PACKAGES LIMITED VS COMMISSIONER OF INCOME-TAX, 1993 PTD-SUPREME-COURT 758 (1993)

(On appeal from the judgment of the High Court of Sindh at Karachi, dated 29-8-1991 passed in 1TR No.12 of 1983).

(a) Income Tax Act (XI of 1922)---

----S.10(2)(iii) & (xvi)---Constitution of Pakistan (1973), Art.185(3)---Assessee claiming deduction of interest on loan borrowed by him for import of machinery---Income Tax Officer disallowed such claim on the ground that interest relating to "pre-production stage" was being capitalised by him, he however, allowed depreciation at 10 per cent. as the machinery was installed and used during the year under assessment---Income Tax Officer's decision in capitalising the assessment of interest was affirmed by the hierarchy of income tax---High Court on reference answered in the affirmative the question referred to it as to "whether in the facts and circumstances of the case Income Tax Appellate Tribunal was justified in not allowing the specified amount being interest on loan for import of certain machinery, under S.10(2)(iii), Income Tax Act 1922"---Plea raised in leave to appeal was that although the High Court did take note of some Indian cases relevant directly or indirectly in the matter, yet it did not notice judgment of Supreme Court reported as 1989 SCMR 61, wherein it was ruled that the amount of interest paid by the purchaser of an industrial concern to the vendee on the unpaid price was an integral part of the profit earning process---Leave to appeal was granted to consider the question: whether the judgment (1989 SCMR 61) in question, supported assessee s case and to what extent as also the related questions required examination.

Commissioner of Income Tax v. Khairpur Textile Mills Ltd. 1989 SCMR 61 rel.

(b) Income Tax Act (XI of 1922)---

----S.10(2)(iii) & (xvi)---Deduction---Assessee having running business when obtained loan for the purchase of additional machinery---Loan was not obtained for installation of machinery in order to go for new products but to add efficiency to the production already in existence---Amount of interest paid by assessee being an integral part of profit earning process related to the carrying on or conduct of business brings the case within the fold of S.10(2)(xvi) of the Act---Deduction of interest under S.10(2)(iii) has to be allowed in full regardless of the fact whether stage was pre-production or otherwise.

Commissioner of Income Tax v. Khairpur Textile Mills Ltd. 1989 SCMR 61; Chellapalli Sugar Ltd. v. Commissioner of Income Tax (1975) 98 ITR 167; AIR 1975 SC 97; 1989 SCMR 61 and 1989 PTD 500 ref.

Commissioner of Income Tax v. Pakistan Industrial Engineering Agencies Ltd. 1992 PTD 954 distinguished.

Sirajul Haque Memon, Advocate Supreme Court and Naraindas C. Motiani, Advocate- on-Record for Appellant.

Shaikh Haider, Advocate Supreme Court and M.S.M. Abbas, Advocate-on-Record for Respondent.

Date of hearing: 17th January, 1993.

JUDGMENT

SAJJAD ALI SHAH, J.---This appeal with leave of the Court is directed against the judgment dated 29-8-1991 of High Court of Sindh, Karachi, whereby Income Tax Reference No.12 of 1983 is answered in the affirmative containing the following question of law:---

"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 interest on loan taken for import of certain machinery, under section 10(2)(iii) of repealed Income Tax Act, 1922:"

2. Briefly stated the relevant facts giving rise to this appeal, as per case of appellant, arc that the appellant is limited company engaged in the manufacture of paper, paper hoard and packing material and filed return of income for the assessment year 1973 74 declaring therein a loss of Rs.5,962,302 on account of unabsorbed depreciation carried forward under the provisions of Income Tax Act 1922. That in the statement of accounts and computation of income for the relevant income year ending 31-12-1972, the appellant had inter alia, claimed deduction for interest amounting to Rs.147,608 on loan borrowed from PICIC for import of machinery. The interest charged for the year by PICK amounted to Rs.147,668. In the accounts the appellant claimed deduction of interest under section 10(2)(iii) of the repealed Income Tax Act, 1922. The Income Tax Officer disallowed the claim on the ground that the interest relating to "Pre-Production Stage" was being capitalised by him and that he would allow depreciation at 10% as the machinery was installed and used during the year under assessment.

