# CHALLAPALLI SUGAR LTD v. THE COMMISSIONER OF INCOME TAX, A.P. HYDERABAD

- **Citation:** [1975] 2 S.C.R. 538
- **Court:** Supreme Court of India
- **Decided:** 1974-10-31
- **Case number:** Civil Appeal No. 1353. of 1970
- **Bench:** H. R. Khanna, A. C. Gupta
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/challapalli-sugar-ltd-v-the-commissioner-of-income-tax-a-p-hyderabad-6178
- **Pages:** 15

## Headnote

.11ldia11 I11come·Tax Ac:t, 1922, Section 10, secs, 10(2), 10(2)(vl), 10(5) a11d
.exp/a11atlon te1 sec. 10(5) a11d Sectio11 208(1) of Compa11ies Act, 1956 (A'.ct 1
.of 1956)-Payment of tax i11 respect of profits or gains-Interest paid li,efore
commencement of produ,~tion on mo11ey borrowed for acquiri11g and lns1'1//i11g
the machiner.y and plant, if coul<I be capitalised and i11c/uded 111 actual cost.
l11c01nc-rax Act, 1961, as amended by Income-Tax (Amendment) Act, 1972
(Act No. 41 of 1972) Sctions 10(2) (xv) and 40 (1ia)-Wealth•tax pai'd by
.assessee on net wealth, whether deductible as business expendilui~ under sec. S
uf Amending Act.
lo all the three appeals the case of the assessee is that the interest for the
period before the com.men;ement of· production on money borrowed for the ·pur.
pose of acquJ ring a.nd installing the machinery and plant should be included in the
:actual cost of the plant and Ill! such capita.lised for the purpose. In Civil Al'J)ea1
No. 1784, the contention of the assessee is that the wealth-tax payable by the
.nssessee is allowable aR n deduction.
.Allowing Civil Appeal No. 1353. of 1970 and dismhsing Civil Appeals Nos.
1784 and 1785 of 1970.
B
c
D
HELD : (i) So far .as the first question is concero~d the legal position for
-determining lhe actual cost .. for the purpose of development rebate is the same
.as for the purpose of depreciation. A reading of the provisions secs. 10,10(2),
10{2)(vi), 10(5) and the explanation to sec. 10(5) will disclose that, while: coo·
sideriog the question of deduction on account of depreciation and development
rebate the wiitten down value has to be taken into account. Written down value
E
in its tum depends on the actual cost of the assets to the assessee. As the. expres·
sioo "actual cost" .has not been defined in the Act, it should be construed in the
sense which ':no cpmmercial man would misunderstand. It would appear that the
.ae<:epted accountani.:y rule for determining the cost of fixed assets is to iD.clude
all expenditure necessary to bring such assets into existence and to put them in
working condition. lo case money is borrowed by a newly started company which
is in the process of constructing and erecting its plant. the interest i'ocurred before
the. commencement of production on such borrowed money can be capitalise:d and
F
added to the cost of (he fixed assets which have been created as a result of suoh
expenditure. The above rule of accountancy should be adopted for deternlioing
the actual c0st of the a:l'Sets in the absen:e of any staMory definition or other
'indication to' the contrary. [543B-D, E; 545F·HJ
Clause (b) of sub-s1~ction (1) of sec:t.ioo 208 of the Companies Act, 1956,
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
G
·section even though such money constitutes share capital. The same principle,
should hold .sood if interest: is paid on money not raised by way of share 'capital
but taken on ·loan for tlie 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.
[54SH-546C]
It is true that for similar fixed assets there can be different actual costs. The
fact that there would be a difference in the actual cost of the plant in case its
H
machinery is acquired and installed with ihe assessee's own money or in case it is
·acquired and installed with borrowed money does not consequently militate
against the princiole that interest oaid in such circumstances can be ~pitalised
-and induded in the actual cost of machinery and plant. [546F·0]
A
B
c
0
E
F
G
H
CHALLAPALLI SUGAR LTD, v, C.I.T. (Khanna, J,)
539
[{111ds, v, .Buenos Ayres Grant/ National Tramways Co. Limided, [1906]

## Text

_Characters 0–39,696 of 45,575. This is a partial read: ask again with offset=39696 for what follows._

538
CHALLAPALLI SUGAR LTD.
v.
THE COMMISSIONER OF INCOME TAX, A.P. HYDERABAD
October 31, 1974
[H. R. KHANNA AND A. C. GUPTA, JJ.]
