotment of an industrial unit under s. 37 of the IT Act, 1961, for the asst. yr. 1973-74 ?

The facts of the case are as follows : The assessee is an individual and the matter relates to the asst. yr. 1973-74 the corresponding accounting

year being the period from 1st April, 1972 to 31st March, 1973. The assessee carries on the business of manufacture and sale of industrial

thermostats under the name and style, Labequip Instrument Corporation. He commenced the said business in 1968 and carried it on in a place in

Triplicane High Road, Madras. The Government of Tamil Nadu formed a functional industrial estate for instruments, electronics at Adyar, Madras.

The assessee applied for allotment of one unit therein to him. The assessee was allotted unit No. 1(5) in the first instance; but the same was later

changed to unit No. 11(4). The terms and conditions under which the allotment was made were set out in the letter issued by the Director of

Industries and Commerce, to the assessee, according to which, the assessee was to pay Rs. 1,02,663 to the Government of Tamil Nadu in respect

of the said allotment and of the said amount 10 per cent was payable in advance and the balance was payable in 30 half-yearly instalments of Rs.

3,080 each together with interest at 8 per cent thereon. The assessee was placed in possession of the unit in December, 1971, whereupon he

shifted his business to the said unit. The assessee also executed an agreement in favour of the Government of Tamil Nadu on 20th April, 1973. It

was mentioned therein that the State Government had thereunder transferred to the assessee, who was described as ""lessee"", the possession of the

property fully described in the schedule thereto by way of lease for the time being with the ultimate object of selling the same. In accordance with

the above agreement, the assessee had to pay Rs. 5,058 on 10th Jan., 1972 (made up of Rs. 3,080 towards principal and Rs. 1,978 towards

interest); Rs. 8,698.50 on 10th July, 1972 (made up of Rs. 3,080 towards principal and Rs. 5,291 towards interest); and Rs. 6,610 on 10th Jan.,

1973 (made up of Rs. 3,080 towards principal and Rs. 3,449 towards interest). The second and third instalments due on 10th July, 1972 and 10th

Jan., 1973, were paid by the assessee on 14th Oct., 1972, and 31st March, 1973, respectively. Consequently, penal interest amounting to Rs.

327.50 and Rs. 81 was collected along with these two instalments.

For the asst. yr. 1973-74, the assessee filed a return disclosing a business income of Rs. 20,962. In doing so, he had deducted Rs. 11,127

being the interest paid by him to the Government of Tamil Nadu. The ITO held that the assessee could not be said to have borrowed capital for his

business and hence the interest paid to the Government of Tamil Nadu was not allowable. By his order dt. 15th Dec., 1973, he determined the

total income as Rs. 35,420.

Aggrieved by the same, the assessee preferred an appeal to the AAC, Madras. The AAC allowed the appeal of the assessee. He upheld the

assessee''s claim for allowance. Thereupon, the Department preferred an appeal to the Tribunal.

With regard to the assessee''s claim for depreciation, the Tribunal remitted the matter to the AAC to consider whether the assessee is entitled to

depreciation, in view of Circular No. 9 of 1943 dt. 23rd March, 1943, issued by the CBDT, in the light of the above circular.

With regard to the payment of interest, whether the assessee is entitled to claim reduction of interest paid by him to the Government of Tamil Nadu

in respect of the allotment of the unit in question, the Tribunal, following the ruling of the Supreme Court in BOMBAY STEAM NAVIGATION

CO. (1953) PRIVATE LTD. Vs. COMMISSIONER OF Income Tax, BOMBAY., was of the view that it cannot be said that the assessee had

borrowed capital from the Government of Tamil Nadu for the purpose of its business by reason of its having undertaken to pay the consideration

for the allotment of a unit in the industrial estate in future instalments. With regard to the contention of the assessee that in any event, interest should

be allowed under s. 37(1) of the Act as expenditure paid out or expended wholly and exclusively for the purpose of the business, the Tribunal was

of the following view :

It has, therefore, to be considered firstly whether the payment of interest by the assessee to the Tamil Nadu Government in respect of the unit

allotted to him in an industrial estate was a capital expenditure and, secondly, whether it could be said to have been laid out wholly and exclusively

for the purpose of the business. Here again, we are of the opinion that the case is governed by the principle laid down by the Supreme Court in

BOMBAY STEAM NAVIGATION CO. (1953) PRIVATE LTD. Vs. COMMISSIONER OF Income Tax, BOMBAY., . As already stated,

the alternate claim of the assessee in the said case was that the interest paid by it in respect of the unpaid purchase money for the acquisition of the

capital asset was expenditure laid out wholly and exclusively for the purpose of the business under s. 10(2)(xv) of the Indian IT Act, 1922. The

contention of the Revenue was that the expenditure, having been incurred in respect of acquisition of a capital asset, could not be considered as

revenue expenditure. The Supreme Court did not accept the contention. The Court pointed out that the expenditure in question had been incurred

by the assessee therein after the commencement of the business. The Court observed that the source of liability could not be said to have arisen

prior to the date on which the business of the assessee-company had commenced. The position is exactly the same in the instant case also. Here

also the assessee had commenced the business in the industrial unit in question in December, 1971. Consequently, the payment of interest by the

assessee to the Tamil Nadu Government in respect of the allotment of the unit in question has to be allowed as a business expenditure under s.

37(1).

The ratio of the decision of the Supreme Court in Challapalli Sugar Ltd. Vs. The Commissioner of Income Tax, A.P., Hyderabad, , was that the

interest paid in respect of the capital borrowed for acquisition of a capital asset but prior to the commencement of the business formed part of the

cost of such asset for the purpose of allowing depreciation and development rebate.

