B.K. Mehta, J.
1. As all these three references relate to the identical question as to whether the payment of interest should be considered as a part of the cost of plant and machinery and, therefore, in the nature of capital expenditure, we intend to dispose of these three references by this common judgment. In order to appreciate the rival contentions urged on behalf of the parties, it would be necessary to notice some facts which have given rise to these references.
2. The assessee-company is engaged in the business of manufacturing high tensile wires for prestressed concrete construction or any other product or products. The assessee-company entered into a contract on March 25, 1961, with Kobe Steel Works Limited, Shinko Wire Company Limited and C. Itoh & Company Limited, all of Japan, for the purposes of establishing and erecting a plant for high tensile steel wires required for prestressed concrete construction. For that purpose, a basic agreement was effected between the aforesaid parties for providing financial collaboration, supply of plant and machinery and furnishing technical know-how. Under that basic agreement, it was, inter alia, agreed that C. Itoh & Company Ltd., and Kobe Steel Works Limited would supply required machinery and equipment as well as technical know-how. Under that basic agreement, it was, inter alia, agreed that C. Itoh & Company Ltd., and Kobe Steel Works Limited would supply required machinery and equipment as well as technical know-how concerning their installation and operation for which a separate sales contract was to be executed between the parties. Pursuant to this understanding arrived at under the basic agreement, a sales contract was executed on the same day, i.e., March 25, 1961, between the assessee-company, C. Itoh & Company Ltd., and Kope Steel Works Limited. According to article 4 of the sales contract the aforesaid two Japanese companies agreed to supply the machinery and plant and equipment for a consideration of Stg. Pounds 2,76,960 CIF Bombay or for Stg. Pounds 2,592,840 for Kobe. It was specifically agreed that should there be any change in the official rate of IMF any time till the final instalment was paid, the difference caused by this change should be adjusted at the time of payment of each instalment. By article 5 of the said contract, it was agreed that 40% of the total value of the important plant should be invested in equity of the assessee-company by the aforesaid two Japanese companies, and the amount equivalent to 40% of the total contracted value of the plant, which was to be utilised towards the payments of plant as due against shipping documents. The balance of 60% of the contracted value of the plant was to be paid as under :
1. 20% of the balance of 60% was to be remitted telegraphically immediately on the said contract coming into effect.
2. Remaining 80% of the balance of 60% was to be paid in 10 equal half-yearly instalments spread over a period of five years. The payment of the first instalment was to be made one year after the date of shipment.
3. It was specifically agreed thereafter as under :
'The due instalment together with interest calculated at the rate of 6% per annum on the outstanding balance of the principal amount shall be remitted telegraphically to CITOH.'
4. By article 6 of the said contract the assessee-company was under an obligation to obtain and deliver to C. Itoh & Company Limited at the time when the sales contract came into effect the letter of guarantee issued by any first class bank or institution in India acceptable to the said firm guaranteeing to pay the outstanding principal and interest defined in article 5 of the said sales contract if the assessee-company could not fulfil the payment of principal and interest amount. By article 18, it was agreed that the said sales contract would come into effect upon approval thereof by the Government of India granting the assessee-company the import licence for plant and also by the Government of Japan after the representatives of the aforesaid three foreign firms signed the said contract.
