Judgment:
1. The assessee is in appeal before us against the order of the learned CIT(A), dt. 6th June, 2000, for asst, yr. 1995-96. First ground in the appeal is against the addition of Rs. 42,54,767 and against the conclusion that Section 40(a)(i) of the IT Act, 1961 (the Act), was applicable to the assessee's case.
2. The assessee-firm is engaged in the business of ship breaking at Alatg Port. During the year under consideration, assessee had purchased two ships for breaking purposes--one from M/s Electra Maritime (Jersey) Ltd. London, at a price of US & 9,01,252.98 and the other from M/s Neter Navigator, Singapore, at a price of US & 30,69,416.5. The purchase price and other terms of purchase were as per the Memorandum of Agreement (MOA) entered into between the assessee and the respective sellers. In the course of assessment proceedings it was observed that as per MOA, assessee was making interest payments to non-resident parties on account of credit facility availed by it for the purchase of ships. Therefore, the assessee was queried as follows : (a) Whether any tax at source has been deducted on interest payments; and (b) If not, why the provisions of Section 40(a)(i) should not be invoked and why the entire interest paid outside India should not be disallowed.
Detailed submissions were made on behalf of the assessee, the gist of which is as follows : (2) Where interest paid is part of purchase price, the same cannot be regarded as interest; (3) Reliance on the decisions in the case of CIT v. Vishakhapatnam Port Trust (1993) 144 ITR 146 (AP), CIT v. Saurashtra Cement & Chemical Industries Ltd. (1975) 101 ITR 502 (Gau), CIT v. Orient Trading Co. (1994) 208 ITR 216 (Guj) was placed.
(4) For an item to fall within the definition of interest, it has to be interest payable in any manner in respect of any moneys borrowed or debt incurred; (5) There should be a borrower-lender relationship for a payment to assume the character of interest; (6) The seller, a non-resident, has not earned any income in India which is liable to tax in India under the Act and, therefore, there was no liability on the part of the assessee to deduct tax at source.
3.1 (1) & (2). As regards the first two arguments, AO referred to the MOA. As per the agreement, immediately after receiving the Notice of Readiness (NOR), buyers have to arrange for the opening bank to instruct the negotiating bank to release the full purchase price to the sellers. The AO, therefore, observed that on delivery, negotiating bank will release the cost of the vessel to the seller, i.e., US S 9,01,252.98. He further, observed that if the contention of the assessee was to be accepted, then on delivery, seller will get the cost of the vessel phis the usance interest of 180 days. In his opinion, this would be illogical because the period of usance was to be counted from the date of delivery, Credit facility was granted from the date of delivery and interest payment became due 180 days after the delivery. Thus, according to the AO, purchase price of the vessel and usance interest were two distinctly different items of payment. Accordingly, the argument that interest was a part of purchase price was rejected.
3.2 (3) As regards the case of Vishakhapatnam Port Trust (VPT for short), supra, AO distinguished it on the ground that in that case, the Court was considering the issue whether interest paid on unpaid purchase price could be regarded as arising out of indebtedness or not because as per the relevant Double Taxation Avoidance Agreement (DTAA), interest was chargeable to tax in India only if it was found arising out of indebtedness. The case of Saurashtra Cement (supra) was distinguished on the ground that in that case the issue was whether there was any business connection or not. Moreover, in case of Saurashtra Cement, delivery was given outside India, whereas in the present case, delivery of vessel was given in India, The case of Orient Trading was distinguished on the ground that in that case, the issue was distinguished on the ground that in that case, the issue was whether amount paid as interest on hundi and late payment of purchase price on the same, should be regarded as interest paid on borrowed capital. AO observed that definition of the term "interest" in the Act is an inclusive one, and hence has a wide scope. In the instant case, he observed, there is no limitation that interest should arise only from borrowed capital.
3.3. (4) With regard to the fourth contention, AO referred to the definition of the term "interest" given in Section 2(28A) of the Act. He also referred to the terms of the MOA and held that the amount fell within the four corners of the definition of the term "interest" and that it could not be considered as any other payment.
3.4. (5) With regard to the fifth contention of the assessee. AO observed that borrower-lender relationship was not a necessary condition for the accrual of interest. According to the definition even a debtor-creditor relationship was sufficient. In the instant case, there was such relationship and the assessee had an obligation to pay interest.
3.5. (6) The sixth contention that the non-resident seller had not earned any income in India was also rejected for the reasons that (a) credit facility was made available to the assessee as per the MOA which had been signed in India by the agent of the seller, (b) the delivery of the vessel was made in India and the credit facility made available to the assessee was being utilised in India.
