Madras Fertilizers Ltd. Vs. Commissioner of Income-tax - Court Judgment

Thanikkachalam, J.

1. Under section 256(1) of the Income-tax Act, 1961, both at the instance of the assessee as well as the Department, the Tribunal referred the following questions for our opinion :

The questions referred in T. C. 166 of 1980 at the instance of the assessee :

'(i) In the facts and circumstances of the case, was the Income-tax Appellate Tribunal correct in holding that the relief under section 80J is allowable only proportionately for a period of five months

(ii) In the facts and circumstances of the case, was the Income-tax Appellate Tribunal right in holding that any part of the expenditure up to the date of commencement of production other than the expenditure relating to marketing was not part of cost of the plant, machinery and building?'

The questions referred in T. C. Nos. 167 and 168 of 1980 at the instance of the Department :

'(i) Whether, on the facts and in the circumstances of the case, the Appellant Tribunal was right in law in holding that the value of assets without deducting therefrom the liabilities should be taken for the purpose of capital computation under section 80J of the Income-tax Act and consequently in directing not to exclude the liabilities while computing the capital employed under section 80J of the Act

(ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the capital computation under section 80J should be done by taking the value of the assets without excluding therefrom the liabilities not merely on the first or the last day of the accounting year but taking it on every day throughout the year as is done for the purpose of interest computation on a daily basis

(iii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the sum of Rs. 35,55,769 representing publicity and promotional expenses incurred by the assessee during the previous years up to March 31, 1970, should be allowed as a deduction, while computing the income of the assessee for the assessment year 1972-73, particularly, as no part of the expenses had been incurred in the previous year relevant to the assessment year 1972-73

(iv) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in holding that a sum of Rs. 11,93,263 incurred by the assessee by way of advertisement expenses in which is included sign board, advertisement in newspaper and magazines, audio-visual advertisement and by way of subsidy to farmers and soil test expenses, should be allowed as admissible deduction under section 35D of the Income-tax Act

(v) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in not upholding that order of the Income-tax Officer as such rejecting capitalisation of the pre-production expenses to the extent of Rs. 9,55,43,174

(vi) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in directing capitalisation of the expenses incurred in respect of raw materials, materials and supplies, fuel, water used in the trial run, expenses incurred by way of debenture issue, debenture trust fees and legal expenses and also a sum of Rs. 64,103 included in the miscellaneous expenses

(vii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in adopting the estimate and directing capitalisation of 75 per cent. of salary, wagers and rent, 60 per cent. of the New York office expenses and 50 per cent. of the travelling and conveyance, postage and telegram, audio base and printing and stationery

(viii) Whether, on the facts and in the circumstances of the case, the basis adopted by the Appellate Tribunal while directing the Income-tax Officer to allow capitalisation of welfare expenses and insurance amount is justified in law

(ix) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the value of hydrogen of Rs. 8,66,000 given to Messrs Madras Refineries Limited was a mere barter transaction, which cannot constitute a sale and in directing the deletion of the amount from the assessment

(x) Whether, on the facts and in the circumstances of the case, the view taken by the Appellate Tribunal on the provisions of section 43A of the Act on the basis of which guidelines were laid down by the Appellate Tribunal for deciding the issue by the Income-tax Officer afresh is reasonable on facts and justified in law?'

2. The assessee, Messrs. Madras Fertilisers Limited, is a Government company established for setting up a fertilizer plant. It entered into an agreement with Chemical Construction Corporation of New York for the construction of a complete fertilizer plant on a turnkey basis. The assessee follows the financial year as its accounting year. The construction of the plant was completed and the same was handed over to the assessee on June 7, 1971, in the previous year relevant to the assessment year 1972-73, which is under consideration. Thereafter, trial runs were conducted. Ammonia was produced first on September 9, 1971. Urea was produced on October 19, 1971. NPK was produced on October 16, 1971. Thus production on commercial scale was commenced from November 1, 1971.

3. Question No. 1 referred at the instance of the assessee relates to the relief claimed under section 80J of the Act, During the previous year relevant to the assessment year under consideration, the assessee-company worked only for a period of five months. The claim for computing the relief under section 80J at six per cent. of the capital was negatived by the Income-tax Officer, but relief was granted at 2 1/2 per cent. of the capital, i.e., for the five months period from July 1, 1971, to March 31, 1972, when the business of the assessee was carried on. Thus, the Income-tax Officer computed the relief under section 80J proportionately for a period of five months and not for the full year. The action of the Income-tax Officer in computing the relief under section 80J as above was upheld by the Appellate Assistant Commissioner. On further appeal, the Tribunal also held, by following an earlier order of its own on this point, that, in working out the relief under section 80J, the assessee is entitled only to the proportionate relief for a period of five months only.

4. In the case of CIT v. Aurofood (P.) Ltd. [1991] 187 ITR 715 (in which one of us V. Ratnam J., was a party), this court, after considering the Circular No. 378 dated March 3, 1984 ( : [1984]149ITR1(Delhi) ) issued by the Central Board of Direct Taxes, held that, even though the industrial undertaking was operative only for a part of the year, it is entitled to the relief under section 80J of the Act for the whole year. In the case of CIT v. Simpson and Co. : [1980]122ITR283(Mad) , it was held by this court that, even if the new undertaking has functioned for only a part of an accounting year, the deduction should be allowed to the full extent of six per cent. or seven and a half per cent. as the case may be, and the percentage is not to be reduced in proportion to the part of the year during which the undertaking was in productive operation. Hence, the Tribunal was not correct in restricting the relief under section 80J to a portion of the year during which period the industrial undertaking was actually working. Hence, we answer this question referred to us in the negative and in favour of the assessee.

5. Question No. (i) referred at the instance of the Department relates to relief claimed under section 80J of the Act. In computing the capital for the purpose of relief under section 80J, the Income-tax Officer excluded certain long-term borrowals, in particular, Rs. 15,52,80,000 borrowed from the Commercial Bank, New York, and Rs. 29,48,00,000 borrowed from the Government of India, applying rule 19A of the Income-tax Rules. On appeal, the Appellate Assistant Commissioner confirmed the order passed by the Income-tax Officer. On further appeal, the Tribunal, following an earlier order of its own on this point, held that, in computing the capital for the purpose of allowing relief under section 80J, the total value of the assets without deducting therefrom any amount by way of liabilities should be adopted.

6. The Supreme Court in Lohia Machines Ltd. v. Union of India : [1985]152ITR308(SC) , held that rule 19A in so far as it excluded borrowed moneys and debts in computation of the capital employed, was not ultra vires section 80J. A new sub-section (1A) was added by the Finance (No. 2) Act 1980, with retrospective effect from April 1, 1972. The position now is that amounts borrowed will have to be deducted in computing the capital employed for the purposes of section 80J. Therefore, the Tribunal was not correct in holding that, in computing the capital for the purpose of relief under section 80J, liabilities should not be deducted. Therefore, we answer this question referred to us in the negative and in favour of the Department.

7. Question No. (ii) referred at the instance of the Department also relates to relief claimed under section 80J of the Act. The Tribunal held the capital computation should be done by taking the value of the assets not merely on the first or the last day of the accounting year, but by taking it on every day throughout the year as is done for the purpose of interest computation on a daily basis.

8. Rule 19A prescribes the mode of computing the 'capital employed' for the purpose of section 80J. It prescribes the mode of computing the capital employed in terms that exclude all borrowed capital and it takes the capital employed only as on the first day of the accounting year and ignore all additional capital employed during the rest of the year. Rule 19A is not incorporated in sub-section (1A) of section 80J. The Supreme Court in the case of Lohia Machines Ltd. v. Union of India : [1985]152ITR308(SC) , upheld the constitutional validity of rule 19A. Hence, the Tribunal was not correct in giving its direction as stated above. Hence, we answer this question referred to us in the negative and in favour of the Department.

9. Question No. (iii) referred at the instance of the Department relates to deduction of publicity and promotional expenses incurred by the assessee during the previous years up to March 31, 1970, while computing the income for the assessment year 1972-73.

