Business Expenditure – Interest on borrowed capital by an assessee carrying on manufacture of ferro-alloys and setting up a sugar plant – where there is unity of control and management in respect of both the plants and where there is intermingling of funds and dovetailing of business the interest could not be disallowed on the ground that the assessee had not commenced its business.

In 1991, the assessee had set up a ferro-alloys manufacturing plant in Raipur, which was engaged in both the manufacture of ferro-alloys, as also, trading of ferro alloys.

In the years 1994-95 and 1995-96, the assessee set up a sugar manufacturing plant at Muzaffanagar in the state of UP. The sugar plant had an installed capacity 2500 RD. The assessee’s trial in respect of sugar plant commenced on 20-03-1996. The assesee spent a sum of Rs. 5,66,79,270/- as pre-operative expenses in respect of the sugar plant which inter alia included financial charges of Rs.3,50,83,472/-.

In its return of income for the assessment year 1996-97, the assessee declared loss of Rs.7,23,18,949/- in which the assessee, inter alia, had claimed the aforesaid sum of Rs. 5,66,79,270/- as revenue expenditure.

The Assessing Officer disallowed the expenditure for the reason that the sugar plant constituted new source of income as it was not the same business in which the assessee was engaged.

The Commissioner of Income-tax (Appeals) came to the conclusion that the expenditure in issue was in the nature of revenue expenditure since the sugar plant project was in the same business fold.

The Tribunal allowed deduction of only that expenditure which was incurred towards finance charges, being a sum of Rs. 3,50,83,472/- incurred for setting up of sugar plant as revenue expenditure u/s. 36(1)(iii). In respect of the balance amount in the sum of Rs. 2,15,95,798/-, the Tribunal restored the matter back to the Assessing Officer to ascertain whether the expenditure was of capital or revenue nature.

On an appeal to the High Court by the Revenue, the High Court observed that the Tribunal had given the finding that there was unity of control and management in respect of the ferro alloys plant as well as the sugar plant and there was also intermingling of funds and dovetailing of business. The High Court held that in the circumstance, it could not be said that the assessee had not commenced its business and hence, interest would have to be capitalised. The High Court confirmed the order of the Tribunal.

The Supreme Court dismissed the civil appeal filed by the Revenue in view of the concurrent finding recorded by court below.

Note: W.e.f. 01.04.2004, the Finance Act, 2003 inserted proviso to section 36(i)(iii) which effectively, prohibits the deduction under this section in respect of interest on capital borrowed for acquisition of an asset for extension of existing business for the period up to the date on which such asset is first put to use.