Commissioner of Income Tax and Another vs Dhampur Sugar Mills Ltd.

We have heard Shri Shambhu Chopra, learned counsel appearing for the income tax Department. Shri R.R. Agarwal and Shri Suyash Agarwal appearing for the respondent-assessee. This income tax appeal filed u/s 260A of the income tax Act, 1961, arises from an order of the income tax Appellate Tribunal, Delhi Bench "C", New Delhi, dated August 31, 2008, in I.T.A. No. 409/Del/2002 (Assistant Commissioner of income tax (A), Najibabad, District Bijnor (UP) v. Dhampur Sugar Mills Ltd., Dhampur, District Bijnor (UP)) for the assessment year 1998-99.

On January 2, 2013, the appeal was admitted on substantial questions of law Nos. 2 to 7 framed in the memo of appeal. Our findings on these issues are discussed as follows:

Question No. 2

(2) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in upholding the order of the Commissioner of income tax (Appeals) who allowed the relief of Rs. 16,21,58,151 out of the addition made for undervaluation of the closing stock?

The income tax Appellate Tribunal has recorded a finding on the issue in paragraphs 5 and 6, as follows:

The next common ground of the Revenue''s appeal relate to the deletion of the addition on account of undervaluation of the closing stock of free sugar in the sugar unit at Dhampur and Rauzagaon. We have considered the rival contentions and found that exactly a similar issue has been decided in favour of the company, vide the income tax Appellate Tribunal order dated February 17, 2003, in I.T.A. No. 4125/Del/93 for the assessment year 1990-91, vide paragraphs 3-6 on pages 4-7. Similarly, decided in favour of the company in I.T.A. No. 7779/Del/92, vide paragraphs 15-18 on pages 6-12 of the order for the assessment year 1989-90. Similarly, decided in favour of the company in I.T.A. No. 6662/Del/94, vide paragraph 7 on pages 203 of the order for the assessment year 1991-92. Similarly, decided in favour of the company in I.T.A. No. 57/Del/96 - Departmental appeal--for the assessment year 1992-93 vide paragraphs 5 and 5.1 on pages 5-7 of the order.

We have carefully gone through the order of the income tax Appellate Tribunal for the assessment year 1992-93 wherein at paragraph 5.1, the issue has been dealt with as follows and the additions were deleted:

The brief history relevant for adjudication of this ground of appeal is as follows:

In the assessment year 1998-99, the assessee was valuing the closing stock by including certain items of expenditure like interest on borrowings, administrative expenses, legal expenses, bank charges, director''s travelling, insurance, etc. In the assessment year 1989-90 the assessee changed the method of accounting and excluded certain items of expenditure relating to selling and distribution, general administration, research and development and interest on loan, while valuing the closing stock. The reason for doing so was that these items did not form part of the manufacturing cost of sugar. The Assessing Officer did not agree with this plea of the assessee and he enhanced the value of the closing stock and made an addition. Similarly in this assessment year also the Assessing Officer made a similar addition. In the assessment year 1989-90, this issue had come up for consideration before the Tribunal in I.T.A. Nos. 7199 and 7779/Del/92 and after considering the issue extensively the Tribunal in paragraph 18 of its order concluded that the change in the method of valuing the closing stock adopted by the assessee was a recognized method and that it had been consistently followed in the subsequent assessment years. The Tribunal also held that the changed method of accounting does not have the effect of avoiding any tax payment. The changed method was thus recognized by the Tribunal. In the light of the decision of the Tribunal referred to above, we are of the view that the order of the Commissioner of income tax (Appeals) deleting the addition made by the Assessing Officer is just and proper and calls for no interference. The third ground of appeal of the Revenue is accordingly dismissed.

The income tax Appellate Tribunal has consistently held for the years 1991-92 to 1997-98 that the changed method of accounting was more scientific and did not result any evasion of payment of tax. The question was considered and decided by the Madras High Court in Commissioner of Income Tax, Tamil Nadu Vs. Carborundum Universal Ltd., , the reasoning of which has been upheld by the Supreme Court on November 5, 2009, in SLP (Civil) No. 6410 of 1995.

The question is thus decided in favour of the assessee and against the Revenue

Question No. 3

(3) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in confirming the order of the Commissioner of income tax (Appeals) who deleted the addition of Rs. 8,64,33,161 made by the Assessing Officer treating the income of the assessee on account of incentives subsidy received on free sale of sugar?

