TaxTMI 
TaxTMI 
2004 (8) TMI 314
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....800 million cubic meters (4.72 MAF) enveloping about 214 km. length of the Narmada valley and surface area of 37,000 hectares. A 460 km. mam canal is to be constructed on the right bank from the reservoir upto Gujarat-Rajasthan Board. The main canal at the head has to have capacity of 1,133 cumecs (40,000 cusecs) which is to be the largest in the world and it is to taper down to about 71 cumecs (2,500 cusecs) at Gujarat-Rajasthan Board. There are to be 35 branches off taking from the main canal. The distribution system network is to be at the length of about 75,000 kms. The supply of water is to be on volumetric basis by rotation to ensure equitable distribution. Further, to ensure timely and reliable supply of irrigation water as also to prevent wasteful and excessive use of water, automatic remote control upto 300 cusecs and above capacity canal network and manual/semi-automatic control below 300 cusecs network of canal was to provide. 3. The project is also to have the river-bed Power house, located underground on the right bank to accommodate six reversible Francis Type turbine units each of 200 MW capacity. The canal-head Power House, also on the right bank is to accommodate ....
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....r Narmada Limited with its registered office at Gandhinagar with an authorized share capital of Rs. 2,000 crores to be divided into 2 crores shares of Rs. 1,000 each. The entire capital will be scribed by the Government and accordingly the Nigam will be a wholly owned Government Company. The Company should be registered as Public Limited Company under the Companies Act, 1956...." 6. Thereafter, the assessee Corporation was incorporated under the Companies Act, 1956 on 24th March, 1988 and the Registrar of Companies, Gujarat issued Certificate of Incorporation The assessee Corporation, thereafter, was granted Certificate for Commencement of Business by the ROC, Gujarat on 9th May, 1988. On formation of the assessee Corporation, the Government of Gujarat, Narmada Development Department vide Resolution No. MPC/1088/23/K, dated 31-8-1988 transferred en-bloc the entire staff and officers of the Circles and office other heads etc. working under the control of Narmeda Development Department to the assessee Corporation. Further, the Government of Gujarat also transferred assets of Sardar Sarovar Narmada Project to assessee Corporation and to effect that transfer the Government of Gujarat ....
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.... Gujarat. Note No. 10 forming part of the accounts in the Annual Report 1988-89 incorporate the fact as under: "(10). Government of Gujarat has transferred an operating branch of Mahi Canal to the Company vide Government letter No. EMT/1887/4387/2-G dated 19-3-1987 for Rotational Water Supply System of irrigation during the period Income received by the Company from operating branch is to be passed on to the Government of Gujarat." 10. No profit and loss account was prepared by the assessee in any of the years and in Note No. 7 forming part of the accounts in the Annual Report 1988-89 it is observed that "(a) No Profit and Loss Account for the period from 24th March, 1988 to 31st March, 1989 has been prepared as the Projects of the Company are under construction and the Company's operation of supply of water and power has not commenced by 31st March, 1989. (b) Most of the items classified under incidental expenditure during construction, according to the Company, are relating to the Project and it is, therefore, the intention of the Company to capitalize the same as and when commercial operations commence." 11. The position of the project executed and establishment of infrastru....
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.... in completion stage. Total 767.23 LCM earthwork (99.17% of revised qty.) 150.55 Ism lining (99.98%) and 20.86 LCM structured concrete (97.66%) are completed upto March, 2000. The Narmada Main Canal works from 144 kms. To 264 kms. Reach (i.e. from Mahi river crossing to Saurashtra Branch Canal offtake) are in progress. Total 633.89 LCM excavation (96.35%), 120.19 LSM lining (95.28%) and 4.73 LCM (92.38%) structural concrete are completed upto March, 2000. The works of six major canal siphons on major rivers i.e. Shedhi, Saidak, Mohar, Watrak, Meshwo and Sabarmati are in progress and on Khari is completed". While in the Report under head 'Distribution System' it is stated that "Phase-I - "Sardar Sarovar (Narmada) Project Command under Phase-I (i.e. area under NMC ch. 0 to 144 km.) covers culturable command area of 4.47 lakh Ha. Between the rivers Narmada & Mahi. The survey, investigation, planning, designing and estimating of distribution system upto 40 Ha. Block has been completed. The work of Distributories and some minors are nearly completed. Out of remaining works distributories & minors 41 works amounting to Rs. 262 crores have been awarded. For remaining works tenders are b....
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....rovision to continue to operate once construction is complete and, therefore, the Nigam was carrying on the construction business and, therefore, the moment it had put first bricks for construction and started its first activity with regard to construction, it has commenced its business activity. 17. The Assessing Officer did not accept this contention of the assessee. He-held that had the intention of the Government of Gujarat was only to incorporate the assessee Corporation, with a view to merely construct dam, canal system etc. it would not have been registered as a Company under section 25 of the Companies Act, 1956, because undoubtedly, the project is for promoting useful object for general public. The fact that the Government had contributed towards capital of the assessee Corporation and not advanced any loan etc. also goes to establish the fact that the Government did not see the Corporation as a contractor for the construction of Sardar Sarovar Dam. The Assessing Officer narrated the main object of the assessee Corporation as under: "To undertake "execution" of the Sardar Sarovar Project comprising a dam across the river Narmada in the Nandod Taluka of Bharuch district i....
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....m Sardar Sarovar Project were envisaged by the Board of Directors of the Company. As per Corporate philosophy for the healthy functioning of a Corporate democracy, right of information to members of a company is necessary therefore, a Directors' Report is given a statutory recognition. Section 217 of the Companies Act, 1956 prescribes the information which must be made available by the Board of Directors to a member. One such information, as per sub-section (1) of section 217 is in respect of state of the Company's affairs. A Director may incur liability to individual shareholders who acts in reliance upon a negligent or mis-statement made in the Directors' Report, penalty for failure to take reasonable steps to comply with provisions of section 217(1) to (4) is prescribed in sub-sections (5) & (6). In the case of India Polyfibres Ltd. v. Asstt. CIT [1997] 58 TTJ (All.) 84 the ITAT even gone to the extent and held that an entry in the log-book (maintained on day-to-day basis) cannot be relied on in preference to Director's Report." 17.3 He thereafter reproduced note 7 as extracted above from the Schedule-I notes forming part of the accounts of annual report 1988-89 and observed th....
