Prepayment penalty charges & upfront fees are revenue expenditure

ITAT Kolkata

Sarat Chatterjee & Co. (VSP) (P.) Ltd.

v.

Assistant Commissioner of Income-tax

IT Appeal NOs. 1531 & 1544 (KOL.) of 2010

Assessment year 2006-07

Date of Decision – May 31, 2012

ORDER

C.D. Rao, Accountant Member

The above two appeals one filed by the assessee and the other filed by the Revenue are against order dated 20.05.2010 of the CIT(A)-VIII, Kolkata pertaining to A.Yr. 2006-07.

2. In this appeal the assessee has raised the following grounds :-

“1.  For that the Ld. Commissioner of Income Tax (Appeals) VIII, Kolkata erred in upholding the addition of Rs. 34,80,019/- by way of disallowance resorted to by the Ld. Assistant Commissioner of Income Tax, Circle 9, Kolkata on the alleged premise that this amount represented expenditure of capital nature and the alleged findings on that behalf is wholly arbitrary, unreasonable, and perverse.

 2.  For that the action of the Ld. Commissioner of Income Tax (Appeals) VIII, Kolkata in upholding the impugned finding of the Ld. Assistant Commissioner of Income Tax, Circle 9, Kolkata was contrary to law and facts as none of the conditions precedent for holding such expenditure as being capital in nature existed and/or fulfilled in the instant case and the purported finding on that behalf is altogether flawed, erroneous and perverse.

 3.  For that the Ld. Commissioner of Income Tax (Appeals) Viii, Kolkata acted unlawfully in upholding the alleged finding of the Ld. Assistant Commissioner of Income Tax, Circle 9, Kolkata that the expenditure of Rs. 34,80,019/- constituted deferred revenue expenditure as per the provisions of the Income Tax Act, 1961 and the impugned finding in this respect was capricious, unjustified, wrong and perverse.”

3. The brief facts relating to grounds raised by assessee as appearing in the impugned order are as under :-

“The appellant company, carrying on the business of Stevedoring & Clearing Agents, Ship Handlers. Transport & Commission Agents had filed its return of income for the assessment year 2006-07 on 03.11.2006 disclosing total income of Rs. 3,1766,597/-. The return was filed along with properly audited accounts and the tax audit report u/s. 44AB of the I.T. Act, 1961. The return was assessed u/s. 143(3) on 28.12.2008 and the total income ‘has determined at Rs. 3,76,21,360/-.

In arriving at the assessed income, the Assessing Officer, inter alia, disallowed. Rs. 34,80,0I9/- out of bank charges on the finding that the said amount is in the nature of capital expenditure. Under the ‘Bank Charges’ head the assessee incurred the following expenses inter alia,

Rs. 14,24,000/- being ‘front fee for term loan &

Rs. 20,56,019/- being Prepayment penalty charges’

Both these expenses were incurred in relation to obtaining bank loans to finance procurement of heavy machinery and were purely in the nature of revenue expenditure. Capital expenditure in this connection was duly incurred being the capital cost of the machineries financed by the ‘Term loans” that were received from the Banks/Financial institutions.

The Assessing Officer’s finding as to the amount of Rs. 14,24,000/- being ‘Upfront fee for term loan and Rs. 20,56.019/- being ‘prepayment penalty charges are in the nature of capital expenditure is not correct. Both these are revenue expenses incurred to finance the acquisition of capital goods on which depreciation has been claimed by us year to year. These were expenses incurred to obtain either loans or to reduce the cost of such loans which were duly utilized to acquire capital goods. Actually the expenditure that was incurred to ‘bring into existence an asset’ was the amount of loan and the amount of loan has not been claimed as revenue expenditure. The expenses incurred for obtaining the loan cannot be equated with the amount of loan.

In course of the assessment proceeding it was explained and the Assessing Officer also accepted in principle, that these expenses resulted in the business being benefited. The Assessing Officer’s finding that the said expenses resulted in enduring benefit is not correct. Only the loan amounts which were utilized to acquire the capital assets were expenses incurred ‘with a view to bringing into existence an asset’ and there is no dispute regarding the capital nature of such expenditure.

Enduring benefit for the business is derived from the capital goods purchased and not by getting some reduction in the interest outgo. By applying the Assessing Officer’s logic we have already derived the benefit when we acquired the capital assets by obtaining loans and not at that point when by changing and negotiating with a new lender we were able to extract some ret benefit so far as our interest outgo is concerned. By paying a lesser amount by way of interest we not only obtained a benefit for our business, we were able to return increased amount of Total Income which resulted in a benefit for the exchequer also as an increased amount of income tax was paid compared to the amount which would have been payable had there been no decrease in the payment of interest on the loans.

