CIT Vs. MERCHEM LTD.

JUDGEMENT

(1.) The question raised in the connected appeals filed by the Revenue against the very same assessee is whether the Tribunal was justified in holding that pre-operation expenditure incurred by the assessee for setting up of a new industrial unit by way of expansion of production is allowable as revenue expenditure. We have heard standing counsel appearing for the appellant and Sri R. Vijayaraghavan, counsel appearing for the respondent-assessee. The assessee is engaged in the manufacture of rubber chemicals and it had a factory at Edayar in Ernakulam. However, during the previous years relevant for the assessment years 1996-97 and 1997-98, the assessee was engaged in setting up of a new industrial unit which was also for manufacture of the same product or in other words, the new industrial unit was set up in the same line of business by way of expansion of production. For the assessment year 1996-97, the assessee claimed deduction of Rs. 24,21,333 towards various items of expenditure incurred in the setting up of the new factory. Similarly, for the next assessment year 1997-98, the assessee claimed deduction of Rs. 54,04,739 out of which Rs. 25,69,663, according to the statement furnished by the assessee in court, represents interest paid by the assessee for the term loan availed of from IDBI. From the break-up details of the disputed expenditure furnished by the assessee, it is clear that the entire items of expenditure claimed, which are in the nature of staff welfare expenses, vehicle running and maintenance charges, advertisement charges, etc., represent expenditure attributable exclusively to the new factory set up by the assessee at Eloor. Standing counsel appearing for the Revenue mainly relied on the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT, 1975 98 ITR 167 and contended that the assessee is entitled to claim deduction of preliminary expenditure incurred for setting up of the new factory, irrespective of whether it is under expansion scheme or not. He has relied on the statutory provisions, namely, the definition of "actual cost" contained in section 43(1) read with Explanation 8 thereto, section 37(1) and section 36(1)(iii) and its proviso for the proposition that interest paid on borrowed funds for acquisition of plant and machinery and other capital goods-up to the date of commissioning should be treated as part of actual cost on which the assessee is entitled to depreciation and other eligible, deductions on, the capital employed and under no circumstance interest on borrowed funds could be allowed as deduction in the computation of income of the previous year in which such plant and machinery was not put to use. Counsel appearing for the assessee relying on several judgments and particularly that of the Supreme Court in Deputy CIT v. Core Health Care Ltd., 2008 298 ITR 194 contended that irrespective of whether the amount borrowed is for acquisition of capital asset or for meeting revenue needs, interest is allowable under section 36(1)(iii) of the Act. So far as the other items of expenditure are concerned, his contention is that the entire expenditure is allowable as revenue in nature. Even though counsel for the assessee has relied on the decisions of various High Courts, we do not think there is any need to go into those decisions because the two decisions of the Supreme Court above referred are essentially on the same question.

(2.) We feel, it would be useful to refer to the relevant statutory provisions, and accordingly section 36(1)(iii) with its proviso, section 43(1) with Explanation 8 and section 37(1) are extracted hereunder for easy reference:

(3.) The scheme of the Act provides for computation of various heads of income after granting eligible deductions and allowances which are specifically provided under the Act. Section 29 of the Act says that income from business or profession has to be computed in accordance with the provisions of sections 30 to 43D. Among the various provisions providing for deductions and allowances, it is pertinent to note the scope of section 37(1) which is the residuary provision for allowing all items of business expenditure which are not otherwise eligible for deduction under the Act with the exclusion of personal expenditure and expenditure that is of a capital nature. In our view, it is the duty of the assessee to claim under what provision of the Act, he seeks to claim deduction of an expenditure in the computation of business income and unless it is proved that, that item falls under the provision under which it is claimed, the Assessing Officer is not free to allow it. In this case, admittedly the assessee has claimed the entire pre-operation expenditure in respect of new industrial unit that was being set up in the two previous years relevant for the assessment years as revenue expenditure allowable under section 37(1) of the Act. However, the Assessing Officer on verifying the accounts noticed that in the balance-sheet the assessee has styled the pre-operation expenditure as one to be carried forward to be capitalized and apportioning to various assets on commissioning of the project. In other words, the assessee which showed in its books of account the entire pre-operation expenditure as a capital expenditure, claimed the same as revenue expenditure for the purpose of deduction under the Act. As already stated, section 37 prohibits granting of any deduction which is of a capital nature. Admittedly the assessee has incurred expenditure only for the purpose of setting up of new industrial unit which was not commissioned in any of the two previous years relevant for the assessment years involved. Therefore, in our view, the entire expenditure incurred for setting up of new industrial unit, though under expansion scheme, for the manufacture of very same product, is capital in nature. Business expenditure of a revenue nature allowable under section 37 are those incurred for carrying on, existing business and not investments made for setting up of a new plant for operation in future.