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....g said clarification from the Company Law Board, SSNNL has not prepared profit and loss account and has exhibited revenue expenditure not allocable to specific project in a separate schedule under heading "Incidental Expenditure pending capitalization"." 17.5 He then reproduced the excerpts from the decision of the Madras High Court in the case of Coimbatore Spg. & Wvg. Co. Ltd. v. CIT [1974] 95 ITR 375 which read as under: "The practice of exaggerating inflation of stocks in statements given to banks to get loan is not shown to exist or that it has been recognized in the commercial circles or by courts. Even assuming that such a practice exists the Tribunal is not expected to take judicial notice of such sub-standard morality on the part of the assessee so as to enable them to go back to their own sworn statements given to the banks as to the stocks held and hypothecated by them to the banks. In a case like this where the assessee is confronted with his own sworn statements which show a different state of affairs then the own shown in his own books of account, heavy burden lies on the assessee to prove that the books of account alone give the correct picture, and the sworn state....
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....he prospective return from the project, take risk to borrow funds at such a high rate of interest. 17.10 He found nothing in Memorandum & Articles of Association of the Company or in any of the notification or resolution issued by the Government of Gujarat that once the construction of Sardar Sarovar Project was completed, the assessee corporation would be wound up and canals & power houses would be transferred to Government of Gujarat. Therefore, he held that in all probabilities the intention of the Government of Gujarat is that the assessee Corporation should construct and own the above project. 17.11 He further noted from para-5 of the assessee corporation's letter dated 28-12-1989 (A copy of which is enclosed as Annexure B to this order) wherein the assessee corporation itself pleaded that unless and until the Dam is constructed, canals start functioning, power houses are set up and supply of water and electricity for irrigation etc. started the business of Corporation cannot be said to be set up and all expenditure till then would be capital expenditure. 17.12 On the basis of the above material, the Assessing Officer held that intention of the Government of Gujarat to inco....
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....t from contractors, rent from employees, recovery from contractors, guest houses and other misc. receipts including hire charges for machinery were inextricably linked with the set up of the Sardar Sarovar Project he held that in view of decision of the Supreme Court in the case of CIT v. Bokaro Steel Ltd. [1999] 236 ITR 315, would go to reduce the cost of project of the assessee corporation and, therefore, the assessee would be liable to pay interest earned from banks. 17.16 However in the opinion of Assessing Officer, the income from interest was chargeable to tax, in view of the decision of the Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilisers Ltd. v. CIT [1997] 227 ITR 172. Contention of the assessee regarding non-chargeability of the interest on the ground that interest from bank on Short-Term Statutory Deposits and others as per statutory requirements under the Rule 3A of the Companies (Acceptance of Deposits) Rules, 1975 and that the interest expenditure incurred by it exceeds the interest income as well as the claim of deduction under section 57(iii) of the Act, was not accepted by the Assessing Officer, as according to him, what section 57(iii) provide....
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....e is exempt under section 10(20A) of the Act, being an authority constituted in India for the development or improvement of cities, towns, villages etc. relying upon the decision of Gujarat Industrial Development Corpn. v. CIT [1997] 227 ITR 414 (SC). The contention of the assessee was not found acceptable by the Assessing Officer, because the assessee has failed to produce any evidence that it was an authority constituted in India for the said purposes. He observed that a Company incorporated under the provisions of the Companies Act, 1956, whether private or section 617 Company viz. Government Company cannot claim to be an authority. He also observed that in Memorandum and Articles of the Association of the Company, there was nothing to do with satisfying the needs for housing accommodation for the purpose of planning development and improvement of cities, towns and villages. He, therefore, held that case of the assessee does not fall within the ken of the Supreme Court's verdict in the case of Gujarat Industrial Development Corpn. 18. The CIT(A) in the appeal against the order of the Assessing Officer for the assessment year 1989-90 accepted the claim of the assessee of having ....
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....t was transferred to the public limited company, i.e. appellant on deputation basis. These actions show very clearly that the work of construction or execution of Sardar Sarovar Project had already been started under the supervision and control of the Gujarat Government which was subsequently transferred to the appellant-company. Not only the man power deployed on the above project was transferred as pointed out above, the Government vide its resolution dated 27-10-1988 G.R.No. COR-1488-M transferred total assets worth Rs. 533.09 crores to the appellant-company. This amount figures in the total work in progress at the end of year 1991-92. The total assets transferred by the Gujarat Government at Rs. 533.09 crores included assets of dam valued at 168.21 crores, assets of canal system worth Rs. 167.99 crores and assets of hydro power stations worth Rs. 117 crores. The transfer of work in progress or the assets worth Rs. 533.09 crores irresistibly lead to the conclusion that the work on the construction and execution of project had already begun much prior to the incorporation of appellant corporation. Therefore, when the appellant corporation received the man power and work in progre....
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....l intervention of the Supreme Court. However, in spite of its complicated nature, the fact cannot be denied that the business of the project commenced right from the day when the construction or the execution of the scheme started. In its nature and facts the scheme is identical to Konkan Railway project undertaken by the Indian Railways under Konkan Railway Corporation Ltd. In that case similar dispute had come for adjudication before CIT(A)-III, New Delhi. After carefully considering the reasons discussed by Ld. CIT(A) in his order dated 8-3-1997 in Appeal No. 129/96-97 and the facts and circumstances of appellant's case, it is held that the business of the appellant-company had commenced during the financial year as such. This ground is accordingly decided in favour of the assessee." 18.1 As regards treatment of interest of Rs. 9,84,131, he held that it was income from other sources by observing in paragraph 31 as under: "31. The contention of the appellant has been carefully examined. The facts discussed in the assessment order have also been perused. The amount of Rs. 9,84,131 has been earned by the appellant on the short-term deposits with the banks. The above income has no....
