Capitalised pre-production interest on construction finance forms part of actual asset cost and qualifies for depreciation.

Interest paid on share capital raised for construction purposes, where statutorily sanctioned, remained distinct from dividend and did not require a reference on that characterization issue; the revenue failed on that point. Capitalised pre-production interest incurred to finance construction of fixed assets was treated as part of the actual cost of plant and machinery because it was expenditure necessary to bring the assets into existence and working condition. Depreciation was therefore allowable on the enhanced cost, and the reference was answered for the assessee on the capitalisation issue.

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Issues: (i) Whether the payment made to shareholders on the issue of new share capital was by way of dividend or interest so as to require a reference on that question. (ii) Whether interest paid on share capital raised for construction purposes and capitalised could be included in the actual cost of plant and machinery for claiming depreciation.

Issue (i): Whether the payment made to shareholders on the issue of new share capital was by way of dividend or interest so as to require a reference on that question.

Analysis: The governing provision permitted payment of interest on share capital issued to finance construction expenses, and the sanctioned payment under that provision could not be confused with dividend rights. The character of the payment as interest remained distinct from dividend, and no error was shown in the refusal to refer that question as one of law.

Conclusion: The question did not call for a reference and the revenue failed on this issue.

Issue (ii): Whether interest paid on share capital raised for construction purposes and capitalised could be included in the actual cost of plant and machinery for claiming depreciation.

Analysis: The applicable accountancy principle is that the cost of fixed assets includes expenditure necessary to bring them into existence and working condition. The Supreme Court authority on capitalisation of pre-production interest, read with the statutory recognition given to interest paid on money raised for construction expenses, supported treating such capitalised interest as part of the actual cost of the assets.

Conclusion: The capitalised interest formed part of the actual cost and depreciation was allowable; this issue was decided in favour of the assessee.

Final Conclusion: The reference was answered for the assessee, and the capitalised interest was held to be includible in the cost of the assets for depreciation purposes.

Ratio Decidendi: Interest incurred before commencement of production for financing construction of fixed assets, including interest on share capital raised for that purpose where statutorily sanctioned, is capital expenditure forming part of the actual cost of the assets and is allowable for depreciation.

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