1. The Appellate Tribunal has referred the following question under Section 256(1) of the I.T. Act, 1961:
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the guarantee commission of Rs. 33,238 paid by the assessee was expenditure of a capital nature and was hence not allowable as a deduction in computing the total income for the assessment year 1968-69?"
2. The assessee, a company, purchased, for the purpose of its business, some items of machinery on deferred payment terms. Under the terms of purchase, there was to be an immediate payment of 10% or 20% of the cost of the machinery. The balance was to be paid on a deferred basis in half-yearly or yearly instalments. For assuring the due payment of the instalments, the assessee had to obtain a guarantee executed by a bank in favour of the sellers of the machinery, who were abroad, and the bank charged commission at a percentage of the amount guaranteed. This com- mission totalled to Rs. 33,238.28. It consisted of commission at 1% on the outstanding balance and also of commission guaranteed on the additional liability consequent on devaluation of the Indian rupee. The assessee claimed the aforesaid amount as deduction in its assessment for the assessment year 1968-69, for which the previous year ended on 31st December, 1967. The ITO held that the amount of guarantee commission was capital in nature and, therefore, disallowed it.
3. On appeal, the AAC held that while the expenditure for the purchase of the assets was undoubtedly capital, the expenditure for discharging the liability in instalments could not be "regarded as capital expenditure. He, therefore, allowed the expenditure as a revenue outgoing. The department appealed to the Tribunal, and the Tribunal, following the decision of the Calcutta High Court in CIT v. Fort Gloster Industries Ltd.  79 ITR 48, held that the payment of guarantee commission was concerned with an expenditure incurred by the assessee in connection with purchase of machinery, that it went to increase the actual cost to the assessee of the machinery, and that, therefore, the expenditure was of capital nature. In the result, the disallowance made by the ITO was found to be proper. The assessee has obtained reference of the question already set out.
4. While the assessee's counsel contended that the present case was governed by the principles of the decision in India Cements Ltd. v. CIT , the learned counsel for the revenue submitted that the case was governed by the principles of the decision in Challapalli Sugars Ltd. v. CIT . Both the decisions are of the
5. In the decision in India Cements Ltd. v. CIT ,
reference is made to some of the earlier decisions of the Supreme Court. It would, therefore, be appropriate to start with the decision in State of Madras v. G. J. Coelho . That was an
appeal against the judgment of this court rendered under the Madras Plantations Agrl. I.T. Act, 1955. The assessee in that case purchased an estate for a sum of Rs. 3,10,000. He borrowed Rs. 2,90,000 at varying rates of interest and he paid a sum of Rs. 22,628-9-8 as interest on the safd borrowing and he claimed this amount as a deduction in the agricultural income-tax assessment.
6. The Agrl. ITO disallowed part of the aforesaid claim on the ground that the provision of Section 5(k) would permit allowance of only 25% of the agricultural income of that year. He disallowed the balance. The assessee lost before the Assistant Commissioner and also before the Agricultural Income-tax Appellate Tribunal. The High Court, on revision, allowed the entire amount, and the correctness of the allowance as made by the High Court was the subject-matter of the appeal before the Supreme Court. Section 5(e) of the Madras Plantations Agrl. I.T. Act corresponded to Section 10(2)(xv) of the Indian I.T. Act of 1922, which itself corresponds to Section 37 of the I.T. Act of 1961 and permitted the allowance of expenditure incurred wholly and exclusively for the purpose of the plantation. Section 5(k) permitted the allowance of interest on any amount borrowed and actually spent on the plantation from which income was derived. This provision was found to be inapplicable to that case, because the amount had been borrowed for the purpose of the plantation and not for being spent on the plantation itself. Therefore, the matter had to be considered only under Section 5(e). The Supreme Court held that in ordinary commercial practice payment of interest would not be termed as "capital expenditure" and that the expenditure was not also of a personal nature. At page 194, it was observed as follows:
"In this connection, it is pertinent to note that what the Act purports to tax is agricultural income and not agricultural receipts. From the agricultural receipts must be deducted all expenses which in ordinary commercial accounting must be debited against the receipts. There is nothing in the Act which prohibits such expenses from being deducted. No farmer would treat interest paid on capital borrowed for the purchase of the plantation as anything but expenses, and as long as the deductions he claims, apart from any statutory prohibition, can be fairly said to lead to the determination of the true net agricultural income, these must be allowed under the Act. In principle, we do not see any distinction between interest paid on capital borrowed for the acquisition of a plantation and interest paid on capital borrowed for the purpose of existing plantations: both are for the purposes of the plantation."
