Loan obtained is not an asset or an advantage of enduring nature – SC

Section 37 of the Income Tax Act pertains to general allow ability of business expenditure while computing Profits or Gains from Business or Profession. According to Section 37(1), any expenditure, not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.

Let us refer to the case of India Cements Ltd. v. CIT (1966), where the issue under consideration was whether the amounts expended by the assessee in obtaining the loan in the nature of stamp duty, registration fees, lawyer’s fees, etc., were allowable as a deduction under section 37(1) or not.

Facts of the Case:

The appellant obtained a loan of Rs. 40 lakhs from the Industrial Finance Corporation secured by a charge on its fixed assets.
In connection therewith it spent a sum of Rs. 84,633 towards stamp duty, registration fees, lawyer’s fees, etc., and claimed this amount as business expenditure.
The ITO held that the expenditure was incurred in obtaining capital and should be distinguished from interest on borrowed capital which was alone admissible as a deduction.

Order passed by Appellate Authorities and High Court

The Commissioner (Appeals) confirmed the order of the ITO.
The Tribunal was of the view that the whole of the mortgage loan was used firstly to discharge the loan of Rs. 25 lakhs and the balance for working funds and, as such, the whole of the amount was purely for the purposes of augmenting the working capital of the company and that it could not be stated that it was used for capital purposes.
Accordingly, the claim was allowed.
On reference, the High Court restored the ITO’s order.
It held that the borrowings were an advantage which the company derived for the duration of the loan and thus, capital in nature.
Aggrieved with the order of HC, assessee appealed before the Supreme Court

Observations of SC on whether loan obtained could be treated as an asset or advantage for the enduring benefit of the business of the assessee or not

SC was unable to agree that a loan obtained could be treated as an asset or advantage for the enduring benefit of the business of the assessee.
A loan is a liability and had to be repaid and, in SC’s opinion, it was erroneous to consider a liability as an asset or an advantage.
Although the conclusion of the HC was correct, SC was not able to agree with the principle that the nature of the expenditure incurred in raising a loan would depend upon the nature and purpose of the loan.
A loan may be intended to be used for the purchase of raw-material when it is negotiated, but the company may after raising the loan change its mind and spend it on securing capital assets.
Was the purpose at the time the loan is negotiated to be taken into consideration or the purpose for which it is actually used?
Further suppose that in the accounting year the purpose is to borrow and buy raw- material but in the assessment year the company finds it unnecessary to buy raw-material and spends it on capital assets.
Would the income tax officer decide the case with reference to what happened in the accounting year or what happened in the assessment year?

In SC’s opinion, it was rightly held by the Nagpur Judicial Commissioner in Nagpur Electric Light and Power Co. v. Commissioner of Income Tax, that the purpose for which the new loan was required was irrelevant to the consideration of the question whether the expenditure for obtaining the loan was revenue expenditure or capital expenditure.
To summarise this part of the case, SC was of the opinion that:
1. the loan obtained is not an asset or advantage of an enduring nature
2. that the expenditure was made for securing the use of money for a certain period
3. 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)

Observations of SC on the contention of the appellant that even if it is revenue expenditure, it was not laid out wholly and exclusively for the purpose of business

SC was unable to accept this contention.
In Eastern Investments Ltd. v. Commissioner of Income Tax SC held that the Eastern Investments Ltd., an investment company, when it borrowed money on debentures, the interest paid by it was incurred solely for the purpose of making or earning such income, profits or gains within the purview of Section 12(2) of the Indian Income Tax Act.
It held on a review of the facts that the transaction was voluntarily entered into in order indirectly to facilitate the running of the business of the company and was made on the ground of commercial expediency.
This case, in SC’s opinion, directly covered the present case.
In some respects, their position may be different but in determining the question whether raising money was incidental to a business or not, SC could not discern any difference between an investment company and a manufacturing company.

In that case, SC was not considering whether the expenditure was in the nature of a capital expenditure or not, because it was agreed all through that the expenditure was not in the nature of capital expenditure, and the only question which SC dealt with was whether the expenditure was incurred solely for the purpose of making or earning income, profits or gains.
It was held in that case that the payment of interest and a sum equivalent to 11/16th of the profits of the business of the assessee in pursuance of an agreement for obtaining loan from the lender were in a commercial sense expenditure wholly and exclusively laid out for the purpose of the assessee’s business and they were, therefore, deductible revenue expenditure.

Therefore, the SC held that the amount spent was not in the nature of capital expenditure and was laid out or expended wholly and exclusively for the purpose of the assessee’s business and was, therefore, allowable as a deduction under section 37(1).

In conclusion:

Where there is no express prohibition, an outgoing, by means of which an assessee procures the use of a thing by which it makes a profit, is deductible from the receipts of the business to ascertain the taxable income.
Further, obtaining capital by issue of shares is different from obtaining loan by debentures. A loan obtained cannot be treated as an asset or advantage for the enduring benefit of the business of the assessee.
The act of borrowing money was incidental to the carrying on of business, the loan obtained was not an asset or an advantage of enduring nature, the expenditure was made for securing the use of money for a certain period, and it was irrelevant to consider the object with which the loan was obtained

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