Whether for the purpose of determining the applicability of section 47, the condition for wholly-owned subsidiary is to be seen on the last date of financial year and explanation 6 to section 43(1) is not applicable?

DCIT, New Delhi Vs M/s NTPC- SAIL Power Supply Co. Ltd. (Dated: March 25, 2011)

Whether for the purpose of determining the applicability of section 47, the condition for wholly-owned subsidiary is to be seen on the last date of financial year and explanation 6 to section 43(1) is not applicable?

Whether where the shareholding pattern is changed and the assessee company seized to be a subsidiary company, the transfer of asset from the original company is not covered under section 47(iv)?

Whether the assessee will be entitled to depreciation on the cost at which the assessee company acquired the plant since the assessee company seized to be a subsidiary and the transaction in the hands of the assessee company has to be treated as transfer at the cost at which it had acquired the asset?

Whether after insertion of proviso to section 36(1)(iii), the interest paid on capital borrowed for acquisition of an asset for extension of existing business or profession for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, is rightly not allowed as deduction and the interest income earned on FDRs made from surplus fund and interest earned on margins and advances made for expansion work is rightly assessed under the head `income from other sources’.

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ORDER PER BENCH :

All these six appeals filed by the revenue arise out of the order of CIT (Appeals)-XVIII, New Delhi dated 19.07.2010. The grounds of appeal in ITA Nos.4668 to 4672/Del/2010 read as under :-

“1. That on the facts and circumstances of the case and in law, the ld. CIT(A) erred in allowing the depreciation on the power plants as per the cost of acquisition of the assets less depreciation which was actually allowed till the Assessment Year 200 1-02, in terms of the provisions of Section 32 r.w.s. 43 of the IT Act, 1961.

2. That on the facts and circumstances of the case and in law the ld. CIT(A) erred in ignoring the fact that the provisions of Section 47(iv) r.w.s. 43 and Explanation 3 to Section 43( 1) of the IT Act, 1961 and the cost of the power plants acquired by the appellant were taken at the WDV in the books of the transferor namely Steel Authority of India (SAIL) instead of the cost at which the assessee had acquired the above assets on the basis of valuation by MECON.

3. The appellant craves to be allowed to add any fresh grounds of appeal and/or delete or amend any of the grounds of appeal.”

The grounds of appeal in ITA No.4673/Del/2010 read as under :-

“1. That on the facts and circumstances of the case and in law, the Ld. CIT(A) erred in allowing the depreciation on the power plants as per the cost of acquisition of the assets less depreciation which was actually allowed till the Assessment Year 2001¬02, in terms of the provisions of Section 32 r.w.s. 43 of the IT Act, 1961.

2. That on the facts and circumstances of the case and in law the Ld. CIT(A) erred in ignoring the fact that the provisions of Section 47(iv) r.w.s. 43 and Explanation 3 to Section 43(1) of the I.T. Act, 1961 and the cost of the power plants acquired by the appellant were taken at the WDV in the books of the transferor namely Steel Authority of India (SAIL) instead of the cost at which the assessee had acquired the above assets on the basis of valuation by MECON.

3. That on the facts and circumstances of the case and in law the Ld. CIT(A) erred in deleting the addition of Rs. 3,31,58,000/- only by holding that the addition of interest earned at Rs. 3,31,58,000/- on deposits and advances made for the new unit being established instead of being set off/netted off against the interest on borrowed sums utilised for the new unit and capitalised can not be sustained, relying on the judgement in the case of CIT Vs Kamal Cooperative Sugar Mills Ltd. [2000] 243 ITR.

4. That on the facts and circumstances of the case and in law the Ld. CIT(A) erred in ignoring the fact that the assessee was expanding its existing business and interest expense during construction period was not an allowable revenue expenditure and that case ratio of Tuticorin Akali Chemicals Fertilizers Ltd. VS.CIT 227 ITR 172 (SC) was clearly applicable.