.11ldia11 I11come·Tax Ac:t, 1922, Section 10, secs, 10(2), 10(2)(vl), 10(5) a11d
.exp/a11atlon te1 sec. 10(5) a11d Sectio11 208(1) of Compa11ies Act, 1956 (A'.ct 1
.of 1956)-Payment of tax i11 respect of profits or gains-Interest paid li,efore
commencement of produ,~tion on mo11ey borrowed for acquiri11g and lns1'1//i11g
the machiner.y and plant, if coul<I be capitalised and i11c/uded 111 actual cost.
l11c01nc-rax Act, 1961, as amended by Income-Tax (Amendment) Act, 1972
(Act No. 41 of 1972) Sctions 10(2) (xv) and 40 (1ia)-Wealth•tax pai'd by
.assessee on net wealth, whether deductible as business expendilui~ under sec. S
uf Amending Act.
lo all the three appeals the case of the assessee is that the interest for the
period before the com.men;ement of· production on money borrowed for the ·pur.
pose of acquJ ring a.nd installing the machinery and plant should be included in the
:actual cost of the plant and Ill! such capita.lised for the purpose. In Civil Al'J)ea1
No. 1784, the contention of the assessee is that the wealth-tax payable by the
.nssessee is allowable aR n deduction.
.Allowing Civil Appeal No. 1353. of 1970 and dismhsing Civil Appeals Nos.
1784 and 1785 of 1970.
B
c
D
HELD : (i) So far .as the first question is concero~d the legal position for
-determining lhe actual cost .. for the purpose of development rebate is the same
.as for the purpose of depreciation. A reading of the provisions secs. 10,10(2),
10{2)(vi), 10(5) and the explanation to sec. 10(5) will disclose that, while: coo·
sideriog the question of deduction on account of depreciation and development
rebate the wiitten down value has to be taken into account. Written down value
E
in its tum depends on the actual cost of the assets to the assessee. As the. expres·
sioo "actual cost" .has not been defined in the Act, it should be construed in the
sense which ':no cpmmercial man would misunderstand. It would appear that the
.ae<:epted accountani.:y rule for determining the cost of fixed assets is to iD.clude
all expenditure necessary to bring such assets into existence and to put them in
working condition. lo case money is borrowed by a newly started company which
is in the process of constructing and erecting its plant. the interest i'ocurred before
the. commencement of production on such borrowed money can be capitalise:d and
F
added to the cost of (he fixed assets which have been created as a result of suoh
expenditure. The above rule of accountancy should be adopted for deternlioing
the actual c0st of the a:l'Sets in the absen:e of any staMory definition or other
'indication to' the contrary. [543B-D, E; 545F·HJ
Clause (b) of sub-s1~ction (1) of sec:t.ioo 208 of the Companies Act, 1956,
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
G
·section even though such money constitutes share capital. The same principle,
should hold .sood if interest: is paid on money not raised by way of share 'capital
but taken on ·loan for tlie 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.
[54SH-546C]
It is true that for similar fixed assets there can be different actual costs. The
fact that there would be a difference in the actual cost of the plant in case its
H
machinery is acquired and installed with ihe assessee's own money or in case it is
·acquired and installed with borrowed money does not consequently militate
against the princiole that interest oaid in such circumstances can be ~pitalised
-and induded in the actual cost of machinery and plant. [546F·0]
A
B
c
0
E
F
G
H
CHALLAPALLI SUGAR LTD, v, C.I.T. (Khanna, J,)
539
[{111ds, v, .Buenos Ayres Grant/ National Tramways Co. Limided, [1906] 2 Cl.,
D. 654, Corporation of Blrmln;ham v. Barne8 (H. M. Inspector of Taxes), 1!>
Tax Cases t95, India Cements Ltd, v. Comm/ss/011er of Income.tax; Madras,
(1966] 60 !TR 52 referred 10.
Commissioner of lncome·Tax Madras v. L, G. Balakrishnan and Bros. (I')
Ltd, [1974] 95 I.T.R .. 284 and Commissioner of Income-tax v. /. K. Cotton
Sp/111t/11g & Weaving Miils. Income-tax reference No. 234 of
1972 decided
on Muy 13, 1974, by Allahabad High Court, approved.
(ii) In Tra1•t111core Titanium .Product Ltd. v. Commissioner of /nG·ome-Tax,
K<"rala [1966] 60 ITR 277, the Supreme Court held that the amount of Wealth·
Tax paid by nn assessee on his net wealth under the Wealth-Tax Act is not
.i
permissible deduction under sec. 10(2) (xv) of the Act in his income-tax assess·
ment. After this decision when the matter was considered by a larger Bench con·
sisting of five Judges in the case of Indian Aluminium Co. Ltd. v. Commissioner
of Income-Tax, West Bengal, [(1972) 84ITR 735] this Court held that the Wealth.
