Madhya Pradesh H.C : Whether, on the facts and in the circumstances of the case, the CIT had jurisdiction to revise the orders of of assessment under s. 263 ?

Counsel Appeared

B.L. Nema, for the Assessee : B.K. Rawat, for the Revenue

C.P. SEN, J.:

This judgment will also dispose of Misc. Civil Case No. 216 of 1981 (Kashiram Ramgopal vs. CIT) as a common question is required to be answered by this Court. As per directions given by this Court in the order dated October 13, 1980, passed in Misc. Civil Cases Nos. 113 of 1976 and 114 of 1976, the Tribunal has referred the following two questions for opinion of this Court, in respect of the asst. yrs. 1968-69 and 1969-70.

” 1. Whether, on the facts and in the circumstances of the case, the CIT had jurisdiction to revise the orders of of assessment under s. 263 ?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in disallowing interest paid to the M. P. State Finance Corporation ? “

In the other case (Misc. Civil Case No. 216 of 1981) reference has been made by the Tribunal as per order of this Court dated October 13, 1980, in Misc. Civil Case No. 483 of 1975, referring the second question for the opinion of this Court.

The assessee is a registered partnership firm carrying on business in grains, oil-seeds, pulses, hemp, rice and dal mill, with its head office at Seoni and branches at Calcutta, Banaras and Kawlari. The firm wanted to expand its business by starting a factory to utilise the waste product of the rice and dal mill for manufacturing straw-boards and for that purpose took a loan from the M. P. State Finance Corporation. The factory actually started production in the asst. yr. 1971-72, which means, that in the assessment years in question, the factory had not commenced its production. This reference arises out of assessment for the asst. yrs. 1968-69 and 1969-70 and the other reference arises out of assessment for the asst. yr. 1970-71, Deepawali year 2025-2026 (previous year ending on November 9, 1969).

4. The ITO, while completing the assessment of the assessee in the status of a registered firm under s. 143(3) of the IT Act, 1961, determined the total income at Rs. 91,690 and Rs. 84,803, respectively, amongst others, allowing deduction of interest paid to the M.P. Finance Corporation for the loan taken for setting up Kasturi Straw-board Factory by the assessee. The deduction allowed by the ITO under s. 36(1)(iii) was Rs. 6,352 for the asst. yr. 1968-69 and Rs. 19,934 for the asst. yr. 1969-70. Appeals were preferred by the assessee and the AAC deleted some of the additions made by the ITO, but did not consider allowance of deduction made by the ITO towards payment of interest to the M. P. State Finance Corporation. But, in the meanwhile, the CIT by invoking his powers under s. 263 of the Act, reviewed the assessment, by disallowing interest paid to the M.P. State Finance Corporation, by saying that the deductions were not considered by the AAC and that the interest was not deductible as the straw-board factory had not commenced production in those assessment years and actually started production only in the year 1971-72. The order was affirmed in appeal by the Tribunal. For the asst. yr. 1970-71, the ITO did not allow deduction of Rs. 38,581 towards interest paid to the M. P. State Finance ‘Corporation, in view of the orders passed in the previous assessment years as the payment did not pertain to the existing business. But, on appeal, the AAC allowed deduction of interest, saying that the assessee will be entitled to the deduction claimed, even though the plant and machinery purchased for the new business were not used in the year of account, by relying on Calico Dyeing and Printing Works vs. CIT (1958) 34 ITR 265 (Bom). On appeal by the Department, the Tribunal restored the order of the ITO, holding that production started in the next assessment year, i.e., 1971-72, and, therefore, the amount cannot be deducted under s. 36(1)(iii), as no business was carried on by the straw-board factory, which was still under construction, erection and installation. The Tribunal relied on the decision of the Supreme Court in CWT vs. Ramaraju Surgical Cotton Mills Ltd. (1967) 63 ITR 478 (SC). Question No. 1 is taken up first. The CIT reviewed the assessment for the asst. yrs. 1968-69 and 1969-70, under s. 263 of the Act, and negatived the plea of the assessee that the order of the ITO had merged in the order of the AAC and as such could not be reviewed. The CIT held that since the question of disallowance of interest on borrowings from the M. P. State Finance Corporation was not considered in the appeal before the AAC, there was no question of merger of the ITO’s order on this point in the order of the AAC since the straw- board factory had commenced production only in the next assessment year, i.e., 1971-72. Interest paid could not be deducted under s. 36(1)(iii) of the Act, as in the assessment year in question, the factory was still under construction, erection and installation and it cannot be said that interest was paid for the business of the assessee. The matter is concluded by a recent Full Bench decision of this Court in CIT vs. K. L. Rajput (1987) 59 CTR (MP) 65 : (1987) 164 ITR 197 (MP), where it was held (headnote) : ” The doctrine of merger applies to income- tax proceedings but the extent of its application depends on the scope and subject- matter of the appeal and the decision rendered by the appellate authority. Where an appeal has been preferred by the assessee to the AAC from an order of assessment made by the ITO in respect of only some of the items covered by the ITO’s order and the remaining items, forming part of the ITO’s assessment order, were not agitated or the AAC did not consider them suo motu and no decision of the AAC is, therefore, made in respect of the remaining items, the ITO’s order merges with the appellate order of the AAC, only to the extent it was considered and decided by the AAC, but the matters which are not covered by the appellate order of the AAC are left untouched and to that extent, the ITO’s assessment order survives permitting exercise of revisional jurisdiction by the CIT under s. 263 of the IT Act, 1961. ” Therefore, the first question is answered in the affirmative and in favour of the Revenue.