In the assessment order the Assessing Officer has elaborately quoted from the Judgement in the case of Gujarat Mineral Development Corpn. Ltd. v. CIT [1983] 143 ITR 822 (Guj.) to highlight the tests to be applied in determining ‘capital expenditure’. There is no dispute regarding the tests to be applied in determining ‘capital expenditure’. However the assessment order is silent on how the tests were applied in our case. In the show cause issued in course of the assessment proceeding and also in the assessment order, the Assessing Officer has indicated that the expenditure in question should have been treated as ‘deferred revenue expenditure’. It has also been explained in the assessment order through a hypothetical scenario.’ All these reasoning by the Assessing Officer proves that the Assessing Officer himself is convinced that the expenses in question were not in the nature of capital expenditure or otherwise where is the scope for treating the amounts under ‘deferred revenue expenditure’?

However, the Assessing Officer’s proposal to treat the amounts as ‘deferred revenue expenditure’ is not supported by the provisions of the Income Tax Act, 1961 as in the said statute there are specific provisions for allowance of expenses spread over certain number of assessment years like in Sections 35A, 35D, 35DD, 35DDA, etc. The expenditure under consideration does not fall under any of such ca1eorics for which deferred allowance spreads over successive assessment years are prescribed in the Income Tax Act, 1961.”

3.1 Aggrieved by this assessee went in appeal before ld. CIT(A). The ld. CIT(A) after taking into consideration of the various submissions which was recorded at pages nos. 8 to 12 concluded that :

“In this ground, the appellant is disputing the action of the Assessing Officer (AO) in disallowing part of Bank Charges claimed by it by holding it as capital expenditure. The appellant’s case is that this expenditure was incurred in connection with procurement of Term Loans from Banks/Financial institutions and hence should be adjudged as revenue expenditure.

The appellant’s submissions on this issue are a matter of record and have been perused. The Bank Charges consist of ‘Upfront fee for Term loan’ & ‘Prepayment penalty charges’. By the appellant’s own admission, these have been used to obtain bank loans to finance procurement of machinery. In my opinion, it is not a case of equating expenses incurred for obtaining loan with loan itself. The expenditure has ultimately resulted in enduring benefit to the appellant in the shape of new machineries which it had purchased. Logically, therefore, it should be capitalized. Under the circumstances, I uphold the AO’s action on this issue and dismiss this ground of appeal.”

3.2. Aggrieved by this now assessee is in appeal before us.

4. The revenue has raised the following grounds :

“1.  Whether the ld. CIT (Appeals)-VIII, Kolkata is correct in law and on the facts and circumstances of the case in treating the expenditure of Rs. 20,18,744/- as revenue expenditure when it is seen that the expenditure was incurred for new concrete floor was constructed.”

4.1 The brief facts in respect of ground raised by the revenue are that while doing the scrutiny assessment the AO has observed that assessee has debited an amount of Rs. 20,18,744/- in P&L account which was relating to repair and maintenance charges. Based on the explanations of section 30 of the IT Act the ld. AO has treated the same as capital in nature and added to the income of assessee.

4.2 On appeal the ld. CIT(A) after taking into consideration of the various submissions and the expenditure incurred for godown maintenance for the past five years deleted the same by observing as under :-

“In the instant case, floors have been repaired, which in a godown, is necessary for normal wear and tear. Fabrication does not necessarily mean that a new asset has been brought to existence. In this case, keeping in view, the WDV of the assets, the amount spent on fabrication is comparatively small and, in my opinion, that is indicative of the fact that the purpose here has been for normal maintenance. Also, if the overall size of the assets, as evident from their WDV is kept in mind then the amount claimed by the appellant for current repairs does not appear to he substantial. No inference can be drawn from here that any new asset has been created. Neither has the A.O. pointed out any such creation of a new asset(s). The appellant in its submission has referred to the 2004 tsunami. In my opinion, natural disasters also necessitate higher spending on assets to make them usable but, it should be kept in mind that, as no asset is being created, the expenditure concerned would be in the nature of current repairs only. Under the circumstances, I feel that the appellant’s claim of this expenditure as current repairs is justified. The A.O is directed to delete this addition. This ground of appeal is allowed.”