5. The appellant craves to be allowed to add any fresh grounds of appeal and/ or delete or amend any of the grounds of appeal.

4. The assessee company was incorporated on 8.2.1999 with the paid up capital of Rs.1000/- only consisting of 100 shares of Rs.10/- each. Out of 100 shares, 98 shares were subscribed by M/s. Steel Authority of India Limited (hereinafter referred to as SAIL) and 1 share each by Shri S.C.K. Patne and Shri Ranjit Chakrabarty, both employees of SAIL. The SAIL owned and operated captive power plants at Durgapur and Rourkela which were necessary for the continuous operation of critical areas of plant. As per the decision of Government of India, the public sector undertakings were to remain in their core activities only. The core activity of the SAIL is steel production and consequent to the decision of Government of India, power plants were to be shifted to NTPC which is again a public sector undertaking indulged in the core activity of power production. The captive power plants were transferred to the assessee, which becomes joint venture company owned equally by SAIL and NTPC. This transfer was made on the basis of valuation done by MECON Limited. The agreement was entered into between SAIL and NTPC regarding the ownership, management and power purchase agreement etc. which were subsequently approved by the Board of Directors. Consequent upon the approval by the Board of Directors of the assessee company, the shareholders agreement was executed on 16.3.2001. The transfer of shares from SAIL to NTPC was completed on 22.3.2001 by Stock Holding Corporation of India Limited which is also public sector undertaking. The assessee company claimed the depreciation in the assessment year 200 1-02 of the value of the power plants at which they were acquired by the assessee. The depreciation was denied by the Assessing Officer on the basis that this company was a wholly owned company of SAIL and that the provisions of section 47(iv) of the Income-tax Act were attracted. The fact that the SAIL admitted that the capital gain tax on the slump sale in terms of section 50B of the Income-tax Act of these two captive power plants was ignored. The assessee has claimed that firstly, it was not 100% owned subsidiary of SAIL and, secondly, the capital gain tax has been admitted by the transfer-or.

5. At the time of hearing, the learned DR as well as learned AR submitted that this issue has been decided in favour of the assessee by the decision of ITAT, Bench ‘E’, New Delhi in ITA No.03/Del/2005 in the assessment year 2001-02 order dated 19.3.2010 where the ITAT has decided the issue in favour of the assessee.

6. After hearing both the sides, we find that ground nos. 1 & 2 are covered by the decision of ITAT, Delhi Bench ‘E’ in its order dated 19.3.2010 in ITA No. 03/Del/2005 and the ITAT has decided the issue as under :-

“6. We have heard the parties at length and perused the material available on record. As regards the first contention, we concur with the views of ld. CIT (A) that merely two shares issued in the names of two employees of SAIL cannot be said that the assessee was not a wholly owned subsidiary of SAIL. It is not the case that the employees became the share holders from the public issue. Moreover it is not a case where the privatisation of portion of SAIL is being done by SAIL by incorporating the assessee company. Since no scheme for privatisation has been placed on record and from the material available on record, the two employees share holders appear to be nominee share holders of SAIL. Nothing has been placed on record that the said employees have been taken as partners of two persons of Government for commercial purposes. We concur with the views of ld. CIT (A) that no company can ever be held as wholly owned subsidiary as for registration/incorporation of a private limited company minimum two share holders are required and if the contention of the assessee is accepted, then there can never be a 100% holding-subsidiary company concept. Therefore for all purposes, we find no infirmity in the order of ld. CIT (A) for confirming the action of the A.O., treating SAIL as 100% holding company since the date of incorporation and on 07.03.2001 when the assessee company took over two captive power plants i.e. Durgapur Steel Plant and Rourkela Steel Plant. The A.O. vide page 7 to 9 of his order has pointed out clauses 7, 8, 9 and 10 of articles of association and other findings that the shares of Sh. S.C.K. Patne and Mr. Ranjit Chakrabarty are non transferable and nothing has been brought on record where the shares held by these two persons are in their individual capacities or as nominee of SAIL. In the Chairman’s speech for the year ending 31.03.2001, it has been mentioned about the incorporation of 100% wholly on subsidiary of SAIL. Therefore, on this contention of the assessee, the case of the assessee is covered u/s 47(iv) of the Act and therefore the transfer of captive power plant cannot be treated as transfer to the assessee company. As regards the actual cost of the transferred capital assets to the transferee company i.e. the assessee, it shall be the same as would have been if the transfer-or had continued to hold capital assets for the purpose of its business. Therefore the second contention of the assessee with regard to slump sale u/s 50B will not help the assessee in view of explanation 6 to section 43 and section 47(iv) of the Act.

