IN THE HIGH COURT OF GUJARAT AT AHMEDABAD TAX APPEAL No 273 of 2002 with TAX APPEALS NOS. 285, 286, 299 and 348 of 2002 with TAX APPEALS NOS. 374, 375, 376, 377, 381 & 382 of 2002 with TAX APPEALS NOS. 383, 384, 385, 359, 360 & 362 OF 2002 with TAX APPEALS NOS. 128, 129, 195, 196, 197, 198, 199, 257, 258, 259, 300, 361, 380 of 2002 with TAX APPEALS NOS. 22 and 23 of 2003 For Approval and Signature: Hon'ble MR.JUSTICE R.K.ABICHANDANI and Hon'ble MR.JUSTICE A.L.DAVE ============================================================ 1. Whether Reporters of Local Papers may be allowed : YES to see the judgements? 2. To be referred to the Reporter or not? : YES 3. Whether Their Lordships wish to see the fair copy : NO of the judgement? 4. Whether this case involves a substantial question : NO of law as to the interpretation of the Constitution of India, 1950 of any Order made thereunder? 5. Whether it is to be circulated to the concerned : NO Magistrate/Magistrates,Judge/Judges,Tribunal/Tribunals? -------------------------------------------------------------- COMMISSIONER OF INCOME TAX (Appellant in all Appeals) Versus VIJAY SHIP BREAKING CORPN (Respondent in Tax Appeal No. 273 of 2002) M/S. ANNAPURNA SHIP BREAKERS (Respondent in Tax Appeal No. 374 of 2002) M/S. GAUTAM SHIP BREAKING INDUSTRIES (P) LTD.(Respondent in Tax Appeal Nos. 375 & 376 of 2002) M/S. BHARAT SHIP BREAKERS CORPORATION (Respondent in Tax Appeal No. 377 of 2002) M/S. TRIVENI SHIP BREAKING (Respondent in Tax Appeal No. 380 of 2002) M/S. MADHAV INDUSTRIAL CORPORATION (Respondent in Tax Appeal No. 381 of 2002) M/S. WESTERN SHIP BREAKING CORPORATION (Respondent in Tax Appeal Nos. 199, 259, 286, 382 of 2002 & Tax Appeal Nos. 22 and 23 of 2003) M/S. SHIP TRADE CORPORATION (Respondent in Tax Appeal No. 383 of 2002) M/S. MADHAV STEELS (Respondent in Tax Appeal 384 of 2002) M/S. SHIP TRADE CORPORATION (Respondent in Tax Appeal Nos. 359 & 385 of 2002) M/S. GAUTAM SHIP BREAKING IND. (P.) LTD. (Respondent in Tax Appeal No. 285 of 2002) M/S. SHIRIJI TRADERS (Respondent in Tax Appeal No.299 of 2002) M/S. A.G. SCRAP CORPORATION (Respondent in Tax Appeal No. 300 of 2002) M/S. BHARAT SHIP BREAKING CORPORATION (Respondent in Tax Appeal Nos. 257, 258 & 361 of 2002) MADHAV INDUSTRIAL CORPORATION (Respondent in Tax Appeal Nos. 128 & 129 of 2002) M/S. APPOLLO VIKAS STEEL PVT. LTD. (Respondent in Tax Appeal Nos.195, 196, 197 & 198 of 2002) M/S. PRIYA BLUE INDUSTRIES PVT. LTD. (Respondent in Tax Appeal Nos. 360 & 362 of 2002) M/S. MAHALAXMI SHIP BREAKING CORPORATION (Respondent in Tax Appeal No. 348 of 2002) -------------------------------------------------------------- Appearance: MR.MIHIR JOSHI, MR.PRANAV G.DESAI MR. TANVISH U. BHATT ADVOCATES - in all the appeals for the Revenue MR. P.CHIDAMBARAM, SR.ADVOCATE WITH MR.S.N.SOPARKAR, SR. ADVOCATE FOR MRS SWATI SOPARKAR, ADVOCATE, MR.K.H.KAZI, MR. K.C.PATEL, SR. ADVOCATE, MR.R.K.PATEL, MR.BHARGAV KARIA, MR. M.K. PATEL, MR. MANISH KAJI, MR.TUSHAR HEMANI Advocates - in respective appeals for the assessees MR.J.P.SHAH, Advocate, as intervener. -------------------------------------------------------------- CORAM : MR.JUSTICE R.K.ABICHANDANI and MR.JUSTICE A.L.DAVE Date of decision: 20/03/2003 ORAL JUDGEMENT I. Questions of law involved in these appeals (Para-1). II. Brief facts (Paras 2 to 6). III. Contentions and cases cited for the Revenue (Paras 7 and 7.1). IV. Contentions and cases cited for the Assessees (Paras 8 and 8.1). V. Reasoning (Paras 9 to 27). VI. Decision (Paras 28 to 30). (Per : MR.JUSTICE R.K.ABICHANDANI for the Court) 1. This group of 32 matters has been argued together having regard to the nature of controversy and the common questions of law involved, which are as under : I. QUESTIONS OF LAW INVOLVED IN THESE APPEALS: 1. In Tax Appeal No. 273/2002:- [1] Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of definition of term `interest' u/s. 2[28A] of the Income Tax Act, 1961? [2] Whether the Appellate Tribunal was right in law and on facts in deleting the disallowance under section 40[a][i] of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195[1] of the Act? [3] Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes the character of purchase price and therefore not liable to deduction at source u/s 195[1] of the Act? [4] Whether the Appellate Tribunal was right in law and on facts in allowing the deduction u/s 80HH and 80I to the assessee holding that ship breaking activity gives rise to manufacture