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...., however, upheld the validity of reopening of assessment in the appeal for the first year and further rejected the claim of the assessee for exemption under section 10(20)/(20A) of the Act in all the years in appeals. In the appeal for the assessment years 1990-91 onwards, the CIT (A), however, upheld the order of the Assessing Officer and rejected all the contentions of the assessee. He observed that the Assessing Officer has brought on record substantial evidences and facts which indicated that the activity of the appellant-company was of pre-operative nature and the commencement of the business would start only when the appellant-company starts exploitation of the project. He has also brought on record some important evidences which indicated that the exploitation of the project was definitely envisaged by the appellant Corporation. With regard to reliance placed on the appellate order in its own case for assessment year 1989-90, he pointed out that the conclusion arrived at by the CIT(A)-IX was solely based on the decision of CIT(A)-III, New Delhi in the case of Konkan Railway Corporation Ltd. In that case in the relevant previous year, the project of Konkan Railway Corporatio....
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....lant Corporation when it came into existence. The value of the project at that stage was estimated to be Rs. 533.09 crores and this value of the project was treated as share capital contribution by the Government of Gujarat. The mega project under progress was in the process of building up capital assets which can be equated with construction of factory building and fabrication of plant and machinery in the case of a manufacturing company. This is further evidenced from the fact that the capital contribution by the Government of Gujarat was debited under the heads of major capital outlay, Rs. 415.73 crores was debited under the head, "4701 capital outlay on major and medium irrigation" and the balance Rs. 117.36 crores were debited under the head "4801 capital outlay on power projects". It is thus obvious that the whole investment by the Government of Gujarat in the project which was till then owned by the Government of Gujarat and was known as Sardar Sarovar Narmada project was a capital investment for creating irrigation and hydro electric power generation infrastructure. No part of the investment till then was considered to be of revenue nature. It is, therefore, consequence th....
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....o such P&L A/c. was prepared for the obvious reason that the appellant Corporation was not engaged in any contract work for anybody else. From the Memorandum of Association, it is apparent that the appellant Corporation was the owner of the capital work in progress and was entitled to exploit the project after the project reaches to a stage where revenue generation either through irrigation or power distribution or in any other way was possible. 18.3 He then referred to certain clauses of Memorandum of Association in this regard and observed in paragraph 6.6 of his order that: "From the above, it is obvious that the appellant Corporation, by no means, was functioning as a contractor for any other party, but the object and activities of the appellant Corporation extended to exploitation of the project for revenue generation after its completion. This line of argument of the ld. counsel for the appellant, therefore, is not acceptable and, therefore, as a consequence, it follows that during the previous year, the appellant Corporation was still in the process of acquisition and construction of capital assets and there was no commencement of business activity." 18.4 Looking to the ex....
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....he appellant would commence only when water starts flowing from the canals and/or when power houses start generating electricity. 19. The Revenue is in appeal in assessment year 1989-90 and against that appeal the assessee filed cross-objection and for all other years challenging the findings of the CIT(A) upholding the validity of the proceedings under section 147 of the Act that the assessee is not entitled to deduction under section 10(20A) of the Act and treating the income from interest as income from other sources and in holding that claim of interest is not allowable and that no appeal lies against charging of interest under sections 234A, 234B. In assessment year 1999-2000 a also changed (sic) the levy of interest under section 234D of the Act. 20. In the appeal for assessment year 1989-90 the clam is also raised by the assessee for deduction under section 10(33) in respect of dividend from Units but the same was not pressed. 21. The learned counsel of the assessee submitted that the assessee Corporation was incorporated on 24-3-1988 to take over the construction of on-going project and it had started working on the project, the moment it had taken over the same from the....
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....ion of Supreme Court in the case of Bokaro Steel Ltd. He also submitted that the assessee is a local authority and, therefore, exempt from taxation under section 10(20)/(20A) of the Act. In support of challenge to re-open the assessment year 1989-90 in cross-objection, he submitted that the reopening was to assess the interest received from contractors and the same amount has not been ultimately assessed, therefore, the reopening of the assessment year is invalid and bad in law, in view of decision in the cases of CIT v. Bokaro Steel Ltd. [1988] 170 ITR 522 (Pat.) and on appeal to Supreme Court in ITO v. Lakhmani Mewal Das [1976] 103 ITR 437 and CIT v. Simon Carves Ltd. [1976] 105 ITR 212 (SC). He also submitted that the motive was not to earn income, and in that connection referred to the decision of Bangalore Tribunal in the case of Jindal Vijaynagar Steel Ltd. v. Asstt. CIT [2003] 87 ITD 630. In any case, he submitted that interest paid on borrowings or making deposits, on which the assessee earned interest be allowed as deduction under section 57 of the Act. 22. The learned Departmental Representatives, on other hand, submitted that there was neither commencement of the busine....
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.... basis on the rotational water supply system with automated regulation of the canals by means of computerized controls for optimizing the use of scarce water and minimizing danger of water logging and salinity in soil. The project would also provide irrigation to 18 lakhs hectares of land in Gujarat and 37,500 hectares of land in Maharashtra. It is also have underground excavation for the river bed powerhouse to start generating power, when reaches height at 110 meter, Gujarat Government did the said work departmentally and on being advised, incorporated the assessee Corporation and transferred the work-in-progress etc. to the assessee on ownership basis. The Government of Gujarat is the main shareholder of the Company, as seen from the G.R. No. COR-1488-H dated 27th October, which reads as under: "Preamble.- The Government of Gujarat has set up a Government Company viz., Sardar Sarovar Narmada Nigam Limited to execute the works of the Sardar Sarovar Narmada Project. (2) The authorized share capital of the Nigam has been fixed at Rs. 2,000 crores (Rupees two thousand crores) divided into 1,00,00,000 (One crore) equity shares of Rs. 1,000 (One thousand) each and 1,00,00,000 (one c....
