|
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, as per the proviso to Section 40(a).
It was, therefore, submitted that no prejudice was caused
to the assessee if the provisions were complied with even
later on. It was pointed out that tax deduction at
source was one of the ways contemplated by section 4(2)
of the Act for recovery of tax in respect of the income
chargeable under sub-section (1) thereof besides the mode
of advance payment. It was argued that shipbreaking was
neither a manufacture nor production of any article or
thing.
7.1 The learned counsel, in support of his
contentions, relied upon the following decisions :
[a] In Bombay Steel Navigation Company v. C.I.T.,
reported in 56 ITR 52, in a case where the
parties had agreed that assets of the value of
Rs.81,55,000=00 be taken over by the assessee
company and out of that consideration,
Rs.29,99,000=00 were paid by the assessee company
and the balance remained unpaid for which
interest was to be paid, it was held that an
agreement to pay the balance of consideration due
by the purchaser does not in truth give rise to a
loan. The Supreme Court held that a loan of
money undoubtedly results in a debt, but every
debt does not involve a loan. Liability to pay a
debt may arise from rival sources, and the loan
is only one of such sources.
[b] The decision in Agarwal Chamber of Commerce Ltd.
v. Ganpatrai Hiralal, reported in 33 ITR 245 was
cited to point out that, in context of the
provisions of section 40(2) of the Indian Income
Tax Act, 1922, the Supreme Court held that, under
the said provision which was essentially a
machinery and enabling section, the tax to be
realized from a non-resident could be levied upon
the agent in the same manner as it could have
been levied upon and recovered from a
non-resident. It was held that the Hapur firm
being an agent could be held liable under Section
40(2) and 42(1) of the Act of 1922 as an assessee
for income tax on the profits made on the
respondents' transactions at Hapur and was
therefore entitled under the proviso to section
42(1) to retain the estimated amount of income
tax payable on the amount of respondents' profits
which, in that case, were deducted, retained and
actually paid. The Court held that if the Hapur
firm rightly paid the tax on the profits, the
respondents cannot be allowed to challenge the
amount on the ground that his total world income
was not taxable and he was entitled to his
profits without deductions. That was a question
which had to be agitated by the non-resident
assessee at the time of his assessment. It was
held that those persons who are bound under the
Act to make deductions at the time of payment of
any income, profits or gains are not concerned
with the ultimate result of the assessment.
[c] The decision of the Delhi High Court in
J.K.Synthetics Ltd. v. Assistant Commissioner
of Income Tax, reported in 185 ITR 540 which was
rendered in context of the provisions of sections
9(1)(v) and 195(2) of the said Act, was cited for
the proposition that the interest payable to the
foreign supplier of raw material was deemed by
section 9(1)(v) to accrue or arise in India and
the proviso to section 195(2) made section 195(2)
inapplicable in such case. In that case, the
petitioner had to remit interest to a foreign
supplier of raw material which it claimed was
exempt from tax in the provisions of section
10(15)(iv)(c) of the said Act. The petitioner
applied for exemption from deduction of tax at
source. That application came to be rejected and
the petitioner challenged the order refusing
exemption. It was held that the application for
grant of a certificate of exemption from
deduction of tax at source could not have been
made under any other provisions of the Act except
section 195(2), and that the respondent was right
in declining to grant any exemption certificate
to the petitioner.
[d] The decision of the Supreme Court in Transmission
Corporation of A.P. Ltd. and another v.
C.I.T., reported in 239 ITR 587, which was
rendered in context of the provisions of section
195 of the said Act, was cited for the
proposition that the purpose of sub-section (1)
of section 195 is to see that, on the sum which
is chargeable under Section 4 of the Act, for
levy and collection of income tax, the payer
should deduct income tax thereon at the rates in
force, if the amount is to be paid to a
non-resident. The said provision is for
tentative deduction of income tax thereon subject
to regular assessment and by the deduction of
income tax, the rights of the parties are not, in
any manner, adversely affected. Further, the
rights of the payee or recipient are fully
safeguarded under Sections 195(2), 195(3) and
197. The only thing which is required to be done
is to file an application for determination by
the assessing officer that such sum would not be
chargeable to tax in the case of the recipient,
or for determination of the appropriate
proportion of such sum so chargeable, or for
grant of certificate authorizing the recipient to
receive the amount without deduction of tax, or
deduction of income tax at any lower rate. On
such determination, tax at the appropriate rate
could be deducted at the source. If no such
application is filed, income tax on such sum is
to be deducted and it is the statutory obligation
of the person responsible for paying such "sum"
to deduct tax thereon before making payment.