and production of altogether a new article or thing? In Tax Appeal Nos. 285, 286, 299 and 348 of 2002:- [1] Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of definition of term `interest' u/s 2[28A] of the Income Tax Act, 1961? [2] Whether the Appellate Tribunal was right in law and on the facts in deleting the disallowance under section 40[a][i] of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195[1] of the Act? [3] Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes the character of purchase price and therefore not liable to deduction at source u/s 195[1] of the Act? In Tax Appeal Nos. 374, 375, 376, 377, 381 and 382 of 2002:- [1] Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of definition of term `interest' u/s 2[28A] of the Income Tax Act, 1961? [2] Whether the Appellate Tribunal was right in law and on facts in deleting the disallowance under section 40[a][i] of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195[1] of the Act? [3] Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes the character of purchase price and therefore not liable to deduction at source u/s 195[1] of the Act? [4] Whether the Appellate Tribunal was right in law and on facts in holding that `usance interest' is not interest as envisaged in the Double Taxation Avoidance Agreement? In Tax Appeal Nos. 383, 384, 385, 359, 360 and 362 of 2002: [1] Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of definition of term `interest' u/s 2[28A] of the Income Tax Act, 1961? [2] Whether the Appellate Tribunal was right in law and on facts in deleting the disallowance under section 40[a][i] of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195[1] of the Act? [3] Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes the character of purchase price and therefore not liable to deduction at source u/s 195[1] of the Act? [4] Whether the Appellate Tribunal was right in law and on facts in holding that `usance interest' is not interest as envisaged in the Double Taxation Avoidance Agreement? [5] Whether the Appellate Tribunal was right in law and on facts in allowing the deduction u/s 80HH and 80-I to the assessee, holding that ship breaking activity gives rise to manufacturing and production of altogether a new article or thing? In Tax Appeal Nos. 128, 129, 195, 196, 197, 198, 199, 257, 258, 259, 300, 361, 380 of 2002 and Tax Appeal Nos. 22 and 23 of 2003: Whether the Appellate Tribunal was right in law and on facts in allowing the deduction u/s 80HH and 80-I to the assessee, holding that ship breaking activity gives rise to manufacturing and production of altogether a new article or thing? II. BRIEF FACTS: 2. The Tax Appeals Nos. 273 of 2002 and 196 of 2002 have been argued as the lead matters. This is because the main judgement of the Tribunal from which the first three questions of law raised in Tax Appeal No. 273 of 2002 arise has been followed by the Tribunal in other matters and the substantive judgement which has been rendered on the fourth question which is a sole question in Tax Appeal No. 196 of 2002 has been decided by the Tribunal in the order from which that appeal arises which has been followed by the Tribunal in other matters. 3. The learned counsel for the appellant - Revenue have filed paperbook in Tax Appeal No.273 of 2002. The learned counsel for the respondents - assessees have also filed common paperbook in Tax Appeal No.273 of 2002 and separate paperbook Nos.1 and 2 in Tax Appeal No. 348 of 2002, Tax Appeal No.196 of 2002 and a compilation in Tax Appeal No.196 of 2002. All the learned counsel have argued all these appeals referring to the record of the Tax Appeal No. 273 of 2002 and Tax Appeal No. 196 of 2002 and these paperbooks and have stated that all other appeals involve identical points since the Tribunal has decided those matters on the basis of its detailed orders made in these two appeals. We would therefore discuss the facts with reference to the record of these two appeals. 