1. This appeal by the revenue relates to the assessment year 1978-79.
The assessee is a company. This is the first accounting year in which the assessee commenced manufacturing operations. The assessee had placed an order with one Dave Trading Co. of Bombay for purchase of certain wooden vats and niters. The order was placed on 29-5-1976 and delivery had to take place by August 1976. The Bombay company however, did not even commence manufacture of the asset by the stipulated date of delivery and there was much further delay. The assessee, therefore, sought for compensation from the Bombay company to the extent of Rs. 46,000 of which the break up was as under: This was by a letter dated 1-2-1977. However, eventually a settlement was arrived at and the Bombay concern paid the assessee Rs. 16,000 in February 1977. Subsequently, the assessee placed an order with another concern in Ernakulam in April 1977 and obtained the machinery at a much enhanced cost. In this assessment year, for which the accounting period is from 1-4-1977 to 31-3-1978, the assessee claimed depreciation on machinery. The ITO worked out the capital cost and in so doing made a deduction of Rs. 16,000 under Section 43(1) of the Income-tax Act, 1961 ('the Act') to arrive at the actual cost of machinery.
2. The assessee "appealed to the Commissioner (Appeals) and submitted that deduction under Section 43(7) of Rs. 16,000 should not have been made because the amount received was not a contribution by the Bombay company towards the cost of machinery but represented compensation for cancellation of the contract which resulted in the assessee having to pay escalated price of machinery incurring expenditure by way of interest and incurring a loss of profit on account of delayed production. The Commissioner (Appeals) agreed with the assessee and held that the amount of Rs. 16,000 should not have been deducted under Section 43(1). The revenue is aggrieved.
3. It was submitted by the learned departmental representative that Rs. 16,000 had to be rightly excluded under Section 43(1) as reimbursement of cost. The learned counsel for the assessee opposed this plea on account of the fact that the amount of Rs. 16,000 did not represent reimbursement of cost by the Bombay company. In this regard he cited the decisions of the Tribunal in Laxmi Udyog v. ITO and McDowell & Co.
Ltd. v. ITO  18 ITJ 56.
4. The learned departmental representative sought to raise an additional ground which is really an alternative contention. This was to the effect that since the assessee was allowed capitalisation of expenditure incurred prior to setting up of the business, the receipt of Rs. 16,000 should go to reduce the expenditure and, thus, the capital cost would stand reduced on general principles. This plea was also opposed by the learned counsel for the assessee submitting that the ITO had only invoked the provisions of Section 43(1) and the revenue should either stand or fail by the provisions which had been relied on.
5. We have considered the rival submissions. The relevant portion of Section 43(7) reads as under: 'actual cost' means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority: It is clear that in terms of Section 43(7) the actual cost of asset to the assessee, according to commercial principles, has to be first determined. From this has to be reduced the portion of the cost met by any other person directly or indirectly which would give the figure of 'actual cost' within the meaning of the Act. It is, therefore, open to the revenue to make any submission within the framework of Section 43(7) to substantiate the claim that the actual cost determined for the income-tax purposes by the first appellate authority is erroneous. We, therefore, hold that the alternative contention urged by the revenue merits consideration.
6. In the present case, the assessee had placed an order for certain machinery with Dave Trading Co. of Bombay. The default of the company put the assessee to loss. Only one of the components was the escalating price they have to pay if the orders were placed elsewhere. In addition there was loss of interest and loss of profit. A lump sum of Rs. 16,000 was paid against the claim of Rs. 46,000. This was a payment by Dave Trading Co. to the assessee. The assessee eventually placed orders for the machinery with a third party with whom Dave Trading Co. had no concern. The assessee paid the price fixed to the third party. The amount of Rs. 16,000 paid by Dave Trading Co. did not go to meet directly or indirectly any portion of the cost of the asset paid by the assessee to the third party. Hence, no deduction could be made under Section 43(1) on the ground that a portion of the cost of the asset subsequently acquired was met directly or indirectly by Dave Trading Co. It is, therefore, not necessary to advert to, the cases relied on behalf of the assessee as this part of the contention of the assessee has been found acceptable by us.
7. Coming to the alternative contention of the revenue, the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT  98 ITR 167 is an authority for the proposition that 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. So, if there are outgoings they will be capitalised.
If there are receipts which have a bearing on the outgoings then the receipts would have to be set off against the outgoings and only the net amount would have to be capitalised to arrive at the actual cost according to commercial principles. In the present case, out of the claim of Rs. 46,000, Rs. 26,000 was towards the additional cost of machinery. The balance amount was towards loss of interest and loss on account of delay in production. Eventually, the assessee received only Rs. 16,000. The proportionate amount towards the additional cost of machinery would be 26/46 X 16,000, i.e., Rs. 9,000. The expenditure incurred prior to commencement of business was capitalised only to the extent of 75 per cent. Therefore, in round figures about Rs. 6,500 out of this amount would be attributable to reimbursement of expenditure on the asset up to the stage they were ready to be put into use. To arrive at the actual cost in commercial terms, which is the starting point of Section 43(1) Rs. 6,500 would have to be deducted from the cost as taken in the assessment and no more. To this extent the revenue succeeds in its appeal. The depreciation, etc., will be worked out by the ITO after recomputing the actual cost in accordance with our aforesaid findings.