10. The following expenditure were incurred by the assessee under the head 'Publicity and promotional expenses' during the years 1967-68, 1968-69 and 1969-70 and prior to March 31, 1970 :

Rs.1. Seeding programme expenses 12,09,7872. Expenses under technical assistance agreement 8,37,0183. Establishment expenses 6,61,0954. Advertisement and sales promotion expenses 7,37,7235. Depreciation on assets in marketing anddistribution projects 60,0356. Soil testing laboratory expenses 50,111

11. The Income-tax Officer disallowed a sum of Rs. 35,55,769 - incurred towards publicity and promotional expenses since the expenditures were incurred prior to April 1, 1970. On appeal, the Appellate Assistant Commissioner confirmed the order passed by the Income-tax Officer. On further appeal, the Tribunal held that the sum of Rs. 35,55,769 should be allowed as a deduction in the assessment year under consideration even though incurred prior to March 31, 1970.

12. Learned standing counsel appearing for the Department submitted as under :

All these expenses were incurred during the years 1967-68, 1968-69 and 1969-70 and before March 31, 1970. For the purpose of Income-tax, deduction can be permitted in respect of only those expenses and losses which are incurred in the relevant accounting year. Losses and expenses incurred before the commencement of that year, cannot be a subject of any allowance in that year. The assessee is following the mercantile system of accounting. These expenses cannot be allowed either under section 28 or under section 37 of the Income-tax Act, 1961. Further, it is capital expenditure, and, therefore, it cannot be allowed.

13. On the other hand, learned counsel for the assessee submitted as under :

Though these expenses were incurred over a period and the claimed expenditure related to the period prior to April 1, 1970, they were incurred only for the purpose of distributing fertilizers imported by the Government of India. The assessee was proposing to manufacture and sell in the market fertilizer of a particular variety. Therefore, unless advance action was taken to popularise the nature of the commodity to be produced and a climate for purchase was created, the assessee could not either put the commodity into the market or make any substantial sale of the commodity. The fertilizers imported were similar to what the assessee is going to produce. Therefore, the expenses incurred for promotion and publicity were directly connected with the sale. The entire expenses were incurred prior to the actual making of the sales. The expenses though called publicity and promotional expenses were in fact expenses of sale, in view of the fact, that, but for incurring these expenditures, the assessee would not have been in a position to put in the market or sell the new commodity which the assessee was to manufacture. Hence, there is no reason to disallow these expenses which clearly related to the sales of the year. The expenditure related to the sales under the assessee's trade name. The gigantic size of the operation compelled the assessee to start promotional and publicity expenses far ahead of the actual sales. Alternatively, it was claimed that these amounts should be allowed as additions to the value of the plant.

14. Learned standing counsel for the Department, while elaborating his arguments, pointed out that, in the present case, the assessee-company started its business only on November 1, 1971, and any expenditure incurred prior to that date cannot be allowed in the assessment year 1972-73. Learned counsel pointed out that there is a clear distinction between the commencement of the business and the setting up of a business. A business can be said to be set up when it is established and is ready to start its business. According to learned counsel, the distinction is that when a business is established and is ready to commence business, then it can be said of that business that it is set up. There may be an interval between the setting up of a business and its actual commencement and all expenses incurred during that period can be considered as permissible deductions. Thus learned counsel, relying upon the decision of the Bombay High Court in Western India Vegetable Products Ltd. v. CIT : [1954]26ITR151(Bom) submitted that this is the basis on which the expenditure incurred in the accounting relevant to the assessment year under consideration alone is permissible deduction and not any expenditure incurred prior to that.

15. Further, learned standing counsel for the Department relied upon a decision in the case of CIT v. Basant Rai Takhat Singh [1933] 1 ITR 197. According to the facts arising in that case, the assessee took a lease from a cantonment authority for a period of 30 years. Under the terms of the lease, he had to erect certain permanent buildings which were to become the property of the lessors on the determination of the lease. He erected the buildings and received rents from third persons to whom he had leased the buildings. In computing the tax payable by the assessee in respect of the rents so received, the assessee claimed that allowance should be made for the expenditure incurred by him in erecting the buildings. On these facts, the Judicial Committee of the Privy Council held that the assessee was not entitled to the deduction claimed inasmuch as the expenditure for erection of buildings was not incurred in the year in respect of which the income sought to be assessed arose, but occurred many years before.

16. Another decision relied upon by learned standing counsel was that in A. Y. S. Parisutha Nadar v. CIT : [1962]46ITR1041(Mad) . In that case, this court held that section 10(2)(xv) of the Indian Income-tax Act, 1922, relating to expenditure laid out or expended wholly and exclusively for the purpose of the assessee's business, clearly indicates that the expenditure should relate to a business which is already in existence and not to one that is to come into existence in the future.

17. Another decision relied upon by learned counsel for the Department was that in CIT v. Sarabhai Sons P. Ltd. : [1973]90ITR318(Guj) . According to the facts arising in that case, the assessee, a private limited company, decided to start a new business for the manufacture of scientific instruments and communication equipment. It placed orders for machinery and equipment in January, 1966, and some of the machinery was received in February, 1966. It also placed orders for raw materials and stores and took on lease premises from an industrial estate. These preparations went on an in July, 1966, the machinery was installed and production was commenced. The assessee claimed to deduct a sum of Rs. 16,237 spent in connection with the new business during the period ending March 31, 1966, for the assessment year 1966-67. On these facts, the Gujarat High Court held (headnote) : 'that the new business could not be said to be ready to discharge the function for which it was established, namely, the manufacture of scientific instruments and communication equipment until the machinery necessary for the purpose of manufacture was installed. Obtaining land on lease, placing orders for machinery and raw materials were merely operations for the setting up of the business. In the present case, the business could not be said to be set up until July 1966, when the machinery had been installed and the factory was ready to commence business. Revenue expenditure incurred before that date would not be a permissible deduction in the assessment for the assessment year 1966-67.'

18. Reliance was also placed upon a decision in the case of CIT v. Forging and Stamping Pvt. Ltd. : [1979]119ITR616(Bom) , wherein, on considering the facts arising in that case, the Bombay High Court held that (headnote) 'though the machinery was installed on August 27, 1963, and it was tested some time in January, 1964, the factory of the assessee was ready to commence production at least with effect from June 10, 1964, and it was on that day that the business of the assessee must be said to have been set up. Therefore, the expenditure incurred by the assessee-company from June 10, 1964, should be allowed as a deduction in determining its business profits under section 28 of the Income-tax Act, 1961.

19. Yet another decision relied upon by learned counsel for the Department was that in Bhodilal Menghraj and Co. P. Ltd. v. CIT : [1979]119ITR968(Bom) . In that case, the Bombay High Court, following the decision in CIT v. Industrial Solvents and Chemicals Pvt. Ltd. : [1979]119ITR608(Bom) , the decision in Western India Vegetable Products Ltd. v. CIT : [1954]26ITR151(Bom) , the decision of the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. : [1967]63ITR478(SC) and four decisions of the Gujarat High Court, viz., Sarabhai Sons Pvt. Ltd.'s case : [1973]90ITR318(Guj) ; CIT v. Saurashtra Cement and Chemical Industries Ltd. : [1973]91ITR170(Guj) ; Sarabhai management Corporation Ltd. v. CIT : [1976]102ITR25(Guj) and Prem Conductors Pvt. Ltd.'s case : [1977]108ITR654(Guj) , held that the assessee in that case cannot claim deduction of an expenditure of Rs. 92,400 as revenue expenditure till it could be regarded as having set up its business. Therefore, according to learned standing counsel for the Department, the expenditure incurred prior to November 1, 1971, cannot be allowed as a deduction in the assessment year 1972-73 in the present case.

20. In order to support his contentions, learned counsel appearing for the assessee relied upon a decision in Calcutta Co. Ltd. v. CIT : [1959]37ITR1(SC) . According to the facts arising in that case, the assessee bought lands and sold them in plots fit for building purposes undertaking to develop them by laying out roads, providing a drainage system and installing lights, etc., when the plots were sold, the purchaser paid only portion of the purchase price and undertook to pay the balance in instalments. The assessee, in its turn, undertook to carry out the developments within six months but time was not the essence of the contract. In the relevant accounting year, the assessee actually received in cash only a sum of Rs. 29,392 towards sale price of lands, but in accordance with the mercantile system of accounting adopted by it, it credited in its accounts the sum of Rs. 43,692 representing the full sale price of lands. At the same time, it also debited an estimated sum of Rs. 24,809 as expenditure for the development it had undertaken to carry out, even though no part of that amount was actually spent. On these facts, the Supreme Court held as under (headnote) :

'That the sum of Rs. 24,809 represented the estimated amount which would have to be expended by the assessee in the course of carrying on its business and was incidental to the business and, having regard to the accepted commercial practice and trading principles, was a deduction which, if there was no specific provision for it under section 10(2) of the Income-tax Act, was certainly an allowable deduction, in arriving at the profits and gains of the business of the appellant, under section 10(1) of the Act, there being no prohibition against it, express or implied, in the Act.

