2025 (3) TMI 659 - HC - Income Tax

Asset Reconstruction Cost is an Ascertained Liability Under AS 29; Interest Deductible Under Section 36(1)(iii)

The HC held that the provision for Asset Reconstruction Cost (ARC) qualified as an ascertained liability under AS 29, rejecting the AO and Tribunal's view ... Disallowance of depreciation claimed on account of Asset Reconstruction Cost [‘ARC’] being an ascertained liability -provision itself was made in light of Accounting Standard 29 [AS 29] on the basis of the same constituting a present obligation and which could be reasonably estimated - AO proceeded to disallow the said provision holding that it was not in the nature of an ascertained liability distinction between the words ‘extension’ and ‘expansion’ as well as how the phrase ‘extension of business’ itself should be understood HELD THAT:- We are of the firm view that the usage of the phrase ‘if any damage is caused’ in the lease agreement cannot be construed as detracting from the right of the assessee to provision for a liability which flowed from an existing obligation and the occurrence of which was not liable to be viewed as an improbability. In our opinion, the phrase ‘if any damage is caused’ as it occurs in the agreement would only be germane to the issue of actual computation of the expenditure that would be incurred in the course of restoration. The obligation to repair and restore forms the core of the contractual obligation which stood placed upon the assessee. It was therefore entitled to provision for such an expense provided it was considered probable and could be quantified on the basis of a reasonable estimation. The usage of the phrase ‘if any damage is caused’ did not transform that obligation into a contingent liability. We thus find ourselves unable to countenance the view expressed by the AO and the Tribunal in this respect. The usage of the expression ‘probable’ is equated to ‘more likely than not’. Thus, it is the reasonable likelihood of the outflow as opposed to a remote or uncertain possibility which is deemed to be germane and relevant. It thus has to be viewed as distinct from unforeseen liabilities and obligations. As we view the contract term, we have no hesitation in recognising the same as being the manifestation of a positive commitment to repair and restore. The duty to repair and restore stands attached to the removal of equipment as well as the liability to restore the premises to its original condition. The contract thus constitutes the past event and which in turn creates an obligation in praesenti pertaining to a liability which is probable and ascertainable. Thus, the only facets which are left to conjecture are the exact timing and the amount of outflow that may occur. We are thus of the considered opinion that the provisioning for ARC qualified the prescriptions of AS 29 and the assessee was thus justified in accounting for the same. The ARC obligation clearly met the test of a positive obligation flowing from a past event, being a conceivable probability as well as being measurable. In any event, both the AO as well as the Tribunal appear to have proceeded on the basis that only an ascertained liability could have been provisioned for. That view is not only erroneous but also unsustainable in law. Tribunal in any case failed to notice or engage with the contention of the assessee in the alternative and which was based on Section 37 of the Act. By placing its case within the ambit of Section 37, the assessee stood relieved of getting into the quagmire of ‘actual cost’ and other related issues. All that it was left to establish was that the expenditure had been laid out. As the Madras High Court correctly explains in Vedanta [2020 (2) TMI 890 - MADRAS HIGH COURT], the usage of the expression ‘laid out’ and ‘expended’ in Section 37 are indicative of that section not being confined to immediate expenditure but also factoring for situations where an amount may be set apart for a determined or specified objective. The appellant was thus clearly entitled to succeed on this point. Addition u/s 36 (1) (iii) - whether the interest burden borne by the assessee in respect of the capital borrowed was liable to be permitted as a deduction in computing its income? - On a reading of the principal part of Section 36 (1) (iii), it becomes evident that such a deduction could be validly claimed as long as capital has been borrowed and interest burden has been shouldered coupled with the capital itself having been obtained for the purposes of business. The distinction which was sought to be canvassed for our consideration and the arguments based thereon would clearly distract us from discerning the true intent and purpose underlying the insertion of the Proviso to Section 36 (1) (iii). We express our hesitation in founding our judgment on the perceived distinction between the words ‘extension’ and ‘expansion’ especially since etymologically both appear to have been employed interchangeably and on many occasions, deemed to be synonyms of each other. Authoritative work explains that the word ‘extend’ is clearly flexible, lending itself to a variety of meanings dependent upon the context in which it may be used. While so explaining the meaning of the word ‘extend’, it also significantly states that it would also imply increase, amplify as well as any action which would be in tune with its well-known synonyms such as expand including the ‘extension of business’. Thus, it leads to the inevitable conclusion of both ‘expand’ and ‘extend’, essentially seeking to convey enlargement or expanding over and above what may have originally existed. We also contemplate both words envisaging the spread of or addition to what may exist, both in its vertical as well as horizontal forms. It is this synonymous and similar meaning ascribed to the words ‘extend’ and ‘expand’ which weighs upon us and convinces us to desist from toeing this line of reasoning. We are thus of the considered opinion that the question which stands posited would have to answered on an independent evaluation of the scheme of Section 36 (1) (iii) read along with the Proviso and the legislative intendment underlying the insertion of that amendment in the Act. We are thus of the firm view that it would be imprudent and unwise to base our answer solely on the purported difference which Mr. Jolly sought to advocate based on the usage of word ‘extension’ in Section 36 (1) (iii) as contrasted with ‘expansion’ as appearing in other parts of the statute. In order to underline the core and essence of that provision, suffice it to note that Section 36 (1) (iii) enables an assessee to claim a deduction on interest paid in respect of capital borrowed for purposes of business. Judicial precedents have consistently held that the said provision is clearly not concerned with whether the intendment of borrowing is for the creation of a capital or a revenue asset. The