7. As regards the third contention of the assessee that it became a joint venture company with equal shares of SAIL and NTPC and therefore the assessee company is not wholly owned subsidiary as at 31.03.2001. The views of the ld. CIT (A) in this regard are that a change in the constitution of the company i.e. in the shareholding before the close of the relevant period will not make the application of the above provisions ineffective as the relevant date for consideration is the date of transfer of the units and on such date the assessee was a wholly owned subsidiary. It was argued before the ld. CIT (A) as well as before us that section 5 of Income-tax Act defines the scope of total income and it is specified under sub clause that tax-ability is on all incomes which accrues or arises or is deemed to be accrue or arise in India during such year. It has been held in CIT vs. Bangalore Transport Co. Ltd. 66 ITR 373 (SC) that profitability or liability for any previous year accrue at the end of year and not during the year. Further in the case of E.E. Sasson & Co. Ltd. Vs. CIT, it has been decided that liability to tax does not accrue on day to day basis. Hence, in the light of above stated cases the holding of Steel Authority of India Ltd., as at the end of the previous year is to be considered and not the positions during the year. Hence Explanation 6 of section 43(1) is not applicable in this particular case as at the end of previous year SAIL, Power Supply Company Pvt. Ltd. was Joint Venture company of NTPC and Steel Authority of India Ltd. There are a number of enclosures by way of letters and approvals by various Government of India Ministries and bodies to show that the company was always converted as a Joint Venture between SAIL and NTPC even before the transfer of fixed assets. The ld. Counsel for the assessee invited our attention to the decision of ITAT Mumbai Bench in the case of Essar Oil Ltd. vs. DCIT reported in (2007) 13 SOT 691 on the identical issue. The head notes of the said decision for the sake of clarity are reproduced as under :-

“(I) Section 49, read with sections 47, 47A and 32 of the Income-tax Act, 1961-capital gains-cost with reference to certain modes of acquisition-assessment year 1993-94-Whether provisions of section 47 are withdrawn on occurrence of events mentioned under section 47A and transaction has to be treated as a transfer under section 2(47)(v)(vi), as case may be, and transfer-or-company is liability to pay capital gains tax-Held, yes-Whether in hands of transferee, valuation/cost of asset regarding which exemption granted under section 47(iv) has been withdrawn under section 47A, shall be cost for which such asset was acquired by it– Held, yes– Assessee company, which was a wholly owned subsidiary of holding company ‘E’, had taken over a division of ‘EG’ with effect from 31.5.1992 as a going concern – Assessee claimed depreciation on fixed assets and for that purpose had taken WDV of fixed assets at Rs. 130.52 crore-Assessee ceased to be wholly owned subsidiary of transfer-or-company ‘EG’ on 30.09.1994, but Assessing Officer rejected this fact on ground that subsequent events would not have any material change with respect to changing of cost of acquisition of capital assets acquired from holding company-Assessing Officer held that assessee satisfied all conditions laid down in section 47(iv), read with explanation 6 to section 43(1) and, accordingly, took WDV of assets in books of ‘EG’ at Rs.203.89 crore as cost of acquisition of assets by assessee for computation of depreciation – Whether since assessee-company ceased to be a subsidiary of transfer-or-company, provisions of section 47(iv) would not apply and, therefore, transaction was to be treated as transfer-Held, yes-Whether cost for which assessee had acquired asset should be cost of acquisition for purpose of computation of depreciation and, therefore, assessee was entitled to depreciation on cost of assets as Rs. 130.52 crore-Held, yes.”