4.3 Aggrieved by this now the revenue is in appeal by taking the above grounds.

5. We want to dispose of the revenue’s appeal first.

6. At the time of hearing before us the ld. DR appearing on behalf of the revenue relied on the orders of AO. However, he could not bring any contrary material against the findings of ld. CIT(A) which was incorporated in the preceding paragraphs.

7. On the other hand, the ld. Counsel appearing on behalf of assessee reiterated the submissions made before the revenue authorities which are as under :-

“The maintenance of the godown in proper condition is a must to prevent any accident and is a must as per the guidelines of the Port Authorities. Detailed clarifications in respect of the items cited by you is furnished (Annexure-6). The importance of the jobs can be gauged from the fact that we have to employ a leading organization like Larsen & Toubro Ltd. for some of the jobs to ensure proper repairs and longevity and also to reduce the time of repairs as Larsen & Toubro Ltd. has got fully mechanised system to handle such work.

The Assessing Officer, without going into the merits of our submission summarily rejected the arguments with the terse observation – “Assessee submitted various decisions, which not cover amended provisions of Section 30. A sample example is 6l Mtr. Fabrication @ Rs. 9000/- per Mt., is not repair but expenditure in nature of capital’. He has also observed that in the records of last three sears no sizeable expenditure of this nature is reflected. The Assessing Officer’s observation is not correct and not supported by the actual facts as may kindly be seen from the following figures:

From the above chart it is clear that expenses for godown repairing were incurred every year and the quantum varied depending on the actual requirement.

In this context your kind attention is drawn to the fact that disaster in the form of Tsunami struck South East Asia and India on the 26th of December, 2004. The same was the worst natural disaster in the recorded history of Planet Earth. Our godowns being located on the South East of India were severely damaged and to bring the godowns back to normal condition we had to incur much more than the average of expenses on this account.

So the Assessing Officer’s finding in this context is absolutely wrong and illegal and you are requested to kindly delete the addition of Rs. 20,18,744/- on this account.”

8. After hearing the rival submissions and on careful perusal of materials available on record, keeping in view of the fact that the ld. CIT(A) has rightly observed that no inference can be drawn from the facts of the case that new asset has been credit, neither the AO has pointed out any such creation of the new asset. It is further observed the expenditure incurred for godown maintenance for the past five years has been allowed by the revenue as revenue expenditure. Under these circumstances, we find no infirmity in the orders of ld. CIT(A) to be interfered with.

9. In the result the revenue’s appeal is dismissed.

10. As regarding the assessee’s appeal which is relating to the confirmation of addition of Rs. 34,80,019/- the relevant observations of the AO as well as the ld. CIT(A) are incorporated in the preceding paragraphs.

11. At the time of hearing before us, the ld. Counsel appearing on behalf of assessee has reiterated the submissions made before the revenue authorities which are as under :-

“Under the ‘Bank Charges’ head the assessee incurred the following expenses inter alia, Rs.14,24,000/- being ‘Upfront fee for term loan’ & Rs. 20,56,019/- being ‘Prepayment penalty charges’.

Both these expenses were incurred in relation to obtaining bank loans by shifting the same from Consortium of Banks (with State Bank of India, State Bank of Hyderabad and ING Vysya Bank Ltd) to ABN AMRO Bank against the Floating Crane which was put to use in the financial year 2003-04 and depreciation on this asset has been claimed by us year to year starting from the financial year 2003-04 (photo copy of Depreciation Schedule enclosed) and as such were purely in the nature of revenue expenditure. Capital expenditure in this connection was duly incurred being the capital cost of the machineries financed by the Term loans” that were originally received from the Banks/Financial institutions (State Bank of India, State Bank of Hyderabad and ING Vysya Bank Ltd).

The Assessing Officer’s finding as to the amount of Rs. 14,24,000/- being ‘Upfront fee for term loan’ and Rs. 20,56.019/- being ‘prepayment penalty charges’ are in the nature of capital expenditure is not correct These were expenses incurred subsequent to completion of construction of Floating Crane and utilisation of the same for the business of the assessee company in the year 2003-04 and to reduce the cost of such loans which were originally utilized to acquire capital goods. It is also required to state that all the related expenses including interest paid on term loans were capitalised till the point of completion of the construction of Floating Crane. The expenses incurred for shifting the loan from Consortium of Banks (with State Bank of India, State Bank of Hyderabad and ING Vysya Bank Ltd) to ABN AMRO Bank cannot be equated with the amount of loan.

In course of the assessment proceeding it was explained and the Assessing Officer also accepted in principle, that these expenses resulted in the business being benefited. The Assessing Officer’s finding that the said expenses resulted in enduring benefit is not correct.