Proviso, however, seeks to carve out an exception in respect of the acquisition of an asset which may be utilized for or in the course of extension of an existing business and thus disables the assessee from deducting interest paid on that borrowing during the period when the capital was first borrowed and till such time as the asset is put to use. Thus, the interest borne on borrowed capital during this period alone is sought to be removed from the ambit of Section 36 (1) (iii). We thus recognize the principal purpose of the Proviso as being merely to exclude a claim of interest paid on borrowed capital as a deduction and borne during the period identified above. The submissions, therefore, based on a conceived difference between ‘extension’ or ‘expansion’ of an existing business are of little relevance or import. Tribunal, unfortunately has confounded the issue by thereafter alluding to the recitals appearing in the Directors Report relating to the enhancement of the appellant’s network on account of the addition of 5096 cell sites during the year in question. The findings of the Tribunal rendered in this regard are not only contradictory but also clearly convoluted. This since the cell sites could have either been works in progress or completely constructed. While at one place it holds that they had not been put to use, it does a complete turnaround by resting its decision on the Directors Report and which clearly refers to completed and operationalised cell sites. These observations are thus clearly incompatible. Therefore and in our considered opinion, the scope of the remand would necessarily entail the AO not only examining the aspects pertaining to a common pool of funds as framed by the Tribunal but also whether the cell sites had been actually brought into use. The exercise which the AO would thus be obliged to undertake would have to cover the twin issues that we have identified above bearing in mind the construction that we have placed on Section 36 (1) (iii) of the Act. We would thus answer Question A in the affirmative and in favour of the assessee. Insofar as Question B is concerned, we direct the AO to re-examine the issues emanating from Section 36 (1) (iii) bearing in mind the enunciation of the scope of that provision as explained by us in terms of this judgment. We also expand the scope of the remand in light of the observations which appear hereinabove and to thus include the twin issues of a common pool of funds as well as cell sites having been put to use. Question C concededly stands concluded by the decision of the Supreme Court in Bharti Cellular [2024 (3) TMI 41 - SUPREME COURT] and thus needs no further elaboration. 1. ISSUES PRESENTED and CONSIDEREDThe Court considered the following core legal questions:Whether the ITAT erred in upholding the disallowance of depreciation claimed on Asset Reconstruction Cost (ARC) as an ascertained liability, or alternatively allowing deduction for such expenditure in the year of execution of lease agreements or over the period of the leaseRs.Whether the ITAT erred in holding that installation of cell site towers amounted to 'extension of existing business' under Section 36 (1) (iii) of the Income Tax Act, 1961, thus warranting proportionate disallowance of interestRs.Whether the ITAT erred in misbranding the discount offered by the Appellant to pre-paid sim-card distributors as commission, upholding disallowance under Section 40 (a) (ia) of the ActRs.Whether the ITAT erred in deleting the disallowance on account of commission paid to distributors by ignoring the factual matrix and solely relying on the decision of the DRP, AhmedabadRs.Whether the ITAT erred in deleting the disallowance of penalty paid to the Department of Telecommunications, given that penalty expenses, being penal in nature, are not allowable under Section 37 of the ActRs.2. ISSUE-WISE DETAILED ANALYSISDepreciation on Asset Reconstruction Cost (ARC):Legal Framework and Precedents: The Court considered Sections 32 and 37 of the Income Tax Act, 1961, and Accounting Standard 29 (AS 29) which deals with provisions, contingent liabilities, and contingent assets.Court's Interpretation and Reasoning: The Court found that the Tribunal erred in not addressing the alternative plea under Section 37. It emphasized that a provision could be made if it aligns with AS-29, which allows for provisions when a liability is probable and can be estimated reliably.Key Evidence and Findings: The Tribunal had rejected the ARC as an ascertained liability, focusing on the lease agreement's language, which included the phrase 'if any damage is caused.'Application of Law to Facts: The Court concluded that the ARC obligation met the test of a positive obligation flowing from a past event, being a conceivable probability, and measurable, thus qualifying for deduction under Section 37.Treatment of Competing Arguments: The Court dismissed the view that only an ascertained liability could be provisioned for, emphasizing the distinction between a contingent liability and a provision under AS-29.Conclusions: The Court held that the assessee was entitled to succeed on the point of ARC provisioning under Section 37.Interest on Borrowed Capital for Cell Site Towers:Legal Framework and Precedents: The Court examined Section 36 (1) (iii) of the Income Tax Act, focusing on the Proviso concerning interest on borrowed capital for asset acquisition.Court's Interpretation and Reasoning: The Court found the Tribunal's findings contradictory regarding whether the cell sites were put to use. It emphasized that the Proviso aimed to exclude interest deduction during the period before the asset is put to use.Key Evidence and Findings: The Tribunal had noted that the installation of towers was ongoing, yet also referenced the Director's Report indicating network expansion.Application of Law to Facts: The Court recognized the need to ascertain whether the cell sites were operational to determine the applicability of the Proviso.Treatment of Competing Arguments: The Court rejected the distinction between 'extension' and 'expansion' of business, focusing on the legislative intent and the Proviso's purpose.Conclusions: The Court remanded the matter to the AO to examine the common pool of funds and whether the cell sites were put to use.3. SIGNIFICANT HOLDINGSDepreciation on ARC: The Court held that the provisioning for ARC qualified under AS-29 and Section 37, emphasizing that a provision can be made for probable liabilities that can be estimated reliably.Interest on Borrowed Capital: The Court clarified that the Proviso to Section 36 (1) (iii) excludes interest deduction for the period before an asset is put to use, dismissing the distinction between 'extension' and 'expansion' of business.Final Determinations: The Court answered the question on ARC in favor of the assessee and remanded the issue of interest on borrowed capital for further examination by the AO.