8. The arguments advanced by the ld. Counsel for the assessee before the ld. CIT (A) and before us including the citation of decision in the case of Essar Oil Ltd. (supra), reading the provisions of section 47, 47A, section 2(47)(v) or (vi) and section 32, we are of the view that transaction in the present case has to be treated as transfer and the transferor company is liability to pay capital gains tax. In the hands of the transferee, the cost of asset regarding exemption u/s 47(iv) cannot be given and the same has to be treated as withdrawn u/s 47A of the Act and the cost of assets in the hands of the transferee shall be cost for which the assessee company acquired. Since the assessee company seized to be a subsidiary of transferor company, provisions of section 47(iv) will not apply and therefore the transaction in the hands of the assessee company has to be treated as transfer at the cost at which it had acquired the asset. The A.O. is directed to act as directed above. The assessee gets the relief accordingly. Thus, ground no.1 of the assessee is allowed.”

The facts remain the same and respectfully following the same, we dismiss ground nos. 1 & 2 in all the appeals.

9. Brief facts of the issue are as under :-

The assessee company was in the procession of expansion of its business by setting up new units at Bhilai for generation of power. Separate books of account and records were maintained for the new units being set up under expansion programme. For financing the expansion plans, the assessee company has raised the additional capital of Rs. 45,000 lakhs during the year. The outstanding of borrowed term loans as on 3 1.3.2007 was as under :-

10. The learned DR relied on the order of Assessing Officer and also submitted that the interest earned on the FDR is to be assessed as income from other sources in view of the decision of Honourable Supreme Court in the case of Tuticorin Alkalies Chemicals Fertilisers Ltd. vs. CIT 227 ITR 172 (SC). The learned DR also submitted that as per the amended provision in section 36(1)(iii) by the Finance Act, 2004, the interest paid in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalised in the books of account or not) for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction. Further the interest earned on the bank deposits are to be taxed as income from other sources in view of the decision of Honourable Supreme Court in the case of Tuticorin Alkalies Chemicals & Fertilisers Limited vs. CIT 227 ITR 172. She submitted that the principle of netting of interest shall not be applicable to the facts of the assessee’ s case and the order of CIT (A) deserves to be set aside.

12. After hearing both the sides, we hold as under.

Prior to the inserting of proviso to section 36(1)(iii), the interest paid on capital borrowed for the purpose of extension of existing business or profession was being allowed as deduction u/s 36(1)(iii) of the Income-tax Act as revenue expenditure. By inserting proviso to this section w.e.f. 1.4.2004 by the Finance Act, 2004, the amount of interest paid in respect of capital borrowed for acquisition of an asset for extension of existing business or profession whether capitalised in the books of account or not, for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction. The assessee company was running two power plants. Thereafter a new power plant was to be set up at Bhilai for generation of power. Company raised term loan for setting up this new plant. The separate books of account were maintained for this new unit. The assessee has worked out the amount of interest payable or paid relating to the borrowings utilized for expansion purposes. Similarly, the assessee also worked the earning of interest on the FDRs of surplus fund and interest on margins/advances made for the purpose of expansion. The assessee has adjusted the interest income towards the IEDC (incidental expenses during construction) by adopting the matching principle in respect of the interest earned on the FDRs of surplus fund and margins and advances made for the purpose of expansion. Admittedly, these incidental expenses were incurred during construction period of setting up new unit at Bhilai and whatever not related to this expansion work was claimed as revenue expenditure in the books which had been allowed. The CIT (A) granted the relief by following the judgement of Honourable Supreme Court in the case of Bongaigaon Refinery & Petrochemicals Ltd. vs. CIT 251 ITR 329 where the decision of Tuticorin Alkalies Chemicals & Fertilisers Ltd. vs. CIT 227 ITR 172 was also referred. We would like to state that in the decision of Bongaigaon Refinery & Petrochemicals Limited, Hon’ble Supreme Court has held as under :-