3.6 (7) Lastly, it was contended by the assessee that it had obtained a term loan from S.B.I., Bhavnagar branch, which was repaid within 180 days. In other words, the contention was that interest was paid to an Indian bank and hence no liability to deduct tax arose. The AO observed that payment was made by the bank to the seller under irrevocable letter of credit (LC) and hence the role of the bank was that of an agent of the assessee. Thus, this contention too was rejected.
4. In view of the facts discussed above, AO held that assessee was liable to deduct tax at source on the usance interest paid by it under the terms of L.C. through which the assessee had paid the purchase price of the ship as per the terms of the MOA entered into by the assessee and the non-resident seller of the ship. Assessee not having discharged this liability, AO invoked the provisions of Section 40(a)(i) and disallowed the interest of Rs. 42.54,767.
5. CIT(A) confirmed the disallowance by making the following observations ; (1) MOA separately mentioned the purchase consideration and interest payable; (2) Separate invoices and drafts are to be prepared for original price and interest amount; (3) Section 2(28A) includes "debt incurred" and hence the provisions of DTAA and the Act are on the same lines; (4) When purchase consideration was not immediately paid, a debt was certainly incurred in the form of unpaid purchase consideration ; (5) Like the AO, CIT (A) also distinguished the case of Vishakhapatnam Port (supra) and observed that as per the relevant treaties (U.K. and Singapore), the term "interest" was not restricted to interest on bonds, securities or any other form of indebtedness; (6) Reliance was placed on the decision of the Delhi High Court in the case of J.K. Synthetics v. Asstt. CIT (1990) 185 ITR 540 (Del); (7) Reliance was placed on the decision of the Supreme Court in the case of Transmission Corporation of A.P. Ltd. v. CIT (1999) 239 ITR 587 (SC). It was held that the scheme of tax deduction at source applied not only to the amount paid which wholly bears income character, but also to gross sums, the whole of which may not be income or profits of the recipient; (8) Assessee did not file any application under Section 195(2) for determination of the issue whether interest payable by it to the two non-resident concerns was liable to tax or not. Hence, Section 9(1)(v) was applicable; (9) Assessee had taken a plea that the sellers had shown both the amounts, i.e., sales consideration and interest as sales consideration in their books of account. To this, the CIT(A) observed that accounting entries do not make a difference to the nature of receipt.
(10) C1T(A) also rejected the plea of the assessee that after discounting the bill, interest was payable to a resident, i.e., a branch of SBI in Singapore, as having no merits. In view of the above findings, CIT(A) confirmed the disallowance of Rs. 42,54,767.
6. Mr. Saurabh Soparkar, the learned counsel for the assessee, at the outset, apprised us of the entire modus operandi of the transaction of buying the ship. First, a Memorandum of Agreement (MOA) is entered into between the identified seller and identified buyer (the assessee). The MOA specifies the ship as well as the price at which it is to be bought. Mode of payment is prescribed which is by means of 100 per cent confirmed irrevocable 180 days usance Letter of Credit (L.C.) acceptable to sellers through any nationalised Indian Bank (referred to as the opening bank for short) to be established in favour of the seller for net amount. The L.C. is to be advised through and confirmed by a foreign bank (known as the negotiating banker) on behalf of the seller. The L.C. has to be released immediately after the Notice of Readiness (NOR) has been given to the buyer or his authorised representative. The MOA mentions that immediately after the NOR complete in all respects has been served to the buyers, buyers shall immediately arrange with the opening bank to instruct the negotiating bank to release the full purchase price to the sellers. After the released of full purchase price, the negotiating bank shall pass on the relevant documents to the opening bank for onward transmission to the buyers. The documents, inter alia, consist of commercial invoice certifying the details of the vessel and purchase price, invoice for interest amount for 180 days usance from the date of NOR. Bill of Sale in favour of the buyers certifying that the vessel is free from all encumbrances, LDT proof and so on. The vessel is then physically delivered to the buyers.
7. Mr. Soparkar then took us through the various documents placed in the paper book viz., intimation to the effect that L.C. dt. 17th Sept., 1994, is opened, NOR dt. 19th Sept., 1994, issued by the agents for the vendors, instruction dt. 20th Sept., 1994, issued by the buyer to its bankers to release the proceeds of L.C. to the beneficiaries since it has accepted the NOR, message dt. 20th Sept., 1994, to the beneficiary that the buyers have accepted the NOR, certificate of physical delivery dt. 21st Sept., 1994, commercial invoice dt. 22nd Sept., 1994, interest invoice, dt. 22nd Sept., 1994, and Bill of Sale dt. 22nd Sept., 1994.
8. By apprising us of the above facts and taking us through the various documents, Mr. Soparkar emphasised on the point that the sale was not complete till the bill of sale was issued. It was only on issue of Bill of Sale, the property in the ship passed to the buyer. Referring to the provisions of Section 40(a)(i) and Section 195, it was contended that assesses was not responsible to make any payment to a non-resident.