5. The plant and machinery were supplied to the assessee-company in the calender year 1962. Under the terms of sales contract referred to above, the CIF value of the plant and machinery amounted to Rs. 39 lakh which was payable as under :
Rs.(1) By down payment on signing the contract 4.68 lakh(2) By allotment on equity shares to the foreigncollaborators in Japan 15.60 lakh(3) By deferred payment instalments spread overa period of five years 18.72 lakh
6. According to the sales contract, it was agreed between the assessee-company and the foreign suppliers that for the supply of plant and machinery on credit terms offered to the assessee-company, an additional amount of Rs. 3,65,040 was to be paid by the asseessee-company as interest at the rate of 6% on the outstanding balances of the principal amount. The revelant assessment years with which we are concerned in these three references are respectively 1964-65, 1965-66, 1966-67 and 1967-68 to 1969-70. The assessee-company went into actual production on September 1, 1963. It appears that the assessee-company had by that time incurred an expenditure of Rs. 9,09,493 out of which capitalised expenditure of Rs. 4,51,676. It should be noted that according to the sales contract, the payment was to be made in Stg. Pounds and it was specifically agreed between the parties that in case of any change in the official rate of International Monetary Fund at any time till the final instalment was paid, the difference caused by the change would be ajusted at the time of payment of each instalment due. On account of devaluation of rupees by the Government of India on June 6, 1966, the assessee-company was required to pay an additional price of Rs. 4,62,851 including interest of Rs. 32,291. The assessee-company sought to capitalise this additional payment in the previous year relevant to the assessment year 1967-68 which is the subject-matter of Income-tax Reference No. 78 of 1975. It appears that the Income-tax Officer while assessing the assessee-company for the assessment year 1964-65, allowed the amount of Rs. 3,65,040 being the interest on the deferred payment of instalments to be capitalised and allowed depreciation and development rebate thereon as on the other capitalised expenditure and added the same to be carried forward as the unabsorbed business loss. It appears that the Additional Commissioner of Income-tax on examination the record noticed that the Income-tax Officer had wrongly included in the total cost of the plant an machinery the aforesaid sum of Rs. 3,65,040 on account of interest on deferred payments which started from November, 1963, and since it was on account of the payment of interest after the assessee-company went into production, he held that the assessee-company was not entitled to capitalise it and claim depreciation and development rebate thereon. In the opinion of the Additional Commissioner of Income-tax the amount of interest should have been allowed as revenue expenditure for the year in which it fell due. He, therefore, was of the opinion that the assessment was erroneous as it operated prejudicially to the interest of the revenue. A notice was, therefore, issued to the assessee-company to show cause why an order should not be made under section 263 of the Income-tax Act, 1961, for remedying the said error. The Additional Commissioner after hearing the assessee-company by his order of February 20, 1971, held that the Income-tax Officer was in error in allowing the amounting of Rs. 3,65,040 to be capitalised as sought to be done by the assessee-company. He, therefore, directed that the said amount be excluded from the actual cost of the plant and machinery and the depreciation and development rebate attributable to the same be withdrawn. He also directed that the interest due on the deferred payments may be allowed as revenue expenses in the years when they become due or paid, as the case may be. The assessment was, therefore, directed to the revised in accordance with the directions given in the said order.
7. The assessee-company being aggrieved with this order of the Additional Commissioner went in appeal before the Appellate Tribunal. Meanwhile, for the subsequent assessment years, namely, 1965-66 and 1966-67, with which we are concerned in Income-tax Reference No. 136 of 1974, the Income-tax Officer excluded the amount of Rs. 3,65,040 from the written down value of the machinery and plant. The assessee-company, therefore, carried the matter in appeal before the Appellate Assistant Commissioner, who upheld the order of the Income-tax Officer and dismissed the appeal. The assessee-company, therefore, carried the matter to the Tribunal.
8. Similarly, for assessment years 1967-68 to 1969-70, the Income-tax Officer did not allow the claim of the assessee-company for adding Rs. 3,65,040 to the cost of machinery and plant and disallowed the additional claim of Rs. 32,291 which was the payment of additional amount of interest due to devaluation of rupee. The assessee-company carried the matter in appeal before the Appellate Assistant Commissioner who dismissed the appeal and affirmed the order of the Income-tax Officer. The Appellate Assistant Commissioner allowed the payment of interest as revenue expenses. The assessee-company, therefore, also carried the matter pertaining to the assessment years 1967-68 to 1969-70 before the Tribunal. The Appellate Tribunal disposed of the appeal pertaining to the assessment considered the entire material placed on record before it on behalf of the assessee-company and on appreciation thereof was satisfied that the interest has been shown to be part and parcel of the actual cost of machinery; and though the payment of interest was contingent to the deferred payments of instalments, in the opinion of the Tribunal, on consideration of the sales contract, the invoices and the other connected documents, the interest payment was a part and parcel of the cost of machinery and it had been paid with the principal amount till the final payment of instalment was made. The payment of interest being part of the cost of machinery, the Tribunal found that the Additional Commissioner was not right in holing that it was revenue expenditure. The Tribunal, therefore, held that the assessee had successfully established the said expenditure to be of capital nature. The Tribunal, therefore, in the case of the subsequent assessment years allowed the appeals of the assessee-company and permitted it to deduct the amount of Rs. 3,65,404 as well as Rs. 32,291 being the amount of interest as part of the cost of machinery and permitted the assessee-company to capitalise the same so as to claim depreciation and development rebate thereon according to law. At the instance of the revenue, the question referred to us in Income-tax Reference No. 54 of 1974 is in the following terms :
'whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that the amount of Rs. 3,65,040 was capital expenditure on which depreciation and development rebate is admissible and is not revenue expenditure ?'
