The Judgment of the Court was delivered by
DIVAN C.J. - In this case the Tribunal has referred two questions to us, one at the instance of the assessee and the other at the instance of the revenue. The facts leading to this reference are as follows :
The assessee is a public limited company and follows the mercantile system of accounting. The assessment year under consideration is 1964-65, the relevant previous accounting year being the financial year 1963-64. The assessee manufactures safety glasses, wired glasses and figured glasses. The assessee started construction of its factory at Anand in Kaira District in the accounting year 1961-62 and imported machinery from West Germany for the erection of this factory. The erection and installation of machineries were mainly entrusted to German technicians who had been directly delegated by the West German suppliers of the machinery. The plant was commissioned and put into service from October 9, 1963. The assessee company incurred various expenses before the commencement of production. The expenses which were incurred, amounting to Rs. 4,80,873, had been capitalised and the assessee claimed depreciation thereon. These items of expenditure were debited to factory building and various plants and machinery but the ITO noted that they included an aggregate amount of Rs. 1,13,790 representing payment of salary, pocket money, etc., to the foreign technicians employed in the erection work. In his order the ITO discussed the position and concluded that except for Rs. 1,18,790 the rest of the expenses, that is, the sum of Rs. 3,67,083, were of the nature described in ss. 30 to 36 and would be allowable either under those sections or under s. 37 as revenue expenditure but for the fact that the expenses were incurred prior to the commencement of business at Anand factory. At these initial expenses were incurred prior to the commencement of business, they were disallowed as capital expenses but as none of them brought into existence any tangible or depreciable assets or added to the value of depreciable assets, he did not allow any depreciation in respect of Rs. 3,67,083, that being the difference between the aggregate amount of Rs. 4,80,873 which was claimed by the assessee as available for depreciation and the aggregate of Rs. 1,13,790 which was the amount allowed by the ITO. On appeal by the assessee, the AAC agreed with the view of the ITO and dismissed the assessees appeal as regards this item. The assessee went in further appeal to the Tribunal. The Tribunal found that the exact nature of the work done by the foreign technicians had not been explained and the ITOs statement that the majority of the expenses were in the nature of expenses described in ss. 30 to 36 or were deductible under s.37 but for the fact that the expenses were incurred prior to the commencement of the factory, had not been disputed. The Tribunal also dismissed the assessees appeal regarding this item of Rs. 3,67,083.
An item of Rs. 72,537 has also been the subject-matter of appeal before the Tribunal. This amount of Rs. 72,537 represented the salary and perquisites of foreign technicians incurred after the commencement of production. This item was disallowed by the ITO. The assessee had capitalised a substantial portion but claimed Rs. 72,537 being the salary, pocket money, rent, etc., incurred for these German technicians as revenue expenditure. The ITO did not allow the claim. The AAC also, for reasons discussed by him, confirmed the order of the ITO and the Tribunal held that the amount was entitled to be capitalised and was available for depreciation and development rebate if the other conditions were fulfilled. In the original order which the Tribunal passed, the tribunal had not allowed depreciation regarding this item but subsequently by a rectification order it directed as above and thereafter two questions have been referred to us, one at the instance of the assessee, namely :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was not entitled to depreciation on expenditure of Rs. 3,67,083 out of Rs. 4,80,873 being expenditure incurred prior to the commencement of the factory at Anand ?'
and the other question at the instance of the Commissioner, namely :
'Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the salary and perquisites paid to foreign technicians after the commencement of the business, namely, Rs. 72,537, should be capitalised and added to the cost of the machinery entitling it to the claim of depreciation and development rebate ?'
Now, it must be pointed out that the application under s. 256(1) of the I.T. Act, 1961, was by the assessee. There was no application by the revenue asking that a particular question regarding Rs. 72,537 should be referred to the High Court for its opinion. Under these circumstances, the question arises whether the Tribunal was right in referring the question which it directed to be referred at the instance of the revenue. In this connection, it may be pointed out that there has been a recent decision of the Supreme Court in CIT v. V. Damodaran : 121ITR572(SC) . There the Supreme Court has pointed out (headnote) :
'In every case, it is only the party applying for a reference who is entitled to specify the question of law which should be referred. Nowhere in the I.T. Act, 1961, is there is a right given to the non-applicant to ask for a reference of a questions of law on the application made by the applicant. Where the order of the Tribunal under s. 254 has decided the appeal partly against one party and partly against the other, the party who is aggrieved and who desires a reference to the High court must file a reference application : It is not open to him to make a reference application filed by the other party the basis of his claim that a question of law sought by him should be referred. Where, however, the order made by the Tribunal operates entirely in favour of one party, although in the course of making the order the Tribunal may have negatived some points of law raised by that party, not being a party aggrieved by the result of the appeal, it is not open to that party to file a reference application. On a reference application being filed by the aggrieved party, it is open to the non-application to ask for a reference of those questions of law which arise on its submissions negatived in the appeal by the Tribunal.'
