ORDER
R.S. Syal, A.M.
1. This appeal by the assessee emanates from the order passed by the CIT(A) on 22nd Nov., 1995, in relation to the asst. yr. 1990-91. The following three effective grounds read as under :
1. That the learned CIT(A) has erred in not allowing the interest payable of Rs. 97.07 lakhs to the Central Government @ 14 per cent per annum on the loan of Rs. 693.39 lacs as a revenue expenditure.
2. That the learned CIT(A) has erred in not holding that the subsidy of Rs. 97.07 lacs granted by the Central Government by adjustment of interest as exempt from tax.
3. That the learned CIT(A) has erred in concluding that grant of subsidy equivalent to the interest payable is a waiver.
2. The facts concerning this appeal are that the assessee had debited a sum of Rs. 97,07,460 to its P&L a/c as “Provision for interest” and claimed deduction thereof. While framing the assessment under Section 143(3) the AO called upon the assessee to explain as to why this sum be not disallowed. It was stated on behalf of the assessee that it had provided for Rs. 97.07 lacs towards interest @ 14 per cent on the loan amounting to Rs. 6,93,39,000 outstanding on the date when the undertaking was handed over to it by the Government. It was further stated that as per letter No. 14/3/86-NSU/Sugar-Desk-I, dt. 25th Oct., 1989, of the Department of Food, Ministry of Food and Civil Supplies, the interest on loan was liable to be treated as capital subsidy to enable the assessee unit to rehabilitate and improve its functioning. The learned AO observed that the assessee was not liable to pay any interest on the outstanding Government loan and in fact it had received a capital subsidy, of the equivalent amount. The claim of deduction for Rs. 97.07 lakhs was jettisoned as in the opinion of the AO the assessee had neither incurred any expenditure nor there was any liability to pay in this regard. The book entries made by the assessee claiming deduction were held to be irrelevant for the purpose of computing the taxable income. The first appeal did not change the fortune of the assessee.
3. Before us the learned counsel for the assessee contended that both the authorities below had erred in appreciating the factual aspect in its entirety. It was stated that the assessee was originally engaged in the business of manufacture and sale of sugar and management of the undertaking was taken over temporarily by the Government of India on 2nd Feb., 1979, under the Sugar Undertaking (Taking Over of Management) Act, 1978. It was explained that on 1st Feb., 1986, the undertaking was again handed over to the assessee and at that time the company owed a loan of Rs. 693.39 lacs to the Government. The interest liability on the aforesaid loan till 31st Jan., 1986, was waived by the Government of India. It was further stated that in respect of the interest payable after 1st Feb., 1986, the Government agreed to grant subsidy equivalent to the interest liability on the outstanding loan for a period of five years. While referring to pp. 42 onwards, being the agreement of the assessee with the Government, it was stated that the rate of interest during the period of moratorium of five years was settled at 14 per cent per annum and it was agreed that this interest would be credited as subsidy to the assessee-mill by the Government. It was, therefore, asserted that the liability for payment of interest @ 14 per cent was very much there and hence there was no question of not granting deduction on this count. A further reference was made to p. 11 of the paper book, being a letter from Ministry of Food, Government of India, to the manager, Indian Bank, New Delhi, showing that interest @ 14 per cent on loan of Rs. 693.39 lacs was to be charged and given back as subsidy through book adjustment. It was therefore, urged that the learned CIT(A) had not appreciated the facts in confirming the addition which was wrongly made by the AO. A strong objection was taken to the finding of the learned CIT(A) in holding that there was a waiver of interest by the Government. It was asserted that there was in fact no waiver rather the liability to pay interest was there but the same was directed towards the assessee in the shape of subsidy for rehabilitation purposes.