Once when instructions were issued to the opening banker to release the L.C., it was the responsibility of that banker to make payment and that such payment was on principal-to-principal basis. It was vehemently argued that opening banker could not be considered as the agent of the assessee. It was very emphatically reiterated that assessee's obligation was only towards the opening banker and opening banker was independently obliged to make payment to the beneficiary of the L.C.Section 195 was not applicable, it was stated, because there was no obligation on the part of the assessee when credit was released as no sale had yet taken place, and moreover, no payment, either made or credited, was entered in the books of assessee. For the contention that payment by opening banker to negotiating banker was on principal-to-principal basis and that the assessee was in no way liable to make payment to the non-resident seller, Mr. Soparkar relied on the decisions of the Supreme Court in the case of (a) Federal Bank Ltd. v.V.M. Jog Engineering Ltd. and Ors.U.P.Co-operative Federation Ltd. v. Singh Consultants & Engineers (P) Ltd. 1988 (1) SCC 174, (c) United Commercial Bank v. Bank of India and Ors.
AIRTarapore & Co. v. V.O. Tractors Export, Moscow 1969 (V SCC 233. It was submitted that since assessee's liability was towards the opening banker which was an Indian bank, payment of interest to it clearly fell within the exception specified in Sub-clause (a) of Clause (iii) of Sub-section (3) of Section 194A of the Act.
9. Mr. Soparkar pointed out that the L.C. was subject to "Uniform Custom & Practice for Documentary Credits" (UCPDC) issued by International Chambers of Commerce (ICC). In it our specific attention was invited to Article 3 of ICC Brochure No. 222 as extracted in the decision of M/s Tarapore & Co. (supra) and which is reproduced below ; "An irrevocable credit is a definite undertaking on the part of an issuing bank and constitutes the engagement of that bank to the beneficiary or, as the case may be, to the beneficiary and bona fide holders of drafts drawn and/or documents presented thereunder that the provisions for payment, acceptance or negotiation contained in the credit will be duly fulfilled, provided that all the terms and conditions of the credit are complied with.
An irrevocable credit may be advised to a beneficiary through another bank without engagement on the part of that other bank (the advising bank), but when an issuing bank authorises another bank to confirm its irrevocable credit and the latter does so, such confirmation constitutes a definite undertaking on the part of confirming bank either that the provisions for payment or acceptance will be duly fulfilled or, in the case of a credit available by negotiation of drafts, that the confirmation (sic) drafts without recourse to drawer.
Such undertakings can neither be modified nor cancelled without the agreement of all concerned." "In documentary credit operations all parties concerned deal in documents and not in good's.
Payment, acceptance or negotiation against documents which appear on their face to be in accordance with the terms and conditions of a credit by a bank authorised to do so, binds the party giving the authorisation to take up the documents and reimburse the bank which has effected the payment, acceptance or negotiation........" Thus, by the above arguments it was contended that assessee never made any payment of interest to any non-resident and hence was not liable to deduct tax at source.
10. At this juncture, it may not be out of place to mention that along with the present appeal, seven other appeals on the same issue were also fixed and heard. The above arguments made by Mr. Soparkar are for all the eight appeals which shall be disposed of separately by orders of even date. Similarly, Mr. M.P. Sarda and Mr. K.C. Patel have also advanced certain arguments which are common to all the eight appeals.
Unless there are distinguishing features depending upon the facts in each appeal, they shall not be repeated in our orders for other appeals.
11. The first contention of Mr. Sarda was that Section 195 was not applicable because of the operation of Double Taxation Avoidance Agreements (DTAA) entered into by India with the countries which were concerned in the present transactions. The countries with which we are concerned in all the eight appeals are United Kingdom (UK), Singapore, Belgium, United Arab Emerates (U.A.E.), United States of America (U.S.A.), Cyprus and Germany. It was submitted that wherever DTAA was in operation, it would override the provisions of the Act. For this reference was made to the decision in the case of Vishakhapatnam Port Trust (supra). It was pointed out that Department's special leave petition (SLP) against this judgment of the Andhra Pradesh High Court was dismissed by the Supreme Court [(186 ITR 34 (St)]. It was submitted that the facts in the case of Vishakhapatnam (supra) were identical to the facts in the assessee's case where the question of deferred payment of purchase price was involved. It was further pointed out that wherever interest on deferred payment was to be included in the meaning of the term "interest", it was specifically provided. In this connection reference was made to the Indonesian Treaty 171 ITR 35 (St)] and Phillipino Treaty [219 ITR 71 (St)]. Section 90(2) was then referred to to emphasise the binding nature of treaty. Mr. Sarda placed reliance on the Board's Circular No. 728, dt. 30th Oct., 1995. Reliance was placed on the decision of the Calcutta High Court in the case of CIT v. Davy Ashmore India Ltd. (1991) 190 ITR 626 (Cal) and of the Bombay High Court in the case of CIT v. Cooper Engineering Ltd. (1968) 68 ITR 457 (Bom). Elucidating the principle of ejusdem generis, it was contended that the term "interest" in the relevant DTAAs was used with particular reference to income from Government securities, bonds, debentures, etc. therefore, debt claims of every Kind" should be understood to be including only claims of similar nature.