In the instant case, the Tribunal has negatived some of the legal submission made by the revenue on the question of Rs. 72,537. The appeal before the Tribunal was partly decided against the revenue so far as the question of Rs. 72,537 was concerned and partly decided against the assessee in so far as the question of Rs. 3,67,083 was concerned. Under these circumstances, it was not open to the non-applicant, that is, the Commissioner, to make a reference application filed by the assessee the basis of his claim that a question of law should be referred. Hence, it was not competent to the Tribunal to refer the question that it has done at the instance of the Commissioner.
After the above decision of the Supreme Court in CIT v. V. Damodaran : 121ITR572(SC) , a similar point arose before a Division Bench of this high Court in CIT v. Mascalchi Mario (Income-tax Reference No. 185 of 1978, decided on February 25, 1980 (see p. 49 infra (Appendix II)). There, after citing the principle laid down in CIT v. V. Damodaran, the Division Bench observed that reference in such a case would be void and that such a void reference could not be entertained. Accordingly, the Division Bench declined to answer the question which had been referred to the High Court for its decision at the instance of the non-applicant. Following the same principle it must be held in the instant case also that the reference of question No. 2 at the instance of the Commissioner was void reference because the Tribunal had no jurisdiction under the provisions of the I.T. Act to make that reference. Hence, so far as question No. 2 is concerned, we decline to answer question No. 2 which has been referred to us in the instant case at the instance of the Commissioner.
As regards question No. 1, that is, the question referred to us at the instance of the assessee, the ITOs order points out how the aggregate amount of Rs. 4,80,873 was claimed by the assessee, that being the amount in respect of which depreciation should be allowed. In para. 16(b) of his order the ITO has pointed out that the construction and installation of machineries and plants imported from West Germany in the factory at Anand was completed and the production was commenced from October 9, 1963. Erection and installation of machineries was done by the German technicians, majority of whom were directly delegated by 'Image' of West Germany, which supplied the said machineries to the assessee-company. In all, there were eight German technicians for each of whom there was a separate service agreement, copies of which had been furnished to the ITO. The details of payments made to and expenditure incurred for these technicians during the year relevant to the assessment year 1964-65 show that the total expenditure came to Rs. 1,13,790 and that expenditure was, as we have said, allowed as being available for depreciation. In para. 19 the rest of the items aggregating to Rs. 4,80,873 have been dealt with by the ITO. The details of the expenditure amounting to Rs. 4,80,873 are given as annex. 'D' to the order of the ITO. The break-up shows that the items of capital expenditure had been debited to factory building, furnace plant (R-20), further plant (R-100), laminating plant, batch house plant and electric machinery. The ITO then considered the question whether the assessee was entitled to depreciation on the above capitalised expenditure amounting to Rs. 4,80,873. 'Capital expenditure', according to the ITO, had not been defined in the Act and it has often been said by the judiciary that it is difficult to lay down a general test which is both sufficiently accurate and reliable to cover all or even a great number of possible cases. According to the ITO, the expenses which bring into existence an enduring benefit to the business without an addition to the value of any capital asset are of capital nature but no depreciation on the amount spent for the acquisition of such an advantage is admissible under s. 32 of the Act. Albeit, by such an expenditure an asset of intangible nature may have come into existence, but such an asset is not contemplated by s. 32 of the Act for the allowance of depreciation. According to the ITO, the expenditure shown in annex. 'D' was all of the nature of initial expenditure, having been incurred prior to the commencement of the business and the same was regarded as on capital account, for it was incurred not for earning the profits but in setting the profit-earning machinery in motion. According to the ITO, an outlay even though of revenue nature is deemed to be of capital nature, when it is made for the initiation of a business, when it is made for the acquisition of a business. The said expenses have been incurred for the acquisition of an asset, the acquisition of which was a condition precedent to the carrying on of the business. For an allowance of depreciation under s. 32, according to the ITO, the asset which had been acquired by any expenditure should not only be a tangible asset but should also be of depreciable nature. As we have pointed out earlier, the ITO came to the conclusion that if this item of expenditure had been incurred after the factory started production, the amount would have been allowed either under ss. 30 to 36 or under s. 37 of the I.T. Act, and this position was not disputed before the Tribunal when the matter reached the Tribunal.