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....ncurrence of the Finance Department dated 30-6-1988 on this department's file No. COR/1488/ H. By order and in the name of the Government of Gujarat...." 23.1 A close reading of the GR, it clearly shows that the assessee Corporation took over the project with all the assets, rights and liabilities of the project and on transfer they stood vested in it. The assessee Corporation, thus, becomes owner of the dams by acquiring the project for a price. In other words, the dams, power houses etc. would be belonging to the assessee Corporation and thenceforth whatever was to be done was on its own account and it was not in the account of Government of Gujarat or other three States viz., Madhya Pradesh, Rajas than and Maharashtra. The dams or the power houses are to be constructed not as a piece of art or an archeological monument and are with a view to and enable supply of water and electricity. They are in the nature of infrastructure and usufruct is the supply and regulation of water and generation of electricity to be supplied and distributed to cater the need of four States on volumetric basis and on rotational water supply system. The project is, therefore, not only for construction ....
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....ort-term deposit etc. as income liable to tax under the head "Income from other Sources" and raised total tax demand of Rs. 29,04,98,844 which includes interest of Rs. 16,75,27,923 for the assessment years 1989-90 to 1994-95 and 1997-98. The Company had preferred Appeals before the Commissioner of Income-tax (Appeals) and the same has passed an order in November, 2000 for the assessment year 1989-90 accepting the appeal of the Company that business of the Company has commenced since inception. The Company is also advised that the business of the company has commenced and as the expenditure far exceeds the income in all those years, there would not be positive income and hence no tax provision is made for the demand raised." "10. Since the Project of the Company is under execution, no profit and loss account for the year has been prepared. In absence of revenue (except income from other sources) and thereby profits, no provision is considered in the accounts in respect of Redemption Reserve/Sinking Fund or Deep Discounting and Non-Convertible Bonds/Debentures issued by the company from time to time. However, to provide adequate comfort to the investors, a Tripartite agreement has b....
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.... Means of Finance: (Rs. in crores) Funds already raised 2597.63 Funds to be raised 6402.37 -------- Total 9000.00 -------- The project cost does not include interest on market borrowings estimated at Rs. 1,686 crores upto the year of the completion of the project. It is estimated that this would be funded through budgetary support from Gujarat Government and through Water and Electric....
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....id reason for upward revision by the Government. A Cabinet subcommittee is reported to be seized of this matter. 4. Revenue from Hydel generation (Gujarat share-16 per cent) has been taken as per Techno Economic appraisal of the Power project of Sardar Sarovar Project by the Central Electricity Authority, Government of India (Page No. 22 of the prospectus). (c) Auditors Report "A. Profit & Loss" The project of the SSNNL is under construction and no commercial activity has been commenced and in view of reliance on legal opinion of counsel and authoritative pronouncement the SSNNL has also approached Company Law Board for clarification, to exhibit revenue expenditure not allocable to specific project in a Schedule instead of preparing Profit & Loss Account as required under section 211 of the Companies Act, 1956, pending said clarification from the Company Law Board, SSNNL has not prepared profit and loss account and has exhibited revenue expenditure not allocable to specific project in a separate schedule under heading "Incidental Expenditure pending capitalization." (Page No. 35 of Prospectus) (v) Assessee's letter dated 28-12-1989 filed in the proceedings for assessment year ....
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....r commenced its business. The assessee is not engaged in any business of construction of dams or power-house for others. It has to construct the dam for own self so as to regulate and supply of water and electricity. Constructed portion of the project is not its stock-in-trade but capital asset. Where the construction is part of stock-in-trade it might be said that it started its business activity the moment it put in the first brick to continue the taken over project. In case of construction of capital asset or infrastructure it could not be said to have or commenced the business. It is normally when it is ready to provide or produce the usufruct. The assessee Corporation being engaged in constructing infrastructure, the dam in this case, cannot be said to have set up its business or it had commenced business. At best it can be said that it had taken steps to provide the infrastructure. It is only when the infrastructure is ready to exploit, it can be said to be started and/or set up its business or commenced its business. Let us examine the cases relied upon by the parties on these issues. 23.4 In the case of Western India Vegetable Products Ltd. the assessee company was incorpo....
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....nce business, then it can be said that business has been set up, but before it is ready to commence business, it is not set up. 23.5 In the case of Sarabhai Management Corpn. Ltd., wherein assessee company's main object was to acquire immovable property and to give it out either on leave and licence or on lease as residential or in the alternative, business accommodation, with all appurtenant amenities including the amenities of storage, watch and ward facilities, canteens, refreshment rooms etc. It purchased a bungalow together with the appurtenant compound on 28-3-1964 and thereafter building repairs, rewiring, installation of lift etc. were carried on by the company for the purpose of converting the residential accommodation to business and storage accommodation and to render the premises more serviceable to its prospective licensees or lessees. It claimed that it was in a position to offer services to licensees on and from October, 1964 to March 1965 and claimed expenditure as business expenditure. The Assessing Officer, the AAC as well as the Tribunal held that the company could not be said to have been ready to commence business prior to May, 1965, the date on which it gave ....
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....t before it can be said that the business was set up. Test to be applied is as to when a business would regard a business being commenced and the approach must be from a common sense point of view. In this case, the assessee company was incorporated in November, 1963 with the object of manufacturing aluminum and copper conductors. The assessee claimed expenditure from the period 4-11-1963 to 31-12-1964 as business expenditure. The ITO, however, came to the conclusion that the company has started its business during the year, as it only started production of conductors on June 27 and for the period from January 1,1965 to June 26, 1965 the claim of expenditure, was disallowed. The matter was carried to the High Court and the High Court held that Article 3 provides the take over by the assessee company in another company and by a Resolution of Board of Directors of the company dated 6-4-1964 the assessee company acquired business of other company viz. Prem Industrial Corpn. Since selling of the goods manufactured by the company is a part of the business activity, it could be said that assessee company commenced its business and its business was set up when it started securing orders a....