“ The High Court has already held that the interest income derived by the assessee during its formative period was taxable. What remains for consideration is the income which the assessee derived from house property, its guest house, charges for equipment and recoveries from the contractors on account of water and electricity supply. These items are covered by the decision in Bokaro Steel Ltd.’s case [1999] 236 ITR 315 (SC). To the extent that it relates to these items, i.e., items excluding interest, the question must be answered in the affirmative and in favour of the assessee. The order under challenge will stand modified to that extent.”

Honourable Apex Court has not deliberated on interest income but the interest income during the formative state was held to be taxable. The issues on which Apex Court deliberated were related only to the income derived from house properties, guest house, charges for equipment and recoveries from the contractor on account of water and electricity supply. Therefore, the ratio decided by Honourable Supreme Court does not cover the interest income. In the decision of CIT vs. Bokaro Steel Limited 236 ITR 315 (SC), the Honourable Supreme Court has held that the interest earned was inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of assets and these are receipts of capital nature. However, the decision of Honourable Supreme Court in the case of CIT vs. Bokaro Steel Limited was delivered in December, 1998, and thereafter a proviso has been added to section 36(1) (iii) of Income-tax Act w.e.f. 1.4.2004. By inserting this proviso to section 36(1)(iii), the interest paid on capital borrowed for acquisition of an asset for extension of existing business or profession for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction. The assessee has claimed the adjustment of interest against the incidental expenses during construction on the basis of matching principle is also not as per law. As we have stated above, the interest earned on FDRs made from surplus fund and interest earned on margins and advances made for expansion work shall be assessed under the head ‘income from other sources’. The set off claimed against the incidental expenses during the construction of new plant of which main component of this expense is interest paid on borrowed capital. The netting of interest in the case of CIT vs. Shri Ram Honda Power Equip 289 ITR 475 (Delhi) was allowed only for the purpose of deduction u/s 80HHC in view of provisions of section 80HHC (3)(baa). In the decision also, the Honourable Delhi High Court has clearly held that surplus funds parked with the bank and interest is earned thereon can only be categorised as income from other sources and such receipts merits separate treatment under section 56 of the Income-tax Act. Therefore, the principle of netting cannot be adopted in the assessee’ s case. The Honourable Delhi High Court in the case of Shri Ram Honda Power Equip (supra) has held as under :-

“To summarise the conclusions:

(i) In computing what the profits derived from exports for the purposes of section 80HHC (1) read with section 80HHC (3) are, the nexus test has to be applied to exclude that which does not partake of profits that can be said to have been derived from the business of exports.

(ii) In the specific context of clause (baa) of the Explanation to section 80HHC, while determining the “profits of the business”, the Assessing Officer has to undertake a two-step exercise in the following sequence. He has to first “compute” the profits of the business under the head “Profits and gains of business or profession.” In other words, he will have to compute business profits, in terms of the Act, by applying the provisions of sections 28 to 44 thereof

(iii) In arriving at the profits of the business by the above method, the Assessing Officer will exclude all such incomes which partake of the character of “income from other sources” which in any event are treated under sections 56 and 57 of the Act and are therefore not to be reckoned for the purposes of section 80HHC.

(iv) Where surplus funds are parked with the bank and interest is earned thereon it can only be categorised as income from other sources. This receipt merits separate treatment under section 56 of the Act which is outside the ring of profits and gains from business and profession. It goes entirely out of the reckoning for the purposes of section 80HHC.

(v) Interest earned on fixed deposits for the purposes of availing of credit facilities from the bank, does not have an immediate nexus with the export business and therefore has to necessarily be treated as income from other sources and not business income.