As pointed out earlier, the AAC merely confirmed the order of the ITO and the Tribunal, while dealing with this part of the claim of the assessee, merely states :
'In our view, therefore, these are expenses of revenue nature but having been incurred prior to the starting of the factory these are expenses of preliminary nature which cannot be capitalised in such a way as to allow depreciation. Hence, we do not see any substance in this ground.'
The question as to what is to happen to expenses incurred by an assessee up to the stage of commencement of regular production has been dealt with by the Supreme Court in Challapalli Sugars Ltd. v. CIT : 98ITR167(SC) . The question before the Supreme Court was as to how the interest paid before the commencement of production on amounts borrowed by the assessee for the acquisition and installation of plant and machinery should be treated, namely, whether they should be treated as part of the actual cost of acquisition of the capital asset in question. The question arose before the Supreme Court in the context of the question whether depreciation was allowable in respect of this component of the actual cost, the component being the interest paid before commencement of production on amounts borrowed for the acquisition and installation of the plant and machinery. Khanna J., speaking for the Supreme Court, pointed out that there was no definition in sub-s. (5) of s. 10 of the Indian I.T. Act, 1922. At page 172 of the report (98 ITR) he has pointed out :
'It has not been disputed that so far as the question before us is concerned the legal position for determining the actual cost for the purpose of development rebate is the same as for the purpose of depreciation.
It would appear from the above that, while considering the question of deduction on account of depreciation and development rebate, we have to take into account the written down value. Written down value in its turn depends upon the actual cost of the assets to the assessee. The expression actual cost has not been defined in the Act, and the question which engages our attention is whether the interest paid before the commencement of production on the amount borrowed for the acquisition and installation of the plant and machinery can be considered to be part of the actual cost of the assets to the assessee.'
After examining the accountancy practice and the standard text books on accountancy, the Supreme Court pointed out at page 175 of the report :
'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.'
Now the Supreme Court had emphasised, apart from the question of interest that all expenditure necessary to bring the assets into existence and to put those assets in a working condition is part of the actual cost of the assets to the assessee and it is in the light of that actual cost thus arrived at that the question of depreciation has to be considered by the I.T., authorities.
In Arvind Mills Ltd. v. CIT : 112ITR64(Guj) , a Division Bench of this High Court consisting of J. B. Mehta J. and one of us (P. D. Desai J.) considered the question in terms of the decision in Challapalli Sugars Ltd. v. CIT : 98ITR167(SC) and pointed out that the expression 'actual cost' in the context of the statutory provisions of ss. 33(1) and 43A of the I.T. Act, 1961, must be understood in the sense in which no commercial man would misunderstand. The word 'cost' is not synonymous with 'price'. Besides the price of machinery and plant, cost takes in other items of expenditure such as freight or warehouse charges or insurance chargers, legal expenses incurred in acquiring a property or brokers charges on purchasing investments, before the commencement of the production, on the capital contributed or borrowed to acquire such assets. In other words, in determining the actual cost of fixed assets, all expenses necessary to bring such assets into existence and to put the assets in working condition may legitimately be taken into account.
To the same effect is another decision of a Division Bench of this High Court in CIT v. Saurashtra Cement & Chemical Industries Ltd., (Income-tax Reference No. 26 of 1973, decided on August 25, 1975 (see p. 47 infra (Appendix I)). In that case the question was whether the amount spent by the cement factory by way of electrical expenses on tests and trials for its cement plant which had not started working at the time when those trial runs were made should be considered as capital expenditure which should be added to the cost of production of cement plant for the purpose of depreciation and development rebate. After pointing out the principle laid down by the Supreme Court in Challapalli Sugars case : 98ITR167(SC) , the Division Bench observed (p. 48 infra (Appendix I)) :
'The Supreme Court accepted this accountancy rule for the purpose of determining the actual cost of assets to the assessee. The expenses required for bringing the assets into working condition are considered by accepted accountancy rule as part of the cost of assets and this being the observation of the Supreme Court regarding the accepted accountancy rule, it is obvious that in the case before us, the amount of Rs. 11,900 which was required for test and trial was necessary for putting the plant in working condition. It is common sense and a matter of common knowledge that test and trial of the plant had to be taken before the plant goes into actual production so that any defects in the plant and machinery can be detected at an early stage and can be rectified and without test and trial no plant can ever go into actual production. Under these circumstances, the amount of Rs. 11,900 incurred for test and trial can properly be considered as part of the cost of fixed assets to the assessee and hence can be taken into consideration as part of the capital expenditure which would qualify for depreciation and development rebate.'