[e] The decision of the Bombay High Court in C.I.T.
v. Vishnudayal Dwarkadas, reported in 123 ITR
140 was cited to point out that, in a case where
under the agreement between the parties, the
entire price, both for the moveable and immovable
properties, agreed to be sold, was to be paid to
the assessee by the vendor on May 1, 1958, and
since the purchaser was unable to pay the same on
that date, and paid it on the execution of the
sale deed, on January 25, 1959, the sum of
Rs.15,083=00 was paid by way of interest, it was
held that this amount was not part of the
purchase price, but was a payment by way of
interest and constituted a revenue receipt in the
hands of the assessee. The Court rejected the
contention that the amount of interest was part
and parcel of the sale price.
[f] The Supreme Court, in Keshuram Industries &
Cotton Mills Ltd. v. Commissioner of Wealth
Tax, reported in 59 ITR 767, while considering
the definition of the word "debt" and noticing
the judgements which were cited at the Bar, held
that there was no conflict on the definition of
the word "debt", and that all the decisions
agreed that the meaning of the expression "debt"
may take colour from the provisions of the
concerned Act; it may have different shades of
meaning. It was held that the definition of word
"debt" to the effect that a debt is a sum of
money which is now payable or will become payable
in future by reason of a present obligation;
"debitum in praesenti solvendum in futuro" was
unanimously accepted. The Supreme Court also
held that in the expression "debt owed", the verb
"owe" means " to be under an obligation to pay",
and it does not really add to the meaning of the
word "debt".
[g] The decision of the High Court of Justice (King's
Bench Division) in Hudson's Bay Company v. Thew
(Surveyor of Taxes), reported in VII Tax Cases,
206 was cited to point out that, in a case where
the company entered into an agreement with
purchaser unable to provide the whole purchase
money in one sum, under which the purchaser was
to pay certain sum down when the contract was
signed and the balance by equal annual
installments, each with interest calculated on
the balance of the purchase money remaining
unpaid, and it was argued that this interest
which was interest paid in respect of their
forbearing to collect for a certain time their
purchase money, that is interest on unpaid
purchase money was not income, Rowlatt, J.
negativing the contention held that, "They have
got a covenant from the purchaser to pay the
purchase money and he remained debtor to them for
the purchase money; but until he pays it, he pays
interest; if they had collected the money and had
been paid it, they would have invested it and got
interest. The purchaser has not paid it, and he
therefore pays interest instead until he does pay
it. It is no good repeating myself, but I cannot
see why that is not interest but is capital".
[h] The decision of Court of Appeal in United City
Merchants (Investments) Ltd. and others v.
Royal Bank of Canada, reported in (1981) 3 All.
E.R. at page 142, was cited for the proposition
that the Letter of Credit is regarded as almost
equivalent to cash in the seller's hand. It is
his guarantee that payment for his goods will not
be held up by the buyer on some pretext as to
their quality. The holder of an irrevocable
letter of credit need not fear that he may have
to bring an action to recover the price and be
met with a specious counter claim that enables
the buyer to get leave to defend and so keep him
out of his money for the months or years that may
pass before the action can be brought to trial.
The seller can use the letter of credit to
finance other business; it is, as has been said
more than once, part of the life blood of
commerce. (Griffiths LJ at page 151 of the
report). The Court of Appeal cited with approval
"a classic passage" of the judgement of Jenkins
LJ in Malah (Trading as Hamzeh Malas & Sons) v.
British Imex Industries Ltd., reported in (1958)
1 All E.R. 262 at page 263, in which it was
stated that the opening of a confirmed letter of
credit constituted a bargain between the banker
and the vendor of the goods, which imposed on the
banker an absolute obligation to pay,
irrespective of any dispute which there may be
between the parties whether the goods are upto
contract or not. It was held that an elaborate
commercial system had been built up on the
footing that the banker's confirmed credits are
of that character, and, it would be wrong to
interfere with that established practice. It has
to be remembered that a vendor of goods selling
against the confirmed letter of credit is selling
under the assurance that nothing will prevent him
from receiving the price. That is of no mean
advantage when goods manufactured in one country
are being sold in another.