Tax paid by the assessee which was a trading company on assets held by it for the
purpose of business was deductible as a business expenditure in computing the as·
sessee's income from business. Sub>eque.nt to this decision, the Income-Tax Act,
1961 was amended first by means of an Ordinance and later by means of the In·
come-Tax (Amendment) Act, 1972 (Act No. 41 of 1972). The result of this
amendme11t is that any sum paid on account of Wealth-Tax cannot be deducted
in computing the income of an assessee chargeable under the head "Profits and
Gains of business, profession or Vocation" or "Income from other sources". The
saving clause contained in section 5 of the amending Act provided :-
"Where, before the 15th day of July, 1972 being the date on which
the Income-tax
(Amendment) Ordinance,
1972 came into force, the
Supreme Court has, qit an appeal in respect of the assessment of an as·
sessee for any particular assessment year, held that wealth-tax paid by
the assessee is deductible in computing the total income of that year,
then, nothing contained in sμb-clause (iia) of clause (a) of section 40,
or sub-section (IA) of section 58, of the principal Act, as amended by
this Act, or, as the case may be, section 4 of this Act, shall apply to
the assessment of such assessee for that particular year." [549F-550F]
What is necessary to attract this section is that this Court should have held before
July 15, ·1972 on an appeal in respect of an assessment of the assessee for ·any
particular assessment year that the wealth-tax paid by the a.ssessee is deductible in
computing the total income ·of that year.
Once that is the eff~ of a decision
given by this Court before July 15, 1972 the fact that the judgment in which the
above finding is recorded is given in other appeals, which are heard together along
with the appeal of the assessee, and the further fact that assessee's appeal is not
disposed of before July 15, 1972, would not take the case of the assessee out of
the purview of section 5. The case of the assessee in Civil Appeal No. 1784 is
covered by se.:. 5 of the Amending Act. [551G·552A)
C!vIL APPELLATE JURISDICTION : Civil Appeal No. 1353
of
1970,
From the Judgment and order dated the 5th September, 1969 of
the Andhra Pradejh High Court in Case No. 64 of 1965 and
Civil Appeals Nos. 1784 & 1785 of 1970.
From the Judgment & Order dated the 18th August, 1965 of the
Calcutta High Court in I.T.R. No. 148 and 149 of 1961.
N.A. Palkhivala, S. T. Desai and T. A. Ramachandran, for
the
appellant (in C.A. No. 1353 of 1970.)
V. S. Desai, ]. Ramamurthi and R. N. Sachthey, for the appellant
(in C.A. 1784-85.)
V. S. Desai, J. Ramamurthi, S. P. Nayar and R. N. Sachthey, for
the respondent (in C.A. 1353 of 1970.)
54 0
SUl'REME COURT REPORTS
p 975 J 2 s.c.R.
N. A. P<llkhiwa/a, S. T. Des<li, A. K. Varma, Ral'inder Narain,
J. B. Dculachanji, 0. C. Mathur, and K. J. John, for the Tntc.rvcners
Nos. 1 and 3 (in C.A. No. 1784 .. 85 /70.)
N. A. Pa/khiwalo, Bhakta, J. B. Dadachan;i, R<lviiuler /VL1rai11,
0. C. Mathur, for lntervencrs Nos. 1 and 3 (in C.A. 1784-8Sj70.)
D. N. Gupta ~or Intervener No. 2 (in C.A. 1784·85170.)
The Judgment of the Court was delivered by
KHANNA J.-Appeal No. 1353 of 1970 on certificalc is directed
ag<1inst the j~dgment of Andhra Pradesh High Court whereby the High
Court answered the following question on reference made to it under
section 66(1) of the Indian Income-tax Act, 1922 (hereinafter referred to ~s the Act) against the am:ssee and in favour of the revenue :
"Whether the interest payment of Rs. 2,38,614/-
represents an element on the actual cost of the machinery,
plant etc. to the asseessee and as such depreciation and development rebat() arc admissible with reference to this amount
also ?"
The matter relates to the asS()SSment year 1959-60, the corresponding accounting year for which ended on June 30, 1958. The
assessee is a public limited company engaged in the manufacture and
sale of sugar. The company went into production on January 22,
1958. The assessee company ha.cl borrowed considerable sum of
money from 'the Industrial Finance Corporation of India for th1~ instal·
lation of machinery and plant. During the relevant year and for the
period prior to the commencement of its business the assessee paid
Rs. 2,38,614 as interest. The case of the assessee is that the payment
of interest added to the cost of machinery and plant to the :assessee
and as such while calculating depreciation admissible to the assessee,
the inter1~t paid should be treated. as part of the cost of the machinery
· and plant to the a:ssessee.