12. Referring to the decision of the Ahmedabad Bench of the Tribunal in the case of Mayank Electro Ltd. v. ITO (2001) 71 TTJ (And) 612, Mr.
Sarda contended that interest partakes the character of the payment on which it is awarded. Reliance was placed on the decision of the Supreme Court in the case of CIT v. Govinda Choudhary & Sons (1993) 203 ITR 881 (SC) and of the Kerala High Court in the case of United Construction Contractors v. CIT (1994) 208 ITR 914 (Ker). In any case, if two views were possible, the one favourable to the assessee should be adopted as was held by the Supreme Court in the case of CJT v. Vegetable Products Ltd. (1973) 88 ITR 192 (SC).
13. Finally, referring to the decisions in Dr. Sham Lal Narula v. CIT (1964) 53 ITR 151 (SC), T.N. Govindaraju Chetty v. CIT (1967 66 ITR 465 (SC) and Kesoram Industries & Cotton Mills Ltd. v. CIT (1966) 59 ITR 767 (SC) which have been relied upon by the learned Departmental Representative in his written submissions, it was submitted that these decisions have been considered in the case of Vishakhapatnam Port Trust (supra). The decision in Transmission Corpn. of A.P. Ltd. and Anr. v.CIT (1999) 239 ITR 587 (SC), also relied upon by the learned Departmental Representative totally on a different issue, it was contended. Mr. Sarda concluded his arguments by referring to the decision of the Bombay High Court in the case of CJT v. Smt. Godavari Devi Saraf (1978) 113 ITR 589 (Bom), to the effect that since there is only one decision on the issue, that is, in the case of Vishakhapatnam Port Trust (supra), the same is binding and should be followed.
14. Mr. K.C. Patel took us through the various terms of L.C. and the invoices to emphasise the fact that payment made by the assessee was to a resident bankers only and that interest, though separately mentioned in the MOA and separately invoiced, was part of purchase price only. He also referred to various opinions placed on record to show that tax was not deductible at source on usance interest. He also referred to various judicial pronouncements placed in the paper book, most of which have been referred to by the earlier, and hence are not repeated.
15. The learned Departmental Representative firstly laid stress on the definition of the term "interest" given in Section 2(28A) of the Act.
This, it was submitted, had to be read with Section 9(1)(v) of the Act.
Since usance interest fell within the definition of the term "interest" and since it was deemed to accrue in India, as per Section 195 the assessee was liable to deduct tax at source from such payment. Not having done so, Section 40(a)(i) came into play and hence, this disallowance was rightly made.
16. The learned Departmental Representative then strongly attempted to refute the contention made on behalf of the assessee that impugned interest was a part of purchase price. For this, our attention was drawn to several documents-notably amongst them being, MOA, Bill of Entry, Bill of Sale, L.C. and so on. In all these documents, it was submitted, interest was clearly segregated and shown separately and hence under no circumstances it could be considered part of the purchase cost. The learned Departmental Representative invited our attention to a sample application form for raising short-term foreign currency loan/credit. The columns, according to the learned Departmental Representative clearly indicated that availing suppliers credit was subsequent to purchase of ship and therefore, it was contended that interest was separate and in addition to the purchase price.
17. The teamed Departmental Representative also vehemently opposed assessee's strong reliance on the decision in Vishakhapatnam Port Trust (supra). In this connection it was submitted that in the present case provisions of Section 2(28A) and Section 9(1)(v) were the guiding force. These provisions had come on the statute book w.e.f. 1st June, 1976. On the other hand, the decision in Vishakhapatnam Port's case was rendered with reference to asst. yrs. 1970-71 to 1974-75 and hence, it was not applicable to the present case. Further, it was contended that the same decision was rendered in the context of earlier DTAAs wherein interest income was defined with reference to indebtedness. In the present DTAAs, it is defined with reference to "debt claim of every kind". The extended meaning of the term "interest" is thus in line with the exhaustive definition in Section 2(28A). Reference was made to the decision of the Supreme Court in the case of CIT v. Toshoku Ltd. (1980) 125 ITR 525 (SC) wherein it is held that a credit balance represents a debt. In the present case, the moment ship is delivered to the assesses, credit balance appears in the name of the sellers of the ship and, therefore, it is a debt. Interest on such debt, it was contended, is clearly covered under the definition in Section 2(28A) and under the DTAA. Further, the decision in Vishakhapatnam was rendered in context of Section 9(1)(i) which was held to be overridden by the DTAA under Section 90. However, no such limitation exists for the new definition of interest given in the DTAA. With regard to the decision in the case of Bombay Steam Navigation (P) Ltd. v. CIT (1965) 56 ITR 52 (SC), and on which reliance was placed by the assessee, it was submitted that, in fact, the said decision supports the case of the Revenue. According to the learned Departmental Representative, in that case the Supreme Court held that interest on unpaid consideration of assets are separate from capital part as well as loan part of assets consideration. Similarly, in the present case usance interest is separate from deferred purchase consideration. As regards UCPDC, it was submitted that its relevance was only for resolving disputes between opening bank and negotiating bank. Finally, the learned Departmental Representative concluded his arguments by submitting that all the decisions relied upon by the assessee were distinguishable on facts.
