Deductibility of interest paid on borrowed capital by an existing company for setting up a new line of business

A loan taken or capital borrowed is, by itself, not a capital asset, nor does it give an advantage of an enduring nature; as long as interest is paid on capital borrowed or loan taken in respect of new line of business which is in the same business fold for the purposes of ascertaining income under section 28 of the IT Act, it can be claimed as a deduction under section 36(1)(iii) of the Act.

HIGH COURT OF DELHI

CIT

v

Monnel Industries Ltd.

ITA No. 450/2008

November 21, 2008

RELEVANT EXTRACTS:

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5.8 In determining whether two lines of businesses constitute the same business and to this end, whether nature of the two businesses has to be looked at, was a proposition, the Supreme Court rejected in the case of a Produce Exchange Corporation Ltd v. CIT: (1970) 77 ITR 739. In this case, the assessee carried on business in diverse commodities as also in stocks and shares. The issue was whether the losses suffered by the assessee in the sale of shares of Public Limited Company could be set off against profits from transactions in other commodities in the relevant year. In the said case the Supreme Court noted that the Calcutta High Court had followed the test laid down by it in Shree Ramesh Cotton Mills Ltd v. Commissioner of Income Tax: (1967) 64 ITR 317, wherein in determining whether the two lines of businesses constitute the same business, they had applied the yardstick, whether the nature of the two businesses was the same. The Supreme Court, however, reversed this view of the Calcutta High Court by holding as follows:-

“We need not consider whether the ultimate decision of the High Court in Shree Ramesh Cotton Mills Ltd’ s case on which reliance was placed is correct, but we are unable to agree with the High Court that the decisive test for determining whether the two lines of businesses constitute the same business is the nature of the two businesses.”

6. The aforesaid view taken by the Supreme Court was re-affirmed by it, in the case of B.R.Ltd v. V.P.Gupta, Commissioner of Income Tax, Bombay: (1978) 113 ITR 647. In B.R.Ltd (supra), the Supreme Court was called upon to decide whether unabsorbed losses suffered in the business of import of woolen fabrics could be set off from the profits earned in respect of export of cotton textiles . The Supreme Court in the said case, approved the ratio of the judgments of its own court in the case Prithvi Insurance (supra), and Produce Exchange (supra). In doing so it also noted the observations made in the decision of the Supreme Court in the case of Standard Refinery and Distillery Ltd v. Commissioner of Income Tax: (1971) 79 ITR 589 and finally concluded that, tests for ascertaining whether the two lines of businesses were the same business was not dependent on determination of the nature of goods dealt with. The decisive test according to the Supreme Court was the unity of control and not the nature of two lines of businesses. It further held that even though the fact that one business cannot be conveniently carried on after the closure of the other business may furnish a strong indication that the two businesses do not constitute the same business, but as already held in Prithvi Insurance (supra) no decisive inference can be drawn from the fact that after the closure of one business the other cannot be conveniently carried on.

6.1 Based on the aforesaid tests, let us examine the findings returned by Tribunal in coming to the conclusion that there is a unity of control and management, interlacing and dovetelling of finances. The Tribunal in the instant case found as a fact in paragraph 30-31 of the impugned judgment that there was a common Board of Directors controlling the ferro alloys plant, as well as, the sugar plant which, operated from the head office located at Delhi, funds for the two plants were common and hence, there was inter-mingling and interlacing of funds, as also the fact, that even though the two divisions were geographically located at different sites, marketing of the final products was carried out under the supervision and control of the same set of executives at the head office. Applying the tests discussed hereinabove to facts as determined by the Tribunal, we have no difficulty in holding that the sugar plant and the ferro alloys plant were in the same fold of business.

6.4 The Gujarat High Court, after analyzing the decision of the Bombay High Court in Calico Dyeing and Printing Works v. Commissioner of Income Tax: (1958) 34 ITR 265 and of the Supreme Court in India Cements Ltd v. Commissioner of Income Tax: (1966) 60 ITR 52 and in Challapalli Sugars Ltd v. Commissioner of Income Tax: (1975) 98 ITR 167, concluded as follows:-

“It is no doubt true that in the case of Challapalli Sugars Ltd the Supreme Court has unequivocally observed that interest paid on the borrowing utilised to bring into existence a fixed asset which has not gone into production goes to add to the cost of installation of that asset. But these observations have been made with reference to a situation wherein it was not possible to contend that the borrowing on which interest was paid was made for the purpose of any business. The company which had made the borrowing in that case had not yet started production, and hence had not commenced any business when it borrowed the amount in question. Therefore, it was not possible to say in that case that the borrowing was made” for the purposes of the business? to bring the case within the ambit of Section 10(2)(iii) of the Indian Income Tax Act, 1922 (which is equivalent to Section 36(1)(iii) of the Act of 1961). If the said borrowing was not “for the purpose of business” in as much 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.

