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Income Tax Appellate Tribunal, ‘A’ BENCH, CHENNAI
Before: SHRI V. DURGA RAO & SHRI G. MANJUNATHA
against common order passed by the learned Commissioner of Income Tax (Appeals)-8, Chennai, dated 09.11.2017 and pertain to assessment years 2013-14 & 2014-15. Since, facts are identical and issues are common, for the sake of convenience, these two appeals are heard together and are being disposed off, by this consolidated order.
The assessee has more or less filed common grounds of appeal for both assessment years, therefore, for the sake of brevity, grounds of appeal filed for the assessment year 2013- 14 are reproduced as under:-
“1. The learned CIT (Appeals) erred in confirming the disallowance of finance cost of Rs.19,08,81,851/- attributable to Capital Work in Progress and Project Work in Progress.
2. The CIT (Appeals) erred in not accepting the appellant’s contention in attributing and apportioning finance cost to Capital Work in Progress and Project Work in Progress (Inventory) when there is specific borrowing for the Capital Work in Progress.
3. The CIT (Appeals) erred in ignoring the appellant’s contention that they have been consistently following from inception the policy of charging interest to the Profit & Loss account when the borrowing is not specific towards acquisition of fixed assets or for execution of specific projects and capitalizing interest in respect of borrowings specific to acquisition of fixed assets which they have been consistently following which is in line with the Accounting Standard “AS-16 Borrowing Cost” issued under The Companies Act,2013 amended from time to time.
4. The CIT (Appeals) erred in ignoring the appellant’s contention that interest cannot be disallowed by attributing the finance cost to project work in progress which is an inventory for appellant’s business.”
Brief facts of the case extracted from for the assessment year 2013-14 are that the assessee company is engaged in the business of manufacturing, installation, commissioning and maintenance of windmills filed its return of income for assessment year 2013-14 on 30.11.2013 declaring loss of Rs.1,02,01,46,379/-. The case was taken up for scrutiny and during the course of assessment proceedings, the Assessing Officer noticed that the assessee has borrowed funds from various banks and financial institutions and claimed interest expenditure of Rs.64.20 crores.
It was further noted that the assessee is having short term and long term borrowings of Rs.424 crores. It was also noted that the assessee has shown capital work in progress of Rs.9.86 crores and project work in progress of Rs.116.31 crores.
Therefore, the Assessing Officer called upon the assessee to explain as to why interest cost attributable to capital & project work in progress cannot be disallowed and added back to work in progress account. In response, the assessee submitted that it is following a method of accounting to account interest pertains to loans taken for specific purpose to capital work in progress or project work in progress, however, interest paid on loans taken for general business purpose has been debited into profit & loss account as and when such expenditure was incurred and therefore, question of allocation of interest expenses to capital work in progress and project work in progress does not arise.
The Assessing Officer, however, was not convinced with explanation furnished by the assessee and according to him, the assessee has not allocated specific cost to the projects in line with concept of matching principles of accounting and thus, worked out interest of Rs.19,08,81,851/- relatable to capital work in progress and project work in progress and also disallowed total interest expenses u/s.36(1)(iii) of the Income Tax Act, 1961, and added back to the total income. The relevant findings of the Assessing Officer are as under:-
“5. Disallowance of Finance cost on Capital and Project work in progress:
The assesse had borrowed funds from various Banks and Financial institutions and claimed expenditure of Rs. 64,20,50,016/- as finance cost in its Profit a Loss accounts. From the Balance sheet, it is found that there is a Long Term Borrowings of Rs. 114,97,17,862/- and a Short Term Borrowings of Rs.309,41,95,492/- which is totaling Rs. 424,39,13,354/- for the relevant assessment year 2013-14. During the scrutiny proceedings it is found that the assessee is also having CWIP of Rs. 9,85,95,864/- and Project Work in Progress (Capitalized in A.Y. 2014-15) of Rs.116,31,22,097/- which is totaling - Rs. 126,17,17,961/-. In relation to above facts, the assesse was asked to explain the utilization of borrowed funds and interest break up which is apportioned towards fixed asset CWIP and Project Work in Progress
(Capitalized in A.Y. 2014-15). The assessee has borrowed funds and paid a Finance cost of Rs. 64,20,50,016/- and claimed the same as revenue expenditure. On scrutiny of the books of accounts it is found that the assessee had failed to apportion the interest pertaining to capital in nature and same is computed hereunder:-
The Finance cost pertaining to the Capital Work in Progress and Project Work in Progress which is claimed as revenue expenditure in profit a toss account amounting to Rs 19,08,81,851/- will be treated as Capital in nature under section 36(1) of the income Tax Act, 1961 and the same is added back to the total income returned.”