4. A further submission was advanced to the effect that the capital subsidy was given to the assessee for the purposes of addition to the plant and machinery and in the modernization, etc. of the mill. Our attention was drawn towards the correspondence of the assessee with the Government of India and the replies given on behalf of the Government placed at pp. 50 to 55 of the paper book. It was contended that the perusal of these letters clearly revealed that the subsidy granted was capital in nature enabling the assessee-company to improve its functioning by modernization and expansion, etc. It was contended that the claim of the assessee before the authorities below was that the assessee was liable to deduction for Rs. 97.07 lacs being the interest liability incurred by the assessee and also no amount of this count was taxable in view of the fact that the subsidy was capital in nature. While referring to the decision of Hon’ble AP High Court in the case of CIT v. Chitra Kalpa (1989) 177 ITR 540 (AP) and that of Bombay High Court in the case of Sadichha Chitra v. CIT (1991) 189 ITR 774 (Bom) it was pointed out that the subsidy granted by the Government in connection with the capital assets could not be taxed. A further reliance was placed on the decision of the Hon’ble Supreme Court in the case of Sahney Steel & Press Works Ltd. and Ors. v. CIT (1997) 228 ITR 253 (SC) to assert that only the subsidy received on account of revenue expenses was liable to be taxes and not otherwise. It was contended that the purpose of this subsidy was to modernize its plant and machinery and further augment the installed capacity by purchasing new machinery and hence the same could not be taxed as revenue receipt. While referring to p. 105 of the paper book, being the certificate issued by the chartered accountant, it was contended that the entire amount of Rs. 97.07 lacs was actually spent on expansion work. This certificate was stated to be furnished to the Ministry of Food in compliance with the terms and conditions of utilization of the capital subsidy. It was, therefore, urged that the order of the learned CIT(A) was not in consonance with the settled legal view and deserved to be overturned.
5. In the oppugnation the learned Departmental Representative strongly supported the order passed by the CIT(A). It was vehemently contended that no interest was actually paid by the assessee to the Government of India, which was ultimately adjusted in the shape of subsidy. It was stated that the entries passed by way of book adjustments were nothing but a mere eyewash to claim deduction for Rs. 97.07 lacs without offering the same amount for taxation. It was contended, relying upon the case of Colaba Central Cooperative Consumer’s Wholesale & Retail Stores Ltd. v. CIT (1998) 229 ITR 209 (Bom) that there was in fact a waiver of interest by the Government during the moratorium period of 5 years and as such no deduction could be claimed. A further submission was advanced to the effect that the passing of entries in the books of accounts was not determinative of the deducibility of expenditure for the purposes of computing total income. While relying on Kedarnath Jute Mfg. Co. Ltd. v. CIT (1971) 82 ITR 363 (SC) and Sutlej Cotton Mill Ltd. v. CIT (1979) 116 ITR 1 (SC) it was submitted that the mere claim in the books of account could not entitle the assessee to deduction when the effect of the transaction was that there was no liability to pay interest and in fact the interest was waived by the Government.
6. On the nature of subsidy it was contended on behalf of the Revenue that the same was taxable. While relying on the decision of Hon’ble Supreme Court in the case of Sahney Steels & Press Works Ltd.’s case (supra) and V.S.S.V. Meenakshi Achi and Anr. v. CIT (1966) 60 ITR 253 (SC) it was contended that the Hon’ble Supreme Court has categorically laid down that the subsidy was taxable. In the final analysis the learned Departmental Representative urged that the order of the CIT(A) was in accordance with the law and did not warrant any interference.
7. We have considered the rival submissions in the light of material placed before us and precedents relied upon. There is no dispute about the fact that the undertaking of the assessee which was earlier taken over by the Government was handed over to the assessee-company and as a result of the agreement entered into by the Government of India with the assessee on 31st Jan., 1986, and its modification thereafter, the assessee was liable to make repayment of loan to the tune of Rs. 693.39 lakhs outstanding on the date of handing over. It was an interest-bearing loan and was to be repaid in twenty equal yearly instalments after a moratorium period of five years. The agreement specifically provides that the interest accruing @ 14 per cent per annum during the period of moratorium will be credited as subsidy to the mill by the Government. There is also no quarrel about the fact that the interest was not to be physically paid and then received back as subsidy, but was to be book adjusted. In order to decide the controversy in this appeal we have to examine the issue from two angles viz., (i) whether the assessee was entitled to any deduction on account of interest, and (ii) whether the subsidy was capital in nature. If either the liability to pay interest is found to be non-existent or the subsidy is found to be revenue, the amount in question can’t escape tax. We will examine both the aspects one by one.