18. In his rejoinder, referring to the decision in the case of Vishakhapatnam Port Trust (supra), Mr. Soparkar submitted that the said decision recognises that DTAA prevails over the Act and it is not interest within the meaning of DTAA. The expanded definition in Section 2(28A) and the provisions of Section 9(1)(v) governs only the Act. But if the assessee's case falls within DTAA, then those expanded provisions are not material. It was also submitted that interest cannot be divorced from its main source. Thus, it is a part of purchase price.
19. We have given our utmost consideration to the rival contentions and the material on record. At the outset, it may be stated that both the sides have made elaborate arguments and have placed voluminous material before us. Numerous judicial pronouncements have been cited before us.
The entire material has been duly considered. Whereas there cannot be any quarrel over the propositions laid down in those decisions, we shall deal with only those decisions which, in our opinion, are relevant to decide the issue on hand.
20. The issue is, whether the assessee is liable to deduct tax at source on usance interest under Section 195(1) of the Act on the credit availed by it for purchasing ship from a non-resident under Letter of Credit opened by a resident bank in favour of the non-resident seller of ship.
21. "Usance Interest" are the key words. Let us first understand the meaning of the word "usance". Webster's Comprehensive Dictionary (Deluxe Encyclopedic Edition 1996) describes "usance" as "a period of time, variable as between various countries, which, by commercial usage, is allowed, exclusive of days of grace, for payment of bills of exchange, especially foreign". The Law Lexicon by P. Ramanath Aiyar (2nd Edn.--2000) describes it is "the time which it is the usage of the countries, between which bills are drawn, to appoint for payment of them". In short, usance is the time allowed for payment of bills of exchange. Nothing much turns on the meaning of the word "usance" except that it merely indicates that the "interest" we are dealing with is the interest which is payable on a foreign bill of exchange. In essence, we need to properly understand the term "interest" in the context with which we are concerned. In other words we need to understand the true nature of the payment which is described as interest. The agreement between the parties should be the first and the best guide to throw some light on the true nature of the payment. The agreement is for the purchase of a ship. The purchase of ship is the only transaction for which the agreement is entered into. Although, the purchase price of the ship and interest for 180 days from the date of NOR are separately mentioned in the agreement, nonetheless, it remains a single transaction of purchase and sale of ship. The agreement categorically provides that the total amount shall be payable by means of 100 per cent confirmed irrevocable 180 days usance Letter of Credit. This clearly indicates that interest, though separately mentioned in the MOA, is part of the same transaction and cannot be meted out a separate treatment altogether from the main component i.e., the purchase price.
In other words, the point we are trying to drive home is that what governs a purchase transaction, will also govern the component thereof.
It also needs to be appreciated that there is no right of prepayment by the buyer to the seller, that is to say, irrespective of the point of time when the buyer makes payment within 180 days, the buyer shall have to pay the interest component as specified in the MOA. This proposition also leads us to the conclusion that by entering into the MOA, buyer did not incur any debt in the sense that any loan or advance had been raised to be indebted to the seller. This is a sure and simple purchase transaction entered into by the buyer where, in terms of the L.C., he has to make the total payment which is inclusive of interest. It is well established that nomenclature cannot decide the true nature of the payment. It is the essential characteristic of the transaction which would govern the true nature of the payment.
22. This issue can be looked at from a different angle also. From the seller's viewpoint, the exclusive selling price and interest would not be arising from two different sources. The word "source" means something from which income arises. In the present case, the purchase price and interest both are arising from the same source, i.e., the transaction entered into with the buyer for sale of ship. This aspect also leads us to the conclusion that the interest amount, though separately mentioned in the MOA and though described as "interest", it partakes the character of the purchase price for the buyer and should be treated as part of purchase price.