Being aggrieved by the assessment order, the assessee preferred an appeal before the learned CIT(A). Before the learned CIT(A), the assessee has reiterated its arguments made before the Assessing Officer and contended that interest expenditure debited into profit & loss account is on general loans taken for purpose of business and thus, same need not be allocated to capital work in progress and project work in progress. The learned CIT(A), after considering relevant submissions of the assessee and also by relied upon certain judicial precedents, including decision of the Hon'ble Supreme Court in the case of Challapalli Sugars Ltd. Vs. CIT 98 ITR 167(SC), sustained additions made by the Assessing Officer towards capitalization of interest relatable to capital work in progress and project work in progress. The relevant findings of the learned CIT(A) are as under:-
“6. The objections of the assessee are considered. It is seen that the Assessing Officer has correctly worked out the amount of borrowed capital utilised towards creation of capital work in progress as well as business work in progress for the respective years considering the year end balances. The computation based on year end balances can be disputed. However, the principle behind the disallowance of interest as revenue expenditure and capitalisation of the same cannot be disputed. Several Courts have held that all expenditure directly and indirectly related to acquisition of any assets shall he capitalised along with the cost of the said assets. In this regard, some of the decisions are brought to focus as under:-
1.Guzdar Kajoria Coal Mines Ltd. (85 ITR 599) (1972 SC)
Original cost of the asset to the assessee is a question of fact which has to be determined on the basis of evidence or material placed before or available with Assessing Officer. If circumstances exist showing that fictitious price has been put on the asset or there is a fraud or collusion between the vendor and the assessee and there has been inflation or deflation of value for ulterior purposes, it is open to Assessing Officer to refuse to accept the price mentioned by the assessee and to ascertain what the actual cost was or to determine the allocation between the depreciable and non- depreciable assets.
2.Challapalli Sugars Vs CIT 98 ITR 167(SC)
As the expression of ‘actual cost’ has not been defined, it should be construed in. the sense which no commercial man would misunderstand. For this purpose, it would be necessary to ascertain the connotation of the expression in accordance with the normal rules of accountancy prevailing in commerce and industry. The accepted accountancy role for determining cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition.
Similarly, the Supreme Court has also upheld the matching principle for allowing expenditure with respect to specific incomes and specific heads.
J. K. Industries and another (Supreme Court) (29 7 ITR 176) The matching principle can be applied by matching expenditure against specific revenues as having been used in generating those specific revenues or by matching expenses against the revenue of a given period in general on the basis that the expenditure pertains to that period.
Tuticorin Alkali Chemicals and Fertilisers Ltd. (SC) (227 1TR 172)
The second reason given by the High Court was that the Institute of Chartered Accountants of India was a recognised authority on accounting principles. This fact has been recognised by this Court in the case of Challapalli Sugars Ltd v. CIT (1975J 98 ITR 167. Therefore, its view has to be respected.
It is true that this Court has very often referred to accounting practice for ascertainment of profit 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 accountancy practice. Accounting practice cannot override section 56 or any other provision of the Act. As was pointed out by Lord Russell in the case of B. S. C. Footwear Ltd. (supra), the lncome-tax Law does not march step by step in the footprints of the accountancy profession.