The expression 'profits or gains' in section 10(1) of the Income-tax Act has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted therefrom - whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date.'

21. The principle laid down in this decision is, however, subject to the exception that, in the case of a single venture, the expenditure incurred by the assessee in respect of that venture during the prior years must be allowable while assessing the profits of that venture. But, according to the facts arising in the present case, the assessee is not doing a single venture.

22. Another decision relied upon by learned counsel for the assessee was that in Addl. CIT v. Farasol Ltd. . According to the facts arising in that case, the assessee, a foreign company, entered into a contract with the Oil and Natural Gas Commission. The formal contract was executed in February, 1964, and actual drilling operations were started in December, 1964. The assessee claimed the following expenses in assessment year 1966-67 for which it had been allowed to have the period from September 10, 1964, to December 31, 1965, as the previous year. On these facts, the following question was referred to the High Court for its opinion, viz., whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing the expenditure of Rs. 3,26,794 and Rs. 19,126 incurred before February 17, 1964, from the total income for the assessment year 1966-67. While answering this question, the Rajasthan High Court held as under (at page 376) :

'We are, however, of the opinion that the Tribunal was not right in disallowing the aforesaid expenditure that was claimed by the assessee on the ground that it related to the period prior to the previous year relevant to the assessment year in question. In the present case, the only income that was derived by the assessee in India was from the contract which was entered into by it with the Oil and Natural Gas Commission. The aforesaid contract was in the nature of a single transaction and the expenditure that was claimed by the assessee has been found to be incurred in connection with that contract. In our view, the Income-tax authorities have erred in holding that the said expenditure should be treated as expenditure of capital nature. The said expenditure was a part of the process of profit-making by the assessee in the assessee in the contract which was entered into by it with Oil and Natural Gas Commission and without incurring the said expenditure, the assessee would not have been able to obtain the said contract and to perform it. The aforesaid expenditure of Rs. 3,26,794 and Rs. 19,126 claimed by the assessee should have been allowed and it has been wrongly disallowed by the Income-tax authorities.'

23. This decision is based upon the principle that, if the profit of a single venture is taxed in the year in which the venture came to an end, the expenditure incurred by the assessee in respect of that venture during the prior years may be allowed.

24. Another decision brought to our notice by learned counsel for the assessee was that in the case of Hindustan Aluminium Corporation Ltd. v. CIT : [1983]144ITR474(Cal) , wherein, it was held as under (headnote) :

'The assessee, a manufacturing company incorporated in 1958, entered into agreements with four different U. S. organisations. Three of them were for securing rights of a permanent nature and the assessee capitalised the expenditure incurred in respect of them. The fourth agreement was for the training of the assessee's employees and for furnishing technical advice and information for 20 years. Under this agreement, the assessee allotted 12,000 shares of the value of Rs. 10 per share in 1960. The assessee sought to spread this expenditure over 20 years and claimed Rs. 66,666 as revenue expenditure for 1973-74.'

25. On these facts, the Calcutta High Court held as under (headnote) :

'In the instant case, the expenditure though made initially was not for the starting of the business. Reading the agreement as a whole it appeared that the aim and object of the expenditure was not to bring into existence any asset of enduring advantage or benefit for the assessee's business but to produce profits in the conduct of its business. The assessee had not acquired any capital asset under the agreement. Having regard to the facts and circumstances of the case and specially in the nature of the obligations undertaken by the agreement and the background of the other three agreements, the purpose of the expenditure was to get rid of the annual expenditure which was necessary to be incurred for carrying on business. The sum of Rs. 66,666 was allowable as revenue expenditure for the assessment year 1973-74.'

26. According to the facts in that case, the expenditure claimed was not for the starting of the business. The business was a running concern. The expenditure incurred was spread over 20 years and the expenditure relating to the assessment year 1973-74 was claimed in that year. It is on these facts that the above said decision was rendered. Therefore, the facts arising in that decision are different from the facts arising in the present case.

27. Reliance was also placed upon the decision in the case of Security Printers of India (P.) Ltd. v. CIT : [1970]78ITR766(All) . According to the facts arising in that case, the assessee was a limited company. It was incorporated in April 6, 1957. For the assessment year 1958-59, the assessee claimed deduction of certain expenses. Some of these expenses related to the period prior to the incorporation of the assessee-company. The said expenses were in the nature of travelling expenses of the directors to explore possibilities of business, for procuring an import licence, to collect details or secure orders and to study techniques of security printing. The said expenses were disallowed by the Income-tax Officer on the ground that these were pre-incorporation expenses of the company and were capital in nature. The Appellate Assistant Commissioner held that the expenses were all of a revenue nature and as they had been incurred by the promoters of the assessee-company in connection with the business, which was subsequently taken over by the company on its incorporation, they were allowable as business expenses. The Tribunal, however, disallowed a part of the expenses on the ground that they were capital expenses. On reference, the High Court disagreed with the Tribunal and held that 'the expenditure incurred by a businessman or his agent on foreign tours to acquaint himself with new and modern techniques is revenue in character. The High Court further pointed out that the main consideration which has got to weigh with the court is whether the expenditure was a part of the process of profit-making, or it was designed to bring into existence a new asset.'

28. It remains to be seen that on the facts, it was found that, before the assessee-company was incorporated, its promoters had not only made preliminary arrangements for obtaining orders for security printing, but they had also actually commenced trade operations and that inasmuch as the receipts resulting from these transactions which had taken place before the incorporation of the assessee-company had been included in its first assessment for the year 1958-59, the revenue expenses attributable to these receipts should also be allowed in that assessment. Therefore, the facts arising in that case are different from the facts arising in the present case. Hence, the decision in Security Printers of India P. Ltd. v. CIT : [1970]78ITR766(All) will also not be applicable to the facts of the present case.

29. The next decision relied upon by learned counsel for the assessee was that in the case of CIT v. Saurashtra Cement and Chemical Industries Ltd. : [1973]91ITR170(Guj) . According to the facts arising in that case (headnote) :

'A company was formed in 1956 for the manufacture and sale of cement. As part of its business the assessee obtained a mining lease for quarrying limestone and started the mining operations in 1958. It claimed the expenditure incurred for the purpose of extracting limestone as also depreciation and development rebate for the machinery installed for that purpose for the assessment years 1960-61 and 1961-62.'

30. On these facts, the High Court held as under (headnote) :

'That the activities which constituted the business of the assessee were divisible into three categories, the first category consisted of the activity of extrication of limestone by quarrying the leased area of land. This activity was necessary for the purpose of acquiring the raw material to be utilised in the manufacture of cement. The second activity comprised the activity of manufacture of cement by user of the plant and machinery set up for that purpose; and the third category consisted of selling manufactured cement. These three activities combined together constituted the business of the assessee. The activity of quarrying the leased area of land and extracting limestone from it was as much an activity in the course of carrying on the business as the other two activities of manufacture of cement and sale of manufactured cement. This activity came first in point of time and laid the foundation for the second activity and the second activity when completed laid the foundation for the third activity. Hence, the assessee commenced its business when it started the activity of extraction of limestone. Since extraction of limestone commenced in 1958, the assessee was carrying on business during the relevant years of account. The expenditure incurred by the assessee in carrying on the activity of extraction of limestone as also depreciation allowance and development rebate in respect of machinery employed in extracting limestone were deductible in computing the trading profits of the assessee for the assessment year 1960-61 and 1961-62.'

31. Thus, this is also a case where the assessee did not claim any pre-production expenditure. The depreciation and development rebate were claimed after the commencement of the business out of the trading profits. Hence, this decision will not be applicable to the facts of this case.