The income-tax officer rejected the above claim of the assessee
and held that the interest paid from year to year was an admissible
item of :revenue expenditure and no depreciation could be allowed
· on the . capitalised amount of the expenditure incurred on account of
interest. No part of the above amount, according to the inc1::1me-tax
officer, should be taken as expenditure attributable to the erei~tion of
the machinery or other nssets. The Appellate Assistant Commissioner
-0n appeal reversed the decision of the income-tax officer on this
aspect. The Appdlate Assistant Commissioner held that during the
period <?f constr~ction. when money. was borrowed for the purpose of
pur~~as111g and. ms!31Img the machmery, the payment of inte!·est was
the cost of mamtammg the borrowal" and as such could be i.nc!udr.d
as part of the capital cost. On further appeal the Income-tax
Appellate Tribunal held that the cost to the assessee must include
all expenditure which it had to incur for acquiring and installing the
asset., The !nterest paid or payable during the period of acquisition
and mstallahon could, therefore, be considered as part of the cost to
the assessee.
A
B
c
D
E
F
G
H
A
B
c
CHALLAPALLI SUGAR LTD. v. c.I.T. (Khanna, /.)
541
The question reproduced above was then referred to the High
Court. The High Court held that where a plant is constructed out of
borrowed money, the interest on the loan up to the date of the
cominencement of the business could not be capitalised or treated as
part of the actual cost of the plant .
. Similar question arises in civil appeals Nos. 1784 and 1785 of
1970 which have been filed by the Commissioner of Income-tax on
certificate against the judgment of the Calcutta High Court whereby
the High Court answered the following question in reference under
section 66(1) of the Act for assessment years 1955-56 and 1959-60
against the revenue and in favour of the assessee company :
"Whether qn ·the facts and in the circumstances of the
1:ase, the assessee. was entitled under the provisions of sections 10(2) (vD, 1Q(2}(vi-a) and 10(2)(vi-b) and 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
nionies borrowed at part of the actual cost for the purpose
of depreciation allowances and development rebate ?"
D
In civil appeal No. 1784 of 1970, which relates to the assessment
year 1959~60, the following additional question was also answered
by the High Court against the revenue and in favour of the assessee :
E
F
'
"Whether the wealth-tax payable by the assessee under .
the provisions of the Wealth-tax Act of 1957 is allowable
as a deduction under section 10(1)
or under section
10(2)(xv) of the Indian Income-tax Act?"
The assessee company in these two appeals, M/s Standiltd Vacuum
Refining Co. of India Ltd. (now known as Hindustan Petroleum
Corporation Ltd.), was incorporated on July 5, 1952 and commenced
its business in September 1954. In June 1953 it borrowed rupees
four crores on debenture at th~ rate of Rs. St per cent. interest from
the public. The interest was to run from June 1953. The ·above
amount together with rupees twelve crores financed by the company
was used .in setting up a refinery for which plant and machinery were
imported from abroad. The refinery started work on September 1,
1954, from which date depreciation began to be calculated.
The
assessee company capitalised all the expenses during the period of
construction, including the interest amounting to Rs. 23,53,284 which
had accrued from the date of borrowing to the date of the commenceG ment.of the business on the aforesaid loan and claimed depreciation
on full amount. The income-tax officer did not include interes• on
debentures in arriving at the figure of actual cost and as such rejected
the claim of the assessee in this . respect.' The Appellate Assistant
Commissioner agreed with the Income-tax officer. The Tribunal on
further appeal held that the assessee was also entitled to depreciation
H
on the capitalised interest of Rs .. 23,53,284 paid to the debentore
holders.
The relevant facts so far as the second question in civil appeal
No. 1784 of 1970 is concerned were as follows. The assessee-
542
SUPREME COURT REPORTS
[1975] 2 S.C.R.
company filed a ret~irn showing an income of Rs. 1,52,88,497 for the
assessment year 1959-60, the relevant accounting year for which was
the calendar year 1958.
In arriving at the above figure
o:f the
income the assessee claimed a sum of Rs. 5,04,000 representiJ1g the
provisi~n for wealth-tax payable by it for the previous year re:levant
to the date of valuation, viz., Dec:ember 31, 19~8. The income-tax
officer held that the provision for the payment of wealtID-tax .. did not
amount to expenditure laid out wholly and exclusively for the purposes
of the business.
The Appellate Assistant Commissioner agreed with
the income-tax officer.
On second appeal the Appellate Tribunal held
that the above amount could be allowed at the time when actual payment was. made.
The High Court, as already mentioned, answered both the. questions in favour of the assessee and against the revenue.
This judgment would dispose of all the three civil appeals.
In appeal before us Mr. Palkhivala on behalf of the assessees in
the three appeals has argued that in,terest for the period befor,~ the
commencement of producti.on on money borrowed .for the purpose of
acquiring and . installing the machinery and plant should be included
in the actual cost of the plant and as such capitalised for the purpose.
As against that, Mr. Desai on behalf of the revenue has supported the
view taken by the Andhra Pradesh High Court. After' hearing the
lr.arned c()unsel for the parties, we are of the opinion that the submiSEsion made by Mr. Palkhivala is well-founded.
