A.C. Sen, J.
1. This is a reference under Section 66(1) of the Indian Income Tax Act, 1922. The following question has been referred to us for our decision.
'Whether on the facts and in the circumstances of the case, the assessee was entitled under the provisions of Sections 10(2)(vi), 10(2)(vi-a) and 10(2)(vi-b) read with Section 10(5) of the Indian Income Tax Act to treat the sum of Rs. 23,53,284 being the amount of interest paid on monies borrowed as part of the actual cost for the purposes of depreciation allowances and development rebate?'
2. Facts relevant to the question referred are as follows.
3. The assessee-company was incorporated on 5th July 1952 and commenced its business from September, 1954. In June 1953, it borrowed rupees four crores on debentures at the rate of 51/4% interest from the public, the interest to run from June. 1953. This sum together with rupees twelve crores financed by the company were used in setting up the refinery for which plant and machinery were imported from abroad. The refinery started work on the 1st September, 1954, from which date depreciation began to be calculated.
4. The assessee-company had capitalised all the expenses incurred during the period of construction including the interest of Rs. 23,53,284, which had accrued from the date of borrowing to the date of the commencement of the business on the aforesaid debenture loan and claimed that depreciation must be allowed on the full amount.
5. The only point for consideration is whether the aforesaid sum of Rs. 23,53,284, paid as interest from the date of borrowing to the date of the commencement of business on the aforesaid debentures, that is to say, during the period of the setting up of the refinery can be said to form part of the actual cost of the refinery. The argument on behalf of the Revenue is that as the said sum was paid to the debenture-holders for procuring the loan it cannot enter into the cost of construction. In other words, according to the Revenue, actual cost of the capital asset, namely, the refinery, includes the cost for procuring materials and services for setting up the capital asset, but not the cost of procuring the funds with which the said materials and services are procured.
6. Let us examine the validity of the above argument. Depreciation and development rebate are allowed on the written down value of the capital asset. Section 10(5)(a) says that written down value means in the case of assets acquired in the previous year, the actual cost to the assessee. Therefore, depreciation and development rebate are allowed in the case of assets acquired in the previous year on the actual cost to the assessee of the capital asset. Capital asset may be acquired by the assessee either out of his own savings or with borrowed capital. When capital asset is acquired with borrowed capital the assessee is ordinarily required to pay interest on such amount borrowed while the capital asset is being acquired, that is to say, until it is fit for the commencement of business. Expenses are incurred by the assessee in buying the other materials including machinery for the construction of the capital asset, in paying wages of labourers engaged for the work of construction and in paying remuneration to erection engineer, architects, designers etc. It is not disputed that such expenses do form part of the actual cost to the assessee in acquiring the capital asset. If a machine is imported from abroad, amounts paid on account of freight and for transporting it from the harbour to the factory site certainly form part of the actual cost to the assessee in acquiring the capital asset. In the case of a machine, invoice price alone is not the actual cost; certain other expenses incurred in installing the machine also enter into the actual cost. Whatever expenses are essential to the erection of the capital asset are certainly included in the actual cost to the assessee. Is the payment of interest essential to the acquisition of a capital asset? When a capital asset is acquired by an assessee with his own money he is not required to pay any interest, so it may be argued that payment of interest is not essential to the acquisition of a capital asset but this argument does not bear scrutiny. Employment of an erection engineer may be necessary in one case and may not be necessary in another. From this it cannot be said that in an appropriate case the employment of an erection engineer is not essential to the erection of a factory. Similarly, where an assessee cannot acquire a plant except with the aid of a loan, the loan is essential to him for the acquisition of the plant, and payment of interest too must be regarded as essential to the acquisition of the plant.
7. It is contended on behalf of the Revenue that in that case when interest is paid even after the commencement of business such interest too must be added to the cost of the plant, The short answer is that such interest is paid after the plant has been established and hence it cannot form part of the cost of establishing the plant.
8. On general principle there is scarcely any distinction between payment made to a supervisor who supervises the erection of a plant and the payment made by way of interest on the amount borrowed for the acquisition of the capital asset. If payment to a supervisor is an element in the actual cost incurred by the assessee in having the plant there is no reason why payment of interest should not be an element in such costs.
9. Let us turn to commercial practice to see whether interest paid on capital borrowed for the establishment of a plant is regarded as an element of the actual cost incurred for its establishment. The Tribunal has quoted an extract from Cropper's Higher Book-keeping and Accounts for the purpose of showing that interest paid on the paid up capital raised for the purpose of providing plant, which, during the long period of construction, will be unproductive of revenue may be capitalised as part of the cost of construction. The extract runs as follows :--
'The student will realise that the principle of allowing interest to be paid and charged to capital in such cases is perfectly reasonable. Capital expenditure over a long period must perforce involve the question of interest as an additional cost. If the work were undertaken by an independent contractor he would, of course, take interest into account when preparing the estimates on which to base his tender. The final cost of construction work is made up of the cost of machinery, materials, labour, supervision and establishment charges, plus interest on capital employed, which, but for its employment in that way, would be invested in good, securities, paying a reasonable rate of interest.'