4. The assessee firm was engaged in the business of ship breaking at Alang Port during the previous year relevant to the A.Y. 1995-96. Old and condemned ships were acquired by the assessees for demolishing purpose. The two ships which were purchased by the assessee for breaking purposes were MV Krasnozarodsk and M.V.Global Hope. Krasnozarodsk was purchased by the assessee from M/s Electra Maritime (Jersey) Ltd., London under Memorandum of Agreement (MOA for short) dated 15th March 1993 for a total purchase price of the ship which was agreed at US $ 901252.98 calculated at the rate of US $ 184.5 per long ton of LDT. It appears that the ship was manufactured in 1965 in Finland. In the MOA, credit for 180 days usance period from the date of physical delivery of the vessel at safe anchorage Alang was agreed and rate of interest was stipulated in para 2 thereof flat at 6% per annum. The other vessel M.V. Global Hope was purchased by the assessee from M/s Neter Navigator, Singapore under MOA dated 14th July 1994 for the total purchase price which was agreed at US $ 3069416.5 calculated at the rate of US $ 166.06 per long ton. The ship appears to have been manufactured in U.K. in 1969. Interest was stipulated to be paid at 7.25% from the date of notice of release for 180 days of usance period worked out on the purchase price of the ship. In both the cases the amounts were to be paid by means of irrevocable 180 days usance letter of credit (L.C.) as in all other cases. 4.1 During the course of scrutiny proceedings, the assessing officer (Assistant Commissioner of Income Tax, Central Circle 1, Rajkot) observed that, as per the terms of the MOA, the assessee was making interest payment to the non-resident parties on account of credit facility availed by it for the purchase of the ships. Therefore, he raised queries by letter dated 2nd January 1998 inquiring as to whether tax was deducted at source on such interest payments and if it was not so deducted, then calling upon them to show as to why the provision of section 40(a)(i) of the Income Tax Act, 1961 ("the Act" for short) should not be invoked in the assessee's case and why the entire interest paid outside India should not be disallowed in the course of assessment. After considering the submissions made by the assessee and the material on record, the assessing officer negatived the contention of the assessee that both the principal amount of the purchase price of the ship and the interest amount paid on the usance credit constituted the purchase price of the ship. It was held that the purchase price of the ship was separately mentioned in the MOA and that the usance interest amount which was also separately mentioned was not part of the purchase price. The officer held that any other view would be illogical because if the contention of the assessee is to be accepted, then it would lead to a situation where as soon as the delivery of the vessel was made, the seller would get the price of the vessel plus the usance interest of 180 days though the usance period would be counted only after the date of delivery. It was held that the purchase price of the vessel and the usance interest were two distinct items of payment. It was also held that the reliance by the assessee on the decision of the Andhra Pradesh High Court in C.I.T. v. Vishakhapatanam Port Trust, reported in 144 ITR 156 was misconceived, because, that decision was given in respect of the A.Y.s 1970-71 to 1974-75 when the term "interest" had not been defined in the Act. It was noticed that, in the Andhra Pradesh case, as per the Double Taxation Avoidance Treaty (with Germany), which had an overriding effect on the Act, interest, in the case of non-resident was chargeable in India only if it was found to be arising out of indebtedness. The assessing officer held that, in the instant case, interest was defined under section 2(28A) to include payment of interest on any claim or obligation. The decision of this Court in C.I.T. v. Saurashtra Cement & Chemicals Ltd., reported in 101 ITR 502, was also held not to apply to the assessee's case since, in that case which was relatable to the provisions of section 9(1)(i) of the Act, the issue before the Court was whether there was any business connection of the non-resident with the assessee. In that case, the agreement had been signed outside India, and delivery and payment had been taken outside India. The assessing officer held that whatever principal amount or interest amount was paid as per the MOA to the non-resident through the bank by means of letter of credit was paid on behalf of the assessee. Therefore, the contention that the payment was made to the bank in India and not to the non-resident seller was negatived. The assessing officer, therefore, by his order dated 30th march 1998 disallowed the expenditure of usance interest payment under the provisions of section 40(a)(i) of the said Act in respect of both the ships. In the same order, he considered the assessee's claim of deduction under Sections 80HH and 80I of Rs.21,23,798 made on the ground that the assessee was an industrial undertaking engaged in the activity of manufacture. The assessing officer held that ship breaking would not constitute any manufacturing activity. Applying the ratio of the decision of the Supreme court in C.I.T. v. N.C.Budhdharaja, reported in 204 ITR 412, it was held that ship breaking did not constitute any activity of manufacturing or production. 