2017 (12) TMI 1896 - AT - Income Tax

Reset fee deduction denied as capital expenditure during construction period under section 36(1)(iii) proviso

The ITAT Chennai upheld the Revenue's disallowance of reset fee deduction, ruling it must be capitalized as part of asset cost during construction period ... Disallowance of ‘reset fee’ charged and paid by the assessee during the relevant previous year - HELD THAT:- The reset fee is again only in the nature of interest, defined u/s. 2(28A) to include any service fee or charge in respect of moneys borrowed or debt incurred. The same stands paid during the relevant financial year, so that the condition of sec 43B stands satisfied. Further, in view of the proviso to sec 36(1)(iii), effective AY 2004-05, the same would stand to be a part of the cost of the capital asset/s toward acquiring which the borrowing stands applied; the interest being incurred during the construction period. The year under reference in Gujarat Guardian Ltd. [2009 (1) TMI 13 - HIGH COURT DELHI] was AY 1996-97, whereat the said proviso was not on the statute book. In fact, even prior to A.Y. 2004-05, one could contend of capitalization of the interest cost in view of Explanation 8 to s. 43(1), defining ‘actual cost’, providing that the interest incurred in relation to acquisition of an asset, so much of it as is relatable to the period after the asset is ‘first put to use’, would not form part of the cost of the said capital asset. The interest during the construction period, i.e., prior to it being ‘first put to use’, would thus stand to be capitalized. Therefore the proviso to sec 36(1)(iii) is clarificatory and, thus, retrospective in nature, as indeed held in JCT Ltd. [2004 (10) TMI 53 - CALCUTTA HIGH COURT]. The non-capitalization of interest in books, following Accounting Standards or otherwise, stands rendered as of no consequence in view of the clear language of the provision. The position of law, however, for A.Ys 2004-05 and the subsequent years, is without any shadow of doubt, as clarified in Dy. CIT v. Core Health Care Ltd. [2008 (2) TMI 8 - SUPREME COURT] The Revenue’s stand is, accordingly, upheld, dismissing the assessee’s ground. We may though add that the Revenue has, capitalizing the interest cost, considered the same for grant of depreciation. Computation of the ‘profits of the business’ under Explanation (baa) to s. 80HHC, which provides for exclusion of, among others, receipts by way of brokerage, commission, interest, rent, charges or any other receipts of similar nature, included in the profit or gain computed u/s. 28 - HELD THAT:- As perused the order by the tribunal in the assessee’s case for A.Y 2003-04 [2009 (8) TMI 970 - ITAT CHENNAI] With reference to the decisions by the Hon'ble Apex Court reported at [2007 (11) TMI 10 - SUPREME COURT] and [2007 (4) TMI 202 - SUPREME COURT], the rationale for the exclusion of the independent incomes in the computation of the export profits stands explained. We find no reason for a different view, save qua ‘income’ by way of sale of scrap in view of the decision in Punjab Stainless Steel Industries [2014 (5) TMI 238 - SUPREME COURT] We do likewise, including remission, for the same reason/s, as was done by the tribunal in that case qua some receipts, viz. unclaimed/unspent liabilities; recoveries from employees - Furniture, etc. Further, the remission, instead of being variously to the AO and the first appellate authority, as done by the tribunal in that case, would be uniformly to the file of the ld. CIT(A), who shall decide after hearing the parties before him. As regards receipts by way of testing fees and others for the same reason, i.e., being independent incomes, would stand to be excluded in computing the profits of the business. As regards the sale of scrap, there shall be no exclusion under Explanation (baa) in its respect as the same is to be regarded as a reduction in the cost of raw-material and, further, the sale shall not stand to be included in the amount of ‘total turnover’ of the business. This, however, shall not extend to the sale of power, which shall stand included in the total turnover. Before parting with this issue, we make it clear that the exclusion, in view in ACG Associated Capsules Pvt. Ltd. [2012 (2) TMI 101 - SUPREME COURT] relied upon by the assessee before us, is only qua the ‘income’ in relation to the receipts by way of sale of power, crane charges, testing charges, etc., i.e., after netting identifiable costs incurred in relation thereto. Interest on delayed payments against supply of crude and interest on loans/advances as ‘income from other sources’ - assessee claims the same as forming part of the business income and, in the alternative, only the net income on account of interest being liable to be excluded in view of the decision in ACG Associated Capsules Pvt. Ltd. [2012 (2) TMI 101 - SUPREME COURT] - HELD THAT:- Hon'ble Apex Court has in Bokaro Steel Ltd [1998 (12) TMI 4 - SUPREME COURT] and Karnal Co-operative Sugar Mills Ltd. [1999 (4) TMI 7 - SC ORDER] applied the same principles, to find, in the facts and circumstances of the case, the interest income as incidental to the acquisition of the asset/s or the setting up of the plant and machinery, so as to be a capital receipt which would go to the reduce the cost of the relevant asset, in the same manner as the interest cost on borrowings applied for the same stands to be included as a part of the actual cost of the asset u/s. 