10. Cropper is clearly of opinion that the interest paid on paid up share capital raised for the purpose of providing a plant until it is ready to go into production forms part of the cost of construction. If that be so, interest paid on debentures issued for the purpose of providing a plant must be an element in the cost of construction.
11. It is argued on behalf of the Revenue that interest on paid up capital raised for the purpose of erecting a plant will be included in cost by an accountant according to the principles of accountancy, but such interest may not be an item of cost for income-tax purposes. We cannot accept this argument. The term 'cost' has not been defined in the Income-tax Act There is nothing in that Act which says, that interest can never form part of cost of construction. That being the position, reference may be made to commercial practice to ascertain the meaning of cost as contemplated by Section 10(5)(a) and the principles of accountancy are in accord with ordinary commercial principles. If an accountant in consonance with the principles of accountancy regards interest as an element of cost and such interest is paid on share capital raised on debentures issued for obtaining a capital asset, he does so according to commercial principles. Therefore, in our opinion, in the instant case, if we apply the principles of accountancy and for the matter of that the ordinary commercial principles there is no reason for excluding the interest paid on the debentures issued till the plant is ready for production from the actual cost of construction.
12. On behalf of the assessee reference has been made to the case of Hinds v. Buenos Ayres Grand National Tramways Co. Ltd (1906), 2 Ch 654, in support of the contention that in the instant case interest on debentures certainly forms, part of the cost of the assessee within the meaning of Section 10(5)(a). In that case, a Tramway Company, for the purpose of converting its undertaking to a system of electric traction, issued conversion debenture stock. The directors passed resolutions that the interest on this stock should be treated as part of the cost of construction, and chargeable to capital account during the construction of the works. The company commenced the works and were carrying them out themselves without employing a contractor. A share-holder in the company issued a Writ asking for a declaration that the interest on the conversion debenture stock was not part of fee cost of the conversion, and ought not to be during any period whatever charged to capital account, but should be considered payable out of revenue. It was held m that case feat there was no general rule of law which compelled companies to charge to revenue account interest on money borrowed for the purpose of constructing works, or prohibited them from charging it, during construction, to capital account, that in the absence of any provision to the contrary companies were entitled to act in the same way as commercial men dealing honestly in their own business and, therefore, that the company were at liberty to charge the interest in question to capital account. The relevant portion in the judgment of Warrington J. is quoted below :--
'Now, what is it that the company are really proposing to do? They are creating a capital asset by means of which they will hereafter earn, or they hope to earn, profits for the company. The are not simply employing contractors to find the money and do the work. They are finding the money themselves, and they find the money by borrowing it. What does each mile of line cost them under these circumstances--what is it that they expend in constructing each mile of line, taking the amount of the borrowed money expended am that line to be 10,0001., that being the company's estimate? The money is borrowed for that particular purpose--The 10,0001. They have to pay interest on that 10,0001, during the period that construction is taking place. In my opinion that asset which they are so constructing costs them not only the 10,0001, but the 10,0001, plus the amount of interest during that period of construction; and that is what they are out of pocket during the construction of that mile of line. Now, it seems to me that the company are entitled--I do not say that they are bound to do it if they think fit to charge in their accounts as the cost of that mile of line not only the 10,0001., but the 10,0001, and the interest on it during the period of construction.'
13. His Lordship is clearly of opinion that there is no general rule of law which compels a company to charge interest on money borrowed for the purpose of construction against revenue, and prohibits it from charging that interest, during construction, to capital account.
14. On behalf of the Revenue it is conceded that the interest paid on the debentures issued is certainly chargeable to capital account but that the interest cannot form part of cost of construction for the purpose of depreciation and development rebate. If the interest paid is chargeable to capital account if ft is paid on borrowings made for the purpose of having a capital asset, it is difficult to understand why interest should not be taken into consideration in determining the actual cost to the assessee in acquiring the capital asset. Interest may be paid as a consideration for procuring the money for the purpose of construction, but if the procreation of the money is necessary for purpose; of construction and if the money so spent represents cost of construction, the interest paid on such money, in our opinion, should be added in order to determine the actual cost. The actual cost is the money so spent plus interest actually paid thereon.