32. Another decision relied upon by learned counsel for the assessee was that in Aska Co-op. Sugar Industries Ltd. v. CIT [1978] 113 ITR 376. The facts arising in this case are as under (headnote) :

'The assessee, a co-operative society engaged in the manufacture of sugar and molasses, purchased sugarcane from cultivators. In November, 1967, the assessee adopted a scheme whereby a subsidy would be advanced to the cultivators for the early planting of sugarcane. The scheme also provided for penalty and refund of the advance with interest, if there were default in undertaking early cultivation or in delivering the sugarcane. The assessee advanced amounts under the scheme during the period between November 10, 1967, and June 30, 1968. The amounts were shown as suspense and in the assessment year 1970-71, a sum of Rs. 6,86,464 was claimed by way of deduction. The Tribunal held that the claim related to revenue expenditure but was not admissible in the year under consideration.'

33. On a reference, the High Court held as under (at page 379) :

'The nature of the arrangement was such that it would not have been possible to assess the performance and take a final decision in the matter during or at the close of the preceding assessment year. In fact, the terms of the agreement are such that the relative position could only be determined after the supply had been effected. In the facts of the case, therefore, the appropriate year in which the amount could be taken into account is the assessment year and the assessee had rightly claimed the deduction in this year and not the previous year. No cogent reason has been advanced by any of the authorities of the Revenue for rejecting the claim. On the facts of the case, we are led to hold that there is force in the assessee's stand that the amount became due for deduction during the year.'

34. In this case also, the assessee did not claim any expenditure incurred prior to the commencement of the business. The assessee-company was a running concern. The expenditure incurred in the year 1967 was kept under suspense account and claimed during the later year, when the trading profits were taken into consideration for the assessments. Therefore, this decision rendered on the facts arising in that case, will not be applicable to the facts of the present case.

35. Yet another decision relied upon by learned counsel for the assessee was that in CIT v. Sitalakshmi Mills Ltd. : [1983]141ITR415(Mad) . This decision deals with deduction of provision for gratuity under section 37(1) of the Income-tax Act. While considering this aspect, this court held as under (at page 417) :

'A provision for gratuity, although it has to be charged against current profits, is not an item of expenditure strictly so-called, nor is it laid out or incurred by the assessee, in the sense that money goes out. A provision for gratuity is merely a charge against profits, and as a provision, it is merely segregated from the current profits. Courts have held that allowance must be made for this provision, notwithstanding that no money goes out or is spent out by the assessee during the year, because, according to sound principles of commercial accounting, net profits will not be properly ascertained, if this provision is not made and the amount is not charged against the profits of the year's trading.'

36. This decision was rendered on entirely different facts. Hence it will not be applicable to the facts of the present case.

37. A cumulative effect of reading all these decisions would go to show that deduction can be permitted in respect of only those expenses and losses which are incurred in the relevant account year. Losses and expenditures incurred before the commencement of that year cannot be the subject-matter of any allowance. For the purpose of computing yearly profits and gains, each year is a separate self-contained period of time in regard to which profits earned or losses sustained before its commencement are irrelevant. Where the accounts are kept on mercantile basis, allowance must be granted in the year in which the liability is incurred, irrespective of the question whether the disbursement has been made or not. But, if the profits of a single venture are taxed in the year in which the venture comes to an end, the expenditure incurred by the assessee in respect of that venture during the prior years must be allowed. But this rule has no application where the activities do not constitute a single transaction. Therefore, the Tribunal was not correct in the present case in holding that the expenditures incurred during the years 1967-68, 1968-69 and 1969-70 prior to March 31, 1970, are allowable as deduction in the assessment year 1972-73.

38. Learned counsel for the assessee contended that the expenditure incurred in the years 1967-68, 1968-69 and 1969-70 and prior to March 31, 1970, should be alternatively considered as capital expenditure added to the value of actual cost. The Supreme Court in the case of Challapalli Sugars Ltd. : [1975]98ITR167(SC) held that any expenditure which is necessary to bring an asset in existence and to put it in working condition will go to inflate the actual cost of the assets. Applying this test, on an analysis of the expenditure incurred under this head, the Income-tax authorities came to the conclusion that Rs. 35,55,769 cannot be said to be an expenditure which was necessary to bring any asset into existence and put any asset in working condition. Hence it was held that there is no question of adding this expenditure to the cost of the plant. On appeal, the Tribunal pointed out that, by their very nature promotional and publicity expenses relate to the fact of sale and hence they are revenue expenditure and cannot be treated as capital in nature. The Tribunal is the highest fact-finding authority. On the facts, the Tribunal came to the abovesaid conclusion. Hence, we cannot now say that these expenditures are capital in nature. Hence, we answer this question referred to us in the negative and in favour of the Department.

39. Question No. (iv) in the Department reference relates to relief claimed under section 35D of the Act. The assessee claimed deduction of the following amounts under section 35D of the Act :

Rs.I. Advertisement :Sing boardsAdvertisement newspaper/magazines 1,67,427Promotional material 40,767Audio-visual 2,85,115Other advertisement 5,73,861II. Subsidy to farmers:Field extension programme demonstration plotstechnical extension plots, farmer/dealermeetings, field days 1,15,407III. Soil test bags 6,045IV. Other advertisements 3,066V. Warehousing and other handling expenses 59,340VI. Depreciation 2,84,128-----------15,36,631-----------

40. For the purpose of amortisation under section 35D, an amount of Rs. 63,09,776 was claimed by the assessee. The Income-tax Officer granted the allowance in respect of all the amounts except two items, viz., Rs. 12,52,503 on account of advertisement and publicity and Rs. 2,84,128 towards depreciation. The Appellate Assistant Commissioner, on appeal, confirmed the order passed by the Income-tax Officer. The Tribunal, on further appeal, held that the amount of Rs. 11,93,263 in their opinion would clearly come under the provisions of section 35D. The Tribunal pointed out that, as regards warehousing and other handling expenses. The assessee is not in a position to show how they are relevant to survey or other preliminary enquiries referred to in section 35D. The Tribunal also observed that depreciation claimed would not constitute an expenditure, even though it would be a proper deduction in the profit and loss account, for the purpose of determining the profit. Accordingly, the Tribunal upheld the disallowance of Rs. 59,240 and Rs. 2,84,125 and directed the allowance of the balance.

41. Learned standing counsel for the Department contended that these expenditures are not covered by the provisions of section 35D of the Act. According to learned standing counsel for the Department, the primary condition is that the assessee should have incurred an expenditure when the business is in existence. Learned standing counsel pointed out that the expenses in the present case are in the nature of advertisement and publicity and hence these expenses cannot be said to be an expenditure in connection with conducting a market survey or any other survey necessary for the business of the assessee. Learned standing counsel further submitted that, at the time when these expenditures were incurred, the business was not in existence. To elucidate the meaning of the word 'survey', learned standing counsel relied upon various dictionaries. Therefore, according to learned standing counsel for the Department, the Tribunal was not correct in allowing the expenditure claimed under this head.

42. On the other hand, learned counsel for the assessee submitted that the expenses relating to advertisement included signboards, advertisement in newspapers and magazines, etc., audio-visual advertisement expenditure and also subsidy to farmers which covers field extension programmes, expenditure on demonstration plots, farmer/dealer meetings and also soil test expenses and other expenses relating to market appreciation necessary for the business of the assessee. Therefore, according to learned counsel for the assessee, this expenditure definitely falls under sub-clause (iii) of sub-section (2)(a) of section 35D of the Act, Learned counsel further pointed out that in fact two items of expenses, viz., Rs. 59,240 incurred towards warehousing and other building expenses and a sum of Rs. 2,84,128 claimed as depreciation were disallowed by the Tribunal since they do not fall under section 35D(2)(a)(iii) of the Act.

43. On general principles the Income-tax law does not permit the deduction of capital expenditure, except to the extent permitted by the statute. The concept of amortisation in Income-tax law involves the write-off of capital expenditure either in whole or over a period of years.