Enduring benefit for the business is derived from the capital goods purchased and not by getting some reduction in the interest outgo. By applying the Assessing Officer’s logic we have already derived the benefit when we acquired the capital assets by obtaining loans and not at that point when by changing and negotiating with a new lender we were able to extract some net benefit so far as our interest outgo is concerned. By paying a lesser amount by way of interest we not only obtained a benefit for our business, we were able to return an increased amount of Total Income which resulted in a benefit for the exchequer also as an increased amount of income tax was paid compared to the amount which would have been payable had there been no decrease in the payment of interest on the loans.

On an analysis of the sequence of events it is seen that the assessee company even after allowing for the sum of Rs. 20,52,419/- paid as prepayment charges, is still benefited by a sum of Rs. 72,75,295/- on account of reduction in rate of interest due to shifting of the loans to ABN Amro Bank. A detailed note on the sequence of events in connection with the original sanction and subsequent switch over of the loans is appended below:

Note on Term Loan availed by M/s. Sarat Chatterjee & Co. (Visakhapatnam) Pvt. Ltd. from ABN Amro Bank against Floating Crane by shifting the Loan Accounts from Consortium of Banks comprising State Bank of India as the Lead Bank, State Bank of Hyderabad and ING Vysya Bank Ltd. as Member Banks.

1. The Company M/s. Sarat Chatterjee & Co. (Visakhapatnam) Pvt. Ltd. was sanctioned Rupee Term Loan under consortium arrangement with State Bank of India as lead Bank, the following amounts:

2. The sanctions were released in the year 1999-2000 under various sanction as follows :

3. The loans were sanctioned initially at interest rates upto 17.34% by ING Vysya Bank Ltd. and at 15.50% by State Bank of India and State Bank of Hyderabad. The said loans were to be repaid as per the schedule of repayment fixed by the Banks under the consortium arrangement.

4. The draw-down of the loans with respective Banks commenced on the following dates

5. As on 01.04.2005, the following balances were outstanding against the term loans with the concerned Banks respectively

6. The respective charges were created with ROC on 17.05.2000 and the repayment in instalments commenced from 01.10.2001.

7. Due to delay in project implementation for reasons beyond the control of the Company, the commencement of commercial operations was delayed. Since the company was not in a position to pay the instalments as scheduled, the repayment was rescheduled w.e.f. 01.01.2004 as follows:

8. In view of the hardships faced, on 08.07.2004, the Company represented to the consortium of Banks to reconsider waiving a part of interest and also to reduce the rate of interest in order to lessen the burden of the company due to cost over runs and time over runs caused by delay in construction of the Floating Crane by M/s. Hindustan Shipyard Ltd.,

9. Further on 10.01.05, a request was made to consider FCNR-B loan. The leader of the consortium i.e.; State Bank of India then considered FCNR-B loan at 525 BPS over the 6 months LIBOR. The said interest rate technically worked out to 8.66% per annum straight away. Further, the risk of the unfavourable movement in the exchange rate and the likely increase in LIBOR rate would have possibly added further burden on the Company.

10. However, the then prevailing rates in the market on FCNR-B loans were at about 200 bps over the LIBOR. The Company, on 28.05.2005, therefore, requested State Bank of India to consider reducing the rate of interest to 250 bps over the six months LIBOR and to re-set the same every 6 months in order to enable the Company to bear the cost in line with the prevailing market conditions.

11. Further, since the State Bank of India did not agree to bring down the spread over the 6 months LIBOR rate, the Company again made a request on 2nd September, 2005 to consider reducing the rate of interest on term loan to 8.25% per annum by continuing the same as rupee loan in order to contain the costs. At the same time the company started exploring alternative borrowing options as are available in the market. In the process, the Company submitted its proposal to ABN Amro Bank among various Banks for considering takeover of the loan from the consortium.

12. The request of the Company was considered by ABN Amro Bank who sanctioned a term loan of Rs. I 4,24,00,000/-at overall cost of 8.25% per annum.

13. Upon receipt of the approval from ABN Amro Bank, the Company made a plea to the consortium of Banks to reduce the rate of interest to at least 8.25% and agreed to continue with the consortium of Banks itself if the cost of interest was brought down to the desired level. The consortium of Banks could not favourably respond and agreed to ABN Amro Bank taking over the loans.