8. First of all we will deal with the first aspect, namely, the deduction of interest on loan. The assessee had claimed the deduction for the sum under consideration by way of debit to its P&L a/c. As per the view of the AO and the CIT(A) no amount was deductible on this count and the fact that the book entries were passed was not determinative of the claim for deduction. We fully agree with the finding of the authorities below insofar as the fact that entries in the books of accounts are not determinative of the real transaction and rather it is the substance of the transaction that matters. The various authorities relied upon by the learned Departmental Representative support this view. But the fact remains that we have to examine the real nature of the transaction irrespective of the way in which it is reflected in the books of accounts. If a claim for deduction is made in the books of accounts which is not legally tenable, no deduction can be allowed on that count. In the like manner if no deduction is claimed in the books of accounts but the assessee, in fact, is entitled to it in accordance with the provisions of the Act, then, in our considered opinion there is no impediment in granting the same. Referring to the facts of the case, we are satisfied that the mere fact that the assessee had claimed deduction for interest in its books of accounts could not make or mar the claim in this regard. In order to determine the eligibility of deduction we have to examine as to whether there was really any liability on the assessee to pay interest in question. If no liability to pay any interest turns out, there cannot be any question of deduction and vice versa. A perusal of agreement placed at page Nos. 42 onwards of the paper book clearly shows that the liability to pay interest @ 14 per cent per annum during the moratorium period of five years was there on the assessee. It is clearly brought out from the amendment to the agreement as well placed at p. 48 of the paper book that the interest would accrue during the moratorium period @ 14 per cent per annum. The letter written by the Director, Ministry of Food, Government of India to the bank placed at p. 11 clearly stipulates that “it has been agreed that the interest @ 14 per cent on loan of Rs. 693.39 lakhs may be charged and given back as
subsidy through book adjustment”. The letter written by the Director, Ministry
of Food, to the assessee on 25th Oct., 1989, placed at p. 52 of the paper book
clearly reads that “the outstanding loan bears an interest from the date of
handing over of the mill @ 14 per cent per annum”. It is, therefore, crystal clear
that the assessee was liable to pay interest @ 14 per cent per annum on the
amount of loan, which in the year under consideration amounted to Rs. 97.07
lacs. As the liability to pay such interests was there upon the assessee, we do
not see any reason as to why the claim for deduction of interest should be
negatived.
9. The second aspect of the controversy is the decision on the nature of subsidy. If it is found out that the subsidy was revenue in nature then it has to be taxed in accordance with the provisions of the Act, and in the converse situation the same cannot be considered for taxation, being capital in nature. Both the sides have heavily relied upon the decision of the apex Court in Sahney Steel & Press Works Ltd.’s case (supra). The facts of this case are that a notification was issued by the Andhra Pradesh Government that certain facilities and incentives were to be given to all the new industrial undertakings which commenced production on or after 1st Jan., 1969, with capital investment not exceeding Rs. 5 crores. The incentives were to be allowed for a period of five years from the date of commencement of production. The incentives were available unless and until production had commenced. These incentives were to be given by way of refund of sales-tax and also by subsidy on power consumed for production to the extent stated in the notification, Exemptions were also given for payment of water rate. The assessee-company obtained refund totalling Rs. 14,665.70 being the refund of sales-tax on purchase of machines, purchase of raw materials and sale of finished goods. The ITO while making the assessment for the year 1974-75 included the said amount in the assessable income of the assessee which was confirmed in the first appeal. However, the Tribunal upheld the contention of the assessee by holding that subsidy was in the nature of capital receipt. The Hon’ble High Court by reversing the order of the Tribunal held the amount as taxable. When the matter travelled to the Hon’ble Summit Court, it was found that the assessee was free to use the money in its business entirely as it liked and was not obliged to spend the money for a particular purpose. It was also observed that the subsidies were not granted to bring into existence any new asset. Eventually the amount was held to be revenue receipt and liable to tax accordingly. A perusal of this judgment brings to light that any subsidy which is granted to assist the assessee in carrying out its business operations and to meet out the Revenue costs is liable to tax. However, if the purpose is to help the assessee to set up or expand its business by purchasing capital assets, the same is capital in nature. It, therefore, boils down that the decisive factor in determining the nature of subsidy is the purpose for which it is granted.