36(1)(iii) r/w s. 43(1), more particularly A.Y 2004-05 onwards. We may at this stage also dwell on the quantum of exclusion (reduction) under Explanation (baa). This is as, even if regarded as income from other sources, in-as-much as the interest cost relatable to the interest receipt, where incurred, is thus deductible u/s. 57(iii) (the onus to establish which would be on the assessee), and it is only the net (interest) income that would stand to be excluded. This is as the said interest cost, debited to the profit and loss account of the company, cannot therefore continue to be claimed or regarded as deductible u/s. 36(1)(iii) as business expenditure. Where, however, assessable as business income, as in the case of that received from trade debtors, no adjustment qua interest receipt may be required as the corresponding interest cost – the financing cost being incurred in relation to the entire debt portfolio, i.e., rather than the debt representing the delayed payment only, may be considered as standing reduced to that extent, i.e., by and to the extent of the interest received/receivable. The same, it may be noted, is akin to the realization by way of sale of scrap, which is to be regarded only as a reduction in the cost of raw-material and not as an independent income. We, accordingly, only consider it proper, in the absence of the requisite details, while confirming the validity of the principles relied upon by the Revenue, to remit the matter back to the file of the ld. CIT(A) for a decision on merits after hearing the parties before him. We decide accordingly. Deduction in respect of the revamping cost of it’s existing Visbreaker unit, work on which was abandoned midway by the assessee - whether the write off is deductible for the current year? - Nature of expenditure - HELD THAT:- Even if there is a debit to the profit and loss account for the current year, i.e., the year of write off, the same would stand offset by the write back of the provision to that extent, being no longer required, neutralizing the said debit. There is thus no charge or taxable event for the current year. Further still, the write off being sanctioned by the Board only on 14.04.2004, the same could be effected in the accounts only for the following year; the current expiring on 31.03.2004. Each year is a separate and independent unit of assessment, and income of each year is assessable only for that year. This represents trite law, apparent from a bare reading of ss. 3, 4 & 5 of the Act. Reference in this context may also be made to the decision in CIT v. British Paints India Ltd. [1990 (12) TMI 2 - SUPREME COURT] There is, thus, at the threshold, no basis for the impugned expenditure being considered for allowability for the current year. We are, we may add, conscious that this is not the reason advanced by the Revenue for non-acceptability of the assessee’s claim. Whether this would constrain the Tribunal from taking cognizance of the material on record and decide in accordance with law, i.e., after determining the facts? - It is the correct legal position that is relevant, and not the view that the parties may take of their rights in the matter (CIT v. C. Parakh & Co. (India) Ltd. [1956 (3) TMI 1 - SUPREME COURT], Kedarnath Jute Mfg. Co. Ltd. [1971 (8) TMI 10 - SUPREME COURT]. The tribunal as an appellate authority, is under bounden duty to correct the errors, if any, attending the proceedings for assessment, issuing appropriate directions. As explained in CIT v. Walchand and Co. (P.) Ltd. [1967 (3) TMI 2 - SUPREME COURT] the tribunal is to deal with and determine all the questions which arise out of the subject matter of appeal, in light of the evidence and consistently with the justice of the case. Without prejudice to the foregoing, i.e., the reason/s for which we consider the assessee’s claim as not valid for the current year, the costs incurred and, thus, being claimed, are only capital expenditure. That the same did not finally result in a capital asset would not in any manner change the character of the expenditure as capital expenditure; rather, only imply the same to be a capital loss, i.e., a loss in the capital field or on capital account. The same, without doubt, stands incurred only for the purpose of business, but being capital in nature, is impermissible for deduction u/s. 37(1). A capital expenditure, merely because it is infructuous, would not alter its character as such, as indeed is the case qua a revenue expenditure. That an expenditure is abortive or does not serve its intended purpose is by itself no reason for it being not allowed or allowed, where otherwise allowable or, as the case may be, not deductible, i.e., for that reason. The decision in Tamil Nadu Chemical Products Ltd. [2002 (9) TMI 80 - MADRAS HIGH COURT] is in respect of deduction u/s. 35AB qua technical know-how, a capital expenditure, with the said deduction being in the nature of a capital allowance, as depreciation allowance u/s.32(1), and has therefore no application in the facts of the present case. The assessee’s case is accordingly without merit. Depreciation on gas sweetening plant - plant was kept ‘read-to-use’ though could not be used for reasons and circumstances beyond the control of the assessee - words ‘used for the purposes of business or profession’, occurring in sec. 32(1) - HELD THAT:- As in view of the clear finding of the relevant plant being not put to use at any time after its installation, the same could