But, as already stated, only the second and third instalments payable on 10th July, 1972, and 10th Jan., 1973, were paid by the assessee during

the relevant previous years, viz., on 14th Oct., 1972, and 31st March, 1973, respectively. The first instalment payable on 10th Jan., 1972, was

paid on 24th Aug., 1972, which date does not fall within the previous year relevant to the assessment year under consideration. Consequently, Rs.

9,148.50 being the aggregate of the second and third instalments could be allowed.

It is contended by Mr. N. V. Balasubramaniam, learned counsel appearing for the Revenue, that the Tribunal erred in law in allowing the

deduction of a sum of Rs. 9,148.50 representing the interest paid to the Government of Tamil Nadu for allotment of an industrial unit under s. 37 of

the Act. No one appeared on behalf of the respondent/assessee. In the instant case, we are of the opinion that there is no error of law in the above

view expressed by the Tribunal. The Supreme Court in Bombay Steam Navigation Co. (1953) P. Ltd. vs. CIT (supra), with reference to s. 10(1)

of the Indian IT Act, 1922, has observed as follows :

Tax is payable under s. 10(1) by an assessee on its profits or gains earned in the business, profession or vocation carried on by him in the year of

account. If no business at all is carried on in that year, liability to tax does not arise under s. 10(1).

Clause (iii) of sub-s. (2) of s. 10 provides :

''Such profits or gains shall be computed after making the following allowances, namely.......

(iii) in respect of capital borrowed for the purposes of the business, profession or vocation, the amount of interest paid''.

The proviso and the Explanation with which we are not concerned in these appeals need not be set out.

The expression, ''such profits or gains'' in sub-s. (2), on the plain language used by the legislature, means profits or gains of a business carried on in

the year of account. In the computation of profits and gains of a business carried on in the year of account, allowances set out in cls. (i) to (xv) are

permissible : some of these permissible allowances are of the nature of revenue outgoings, and others are of the nature of capital outgoings. Gross

profits or gains must undoubtedly be of the nature of revenue receipts. But in the computation of taxable profits from the receipts of the business,

not only revenue deductions but certain capital deductions are permitted to be made, e.g., depreciation, sums paid to scientific research

associations, expenditure of a capital nature on scientific research and other expenditure of a capital nature. By cl. (iii) of sub-s. (2), interest paid in

respect of capital borrowed for the purpose of the business, profession or vocation is a permissible allowance in the computation of the profits or

gains. The expression ''capital'' used in cl. (iii) in the context in which it occurs means money and not any other asset, for interest is payable on

capital borrowed and interest becomes payable on a loan of money and not on any other asset acquired under a contract. Interest paid need not

however bear the character of a revenue outgoing. To be admissible as an allowance under cl. (iii), interest must be paid in respect of capital

borrowed : interest paid, but not in respect of capital borrowed, cannot be allowed.

However, the Supreme Court upon the facts of the case held that the allowance claimed by the assessee is a permissible deduction under s. 10(2)

(xv) of the Indian IT Act, 1922, and observed as follows :

Sec. 10(2) requires that in computing the taxable profits or gains of a business which is carried on in the year of account allowances of the nature

described in cls. (i) to (xv) should be made. If no business was carried on in that year, the allowances are not permissible. But interest in respect of

which allowance is claimed was paid at a time when the business was carried on, and the source of liability to pay interest was also incurred within

the period in which the business was carried on.

We are, therefore, of the view that the allowance claimed is a permissible deduction under s. 10(2)(xv).

Sec. 37(1) of the IT Act, 1961, reads as follows :

Any expenditure (not being expenditure of the nature described in ss. 30 to 36 and not being in, the nature of capital expenditure or personal

expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing

the income chargeable under the head, ''Profits and gains of business or profession.

From a reading of the above section, it is clear that s. 37(1) of the Act provides that any expenditure not being expenditure of the nature described

in ss. 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively

for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ""Profits and gains of business or

profession"". In the instant case, the assessee had already commenced his business in 1971 and later acquired the industrial unit from the

Government of Tamil Nadu in 1973. The interest payable to the Government of Tamil Nadu by the assessee is not on a loan of money borrowed.

To be admissible as an allowance, interest must be paid in respect of capital borrowed; interest paid, but not in respect of capital borrowed cannot

be allowed. However, the assessee is entitled to the benefit under s. 37(1) of the Act for the interest paid in respect of the assessment years when

the business was carried on as the source of liability to pay interest is incurred within a period in which the business was carried on. Accordingly,

payment of interest by the assessee to the Tamil Nadu Government in respect of allotment of the unit in question has to be allowed as a business

expenditure under s. 37(1) of the Act. Upon the facts of the instant case, the assessee had commenced his business in December, 1971, at

Triplicane and subsequently applied for allotment of the industrial unit in the year 1973. In this connection, the Tribunal, upon the facts of the case,

held as follows :

But as already stated, only the second and third instalments payable on 10th July, 1972, and 10th Jan., 1973, were paid by the assessee during

the relevant previous years, viz., on 14th Oct., 1972, and 31st March, 1973, respectively. The first instalment payable on 10th Jan., 1972 was

paid on 24th Aug., 1972, which date does not fall within the previous year relevant to the assessment year under consideration. Consequently, Rs.

9,148.50 being the aggregate of the second and third instalments could be allowed.

Accordingly, we are of the considered opinion that there is no error of law in the view expressed by the Tribunal, as the same is in conformity with

the ratio of the Supreme Court ruling in Bombay Steam Navigation Co. (1953) P. Ltd.''s case (supra). Accordingly, we answer the question

referred to us in the affirmative in favour of the assessee and against the Revenue. There shall be no order as to costs.