10. Now we will proceed to ascertain the purpose for which the subsidy in question was granted to the assessee. The agreement of the assessee with the Government of India stipulates that the interest accruing during the period of moratorium will be credited as subsidy to the mill by the Government. Subsequently on 12th Oct., 1989, a letter was addressed by the assessee to the Ministry of Food, seeking clarification as regards the purpose for which the subsidy was to be utilized. Thereafter on 25th Oct., 1989, a letter was written by the Ministry of Food and Civil Supplies. Para 2 of the said letter provides that the interest due and actually paid by the mill during the period of moratorium will be paid back to the factory as capital subsidy. The purpose of utilization of the subsidy is stated to be “in order to enable the factory to improve its functioning and rehabilitate it financially by modernization, expansion, etc.” A further clarification was given by the Ministry of Food & Civil Supplies on 8th Dec., 1989, stating that “the objective of granting moratorium on the payment of loan and thus for the subsidy amount, as being to enable the factory to improve its financial performance and take steps towards rehabilitation and meeting the various essential and other items including those of capital expenditure for modernization and expansion, etc., and to boost up the cane development activity in the area of operation of the factory as required for rehabilitation of the factory. The purpose of the moratorium and through adjustments of subsidy is not that it may be utilized towards any avoidable expenditure or for distribution of profits, etc. All essential expenditure items including those required towards both short and long-term rehabilitation has been of the sugar factory are made, as per letter and spirit of the agreement”. These letters written by Government clearly bring out that the purpose of subsidy was to enable the assessee to take steps towards rehabilitation and incurring capital expenditure for modernization and expansion. When a subsidy is granted to assist a unit in setting up or rehabilitate or expand “its capital base by installing new plant and machinery etc., the same is capital in nature and cannot be charged to tax. In Sadichha Chitra’s case (supra) it was laid down that the subsidy granted to the film producers to produce new and better films or to assist an assessee in acquiring a capital asset was distinguishable from enabling the assessee to recoup revenue expenditure, and hence did not constitute revenue receipt assessable to tax. To the similar effect in the case of CIT v. Ruby Rubber Works Ltd. (1989) 178 ITR 181 (Ker)(FB) holding that if any amount is paid by the Government with an express purpose and it has nothing to do with its trade in the sense of acquiring profits or gains of the trade, certainly it is not income in the hands of the recipient.
11. Next we will examine the case of V.S.S.V. Meenakshi Achi (supra), heavily relied upon by the learned Departmental Representative. In that case the assessee owned rubber plantations. The payments were made to the assessee against the expenditure incurred on the maintenance of the plantations. It was held that as the amount from the fund earmarked for the assessee on the basis of rubber produced by it was paid against the expenditure incurred for maintaining the rubber plantations and producing the rubber, the amounts received were revenue receipts and, therefore, liable to be included in the assessable income.