not, clearly, be considered as a part of the block of assets, on which alone depreciation is to be allowed for the current year. The depreciation for AY 1997-98, as we understand, stands allowed in view of trial run. A trial run is a part of the setting up of the plant for actual use, i.e., for the purpose for which it stands acquired. The same is thus only a part of the commissioning of the plant. No wonder, the cost of trial production, wherein all the technical glitches stand to be removed and the production capability verified, including as to the quality of the output, stands to be capitalized as part of the project (asset) cost, on which depreciation is to be, upon user, allowed. The matter stands examined in some detail in G. Shoes Exports [2016 (12) TMI 1140 - ITAT MUMBAI] We may, before parting with our order, address the decision in CIT v. Vayithri Plantations Ltd. [1980 (1) TMI 27 - MADRAS HIGH COURT] relied upon by the tribunal in the assessee’s case for AY 1998-99 supra. The same, as its reading reveals, is distinguishable on facts as well as in law. We have, firstly, explained that this is a case of complete non user and not a case of passive user, as was found by the Hon'ble Court in that case. The plant is idle since its installation in f.y. 1996-97, i.e., for years, for want of raw-material, which appears to be banned. There is in fact, strangely, no explanation, at any stage, in this respect. The assessee company has ostensibly found an alternate method for achieving the results (production) sought to be attained by using the gas sweetening plant. Could it be then said that the said plant is being used and, further, for the purposes of the assessee’s business? There is, under the circumstances, no passive user for the assessee’s business, with even the claim of the ready-to-use state being suspect, so as to require verification. In fact, the ‘ready to use’ argument loses significance under the circumstances, which is relevant only where it amounts to a passive user. The non user in Vayithri Plantations Ltd. [1980 (1) TMI 27 - MADRAS HIGH COURT] was on account of labour unrest, an aberration. The same was, under the circumstances, regarded by the Hon'ble Court as a case of passive user. Availability of raw material for which the plant is designed (even if not on a regular basis), is, on the other hand, integral to its’ functioning and not extraneous thereto, as was found by the Hon’ble Court in that case. It may be that the company has found alternate sources for achieving the desired result, or an alternate technology so as to discard the earlier arrangement as unfeasible or uneconomical or, plainly, as not legal/keeping with public policy – as, for example, where the raw material (sour gas) has, or results in, (higher) pollutant/s. We have, on principle, abundantly clarified that a passive user, even citing examples thereof, where so, would entitle depreciation. Two, the Hon'ble Court in that case disregarded the Revenue’s contention of the words ‘put to use’ in the following year, as appearing in the second part of s. 33, on the ground that the same may hold or apply where a new business is being set up, so that the asset is first put to use in that year. The two limbs were separate. The words ‘used’ and ‘put to use’, occurring in sec. 32(1) and the second proviso thereto respectively, however, form part of one integrated code, to be assigned the same meaning and understood in the same sense. It could not be otherwise. The said decision would therefore not apply in the present case. Further, we also clarify that we state so on the basis of an appreciation of facts, which is, with respect, missing in the tribunal’s order supra. In fact, the cited decision by the Hon'ble High Court was relied upon only by the ld. third member. In view of the foregoing, we are not inclined to consider the assessee’s case as covered by the decision by the tribunal in its’ own case for A.Y 1998-99. As, however, no specific arguments in relation to this ground were made at the time of hearing, and the matter heard summarily on the basis of it being covered by the tribunal’s order supra, we only consider it proper to, in the interest of justice and the fairness of procedure, restore the matter back to the file of the ld. CIT(A) for a decision on merits per a speaking order in accordance with law and after allowing both the parties before him a reasonable opportunity of hearing. The principle of res judicata, we may add, has no application in the proceedings under the Act. Why, in that case, the AO was bound to allow depreciation, and could not have adopted the view he does (refer, inter alia, New Jehangir Vakil Mills Ltd. [1963 (4) TMI 60 - SUPREME COURT]. The tribunal is, in our view, in view of its findings, obliged to direct so. Further, we may clarify, that the ld. CIT(A) need not constrain himself by the opinion expressed by us in this order and, rather, is to take an independent decision, of course having regard to and taking guidance from our observations, which though shall have persuasive value, answering the questions/issues posed/raised by us, or any other he deems relevant and proper, for the purpose. The ‘ready-to-use’ claim, where found as relevant by him, shall require being verified. That is, his is to be an independent order, determining and taking into account the relevant facts, and the law in the matter; with we considering it proper to do so, so as to remove the procedural infirmity as well as a lack of proper examination of the relevant facts. We decide accordingly. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Tribunal include:(a) Whether the 'reset fee' paid by the assessee to Oil Industries Development Board (OIDB) in restructuring its loan qualifies as deductible interest under sections 36(1)(iii) and 43B of the Income Tax Act, or whether it must be capitalized as part of the cost of the capital asset under the proviso to section 36(1)(iii) effective from AY 2004-05.(b) The correct computation of 'profits of the business' under Explanation (baa) to section 80HHC, specifically whether certain receipts such as brokerage, commission, interest, rent, testing fees, and sale of scrap should be excluded from total turnover or profits for export profit computation.(c) The classification and tax treatment of interest on delayed payments and interest on loans/advances received by the assessee-whether such income constitutes business income or income from other sources, and the consequent impact on exclusion under Explanation (baa) to section 80HHC.(d) The maintainability and allowability of deduction claimed by the assessee for the write-off of revamping costs of an existing visbreaker unit which was abandoned midway-whether such expenditure is revenue in nature or a capital loss.(e) The allowability of depreciation on a gas sweetening plant which was installed but not used during the relevant assessment year-whether the plant was 'used' or 'ready to use' within the meaning of section 32(1), and if depreciation is admissible despite non-operation due to non-availability of raw material.2. ISSUE-WISE DETAILED ANALYSIS(a) Deductibility of Reset Fee as Interest or CapitalizationThe assessee had paid a 'reset fee' of Rs. 13.48 crore to OIDB to restructure existing high-cost loans by reducing interest rates. The Revenue treated this fee as interest under section 2(28A), which defines interest to include any service fee or charge in respect of borrowed money, making it deductible under section 36(1)(iii) subject to capitalization proviso effective from AY 2004-05.The Tribunal noted that the reset fee was a one-time payment in lieu of recurring higher interest cost and thus fell within the definition of interest. Reliance was placed on the decision in CIT v. Gujarat Guardian Ltd. where prepayment charges were held to be interest and deductible under section 43B only upon payment.However, the proviso to section 36(1)(iii), introduced by the Finance Act 2003 effective 01.04.2004, mandates capitalization of interest paid on capital borrowed for acquisition or construction of an asset during the period before the asset is first put to use. Since the loan was for financing refinery expansion, the reset fee (interest) had to be capitalized as part of the project cost.The Tribunal rejected the assessee's claim for deduction in the year of payment and upheld the Revenue's view that the reset fee should be capitalized. It further noted that capitalization does not depend on accounting treatment but on the statutory provision, supported by the Supreme Court's ruling in Dy. CIT v. Core Health Care Ltd. The Revenue's approach of granting depreciation on the capitalized interest was also affirmed.(b) Computation of Profits under Explanation (baa) to Section 80HHCExplanation (baa) excludes from business profits certain independent receipts such as brokerage, commission, interest, rent, and similar receipts when computing export profits under section 80HHC. The assessee challenged the exclusion of receipts like sale of scrap and testing fees from total turnover and profits.The Tribunal relied on its own earlier decision for AY 2003-04 and Supreme Court precedents explaining the rationale for excluding independent incomes from export profit computation. It distinguished the sale of scrap from other independent incomes, holding that scrap sales represent a reduction in raw material cost and should not be excluded from profits nor included in total turnover for export profit calculation. However, sale of power was held to be part of total turnover.Receipts such as testing fees and other similar incomes were upheld as independent and thus excluded. The Tribunal clarified that the exclusion under Explanation (baa) applies only to net income after deducting related expenses, following the Supreme Court's decision in ACG Associated Capsules Pvt. Ltd.(c) Classification of Interest on Delayed Payments and Interest on Loans/AdvancesThe assessee contended that interest on delayed payments and interest on loans/advances should be treated as business income or, alternatively, only the net interest income should be excluded under Explanation (baa). The Revenue classified such interest as income from other sources under section 56.The Tribunal noted conflicting precedents: the Revenue relied on South India Shipping Corporation Ltd. and Tuticorin Alkali Chemicals & Fertilizers Ltd. which held that income classification depends on the manner of derivation; the assessee relied on Bokaro Steel Ltd. and Karnal Co-operative Sugar Mills Ltd. which treated interest incidental to acquisition of assets as capital receipts reducing asset cost.The Tribunal found the assessee's alternate claim misconceived because Explanation (baa) applies only to business income, and the Revenue's classification as income from other sources precludes that. It also explained that if interest income is assessable under other sources, only net interest income (interest income less related interest expense deductible under section 57(iii)) could be excluded under Explanation (baa).Given lack of details, the Tribunal remitted the matter to the CIT(A) for fresh adjudication on merits after hearing both parties.