In this instant case, as the Tribunal has pointed out in its order, the statement of the ITO that the majority of the expenses which are in dispute were in the nature of expenses described in ss. 30 to 36 or were deductible under s. 37 but for the fact that the expenses were incurred prior to the commencement of the factory, had not been disputed. This would indicate that these items of expenditure were necessary for the purpose of running the factory but simply because the production had not commenced, the Income-tax Appellate Tribunal and the lower authorities in the I.T. Dept., did not allow these expenses to be added to the cost of construction. It must be borne in mind that all expenses necessary for putting the plant into production stage are part of the cost construction. That is the accountancy principle which has been recognised by the Supreme Court in Challapalli Sugars case : 98ITR167(SC) . If that is so, in the case before us since the total items of expenditure aggregating to Rs. 3,67,083 have not been disputed and the only reason why the amount of Rs. 3,67,083 was not added to the cost of construction was that the items were such as would have been deductible under ss. 30 to 36 or under s. 37 of the I.T. Act, 1961, but for the fact that the expenses were incurred prior to the commencement of the factory going into production, indicates that all these expenses were necessary for putting the new plant of the assessee-company into production and these expenses having been incurred prior to the date of actual production went to swell the actual cost of assets to the assessee-company. As has been pointed out by the Division Bench of this High Court in Arvind Mills case : 112ITR64(Guj) , in Challapalli Sugars case : 98ITR167(SC) before the Supreme Court, apart from the item of interest on the borrowed capital, all other items of expenditure incurred up to the stage of going into production had been capitalised. At page 76 of the report the Division Bench pointed out :
'The assessee-company capitalised all the expenses during the period of construction, including interest amounting to Rs. 23,53,284 which had accrued from the date of borrowing to the date of the commencement of the business on the aforesaid loan.'
Therefore, all items of expenditure incurred during the period of construction of the plant were capitalised and such capitalisation of expenses incurred prior to the machinery going into production was approved by the Supreme Court. It must be pointed out that in Challapalli Sugars case : 98ITR167(SC) before the Supreme Court the only dispute was with reference to the item of interest paid on the amounts borrowed by the assessee-company, being interest for the period prior to the actual commencement of the production of the company, but as regards the capitalisation of the rest of the amounts before the Supreme Court there was no dispute whatsoever and the observation of the Supreme Court were that all expenses necessary for putting the plant into production were part of the actual cost of the plant and machinery to the assessee and it was in the light of that actual cost that depreciation and development rebate would have to be worked out.
In the instant case, the finding of the Tribunal is that these expenses of Rs. 3,67,083 had been incurred prior to the plant of the company going into production. They were leading up to the stage of production. Necessarily, therefore, they were required to be incurred by the assessee-company for putting its plant into production. The actual production, as we have pointed out earlier, started on October 9, 1963. Therefore, the amount of Rs. 3,67,083 being the aggregate amount of expenses incurred under different heads for the period prior to the commencement of the production must be treated as part of the actual cost of its plant and machinery to the assessee.
Under these circumstances, the conclusion of the Tribunal that the assessee was not entitled to depreciation of Rs. 3,67,083 out of Rs. 4,80,873 being expenses incurred prior to the commencement of the factory at Anand was not correct. In the light of the decision of the Supreme Court in Challapalli Sugars case : 98ITR167(SC) , it must be held that the expenditure of Rs. 3,67,083 was incurred as part of the actual cost of the plant and machinery in question to the assessee and, therefore, the assessee was entitled to depreciation on this item of expenditure.
We, therefore, answer question No. 1 referred to us at the instance of the assessee in the negative, that is, in favour of the assessee and against the revenue. As we have indicated earlier, in view of the legal position arising from the decision of the Supreme Court in CIT v. V. Damodaran : 121ITR572(SC) , we decline to answer question No. 2 which has been referred to us at the instance of the Commissioner, who was non-application before the Income-tax Tribunal at the stage when the application under s. 256(1) was heard by the Tribunal.
This reference is disposed of. The Commissioner will pay the costs of this reference to the assessee.