Business expenditure — Interest on borrowed capital — Prior to insertion of proviso to S. 36(1)(vi) w.e.f. 1-4-2004, an assessee was entitled to claim deduction of interest on capital borrowed for the purposes of its business, irrespective of its use bein

[Dy. CIT v. Core Health Care Ltd., (2008) 298 ITR 194
(SC)]

The assessee-company was engaged in the business of
manufacture and sale of intravenous solutions. For the A.Y. 1992-93 the assessee
claimed deduction towards expenses aggregating to Rs.2,12,05,459 which included
interest on borrowings of Rs.1,56,76,000 utilised for purchase of machinery.

During the assessment year under consideration the assessee
had installed new machinery. The Assessing Officer, disallowed the amount of
Rs.1,56,76,000 placing reliance on the judgment of this Court in Challapalli
Sugar Ltd. v. CIT, (1975) 98 ITR 167, inter alia, on the ground that
during the assessment year under consideration the assessee had installed new
machinery on which production had not started.

On appeal, the Commissioner of Income-tax (Appeals) confirmed
the addition of interest amount on borrowings of Rs.1,56,76,000. The matter was
carried in appeal by the assessee. The Tribunal held that the Department was not
justified in adding Rs.1,56,76,000 in the income of the assessee. This decision
was confirmed by the High Court.

On appeal by the Department, the Supreme Court noted that
before the High Court it was not the case of the Department that a new business
was set up or commenced during the assessment year under consideration. It was
undisputed before the High Court that three additional machines were installed
by the assessee during the assessment year under consideration for the
production of intravenous injectibles.

The Supreme Court upon reading the provisions of S.
36(1)(iii) held that interest on moneys borrowed for the purposes of business is
a necessary item of expenditure in a business. For allowance of a claim for
deduction of interest under the said Section, all that is necessary is that,
firstly, the money i.e., capital, must have been borrowed by the assessee;
secondly, it must have been borrowed for the purpose of business; and, thirdly,
the assessee must have paid interest on the borrowed amount. All that is germane
is : whether the borrowing was, or was not, for the purpose of business.

The expression ‘for the purpose of business’ occurring in S.
36(1)(iii) indicates that once the test of ‘for the purpose of business’ is
satisfied in respect of the capital borrowed, the assessee would be entitled to
deduction u/s.36(1)(iii). This provision makes no distinction between money
borrowed to acquire a capital asset or a revenue asset. All that the Section
requires is that the assessee must borrow capital and the purpose of the
borrowing must be for business which is carried on by the assessee in the year
of account.

What clause (iii) emphasises is the user of the capital and
not the user of the asset which comes into existence as a result of the borrowed
capital unlike S. 37 which expressly excludes an expenses of a capital nature.
The Legislature has, therefore, made no distinction in S. 36(1)(iii) between
‘capital borrowed for a revenue purpose’ and ‘capital borrowed for a capital
purpose’. An assessee is entitled to claim interest paid on borrowed capital
provided that capital is used for business purpose irrespective of what may be
the result of using the capital which the assessee has borrowed.

Further, the words ‘actual cost’ do not find place in S.
36(1)(iii) of the 1961 Act. The expression ‘actual cost’ is defined in S. 32,
32A, etc. of the 1961 Act, which is essentially a definition Section which is
subject to the context to the contrary. S. 43(1) defines ‘actual cost’. The
definition of ‘actual cost’ has been amplified by excluding such portion of the
cost as is met directly or indirectly by any other person or authority.
Explanation 8 has been inserted in S. 43(1) by Finance Act, 1986 (23 of 1986),
with retrospective effect from April 1, 1974.

It is important to note that the words ‘actual cost’ would
mean the whole cost and not the estimate of cost. ‘Actual cost’ means nothing
more than the cost accurately ascertained. The determination of actual cost in
S. 43(1) has relevance in relation to S. 32 (depreciation allowance), S. 32A
(investment allowance), S. 33 (development rebate allowance), and S. 41
(balancing charge). The ‘actual cost’ of an asset has no relevance in relation
to S. 36(1)(iii) of the 1961 Act, the Supreme Court however observed that in the
present appeal it was concerned with the A.Ys. 1992-93, 1993-94, 1995-96 and
1997-98.

The Supreme Court noted that a proviso has been inserted in
S. 36(1)(iii) of the 1961 Act which denies deductions of interest for the period
beginning from the date on which the capital was borrowed for acquisition of
asset till the date on which the asset was first put to use. The Supreme Court
held that proviso has been inserted by the Finance Act, 2003, with effect from
April 1, 2004. Hence, the said proviso will not apply to the facts of the
present case. The Supreme Court therefore held that the said proviso would
operate prospectively.

The Supreme Court held that the Assessing Officer was not
justified in making disallowance of Rs.1,56,76,000 in respect of borrowings
utilised for purchase of machines.

Note : The said decision was followed in the following
cases :