NASIR ASLAM ZAHID, J.- The applicant/assessee is a public limited company, registered under the Companies Act 1913 and is engaged in the manufacture and production of packing material, paper bond etc. During the previous year ending 31.12.1972, the applicant-had borrowed capital from PICIC which was utilized in importing some machinery. The said machinery was installed during the previous year. On such borrowed capital, the ,applicant/assessee had paid interest to PICIC. The Income-tax Officer while framing the assessment for the assessment year 1973-74 in respect of the income of the assessee for the previous year ending 31-12-1972, disallowed a sum of Rs. 1,47,668 out of the interest claimed by the assessee as follows:- "Interest relating to preproduction stage capitalised. However', depreciation @ 10% will be allowed as machinery is installed and used during the year under assessment."
The applicant filed an appeal against the assessment before the Appellate Assistant Commissioner challenging, inter alia, the dis-allowance of the said amount of interest. The Appellate Assistant Commissioner dismissed the appeal on the point of dis-allowance of interest.
The applicant files a further appeal before the Income-tax Appellate Tribunal but the same was also dismissed by order dated 27-7-1980 observing as follows:- "After hearing both the sides and going through the ((I)) cord, we find that the undeniable position before the two officers b low was that capital was borrowed to import machinery, the cost whereof had been capitalised. The machinery was, however, not commissioned during the previous year and hence the interest relatable to loan utilised for this machinery could not be allowed as a revenue expense."
The applicant filed an application under section 126(1) of the Income-Tax Ordinance. 1979 praying that the following two questions be referred to the High Court :- "1. Whether in the facts and circumstances of-the case, the Tribunal was legally justified in confirming the finding of the Income-tax Officer that the sum of Rs.1,47,668 being interest on capital borrowed for import of additional machineries was not an admissible deduction under section 10(2)(iii) of the Income Tax Act, 1922 ?
2. Whether there is any evidence or material on the record in support of the Tribunal's finding that the machineries for the import which capital was borrowed on which interest was admittedly paid during the relevant previous year, was not "commissioned" during the previous year, particularly as depreciation was allowed on the cost of those very machineries ?"
After hearing the representatives of the parties, the Tribunal look the view that the aforesaid question No. 2 did not arise out of the order dated 27-7-1980 of the Tribunal but deemed it necessary to refer the aforesaid. Question No.1 with certain modification to this Court for its opinion.
The Tribunal, therefore, has referred the following question of law to this Court for opinion :- "Whether in the facts and circumstances of the case, the Appellate Tribunal was justified in not allowing the sum of Rs. 1,47,668. Being the interest on loans taken for import of certain machines, under section 10(2)(iii) of the repealed Income-Tax Act, 1922 ?"
2. We have heard Mr. Khalifa Salahuddin, learned counsel for the applicant/assessee and Mr. Sheik Haider, learned counsel for the Department.
3. The question referred to us has to be answered on the basis of the relevant provisions contained in the repealed Income-Tax Act 1922. According to Mr. Khalifa Salahuddin, the interest paid on capital borrowed from PICIC was allowable under section 10(2)(iii) of the Act whereas, according to Mr. Sheikh Haider, the aforesaid provisions was not applicable and section 10(2)(xvi) would apply.
Sub-section (1) of section 10 provides that, subject to the provisions of this Act. The tax shall be payable by an assessee under the head, profits and gains of business, profession or vocation, in respect of the profits or gains of any business, profession or vocation carried on by him. According to sub-section (2) of section 10. such profits or gains are to be computed after making the allowances specified in the various clauses of that sub-section. Clause (iii) of section 10(2) on which reliance has been placed by the assessee makes provisions for allowance in respect of the amount of interest paid on capital borrowed for the purposes of the business, profession or vocation. Clause (xvi) of section 10(2) is as follows:- "Any expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation."
4. Mr. Khalifa Salahuddin, learned counsel for the applicant, in support of his plea that the assessee was entitled to allowance for the aforesaid interest paid on capital borrowed froth PICIC, relied upon the following judgments :-
(a) Calico Dyeing and Printing works vs Commissioner of Income-tax -(1958) 34.I.T.R. 265.
In this case, the assessee who carried on the business of bleaching, dyeing and printing cloth, borrowed money in the year in question in order to extend its business, purchased land and erected an additional plant and machinery and paid interest on the borrowed capital. In its assessm ent to income-tax in the relevant assessment year, claim of the assessee to deduction of the interest so paid under section 10(2)(iii) of the Income-Tax Act, 1922, was rejected on the ground that the plant and machinery were not used for the business in the year in question. It was held by the Bombay High Court, on a reference under Income-tax Act, that the assessee was entitled to the deduction claimed, even though the plant and machinery were not used in the year of account. It was observed that where the assessee claims deduction of interest paid on capital borrowed Under section 10(2)(iii) of the Act, all that the assessee has to show is that the capital which was borrowed was used for the purposes of the business of the assessee in the relevant year of account. It does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset. It was further held that if the capital is used in the year of account and the use is for the purpose of 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.