44. Before the Tribunal, the assessee claimed deduction of Rs. 15,36,361 under section 35D of the Act. According to the assessee, a sum of Rs. 10,68,744 was incurred towards advertisement. Under the head 'Advertisement', the assessee claimed a sum of Rs. 1,07,227 towards signboards, Rs. 40,707 towards advertisement in newspapers and magazines, Rs. 2,85,115 towards promotional materials, Rs. 5,73,861 towards audio-visual and Rs. 1,576 towards other advertisements. Under the head subsidy to the farmers. The assessee claimed Rs. 1,15,407. This expenditure was incurred towards field extension plots, farmer/dealer meetings, etc. A sum of Rs. 6,046 was claimed towards soil test bags and Rs. 3,066 was claimed towards other advertisement charges.

45. The provisions of section 35D(2)(a) are as under :

'35D.(2) The expenditure referred to in sub-section (1) shall be the expenditure specified in any one or more of the following clauses, namely. -

(a) expenditure in connection with -

(i) preparation of feasibility report;

(ii) preparation of project report;

(iii) conducting market survey or any other survey necessary for the business of the assessee;

(iv) engineering services relating to the business of the assessee : Provided that the work in connection with the preparation of the feasibility report or the project report or the conducting of a market survey or of any other survey or the engineering services referred to in this clause is carried out by the assessee himself or by a concern which is for the time being approved in this behalf by the Board.'

46. Sub-clause (iii) of sub-section (2) (a) of section 35D mentions about conducting a market survey or any other survey, necessary for the business of the assessee. The business of the assessee herein is manufacture of fertilizers and marketing the products. Considering the nature of the assessee's business, the Tribunal found that expenditure incurred under various heads as stated above are necessary for marketing the products. The word 'survey' occurring in section 35D(2)(a)(iii) should be understood in the context of the nature of the business carried on by the assessee. There is no point in attributing the mere dictionary meaning to this word. It remains to be seen that the word 'survey' does not mean a mere onlooking or overlooking of what happened, but would also include, attracting customers to a particular spot demonstrating to them the utility, value of the assessee's products and studying therefrom the business possibilities or determining the action necessary to extend the business. Hence, we are also of the view that no part of the expenditure claimed and allowed under the abovesaid heads can be considered as not connected with the conduct of a market survey or any other survey necessary for the business of the assessee.

47. The Tribunal, on considering the nature of survey item of the expenditure involved in the light of the abovesaid provisions contained in section 35D(2)(a)(iii) of the Act rightly came to the conclusion that, except for two items of expenditures claimed under the heads warehouse and other handling expenses and depreciation, the balance is allowable as deduction. Hence, we consider that there is no infirmity in the order passed by the Tribunal on the abovesaid aspect. Therefore, we answer question No. (iv) referred at the instance of the Department in the affirmative and against the Department.

48. Question No. (ii) referred at the instance of the assessee and questions Nos. (v) to (viii) referred at the instance of the Department relate to capitalisation of pre-production expenditure for the purpose of depreciation and development rebate.

49. Question No. (v) referred at the instance of the Department pertains to capitalisation of pre-production expenditure to the extent of Rs. 9,55,43,174. The assessee requested the Income-tax Officer to capitalise the total expenditure of Rs. 9,55,43,174 incurred as pre-production expenditure under various heads. The Income-tax Officer did not accept the claim made by the assessee. On appeal, the Appellate Assistant Commissioner found that the expenditure claimed as relating to construction could be classified under the following heads :

Rs.I. Process materials :Raw materials 1,20,16,460Material and supplies 1,66,21,153Power, fuel and water 1,18,68,627-----------4,04,96,240-----------This includes the following itemsdebited in miscellaneous expenses :i. Materials and supplies 10,694ii. Power, water and fuel 5,65,697II. Expenses incurred in connection withthe borrowals :Debenture issue expenses 53,15,227Debenture trust fees 1,13,906Legal expenses 2,02,563III. Establishment charges :Rs. Rs.Salaries and wages 75,61,319Welfare expenses 9,81,047Rent 3,82,650Miscellaneous expenses 75,74,728Rent and taxes 62,788Insurance 19,15,993Auditor fees 39,700Directors' travellingexpenses 30,700Publicity and promotional 1,86,208 1,87,35,319----------IV. Depreciation 3,07,51,196V. Income-tax 5,03,003-------------9,55,43,174-------------

50. The Appellate Assistant Commissioner, on analysing the expenditure claimed under this head, in the light of the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT : [1975]98ITR167(SC) directed the Income-tax Officer (1) to include a sum of Rs. 4,04,96,240 being the cost of process materials used in the trial run in the actual cost of plant and machinery, (2) to include Rs. 56,31,696 incurred in connection with borrowals on account of debenture issue expenses, debenture trust fund and legal expenses in the actual cost of plant and machinery, (3) to allow 60 per cent. of the expenses on account of salaries, wages and rent as forming part of the actual cost, (4) not to capitalise welfare expenses, taxes, insurance, audit fees, directors' travelling expenses and publicity and promotional expenses, (5) to capitalise the repair expenses of Rs. 64,100 and (6) to allow 60 per cent. of the expenditure, in respect of New York office expenses, and 50 per cent. in respect of travelling and conveyance, postage and telegrams, audio and printing and stationery.

51. Thus, out of establishment expenses of Rs. 32,67,309, miscellaneous expenses of Rs. 28,37,128 were not considered for working out the actual cost and the balance was include. Aggrieved by this, assessee and the Department went in appeal before the Tribunal. The assessee contested the disallowance of 40 per cent. of the salaries, wages, rent and a portion of the New York office expenses, travelling and conveyance, postage and telegrams, audio base and printing stationery and specified amounts under establishment charges and miscellaneous expenses. In the Departmental appeal, the Department objected to the allowance of pre-production expenses, relating to raw materials, materials and supplies, power, fuel and water, debenture issue expenses, 60 per cent. of salary, rent and repairs contract labour and the establishment expenses consisting of postage and telegrams and travelling and conveyance. The Tribunal, after hearing the parties and after considering various decisions in this aspect, held that : (a) the sum of Rs. 4,04,96,240 being the expenses for raw materials, materials and supplies, fuel, water, etc., used in trial runs are includible in actual cost. (b) a sum of Rs. 56,31,696 borrowings by way of debenture trust fee and legal expenses should be allowed to be capitalised. (c) (i) cost of Rs. 1,87,35,399 being establishment charges, Rs. 79,44,069 being 75 per cent. of the salaries, wages and rent should be added to the cost of the assets, (ii) in so far as Rs. 9,81,047 and Rs. 19,15,933 relating to welfare expenses and insurance, are concerned, in the absence of details, the Income-tax Officer was directed to analyse the expenses, and allow on proportionate basis, the welfare expenses, pertaining to staff on construction work and to allow insurance amount relatable to plant and machinery, during the period of transportation to site, (iii) the Income-tax Officer was directed to capitalise other insurance amounts relating to either after erection or in respect of plant and machinery in stationary position in the site, (iv) in respect of miscellaneous expenses, the Tribunal confirmed the order passed by the Appellate Assistant Commissioner in allowing capitalisation of Rs. 64,103 and 60 per cent. of the New York office expenses and 50 per cent. of travelling and conveyance, etc.

52. Now, learned standing counsel appearing for the Department submitted that the entire expenditure claimed by the assessee would not go towards cost of construction and erection of plant. Expenses incurred on account of raw materials, travelling etc., should not be allocated to plant and machinery. According to learned standing counsel, there was no justification for allocating a good portion of the salary etc., towards the cost of machinery. Learned standing counsel submitted that many items of expenditure which are irrelevant either to the cost of construction or to the erection of the plant were directed to be added towards the actual costs.

53. On the other hand, learned counsel for the assessee submitted as under : All the expenditure were incurred for the purpose of business. During the pre-production period, all the activities were centered around putting up the plant and bringing it up to the working condition. Expenses for manufacture, production or sale have been separated by the assessee itself. The plant went into production on November 1, 1971. The contract was on turnkey basis and the investment came to about Rs. 46 crores. The marketing operations also started in 1967 itself. The assessee spent nearly Rs. 98 lakhs for this. The assessee was carrying on only two activities during this period, viz., putting up the plant and marketing. The expenses relating to marketing had been separately classified. This was done by the Auditor-General and the statutory auditors. The pre-incorporation expenses were already capitalised. There was no expenditure on public issue of shares, etc. During the construction period, the company employed 300 employees. They were employed for construction of building, erection of plant and machinery, etc. The managing director was a technical person. He was paid a salary of Rs. 3 lakhs per year for a period of five years. Therefore, all these items of expenditure went towards the construction and erection of the plant and went to add up to the cost of plant and machinery.