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....leted. Requirement is also complied within a given case where an assessee had undertaken the first of the kind of integrated activities of which the business is overall comprised of. It is not necessary that all the categories of its business activities must start either simultaneously or that the last stage must start before it can be said that the business was set up. The test to be applied is as to when a business would regard a business as being commenced and the approach must be from a common sense point of view. It is also observed that the question whether a business has been set up or not is always a question of fact which has to be decided on facts and in circumstances of each case. In this case, the acquisition of godown where the processing of marine products stated was held to first activity in the process of setting up of the business, as on that date, the assessee is in a position to commence business and because of the arrival fish later on would not postpone the setting up of business, wherein in the present case, the assessee's project was under construction which was not in a position to be said, to be ready to commence business and, therefore, it cannot be said t....
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....d for running hotel business. As against this the on going project of construction of dam, in the present case, was not ready for use and exploitation. 23.9 In the case of Saurashtra Cement and Chemicals Industries Ltd. the assessee company was formed in 1956 for the manufacturing and sale of cement and as part of its business the assessee obtained a mining lease for quarrying limestone and started the mining operations in 1958. The expenditure incurred for the purpose of extracting limestone as also depreciation and development rebate for the machinery installed for that purpose for the assessment years, claimed for the purpose as revenue expenditure. In this case, High Court observed that business of the assessee was divisible into three categories, viz. first category consisted of the activity of extraction of limestone by quarrying the leased area of land and this activity was necessary for the purpose of quarrying raw material to be used manufacturing of cement, second category comprised of the activity of manufacture of cement by use of the plant and machinery, set up for that purpose, and third category combined together constituted the business of the assessee. It was obse....
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....as capital expenses, reducing the interest income of Rs. 2,92,440 from the amount to be capitalized. The ITO rejected the claim of the assessee that interest was not eligible to tax. The matter went upto Supreme Court. One of the finding of their Lordship was that the expenditure would have been deductible as incurred for the purpose of business if the assessee's business had commenced. But that is not the case here. The Supreme Court observed that if a company has not commenced business, there cannot be any question of assessment of its profits and gains of business. 23.11 In the case of Interlink Petroleum Ltd. the Tribunal summarized the principles of law emerging from various judgments from the both sides as under:- "(a) There is a clear distinction between a person commencing business and a person setting up of the business. There may be an interval between setting up of business and the commencement of the business. (b) When a business is established and is ready to commence, then it would be said that the business is set up. (c) The expenses incurred during the interventing period between setting up of the business and the commencement of the business would be permissibl....
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....g unit was obtained by the assessee from Government of India in August, 1955; the assessee had placed orders for purchase of necessary spinning machinery and plant in January and February 1956, and the construction of factory buildings had started in March, 1956, and was in progress on 1st April, 1957, when the WT Act, 1957 came into force. The construction of factory buildings was completed by December, 1957, and the erection of spinning machinery and plant in factory buildings was completed in several stages commencing from June, 1957, and a licence from the Inspector of Factories of working the factory was obtained in June, 1958. The question arose before the Supreme Court on these facts as to when the new spinning unit could be said to have been set up by the assessee; whether it was before 1st April, 1957, or after. The Supreme Court speaking through Bhargava, J. pointed out: 'Thereafter, the High Court referred to a decision of the Bombay High Court in Western India Vegetable Products Ltd. v. CIT and, on its basis, concluded that the proper meaning to be assigned to the expression "set up" in section 5(1)(xxi) would be "ready to commence business". We are unable to agree wit....
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.... legal effects of a transaction in view of the two decisions of the Supreme Court. In the case of Tuticorin Alkali Chemicals & Fertilizers Ltd., it is observed that principles of accountancy do not override the provisions of taxing statute and in this connection their Lordships observed that ".... It is true that this court has very often referred to accounting practice for ascertainment of profits made by a company or value of the assets of a company. But when the question is whether a receipt of money is taxable or not or whether certain deductions from that receipt are permissible in law or not, the question has to be decided according to the principles of law and not in accordance with the accountancy practice. Accountancy practice cannot override section 56 or any other provision of the Act. As pointed by Lord Russell in the case of B.S. Footwear Ltd. [1970] 77 ITR 860 (CA), the income-tax law does not march step by step in the footprints of the accountancy profession." 24.14 Similarly were the observations of the Hon'ble Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd., wherein for the sales-tax liability, the assessee has made no provision in its books of account w....
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....t is true that it had completed a major part of the mega project, but it has not completed the dams to such an extent that it can be exploited for starting supply of water and/or electricity nor it can be said to have set up the business or commenced its business. 23.17 The objects clause contained in the Articles and Memorandum of Association are also an authority of what assessee can do, but here also it does not establish that the assessee corporation was doing or had started its business, in light of the decision of the Supreme Court in the case of Bengal & Assam Investors Ltd. and Oriental Investment Co. wherein it was observed that the object clause is a relevant consideration but not conclusive. It is a matter of fact that whether it had actually commenced its business or had set up the same and that is to be determined by the activity it is engaged in. Mere engagement in construction of the dam by itself is not an activity of business or reaching a stage immediately prior to the commencement and setting up of the business to be carried out, when the construction is complete and reach a stage to be exploited. 23.18 In Delhi case, the business activity has already started. ....