23. Our viewpoint that the interest amount specified in the MOA partakes the character of purchase price gets strengthened from the provisions of DTAA also. The DTAA with Singapore and U.K., with which we are concerned in the present case, makes provision as to how different sources of income have to be dealt with. Some of the sources are business profits, income from immovable property, air transport, shipping, dividends, royalties, interest, capital gains and so on. The fact that a separate article is devoted to interest indicates that interest as envisaged under the DTAA, ought to be a separate transaction altogether and not a part of normal business transaction of purchase and sales. The term "interest" as defined in DTAA with Singapore is as follows : "The term "interest" as used in this article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits; and in particular, income from Government securities and income from bonds and debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this article".
The definition in the DTAA with U.K. is materially on the same lines.
The expression "debt-claims" referred to in the definition of the term "interest" given in DTAA has to be understood in the sense of raising a loan and earning interest therefrom. The expression "debt-claims" is further qualified as follows: "Debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profit." The fact that the term "debt-claims" is qualified by the expression "whether or not secured by mortgage", is indicative of the fact that the "debt-claims" referred to in the definition of the term "interest" means a loan, secured or unsecured". If the term "debt-claims" was to include all sorts of debts, as is the stand of the Department, then, in our opinion, there was no need to qualify the said terms by the expression "whether or not secured by mortgage". If we turn to the facts of the present case, undoubtedly, when the NOR is presented to the buyer under the MOA, the buyer incurs an obligation to make payment to the seller. In broad terms such an obligation to make payment can be described as a debt. But each and every debt is not envisaged to be included in the term "debt-claims" as referred to in the definition of the term "interest" under the DTAA. The view gains further strength when the definition proceeds further and mentions "and in particular, income from Government securities and income from bonds and debentures, including premiums and prices attaching to such securities, bonds and debentures". Applying the principle of ejusdem generis, the terms "debt-claims" will take colour from the associated terms used in the definition i.e., bonds, debentures, etc. Bonds and debentures, as is well known, acknowledge indebtedness for money lent and guaranteeing repayment with interest. Thus, the term "interest" under the DTAA is meant to be interest earned on Government securities, bonds, debentures in particular, and also debt claims whether secured or not. Therefore, it makes sensible reading of the definition if the term "debt-claims" is understood in the same sense as raising a loan and earning interest therefrom. The interest amount specified in the MOA cannot assume the characteristic as envisaged under the DTAA because it is a part of the entire purchase transaction from which it cannot be divorced, and there is no intention between the parties to raise any loan and pay interest thereon, It would be interesting to note that wherever it was necessary, the DTAAs have specifically included deferred payment sales in the term "debt-claims". The treaties with Indonesia and Phillipines are glaring examples of the intention, Thus, the view expressed by us earlier that interest amount specified in the MOA partakes the character of purchase price is further strengthened.
24. Our above view gets fortified by the lone decision direction on the issue rendered by the Hon'ble Andhra Pradesh High Court in the case of Visakhapatnam Port Trust (supra). It would be advantageous to quote extensively from the said decision. At pages 168 to 170 of the report, the Hon'ble High Court has observed as follows : "The law relating to interest arising out of "indebtedness" is well settled. A "debt" is a sum of money which is now payable or will become payable in the future by reason of a present obligation, debitum in praesenti, solvendum in futuro: Webb v. Stenton (1883) 11 OBD 518, 527 (CA). A liability depending upon a contingency is not a debt in praesenti or in futuro till the contingency happened. But if there is a debt, the fact that the amount is to be ascertained does not make it anytheless a debt if the liability is certain and what remains is only the quantification of the amount. The expression "debt" may take colour from the provisions of the concerned Act, It may have different shades of meaning : Kesoram Industries & Cotton Mills Ltd v. CWT (1966) 59 ITR 767 (SC). If money is due to a person and is not paid for but has been withheld from him by the debtor after the time when payment is to have been made, in breach of his legal rights, it is a compensation whether it is liquidated under agreement or statute. The compensation is properly described as interest : (Westminster Bank Ltd. v. Riches (1947) 28 Tax Cases.
159, 189 : (1947) 15 ITR (Supp) 86 (HL). Therefore, when interest is paid not as part of the compensation but is given for the depreciation of the use of the money, it is an independent source of income and is taxable. Dr. Shamlal Narula v. CIT (1964) 53 ITR 151 (SC), and similarly if the right to interest arises because the person is kept out of his money, the interest received is chargeable to tax as income. The same principle would apply if interest is payable under the terms of an agreement and the Court or the arbitrator gives effect to the terms of the agreement and awards interest: T.N.K. Govindaraju Chetty v. CIT (1867) 66 ITR 465 (SC).
But where the interest is merely in name but constitutes part of the compensation or part of the damages, it is not "interest" chargeable to income-tax. As an integral part of such compensation it may be either slumped-up with the other elements in the gross sum or may be separately stated but treated as part of the gross sum, IRC v. Ballantine (1924) 8 Tax Cases. 595 (C. Sess). Mere description of the amount as interest which in fact is part of the compensation does not have the effect of altering the true character of the compensation, Simpson v. Executors of Bonner Maurice as Executor of Edward Kay (1929) 14 Tax Case 580 (CA). That, in fact, is also the position with regard to unpaid purchase money coupled with a liability to pay interest along with each of the instalments.