54. The assessee required that several items of expenditure incurred during construction related to the plant, machinery, buildings and other assets and should therefore be capitalised for the purpose of obtaining depreciation and development rebate. It is well-settled that not merely the actual cost of machinery or plant, but all other expenses going towards the construction of the buildings, erection of plant, etc., form part of the actual cost of the assets.

55. In the decision reported in the case of Challapalli Sugars Ltd. v. CIT : [1975]98ITR167(SC) , the Supreme Court pointed out that the legal position for determining the actual cost for the purpose of development rebate is the same as for the purpose of depreciation. The Supreme Court further pointed out that, as the expression 'actual cost' has not been defined, it should be construed in the sense in which no commercial man would misunderstand. For this purpose, it would be necessary to ascertain the connotation of the expression in accordance with the normal rules of accountancy prevailing in commerce and industry. The accepted accountancy rule for determining cost of fixed assets is to include all expenses necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting it plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of fixed assets which have been created as a result of such expenditure. In the abovesaid decision, the Supreme Court affirmed the decision of the Calcutta High Court in CIT v. Standard Vacuum Refining Co. of India Ltd. : [1966]61ITR799(Cal) and the decision of the Madras High Court in the case of CIT v. L. G. Balakrishnan and Bros. (P.) Ltd. : [1974]95ITR284(Mad) and the decision of the Allahabad High Court in the case of CIT v. J. K. Cotton Spinning and Weaving Mills Ltd. : [1975]98ITR153(All) were approved.

56. Thus, it must be borne in mind that all expenses necessary for putting up the plant into production stage are part of the cost of construction. Where the expenses had been incurred prior to the plant of the company going into production, but were leading up to the stage of production, it was held they were necessarily required to be incurred by the assessee for putting its plant into production and notwithstanding that they represented the aggregate amount of expenses incurred under different heads for the period prior to the commencement of the production, they must be treated as part of the actual cost of the plant and machinery to the assessee (Shree Vallabh Glass Works Ltd. v. CIT : [1981]127ITR37(Guj) ) actual cost of a particular asset is a question of fact which has to be determined on the evidence of the materials produced before or available to the Income-tax authorities.

57. The assessee in the instant case pointed out that the plant went into production on November 1, 1971. The marketing operations started in the year 1967 itself. Thus, the assessee was carrying on only two operations during this period, viz., erecting the plant and marketing. The expenses relating to the marketing had been separately classified. This was done by the Auditor-General and the statutory auditors. According to the assessee, the entire expenditure allocated centered around putting up the plant and bringing it up to a working condition. Expenses for manufacture, production or sale have been already separated by the assessee-company itself. Considering all these facts and analysing the material evidence produced by the assessee, the Tribunal, following the ratio of the decision of the Supreme Court in the case of Challapalli Sugars Ltd. : [1975]98ITR167(SC) , confirmed the order passed by the Appellate Assistant Commissioner in respect of certain items and, in respect of certain other items, directed the assessing authority to analyse the facts and include the same proportionately towards cost of plant, if circumstances warrant the same. Therefore, we find that there is no infirmity in the order passed by the Tribunal in directing to capitalise the amount of Rs. 9,55,43,174 for the purpose of depreciation and development rebate. Therefore, we answer question No. (v) referred at the instance of the Department in the affirmative and against the Department.

58. Question No. (ii) referred at the instance of the assessee states whether the Tribunal was correct in holding that any part of the expenditure up to the date of commencement of production other than the expenditure relating to marketing was not part of cost of plant, machinery and buildings. If the Tribunal had stated so, as pointed out by the assessee, then, the Tribunal was not correct in stating like that, in view of various decisions cited supra. In fact, while considering this aspect, the Tribunal, at one place, stated that 'according to learned counsel, in the light of the decision in Challapalli Sugars Ltd.'s case : [1975]98ITR167(SC) , the entire expenditure allocated by the assessee on the above, taking away the expenditure already separately classified towards marketing, should be added to the cost of plant and machinery.' This does not mean that the Tribunal held that expenditure other than the expenditure relating to marketing was not part of cost of plant and machinery. In fact, the Tribunal, following the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT : [1975]98ITR167(SC) and other decisions, held that 'the actual cost for the purpose of depreciation and development rebate in the present case has to be found by applying the above principles to the figures before us.' Therefore, question No. (ii) as framed and suggested by the assessee does not arise out of the order of the Tribunal. Accordingly, we are not answering the same.

59. Question No. (vi) referred at the instance of the Department relates to capitalisation of expenses incurred in respect of raw materials, materials and supplies, fuel, water power used in the trial run, the expenses incurred by way of debenture issue, debenture trust fee and legal expenses and also a sum of Rs. 64,103 included in miscellaneous expenses.

60. A sum of Rs. 4,04,96,240 was incurred in respect of raw materials and supplies, fuel, water, power, etc., used in the trial runs. This was required to be capitalised for the purpose of allowance of development rebate and depreciation. The trial run forms part of the erection of the plant and machinery. It is not sufficient only to construct a building and install the machinery in the said building and keep it idle. Before actually being put to use, the plant and machinery should be tested first in order to find out whether they are in a fit and proper condition to start functioning. The efficiency of the machinery installed should also be known before the commencement of production. After construction of the building and installing the machinery therein all of a sudden, the plant cannot be allowed to start functioning. To ascertain the above said aspects, a trial run and perhaps more than one trial run would be necessary. It is only during the trial run, adjustments, alignment, modifications, re-alignments of the machinery can be made. The trial run alone will show whether any part of the machinery can be added or removed so as to make the plant and machinery work with higher efficiency. Before handing over the plant and machinery after completion, it must be in a condition to start functioning in a full-fledged manner. Before operating the plant and machinery, it should be tested and the working condition of the plant and machinery should be found to be satisfactory. During trial runs, raw materials, necessary supply of water, fuel, power, etc., are absolutely necessary. It also requires the services of the engineers in working and maintenance as well as for corrections and adjustments. Therefore, the expenses incurred in respect of raw materials, materials and supplies, fuel, water, power, etc., used in the trial run will definitely go to add up to the cost of the assets. According to the facts arising in the decision reported in the case of CIT v. Food Specialities Ltd. : [1982]136ITR203(Delhi) (headnote) : 'The assessee which was engaged in the manufacture of condensed milk set up a new plant for this purpose. After the factory had been erected, but before it was ready for commercial production trial runs were made to test the plant and machinery. The assessee claimed that an amount of Rs. 23,069 spent on purchasing milk used for testing should be included in the actual cost of the machinery.'

61. On these facts, the Delhi High Court held as under (headnote) :

'Determining whether the factory was in a proper working condition was a step in setting up the factory which was the capital asset of the company. Hence, the amount of Rs. 23,069 spent in purchasing the milk had to be regarded as part of the actual cost of the plant for the purposes of computing depreciation and development rebate.'

62. In the case of CIT v. New Central Jute Mills : [1982]135ITR736(Cal) , it was held that (headnote) :

'Expenses incurred for staff training, insurance and power and fuel for installing plant and machinery form part of the actual cost of the machinery and depreciation and development rebate is admissible on such actual cost under section 33 and 34 of the Income-tax Act, 1961.'

63. In the case of Shree Vallabh Glass Works Ltd. v. CIT : [1981]127ITR37(Guj) , the Gujarat High Court held that (headnote) :

'All expenditure necessary to bring assets into existence and to put those assets in working condition is part of the actual cost of the assets to the assessee and it is in the light of that actual cost that the question of depreciation has to be considered by the Income-tax authorities.'

64. In the case of CIT v. Saurashtra Cement and Chemical Industries Ltd. : [1981]127ITR47(Guj) , the Gujarat High Court held that (at page 49) :

'The Tribunal was correct in law in holding that Rs. 9,000 being the expenditure on cement factory lighting and Rs. 11,000 being electrical expenses on test and trial runs for the cement, which had not started working, should be considered as capital expenditure.'