7. Consequently, the entire amount of interest claimed was allowed as deduction.
8. The decision in Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT  56 ITR 52 (SC) is the next case to be referred to. In that case, the assessee-company was incorporated in August, 1953, to take over the passenger and ferry services carried on by a company. The assets of the passenger and ferry Services taken over were valued at Rs. 81,55,000 and the price was to be satisfied partly by allotment of shares, and the balance was to be treated as a loan secured by a promissory note and on the hypo-thecation of all movable properties of the company. The balance which remained unpaid was to carry simple interest at 6% per annum. During the relevant accounting years, the assessee paid interest on the balance outstanding, and the question was whether the interest paid was allowable as deduction under Section 10(2)(iii) or (xv) of the Indian I.T. Act, 1922. Shah and Sikri JJ. held that no capital had been borrowed by the assessee in that case and that the agreement to pay the balance of consideration due by the purchaser did not in truth give rise to a loan. The claim for deduction of the amount under Section 10(2)(iii) was held to be inadmissible. Subba Rao J., as he then was, did not express any view on this point. However, all the three learned judges held that the interest paid was liable to be allowed as deduction under Section 10(2)(xv), and they followed, in cpming to this conclusion, the earlier decision in State oj Madras v. G. J. Coelho it was pointed out as follows :
"The expenditure was incurred after the commencement of the business. The expenditure is not for any private or domestic purposes of the assessee-company. It is in the capacity of a person carrying on business that this interest is paid.
The question then is whether the expenditure is of a capital nature. It is not easy ordinarily to evolve a test for ascertaining whether in a given case expenditure is capital or revenue, for the determination of the question must depend upon the facts and circumstances of each case. The court has to consider the nature and ordinary course of business and the objects for which the expenditure is incurred......If the principal or the interest accruing due was not paid, the Scindias had undoubtedly a right to enforce their lien against the assets of the assessee-company's business, but that cannot be regarded as a ground for holding that the expenditure fell within Section 10(2)(xv). Even in respect of a liability wholly unrelated to the business, it would be open to a creditor to sequester the assets of the assessee's business and such sequestration may result in stoppage of the operation of the business. Expenditure for satisfying liability unrelated to the business even if incurred for avoiding danger apprehended or real to the conduct of the business cannot be said to be revenue expenditure. Nor can it be said that because a liability has some relation to the business which is carried on, expenditure incurred for satisfaction of such liability is always to be regarded as falling within Section 10(2)(xv).
Whether a particular expenditure is revenue expenditure incurred for the purpose of business must be determined on a consideration of all the facts and circumstances, and by the application of principles of commercial trading. The question must be viewed in the larger context of business necessity or expediency. If the outgoing or expenditure is so related to the carrying on or conduct of the business, that it may be regarded as an integral part of the profit earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure."
9. The test formulated in the decision in State of Madras v. G. J. Coelho was summarised at page 61 as follows :
"The test laid down by this court therefore, was that expenditure made under a transaction which is so closely related to the business that it could be viewed as an integral part of the conduct of the business, may be regarded as revenue expenditure laid out wholly and exclusively for the purpose of the business."