3. Appellant filed appeal under section 29 of the repealed Income Tax Act, 1922, and the Appellate Assistant Commissioner rejected the appeal vide order, dated 15-9-1979 observing that since the interest amounting to Rs.147,665 related to the pre-production period, the action of the assessing officer in capitalising the said amount of interest was justified. Appellant filed second appeal and the Income Tax Appellate Tribunal, Karachi confirmed the action of the two officers on the ground that capital was borrowed to import machinery, the cost whereof had been capitalised and the machinery was not commissioned during the previous year, hence interest relatable to the loan utilised for this machinery could not be allowed as revenue expense and that this had to be capitalised. Appellant moved an application under section 136(1) of the Income Tax Ordinance, 1979 for reference of two questions of law to the High Court as under:---

"(1) Whether in 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 to support the Tribunal's finding that machineries for the import of 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?"

4. After hearing the parties, the Tribunal referred only one question to the High Court as under:---

"Whether in the facts and circumstances of the case, the Appellate Tribunal was justified in not allowing the sum of Rs.1,47,688 being the interest on loans taken for import of certain machines, under section 10(2)(iii) of the repealed Income Tax Act 1922?"

5. The High Court after hearing learned counsel for both parties has disposed of the reference vide judgment impugned in this appeal in terms stated above. Against the decision of High Court, this Court has granted leave to appeal vide order, dated 19-11-1991, relevant paragraph from which is reproduced as under:---

"Learned counsel contended that although the High Court did take note of some Indian Cases relevant directly or indirectly in the matter, did not notice a judgment of this Court in Commissioner of Income Tax v. Khairpur Textile Mills Ltd. 1989 SCMR 61. It was ruled therein that the amount of interest paid by the purchaser of an industrial concern to the vendor on the unpaid price was an integral part of the profit earning process. It was related to the carrying or conduct of business and satisfies the test laid down for bringing the case within the fold of section 10(2)(iii); as being, interest on the analogy of it being interest on capital borrowed for the business of the company; and also, under section 10(2)(xvi), as expenditure incurred wholly and exclusively for the purpose of business. The question; whether the above noticed judgment which indeed had taken note of Indian case law, supports the petitioner's case and to what extent as also the related questions require examination. Leave to appeal, accordingly, is granted:"

6. We have heard at length Mr. Sirajul Haq Memon learned ASC for the appellant and Mr. Shaikh Haider learned ASC for the respondent. It would be pertinent at this stage to spot-light and reproduce two provisions of Income Tax Act of 1922, which are under detailed examination for interpretation in connection with payment of tax by an assessee in respect of profits or gains of any business, profession or vocation carried on by him, which .are to be computed after making allowances as contemplated under subsection (2) of section 10 of the said Act:---

"Section 10(2)(iii):

in respect of capital borrowed for the purpose of the business, profession or vocation, the amount of the interest paid.

Section 10 2)(xvi)

any expenditure (not being in the nature of capital or personal expenditure incurred by an assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation."

7. In the leave grant order there is mention that High Court in the impugned judgment has noticed some Indian cases and it was contended before us by learned counsel for appellant/assessee that High Court in the impugned judgment approved ratio of the judgment of Indian Supreme Court in the case of Chellapalli Sugar Ltd. v. Commissioner of Income Tax (reported to (1975) 98 ITR 167 and AIR 1975 SC 97 (but did not apply the ratio to the facts of instant case, hence it becomes desirable and necessary to mention briefly as to what was held in that case. In the said Indian case matter related to the assessment year 1959-60. The assessee/company engaged in the manufacture and sale of sugar went into production on 22-1-1958 borrowed considerable sum of money from Industrial Finance Corporation of India for installation 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 was that payment of interest added to the cost of machinery and plant and as such while calculating depreciation admissible to the assessee the interest paid should be treated as part of the cost of machinery and plant. The Income Tax Officer rejected the claim on the ground that interest paid from year to year was admissible item of revenue expenditure and no depreciation could be allowed on capitalised amount of expenditure incurred on account of interest. The controversy went up to the Supreme Court, which decided this point and the relevant paragraph from the judgment in the report is reproduced as under:---

"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."

