Court upholds investment allowance for synthetic essences in aerated waters despite retrospective effect of definition. Interest disallowance deleted.

Commissioner of Income-tax Versus Vijayawada Bottling Co. Ltd. and Sarvaraya Sugars Ltd.

Commissioner of Income-tax Versus Vijayawada Bottling Co. Ltd. and Sarvaraya Sugars Ltd. - [2013] 356 ITR 625 Issues Involved:
1. Investment allowance eligibility under section 32A of the Income-tax Act, 1961.
2. Disallowance of interest due to lack of nexus between borrowed funds and advances made.

Detailed Analysis:

Issue 1: Investment Allowance Eligibility under Section 32A
Background:
The core issue revolves around whether the assessee is entitled to investment allowance under section 32A of the Income-tax Act, 1961, despite using synthetic essences in the manufacture of aerated waters. The relevant years are 1981-82 and 1982-83 for R.C. No. 85 of 1997, and 1985-86 and 1986-87 for R.C. No. 125 of 1999. The Income-tax Officer initially allowed the investment allowance, but the Commissioner of Income-tax (Appeals) disallowed it, arguing that the items manufactured fell under item 5 of the Eleventh Schedule.

Arguments:
The Revenue argued that synthetic essences should be included under 'blended flavouring concentrates' as per the Explanation added by the Finance Act, 1987, which should have retrospective effect. They cited decisions from the Calcutta and Madras High Courts supporting this view.

The assessees contended that the Explanation could not be applied retrospectively and that it only clarified the definition of 'blended flavouring concentrates,' which should not affect assessments prior to April 1, 1988.

Consideration and Finding:
The court analyzed the relevant provisions of section 32A and the Eleventh Schedule, noting that the Explanation to item 5 was inserted to clarify that 'blended flavouring concentrates' include synthetic essences. The court reviewed legislative documents and case law to determine whether the Explanation should have retrospective effect. It concluded that the Explanation was intended to clarify the definition without denying investment allowance for years prior to 1988-89.

Conclusion:
The court held that the Explanation, though clarificatory, did not intend to deny the investment allowance retrospectively. Therefore, the assessees were entitled to the investment allowance for the relevant assessment years.

Issue 2: Disallowance of Interest Due to Lack of Nexus
Background:
In R.C. No. 125 of 1999, the issue was whether the Income-tax Appellate Tribunal was right in deleting the disallowance of interest on the grounds that the Revenue failed to establish a nexus between borrowed funds and advances made by the assessee to its subsidiary.

Arguments:
The Revenue argued that the Tribunal's decision was based on fresh evidence not presented before the lower authorities, violating rule 29 of the Income-tax (Appellate Tribunal) Rules, 1963. The assessee countered that the Tribunal's finding was a question of fact, which should not be reconsidered by the High Court under section 256(2).

Consideration and Finding:
The court noted that section 36(1)(iii) allows deduction of interest paid on borrowed capital used for business purposes. The Tribunal found that the advances were made from the assessee's own funds, not borrowed funds, based on the evidence presented. The court emphasized that findings of fact by the Tribunal are final and cannot be re-evaluated by the High Court in a reference under section 256.

Conclusion:
The court upheld the Tribunal's decision, affirming that the disallowance of interest was correctly deleted based on the factual finding that there was no nexus between borrowed funds and the advances made.

Final Judgment:
The court answered both issues in favor of the assessee and against the Revenue, affirming the entitlement to investment allowance and the deletion of interest disallowance. The reference cases were disposed of without any order as to costs.