The question is covered by the judgment of the Supreme Court in Commissioner of Income Tax, Madras Vs. Ponni Sugars and Chemicals Ltd., in which it was held in respect of the same scheme, namely, the sugar incentive scheme based on the recommendation of the Sampat Committee that where the object of the assistance under the subsidy scheme is to enable the assessee to set up a new unit or to expand an existing unit, then the receipt of the subsidy would be on capital account.

In the present case, from the orders of the Assessing Officer, the Commissioner of income tax (Appeals) and the income tax Appellate Tribunal we find that the assessee was allowed additional free sale of sugar quota under the scheme for setting up or expanding the sugar unit. The benefit was given to the sugar mills to meet the capital outlay in setting up or expanding the sugar mills.

The Tribunal has relied on the judgment of this court in Commissioner of Income Tax Vs. Kisan Sahkari Chini Mills Ltd., , which was also followed by the Uttarakhand High Court in the case of CIT v. Kishan Sahkari Chini Mills Ltd. in I.T.A. No. 101 of 2006, vide its order dated March 26, 2007.

The question is thus decided in favour of the assessee and against the Revenue.

Question No. 4

(4) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in confirming the order of the Commissioner of income tax (Appeals) who deleted the addition of Rs. 3,00,18,969 on account of pre-operative trial run expenses treating it as revenue expenditure instead of capital expenditure?

Shri Shambhu Chopra, appearing for the Revenue, submits that the assessee has shown these expenses as revenue expenses but has not taken them to the profit and loss account. He submits that these pre-operative trial expenses could not be treated as revenue expenses and were correctly treated by the Revenue as capital expenses.

We find that the question is covered by the judgment in Commissioner of Wealth-tax Madras Vs. Ramaraju Surgical Cotton Mills Ltd., as follows:

(a) CWT v. Ramaraju Surgical Cotton Mills Ltd.:

In this case, the Supreme Court held that where a business unit had been set up by the assessee which was ready to commence production, the assessee was entitled to claim deduction of the expenditure which could not be disallowed on the ground that the same had been incurred prior to the commencement of the actual business of commercial production. The Supreme Court made a distinction between setting up of a unit and the operational function of the unit as a business.

The Calcutta High Court in Commissioner of Income Tax Vs. Kanoria General Dealers (P.) Ltd., and the Madras High Court in Commissioner of Income Tax-I Vs. Sakthi Sugars Ltd., , also found that pre-operative expenses, including cane development expense, travelling expenses, administrative and other expenses, legal and professional charges, electricity charges, rates and taxes, insurance premium, repairs and maintenance charges for building and machinery and motor vehicle and other office equipment maintenance, financial and bank charges, freight and transport, salaries, wages, bonus, etc., workmen welfare expenses, interest charges and depreciation, are to be allowed as revenue expenses.

In SIR SHADI LAL SUGAR AND GENERAL MILLS LTD. Vs. COMMISSIONER OF Income Tax, U. P., this court held that where the erection of the plant has been completed and only a small quantity of raw materials was consumed, there was actually no turning out of the finished products, it could not be said that the business of manufacture had commended. The consumption of raw material, if any, and deduction of the amount claimed as business expenditure could not be allowed. The judgment is distinguishable inasmuch in Sir Shadi Lal Sugar and General Mills Ltd v. CIT (supra) there was no turning out of the finished products, hence it could not be treated to be a trial run or pre-operational expense. Though a new unit was set up but an experiment with deduction of amount claimed by itself could not be allowed as revenue expenses and had to be given treatment as capital expenses.

In the present case, the pre-operation expenses have been detailed in the material produced before the Assessing Officer and which has been referred to in the paper book at pages 14, 15 and 17 in respect to co-generation plant, Rauzagaon; oxalic acid, Dhampur and thus the pre-operational expenses, were revenue expenses and not capital expenses. These expenses were actually claimed as revenue expenses in the computation with the return and were to be allowed as revenue expenses.

The question of law is thus decided in favour of the assessee and against the Revenue.

Question No. 5

(5) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in confirming the order of the Commissioner of income tax (Appeals) who deleted Rs. 2,58,78,987 disallowed by the Assessing Officer on account of interest paid against loan which were utilized for setting up new units treating the same as revenue expenditure instead of capital expenditure?

The Tribunal has relied on the previous years orders in respect of the assessee in holding that the interest paid against loans, which were utilised for setting up new units, had to be treated as revenue expenditure instead of capital expenditure.