8. In the instant case Mr. Memon for appellant/assessee argued that ratio of the case of Chellapalli Sugar Ltd. from Indian jurisdiction supra is fully attracted to the facts of this case for the reason that assessee borrowed capital from PICIC during continuation of business for expanding its business operation by installing new machinery. In the circumstances the case would fall under revenue expenditure as the interest claimed is on capital borrowed when business had already commenced. In this connection another very important and relevant judgment rendered by this Court in the case of Commissioner of Income Tax v. Khairpur Textile Mills and others (reported in 1989 SCMR 61 and 1989 PTDD 500), which is also mentioned in the leave grant order. Briefly stated the facts of the reported case are that Khairpur Textile Mill was owned by Khuirpur State. For the purpose of the said mill, sale-deed dated 3-3-1955 was executed for total consideration of Rs.1,53,87,293 out of which Rs.1,00,00,000 was paid to Khairpur State and as for the balance of Rs.53,87,293 it was stipulated to be paid in instalments with 3% interest on the unpaid balance. During the charge years 1956-57,1957-58,1958-59 and 1960-61 the respondent/assessee paid interest on the outstanding balance of purchase price in the amounts described and claimed deduction of the amount paid during charge years as allowance under section 10(2)(iii) as being interest on capital borrowed for the purpose of the business of the company and also under section 10(2)(xvi) as expenditure incurred wholly and exclusively for the purpose of its business. However the claim was rejected by the ITO for each. charge year holding that the outstanding balance of purchase price payable to the vendor could not be regarded as "capital borrowed" within the meaning of section 10(2)(iii) and so also the payment of interest on the outstanding unpaid balance was not admissible under section 10(2)(xvi) as it was paid on money spent for acquiring the business. Controversy could not be resolved in the competent forums and survived up to the Supreme Court, where a detailed examination of provisions mentioned above was taken in hand in the light of case-law on the subject and concluding paragraph from the said judgment is reproduced as under:

"What is now to be seen is whether the requisite conditions as provided in section 10(2)(xvi) of the Income Tax Act are satisfied in this case to permit the deduction claimed by the respondent-assessee. The expenditure claimed as a deduction under this provision was incurred after the commencement of the business. It is also beyond doubt that it was not for any private or domestic purpose of the respondent-assessee. Further there were stipulations in para. 4 of the sale-deed as under:---

The Company hereby covenants with the vendors as follows:

(a) That the Company shall pay the remainder of the said price within the period and with terms and conditions as shown above in clause I of this deed.

(b) That the company recognises the vendors lien over the property under sale until the stipulated remainder of the said price with interest is paid by the Company.

It was, accordingly, urged that the payment of interest on unpaid instalments was revenue expenditure for the purposes of the business because in the event of the failure to pay interest falling due the vendors would enforce the lien and the business of the assessee's company would come to an end.

According to the sale-deed the acquisition had already taken place on payment of Rs.1,00,00,000 upon the execution of the sale-deed as per para. 2 of the sale-deed and the vendors' covenants incorporated therein.

The expenditure was not for acquisition of an asset or a right of a permanent character, but it was an integral part of the profit-earning process as it was related to the carrying on or conduct of the business. It thus satisfied the test laid down for bringing the case within the fold of section 10(2)(xvi) of the Income-tax Act. Assuming for argument's sake that the business was closed then according to the sale-deed interest would nonetheless be payable on unpaid instalments but it cannot be deducted as an allowance under the above clause in that event as it would not satisfy the requirement. This contingency is wholly irrelevant in the context of the facts stated."

9. It is submitted by Mr. Memon in the instant case that in the case of Khairpur Textile Mills supra, this Court has enunciated correct legal position with regard to the construction of section 10(2)(iii) and (xvi) and has held in unequivocal terms that amount of interest paid by the purchaser of an individual concern to the vendor on an unpaid price being an integral part of profit-earning process relating to the carrying on or conduct of business brings the case within the fold of section 10(2)(xvi). According to Mr. Memon ratio of the judgment is fully attracted to the facts of this case. We feel inclined to agree with him for a variety of reasons stated as under.

10. Firstly claim of assessee for deduction of interest amounting to Rs.147,668 on loan borrowed from PICIC for import of machinery is justifiable and valid for the reason that loan was obtained while company was at the normal stage of production and manufacturing activities were going on. Before the I.T.O. contention was rail d on behalf of assessee that fall in G.P. rate was attributed to increase in cost of paper when there was no corresponding increase in sale price uptil November 1972 as the exercise books produced by the assessee were declared one of essential commodities item, the representative of assessee was asked to furnish documentary evidence which was produced and subjected to deep scrutiny after which I.T.O. gave finding that assessee's contention was found to be correct and his trading version was accepted in view of the facts and past history of the case. This is so stated in the assessment order at page 38 of the paper book.