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....clause, "infrastructure capital company" to mean such company as has made investments by way of acquiring shares or providing long-term finance to an enterprise carrying on the business of developing, maintaining and operating infrastructure facility and Explanation (b) to this section provide for the purposes of this clause "infrastructure capital fund" to mean such fund operating under a trust deed, registered under the provisions of the Registration Act, 1908 (16 of 1908), established to raise monies by the trustees for investment by way of acquiring shares or providing long-term finance to an enterprise carrying on the business of developing, maintaining and operating infrastructure facility, the case of the assessee does not fall in either. Explanation (c) might be applicable to the case of the assessee and it provides that an "infrastructure facility" means (i) a road, highway, bridge, airport, port, rail system or any other public facility of a similar nature as may be notified by the Board in this behalf in the Official Gazette which fulfils the conditions specified in sub-section (4A) of section 80-IA; (ii) a water supply project, irrigation project, sanitation and sewerag....
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....and a setting up of the business. There may be an interval between setting up of business and the commencement of the business. (b) The question as to when business can be said to have been set up and commenced will depend on facts and surrounding circumstances of each case and not on the accounting treatment in the books of account of the assessee though that may be an indication of the legal position. The test to be applied is as to when a businessman would regard a business as being set up and/or commenced and the approach must be from a common-sense point of view. (c) A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. It is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organization that it can be said that the unit has been set up. (d) The assessee can be said to have set up its business from the date when one of the essential categories of its business activities is started and it is not necessary that all categories of its business activities must start either simultaneously or that the last stage must start before it can be said that the bus....
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....nst income from another (section 71). In the facts of this case the company cannot claim any relief under either of these two sections, since its business had not started and there could not be any computation of business income or loss incurred by the assessee in the relevant accounting year. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under any other head. Similarly, any income from a non-business source cannot be set off against the liability to pay interest on funds borrowed for the purpose of purchase of plant and machinery even before commencement of the business of the assessee." "It has been argued that the source from which the company has earned interest is borrowed capital. The company has to pay interest to its creditors on the same borrowed capital. Having regard to the identity of the fund on which interest is earned and interest is payable, the company should be allowed to set off its income against interest payable by it on the same fund. We are of the view that no adjustment can be allowed except in accordance with the provi....
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....chem Ltd. [1995] 214 ITR 489 (Bom.) are erroneous." 24.2 The assessee, the ld. Counsel submits, is not claiming any adjustment of that expenditure under section 56 nor set off under section 70 nor 71 of the Act, but it claims a deduction under section 57 of the interest on the borrowed money, which has been utilized for the purpose of earning interest income, and as such, interest would be allowable as deduction in view of the decision of Supreme Court in case of CIT v. Rajendra Prasad Moody [1978] 115 ITR 519. The Supreme Court, in the case of Tuticorin Alkali Chemicals & Fertilisers Ltd. though specifically observed that there was no claim by the assessee for its allowability under section 57 of the Act, but at the same time it held that such interest could have been deductible while computing the business income but that was not the case of the assessee, and the claim of adjustment was denied under sections 56, 70 and 71 of the Act. In our opinion, therefore, interest which pertains to the borrowings made not for the purposes of making deposits in the bank but made for the purposes of constructing the project which is under completion, even though which have been utilized for m....
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.... and that incident did not supply any evidence of "purpose". Even if it were conceded that the assessee was required to take loans with a view to save her investment in shares it could not be said that the interest in question was expenditure incurred "wholly and exclusively" for the purpose of earning income from investments. The immediate purpose of taking the loan on interest was to pay taxes, etc. It could be that the other purpose was to save one of her sources of income but this would show that the purpose was a dual one and would not be covered by section 57(iii). At the relevant time it was obligatory to make annuity deposit and the earning of interest through such deposit was merely incidental. The interest on the borrowed amount was, therefore, not deductible under section 57(iii)." 24.4 In this case the High Court has also noted the decision of the Supreme Court in the case of Seth R. Dalmia v. CIT [1977] 110 ITR 644. Further in this case heavy reliance is placed on the decision of the Gujarat High Court in the case of Smt. Virmati Ramkrishna v. CIT [1981] 131 ITR 659 which is Appendix to this order and the principles culled out from the decided cases were summarized at....
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....blish merely that the expenditure was incurred in order indirectly to facilitate the carrying on the activity which is the source of the income; the nexus must necessarily be between the expenditure incurred and the income earned; (x) it is not necessary to show that the expenditure was a profitable one or that in fact income was earned; (xi) the test is not whether the assessee benefited thereby or whether it was a prudent expenditure which resulted in ultimate gain to the assessee but whether it was incurred legitimately and bona fide for making or earning the income; (xii) the question whether the expenditure was laid out or expended for making or earning the income must be decided on the facts of each case, the final conclusion being one of law." 24.5 The Supreme Court affirming this decision in Smt. Padmavati Jaikrishna v. Addl CIT [1987] 166 ITR 176 (SC) observed that the High Court was right in holding that meeting the liability for income-tax and wealth tax was a personal one and the dominant purpose for paying Annuity Deposit was not to earn income but to meet the statutory liability of making the deposit. It was also observed that unless the loan is incurred for meeti....
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....nnected with the earning of the director's fees and, hence was not allowable under section 12(2). 24.8 The Court held that "What section 12(2) says in so many terms is that the expenditure must be incurred for the purpose of earning the income and, therefore, there must be some connection or nexus between the expenditure incurred and the income earned. The connection may not be direct: even an indirect connection would be sufficient. But the expenditure in order to be admissible under section 12(2) must be incurred directly or indirectly to facilitate the earning of the income, for then only we can say that the expenditure is incurred for the purpose of earning the income." 24.9 In the case of Seth R. Dalmia the assessee has agreed to purchase a large number of shares from a bank and he had to take delivery of the shares after paying the purchase price. The assessee did not take delivery of the shares by that date, the dividends, rights, bonuses, etc. declared after that date were to be held by the bank for his benefit, and the assessee was to pay interest on the purchase price from April 1,1948 till the actual date of delivery of the shares. The assessee claimed payment of inter....