Before dealing with the contentions advanced, we may set out the
relevant provisions. Section 1@ inter . alia provides for the payment
of tax in respect of profits or gains of any business by an assessee.
Sub-sectiQ!l ( 2) of that section provides that such pr0fits or gains
shall be computed after making the allowances specified therein.
Clause (vi) of that sub-section deals with deductions on account of
depreciation and provides inter alia that deductions would be permissi;,
ble in respect of depreciation of machinery or plant used for the
purpose of business and being the property of the assessee, of a sum
equivalent to such percentage on the written down value thereof as
may in any case or class of cases be prescribed.
"Written down
value" has been defined in sub-section (5) of section 10 in the case
of assets acquired in the previous year, the actual cost to the assessec,
and in the case of assets acquired in the previous year. ·the actual
cost
to
the
assessee,
less
all
depreciation
actually
allowed
to him
under
this
Act
or any
Act repealed · thereby,
or
under executive orders issued when the
Indian lncome--tax Act,
1886 was in for~e. The definition is sub.iect to provisos, but we are
not concerned with them.
The explanation which has been added to
sub-section (5) reads as under :
"Explanation.--For the purpose 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 met directly or indirectly by Government
A
B
c
D
E
F
G
H
A
B
c
D
E
F
G
H
CHALLAPALLI SUGAil LTD. v. C.I.T. (Khanna, 1.)
543
er by any public or local authority, and any allowance in
respect of any depreciation carried forward under clause (b)
of the proviso to clause (vi) of sub-section (2) shall be
deemed to be depreciation 'actually allowed'."
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. So far as the interest after the comme.ncement of
produetion in respect of capital borrowed for the purposes of business is crincerned, the same can be deducted under clause (iii) of subsection (2) of section 10 of the Act.
In finding the answer to the question mentioned above, we have
to bear in mind that it arises ii1''the .context of profits or gains of
business and the permissible deductions on account of depreciation
anq developm~nt rebate relating to the machinery and plant of the
assessee. As the expression "actual cost" has not been defined, it
· should, in our opinion, be construed in the sense which no commercial
man would misunderstand. For this purwse it would be necessary .
to ascertain the connotation of the above expression in accordance
with the normal :rules of accountancy prevailing in commerce and
industry. The word "cost", as observed on · page 424 of Simon's
Taxes B Third Edition, is not synonymous with "price". Other items
of expenditure, such for instance as freight or warehouse charges or
insurance, must in certain cases be added to the price. The matter
has been dealt with in Accountancy by Pickles 1955 Ed. on page 944
under the head "Payment of interest on Construction Capital" as
under:
·
"In the ordinary course of affairs no dividends may be
paid unless such dividends are paid out of profits : interest
o.n debentures (being a ch11rge is, however, payable whether
profits are earned or not). Where company raises share.
eapital and out of the proceeds defrays the expenses of the
construction of any works or buildings or provision of plant
which cannot be made profitable for a lengthened period the
company may pay interest on so much of that share capital
as is paid up for the period and may charge 1o capital the
swm paid by way of interest, provided that the restrictions
imoosed under section 65 of the Companies Act 1948 are
complied with. " ·
-
·
'
4-L319Sup.CI/7S
544
SUPREME COURT REPORTS
(1975] 2 S.C.ll.
It is further observed :
"The interest so paid is 'capitalised', that is to say, it is
treated as part of the cost of constr~c.tion being added theret~
(similarly to legal expenses of acqumng property or brokers
charges <)n purchasing investments)."
In Spicer & Pegler's Practical Auditing 11th Edition it is obscr~ed
on pages 190-{ 91 under the head "Interest Payable Out of Capital
During Construction"
"Interest on debentures issued for a similar purpose can
be charged to capital during the period of construction
(Hinds v. Buenos Ayres Grand National Tramways Co. Ltd.
(1906) 2 Ch. 654)."
In Higher Book-Keeping & Accounts by Cropper Morris
& Fi.son
Seventh Edition, it is observed as under :
"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 the capital employed which, but for its
employment in that way, would be invested in good securities,
paying a reasonable rate of interest."
Section 208 of the Companies Act, 1956 (Act 1 of 1956) deals with
payment of interest on share capital in certain contingencies. Suh·
section ( 1) of that section reads as under:
"(1) Where any shares in a company are issued for the
purpose of raising money to defray the expenses of the cons>-
truction of any work or building, or the provision of any
plant, which cannot be made profitable far a lengthy period,
the company may-·
(a) pay interest 011 so much of that share capital as is
for the time being paid up, for the period and subject
to the conditions a11d restrictions mentioned in subsections (2) to (7); and
( b) charge the sum so paid by way of interest, to capital
as part of the cost of construction of the work or building 04 the provision of the plant."