(b) Challapalli Sugars Ltd Vs. Commissioner of Income-Tax - (1975) 98 I.T.R. 167 (Supreme Court of India).
In this case, the assessee had borrowed money for installation of machinery and interest paid on such loan was claimed by the assessee as part of capital expenditure. The case of the Department was that the said interest was revenue expenditure. In the facts of the case, Supreme Court of India accepted the claim of the assessee making a distinction between a loan taken during the course of business when business had already commenced and a loan taken before the commencement of business. It was held that interest paid before the commencement of production on amounts borrowed by the assessee of the acquisition and installation of plant and machinery forms part of the actual cost of the assets to the assessee within the meaning of the expression in section 10(5) of the Indian Income-Tax Act, 1922, and the assessee would be entitled to the depreciation allowances and development rebate with reference to such interest also. In its judgment, Supreme Court of India distinguished its earlier judgment in India Cements Limited vs. C.I.T. (1966) 60 I.T.R. 52 pointing out that in that case the act of borrowing money was incidental to the carrying on of the business and the assessee was a running concern, whereas, in Challapalli case, the assessee was not a running concern and the loan had been raised by the assessee before commencement of production and not at a later stage.
(c) Commissioner of Income-tax vs. Shah Theatres fol Ltd.- (1988) I. T.R. 499 In this case from Rajasthan High Court (Jaipur Bench), the assessee which carried on the business of exhibition of Motion Pictures/started construction of a cinema and theatre and for that purposes borrowed money. The assessee claimed the interest paid on such borrowing as business expenditure. The Income-tax Officer dis-allowed the claim of interest on the ground that the expenditure was of a capital nature. The Appellate Assistant Commissioner allowed the claim of the assessee for interest on the view that the expenditure was incurred in connection with the extension of an existing business and not for setting up a new business. The Tribunal affirmed the order of the Appellate Assistant Commissioner. On a reference, the High Court affirmed the decision of the Tribunal that the assessee was entitled to the deduction of interest on borrowed capital. In the judgment, Rajasthan High court reviewed the relevant case law from the India jurisdiction on the subject.
As observed, under clause (iii) of section 10(2) of the now repealed Income Tax, 1922, amount of interest paid on capital borrowed for the purposes of the business is an allowable expense. Clause
(xvi) of section 10(2) however, makes it clear that capital expenditure is not an allowable expense.
Under clause (iii), it is not interest on any capital borrowed by an assessee which is admissible but it must be interest on capital borrowed for the purposes of the business of assessee. Interest on capital which has not been borrowed for the purposes of the business is not, allowable under clause (iii). A finding is, therefore, necessary in terms of the requirement of clause (iii) for making an allowance.
6. We may here again refer to the distinction made by the Supreme Court of India in the Challapalli case between a loan taken during the course of business where business had already commenced and a loan taken before the commencement of business and the interest paid on loan taken before the commencement of business could be treated as capital expenditure. It was observed that the accepted accountancy rule for determining cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition and 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 fixed assets created as a result of such expenditure. We agree with the view that interest on loan taken before the commencement of business could be treated as capital expenditure. It follows that interest on capital, borrowed for purposes of business of the assessee, if treated as capital expenditure, will not be an allowable expense under clause (iii) of section 10(2) of the repealed Income Tax Act.
7. In the case before us, we find that interest on the loan was treated as capital expenditure and initial depreciation was also allowed. Capitalisation of the said interest was confirmed by the Appellate Assistant Commissioner. Orders of the Income Tax Officer and the Appellate Assistant Commissioner in this regard were not challenged by the assessee before the Income Tax Appellate Tribunal. Even before us no contention was raised against the orders of the Income Tax Authorities regarding capitalisation of interest. Interest on capital borrowed by the assessee from P.I.C.I.C.
Admittedly being treated as capital expenditure was not covered by clause (iii) of section 10 (2).
8. An argument was raised by Khalifa Salahuddin, learned counsel for the assessee, that the machinery purchased by-the assessee from the capital borrowed from P.I.C.I.C. Had been used by the assessee in its business during the previous year in question and, therefore, the amount of interest on such borrowing was an allowable expense under clause (iii) of section 10(2). In the present case this contention is not relevant. As pointed out, it is the case of the Department as well as the assessee that the interest had been capitalised. If that is so, benefit of clause (iii) could not be extended to cover such amount as an allowable expense.
9. In our view, the Income Tax Appellate Tribunal was justified in not allowing the claim of the assessee in the circumstances of this case where interest on- the loan was capitalised and such orders were accepted by the assessee. The Question referred to us by the Tribunal is, therefore, answered in the affirmative.
There will be no order as to costs.