The question in Challapalli Sugars Ltd’s case (supra) was about computation of depreciation and development rebate under the Indian Income tax Act, 1922, In order to calculate depreciation and development rebate it was necessary to find out ‘the actual cost’ of the plant and machinery purchased by the company. This Court held that ‘cost’ is a word of wider connotation than price’. There was a difference between the price of a machinery and its cost. This Court thereafter pointed out that the expression ‘actual cost’ had not been defined in the Act. It was, therefore, necessary to find out the commercial sense of the phrase. Khanna, J. (as his Lordship then was) observed:
‘As the expression ‘actual cost’ has not been defined, it should, in our opinion, be construed in the sense which no commercial man would misunderstand. For this purpose it would be necessary to ascertain the connotation of the above expression in accordance with the normal rules of accountancy prevailing in commerce and industry. The accepted accountancy rule for determining cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money cart be capitaised and added to the cost of the fixed assets created as a result of such expenditure.’ (p167)
This Court also took note of the provisions of the Companies Act, 1956 and in particular section 208(l)( b). It observed:
“…clause (b) of sub-section (1) of that section pro vides that in case, interest is paid on share capital issued for the purpose of raising money to defray the expenses of constructing any work or building or the provision of any plant in contingencies mentioned in that section, the sums so paid by way of interest may be charged to capital as part of the cost of construction of the work or building or the provision of the plant. The above provision thus gives statutory recognition to the principle of capitalising the interest in case the interest is paid on money raised to defray expenses of the construction of any work 6r building or the “provision of any plant in contingencies mentioned in that section even though such money constitutes share capital. The same principle, in our opinion, should hold good f interest is paid on money not raised by way or share capital but taken on loan for the purpose of defraying the expenses of the construction of any work or building or the provision of any plant. The reason indeed would he stronger in case such interest is paid on money taken on loan for meeting the above expenses.” (p. 175)
This Court also relied on an English case in support of this conclusion in Hindsv. Buenos Ayres Grand National Tramways Co. Ltd [1906] 2 Ch. 654, In Hinds’ case supra) dealing with the question of capitalisation of interest paid on loans taken to install electric traction for tram lines, it was held by Warrington, J.:
“Now, what is it that the company are really proposing to do? They are creating a capital asset by means of which they will hereafter earn, or they hope to earn profits for the company They are not simply employing contractors to find the money and do the work. They are finding the money themselves, and they find the money by borrowing it. What does each mile of line cost them under these circumstances - what Is that they expend in constructing each mile of line, taking the amount of the borrowed money expended on that line to be £ 10,000, that being the company’s estimate? The money is borrowed for that particular purpose the £ 10,000. They have to pay interest on that £ 10,000 during the period that construction is taking place. In my opinion that asset which they are so constructing costs them not only the £ 10,000 but the £ 10,000 plus the amount of interest during the period of construction; and that is what they are out of pocket during the construction of that mile of line. Now, it seems to me that the company are entitled -1 do not say that they are bound to do it (f they think fit to charge in their accounts as the cost of that mile of line not only £ 10,000, but the £ 10,000 and the interest on it during the period of construction. “ (p. 176)
In other words, it was held that the cost of construction will be the amount actually spent and also the interest payable on the amount borrowed during the period of construction.
The judgment in Challapalli Sugars Ltd s case (supra goes to show that the Court was not in any way departing from legal principles because of any opinion expressed by the Institute of Chartered Accountants. The phrase ‘actual cost’ was not defined in the Act. Therefore, it had to be understood in the commercial parlance. To find that out the normal rule of accountancy prevalent in commercial and industrial circles was noted. According to the Institute of Chartered Accountants, actual cost will also include interest paid on borrowed money for the purchase of the assets. Khanna, J., however, did riot stop there. He pointed out that the principle of capitalising interest was to be found in section 208 itself and was also consistent with the views of the English Courts.
In view of the Judicial decisions as above, the action of the Assessing Officer in capitalising the interest is upheld.”
Being aggrieved by the learned CIT(A) order, the assessee is in appeal before us.