10. Reference may now be made to the decision in India Cements Ltd. v. CIT , which is chronologically the next case cited, and on which strong reliance was placed on behalf of the assessee. The assessee in that case borrowed a sum of Rs. 40 lakhs from the Industrial Finance Corporation of India. The loan was secured by a charge on the fixed assets of the company. This amount of Rs. 40 lakhs was utilised to pay off a prior debt of Rs. 25 lakhs to M/s. A. F. Harvey Ltd. and Madurai Mills Ltd., and the balance towards working funds. The assessee incurred a sum of Rs. 84,633 as stamp fees, registration charges, fee for drafting the deed and other legal fees, but it did not charge this expenditure in the profit and loss account. It showed the amount in the balance-sheet as "mortgage loan expenses". In a later year, this sum was written off by appropriation against the profits of that year. The assessee claimed the amount as deduction on revenue account. When the matter came before the Supreme Court, several cases decided by the courts in England and India were noticed and ultimately it was observed at page 63 as follows :
"To summarise this part of the case, we are of the opinion that:
(a) the loan obtained is not an asset or advantage of an enduring nature ;
(b) that the expenditure was made for securing the use of money for a certain period ; and
(c) that it is irrelevant to consider the object with which the loan was obtained. Consequently, in the circumstances of the case, the expenditure was revenue expenditure within Section 10(2)(xv)." (Underlining ours).
11. Thus, these three decisions would show that interest on loans, even if borrowed for the purchase of capital assets or for capital purposes would all be revenue in nature. However, there is a different line of cases where interest paid or other expenses incurred in the purchase or installation of machinery has been permitted to be capitalised and taken to form part of the actual cost of the machinery for the purposes of depreciation, etc. It is necessary to see under what circumstances this can be done. In CIT v. L. G. Balakrishnan and Bros. (P.) Ltd.  95 ITR 284 (Mad), a Bench of this court was concerned with a case where the assessee had entered into a collaboration agreement with a West German firm. It incurred a sum of Rs. 42,712 in a tour abroad undertaken by three of the directors and an engineer. A further sum of Rs. 33,000 was incurred by way of interest on the amount borrowed by the assessee for the purchase of the machinery for setting up the factory. The assessee claimed that these amounts of travelling expenses and interest should be added to the cost of the machinery on which depreciation and development rebate should be allowed. The Appellate Tribunal held that the assessee was entitled to capitalise the interest as well as foreign tour expenses. When the matter came before this court, the nature of each item of expenditure was examined, and it was held that the interest paid was rightly capitalised as part of the cost of the machinery and that the Tribunal was right in allowing the assessee's claim for depreciation and development rebate on that amount also. However, as regards foreign tour expenses, though the expenses connected with the inspection and supervision of the machinery purchased was liable to be capitalised and depreciation and development rebate granted, the expenses incurred in sending engineers for learning the technique of erecting or handling the machinery, which did not enhance the value of the machinery purchased and which did not relate to the purchase of the machinery, could not, it was held, be capitalised. The payment made to the foreign collaborators not being for the acquisition of the machinery was also not permitted to be capitalised. In the course of the judgment, reference was made to the Members Handbook Series, The Institute of Chartered Accountants of India, No. 202, as showing the accountancy practice, and also to Section 208 of the Indian Companies Act, 1956, which permitted payment of interest on share capital in certain contingencies and authorised the interest payments to be treated as capital as representing the cost of construction of the work or building or the provision of the plant, as the case may be. That provision (s. 208) was referred to as showing that the commercial and accountancy practice of capitalising the interest payments under certain circumstances, was accorded recognition by the statute. At page 296, it was stated as follows :
"In this case the assessee has, in fact, capitalised the interest payments made before the factory started functioning and this is in accordance with the normal commercial and accountancy practice. We are not, however, inclined to base our decision on the said commercial or accountancy practice. We are of the view that as the statute has specifically used the expression ' actual cost to the assessee the interest payments made on the amounts borrowed for the purpose of acquiring the machinery can be taken to be an expenditure incurred by the assessee in acquiring the machinery and that will go to add to his actual cost of the machinery..... If the statute has merely used the word 'actual cost' then it is possible to say that the interest payments in question cannot come in within the expression. The intention of the legislature in using the expression 'actual cost to the assessee' appears to be to take into account the assessee's peculiar position at the time of the purchase of the machinery while granting allowance for depreciation and development rebate."