9. In Income-tax Reference No. 136 of 1974, the following question has been referred to us :
'Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that the amount of Rs. 3,65,040 was capital expenditure on which depreciation is admissible and is not revenue expenditure ?'
10. In Income-tax Reference No. 78 of 1975, the question referred to us for our opinion in :
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in holding that the amount of interest of Rs. 3,97,331 interest element included in the total amount payable by the assessee on instalment basis for the acquisition of plant and machinery in question from the foreign collaborators should be treated as part and parcel of the cost of plant and machinery, or was entitled to be added to the cost of plant and machinery on which depreciation and development rebate is admissible ?'
11. At the hearing of these three reference both the sides requested us to reframe the question in Income-tax Reference No. 78 of 1975, because it has not been properly framed. We agree with the suggestion made by both the sides as it appears clearly from the frame of the question that it has been indifferently raised. We, therefore, frame the following questions in this reference so as to bring out clearly the dispute between the parties :
(1) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that the amount of Rs. 3,65,040 was capital expenditure on which depreciation is admissible and not revenue expenditure
(2) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that the amount of Rs. 32,291 being the additional amount of interest paid due to devaluation of rupee is a capital expenditure on which depreciation is admissible and is not revenue expenditure
12. At the outset it should be stated that in the respective statements of cases made to us in these three references, the Tribunal has not collected and co-related the facts as it should have done from the material placed before it. We have, therefore, stated the facts as we have collected from the material which was before the Tribunal and which is also before us.
13. On behalf of the revenue, it was urged that the Tribunal was clearly in error in holding that the amount of Rs. 3,65,040 as well as the amount of Rs. 32,291 were parts of the cost of plant and machinery and, therefore, capital expenditure. It was strenuously urged on behalf of the revenue that the Tribunal did not consider that the payment of interest agreed to be made by the assessee-company was on the balance outstanding from time to time under the sales contract by which the foreign suppliers agreed to supply plant and machinery on deferred payment basis of the balance amount of the sale price of Rs. 39,00,000 for the supply of machinery and plant, after deducting the amount of down-payment and the amount representing the value of equity shares to be allotted to the foreign suppliers. It was urged that the first instalment of the principal amount together with the interest thereon of this balance payment was admittedly to commence one year after the assessee-company went into production and as the amounts in question, namely, Rs. 3,65,040 and Rs. 32,291 represented the amount of interest which had become due and payable and which were in fact paid for the period subsequent to the commencement of the production, they could not be treated as part of the cost of machinery and plant and, therefore, could not have been capitalised on which development rebate and/or depreciation, as the case may be, could be admissible.
14. On behalf of the assessee-company these contentions are sought to be repelled by urging that in the first instance the premises on which the revenue proceeded, namely, that there were separate obligations on the founded, and having regard to all the facts and circumstances which have been established in the cse the only inescapable conclusion which could be reached, as has been done by the Tribunal, was that the so-called amount of interest was a part and parcel of the price of the plant and machinery supplied by the foreign suppliers. In the alternative, it was urged on behalf of the assessee-company that in any case having regard to the mercantile system of account maintained by the assessee-company the liabilities of payment of interest was already incurred in fact and in law in the calender year 1962, when the property, namely, machinery and plant, were transferred to the assessee-company and the question of actual payment of interest was entirely irrelevant so far as the larger question of the nature of payment is concerned.
15. It is in the context of these rival contentions of the parties that we have been called upon to determine the nature of the payment. We have set out the relevant terms and condition on which the foreign collaborators entered into the basic agreement as well as the sales contract with the assessee-company for purpose of setting up and establishing a plant for manufacturing high tensile steel wires for prestressed concrete constructions. Beside these two contract, there is a letter of the Government of India in the Ministry of Steel, Mines and Fuel, of July 16, 1961, according its sanction to the foreign collaboration agreement between the assessee-company and the aforesaid three foreign forms. The approval to the import of plant and machinery was accorded in the following terms :
'I am also directed to convey Government's approval to the import of plant and machinery to the value of Rs. 39 lakhs (c.i.f.) form Japan on deferred payment terms detailed below as originally proposed by you.
