IN THE ITAT MUMBAI
Sheetal Drape (India) Ltd.
Additional Commissioner of Income-tax-4(3)
IT Appeal NO.1323 (MUM.) of 2012
[assessment year 2007-08]
MAY 16, 2012
R.S. Syal, Accountant Member – This appeal by the assessee arises out of the order passed by the CIT(A)-9, Mumbai, on 16-01-2012 in relation to assessment year 2007-08.
2. The first two grounds are against confirmation of disallowance of interest of Rs. 6,57,820/-.
3. Briefly stated, the facts of these grounds are that the assessee incurred total interest expenditure of Rs. 52.69 lakhs. The AO observed that the assessee had taken secured loans, the balance of which was Rs. 4.88 crore. In the Schedule of fixed assets, the assessee had shown ‘Capital work in progress’ amounting to Rs. 1,59,53,085/-, being purchase of new assets in the shape of Office premises at Parshwadeep, 140/142, S.G. Gandhi Marg, Mumbai, and new Godown at Bhiwandi, on which no depreciation was claimed on the ground that such assets were not put to use. On being called upon to file details of datewise payments made for the purchase of these immoveable properties, being office premises and godown, shown as ‘capital work in progress’, the assessee furnished reply which has been reproduced on page 6 of assessment order. Considering all these details, the AO worked out interest amount of Rs. 6,57,820/- relatable to the amount invested in the acquisition of assets being ‘capital work in progress’. Invoking the proviso to sec. 36(1)(iii), the AO opined that this amount of interest was liable to be capitalized. Resultantly, addition was made on this score.
4. The ld. CIT(A), apart from considering the provisions of sec. 36(1)(iii), also took note of Explanation 8 to sec. 43(1) for coming to the conclusion that the interest was rightly capitalized by the AO. He also supported his view with a Full Bench judgment of the Hon’ble Punjab & Haryana High Court in CIT v. Vardhaman Polytech Ltd.  214 CTR (P&H) (FB) 561. The assessee is against the confirmation of such disallowance of interest as revenue expenditure.
5. We have heard the rival submissions and perused the relevant material on record. The ld. counsel for the assessee contended that the ld. CIT(A) was not justified in sustaining the disallowance of interest for the reason that the assessee was already doing its business from a rented premises. The new office premises and godown were stated to have been added in the current year to carry on the same business. It has thus been canvassed that the mandate of proviso to section 36(1)()iii) will not apply. We are not convinced with the contention raised on behalf of the assessee for allowing deduction towards interest on loans which were used for acquiring two premises, which were admittedly not put to use in the current year. Section 36(1)(iii) allows deduction in respect of interest paid on capital borrowed for the purpose of business or profession. Proviso to this provision provides that no interest paid shall be allowed as deduction in respect of capital borrowed for acquisition of an asset for extension of existing business for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which the assessee was first put to use. From the prescription of the above proviso, it is amply borne out that any such interest paid cannot be allowed which is incurred on capital borrowed for acquisition of an asset for extension of existing business. The expression “extension of existing business” has nowhere been defined for the purpose of this provision. What is relevant to consider in this provision is that the reference is first to the existing business and then to its extension. It does not refer to setting up an altogether different or new business. So long as the there is extension of the ‘existing business’, the interest incurred in such circumstance will suffer disallowance. In the absence of any specific statutory meaning to the expression ‘extension of existing business’, we will have to go by its meaning as understood in common parlance. Thus seen, it is manifest that the case before us is of “extension of existing business” and not that of setting up of a new business, inasmuch as the assessee was earlier doing the same business from some rented premises and in the current year it acquired its own premises and godown. Obviously, by having its own premises and doing the same business, the assessee will now be in position to carry on its operation at a much wider scale in a hassle free manner. This would obviously result in extension of its existing business.
6. Further, Explanation 8 to sec. 43(1) provides that : “For the removal of doubts, it is hereby declared that where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use shall not be included and shall be deemed never to have been included, in the actual cost of such asset”. From the command of this Explanation 8 to sec. 43(1), it becomes abundantly clear that the interest paid in connection with the acquisition of an asset after the date from which it is put to use shall not be capitalized. Per contra, the interest paid for the period anterior to its first putting to use, is required to be capitalized. When we consider the proviso to sec. 36(1)(iii) read with Explanation 8 to sec. 43(1), it becomes manifest that the interest paid by the assessee, in the present circumstances, admittedly for the period prior to putting such assets into use, has been rightly held to be not deductible. Our view is fortified by the aforenoted Full Bench judgment of the Hon’ble Punjab & Haryana High Court in Vardhaman Polytech Ltd. in which interest, in such circumstances, has been rightly held to be not deductible. We, therefore, uphold the impugned order and dismiss these two grounds.
