1. Reference made at the instance of the revenue and the notice of motion taken out by the revenue are being disposed by this judgment.
2. The question which has been referred arises on facts which are not in dispute. By a special resolution dated 10th August, 1953, the assessee-company issued 60, 000 ordinary shares of Rs. 100 each. The new share capital was raised to meet a part of the finances necessary for acquiring foreign equipment and services required for the Trombay Thermal Project. The assessee-company had also obtained the sanction as required by s. 107 of the Indian Companies Act, 1913, for payment of interest out of the capital on the newly issued shares. The Government of India had sanctioned payment of interest at the rate of 4% p. a. for a period not exceeding 3 1/2 years. During the assessment years 1955-56, 1956-57 and 1957-58, the total amount of interest paid on capital raised was Rs. 6,75,501.
3. During the previous year relating to the assessment year 1958-59, this amount of Rs. 6,75,501 was allocated to various items of plant and machinery and was thus capitalised. The company claimed depreciation on the value of the plant and machinery including the capitalised amount of interest for the assessment year 1958-59, which was allowed. The claim for depreciation was also allowed for the assessment years 1959-60, 1960-61 and 1961-62. The ITO, however, reopened these assessments and withdrew the depreciation allowed on the capital amount of interest holding that interest on capital paid to the shareholders during the construction and thereafter capitalised could not be a part of the actual cost assessed of the assessee. He took the view that the interest payments were no more that dividends in the particular circumstances of the case. In three separate appeals filed by the assessee, these orders of the ITO were set aside by the AAC who took the view that once the interest on capital had been duly capitalised in accordance with s. 208 of the companies Act, 1956, as also on the principle of commercial accountancy, the method by which the company actually chooses to discharge the liability of the interest payment would not take away the true character and nature of the capitalised interest on capital which only goes to swell the capital cost of the machinery and plant in question. The orders of the AAC were challenged by the ITO before the Appellate Tribunal. The Tribunal while deciding all the three appeals by a common order held that the shareholders of the new ordinary share capital were entitled to interest by virtue of s. 107 of the Indian Companies Act, 1913, and that interest was an outgoing for the company irrespective of the profits or reserve. The Tribunal also held that the company was perfectly justified in capitalising the interest paid as a part of the cost of construction. Thus, the Tribunal held in favour of the assessee that the company was entitled to the claim for depreciation for the assessee years in question.
4. The revenue then asked for two questions to be referred to this court. One question was :
'Whether, on the facts and in the circumstances of the case, the payment made by the assessee to its shareholders on the issue of new 60, 000 ordinary shares in 1953 was by way of dividend or by way of interest as such on the capital ?'
5. The second question was :
'Whether, on the facts and in the circumstances of the case, the assessee-company was entitled to claim depreciation on the capitalised interest for the three assessment years in question ?'
6. The second question has been referred to this court by the Tribunal. With regard to the first question, the Tribunal held that the finding that the character of the payment as interest remained the same despite the fact that some dividend was also paid to the shareholders was a finding of fact and, therefore, no question of law arose therefrom.
7. In this reference a notice of motion has been taken out requiring the Tribunal to refer the first question to this court. It is clear that, in view of the provisions of s. 107 of the Indian Companies Act, 1913, the first question does not arise at all because s. 107 in terms provides for payment of interest on the share capital as is for the time being paid up where any shares of a company are issued for the purpose of raising money to defray the expenses of the construction of any works or buildings or the provision of any plant which cannot be made profitable for a lengthened period. The sanction given by the Central Government under s. 107 in terms permitted payment of interest. The Tribunal was, therefore, right in holding that the right of a shareholder to dividend and to interest as contemplated by s. 107 of the Companies Act should not be mixed up. The Tribunal cannot therefore, be said to have committed any error in not referring the first question to this court.
8. So far as the second question is concerned, in our view, it is concluded by the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT : 98ITR167(SC) . The Supreme Court was dealing with the question as to whether interest paid before the commencement of production on amounts borrowed by the assessee for the acquisition and installation of plant and machinery formed part of the 'actual cost' of the assets to the assessee within the meaning of the expression in s. 10(5) of the Indian I. T. Act, 1922, and whether the assessee would be entitled to depreciation allowances and development rebate with reference to such interest. The Supreme Court has held in that case that the expression 'actual cost' had not been defined and it should be construed in the sense which no commercial man would misunderstand. For this purpose, according to the Supreme Court, it would be necessary to ascertain the connotation of the expression in accordance with the normal rules of accountancy prevailing in commerce and industry, and the accepted accountancy rule for determining the cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. The Supreme Court has observed that 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 can be capitalised and added to the cost of fixed assets created as a result of such expenditure.
9. Now, in Challapalli Sugars Ltd.'s case : 98ITR167(SC) , no doubt, the amounts borrowed were not in the form of capital raised by issue of shares before production. But what is important is that in order to decide the question before it the Supreme Court has taken the aid of s. 208 of the Companies Act, 1956, which is a provision analogous to s. 107 of the Indian Companies Act, 1913, under which in the instant case the issue or ordinary shares was sanctioned by the Government of India. After referring to the provision in s. 208 of the Companies Act, 1956, the Supreme Court observed that interest on moneys which are specifically borrowed for the purchase of a fixed asset may be capitalised prior to the assets coming into production, that is, during the erection stage and the Supreme Court pointed out (p. 175) :
'It would appear from the above that the accepted accountancy rule for determining the 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 can be capitalised and added to the cost of the fixed assets which have been created as a result of such expenditure. The above rule of accountancy should, in our view, be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary.'
10. The Supreme Court further referred to s. 208 of the Companies Act, 1956, and observed as follows (p. 175) :
'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 or 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 if interest is paid on money not raised by way of 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 be stronger in case such interest is paid on money taken on loan for meeting the above expenses.
11. The decision in Challapalli Sugars Ltd.'s case : 98ITR167(SC) is, therefore, clear authority not only for the proposition that interest can be capitalised where it is paid on money taken on loan for construction of any work or building or for provision of any plant but also where interest is paid on share capital which has been raised as contemplated by s. 107 of the Indian Companies Act, 1913.
12. In this view of the matter, the question referred must be answered in the affirmative and in favour of the assessee. Assessee to get the costs of this reference.