Case: Commissioner of Income-tax, Bihar-II, Patna Vs. Bokaro Steel Ltd. Bokaro

Civil Appeal Nos.of 1988 pertain to assessment yearil Appeal Nos.of 1989 pertain to assessment years2. TheAppellate Tribunal had referred the following questions to the High Court for determination under Section 256(1) of the>At the instance of the Revenue, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the hire charges of Rs. 56 received by thefor letting out the plant and machinery to the contractors were not taxable) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the hire charges of Rs. 7,224 received by thefor letting out of the plant and machinery to the contractors were not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the royalty of Rs. 8,530/received from the contractor was not taxable as it was of capital nature and not revenue) Whether, on facts and in the circumstances of the case, the Tribunal was justified in law in holding that the hire charges of Rs. 12,195 received by thefor letting out of the plant and machinery to the contractors were not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the royalty of Rs. 1,22,902 received from the contractors was not taxable as it was capital in nature and not revenue) Whether, on the facts and in the circumstances on the case, the Tribunal was justified in law in holding that the hire charges of Rs. 17,913 received by thefor letting out of the plaint and machinery to the contractors were not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the royalty of Rs. 65,799 received from the contractor was not taxable as it was capital in nature and not revenue) Whether, on facts and in the circumstances of the case, the Tribunal was justified in law in holding that the hire charges amounting to Rs. 46,342 received by thefor letting out of the plant and machinery to the contractors were not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the royalty of Rs. 25,928 received from the contractors was not taxable as it was of capital nature and not revenue) Whether, on facts and in the circumstances of the case, the Tribunal was justified in law in holding that the interest received by theon the amount of Rs. 7,50,502 advanced to the contractors was not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the hire charges of Rs. 182 received by thefor letting out the plant and machinery to the contractors were not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the royalty of Rs. 13,052 received from contractors is not taxable as it is of capital nature and not revenue?(4) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holdingmiscellaneous of Rs. 49 as not taxable) Whether, on facts and in the circumstances of the case, the Tribunal was justified in law in holding that the interest received by theon the amount of Rs. 14,98,993 advanced to the contractor was not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the hire charges of Rs. 3,68,442 received by thefor letting out the plaint and machinery to the contractors were not taxableWhether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the royalty of Rs. 6,504 received from the contractors is not taxable as it is capital in nature and not revenue?(4) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holdingthat the interest received amounting to Rs. 7,39,332 by theon the amount advanced to M/s. Hindustan Steel Ltd. is not taxablethe assessment yeara consolidated reference was made at the instance of the revenue as well as the assessee and the following questions were referredWhether, on facts and in the circumstances of the case, the receipts arising from the letting out the quarters to the outsiders, such as employees of the contractors engaged in the construction of the plaint can be treated as the income of the assessee and/or, in any event, should be adjusted against the cost of construction so as to reduce such costWhether on the facts and in the circumstances of the case, the receipts from the letting out of the properties to outsiders, such as the employees of the contractors engaged in the construction of the plaint are to be assessed as income from property under section 22 of theAct, 1961, or the said income should be assessed under section 28 of theAct, 1961, as business income or in any event, under Section 56 of theAct, 1961, as income from other sourcesWhether on the facts and in the circumstances of the cases, the receipts arising from the letting out of the quarters to the outsiders, such as employees of the contractors, engaged in the construction of the plant can be treated as the income of the assessee and/or, in any event, should be adjusted against the cost of construction so as to reduce such costWhether on the facts and in the circumstances of the case, the interest received from the bank ondeposits is liable to be assessed as the income of the assessee or such interest should reduce the cost of construction of the assessee and, therefore, would not constitute the income of the assesseeee is a corporation wholly owned by the Government of India. It was assessed in the status of a company. TheM/s Bokaro Steel Ltd., was incorporated in January 1954. Its object was to construct and own an integral iron and steel works. Duringunder consideration, the work of construction of the companys factory and installation of the plaint was in the process of completion. The company had not started any business during1) During this period the company had given to the contractors quarters for the residence of the staff and workers employed by the contractors who had been engaged by thefor carrying out the work of construction. The assessee charged the contractors for the use of the quarters so given to the contractors for the residence of his workmen who were engaged in the construction activity of the assesseese assessment yearsin question the assessee had entered into supplementary agreements with its contractors under which the assessee had made certain advances to the contractors to enable them to execute the large scale construction work smoothly. The assessee had agreed to advance these advances to the contractors on payment of interest. The contractors thus did not have to raise funds from outside agencies. For thethis arrangement primarily meant payment in advance of the amounts of the contractors bills for which thehad charged interest. This interest was later adjusted against the dues of theFor the purpose of the construction work the assessee had given on hire certain plant and machinery to the contractors. Against the letting of plant and machinery the assessee received from the contractors income in the form of hire charges. It was not the business of theto let out plant and machinery to others. Thepermitted its use only to its own contractors for the construction work done by the contractors for theThe Tribunal has found that thecharged hire charges for such use of plant and machinery in order to cover the maintenance and wear and tear of the plaint and machinery belonging to theny allowed the contractors to use the stones lying on the assessees land for construction work. The stones lying in the assessees companys land were the capital assets of theThe assessee charged the contractor a certain amount by way of royalty for excavation and use of these stones for constructionThe assessee had, duringthe assessment yearshown in its accounts as income from interest a certain sum said to have been accrued to the assessee from M/s Hindustan Steel Limited from eight locomotives supplied by theto M/s Hindustan Steel Limited. Thehowever, reversed this entry in the next year because eight new locomotives were supplied by M/s Hindustan Steel Limited to the assessee and no interest income actually accrued to the assessee.