Whereas here, parties enter into an agreement to accept a portion of the purchase money immediately and the balance to be paid in certain instalments along with interest on the instalment of purchase money, the agreement though it vested the property agreed to be sold in the purchaser, does not have the effect of converting the price due into a loan. The intrinsic nature of the money due to the vendor is an unpaid purchase money and not as debt. The parties may, however, agree to convert the unpaid purchase money as a debt; Radha Kissen v. Keshardeo, AIR 1957 SC 743. An agreement to pay the balance of consideration due by the purchaser does not in truth given rise to a loan : Bombay Steam Navigation Co. (1953) (P) Ltd. v. CIT (1965) 56 ITR 52, 57 (SC).
When, therefore, there is no agreement initially or any novation between the parties to treat the unpaid purchase money as a debt repayable with interest, even though the purchaser incurred the obligation of paying the sale proceeds to the seller, he does not become, in any sense, a debtor of the seller. If there is no agreement initially or by way of novation to treat the balance of sale consideration as paid off in full and no novation to treat the balance of consideration as a loan, the amount received by the seller cannot be regarded as interest on money lent.
The word "source" means something from which income arises. The seller would have, in a contract for sale of goods, got anyway interest on sale proceeds under Section 61 of the Sale of Goods Act even if the purchaser had not utilised the money : Lakhmichand Muchhal v. CIT (1961) 43 ITR 315 (MP). The interest in such a case is received as part of the purchase price itself, that is to say, as part of the consideration for sale of goods on deferred payment basis and not as a separate source : CIT v. Saurashtra Cement & Chemical Industries Ltd. (1975) 101 ITR 502 (Guj), the mere nomenclature employed by the parties notwithstanding. When the payment of interest is as part and parcel of the agreement to pay the unpaid purchase money on a deferred payment basis, there is no indebtedness (Chittele Venkata Subba Reddi v. Jayanthi Audinarayana A.S. No. 446 of 1964, dt. 2nd Aug., 1968) per Kondaiah J., as he then was), affirmed in L.P.A. No. 267 of 1968, dt. 14th March 1969).
Bearing these well-settled principles in mind, it has to be seen whether interest payable on the agreed instalments of unpaid purchase money can be treated as a separate "source" being interest on any form of "indebtedness" contemplated in Article VIII of the agreement.
We are of the opinion that the interest agreed to be paid along with each of the instalments of unpaid purchase money was agreed to be part of the sale consideration itself and cannot be treated as an independent "source" of income. The words "any other form of indebtedness from sources" in the other territory can only mean interest arising or accruing as a separate "source" of income. It cannot include interest payable on the unpaid purchase money agreed to be part of the sale consideration. There is nothing in the initial contract or any novation converting the interest payable with the instalments as a "loan". Hence the interest specified in Clause 12(a) of the contract is, in our opinion, not, liable to income-tax." Mr. Sarda had tried to distinguish between the term "indebtedness" and "debt-claims". His contention was that the term "debt-claims" was narrower expression than the term "indebtedness" and, therefore, the present case was squarely covered by the decision in Visakhapatnam Port Trust (supra). We do not see any distinction between the two terms but, nonetheless, the decision in Visakhapatnam Port Trust squarely covers the issue on hand. Of course, in that case deferred payment was to be made in certain instalments which carried interest. In the present case, the interest is for 180 days usance under the term of Letter of Credit. In our view, considering the fact that there is no right of prepayment and avoid the interest element, the present case is on a stronger footing than the case of Vishakhapatnam Port Trust (supra).
25. The learned Departmental Representative had strongly relied on the definition of the term "interest" given in Section 2(28A) of the Act and had submitted that the decision in the case of Vishakhapatnam Port Trust was rendered in connection with the assessment years when the said definition was not brought on the statute book. We appreciate the argument of the learned Departmental Representative. However, it is trite law that where DTAA is in operation it would over-ride the provisions of the Act. This is also the view taken by the Andhra Pradesh High Court in the case of Visakhapatnam Port Trust (supra).
This being the position of law, the definition of the term "interest" given in Section 2(28A) of the Act becomes irrelevant for our purpose.
26. Elaborate arguments were advanced on the issue whether the buyer was indebted to the non-resident seller or was he indebted to the resident opening banker. The main plank of Mr. Soparkar's argument in this connection was that the contract between the opening bank and the seller was on principal-to-principal basis and was independent of the contract between the buyer and the seller. Actually these arguments pale away into insignificance since we have already held that interest amount specified in the MOA is a part of purchase price. Suffice it to say that though the contract between the opening bank and the seller is on principal-to-principal basis, yet it cannot come into existence without the underlying contract between the buyer and the seller.
