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Capital employed in the business of a company – term explained by Apex Court

April 21, 2017[2017] 80 taxmann.com 225 (Article)
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Introduction

1.The Hon'ble Supreme Court in Berger Paints India Ltd. v. CIT [2017] 79 taxmann.com 450, in the context of section 35D of the Income Tax Act, 1961 ['The Act'] held that the "premium amount" collected by the company on its subscribed issued share capital cannot be said to be the part of "capital employed in the business of the Company" to determine the upper limit to which the amount of allowable deduction u/s 35D can go.

2. The reasoning given by the court

2.1 Legislative framework:

2.1.1 Section 35D: Amortisation of certain preliminary expenses:

As per extant provisions of Section 35D of the Act, an Indian company or a person resident in India is allowed a deduction of an amount equal to one-fifth of preliminary expenditure [as defined in sub-section (2)] incurred before or after the commencement of his business for each of the five successive previous years starting from the year in which the business commences or, as the case may be, extension of existing unit is completed/new unit commences production or operation.

Sub-section (3) of section 35D provides an upper cap to the total deduction allowable: Where the aggregate amount of the preliminary expenditure exceeds an amount calculated at five per cent—

(a)   of the cost of the project, or
(b)   where the assessee is an Indian company, at the option of the company, of the capital employed in the business of the company,

the excess shall be ignored for the purpose of computing the deduction allowable as above.

The term "capital employed in the business of the Company" is specifically defined in the Explanation (b) to section 35D of the Act as follows:

(i)   in a case referred to in clause (i) of sub-section (1), theaggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the business of the company commences;
(ii)   in a case referred to in clause (ii) of sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the extension of the undertaking is completed or, as the case may be, the new unit commences production or operation, in so far as such capital, debentures and long-term borrowings have been issued or obtained in connection with the extension of the undertaking or the setting up of the new unit of the company;
  (b) "capital employed in the business of the company" means—

Issue for consideration

3. Whether "premium" collected by the Company on its subscribed share capital is "capital employed in the business of the Company" within the meaning of Section 35D of the Act so as to enable the Company to claim higher deduction towards preliminary expenses as prescribed under Section 35D of the Act?

Anaysis

3.1 Firstly, there is no scope in argument that the premium collected by the Company on the issue of shares is a long-term borrowing either in fact or by a fiction of law. Especially, when the term "Long term borrowings" is separately defined in the Explanation (c) to section 35D. Similarly, the premium collected by the Company is nowhere near or akin to a debenture. The only question that remains is whether premium is a part of the share capital and, therefore, to be reckoned as 'capital employed in the business of the company'.

With this background, the Hon'ble Supreme Court in case of Berger Paints India Ltd. (supra) held as follows:

-   If the intention of the Legislature were to treat the amount of "premium" collected by the Company from its shareholders while issuing the shares to be the part of "capital employed in the business of the company", then it would have been specifically said so in the Explanation(b) of sub-section(3) of Section 35D of the Act. It was, however, not said so.
-   Section 78 of the Companies Act which deals with the "issue of shares at premium and discount" requires a Company to transfer the amount so collected as premium from the shareholders and keep the same in a separate account called "securities premium account". It does not anywhere says that such amount be treated as part of capital of the company employed in the business for one or other purpose, as the case may be, even under the Companies Act.
-   Column III of the Form of Annual Return prescribed under the Companies Act which deals with capital structure of the company, provides the break up of "issued shares capital break up". This column does not include in it the "premium amount collected by the company from its shareholders on its issued share capital". This is indicative of the fact that such amount is not considered a part of the capital unless it is specifically provided in the relevant section.

Conclusion

4. Though company's reserve and surplus which include premium collected from shareholders' on issued shares, appears as shareholder's fund, the same is not a part of the issued, subscribed and paid-up capital of the Company. Accordingly it was rightly held by the Hon'ble Supreme Court that the "premium amount" collected by the Company on its subscribed issued share capital is not and cannot be said to be the part of "capital employed in the business of the Company" for the purpose of deciding upper limit of allowable deduction on account of preliminary expenses under section 35D of the Act.

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