The deduction is claimed u/s 36(1)(iii) as an interest paid in respect of capital borrowed for the purpose of business and profession. The assessee treated it as revenue expenditure and then capitalised.

A proviso was added to section 36(1)(iii) by the Finance Act, 2003, with effect from April 1, 2004, as follows:

Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.

We find that the proviso is explanatory in nature inasmuch as in computing the income the deductions are for the purposes of business and profession. Where a new business is set up or an existing business is expanded, the amount borrowed for such purposes ensures to the assessee with enduring benefit. The assessee, therefore, could not treat it on such borrowed capital as revenue expenses.

We do not find that the proviso, which is only explanatory in nature, is applicable prospectively. The deduction claimed u/s 36 are for the purposes of business and profession, which is existing and not from extension of existing business or profession.

The question is thus decided in favour of Revenue and against the assessee.

Question No. 6

(6) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in confirming the order of the Commissioner of income tax (Appeals) who deleted Rs. 1,76,01,088 which was disallowed by the Assessing Officer on account of convertible premium notes after relying upon the decision of the apex court reported in M/s. Madras Industrial Investment Corporation Ltd. Vs. The Commissioner of Income Tax, Tamil Nadu-I, Madras, ?

This question is covered by the judgment of the Supreme Court in M/s. Madras Industrial Investment Corporation Ltd. Vs. The Commissioner of Income Tax, Tamil Nadu-I, Madras, . The business expenditure u/s 37 not being expenditure in the nature described in sections 30 to 36 exclusively for the purpose of the business or profession was held to be allowed in computing income chargeable under the head "Profits and gains of business or profession". Relying upon section 37 it was held that the expenditure should not be of a capital nature. The question whether a particular expenditure is revenue expenditure incurred for the purpose of business must be determined on a consideration of all the facts and circumstances, and by the principles of commercial trading. Ordinarily, revenue expenditure, which is incurred wholly and exclusively for the purpose of business must be allowed in its entirety in the year in which it is incurred. It cannot be spread over a number of years even if the assessee has written it off in his books, over a period of years.

In the present case, from the facts discussed by the Tribunal, we find that the expenditure on convertible premium notes (CPM) was spread over the period of life on CPM for six years. The year of payment was six years and on which the expenditure was incurred by paying maturity value. In this regard the Tribunal recorded the findings in paragraph 26 as follows:

The next grievance in the Revenue''s appeal relates to the deletion of disallowance of expenses on issue of convertible premium notes which was charged to the profit and loss account under loan raising expenses, disallowed u/s 35D as being capital expenses. The facts relating to these grounds are that the assessee-company had offered 37,86,732 convertible premium notes of Rs. 110 each for cash at par (Rs. 35 payable on application and balance Rs. 75 on allotment) by way of right issue to the existing shareholders of the company in the ratio of one CPN for every three shares held as per copy of letter of offer. Out of the above, the assessee-company had issued 36,45,717 CPNs of Rs. 110 each at par allotted on March 8, 1996. CPN holders had the option either to convert the same into one fully paid up share at the end of the three months from the date of allotment, i.e., March 8, 1996, or to convert the same into two shares at the end of the sixth year from March 8, 1996, or to receive maturity value of Rs. 254.40 at the end of the sixth year from March 8, 1996. In the return of income the assessee had claimed Rs. 3,19,44,000 by way of note No. 2 in annexure II to the computation of income stating that though the claim of this amount would fall after six years, i.e., in the year of payment, the assessee should be allowed the paid amount being proportionate premium up to March 31, 1997. It was pointed out that in view of the Supreme Court judgment in the case of M/s. Madras Industrial Investment Corporation Ltd. Vs. The Commissioner of Income Tax, Tamil Nadu-I, Madras, , the claim of the assessee is allowable as revenue expenditure in the year under consideration. The Assessing Officer worked out the calculation and after reproducing the relevant portion of CPN notes, etc., he held that the amount shall be considered only in the year of payment and not in the year under consideration. In appeal the learned Commissioner of income tax (Appeals) has considered the issue in great detail and allowed the claim of the assessee. We have carefully considered the rival submissions and perused the material on record. We have gone through the letter of offer, a copy of which has been filed on record. The terms and conditions of the CPNs given in paragraph 8 of letter of offer are as under:

The convertible premium notes now being offered in terms of this letter of offer are subject to the provisions of the Act, the memorandum and articles of association of the company, the terms and conditions mentioned in the letter of offer, the composite application form and the guidelines for issue and listing of securities issued by the Government of India and the Securities and Exchange Board of India.