Whether the buyer has incurred any debt towards the seller is to be ascertained from the terms of the MOA and then see whether the interest on such debt fits into the definition given either in Section 2(28A) or in the definition as per DTAA, as the case may be. We do not think it necessary to deal with these arguments (i.e. relating to the contract between opening bank and seller) in detail because, as mentioned above, we have already held that the provisions of DTAA will override the provisions of the Act, and that the interest amount specified in the MOA does not fall within the definition of the term "interest" as defined in the DTAA. Similarly, it was argued that the transaction is not complete till the final invoice is raised by the seller and/or till the physical delivery of the ship to the buyer, and hence till then the buyer has not incurred any debt towards the seller. This argument, in our opinion, may perhaps be more relevant when the issue relating to revenue recognition is being considered. However, in the instant case, we are more concerned as to whether the buyer has incurred any debt towards the seller or not and for that one has to go to the agreement between the two parties. But, this argument also loses its importance because of our decision above.
27. In the ultimate analysis, we are of the considered opinion that the definition of the term "interest" as given in the DTAA is a narrower definition than given in Section 2(28A) of the Act, that the provisions of DTAA will prevail upon the provisions of the Act, and that as per the definition of the term "interest" given in the DTAA, the interest amount specified in the MOA partakes the character of purchase price and does not fall within the definition of the term "interest" given in the DTAA. Therefore, the assessee was not liable to deduct tax at source from the said payment of interest and hence disallowance of interest made under Section 40(a)(i) is not warranted. We direct that the assessee be allowed the deduction thereof.
28. Next ground pertains to the addition of Rs. 18,70,019 made on account of closing stock. The assessee is making consignment sale of scrap recovered on breaking of the ship. The consignment stock which remains unsold at the end of the year is considered as closing stock of the assessee and the value thereof is taken into consideration while determing the closing stock. As per the tax audit report, consignment stock is valued at average sale price received during the year. On going through the accounts, AO found that consignment stock had been valued at average rate of consignment sales less 10 per cent for expenses. The assessee was confronted with this discrepancy between what appeared in the books and what was reported by the auditors. The main explanation of the assessee was that direct sales was made of goods which was of better quality whereas consignment sales was made of inferior quality of goods. AO rejected the explanation of the assessee and found no justification for deduction of 10 per cent on account of expenses because according to him none of the expenses were incurred on the date of valuation but were to be incurred sometime in future.
Accordingly, AO valued the consignment stock at average rate of consignment sales. This resulted into the impugned addition.
29. Before the CIT(A) it was argued on behalf of the assessee that it was following the aforesaid method of valuation regularly in the past also. CIT(A) observe that this version of the assessee was not correct insofar as that in the past, the factor of shortage to work out the notional quality of goods had not been considered in the past. In the past, the value of closing stock had been worked out by multiplying the quantity thereof by its market value. In view of these facts, CIT(A) confirmed the addition.
29.1 On due consideration of the matter, we are of the view that since there is a slight difference between the contention of the assessee and the version of the auditors, the matter needs to be investigated more in detail. It would be better if the AO clearly understands what the auditor has to say and what the assessee has to say and then arrive at a proper conclusion. The AO has also not considered the shortage consideration as found by the CIT(A). Under these circumstances, we remand this matter back to the file of the AO with a direction to decide it afresh after giving due opportunity of being heard to the assessee.
30. The third ground in the appeal is against the addition of Rs. 47,566 made on account of alleged discrepancy in interest account. The AO had made this addition pursuant to an order passed under Section 154, dt. 28th Feb., 1997. The CIT(A) rejected this ground of appeal as infructuous as it did not flow from the assessment order under consideration. In our opinion, the CIT(A) was justified in doing so and hence no interference is called for.
31. Last ground in the appeal relates to disallowance under Sections 80HH and 80-I of the Act. The AO was of the view that ship-breaking activity did not constitute manufacturing activity. In this connection the AO relied on the decision of the Bombay Bench of the Tribunal in the case of Virendra & Co. and of the Ahmedabad Bench in the case of Apollo Vikas Steel Ltd. holding that ship-breaking was not a manufacturing activity. CIT(A) confirmed the disallowance.
32. The decision of the Bombay Bench of the Tribunal in the case of Virendra & Co. has since been reversed by the Bombay High Court holding that ship-breaking constitutes manufacturing activity. It has been also held by the Bombay High Court in IT Ref. No. 751 of 1998 with IT Appeal Nos. 900 and 1091 of 2000, dt. 4th May, 2001 (reported as Ship Scrap Traders and Ors. v. CIT and Ors. In view of the decision of the Bombay High Court, we direct that the assessee be allowed deduction under Sections 80HH and 80-I of the Act.