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.... not entitled to deduction under section 57(iii) because he was of the view that the payment of interest by the assessee to the lending bank had really no direct connection with the interest received and, therefore, the interest paid was in the nature of the pre-production expenses and it related to the erection of the factory and purchase of capital goods and, consequently, it had no connection with the earning of interest income. The assessee took the matter in appeal to the Tribunal both against the order of the AAC as well as CIT under section 263. The Tribunal held that the assessee's claim could be combined to the extent of loan drawn and deposited under section 57(iii). However, it rejected the contention of the assessee that the interest paid should be allowed on the footing that even the act of borrowing and depositing was in the course of the business. While dealing with the claim made under section 57(iii) the Tribunal found that there was no dispute that all the borrowed funds had not been deposited to earn interest, and, therefore, it was of the view that only to the extent of the loans deposited, the claim of interest had to be limited. It held that there was close ne....
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....y and that the payment was in the nature of capital expenditure and had been rightly disallowed by the ITO. The Tribunal held that the amount paid by way of interest should be allowed as a deduction as against interest earned from the bank in terms of the loan, that as the assessee had to keep the money in deposit in the bank segregated from its other business assets, the interest earned from the amount would be income from other sources, that by adopting a different method of assessment the ITO could not defeat the assessee's claim, that the interest paid to the Government on the amount borrowed had to be deducted against the interest received and that the difference represented a loss under the head "other sources" which was admissible for set off against income arising from other heads. On reference: The High Court held that:- (i) The purpose of the assessee in obtaining the loan was to defray the cost of the chemical plant which was in the process of erection. Under the agreement, the amount received on the loan had to be utilized for the plant and the money was spent on machinery for the plant. Till the amount was used for the stipulated purpose, the assessee had agreed to ke....
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....e the feasibility of granting relief by amending the Act, by observing as under:- "An examination of the fact situations and the liability imposed by the Act shows that the liability imposed against the petitioner was somewhat odd and even unjust which is accentuated when one notices that no relief is granted on the heavy interest paid to its bankers. Earlier, I have also found that the law as it stands does not permit the authorities or this court to grant relief to the petitioner. Both the eminent counsels with their rich experience in income-tax law practice are unable to find a way out to help the petitioner as the Act stands at present. In my humble view, a way out had to be found to grant relief to the petitioner and others in similar circumstances. But, how that should be done is for Government and Parliament to decide. In order to enable the Government to examine this aspect and initiate necessary remedial measures, I consider it proper to forward a copy of this order to the Government. 24.13 This judgment of the High Court is dated 11th July, 1985 and no remedial action has been made or thought fit by the Government so far. Similarly when the similar matter came reached ....
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....ng separately for earning the interest. However, we may hasten to add that, if any expenditure was incurred like commission for collection or such similar expenditures which may be considered as spent solely for the purpose of earning that income, the position may be different. But that was not so in this case. It could not also be said that the expenditure incurred was to preserve or acquire the asset. Nor could it be said that the expenses were incurred for the purpose of maintenance of the source. The requirement under section 57(iii) that the expenditure should have been incurred "for the purpose of making or earning such income" shows that the object of spending or the end or aim or the intention of such spending was for earning the interest income. There could be no doubt that the expenditure incurred by the liquidator in this case can, by no stretch of imagination, be said to have been incurred with the object or for the purpose of earning the interest income. The Tribunal was, therefore, right in holding that the expenses claimed are not related to the interest income and were not deductible expenditure under section 57(iii)." 24.15 In the case of Sarabhai Sons (P) Ltd. v.....
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....n the case of Tuticorin Alkalies Chemicals & Fertilizers Ltd. and is chargeable to tax under section 56 of the Act as income from other sources and as such the said amount of interest cannot be reduced from the cost of construction on the strength of the decision in the case of Bokaro Steel Ltd. as this case itself had made a distinction between interest receipts and other receipts. In the case of Bokaro Steel Ltd the assessee was incorporated in January, 1964 with an object to construct and own an integral iron and steel work. During the assessment years 1965-66 to 1971-72, the work of construction of the company and installation of the plant was in the process of completion. The company had not started any business during the assessment years in question. Further, during the period the company had given to the contractors, quarters for the residence for the staff and workers employed by the contractors who had been engaged by the assessee for carrying out the work of construction and the assessee charged the contractors for the use of quarters so given. Secondly, during the assessment year in question the assessee had entered into supplementary agreement, under which the assessee....
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....alty received was a capital receipt. As regards the interest income, it was observed that entry which was made initially, was reversed in the next year because in fact the nature of transaction was changed and the assessee did not receive any real income. With regard to the decision of Tuticorin Alkali Chemicals & Fertilisers Ltd.'s case the court observed that the assessee company had invested in short-term deposit, the surplus fund, which was not immediately required and earned interest. It has been held in this case the receipt of interest amount comes under the head "income from other sources". The assessee has not filed any appeal from the findings, which has gone against it. In any case the question now concluded by the decision of Tuticorin Alkali Chemicals & Fertilisers Ltd.'s case. This case, therefore, makes a clear distinction between interest earned on utilization of borrowed money and other misc. income and held that issue of interest earned is covered by decision in the case Tuticorin Alkali Chemicals & Fertilisers Ltd. 24.17 Assessee gave the following note on claim of deduction under section 57(iii) in respect of interest expenditure for earning interest income. ....
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....ier years could not be said to be expenditure of the year. The Gujarat High Court laid down various propositions and applying the same decided against the assessee. Appellant invites attention to proposition No. (viii) which reads as under: "(viii) if, therefore, it is found on application of the principles of ordinary commercial trading that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction," In the appellant's case there is direct nexus between the expenditure incurred and income earned Complete details showing nexus between borrowings and investment has been furnished for assessment years 1989-90 and 2000-01. It may be noted that in the case cited, the partial disallowance (Rs. 6,105 out of Rs. 44,397) was made for interest on the ground that the loan was borrowed to meet personal expenses and tax liability. In the present case, there is no dispute that borrowed funds are used to earn income. Therefore, the facts are distinguishable. On the contrary proposition laid down by Hon'ble Court supports the case of the appellant. 3. CIT v. Seshasayee Paper a....