Regarding the second question, we are of the opinion that the Tribunal was not justified in disallowing interest paid to the M. P. State Finance Corporation, amounting to Rs. 6,552 for the asst. yr. 1968-69, Rs. 19,934 for the asst. yr. 1969-70 and Rs. 38,581 for the asst. yr. 1970-71 towards the capital borrowed from the M. P. State Finance Corporation for starting Kasturi Straw-board factory. It is not disputed that the factory commenced its production in the next year, i.e., 1971-72, and it was at the stage of construction, erection and installation in the earlier assessment years. Sec. 28(i) of the Act provides that the following income shall be chargeable to income- tax under the head Profits and gains of business or profession’,— (i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year’.”

7. Sec. 36(1)(iii) provides for deduction to be allowed in the computation of income referred to in s. 28, of the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession. Admittedly, amongst others, the assessee is carrying on the business of running a rice and dal mill and husk is the waste product of the mill which can be utilised as raw material in the manufacture of straw-boards. That is the reason for which the assessee decided to start a straw- board factory to utilise the waste material of the mill as a raw material for manufacturing straw-boards. For this purpose, the assessee borrowed capital from the M. P. State Finance Corporation and started constructing, erecting and installing the straw-board factory. In fact, this is only an expansion of the existing business of the assessee and it is not a case of starting altogether a new business for that purpose. Therefore, the assessee is entitled to deduct interest paid under s. 36(1)(iii) of the Act from the total income. We are fortified in our view by a direct decision of the Allahabad High Court in Prem Spinning and Weaving Mills Co. Ltd. vs. CIT (1975) 98 ITR 20 (All), the facts of which were more or less similar to the facts of the present case. There, the assessee-company was running a spinning and weaving will and had set up a straw- board manufacturing factory and for that purpose took a loan from the U. P. Financial Corporation. The assessee claimed deduction of the interest paid towards the loan, but the same was disallowed by the Tribunal holding that the straw-board factory was an altogether fresh undertaking with the help of surplus funds and also of borrowed funds and could not be identified with the existing business and the business for which capital was borrowed had not yet started production. It was held (headnote) : ” The memorandum of association of the assessee-company specifically stated as one of the objects of the company the manufacture of straw-board. The straw-board factory was set up by the assessee by utilising its existing surplus funds and by borrowing. The assessee controlled both the ventures of spinning and weaving mills as well as the straw-board factory. The management, trading organisation, administration, funds and the place of business were identical. It could not, hence, be said that the setting up of the straw-board factory was initiation of a different business by the assessee and on that ground the expenditure could not be disallowed. The decisive test was unity of control and not the nature of the two lines of business. “