(i) 20% at the time of signing the contract. (ii) 80% to be paid in instalment spread over a period of five of five years (the first instalment to start one year after the dated of shipment).
2. The rate of interest on deferred payment will be 6% per annum.
3. The other condition detailed in paragraph I(i), (ii), (iii) and (iv) of this Ministry's letter No. PS-40(43)/59 dated 14-10-60 remained unchanged. It is noted that the paid up capital will now be Rs. 45 lakhs.'
16. We also find another letter from the (Under-Secretary to the Government of India in the Ministry of Steel, Mines and Fuel, of September 16, 1961, in the matter of foreign collaboration agreement. The relevant part of the said clarification is in the following terms :
'(ii) the balance of Rs. 23.4 lakhs will be paid on deferred payment terms as shown therein, viz., 20% on signing the contract and 80% in instalment spread over a period of five years (the first instalment to start one year after the date of shipment).
The rate of interest on deferred payment will be 60% per annum.' According to the sales contract, the assessee-company wass to furnish a letter of guarantee from one of the leading banks to the satisfaction of the foregin suppliers. Accordingly, the assessee-company furnished the letter of guarantee of the Industrial Finance Corporation of India. The said letter is of 14th March, 1962, whereby the Industrial Finance Corporation in consideration of C. Itoh & Company and technical service, assistance, etc., on deferred payment basis in terms of the basic agreement and the sales contract, guaranteed that the assessee-company would pay Pounds 1,67,778 in instalment as detailed in the said letter, and in case of their failure to decided on so in spite of notice of demand having been served by C. Itoh & Company Ltd., would make immediate payment in Pounds sterling at the bank designated by the suppliers. The two invoices bearing Nos. 193 and 201 of October 10, 1962, and November 26,1962, respectively, also refer to this deferred payment agreement consisting of the payment of instalments on account of principle an interest as detailed in the said two invoices. The aggregate amount to be paid, according to these two invoice by way of deferred payments, was Pounds 1,67,778 as guaranteed by the Industrial Finance Corporation of India. The assessee-company has having regard to the respective instalment executed promissory note in favour of the supplier to pay the said amount. The assessee-company has also filed the summary from their books to show that they have debited to the plant and machinery account the amount Rs. 39 lakhs being the price of plant and machinery and Rs. 3,65,040 being the amount of interest on December 31,1962. Similarly, the assessee-company having been required to make additional payment of Rs. 4,62,851 including interest of Rs. 32,291 consequent to the devaluation of rupee in June, 1966, debited the said amount on March 31, 1967, to the plant and machinery account,
17. On the above facts, the Tribunal reached the following conclusion :
'......We have gone through the entire material given in the paper book filed by the counsel for the appellant and are fully satisfied that the interest has been shown to be a part and parcel of the actual cost of the machinery. No doubt the interest is contingent to the deferred payment of instalment but on a perusal of the copy of the invoice furnished and the contract agreement an other paper, we find that the interest payment is a part and parcel of the cost of the machinery and it has been paid along with the principle amount till the final payment of instalment is made. Thus the payment of interest being part of the cost of the machinery it cannot be paid held that it is a revenue expenditure.'