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....ture under section 57 (iii) of the Income-tax Act. Therefore, in the facts of the appellant's case the above decision supports the contention and in any event issue raised is not at all relevant. 4. Smt. Padmavati Jaykrishna v. CIT 101 ITR 153 (Guj.) Approved by Supreme Court reported in 166 ITR 716 (SC) In this case the assessee derived income from source in form of interest and dividend and claimed deduction of interest of Rs. 26,986 on interest on loan of Rs. 5,05,055. The Income-tax Officer rejected the claim only in respect of interest on withdrawals on the ground the same cannot be said to be expenditure for earning of income. Gujarat High Court upheld the order of the Assessing Officer. The relevant observation reads as under: "Held, that it could not be said that the result of the borrowing was saving of dividend income from shares because by borrowing loans the assessee had saved her income not only from one source, namely, the shareholding, but from all other sources as well from which she must be receiving income. Saving of income from shares was an incidental result of borrowing loans and that incidental did not supply any evidence of "purpose". Even if it were conce....
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....tinguishable and hence the judgment cannot be applied to the appellant's case. There are decisions of the Court wherein view is taken that such interest expenditure cannot be allowed to be set off against the interest income. Attention is invited to following judgments: 1. Commissioner of Income-tax (Central) Calcutta v. New Central Jute Mills Co. Limited (118 ITR 1005) (Cal.) 2. Addl CIT v. Madras Fertilisers Limited (122 ITR 139) (Mad.) However, appellant submits that as explained above, Gujarat High Court has laid down various propositions in the case of Virmati Ramkrishna v. CIT 131 ITR 659 and as stated in proposition No. (viii) that on application of the principles of ordinary commercial trading, if it is found that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction, which proposition is fulfilled. This being the jurisdictional High Court decision and, therefore, is binding in the State of Gujarat. Applying the same in the fact that there is direct nexus between the borrowings and investments made, the interest expenditure should be allowed as deduc....
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....of any expenditure can only be made in accordance with the provisions of the Act." 24.19 In the case of Padmavati, however, one of the purpose for borrowing was to invest in Annuity Deposit giving earning by way of interest to the assessee and having direct nexus thereto, but even then disallowance was made by observing that borrowings were for discharging personal obligation to make Annuity Deposit and not to earn interest. There was a clear nexus between borrowing and interest but not interest paid and earning of income which was held to be incidental. The Supreme Court approved this view. Similarly in the case of Sarabhai there was a nexus in borrowing and investment in purchase of shares but the interest was disallowed because the purpose to acquire shares was not to earn dividend but acquisition of control over the company. We find that New Central Jute Mills Co. Limited (Cat) and Madras Fertilisers Limited (Mad.) are direct decisions where borrowings for the construction of the factory or plant and machinery were used for making deposit and the interest paid on such borrowings was disallowed because the interest was paid on borrowings made for construction of factory and err....
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....s must necessarily be between the expenditure incurred and the income earned; (x) it is not necessary to show that the expenditure was a profitable one or that in fact income was earned. 24.21 In view of the above and applying these tests, in our opinion, the expenditure of interest paid on borrowings raised by the assessee for the purpose of construction of the dam would not be allowable deduction while computing the income from interest under the head "other sources". 25. The ground regarding claim under section 10(20)/(20A) claiming local authority is not valid. The assessee is not a local authority and, therefore, it cannot be granted exemption. 26. The reopening, though for escapement of interest from contracts not assessed ultimately, cannot be said to be bad in law because the assessee had not filed return at all. In the case of L.N. Dalmia, the assessee borrowed money for acquiring shares in company named Punalur Paper Mills Ltd. [hereinafter referred to as the "PPM"] and had paid interest thereon. The assessee floated another company named Laxmini was and Co. (Export) P. Ltd. [hereinafter referred to as the "LNE"] and sold aforesaid shares of PPM to this newly floated ....
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....sition of shares and such interest would be considered as a capital investment and directed accordingly to capitalize the same and after the sale, the capitalization would increase the amount of loss to that extent. The Tribunal affirmed this decision. In coming to this decision, reliance has been placed in the case of CIT v. Mithlesh Kumari [1973] 92 ITR 9 (Delhi), holding that interest paid on borrowed capital is to be allowed as capital expenditure. In this case, the Delhi High Court considered the interest as part of the capital investment where the facts were that the interest was paid on money borrowed for purchase of and open plot of land which constituted part of the actual cost. The facts before us are different from the facts in the case cited. There the plot of land was for a building purpose and it was not intended for using as income-earning investment while the investment in shares in the case before us are investments made with a view to earning dividend. In the Delhi High Court case in CIT v. Mithlesh Kumari [1973] 92 ITR 9, the interest paid on borrowed amount for the acquisition of such plot of land, therefore, constituted part of the cost of acquisition. The inve....
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....formation of the belief that the income of the assessee had escaped assessment because of his failure or omission to disclose fully and truly all the material facts. In the present case, it is true that assessment was re-opened by incorporating the reasons that interest claimed by the assessee was not allowable deduction, but the facts remains that the assessee has not filed return of income and it was found that it had assessable income and, therefore, the challenge to the proceedings under section 147 cannot have any substance. 26.2 In the case of Simon Carves Ltd. the course observed that an order made by the Assessing Officer at the time of the original assessment was a legally correct order and was not vitiated by any error and the absence of any error does not justify the inference that this was not a case of income escaping assessment. That there is necessarily an element of error in case of income escaping assessment mentioned in section 147(b) of the Act of 1961, such error resulting in income escaping assessment becomes manifest in the light of information coming subsequently into the possession of the Income-tax Officer, whereas in the present case, the order making the....