65. In view of the abovesaid legal position, the Tribunal was correct in holding that the expenditure incurred during trial run go to add up to the actual cost of plant and machinery, on which the assessee is entitled to depreciation and development rebate. Accordingly, we see that there is no infirmity in the order passed by the Tribunal on this aspect.

66. The assessee claimed that another sum of Rs. 56,31,396 as expenditure incurred in connection with borrowing by way of debenture trust fee and legal expenses should also be capitalised for the purpose of depreciation and development rebate. The assessee also incurred a sum of Rs. 64,103 towards miscellaneous expenses. This was incurred towards repair charges. The Tribunal allowed both these expenses as forming part of the actual cost of plant and machinery. Debentures were issued. The process fees and legal charges pertain to the said expenditure. The assessee received unsecured loans of Rs. 40 crores and odd from the Government of India and also utilised the debenture loan for the purpose of purchasing plant and machinery and erecting the building. The Supreme Court in the case of Challapalli Sugars Ltd. : [1975]98ITR167(SC) emphasised that, apart from the question of interest, all expenditure necessary to bring the assets into existence and to put those assets in working condition is part of the actual cost of the assets to the assessee and it is in the light of the actual cost thus arrived at that the question of depreciation has to be considered by the Income-tax authorities. Repair charges and legal expenses also form part of actual cost of plant and machinery (see CIT v. Great Easter Shipping Co. Ltd. : [1979]118ITR772(Bom) ). Therefore, the Tribunal was correct in holding that the debenture trust fee, legal expenses and miscellaneous expenses form part of actual cost of plant and machinery. In that view of the matter, we answer question No. (vi) referred at the instance of the Department, in the affirmative and against the Department.

67. Question Nos. (vii) and (viii) referred at the instance of the Department relate to capitalisation of salaries, wages, rents and welfare expenses and insurance amount. Question No. (vii) relates to capitalisation of 75 per cent. of salaries, wages and rents, 60 per cent. of the New York office expenses and 50 per cent. of the travelling and conveyance, postage and telegrams, audio base and printing and stationery. The items under salaries, wages and rent, as pointed out above, would go both towards erection, etc., of the plant and machinery and also for the other working of the company. While the Income-tax Officer rejected the assessee's claim in respect of these items in its entirety, the Appellate Assistant Commissioner allowed a portion of the same for capitalisation. The Tribunal directed that, out of Rs. 1,87,35,399 being the establishment charge, 75 per cent. of salaries, wages and rent aggregating to Rs. 79,44,069 should be added to the cost of assets for allowing depreciation and development rebate. Out of the total amount of Rs. 77,74,728 being the miscellaneous expenses, made up of contract labour, staff training and recruitment expenses, the Tribunal upheld the Appellate Assistant Commissioner's order in allowing capitalisation of Rs. 64,103 and 60 per cent. of the New York office expenses and 50 per cent. of travelling and conveyance, postage and telegrams, audio base and printing and stationery.

68. The assessee erected the factory on a turnkey basis and employed certain specialists, engineers, etc., paying them substantial salaries. The managing director was a technical person, who was solely in charge during the time of erection. He was paid Rs. 3 lakhs per year during the period of erection. During the period of erection, the salaries and wages would have been spent mostly for the purpose of erection, there being no expenditure in connection with the sales or manufacture. The expenditure relating to marketing has already been separated. Having regard to this fact, and the common knowledge that when a factory is in the process of construction, engineers, technical men and staff normally required for production, marketing and sales would not be engaged, the Tribunal tried to allocate the amounts towards the actual cost out of the abovesaid claim at 75 per cent., disallowing 25 per cent. as against 60 per cent. to 40 per cent. adopted by the Appellate Assistant Commissioner. In the absence of complete details, the Appellate Assistant Commissioner allowed 60 per cent. of the New York office expenses and 50 per cent. of the travelling and conveyance, postage and telegrams, audio base and printing and stationery for capitalisation. This order of the Appellate Assistant Commissioner was confirmed by the Tribunal since, even before the Tribunal the assessee had not furnished any better particulars so as to vary the order passed by the Appellate Assistant Commissioner with regard to these expenditure. In the absence of complete materials, there is justification on the part of the Tribunal in estimating the expenditure that would have gone towards acquiring the capital asset and hence such estimate cannot be considered to be improper.

69. Question No. (viii) referred at the instance of the Department relates to welfare expenses and insurance amount. With regard to the welfare expenses and insurance, it is not known whether any part of these expenditures pertains to staff engaged in the construction work and towards machinery and plant purchased. In the absence of complete details, the Tribunal pointed out that it is not possible to come to the conclusion whether the entire amount should be allowed or disallowed for the purpose of computing actual costs. Therefore, the Tribunal directed that the insurance amount relating to plant and machinery during the period of transportation to the site should be allowed. Other insurance expenses, either after erection or when the machinery was in a stationery position in the site, would not go to add to actual costs.

70. In the case of CIT v. Binny and Co. : [1986]159ITR303(Mad) , this court held that the Tribunal was correct in estimating the capital expenditure to be added to the cost of machinery for the purpose of grant of depreciation allowance. In CIT v. Borosil Glass Works Ltd. : [1986]161ITR286(Bom) and in CIT v. Tata Chemicals Ltd. : [1986]162ITR556(Bom) , it was held that travelling expenses to inspect and place orders, correspondence and postage, insurance premium on plant and erection, technical personnel's remuneration, travelling expenses in connection with design and preliminary engineering work for installation, would form part of the actual cost of the machinery and the building. In CIT v. J. M. A. Industries Ltd. : [1981]129ITR373(Delhi) , the Delhi High Court held that expenditure incurred by way of salaries and wages to technical staff and travelling form part of the actual cost of plant and machinery. In the case of CIT v. New Central Jute Mills : [1982]135ITR736(Cal) , it was held that expenses incurred for insurance for installing plant and machinery and depreciation and development rebate are admissible on such actual cost.

71. Therefore, in view of the abovesaid legal position and in the absence of proper materials on this aspect, we consider that the Tribunal was correct in estimating the expenditure that has got to be added towards the actual cost and further directing the Assessing Officer to add only that portion of the expenditure towards actual cost which really related to the actual cost, for the purpose of depreciation and development rebate. Hence, we find that the order passed by the Tribunal on this point is in order. Accordingly, we answer question Nos. (vii) and (viii) referred at the instance of the Department, in the affirmative and against the Department.

72. Question No. (ix) relates to whether the value of hydrogen of Rs. 8,66,000 given to Messrs. Madras Refineries Ltd. is sale or not. The assessee gave some hydrogen to Madras Refineries Ltd. and raised a debit note for quantities supplied for an amount of Rs. 8,66,000. This amount was taken as sale in the assessment. The Appellate Assistant Commissioner going into the facts accepted the assessee's claim that this was only a loan of hydrogen by the assessee to Madras Refineries Ltd. Hence the Appellate Assistant Commissioner deleted the sum of Rs. 8,66,000. On appeal, the Tribunal accepted the order passed by the Appellate Assistant Commissioner on this point.

73. There were some discussions going on between the assessee and Madras Refineries Ltd., regarding the supply of hydrogen by one concern to another concern. Ultimately, on January 28, 1973, Madras Refineries Ltd. wrote to the assessee to treat the supply of hydrogen on loan basis to be returned by either party, quantity for quantity. This was also accepted by the assessee in its letter dated January 31, 1973. The detailed procedure was settled between the parties on January 7, 1973. The decision is that supply of hydrogen by either party to the other party is not in the nature of sale or purchase. It should be on a loan basis and it shall be regarded as a barter transaction. The assessee never received any money on account of supply at any time from Madras Refineries Ltd. and the debit note raised by the assessee on Madras Refineries Ltd. has also been reversed. The sales tax authorities have accepted this supply of hydrogen to Madras Refineries Ltd. as a barter arrangement. On the facts, it was shown that what had taken place was mere barter transaction. Since there was no sale, Rs. 8,66,000 cannot be considered as sale consideration. Hence the Tribunal was correct in upholding the order passed by the Appellate Assistant Commissioner in dealing with this amount of Rs. 8,66,000. Thus, we answer question No. (ix) referred to us at the instance of the Department in the affirmative and against the Department.