Exer~ise of. P?Wer u~der sub-section ( 1) is, however,
subject to
cert~m restnctl()ns "Yh1ch have been enumerated in the remaining sul>·
sec!Jons of the s~ction, one of :-Vhich requires that no such paymeni~
shall be made without the previous sanction of the Central Govern ..
ment.
Jn Statement on Auditing Practices issued by the Institute of
Chartered Accountants of India (1974) it is observed in paragrapi'-.
2 . 5 as under :
'
. '.'2. 5 Fixed As~cts should be valued at cost and depreciation should be wntten off on a proper and consistent basis.
A
B
D
E
F
G
H
A
B
c
0
E
F
G
CHALLAPALLI SUGAR LTD. v. C.I.T. (Khanna, /.)
545
....
Cost includes all expenditure neci:ssary
~ brin~ . the
assets into existence and to put them m wrokin~ condition.
By way of illustration the following may be mentioned :-
. (i) Legal charges and stamp duties in the case of land,
(ii) Architect's fees in the case of buildings,
(iii) Wages, salaries and installation expenses in the case
of ma~hinery, and
(iv) Interest on borrowings to the extent specified in paragraph 2.22"
Relevant part of paragraph 2 . 22 reads as under :
''2.22 The question often arises as to whether in~rest
on borrowings can be capitalised and added to the fixed
assets which have been created as a result of such expendir
ture.
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 pl~t, the interest incurred before production commences may be capitalised.
'Interest incurred'
means a~tual interest paid or payable in respect of borrowings which are used· to finance capital expenditure.
In no
circumstances, should imputed interest be capitalised, such
as interest on equity or preference capital at a notional rate.
Interest on capital during construction paid in accordance
with the provisions of section 208 of the Companies Act,
1956, may, however, be capitalised as permitted by that
section.
Interest on monies which are specifically borrowed
for the purchase of a fixed asset may be capitalised prior.
to the asset coming into pro4uction, i.e. during the erection
stage.
However, once production starts, no interest on
borrowings for the purchase of machinery (whether for re>-
placement or renovation of existing plant) should be capitafised ............. "
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 whlch 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.
We have already referred to section 208 of the Companies Act
which makes provision for payment of interest on share capital in
H
certa!n contingencies.
Clause (b) of sub-section (1) of that section
provides that in case interest is paid on share capital issued for the
purpose of raisiJ?g . money to defr~Y. the expenses
of constructing
any work or bu1ldmg or the prov1Ston of any plant in contingencies
546
SUPREME COURT REPORTS
[1975) 2 S.C.R.
mentioned in that section, the sum so paid by way .of interest may
be charged to capital as part of the cost of construction of. t!ie work
or building or the provision of the plant, The a~o~e. proVJs1~n thus
gives statutory recognition to the principle. of cap1tal1smg the mter1~st
in case the interest is paid on money raised to defray expenses of
the construction! of any ;Nork or building or the provisipn of any plant
in contingencies.ment1011ed in that section even though su~h money
constitutes share capital.
Uie same principle, in our opimon, should
hold good if interest is paid on money not raise.ct by. way of share
capital but take~ on loan for the purv.os~ of defraymg t~~ expem1es
of the construction of any work or buildmg or the prov1s1011 of any
plant.
The reason indeed would be stronger in case such in;terest is
paid on money taken on loan for meeting the above expenses.
Mr. Desai has argued that if the interest paid on loan incurred
for the purpose of acquisi1ion and installing the machinery of a plant
is to be taken into accourtt in considedng the actual cost of the plant,
the result would be that the actual cost would be
higher
if
the
machinery for the plant is acquired and installed with borrowed money
compared to the cost of such plant in case the money spent for the
acquisition and installation of the above machinery is that which
belongs to th~ assessee.
This undoubtedly is so but it is inevitable
and should not detract from the conclusion at which we have arrivf:d.
Let us take the case of an archite-ct constructing his house. In ca.se
the architect engages another architect tp prepare the plait for his
house and to supervise its construction and pays remuneration to tl11at
other archited for this purpose, the amount so paid to the other
architect shall have to be taken into account in arriving at the figure
of actual cost of the house.
In case, however, the architect constructing the house himself prepares the plan of the hous_e and supervises
its construction, he. would naturally be not paying any remuneration
to himself for the aforesaid work.
The result would . be that in the
latter event the actual c:ost of the house wotil.d be less compared to
the cost of the house in the ·former event even though the house in
all other respects is identi.cal. It would, therefore follow that for
similar fixed assets there can be differt~1t actual cos~. The fact that
there. would. be a ~ifference i_n the actu~I cost of the plant in case ~ts
machmery 1s acqmred and _ mstalled w:ith the assessee's o'\Vn money
or in case it is. ~cquired .and installed with ?orrowed money does not
consequently militate agamst the answer which we propose to give to
the question referred in the three appeals.