12. This decision was cited before the Supreme Court in Challapalli Sugars Ltd. v. CIT  98 ITR 167 and was approved. In the case before the Supreme Court, the assessee was a public limited company engaged in the manufacture and sale of sugar. It had borrowed considerable sums of money from the Industrial Finance Corporation of India for the installation of machinery and plant and paid interest on the borrowings. It claimed the interest as an addition to the cost of the machinery and plant, so that depreciation would be admissible on the total amount of outlay including the interest. The Supreme Court quoted practically the same passage from the publication of the Institute of Chartered Accountants as was quoted by this court in CIT v. L. G. Balakrishnan and Bros. (P) Ltd. and stated the principle applicable in the following words (p. 175):
"It would appear from the above that the accepted accountancy rule for determining the cost of fixed assets is to include all expenditure 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 its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets which have been created as a result of such expenditure. The above rule of accountancy should, in our view, be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary." (Underlined* by us).
13. Before the Supreme Court reference was made to the anomaly of the actual cost varying between the two persons, one who purchased the machinery out of his own resources and the other who purchased it out of the borrowed money. It was pointed out that for identical fixed assets there would be different actual costs. But this was held to be immaterial. The decision in India Cements Ltd. v. CIT was considered at page 178 and was distinguished. The distinction was pointed out in the following words (p. 178) :
"The appellant-company in that case at the time it raised the loan was a running concern. Unlike the assessees in the present appeals, the loan raised by the appellant-company in the cited case was not before the commencement of production but at a later stage. The question of including the interest paid on the loan before the commencement of business in the actual cost of the plant did not arise in that case."
14. The result of the Supreme Court's decision in that case was that the amount paid as interest before the commencement of production with the assistance of the machinery could be capitalised.
15. This distinction in the treatment between the expenditure on interest or other expenses incurred by the assessee before he started carrying on the business and after he commenced his business has also been brought out in Ritz Continental Hotels Ltd. v. CIT . In that case, the assessee was incorporated with the object of carrying on the business of running hotels and restaurants. The assessee entered into an agreement with the LIC under which the LIC was to put up a multi-storeyed building in Calcutta and make it available to the assessee for running a hotel. The assessee paid interest on the outlay made by the LIC in accordance with the terms of the agreement with it, and described the amount paid as rent in its profit and loss account, and claimed it as deduction in the computation of the business income. The Calcutta High Court pointed out that the Tribunal had found as a fact that the expenses were not in connection with any business carried on by the assessee in the year in question but were in connection with the setting up of a new hotel which had not commenced business at the end of the relevant previous year, and that in order to be allowable as expenses, it should be in respect of business, which was carried on by the assessee and the profits of which were computed and assessed, and should be incurred after the business was set up.
16. Thus, it is clear from the cases considered above that an expenditure by way of interest or other charges incurred on borrowing of money for purchase of capital assets or other capital purposes, before the commencement of production or commencement of the business with the aid of such capital assets could be added to the cost of the assets. The passage from the publication of the Institute of Chartered Accountants of India has been sanctified by a judicial pronouncement and can now be taken as a guide in disposing of such claims. The said passage runs as follows ( 95 ITR 284 at p. 294):
" 'The question often arises as to whether interest on borrowings can be capitalised and added to the cost of fixed assets which have been created as a result of such expenditure. The accepted view seems to be that in the case of a newly started company which is in the process of constructing and erecting its plant, the interest incurred before production commences may be capitalised. "Interest incurred" means actual interest paid or payable in respect of borrowings which are used to finance capital expenditure...Interest on capital during construction paid in accordance with the provisions of Section 208 of the Companies Act, 1956, may, however, be capitalised as permitted by that section. Interest on monies which are specifically borrowed for the purchase of a fixed asset may be capitalised prior to the asset coming into production, i.e., during the erection stage. However, once production starts, no interest on borrowings for the purchase of machinery (whether for replacement or renovation of existing plant) should be capitalised. For an existing business, the only interest which may be capitalised is interest paid for financing a completely new unit or a substantial expansion undertaken by the company. Even here only the interest on monies specifically borrowed for the new expansion may be capitalised and that only for the period before production starts.' " (Underlined by us).