5. The order of the Assistant Commissioner of Income Tax was challenged by the assessee before the C.I.T. (Appeals), VI, Ahmedabad, who while confirming the said order, held that the interest was payable by the assessee to the non-resident on debts incurred by deferring payment of purchase consideration in respect of the two ships for the purpose of its business carried on in India. It was held that the Double taxation Avoidance Agreement between the Government of India and the Government of U.K. and Singapore provided for taxation of interest income even in the country of the resident which in the present case was India and that interest income from debt claims of any kind could be so taxed in India. It was held that the amount of interest paid by the assessee to the non-resident concerns were liable to deduction of tax at source under Section 195(1) of the Act and since the assessee had failed to deduct the amount of such tax, the assessing officer had correctly applied the provisions of section 40(a)(i) of the Act for disallowing the claim of interest of Rs.42,52,767. 5.1 The CIT (Appeals) noted that the assessee had debited the purchase price of the ships as was mentioned in the MOA in its books of account and the liability for the interest amount mentioned in the MOA had been separately claimed as revenue expenditure. It was also noted that the purchase consideration excluding interest had been disclosed to the customs authorities for payment of the customs duty. It was held that if interest paid by the assessee to the non-resident concerns for availing of the credit facility for payment of the purchase consideration was also a part of the purchase consideration, the assessee would have been charged customs duty on the interest element also. It was further held that the material showed that both the sale consideration as well as interest thereon had been shown as receipt by the seller from the assessee and therefore, even if the bills under letters of credit were discounted by the sellers earlier than the stipulated 180 days for their usance period, the sellers would have debited the discounting charges paid to the bank in their profit and loss account, because, the interest amount in addition to the purchase consideration had been shown as received by them. On the question of claim of the assessee under section 80HH and 80I, the CIT (Appeals) held that such deduction was not available to the assessee because, the ship breaking was not in the nature of a manufacturing activity. 6. The assessees carried the matter to the Tribunal against the order dated 6-6-2000 made by the CIT (Appeals). The Tribunal held that the purchase of a ship was a single transaction for which the agreement was entered into and although the purchase price of the ship and usance interest for 180 days from the date of the delivery/NOR were separately mentioned in the MOA, nonetheless it remained a single transaction of purchase and sale of the ship. Moreover, the buyer had to make payment of the total amount which was inclusive of interest by letter of credit. It was held that the interest amount though separately mentioned in the MOA was part of the same transaction and cannot be meted out a separate treatment from the main component i.e. the purchase price. The Tribunal observed: "In other words, the point we are trying to drive home is that what governs a purchase transaction, will also govern the component thereof. It also needs to be appreciated that there is no right of pre-payment by the buyer to the seller, that is to say, irrespective of the point of time when the buyer makes payment within 180 days, the buyer shall have to pay the interest component as specified in the MOA". The Tribunal concluded that, by entering into MOA, the buyer did not incur any debt in the sense of raising any loan or advance so as to be indebted to the sellers, and that it was a pure and simple purchase transaction in terms of the L.C. for the total amount including interest. It