In the cuse of Hinds v. Buel1(Js Ayres Grand National Tramways
Col1!pa~y, Limited(_') a tramway company, for the purpose of co'ti.-
v~rting its undertaking to a system of electric traction, issued convel."-
.sion debenture stock.
The directors passed resolutions that the
i:iterest on this stock should be treated a.s part of the cost of constru·::-
bon, and chargeable to capital account during the cons'ruction of the
work~. 'The mell1;o;andum ~nd artic~es of _association of the company
contamed no prov1s1ons relating to this sub1ect. It was held that thei~
(I) [1906] 2 Ch. D. 654.
A
B
c
E
F
G
H
A
B
c
D
E
G
H
CHALLAPALLI SUGAR LTD. v. C.l.T. (Khanna, J.)
547
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.
It was furt4er h~ld that i? the absence of
any provision to the contrary the company was at liberty to charge
the interest in question to capital account. Dealing with the question
of costs for the purpose of construction -and the question whether the
interest paid on money borrowed for such construction could
be
capitalised, Warrington J. observed :
"Now, what is it that the company ar,e 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.
They 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 circutnstanceswhat is it that they expend in constructing each mile of line,
taking the amount of the borrowed money expended on that
line to be £s 10,000, that being the company's estimate?
The money is borrowed for that particular
purpose-the
£s 10,000. They have to pay interest on that £s 10,000
during the period that construction is taking place. In my
opinion that asset which they are so constructing costs them
not only the £s 10,000, but the £s 10,000 plus the an1ount
of interest during the 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 £s 10,000, but the £s 10,000 and the interest on
it during the p-ei:iod of construction."
Mr. Desai has referred to the decision of the House of Lords in
the case of Corporation of Birmingham v. Barnes (H. M. Inspector of
Taxes).( 1) The appellant corporation in this case entered into aa
agreement with a company to lay a tramway track and establish a
tramway service to the compiμiy's works.
By virtue of the work
having been comp!eted and J_he service established by a certain date, the
corporation received from the company in accordance with the terms
of the agreement, a specified sum.
The corporation also spent considerable. sums of money on the renewal of their tramway tracks and
received in that connection grants from the Unemployment
Grants
Committee.
These grants were made under certain conditions to
local authorities to assist them in carrying out at once
approved
schemes of public utility on which a substantial number of unemployed
persons could be engaged.
It was he)d that the payment by the
company and the grant from the Unemployment Grants Committee
should
not be taken . into account in ascertaining the actual
costs to the
corpor~tlon of the tramway track in question for
the purpose of computmg the allowance due to the corporation for
(I) 19 Tax Cases 195.
548
SUPREME COURT REPORTS
[1975) 2 S.C.R.
wear and tear of such tracks. Lord Atkin observed in the above
case:
"What a man pays for construction or f~r the purchase
of a work s1:ems to me to be the cost to hlDl; and . that
whether someone has given him the money to cons~uct or
purchase for himself, or before the event has promised to
give him the money. after he. has paid for the "'.ork, or ater
the event has pronused or given the money which recoups
him what he has spent. In the present case the Corporation
paid the whole of the cost of the tramways out of their funds
unless the first half of the Dunlop contribution was so
applied : as to which there is no evidence, nor is it material."
The above observations were made in the context whether money
contributed by another party can be taken into account in considet'-
,
ing the cost of construction.
No such ques1ion arises in .the present
ca~e. On the contrary, what we are concerned with here· is whether
interest paid on money borrowed for the acquisition and installation
A
B
c
of the machinery of a plant accruing before the commencement of
D
production can be taken into account in considering the actual cost
of the plant Such a question did not arise in the above mentioned case before the House of Lords.
Another case to which reference has been made on behalf of the
revenue is India Cements Ltd. v. Commissioner of Income-tax
Madras.('). The appellant company in that case obtained a loan
of Rs. 40 lakhs from the Industrial Finance Corporation by creating a charge on its fixed assets. In connection therewith the company
spent a siμn of Rs. 84,633 towards stamp duty,
registration fees,
lawyer's fee and claimed this amount as business
expenditure. It
was held that the amount spent was not in the nature of capital
expenditure and was laid Olllt or expended wholly and exclusively for
the purpose of the: assessee's business and was therefore allowable as
a deduction under section 2(xv) of the Act. The act of borrowing
money, it. was observed, was incidental to the carrying on of business
and the loan obtained was not an asset or an advantage of enduring
nature.
This Court accordingly held that the amount of Rs. 84,633
was an allowable expenditure.
This case too is of no assistance to
the revenue.
The appellant company in that case at the time it
raised the loan was a running concern. Unlike the assessees in the
p;esent appeals, the loan raised by the appellant company in the
cited case was not before the commencement of production but at a
later stage.