17. Thus, interest paid on loans borrowed for purchase of machinery and plant can be capitalised in cases, (a) where the business of manufacture is newly set up; or (b) where the assessee has carried out a new expansion. The commercial practice in U.K. is consistent with the decision in Challa-palli Sugars Ltd. v. CIT . The
Chancery Division in Hinds v. Buenos Ayres Grand National Tramways Company Ltd.  2 Ch 654 dealt with the case of a tramway company functioning with horse drawn carriages. The company converted the horse line into an electric traction line. For this purpose, it issued conversion debenture stock. The directors passed a resolution that interest on that stock should be treated as part of the cost of construction and chargeable to capital account during the construction of the works. There was no provision relating to this subject in the memorandum and articles of association. In an action by a shareholder, the question was whether the capitalisation of the interest till each unit of tramway started functioning was proper or not. Warrington J. referred to a number of earlier decisions and observed at page 659 as follows :
"In considering the accounts of a company the only principle by which the court can be guided--of course unless there are some express words, express provisions, or express stipulations on the subject--is the consideration what a commercial man, acting fairly and honestly in the conduct of his business, would consider the proper thing to do."
18. At page 660, it was observed in relation to the case before the court as follows :
"In my opinion, that asset which they are so constructing costs them not only the 10,000 but the 10,000 plus the amount of interest during the period of construction; and that is what they are put of pocket during the construction of that mile of line. Now, it seems to me that the company are entitled--I do not say that they are bound to do it--if they think fit to charge in their accounts as the cost of that mile of line not only the 10,000, but the 10,000 and the interest on it during the period of construction."
19. That decides the present case.
20. This passage and the view of the Institute of Chartered Accountants would show that even in the case of a running business it is possible to capitalise the interest paid for financing a completely new unit or a substantial expansion undertaken by the company. The principle of capitalisation has not to be confined to a newly started business. The principle may apply to a new business or a new unit of an existing business. In regard to the latter, option would be available to the assessee.
21. Mr. Jayaraman, the learned counsel for the revenue, drew our attention to a decision of the House of Lords in Ben-Odeco Ltd. v. Powlson (Inspector of Taxes)  1 WLR 1093. The company in that case was incorporated in 1968 to acquire and hire out an oil drilling rig. It negotiated large loans that were essential for the financing of the construction of the oil rig. The commitment fees and interest charged on the loans came to 494,990. That sum was charged to capital in the taxpayer's accounts. It was claimed that the expenditure on commitment fees and interest was capital expenditure on the provision of machinery or plant and was, therefore, eligible for the capital allowance. Section 41(1)(a) of the Finance Act, 1971, which was the provision to be construed there, contemplated the capital allowance to a person carrying on a trade incurring "capital expenditure on the provision of machinery or plant for the purposes of the trade". It was held by the majority that, in determining whether any capital expenditure qualified for an allowance, a distinction was to be made between expenditure on providing finance to acquire machinery or plant and expenditure incurred on actual provision of such machinery or plant, which included such items as the cost of transport and installation, but not other expenditure more remote in purpose. It was further held that though the loans were essential to the taxpayer company to finance the construction, it was not capital expenditure incurred on the provision of the oil drilling rig and accordingly did not qualify for the allowance. The distinction between "capital expenditure on the provision of machinery or plant" and "capital cost to the taxpayer" was pointed out as showing that while the one drew a line round the taxpayer and plant, the other confined the limiting curve to the plant itself and that the words in the British statute "expenditure on the provision of" focussed attention only on the plant and the expenditure on the plant. It is in that view that the interest and the commitment charges were not allowed to be capitalised. Thus, the decision is not of assistance to the present case, because of the difference in the language of the statute. The Indian statute focusses attention on the assessee by providing for allowance of depreciation, etc., on the cost of the assets to the assessee. The allowance is not based on the a.bstract consideration of only the cost of the assets irrespective of the person who actually installed it and utilised it.