18. A strenuous attempt was made on behalf of the revenue to persuade us that this finding of the Tribunal is without any evidence whatsoever and is, therefore, not warranted in the facts and circumstance of the case. We are afraid we cannot accede to this submission made on behalf of the revenue. In our opinion, it is as a matter of overall agreement of financial and technical collaboration effected between the assessee-company on the one hand and the foreign suppliers on the other that the sessee-company not only got the benefit of technical known - ho for installation and erection of plant and machinery but also received the plant and machinery on deferred payment terms. These agreement for technical and financial collaboration were subject to the approval of the Government of India and were in fact approved by the Government. The Tribunal was right in reversing ing the order of the Additional Commissioner in so far as it treated the payment of interest as revenue expenditure as in the opinion of the Tribunal the reasoning underlying the order of the Additional Commissioner was not justified. We decided on not thinking this view of the matter. The Additional Commissioner was impressed by one important factor that it was always open to the assessee-company to make payment of the entire principle amount at a time without waiting for the period to expire over which deferred payment were spread over. The condition which has impressed the Additional Commissioner is also sought to be pressed into served at the time of hearing of these references. We do not think that this contention is wel l-found for the obvious reason that the assessee-company could not have paid the entire principle amount at a time since it involved the release of foreign exchange by the Government of Ind ia. The entire deal, in our opinion, should be viewed as a package deal by which the foreign supplier agreed to enter into financial and technical collaboration with the assessee-company which as a part of such agreed received plant and machinery on deferred payment terms. It is on doubt true that for extending this facility of payment of price on deferred terms it was the assessee-company should pay interest on the outstanding balance from time to time. But having regard to the entire arrangement between the parties as evidence by the basic agreement and the sales contract coupled with the approval by the Government of India and the accordance with which the invoices were drawn, clearly indicate that thought the arrangement of deferred payment as detailed in the Letter of the Guarantee furnished by the Industrial Finance Corporation as well as in the two aforesaid invoices bifurcated the principle amount and the interest amount, each instalment of payment was a composite instalment comprising of this principle and interest amount. In the facts and circumstance of the case, therefore, it cannot be said that the interest was hot part and parcel of the original price, the payment of which was agreed to be appeared over a period of five years. We decided on not think, therefore, as contended on behalf of the revenue that in substance and effect it was the payment of interest on the principle amount for the payment of which a facility was granted by the supplier by accepting deferred payment terms. In reality, according to the revenue, therefore, the payment of interest was in the nature of payment of revenue expenditure because nothing has been purchased to obtained by the payment of interest.
19. In the ultimate analysis it is always a question of fact as to whether expenditure is of capital nature or not and the answer to this question depends on the facts and circumstance of each case. It cannot be gain said that the obligation of payment of interest was incurred for obtaining deferred payment terms under the contest of purchase of machinery and plant. In other words, it was for the acquisition of asset without which the assessee-company could not have commenced its business. The facility of deferred payment of price granted by the foreign supplier was a part of financial and technical collaboration agreements resulting in spread over of the payment of the actual price over a long period which in turn must necessarily involve the question of payment of interest also. If the spread over, it must follow as a necessary corollary that if interest is a part and parcel of the price it must also be treated similarly since it is for all intents and purposes spent for the acquisition of an asset with a view to initiate business. It was, therefore, urged on behalf of the revenue that the present case would be governed by the ratio of the decision of the Supreme 'Court in Bombay Steam Navigation Co. (1933) Private Ltd. v. Commissioner of Income-tax. In that case the assessee-company was incorporated on August 10, 1953, and it entered into a contract with the Scindia Steam Navigation Company Ltd., with which the Bombay Steam Navigation Company Ltd.m was amalgamated to purchase certain steamers, launches, boats, etc., for a consideration of Rs. 80 lakhs. It was agreed between the parties to the said agreement that the price of the assets sold would be satisfied by allotment to the Scindias of 29, 900 share credited as filly paid up of the face value of Rs. 100 each in the share capital of the assessee-company and the balance would be treated by the assessee-company as a loan granted by the Scindies. The agreement provided for payment of interest at 6% on the unpaid balance of the purchase price. For the assessment years 1955-56 and 1956-57, the Income-tax Officer, Bombay, disallowed the claim of the assessee-company in the computation of its profits and gain for allowance of Rs. 2,74,610 paid by it to the Scindias and Rs. 2,86,823 paid as interest on the balance of the price remaining unpaid. The order of the Income-tax Officer was confirmed by the Appellate Assistant Commissioner as well as by the Tribunal. The High Court of Bombay also confirmed the view of the Tribunal. The assessee-company took the matter in appeal before the Supreme Court. In that context the court said that it is not easy to evolve a test for ascertaining whether in a given case expenditure is capital or revenue, for the determination of the question must depend upon to consider the nature and ordinary course of business and the objects for which the expenditure is incurred. The Supreme Court thereafter observed as under :
'whether a particular expenditure is revenue expenditure incurred d for the purpose of business must be determined on a consideration of all the fact and circumstance, and by the application of principles of commercial trading. The question must be viewed in the larger context of business necessity of expediency. It the outing or expenditure is so relate to the carrying on or conduct of the business, that it may be regard as an integral part of the profit-earning process and not for ac quisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying of the business, the expenditure may be regarded as revenue expenditure.'