Court's reasoning:
6. In the case of Addl. Commissioner ofNew Delhi v. Indian Drugs and Pharmaceuticals Ltd. (1983) 141 ITR 134 , the Delhi High Court considered a case where the work of construction of the factory of the assessee was in progress and production had not commenced. Receipts from sale of tender forms and supply of water and electricity to the contractors engaged in construction as also receipts on account of sale of stones, boulders, grass and trees were held to be receipts not from independent sources but were considered as inextricably linked with the process of setting up of business. These were directly related to the capital structure of business and were held to be capital in nature. We agree with this view taken by the Delhi High Court.The appellant, however, relied upon the decision of this Court in Tuticorin Alkali Chemicals and Fertilizers Ltd. v. Commissioner of(supra). That case dealt with the question whether investment of borrowed funds prior to commencement of business, resulting in earning of interest by the assessee would amount to the assessee earning any income. This Court held that if a person borrows money for business purposes, but utilises that money to earn interest, however temporarily, the interest so generated will be his income. This income can be utilised by the assessee whichever way he likes. Merely because he utilised it tothe interest on the loan taken, till not make the interest income as a capital receipt. The department relied upon the observations made in that judgment (at page 179) to the effect that if the company, even before it commences business, invests surplus funds in its hands for purpose of land or house property and later sells it at profit, the gain made by the company will be assessable under the head "capital gains". Similarly, if a company purchases rented house and gets rent, such rent will be assessable to tax under Section 22 as income from house property. Likewise, the company may have income from other sources. The company may also, as in that case, keep the surplus funds indeposits in order to earn interest. Such interest will be chargeable under Section 56 of theAct. This Court also emphasised the fact that the company was not bound to utilise the interest so earned to adjust it against the interest paid on borrowed capital. The company was free to use this income in any manner it liked. However, while interest earned by investing borrowed capital indeposits is an independent source of income not connected with the construction activities or business activities of the assessee, the same cannot be said in the present case where the utilisation of various assets of the company and the payments received for such utilisation are directly linked with the activity of setting up the steel plaint of the assessee. These receipts are inextricably linked with the setting up of the capital structure of theThey must, therefore, be viewed as capital receipts going to reduce the cost of construction. In the case of Challapalli Sugars Ltd. v. Commissioner ofA.P. (1975) 98 ITR 167 , this Court examined the question whether interest paid before the commencement of production by a company on amounts borrowed for the acquisition and installation of plant and machinery would form a part of the actual cost of the asset to the assessee within the meaning of that expression in Section 10(5) of the IndianAct, 1922 and whether the assessee will be entitled to depreciation allowances and development rebate with reference to such interest also. The Court held that the accepted accountancy rule for determining 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 created as a result of such expenditure. By the same reasoning if the assessee receives any amounts which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets. These are receipts of a capital nature and cannot be taxed as income.The same reasoning would apply to royalty received by the assessee company for stone etc. excavated from the assessee companys land. The land had been allowed to be utilised by the contractors for the purpose of excavating stones to be used in the construction work of assessees steel plant. The cost of the plaint to the extent of such royalty received, is reduced for the assessee. It is, therefore, rightly taken as a capital receipt.he assessment yearthe assessee had shown in its books of accounts a sum of Rs. 7,39,232/as income from interest received from M/s. Hindustan Steel Ltd. for the eight locomotives supplied by theto them. The entry in this regard was reversed in the next year since M/s. Hindustan Steel Ltd. had replaced the right locomotives lent by theto it by new ones. The entire nature of the transaction was changed between the parties. There was a resolution of thein this regard and the income from interest did not result at all as the original agreement ceased to be operative ab initio. The entry in the books which was made was about a hypothetical income which did not materialise and the entry was reversed in the next year. Both the Tribunal as well as the High Court have held that since this entry reflected only hypothetical income, it could not be brought to tax as income. Only real income can be brought to tax.In support of this finding, the assessee has drawn our attention to a decision of this Court in Godhra Electricity Co. Ltd. v. Commissioner of(1997) 225 ITR 746  where the Court, inter alia, examined the cash system and the mercantile system of accounting in the context of hypothetical income. The computation of income is made in accordance with the method of accounting regularly employed by the assessee. It may be either the cash system where entries are made on the basis of actual receipts and actual outgoings or disbursements; or it may be the mercantile system where entries are made on accrual basis, that is to say, accrual of the right to receive payment and the accrual of the liability to disburse or pay. However, in both cases unless there is real income, there cannot be anyConsidering the facts before it, the Court said that although thewas following the mercantile system of accounting and had made entries in the books regarding enhanced charges for the supply of electricity made to its consumers, no real income had accrued to thein respect of those enhanced charges in view of the fact that soon after thedecided to enhance the rate, representative suits were filed by the consumers which were decreed by the Court and ultimately, after various proceedings which took place, thewas not able to realise the enhanced charges. The Court held that no real income had accrued toand hence the entries in respect of enhanced charges did not reflect the real income of the assessee and could not be brought to tax by the. In the present case also the entry which was initially made as interest was reversed the next year because in fact the nature of the transaction was changed and the assessee did not receive any real income. The High Court has, therefore, rightly held this entry as not reflecting the real income of the assessee and hence not exigible to