7. The ld. AR has raised an additional ground, which reads as under:
“Without prejudice to grounds No. 1 and 2, the appellant prays that if the claim of the appellant of allowability of deduction of interest of Rs. 6,57,820/-is not accepted, then as a consequence the said amount should be added to the cost of the office/godown and depreciation may be allowed on the same.
8. This additional ground raises simply a question of law which is rather consequential to our decision on ground nos. 1 & 2 and does not require any further investigation of facts. We, therefore, admit the same following the ratio decidendi of the judgment in the case of NTPC Ltd. v. CIT  229 ITR 383 (SC) and take it up for disposal on merits.
9. Through this ground, the assessee is contending that if deduction of interest amounting to Rs. 6.57 lakhs is not allowed, then such amount should be allowed to be capitalized to the cost of office/godown and depreciation may be allowed on the same. We accept this ground partly to the extent of allowing capitalization of this amount of interest to the cost of office/godown. However, we are not inclined to grant any depreciation on it for the reason that the said office and godown have not admittedly been put to use for the current year. This additional ground is, therefore, partly allowed.
10. Ground nos. 3 to 6 are against confirmation of addition of Rs. 29,22,082/- on account of unaccounted sales.
11. Briefly stated, the facts of these grounds are that the assessee, at the material time, was engaged in the business of manufacturing of furnishing cloth on labour job basis and also trading on semi-whole basis. Value of closing stock was declared at Rs.4.11 crore. The AO observed that the assessee had shown production shrinkage of 12.62% in manufacturing from yarn. It was observed that the assessee, apart from its own manufacturing, had also undertaken purchase of finished goods. The assessee had shown shortage of 3.35% in finished goods. The AO held such shortage to be on higher side when compared with shortage in the preceding year at 2.09% and 1.01% in the year prior to that. Considering all the relevant facts, the AO allowed shortage of finished cloth at 75,000 meters as against the assessee’s claim of 1,26,139 meters. The remaining shortage of 51,139 meters in the finished goods, remained unexplained as per the AO’s version. By applying average rate of Rs.57.14 per metre, the AO held that the assessee had sold such 51,139 meters outside the books of account, in respect of which an addition of Rs. 29.22 lakhs was made.
12. During the course of first appellate proceedings, the assessee furnished details of such shortage claimed by it. The ld. CIT(A) forwarded the same to the AO with a direction to give remand report after due consideration. A copy of such remand report is available on page no. 165 of the paper book and further the assessee’s reply to such remand report is available on page 110 of the paper book. Considering all the relevant facts, the ld. CIT(A) echoed the assessment order on this point. The assessee is aggrieved against the sustenance of such addition.
13. We have heard the rival submissions and perused the relevant material on record. The details of quantity on macro level are available on page 131 of the paper book, from where it can be seen that there are three stages of manufacturing, being, Grey, Semi finished and Finished. In the first stage, the assessee claimed shrinkage at 12.61%, which has not been disputed by the AO. There is no shortage in the second stage. The last stage is of finished goods in which the assessee not only procures semi-finished goods got manufactured by it from outside processors but also the finished goods purchased as such. It is in this stage that shortage occurs due to fents, rags, samples, emboss, shrinkage and re-finished shrinkage, which for the year under consideration stood at 3.35%. Out of the total goods manufactured and packed, the assessee sent 7,05,504 meters for embossing and re-finishing. Page 130 of the paper book contains similar quantitative details for the year ending on 31-3-2006. Production shrinkage, in the first stage, is at 12.01% and the shortage in the last stage of finished goods stands at 2.09%. For such earlier year, the assessee sent 2,16,578.25 meters for embossing and re-finishing. It is this difference between 3.35%, being shortage in finished goods for the current year and 2.09%, being shortage in the finished goods for the preceding year, which has been taken note of by the AO while making the addition, which is subject matter of appeal through the present grounds. Page no. 78 onwards of the paper book is detail of shortage on micro level on bill to bill basis. This tabular statement indicates the Date, Name of the processor, Challan number, Quality, Design number, Pieces and Meters of cloth further divided into three categories. Then, this tabular statement contains percentage of shortage. To illustrate, the first item on page 78 is receipt of 216 meters from the processor. This has been sorted into ‘A’ quality marked as ‘Fresh’ product at 216 meters. There is neither any ‘B’ quality marked as ‘S.L.’ nor ‘C’ quality marked as ‘Second’ from this batch. Thus, production has been depicted at 100%. On the same date, there is another item of receipt of 71.30 meters out of which ‘A’ quality is 71.00 meters and the percentage of production has been shown at 99.58%, thereby leaving shortage at 0.42%. On 14-06-2006, there is receipt of 1003.60 meters out of which ‘A’ quality fabric is 950 meters thereby leaving Fents at 36.50 meters and Samples at 18.00 meters thereby giving output ratio of 94.66% and the resultant shortage at 5.34%. In this way, pages 78 to 88 of the paper book contain bill-wise production ratio with shortage in respect of finished goods for the month of June, 2006. The aggregate percentage of output for June, 2006, is 96.80%, which gives shortage of 3.20%. Page 77 of the paper book is month-wise percentage of output. The ld. AR submitted that pages 78 to 88 have been appended in the paper book, being details only for the month of June, 2006, on sample basis, whereas complete details for whole of the year are available with the assessee, which were duly produced before the ld. first appellate authority, who remanded the matter back to AO for sending remand report. The ld. AR stated that in remand proceedings, the AO considered all such details.