was further held that, in the present case, the purchase price and interest payable were arising from the same source i.e. the transaction entered into with the buyer for sale of ship and not from two different sources. On this basis, the Tribunal concluded that the interest amount though separately mentioned in the MOA and described as "interest" therein, partook the character of the purchase price for the buyer and should be treated as purchase price. According to the Tribunal, its view point was strengthened from the provisions of the DTAA, under which as per the definition of the term "interest", each and every debt was not envisaged to be included in the terms "debt claims" referred to in the definition of "interest". It was held that the expression "debt claims" will take colour from the associated terms used in the definition namely bonds, debentures etc, and that the term "interest" under the DTAA was meant to be interest earned on government securities, bonds etc. It was held that, in the present case, there was no intention between the parties to raise any loan and pay interest thereon. It was noted that the treaties with Indonesia and Philippines specifically included deferred payment of sales while referring to debt claims. The Tribunal placed reliance on the decision of the Andhra Pradesh High Court in Vishakhapatanam Port Trust case (supra) and held that the assessee was not liable to deduct tax at source from the payment of interest to the non-resident and hence, the disallowance of interest made under Section 40(a)(i) was not warranted. 6.1 On the question of the claim of the assessee for deduction under Section 80HH and 80I of the Act, the tribunal relying upon the decision of the Bombay High Court in Ship Scrap Traders v. CIT and Virendra & Co. reported in 251 ITR 806, held that ship breaking results in production of articles and amounts to manufacture, and that deduction should be allowed to the assessee under Section 80HH and 80I of the Act. III CONTENTIONS AND THE CASES CITED FOR THE REVENUE: 7. The learned counsel for the appellant - Revenue contended that, under the M.O.A., payment of interest for the usance period was to be made separately to the non-residents in all these cases. This created a liability on the part of the residents making such payment by means of L.C. to deduct tax at source under Section 195(1) of the Act. If at all according to them no tax was to be deducted, then the proper course was to follow the procedure laid down under Section 195 itself, and there was no option on the part of the residents not to deduct tax from the interest which was payable to the non-residents at the time of making credit to their account or making payment by any mode including by letter of credit, whichever was earlier. It was submitted that the letter of credit was just an arrangement by which the price of the goods and interest on the late payment of the price over the period of 180 days was paid by the buyer to the seller in discharge of his contractual obligations. It was submitted that, interest is income which was chargeable to tax and the interest payable by the resident to the non-resident would be deemed to be arising in India under Section 9(1)(v) of the Act irrespective of the manner in which it may have been paid or wherever it may have been paid. It was also argued that there were ample safeguards in sections 195 and 197 to prevent double taxation and requisite order could be obtained determining whether tax was deductible on such payment, or certificate could be obtained allowing payment of interest to the non-resident without deduction of tax. It was submitted that the payment of the amount of purchase price and interest under the L.C. discharged the underlying debt in respect of the sale of the ship. The learned counsel, therefore, argued that since no deduction was made by the assessees as required by the provisions of section 195(1) nor any order or certificate obtained so as to justify the non-deduction, they were not entitled to deduct the interest amount while computing the income chargeable under the head "profit and gains of business income" in view of the provisions of Section 40(a) of the Act. It was also submitted that where in respect of any such sum tax has been paid or deducted in any subsequent year under Chapter XVII(B), such sum shall be allowed as deduction in computing the income of the previous year in which such tax has been paid or deducted,