It is nobody’s case here that the ownership and management of the straw-board factory is by somebody else other than the assessee. On the other hand, it is undisputed that the assessee decided to start the strawboard factory to utilise the waste product of husk for manufacturing strawboard and for that purpose borrowed moneys from the M. P. State Finance Corporation and started erecting the factory and so it was in fact expansion of the existing business and, therefore, it could be said that interest was paid for the business of the assessee. An inference has been drawn that they are separate concerns merely because separate books of account are maintained by the assessee for the straw-board factory.

In Calico Dyeing and Printing Works vs. CIT (1958) 34 ITR 265 (Bom), it was held that if the capital is used in the year of account and the use is for the purpose of the business of the assessee, it is immaterial whether the user of the capital actually yielded profit or not and it is not open to the Department to reject the claim of the assessee in respect of the interest paid on that capital merely because the use of the capital is unremunerative. Similar view has been taken by this Court in Ram Kishan Oil Mills vs. CIT (1965) 56 ITR 186 (MP), that when the ITO finds that the borrowing transaction was not illusory or colourable and that the capital was borrowed by the assessee for the purposes of the business and the amount of interest was paid, then the claim made by the assessee for deduction on account of the interest paid on borrowed capital has to be allowed. The Supreme Court, in State of Madras vs. G.J. Coelho (1964) 53 ITR 186 (SC), has held that there is no distinction between interest paid on capital borrowed for the acquisition of a plantation and interest paid on capital borrowed for the purpose of an existing plantation. Both are for the purposes of the plantation.

10. Therefore, the second question is answered in the negative, in favour of the assessee by holding that the Tribunal was not right in disallowing interest paid by the assessee to the M. P. State Finance Corporation for the assessment year in question.

11. The cases referred by the Tribunal, in support of its decision are clearly distinguishable. In CWT vs. Ramaraju Surgical Cotton Mills Ltd. (1967) 63 ITR 478 (SC), the assessee was manufacturing absorbent cotton wool and resolved to establish a new spinning unit. The construction of the mill was started in 1956 and completed in 1957. In the assessment to wealth-tax, the assessee claimed deduction of the amount which was laid out in setting up the new unit, under s. 5(1)(xxi) of the WT Act. The Supreme Court held that a unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up and it is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organisation that it can be said that the unit has been set up. It was a case of setting up altogether a new business for the purpose of the WT Act.

12. In Challapalli Sugars Ltd. vs. CIT (1975) 98 ITR 167 (SC), the Supreme Court held that 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 created as a result of such expenditure. This was a case of a new factory being set up and not expansion of the existing business. A Full Bench of the Kerala High Court in CIT vs. Travancore-Cochin Chemicals Ltd. (1975) 99 ITR 24 (Ker) also held that interest paid on borrowed capital till the building, plant or machinery is erected or constructed is part of the actual cost of the project within the meaning of s. 33 r/w s. 43 of the IT Act, 1961, for the purposes of development rebate claimed by the assessee. Again, this was a case of a new factory being set up for the first time.

13. Similar is the view taken by the Madras High Court in CIT vs. L. G. Balakrishnan and Bros. (P.) Ltd. (1974) 95 ITR 284 (Mad), holding that the interest paid on the amount borrowed for the purchase of machinery had rightly been capitalised as part of the cost of the machinery and the Tribunal was right in allowing the assessee’s claim for depreciation and development rebate on this amount also. This was also a case of starting a new business.

14. The questions are answered accordingly, the first question in the affirmative in favour of the Revenue and the second in the negative in favour of the assessee. In the circumstances of the case, there shall be no order as to costs.

[Citation : 170 ITR 41]