14. Now, we advert to remand report dated 15-10-2010, which adds nothing more than that which has been discussed in the assessment order. When we peruse the assessee’s reply dated 01-12-2010 given to the ld. CIT(A) on the remand report, it can be seen that the AO had not contradicted any of the submissions/ material which were made/filed before the ld. first appellate authority. Para 5 of this communication to the ld. CIT(A) reads : “In summary we submit that the Assessing Officer has not contradicted any of the submissions/evidences produced vide letter dated 7/9/2010. The appellant relies upon the submission made vide letter dated 7/9/2010”. The referred letter dated 7/9/2010 is the one which was addressed to the ld. CIT(A), a copy of which is available on paper book page no.56 onwards submitting, inter alia, the quantitative tally on micro level along with date-wise production and shortage in the finished goods segment. From the above discussion, it can be easily inferred that the assessee had maintained complete bill-wise details of the finished goods manufactured or purchased with the respective output in quantitative terms and also the percentage along with the details of fents and samples. These details have been duly taken into consideration by the AO in the remand proceedings. In such a situation, the question arises that if the percentage of shortage has marginally increased, would it call for making any addition on the presumption that such increased shortage, in fact, represents the goods actually manufactured but sold by the assessee outside the books of account? In our considered opinion, the answer to such question can be given only in negative. There may be several reasons for increase or decrease in the percentage of output and the resultant shortage. Various factors such as the quality of raw material purchased, the quality of output required, other relevant market conditions, cause direct impact on shortage. When an assessee maintains bill-wise quantity with the output and also the percentage, the AO cannot simply brush aside such results for reaching a presumption that the assessee had manufactured and sold the finished goods outside the books of account. In such circumstances, the onus is firstly upon the AO to show as to how such quantitative details of are incorrect. We are reminded of the Special Bench order passed by the Amritsar Bench of the Tribunal in the case of Shankar Rice Co. v. ITO  72 ITD 139 (Amritsar) (SB). In this case, almost similar question was raised whereby the A.O. rejected the books of account on the basis of lower yield. The Hon’ble Special Bench has held that the books of account cannot be rejected if there is a minor variation in the output ratio.
15. Coming back to the facts of the instant case, it has been brought to our notice that in the current year, the assessee sent 7,04,504 meters for embossing and re-finishing as against 2,16,578 meters in the immediately preceding year. It has been shown that the shortage in case of embossing and re-finishing is consistent in both the years at around 5%. Due to increase in the number of meters sent for embossing or re-finishing in the current year, the overall percentage of shortage has slightly increased. Page 166A of the paper book is quantity-wise and percentage wise details of shortage before and after re-processing and embossing. On a perusal of this chart, it can be seen that the shortage for the current year out of total quantity of goods manufactured stands at 3.35%, and if such shortage is considered without re-processing and embossing, such percentage comes to 2.17%. In the immediately preceding year, the percentage of shortage before re-processing and embossing is 2.10% and after re-processing and embossing is 1.69%. Thus, there is difference of only 0.48% (2.17% – 1.69%) in shortage for the current year vis-a-vis the preceding year on net basis. From the same table, it can be seen that for the assessment year 2004-05, the percentage of net shortage was at 2.93% in comparison with 2.17% for the current year. The return for the said assessment year 2004-05 was scrutinized by the AO and assessment order was passed u/s. 143(3). Page no. 161 to 164 of the paper book is a copy of the assessment order for assessment year 2004-05, from which it can be seen that no addition on account of shortage was made. Thus, it becomes evident that the shortage of 2.93% has been accepted by the Revenue for the assessment year 2004-05. In that view of the matter, there is no reason to reject lower net shortage of 2.17% for the current year. In view of the foregoing reasons, we are of the considered opinion that the authorities below were not justified in making and sustaining the addition of Rs. 29.22 lakhs on this count, which is hereby ordered to be deleted. These grounds are, therefore, allowed.
16. The last effective ground about levy of interest u/s.234B is consequential.
17. In the result, the appeal is partly allowed.