The convertible premium notes shall also be subject to such other terms and conditions, as may be incorporated in the CPN certificate letter of allotment and/or other documents in respect of these convertible premium notes and the terms and conditions, as may be desired by any Government agency.

The expenditure in this case spread over the period for which the discount has been paid. From the order of the Assessing Officer we find that the entire amount was claimed in two years, namely, in the years 1997-98 and 1998-99.

On the aforesaid facts and circumstances brought before us, we are of the view that the reasoning in the judgment in Madras Industrial Investment Corporation Ltd. v. CIT (supra) is applicable and that the expenditure had to be spread out for a period of six years, and was not allowable in the years 1997-98 and 1998-99 alone. The issue is decided in favour of Revenue and against the assessee.

Question No. 7

(7) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in confirming the order of the Commissioner of income tax (Appeals) who deleted Rs. 58,40,390 disallowed by the Assessing Officer on account loan raising expenses for technical know-how as revenue expenditure instead of capital expenditure?

Shri Shambhu Chopra, appearing for income tax Department, submits that on this question the income tax Appellate Tribunal has followed a judgment in respect of the assessee for the assessment year 1992-93 and in which the Tribunal had set aside the order of the Commissioner of income tax (Appeals) by which the assessee''s claim for deduction of loan raising expenditure was disallowed as capital expenditure.

The Tribunal found that the assessee had claimed the expenses for raising loans for setting up the Barabanki division of the assessee where a new sugar unit was set up and, therefore, the expenditure was of enduring nature. Following the judgment in India Cements Ltd. Vs. Commissioner of Income Tax, Madras, it was held that allowing interest expenses and other over head expenses in connection with a new unit, which was an extension and expansion of the same business, the expense had to be allowed as deduction. Shri Chopra submits that there was no discussion on the facts as to whether the Barabanki unit was the extension and expansion in the same line of business and the nature of borrowing. He submits that the matter should be remanded for consideration by the Tribunal on the question of facts. The Tribunal had erred in relying upon its judgment of the assessee for the year 1992-93 without examining the facts.

Shri R.R. Agarwal submits that there is no dispute that the company engaged in the business of manufacture and sale of sugar. The new unit as Barabanki Division in the same line of business was also set up to manufacture and sell sugar by way of expansion of business. There was no question of treating the Barabanki unit as a new business for the purposes of denying the expenses for obtaining loan as revenue expenses. He has relied upon the judgments of the Supreme Court in Prem Spinning and Weaving Mills Company Ltd. Vs. Commissioner of Income Tax, in which the questions relating to business expenditure on the new unit had come up for consideration. This court held that the test as laid down in CIT v. India Cements Ltd. (supra) is the unity of control. In the said case, the company was running a spinning and weaving mill. It set up a straw-board manufacturing factory, which was a fresh undertaking with the help of surplus funds and also borrowed funds. The Revenue alleged that it is a new business. This court held that the memorandum of association of the assessee-company specifically provided that one of the objects of the company is to manufacture straw-board. The straw-board factory was set up by the assessee by utilising its existing surplus funds and borrowing. The assessee controlled both the ventures of spinning and weaving mill as well as straw-board factory. The management, trading organisation, administration, funds, and the place of business were identical. It could not, therefore, be said that the setting up of the straw-board factory was initiation of a different business by the assessee and on that ground the expenditure could not be disallowed. The decisive test was unity of control and not the nature of the business.

In the present case, the assessee is engaged in manufacture and sale of sugar. The Barabanki unit was set up in the same line of business from the funds borrowed by the company. There is no material to contend that the new unit was under different management or that there is no unity of control between the assessee in respect of business of manufacture and selling sugar and the business of manufacture and sale of sugar in the new unit at Barabanki.

The Tribunal is the final court of facts. We may not go into the question to record any finding or to remand the matter to consider whether there was no unity of control in the business of the assessee and the new unit to be set up at Barabanki.

The question of law is thus decided in favour of the assessee and against the Revenue.

Questions Nos. 2, 3, 4 and 7 are decided in favour of the assessee and against the Revenue. Questions Nos. 5 and 6 are decided in favour of Revenue and against the assessee. The income tax Department will proceed accordingly.