(vi) Once business income has been determined by applying accounting standards as well as the provisions contained in the Act, the assessee would be permitted, in terms of section 37 of the Act, to claim as deduction, expenditure laid out for the purposes of earning such business income.

(vii) In the second stage, the Assessing Officer will deduct from the profits of the business computed under the head “Profits and gains of business or profession” the following sums in order to arrive at the “profits of the business” for the purposes of section 80HHC(3) :

(a) 90 per cent. of any sum referred to in clauses (iiia), (iiib) and (iiic) of section 28, i.e., export incentives;

(b) 90 per cent. of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits; and

(c) profits of any branch, office, warehouse or any other establishment of the assessee situate outside India.

(viii) The word “interest” in clause (baa) of the Explanation connotes “net interest” and not “gross interest”. Therefore, in deducting such interest, the Assessing Officer will take into account the net interest, i.e., gross interest as reduced by expenditure incurred for earning such interest.

(ix) Where, as a result of the computation of profits and gains of business and profession, the Assessing Officer treats the interest receipt as business income, then deduction should be permissible in terms of Explanation (baa) of the net interest i.e., the gross interest less the expenditure incurred for the purposes of earning such interest. The nexus between obtaining the loan and paying interest thereon (laying out the expenditure by way of interest) for the purpose of earning the interest on the fixed deposit, to draw an analogy from section 37, will require to be shown by the assessee for application of the netting principle.

The interest earned on surplus fund parked into FDRs and on margin/advances made for expense on work can be categorised only as ‘income from other sources’. Further, as per the proviso to section 36(iii), the whole of interest as the borrowed capital have to be capitalised for the period till the asset first put to use. Admittedly, the assets were not put to the use in the financial year relevant to assessment year under consideration. Hence, it has to be capitalised.

Further, the deduction of interest or other expenditure under section 57 can be allowed only when it has been borrowed for the purpose of earning of such income. Here the loan was taken for expansion. Deduction u/s 57(iii) of the Income-tax Act is allowable when any expenditure not being in the nature of capital expenditure laid out or expanded wholly and exclusively for the purpose of making or earning such income. Thus, the expenditure to be deductible u/s 57(iii) must be laid out or expanded wholly or exclusively for the purpose of making or earning such income. Unless the expenditure sought to be deducted resulted in making or earning income it could not be said to be laid out or expanded for the purpose of making such income. The wording of section 57(iii) are narrow than the language of sections 36 and 37 of Income-tax Act. Honourable Supreme Court in the case of Smt. Padmavati Jaikrishna vs. Addl. CIT 166 ITR 176 has held that when the dominant purpose for paying annuity deposit was not to earn income but to meet the statutory liability of making the deposit then the expenditure was not wholly or exclusively for the purpose of earning such income.

The interest expenditure paid in respect of capital borrowed for acquisition of an asset for extension of the existing business or profession was allowable as revenue expenditure but by the proviso inserted w.e.f. 1.4.2004 by the Finance Act, 2003, such interest paid in respect of capital borrowed for acquisition of asset for the extension of existing business or profession shall not be allowable for any period beginning from the date on which capital was borrowed for acquisition of the asset till the date on which such asset was first put to use. It has also been made clear by the amendment that whether the interest amount has been capitalised in the books of account or not it will not make any difference in the allow-ability of the deduction. Admittedly, the dominant purpose for the loan taken was for the extension of the existing business by way of setting up a new power generation plant at Bhilai. Since assessee had been denied the benefit by inserting a specific proviso to section 36(1)(iii), therefore, matching principle shall help assessee. Whatever cannot be achieved directly, it can also not be achieved indirectly.

In view of the above facts, we set aside the order of the CIT (A) on this issue and restore the order of the Assessing Officer.

13. In the result, the appeal of the revenue in ITA Nos. 4668 to 4672/Del/2010 are dismissed and appeal of revenue in ITA No. 4673/Del/2010 is allowed.

Order pronounced in open court on this 25^th day of March, 2011.