11. Secondly in the finding of ITO there is reference to pre-production stage which is not supported by the record for the reason that loan was not obtained for installation of machinery in order to go for new products but to add efficiency to the production already in existence, hence question of pre production stage did not arise and in any case reference to pre-production stage was unnecessary as deduction of interest under section 10(2)(iii) is to be allowed in full regardless of the fact whether stage was pre-production or otherwise. Assessee did his best to convince the ITO that loan was obtained to instal machinery to increase efficiency of existing productivity and not for new production and in that connection produced documents but ITO was not convinced. Assessee gave all the details of machineries which were installed which are mentioned in the order of Appellate Assistant Commissioner, relevant paragraph from which at pages 56 and 57 of paper book is reproduced as under:---

"The purchase of following fixed assets imported by the company was financed by a loan obtained from PICIC. The loan disbursed at the beginning of the previous year was DM 2,978,557 which increased to DM 3,243,013 at the year-end. (1) Die cutting and embossing press. (2) Raffinator. (3) Deffibrator raffinator. (4) Two tumbling digestors. (5) Various machines. Of these, machines (1) to (4) were installed during the previous year (i.e. year ended October 31, 1972) whereas machines at (5) were installed in 1971. It is submitted that these machines were added to improve overall efficiency and their going into operation was not tantamount to commencement of commercial production in any sense whatsoever. The company went into commercial production many years ago and the production figures for 1971, 1972 and 1973 are given below to show that the question of pre-production costs cannot arise during 1972 since the production pattern during that year was similar to that in the previous and the succeeding year. It is submitted that the question of capitalisation of interest cannot arise in these circumstances."

12. There was no other material or documents before I.T.O. to justify capitalisation of interest relating to pre-production stage. This finding is affirmed by Income Tax Appellate Tribunal on the ground that it has been rightly so held by two officers below.

13. Thirdly that finding to the effect that machinery was not commissioned during the previous year is not supported by the record and is inconsistent with finding of the I.T.O. to the effect that machinery was used during the previous year.

14. Fourthly, it appears from the record that assessee has not accepted capitalisation of interest and has challenged and claimed it to be revenue expenditure before Appellate Assistant Commissioner, Income Tax Appellate Tribunal and also before the High Court. In the circumstances there is no warrant for presumption by the High Court that assessee was content with and had not challenged capitalisation of interest.

15. Fifthly in this case like in the case of Khairpur Textile Mills supra, assessee was already in business and entitled to appropriate profits and bear the losses which operation continued after obtaining loan for installing additional machineries, hence interest paid on the amount of loan was rightly claimed as revenue expenditure for subsequent charge years. It has been correctly held in the case of Khairpur Textile Mills supra that such expenditure was not for the acquisition of piny property but was so closely related to the business that it could be viewed as an integral part of the conduct of the business. It thus satisfied the test to, bring it within the four corners of section 2(2)(xvi) as revenue expenditure laid out wholly and exclusively for the purpose of business.

16. Lastly we are not pursuaded to agree with the contention of Mr. Shaikh Haider that case of Khairpur Textile Mills supra is distinguishable for the reason that it was a case of running business because in the instant case also facts clearly show that assessee was having running business when he obtained loan for the purchase of additional machinery. In support of the contention reliance by the learned counsel on the case of Commissioner of Income Tax v. Pakistan Industrial. Engineering Agencies Ltd. 1992 PTD 954 is inapt for the reason that case is distinguishable and proposition enunciated therein is different to the effect whether assessee is entitled to allowance under section 10(2)(iii) of the Income Tax Act of 1922, when Tribunal refused such allowance on the ground that assessee had surplus deposit amounts and further observation was made that no prudent businessman would keep a loan and pay higher interest while receiving a lesser amount of interest for his deposits. It was held by this Court that by making such observations and without giving any finding that the amount was not borrowed and employed or utilized for business purposes the conclusion drawn by the Tribunal was based on mere surmises and conjectures.

17. For the facts and reasons mentioned above, impugned judgment of the High Court is set aside and so far reference by the Tribunal to the High Court is concerned, the finding on the question so referred as given by the High Court is reversed and is answered in the negative. Appeal is allowed and there will be no order as to costs.

A.A./P-203/SAppeal allowed.