15. The explanation to Sub-section (5) of Section 10 says that for the purposes of this sub-section, the expression '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 that directly or indirectly by Government or by any public or local authority. So, in ascertaining the actual cost, what has to be considered is the actual cost of the assets of the assessee. The interest paid by the assessee who has borrowed money for the purpose of construction certainly forms part of the actual cost of the capital asset so far as the assessee is concerned.
16. It is argued on behalf of the Revenue that the interest is not an expenditure directly made on the capital asset even though it may be indirectly connected therewith. The argument is untenable. When any amount is spent on a Supervisor to supervise the construction it may be said that the amount is not spent on the capital asset directly but indirectly. But it cannot be suggested that the remuneration of fee Supervisor does not form part of the actual cost of construction.
17. The expression 'actual cost to the person charged of machinery or plant' occurs in Schedule 'D' to the English Income-tax Act. Lord Atkin in explaining the meaning of the expression 'actual cost' in Corporation of Birmingham v. Barnes (1935) 19 Tax Cas 195 observed as follows:
'The word 'actual' is used in the same emphatic sense in Rules 2 and 3 of the rules applicable to Cases I and II of Schedule D in respect of actual wages, actual expenditure and actual loss. I do not read actual cost' to mean anything more than cost accurately ascertained.'
18. If actual cost means cost accurately ascertained then certainly a person acquiring a capital asset with borrowed money will take into consideration interest paid during the period of construction in accurately ascertain-big his cost of construction.
19. Reference was made to a recent decision of the Bombay High Court, namely, Habib Hussain v. Commissioner of Income-tax : 48ITR859(Bom) by both sides in support of their respective contentions. The question of interest on money borrowed for acquiring the capital asset was involved in that case. There the assessee obtained a licence from the owner of a plot to erect a cinema theatre, business premises and residential quarters on the land on payment of a rental of Rs. 4200/- per month. For the purpose of erection of the theatre and starting the business the assessee entered into an agreement with the owner of the plot on the 4th June, 1948 by which the latter agreed to help the assessee in getting prepared suitable plans and designs for the cinema theatre and other buildings, in obtaining permission from the Bombay Municipality for constructing additional sixth floor, in procuring the required finance to enable the as-lessee to complete the construction of a modern theatre and other buildings, in procuring various priorities and permits for scarce materials including cement, steel and petrol for transport, in securing import licences and the various goods for the purpose of the cinema theatre, a securing foreign exchange facilities to enable the assessee to import from abroad the goods required for the purpose of the theatre and other buildings and advise the assessee from time to time during the course of construction of the cinema theatre and buildings. In consideration of the aforesaid services and assistance rendered by the owner of the plot the assessee agreed to pay to the owner a sum of Rs. 3,30,000/- within a period of five years by twenty quarterly instalments of Rs. 16,500. The amount of Rs. 3,30,000/- was debited by the assessee at the close of the accounting year, 31st March, 1950. In the assessment years 1950-51, 1951-52 and 1952-53, the assessee claimed that the said sum should be included in the actual cost of all the depreciable assets to the assessee for the purpose of determining the depreciation allowance allowable to him under Section 10(2)(vi) of the Act.
20. It was held by the Bombay High Court that the meaning of the expression 'actual cost to the assessee' as used in Section 10(5) of the Act was what the assessee had, in fact, expended or laid out for the purpose of acquiring the depreciable assets; the expenditure incurred in getting prepared suitable plans and designs for the construction of the cinema theatre, for construction of a minuet theatre, for securing various priorities and permits for scarce materials including cement, steel, piping and petrol for transport, in securing import licences for various goods for the purpose ot the cinema theatre, and for securing foreign exchange facilities to enable the assessee to import from abroad goods required for the purpose of the said cinema theatre, was liable to be included in the cost of the depreciable assets to the assessee, and that, therefore, such portion of the remuneration as was attributable to these services should be included in the cost of the depreciable assets.
21. This case really supports the contention of the assessee. It cannot be gainsaid that interest paid on money borrowed for the purpose of acquiring a capital asset is in fact expended or laid out for the purposes of acquiring depreciable assets. Their Lordships however observed that the services rendered by the owner of the plot in procuring the required finance to enable the assessee to complete on the said plot of land a modern cinema theatre could not be said to be connected with the acquisition of the depreciable assets. No reason has been offered for this conclusion. But even from this conclusion it does not follow that interest paid on money borrowed for the purpose of construction is not in any way connected with acquisition of depreciable assets. Therefore, the case is of no assistance to the Revenue.
22. We, therefore, agree with the Tribunal that the interest paid on the debentures issued forms part of the actual cost incurred by the assessee in acquiring the capital asset and that such interest must be taken into consideration for the purpose of depreciation and development rebate.
23. The question, therefore, must be answered in the affirmative and in favour of the assessee and the assessee will get their costs from the Revenue.
K.C. Sen, J.
24. I agree.