74. Question No. (x) referred at the instance of the Department relates to the guidelines given by the Tribunal in the matter of regulating the deduction under section 43A of the Act.

75. From the cost of plant and machinery arrived at Rs. 91,69,77,769, the Income-tax Officer deducted a sum of Rs. 48,29,717 applying the provisions of section 43A of the Act and accepted the balance, for the grant of depreciation. The sum of Rs. 48,29,717 is credited in the account called exchange fluctuation benefit. On appeal, the Appellate Assistant Commissioner held that section 43A will be applicable to the facts of this case and the Income-tax Officer was correct in adjusting the amount of Rs. 48,29,717 in the cost of plant and machinery. Accordingly, the order of the Income-tax Officer was confirmed. On further appeal, the Tribunal held that the question of adjusting a sum of Rs. 48,29,717 under section 43A of the Act towards the cost of plant and machinery, should be regulated in the following manner :

'(1) The actual cost of machinery put into operation on the date of its purchase should be ascertained and its rupee equivalent at the rate of exchange paid or stipulated by the assessee in the purchase contract worked out.

(2) In so far as the overall amounts standing to the credit of the Chemical Bank or other parties based on which the assessee had credited a sum of Rs, 48,29,717 to the exchange fluctuation reserves includes not merely amounts borrowed for purchase of assets but also amounts recovered by way of equity, interest realisations, etc., the Income-tax Officer should ascertain the correct purchase amount of the assets before applying the above rate of exchange.

(3) Thereafter, the fact whether the entire machinery was put to use on November 1, 1978, or on different dates should be ascertained.

(4) The exchange rates on each of the above dates should be ascertained and the reduction or increase on account of fluctuation in rates between the date of purchase and date of putting the machinery to use in respect of the outstanding liabilities pertaining to the assets worked out and the difference, if any, only can be adjusted to the cost of machinery, plant, etc., for granting depreciation for the year under appeal.

(5) Similar procedure is to be applied to the subsequent years till the outstandings on account of purchase are wiped off.'

76. Learned standing counsel for the Department submitted as under : The three conditions for applying the provisions of section 43A of the Act are satisfied in this case and hence section 43A is clearly applicable to the facts of this case. The fact that the assessee had actually paid at a rate higher than Rs. 7.279 per U. S. dollar for the purpose of repayment of loan to Chemical Bank is not also very much material to decide the application of section 43A. There is a reduction in the liability in the case of the assessee on account of devaluation of U. S. dollars on December 13, 1971, in which the rate of exchange was reduced from Rs. 7.50 per dollar to Rs. 7.279 per dollar. Therefore, section 43A will apply and the extent of reduction in the liability has to be adjusted in the cost of the plant and machinery.

77. Learned counsel for the assessee submitted as under : The company was set up in 1966. The contract for construction of the plant was given to the contractor in 1967. The trial runs were conducted in September, 1971. The production commenced on commercial scale from November 1, 1971. On September 13, 1977, the U. S. dollar was devalued reducing its value from Rs. 7.50 per dollar to Rs. 7.279. The bank balance and the U. S. dollar liabilities having been affected by the change in exchange rates, the beneficial difference arrived at at Rs. 42,30,316 was credited to the exchange fluctuation reserve account. This represented the net result of a gain of Rs. 48,29,717 and a loss of Rs. 5,99,401 on account of variation in exchange rate. The assessee acquired the assets from more than one source, viz., equity, dollar amounts and interest realisation. Therefore, it is not correct to state as to how much of the U. S. dollar allocations or outstanding would relate to the value of the assets unpaid. Though the assessee owed amounts to the Chemical Bank from whom money had been drawn for the purchase of machinery, the machinery was purchased from other sources also. Therefore, even if section 43A is made applicable, there may not be any impact on the actual cost for the year under consideration. Further, even though the dollar was devalued on December 13, 1971, the rupee was actually floated in relation to the dollar from June 23, 1972. For the purpose of repayment of loan to the foreign bank, dollars were purchased for higher rate than Rs. 7.50 per dollar. Therefore, the actual liability was not certain. This is the factual position as on that date. The provisions of section 43A of the Income-tax Act were enacted to deal with the devaluation of the rupee. This section was not relevant to a situation in which the exchange rate was a floating one.

78. A plain reading of the relevant portion of section 43A makes it clear that all that is meant by saying that section 43A is prospective is that the variation in the actual cost provided under section 43A will be applicable only when depreciation has to be calculated in respect of a previous year relevant to the assessment year 1967-68 or thereafter. Regarding the change in the rate of exchange, all that is provided is that the change in the rate of exchange must take place after the acquisition of the asset in question. All that is required is that the revaluation or devaluation must take place after the asset is acquired, where an assessee incurs an additional liability in Indian currency due to fluctuation in exchange rates in respect of foreign currency loans obtained for purchase of machinery, when it would be entitled to the benefit of this section.

79. A profit or loss will arise on conversion of one currency into another currency in the case of a devaluation but actual conversion or repatriation is not a pre-condition for accrual of profit or for arising of loss even where the accounts are kept on a mercantile basis. Conversion can be considered on a notional basis in such a case. The state of the accounts as at the end of the accounting year has to show a reduction in the liability and a consequent increase in the taxable surplus (see CIT v. Martin and Harris (P.) Ltd. : [1985]154ITR460(Cal) ). Section 43A only deals with the effect of a change in the rate of exchange with the foreign currency concerned in determining the 'actual cost' referred to in section 43, and there is nothing in the language of section 43 to indicate that the actual cost has anything to do with the cost of the asset in question being capitalised or not (CIT v. Tata Hydro Electric Power Supply Co. Ltd. : [1986]159ITR28(Bom) ). Sub-section (2) of section 43A specifically rules out the application of the section for the purpose of development rebate.

80. In the present case, the actual amount of Rs. 42,30,316 credited to the exchange fluctuation reserve account, is the net result of a gain of Rs. 48,29,717 arising from the devaluation of the U. S. dollar on December 13, 1971, and a loss of Rs. 5,99,401 on account of variation in the exchange rate. The three conditions required by section 43A are satisfied in the present case. The assessee has purchased the machinery abroad. For this purpose, loans have been taken from Chemical Bank, New York. The loan in foreign currency is specifically intended to some extent for the purpose of acquiring an asset in respect of which depreciation is claimed. There was devaluation of the dollar in December, 1971. Hence, there is fluctuation in the rate of exchange on that date. The rate of exchange as on date of purchase of the machinery and the rate as on November 1, 1971, are not known. It is also not known whether the entire amount of outstanding is payable immediately on the changed date of fixing the rate of exchange or only a portion thereof. The actual cost has got to be worked out as on November 1, 1971. According to the assessee, that part of the loan payable to the foreign bank in the assessment year under consideration, viz., Rs. 2,54,000 alone should be taken into consideration, because the foreign loan is payable in instalment. The Income-tax authorities, took into account the entire credit mentioned under the head 'Exchange fluctuation reserve account' and treated that as the difference to be adjusted, under section 43A, of the actual costs.

81. In fact, the rate relevant for the application of section 43A would be the rate at the beginning of the accounting year, and not the end or any other date during the interim period. The Income-tax authorities did not consider all these aspects before applying the provisions of section 43A of the Act. Therefore, considering all these aspects and in the absence of the abovementioned particulars, the Tribunal gave certain guidelines for the purpose of applying section 43A of the Act, since the Income-tax authorities failed to consider the applicability of the provisions of section 43A of the Act in the proper perspective. Therefore, we see no reason to find fault with the directions given by the Tribunal in the matter of applying the provisions of section 43A of the Act. In that view of the matter, we answer question No. (x) referred to us at the instance of the Department in the affirmative and against the Department.

82. In the result, we answer the question referred to us in the following manner :

The questions referred at the instance of the assessee in T. C. No. 166 of 1980, question No. (i) is answered in the negative and in favour of the assessee. Question No. (ii) does not arise out of the order of the Tribunal. Hence we are not answering the same. The questions referred in T. C. Nos. 167 and 168 of 1980 at the instance of the Department : Questions Nos. (i) to (iii) are answered in the negative and in favour of the Department.

83. Questions Nos. (iv) to (x) are answered in the affirmative and against the Department.

84. The parties are directed to bear their own costs.