20. We decided on not appreciate how this decision can assist the cause of the revenue, As has been observed above, the interest was paid on the balance of the price, the payment of when was agreed between the assessee-company and the foreign suppliers to be deferred over a period of five years. The price and the interest were to be paid in the fact of the case for purpose of the supply of plant and machinery and transferring them to the assessee-company. In order that every instalment of the price and interest might be paid regular, the assessee-company was required to furnish a guarantee of a leading bank and the assessee-company did in fact furnish the guarantee of the Industrial Finance Corporation of India. In our opinion therefore, the entire arrangement was such that the payment of the principle as well as interest was for purpose of acquiring the plant and machinery, and, consequently, of capital nature. A transaction has to be viewed from the angle of commercial trading and expenditure and expediency, The arrangement with which we are concerned in these reference is to be viewed as a whole.The financial collaboration as well as the technical collaboration which were agreed upon by the assessee-company and the foregin suppliers should be viewed as a whole and as part of such financial and technical collaboration agreement. it was, inter alia, agreed between the parties that the foreign suppliers should supply machinery and plant and the payment of price was to be made in parts and which consequently provided for the payment of the balance amount on referred payment basis. The Tribunal was, therefore, right in considering the arrangement as a whole and reaching the conclusion that the payment of interest was part and parcel of the payment of price of the plant and machinery.
21. It was then said on behalf of the revenue that out of the interest nothing was acquired and it was only with a view to get deferred payment terms that the obligation was incurred. We cannot accede to this submission made on behalf of the revenue. The revenue sought to support this contention by another decision of the Supreme Court in State on Madras v. G. J. Coelho. The respondent in that case before the Supreme Court purc hased an estate in 1950, Known as Silver Cloud Estate, consisting of tea, coffee and rubber plantation in Madras State out of the sale price of Rs. 3.10.000, the assessee borrowed Rs. 2,90,000 at interest varying from 7 to 8 per cent per annum. For the assessment year 1955-56, the assessee claimed to deduction interest on this sum amounting to Rs. 22,628-09-08. The Agricultural Income-tax Officer disallowed Rs. 21,057-15-01, allowing Rs. 1,570-10-07 under section 5(k)of the Madras Plantation Agriculture Income-tax Act since the interest under that section was to be limited to6% or an amount equivalent to 25% or the agricultural income in that year. The assessee carried the matter in appeals to the Assistant Commissioner of Agricultural Income-tax and the Tribunal without success. On reference to the High Court of Madras, the matter was decided in favour of the assessee and the entire amount was allowed to be deduction from his assessable income. The matter was then carried by the state to the Supreme Court, On of the conditions urged on behalf of the state to the state was that the express were really in the nature of capital and were not laid out or expended wholly and exclusively for purpose of plantation. Negative this contention, the Supreme Court reiterated inter alia. from the case law on the point the following principles :
'(1) Outlay is deemed to be capital when it is made for initiation of a business for extension of a business, or for a substantial replacement of equipment.
(2) Expenditure may be treated as properly attributable to capital when it is made not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade.
(3) Whether for the purpose of the expenditure, any capital was with drawn, or, in other words, whether the object of incurring the expenditure was to employ what was taken in as capital of the business.'
22. In our opinion, the first and the second principle help the cause of the assessee-company, but on behalf of the revenue reliance was placed on the following observation made by the court in applying the above principles :
'If we apply these principles to the facts of this case, the answer seems clear that the payment of interest is revenue expenditure. No new asset is acquired with it; no enduring benefit is obtained. Expenditure incurred was part of circulating of floating capital of the assessee. In ordinary commercial practice payment of interest would not be termed as capital expenditure.'