The question c~f in~ludin~ the interest paid
on loan
b~fore the. co1;11mencement ol busmess m the actual cost of the plant
dtd not anse m that case.
•
It may be mentioned that as against the view
taken by the
Andhra Pradesh High Court in the judgment which is the subject
(I) [ 1966] 60 I.T.R. 52.
E
F
G
H
B
c
CHALLAPALLI SUGAR LTD. v. c.LT; (Khanna, I.)
54.9
matter of the apj>eal, three other High <;:ourts have taken the contrary
view and have ·held that interest paid in such circumstances can be ·
capitalised and included in the actual cost of the machinery and plant.
The deeision of the Calcutta High Court in which the contrary view
bas been taken is the subject matter of appeal before us. The view
of Calcut~ High Court. has been followed by the Madras High Court
and the Allahabad High Court. The. decision of the Madras High Court
is in the case of Commissianer of Income..tax Madras v. L. G. Balakrislman and Bros. (P) Ltd.,(t) while that of the Allahabad High
Court is in the case of Commissioner of Income-tax v. /. K. Cotton
. Spinning & Wvg. Mills( 2). After giving the matter our consideration, we are unable to subscribe to the view taken by the Andhra
Pradesh High Court. The correct view. in the matter, in our opinion,
has been taken oy the Calcutta High Court and we afiairm the same.
We may now advert to the second question in civil appeal
No, 1784 on the point whether the wealth-tax payable by the
assessee is Wlowable as a deduction. The High Court, as already
mentioned, answered the second question in favour of the assessee.
Subsequent to the judgment of the High Court this Court in the case
of Travancore Titanium Product Ltd. v. Commissioner of Income-tax
D · Kera/a( 8 ) held that th.e amount of wealth tax paid by an assessee
on his net wealth under the Wealth-tax Act is not a permissib'.e dedu~
i'tion under section: 10(2)<xv) of tl).e Act in .his income-tax assessment. This Court in that context observed that wealth-tax is imposed.
on the owner of assets and not ort any commercial activity. The
fact that in certain special cases the quantum of the liability of a
company to wealth-tax is related to the profits earned would not
alter the character of the tax. It remains a tax charged upon the
E
F
G
H
net wealth and it is not made a tax related to or incidental to the
carrying on of business.
After the above decision, the matter was considered by a larger
Bench consisting of five Judges in the case. of Indian Aluminium Co.
Ltd. v, Commissioner of Income-tax West Bengal(4). This Court held
that the wealth-tax paid by the assessee which was a trading company
on assets held by it for the purpose of business was deductible as
a busines.s expenditure in computing the assessee's income from business. Sikri, C.J. speaking for four of the Judges observed 'that when
a person has a dual capacity of a trader-cum owner, and he pays tax
in respect of property which is used. for the -purpose of trade, the
payment must be taken: to be in the capacity of a trader according
to ordinary commercial principles.
·
Subsequent to the above decision in the case of Indian Aluminium
Co, (supr~) the lnc<?m~tax Act, 1961 was amended first by means
of \Ill ordinance and la~r by means of the Income-tax (Amendment)
Act, 1972 (Act No. 41 of 1972). By section 2 of the amending
Act sub clause (iia) was inserted and was deemed always to have been
(1) [1974) 9S I.T.R. 284,
(2) Income-tax reference No. 234 of 1972 decided on May 13, 1974.
(3) [1966) 60 I.T,R. 277.
(4) [1972) 84 I.T.R. 73S.
550
suPREME couRT REPORTS
L1975] 2 s.~.R~
inserted in clause (a) ,~f section 40 of the Income-tax Act 1961 as
under:
"(iia) any sum paid on accoun.t of wealth-tax."
An explanation was adde:d to the above sub-clause, but it is not
necessary to reproduce th<i same. Section 40 of the Indian Income-t~x
Act, 1961 spec.ifies the amounts which shall not
~? deducted .m
computing the mcome charge:o.ble under the ~eads Profits or ga;ns
of business or profession". According to section 4 of the amending
Act, nothing contained in the Indian Income-tax .Act, 1922. shall be
deemed to authorise, or shall be deemed ever to have authonsed, any
deduction in the computation of the income of any assessee chargeable
under the head "Profits and gains of business, profession or vocati~n"
or "Income from other sources" for the assessment year commencmg
on the 1st day of April, 1957 or any subsequent assessment year,
of any sum paid on accotmt of wealth-tax.
In viiw of the above provisions, it is plain that any sum paid on
account of wealth-tax cannot be deducted in computing the income of
an assessee chargeable under the head "Profits and gains of business,
profession or vocation'' or "Income from other sources". There is,
however, a saving clause contained in section 5 of the amending Act
and it reads as under :
"Where, before the 15th day of July, 1972 being the
date on which the Income tax (Amendment)
Ordinance,
1972 came into for~~.