14. On 12.12.2005, ABN Amro Bank handed over the payments of the respective principal amounts outstanding as follows:

15. At the time of handing over the documents/loans/securities etc. State Bank of India and State Bank of Hyderabad insisted on payment of pre-payment charges due to pre-closure of the loan accounts. Accordingly, the Company had to pay pre-payment charges of Rs. 12,84,000/- to State Bank of India and Rs. 7,68,000/- to State Bank of Hyderabad in order to effect the switch over the amount outstanding against the loans to ABN Amro Bank.

16. The company took a conscientious decision in shifting the accounts to ABN Amro Bank and making the prepayment charges of Rs. 20,52,419/- (comprising Rs. 12,84,000/- to State Bank of India and Rs. 7,68,000/- to State Bank of Hyderabad) since the interest charged by ABN Amro Bank was lower in comparison to that charged by State Bank of India, State Bank of Hyderabad and ING Vysya Bank Ltd.

17. The details of interest that would have been paid by the Company to State Bank of India. State Bank of Hyderabad and ING Vysya Bank Ltd. (in case the accounts had continued with the consortium) are enclosed herewith and the details of interest already paid by the Company to ABN Amro Bank against the term loan of Rs. 14.24 crores sanctioned by them (also enclosed herewith) go to show that the Company has made a clear saving of Rs. 93,27,714/-.

Interest that would have been payable to the consortium Banks.

18. Even after considering the amount of Rs. 20,52,419/- paid as pre-payment charges, the Company is still benefited by a sum of Rs. 72,75,295/- on account of reduction in cost of interest due to shifting of the loan accounts to ABN Amro Bank.

19. The shifting of the loans against the Floating Crane from Consortium of Banks (with State Bank of India, State Bank of Hyderabad and ING Vysya Bank Ltd.) to ABN Amro Bank is therefore fully justified.

Processing fee for sanction of loan can also be treated as interest for the purposes of sec. 36(1)(iii) Chintamoni Hatcheries (P) Ltd. v. Deputy Commissioner of Income-tax [[2000] 17 DTC 262 (Pune-Trib.)]”

12. On further enquiry from the Bench, the ld. Counsel for assessee has filed the correspondence with ABN-AMRO bank and the balance sheets as on 31.03.2003, 31.03.2004, 31.03.2005 and 31.03.2007 and it is observed that this is only the changing over of the term loan from the Consortium Banks i.e. State Bank of India, State Bank of Hyderabad and ING Vysya Bank Ltd. to ABN AMRO bank which was apparent from Schedule-C attached to the balance sheet as on 31.03.2005. Keeping in view of these facts since the assessee has already capitalized the initial loan expenditure along with the interest there is no need to further capitalize Rs.14,24,000/-being upfront fee for term loan and Rs. 20,56,019/- being prepayment penalty charges and the expenditure of the Consortium i.e. State Bank of India, Vizag, State Bank of Hyderabad, Vizag and ING Vysya Bank Ltd. Vizag cannot be capitalized since assessee has not acquired any further additional asset of enduring nature. Therefore he requested to set aside the orders of the revenue authorities and direct the AO to allow the claim of assessee that the upfront fee for term loan as well as prepayment penalty charges as revenue expenditure.

13.On the other hand the ld. DR appearing on behalf of the revenue relied on the orders of the revenue authorities and the observations made by AO as well as the ld. CIT(A)

14. After hearing the rival submissions and on careful perusal of materials available on record, it is observed that from the correspondence of ABN AMRO bank filed by the ld. Counsel for assessee the following terms and conditions are as under :-

15. It is further observed from the balance sheets as on 31.03.2003, 31.03.2004, 31.03.2005 and 31.03.2007 at Schedule-C filed by the ld. counsel the particulars are as under :-

Notes : i) Term Loans from ABN Amro Bank is fully Secured against Floating Crane.

16. On careful perusal of the above material, we are of the view that there is no need to further capitalize the upfront fee for term loan in connection with the transfer of the loans from one bank to another against prepayment penalty charges paid to the existing banks. Especially when the subsequent loan as bearing is having less rate of interest i.e. 10% as against the existing term loan of three banks which is 15%. (as recorded by the AO in the assessment order). Under these circumstances though by a nomenclature the expenditure may be capitalized in the facts and circumstances of the present case, we are of the view that there is no justification on the part of the revenue to capitalize the said expenditure. Therefore we set aside the orders of the revenue authorities and direct AO to delete the addition of Rs. 34,80,019/-.

17. In the result the appeal of assessee is allowed.

18. In the result the appeal of the revenue is dismissed and the appeal of assessee is allowed.