The learned AR for the assessee submitted that the learned CIT(A) has erred in confirming disallowance of financial cost attributable to capital work in progress and project work in progress without appreciating fact that the assessee has not borrowed any loans for specific purpose. The learned A.R for the assessee further submitted that the learned CIT(A) has erred in ignoring contention of the assessee that it was following consistent method of accounting to charge interest to the profit & loss account when borrowing is not for specific purpose towards acquisition of fixed asset or for execution of specific projects. The learned AR further referring to Accounting Standard-16 issued by the ICAI for accounting borrowing cost submitted that the assessee is following Accounting Standard- 16 to charge interest on borrowings, as per which interest on specific loans taken for the purpose of acquisition of any asset has been capitalized to the asset. Therefore, when loans are not for any specific purpose, allocation of interest to capital work in progress and project work in progress is incorrect. The learned CIT(A) without appreciating facts has simply sustained additions made by the Assessing Officer.
The learned DR, on the other hand, strongly supporting order of the learned CIT(A) submitted that facts brought out by the authorities below clearly indicate that the assessee has huge borrowings from bank and financial institutions, however, failed to allocate interest expenses to capital work in progress and project work in progress, even though it has debited other expenses to project work in progress account. The learned D.R further submitted that as per principles of matching concept of accounting, expenses relatable to specific revenue unit needs to be capitalized to work in progress account, when there was no revenue from such unit during relevant financial year. Since the assessee has huge debits in project work in progress, interest relatable to said projects needs to be capitalized . The Assessing Officer well as learned CIT(A) have rightly worked out interest attributable to capital work in progress and project work in progress and thus, arguments of the assessee that interest is not specific to any asset or project is not acceptable.
We have heard both the parties, perused material available on record and gone through orders of the authorities below. Admittedly, the assessee has huge borrowings from banks and financial institutions. It is also an admitted fact that the assessee had also shown huge amount in capital work in progress and project work in progress. It was also an admitted fact that the assessee has not capitalized borrowings cost to project work in progress account, even though revenue was not generated from specific project. It was the contention of the assessee before the authorities below that when the loan was not taken for any specific purpose of acquiring of asset or execution of any project, then interest need not be capitalized to the work in progress account. The assessee further contended that loans taken from banks and financial institutions are not for specific purpose of acquisition of asset or execution of any specific project, therefore, question of allocation of interest expenses does not arise.
We have given our thoughtful consideration to the arguments advanced by the learned AR for the assessee in light of facts brought out by the Assessing Officer and we ourselves, do not subscribe to the arguments taken by the learned AR for the assessee for simple reason that when the assessee is debiting all direct and indirect expenses to project work in progress account, then it ought to have capitalized interest attributable to said project work in progress, when there was no revenue generation from said project. We further noted that as per principles of matching concept of accounting, specific cost relatable to income revenue segment needs to be capitalized, including interest if any, incurred on said project. In this case, it was claim of the assessee that although it has paid huge interest on borrowings from banks and financial institutions, but said loans have not taken for any specific purpose. At the same time, the assessee is also unable to explain with necessary evidence to prove that loans taken from banks and financial institutions are not for any specific purpose of acquisition of any asset or execution of project. Therefore, we are of the considered view that the issue needs to go back to file of the Assessing Officer to ascertain correct facts with regard to nature of loan taken by the assessee and purpose for which such loans were taken. In case, the assessee has taken any loan for specific purpose of acquisition of asset or execution of project, then interest attributable to said purpose needs to be capitalized to work in progress account. Hence, we set aside the issue to file of the Assessing Officer and direct the Assessing Officer to re-examine claim of the assessee in accordance with law.
In the result, appeal filed by the assessee for assessment year 2013-14 is allowed for statistical purposes.
(A.Y.2014-15) 11. The issue involved in this appeal is identical to the issue which we had considered in for assessment year 2013-14. The reasons given by us in preceding paragraph shall equally apply to this appeal, as well.
Therefore, for similar reasons we set aside the issue to file of the Assessing Officer and direct the Assessing Officer to re- examine the issue of capitalization of interest in light of our observations given hereinabve for assessment year 2013-14.
In the result, appeal filed by the assessee for assessment year 2014-15 is treated as allowed for statistical purposes.