12. This judgment, in our considered opinion, does not bring the case of the Revenue any further inasmuch as no amount was given to the present assessee by way of subsidy to recoup the revenue expenditure. The amount given to the assessee was earmarked with a specific purpose in the expansion and furtherance of existing capital outlay. The certificate of chartered accountant placed at p. 105 of the paper book unequivocally states that the sum of Rs. 97.07 lacs was spent on expansion and modernization work.
13. A close study of the legal position as enunciated by various Courts emerging from catena of cases discussed above manifestly draws a line of distinction between a capital subsidy and revenue subsidy. Whereas the former is directed towards the expansion of the capital base and accordingly falls beyond the ambit of taxation, the latter helps the recipient in recouping the revenue expenses and cannot escape the taxation. When the facts of the instant case are decided on the touchstone of the distinction between a capital and revenue subsidy, it becomes palpable that the case of the assessee falls in the former category and hence the amount of subsidy cannot attract tax.
14. On consideration of the matter from both the angles, namely, the existence of the liability of the assessee to pay interest and the nature of the subsidy, being the Revenue, we can’t sustain the action of the first appellate authority.
15. Before parting with the matter, we would like to deal with another contention raised by the learned Departmental Representative to the effect that the interest was waived by the Government and consequently there was neither any expenditure nor receipt on this count. It is noted from the facts of the case that the amount of Rs. 97.07 lacs was not physically paid by the assessee as interest payment nor the equal amount was received as capital subsidy. Both these aspects were recognized in the books of accounts by way of book adjustment. We are at loss to understand as to how the conclusion will differ if the amount is adjusted by way of book entries instead of first paying and then receiving back the same amount. There is no qualitative distinction between the situation where a sum is not paid at all and the situation where it is paid and then received back. It is the substance of the transaction that matters rather than the way in which it is recorded in the books of accounts maintained by the assessee. The Hon’ble Supreme Court in J.B. Bodda & Co. (P) Ltd. v. CBDT (1997) 223 ITR 271 (SC) held, in the context of deduction under Section 80-0, that the formal remittance to the foreign company and receipt thereafter was not necessary and the condition of receiving the income in convertible foreign exchange got satisfied when the gross amount payable to the foreign company was reduced by the commission therefrom and the net amount was finally remitted. In view of these facts we hold that the payment and receipt of interest by way of book adjustment does not alter the nature of transaction. The further argument of the learned Departmental Representative regarding the waiver of interest by the Government is also devoid of merits for the clear reason that there is a marked distinction between the waiver of interest and the payment of interest and receipt of capital subsidy. Whereas in the former case there remains no liability on the assessee to pay the same, in the latter the liability stands but is translated into subsidy by the subsequent action of the Government. The agreement in question categorically provides that the assessee was liable to pay interest @ 14 per cent per annum during the moratorium period and the equal amount was given to the assessee in the shape of subsidy for a specific purpose. In the facts of the present case the Government of India had not waived the interest liability but the same was ascertained in the first step and then converted into subsidy in the second step. That being the position we are not convinced with this argument of the learned Departmental Representative as well. The reliance of the learned Departmental Representative on the case of Colaba Central Cooperative (supra) is misconceived as the facts of that case are distinguishable and bear no resemblance to the factual scenario prevailing in the present case, inasmuch as that case was on diversion of income by overriding title, where it was held that the assessee had not incurred any expenditure at all. Around four decades ago, the Hon’ble Supreme Court in CIT v. Sitaldas Tirathdas (1961) 41 ITR 367 (SC) considered the doctrine of diversion of income and held it to be applicable when by reason of an overriding title or obligation, income is diverted and never reaches the person in whose hands it is sought to be assessed. In contrast the facts of the instant case lie in different compartment where the liability to pay interest was an ascertained liability and had no connection with the receipt of capital subsidy. These were two related but entirely different transactions.
16. In view of the legal position as discussed above in the lights of the facts of the present case, we are satisfied that the learned CIT(A) was not justified in confirming the addition of Rs. 97.07 lacs on account of interest to the Government of India.
17. In the result the appeal is allowed.