23. We do not think that this observation can be of much assistance to the revenue because here in the case before us there was no commencement of business at all. The liability to pay interest was incurred under the agreements and it was to the effect that the interest at the rate of 6% was to be paid on the balance of the price the payment of which was agreed to be deferred over a period of five years. It was, therefore, urged on behalf of the revenue that in any case the interest which has been paid after the assessee-company went into production cannot be allowed to be capitalised and it was pointed out to us that the first instalment of the balance of price of Pounds 1,40,400 was to be paid one year after the date of shipment, and accordingly the first instalment of the balance of the price as well as the interest at the rate of 6% thereon was to be paid on 30th November, 1963. Each of the rema ining subsequent instalments was to be paid thereafter after every six months. It was, therefore, urged that the payment of interest was for the period after the assessee-company went into production and, therefore, on the ratio of the decision of the Supreme Court in Challapalli Sugars Ltd. v. Commissioner of Income-tax, it is only the interest incurred before the commencement of the production which can be capitalised and added to the cost of the fixed assets. We must reject such a board submission made on behalf of the revenue. In Challapalli's case Mr. Justice Khanna, speaking foe the court, said that for the purpose of deduction on account of depreciation and development rebate one has to take into account the written down value; and the actual cost, though not defined, should be construed in the sense which no commercial man would misunderstand. For that purpose the court referred to the connotation of the said expression in accordance with the normal rules of accountancy prevailing in commerce and ind ustry as well as to the provisions contained in section 108 of the Companies Act, 1956. The court referred, inter alia, to the Statement on Auditing Practices issued by the Institute of Chartered Accountants of India (1974) from which paragraph 2.5 was reproduced. The material part of that paragraph so far as relevant for purposes of these reference reads as under :
'....Cost includes all expenditure necessary to bring the assets into the following may be mentione :-
(i) * * * *(ii) * * * *(iii) * * * * (iv) Interest on borrowings to the extent specified in paragraph s. 222. The relevant part of the said paragraph so far asmaterial for these reference is as under :
'The question often arises as to whether interest on borrowings can be cpaitalised and added to the fixed assets which have been created as a result of such expenditure. The accepted view seems to be that in the case of a newly started company which is in the process of constructing and erecting its plant, the interest incurred before production commences may be capitalised. 'Interest incurred' means actual interest paid or payable in respect of borrowings which are used to finance capital expenditure..... Interest on monies which are specifically borrowed for the purpose of a fixed asset may be capitalised prior to the asset coming into production, i.e., during the erection stage. However, once production starts, on interest on borrowings for the purpose of machinery (whether for replacement or renovation of existing plant) should be capitalised....' 'It would appear from the above that the accepted accountancy rule for determining the cost of fined 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 country.'
24. It was urged on behalf of the revenue placing reliance on the above observation that the interest paid after the assessee-company went into production cannot be allowed to be considered as a part of the cost of plant and machinery and consequently cannot be allowed to be capitalised. In our opinion, while advancing this contention, the revenue has lost sight of the meaning of the term 'interest incurred'. It has been explained in paragraph 2.22 reproduced form the Statement on Auditing Practices that 'interest incurred' means actual interest paid or payable in respect of the borrowings which are used to finance capital expenditure. It may be that the disbursement of interest might have taken place in future, but the obligation to pay interest was already incurred. In should be recalled that the assessee-comp any was maintaining its accounts according to the mercantile system of accountancy which has been explained by the Supreme Court in Calcutta Co., Ltd. v. Commissioner of Income-tax. It reads as under :
'The mercantile system of accounting is well-known and this method has been explained in a judgment of this court in Keshav v. Mills Ltd. v. Commissioner of Income-tax :
'That system brings into credit what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal lia bility has been incurred before it is actually disbursed.'.'
25. In the facts of this case, therefore, the obligation to pay interest under the agreements was incurred immediately when according to the agreements machinery and plant were supplied and transferred to the assessee-company. It was in the calender year 1962 that the assessee-company debited the price of plant and machinery to the account of plant and machinery. The fact that the disbursement of that liability was spread over a period of five years would not, in our opinion, make any difference. In that view of the matter, therefore, we decided on not think that the Tribunal was in error in treating this expenditure as capital expenditure and reversing the order of the Additional Commissioner directing to treat this amount as revenue expenditure. In that view of the matter we answer the questions referred to us in Income-tax Reference No. 54 of 1974 and Income-tax Reference No. 136 of 1974 in the affirmative. In Income-tax Reference No. 78 of 1975, we answer both the question raised by us in the affirmative. The Commissioner shall pay costs of these references of the assessee.