(d) Deductibility of Write-off of Abandoned Visbreaker Unit Revamping CostsThe assessee wrote off Rs. 2.31 crore of revamping costs incurred on an existing visbreaker unit, which was abandoned midway due to a decision to build a new unit instead. The Revenue contended the expenditure was capital in nature and not deductible as revenue expenditure.The Tribunal examined the facts: the revamp project was dropped in 1997-98, costs were provided for in books over several years, and the write-off was sanctioned in 2004. It held that the write-off could not be claimed as a deduction in the current year since the costs were identified as dead costs and had been provided for earlier, and each assessment year is separate under the Act.Substantively, the Tribunal held the expenditure was capital in nature as it related to the creation of a capital asset, even though the project was aborted. The character of expenditure as capital does not change because it is infructuous. The Tribunal relied on settled Supreme Court precedents including A.V. Thomas & Co. Ltd., Swadeshi Cotton Mills Co. Ltd., and Hasimara Industries Ltd. It distinguished the assessee's reliance on decisions relating to capital allowances under section 35AB, which are not applicable here.The Tribunal allowed the Revenue's appeal on this ground.(e) Allowability of Depreciation on Gas Sweetening Plant Not Used During Relevant YearThe assessee claimed depreciation on a gas sweetening plant which was installed but not used during the relevant year due to non-availability of raw material (sour gas). The AO disallowed depreciation; the CIT(A) allowed it relying on the Tribunal's earlier order for AY 1998-99 where the plant was held to be 'ready to use' and thus eligible for depreciation.The Tribunal critically examined the earlier order and relevant law under section 32(1), which allows depreciation only on assets 'used for the purposes of business or profession'. It noted the Supreme Court's ruling in Liquidators of Pursa Limited that the asset must be actually used at least for part of the year, though 'used' can include passive use (e.g., standby machines).The Tribunal found no evidence that the plant was kept in a 'ready to use' state during the relevant year, and that the absence of raw material supply was not a temporary suspension but a prolonged non-availability, making the plant incapable of being used. It distinguished cases where passive user was accepted (e.g., temporary idleness due to repairs or labour unrest) from the present case of complete non-use from installation onwards.It further elaborated that 'ready to use' is a notional user and cannot substitute for actual or passive user. The Tribunal emphasized that an asset cannot form part of the block of assets for depreciation unless it is used. It cited authoritative decisions including Dineshkumar Gulabchand Agrawal v. CIT, G. Shoes Exports, and Maps Tours & Travels, underscoring that actual or passive user is necessary for depreciation.Given the absence of material and procedural infirmities in the CIT(A)'s order, the Tribunal remitted the matter back to the CIT(A) for a fresh decision on merits after allowing both parties an opportunity to produce evidence and be heard. It clarified that the CIT(A) must independently examine the facts and law, including verification of the 'ready to use' claim.3. SIGNIFICANT HOLDINGS'The reset fee is again only in the nature of interest, defined u/s. 2(28A) to include any service fee or charge in respect of moneys borrowed or debt incurred. The same stands paid during the relevant financial year, so that the condition of s. 43B stands satisfied. Further, in view of the proviso to s. 36(1)(iii), effective AY 2004-05, the same would stand to be a part of the cost of the capital asset/s toward acquiring which the borrowing stands applied; the interest being incurred during the construction period.''The sale of scrap shall be regarded as a reduction in the cost of raw-material and, further, the sale shall not stand to be included in the amount of 'total turnover' of the business.''The words 'used for the purposes of business or profession' in section 32(1) require actual use, which includes passive user, but excludes mere readiness to use. An asset not put to use at any time during the year cannot be considered as 'used' so as to qualify for depreciation.''An expenditure incurred for a capital asset, even if infructuous or abortive, retains its capital character and cannot be allowed as a revenue deduction under section 37(1).''Where interest income is assessable as income from other sources, only the net interest income (interest income less interest expense deductible under section 57(iii)) can be excluded under Explanation (baa) to section 80HHC.''The Tribunal as an appellate authority is under a bounden duty to correct errors in assessment proceedings, issuing appropriate directions, and must determine all questions arising out of the subject matter of appeal in light of evidence and justice of the case.''The principle of res judicata has no application in proceedings under the Income Tax Act; hence, prior orders do not bind the Assessing Officer or appellate authorities in subsequent years.'