“The question is, is this line of reasoning inconsistent with the view taken by the Bombay High Court in Calico Dyeing and Printing Works, or by the Supreme Court in India Cements Ltd”. On proper analysis the reasoning on which the view taken by the High Court of Bombay and the Supreme Court in the above-referred cases rests is as under:

Section 10(2)(iii) of the Act of 1922 allows deduction of interest on all borrowings which are made “for the purposes of business”. The expression “purposes of business” is comprehensive enough to cover expenditure of revenue nature as well as of capital nature because both the types of expenditures can be incurred for business purposes. Therefore, even if a borrowing is made for incurring an expenditure of capital nature, it remains the borrowing for a business purpose. If that is so, the requirements of Section 10(2)(iii) of the Act of 1922 are fully satisfied and interest paid on such borrowing is entitled to deduction as revenue expenditure. The High Court of Bombay has unequivocally stated in Callico Dyeing and Printing Works that in order to attract the provisions of Section 10(2)(iii) it does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all 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 an actual application thereof in the purchase of a capital asset, seems to be on the ground 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 the investment of the borrowed capital in the purchase of the new asset which brings that asset into existence. Since the transaction of borrowing is not the same as the transaction of investment, the Supreme Court has observed in India Cements Ltd vs Commissioner of Income Tax that, for considering whether payment of interest on a borrowing is revenue expenditure or not, the purpose for which the borrowing is made is irrelevant. Thus, the decisions of the Bombay High Court in Callico Dyeing and Printing Works and of the Supreme Court in India Cements Ltd were given with reference to the borrowings made for the purposes of running businesses, while the decision of the Supreme Court in Challapalli Sugars Ltd was given with reference to the borrowings which could not be treated as made for the purposes of business, as no business had yet been commenced. Thus, there is no incompatibility between these decisions. The Supreme Court itself had distinguished its earlier decision in India Cements Ltd in the following terms in Challapalli Sugars Ltd:

“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 the loan before the commencement of business in the actual cost of plant did not arise in that case.”

In view of this, we conclude that the decisions of the Bombay High Court in Callico Dyeing and Printing Works and of the Supreme Court in India Cements Ltd, hold the field with equal force, even after the decision in Challapalli Sugars Ltd.

7. The upshot of the aforesaid decisions as applied by the Tribunal in instant case is that:-

(i) a loan taken or capital borrowed is, by itself, not a capital asset, nor does it give an advantage of an enduring nature;

(ii) as long as a loan was taken or capital was borrowed for the purposes f business, the assessee is entitled to claim interest paid thereon as deduction under Section 36(1)(iii) of the Act;

(iii) interest may have to be capitalized after the borrowed capital or loan taken is utilized in bringing into existence an asset at the stage of commencement of business. In other words, after the assessee’s business had already commenced then the interest paid on capital borrowed or loan taken can be claimed as deduction under Section 36 (1)(iii) of the Act.

(iv) in coming to the conclusion whether the interest paid on capital borrowed or loan taken in setting up a new line of business ought to be capitalized or treated as revenue expenditure, the test as laid down by the Supreme Court in the case of Produce Exchange Corporation (supra) and Prithvi Insurance Company (supra) would be relevant and;

(v) lastly, as long as interest is paid on capital borrowed or loan taken in respect of new line of business which is in the same business fold for the purposes of ascertaining income under Section 28 of the Act, it can be claimed as a deduction under Section 36(1)(iii) of the Act.

8. In the instant case, the Tribunal has returned the finding that there is a unity of control and management, in respect of the ferro alloys plant as well as the sugar plant and there is also intermingling of funds and dove-tailing of businesses. In these circumstances it cannot be said that the respondent/assessee had not commenced its business and hence, interest would have to be capitalized in terms of the ratio of the judgment in the case of Challapalli Sugars Ltd (supra). If that is not so then, the only other conclusion that is possible on these facts, is that, the interest was paid by the respondent/assessee on borrowed capital for the purposes of business. That being the case, in our view, the Tribunal correctly allowed the financial charges i.e., interest paid to the extent of Rs 3,50,83,472/- as deduction under Section 36(1)(iii) of the Act.

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