22. Having considered the arguments of the learned counsel for the revenue, we may observe that the various decisions bearing on capitalisation of business expenditure have arisen in the different contexts of determining what the actual cost to any given assessee was of items of depreciable machinery, plant, etc., acquired by him. Such expenditure considered for capitalisation might itself be expenditure of a capital nature or it might be expenditure of a revenue nature. In either case, it would be subject to the principles enunciated in the decisions aforesaid. But those principles have no direct bearing on the question of a claim for a straightforward allowance as an expenditure of a revenue nature in the computation of business profits. Nor is it the law that only those expenses which cannot be capitalised can come in for straight deduction as revenue expenditure, for, as we have earlier seen, the accountancy principles, relating to capitalization are themselves not hard and fast rules, but are to be adopted only at the option of the owner of the capital asset. In these circumstances, the discussion to be found in the above cases do not throw further light on the claim in the present case which is unrelated to the working out of the cost of acquisition of any depreciable machinery, plant, or other capital asset. The appropriate tests for a decision of the present case must, therefore, have to be looked for in the three decisions which we have set out at the beginning of this discussion, namely, State of Madras v. G. J. Coelho , Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT  56 ITR 52 (SC) and India Cements Ltd. v. CIT .
23. Mr. Jayaraman contended that the guarantee commission paid in this case was with a view to bringing into existence an asset or an advantage for the enduring benefit of the trade and that it would, therefore, be a capital expenditure. It is not possible to agree with this submission. The expenditure was incurred in the course of carrying on the business. It was not incurred prior to the commencement of the business. The commission is so closely related to the business that it could be viewed as an integral part of the conduct of the business and would be a revenue expenditure. The very nature of the expenditure and the time at which it has been incurred would justify the claim of the expenditure as revenue expenditure.
24. It now remains to consider the decision of the Calcutta High Court in CIT v. Fort Gloster Industries Ltd. relied on for the Commissioner. In that case, the assessee placed an order with a British concern for the purchase of machinery worth Rs. 48,00,000. The British supplier required a guarantee to be given. The Allahabad Bank Ltd. agreed to be the guarantor for a consideration of Rs. 36,000 to be paid to the bank as guarantee commission. The question was whether this guarantee commission was properly capitalised by the assessee enabling it to obtain development rebate allowance on the cost of the asset including the guarantee commission. The Calcutta High Court held that it would be reasonable to conclude that the expenditure incurred by way of guarantee commission was essential for the acquisition of the machinery and should be treated as part of the "actual cost". The facts themselves are not quite clear from the judgment to examine whether it was a case where the claim was made in respect of a period before commencement of business or after it. The decision is, however, not inconsistent with the assessee's claim in the present case, as it was not held there that the guarantee commission should invariably be capitalised, if it related to machinery--the question of its being revenue expenditure had not to be examined.
25. The learned counsel for the Commissioner referred us to the decision of the Supreme Court in Sitalpur Sugar Works Ltd v. CIT  49 ITR (SC) 160. That was a case where the expenditure was incurred in dismantling and refitting an existing plant at a better site. It was held that the expenditure was of a capital nature analogous to the acquisition of a plant. The finding was that the expenditure was not incurred in earning profits, but only for putting up the assessee's factory, that is, its capital, in better shape, so that it might produce larger profits when worked. It was also held that the expenditure resulted in an advantage, which enabled the trade to prosper and which could last for ever. The position here is wholly different, and we do not find any analogy between the matter before us and this decision of the Supreme Court.
26. The expenditure incurred for the purchase of the machinery was undoutedly capital expenditure, for it brought in an asset of enduring advantage. But the guarantee commission stands on a different footing. By itself, it does not bring into existence any asset of an enduring nature ; nor did it bring in any other advantage of an enduring benefit. The acquisition of the machinery on instalment terms was only a business exigency. If interest paid on a credit purchase of machinery could be held to be revenue expenditure, we fail to see how guarantee commission paid to a bank for obtaining easy terms for acquisition of the machinery could be regarded as capital payments.
27. The result is that the question referred is answered in the negative and in favour of the assessee. The assessee will be entitled to its costs. Counsel's fee Rs. 500.