[i] The decision of the House of Lords in Riches v.
Westminster Bank Ltd., reported in (1947) A.C.
390 was cited to point out that, it was held
therein that the essence of interest is that it
is debt. It is a payment which becomes due
because the creditor has not had his money at the
due date. The House of Lords negatived the
contention that the sum in question could not be
interest at all because interest implies a
recurrence of periodic accretions, whereas the
sum came to existence uno flatu by the judgement
of the court and was fixed once for all, holding
that, in truth, the sum represented the total of
the periodic accretions of interest during the
whole time in which payment of the debt was
withheld. The sum awarded was the summation of
the total of all the recurring interest items.
(Lord Wright at page 403 of the report).
Viscount Simon observed: "But I see no reason
why, when the judge orders payment of interest
from a past date on the amount of the main sum
awarded (or on a part of it), this supplemental
payment, size of which grows from day to day by
taking a fraction of so much per cent per annum
of the amount on which interest is ordered, and
by the payment of which further growth is
stopped, should not be treated as interest
attracting income tax. It is not capital, it is
rather the accumulated fruit of a tree which the
tree produces regularly until payment".
[j] The decision of House of Lords in Chancery Lane
Safe Deposit and Offices Co. Ltd. v. Inland
Revenue Commissioners, reported in (1966) 1 All
E.R. 1, was cited to point out that, it was held
that the income tax deducted from so much of the
interest as the appellant had debited to capital
must be accounted for to the revenue because the
appellants calculated and maintained decision to
attribute part of the interest payments to
capital which precluded a contrary and
inconsistent attribution. It was held that the
decision to attribute part of the interest
payments to capital was one that had produced
practical results inconsistent with an allocation
of the sum to revenue and accordingly, bound the
appellants.
[k] The decision of the Madras High Court in
Commissioner of Income Tax Vs. C.C.C. Holdings,
reporting in (2003) 127 Tax Man 281 (Mad) was
cited to point out that, in a case where the
assessee claimed deduction of interest payment to
a foreign banker from its business income, and it
was contended that the interest payment was
towards the amount lent outside India, and
therefore, interest accrued outside India and not
taxable in India, the High Court held that the
person who claims the benefit under the
provisions of the Act, has to prove before the
authorities that he is entitled to the benefit of
deduction by placing proper and sufficient
material to that effect. In the absence of any
such materials, the authorities under the Act
cannot grant any relief based on presumption.
The Court noticed that the Income Tax Officer had
found from the profit & loss account of the
assessee company that the assessee had debited to
its profit & loss account a sum of Rs.3,17,805=00
being the interest amount which the assessee owed
to the collecting foreign banker. The assessee
had not produced any material to disprove its own
entry or to show that the interest was not paid
to a non-resident to take it out of the ambit of
section 40(a)(i) of the Income Tax Act inasmuch
as the said provision provided that the interest
shall not be deductible item in the computation
of total income if the tax payable has not been
deducted at source under Chapter XVII-B of the
Income tax Act.
[l] In W.J. Alan & Company Ltd. v. El Nasr Export
& Import Co., a decision of the Court of Appeal,
reported in Lloyds Law Reports (1972) Vol. I at
page 313 = (1972) 2 All England Reports 127, Lord
Denning M.R. after analyzing the effect of a
letter of credit, held that in the ordinary way,
when the contract of sale stipulates for payment
to be made by confirmed, irrevocable letter of
credit then, when the letter of credit is issued
and accepted by the seller, it operates as
conditional payment of the price. It does not
operate as absolute payment. It is analogous to
the case where under a contract of sale, the
buyer gives a bill of exchange or a cheque for
the price. It is presumed to be given, not as
absolute payment, nor as a collateral security,
but as conditional payment. If the letter of
credit is honoured by the bank, when the
documents are presented to it, the debt is
discharged. If it is not honoured, the debt is
not discharged and the seller has a remedy in
damages against both the banker and buyer.
[m] Decision in V.S.T. Industries v. Collector of
Central Excise, Hyderabad, reported in 1998(97)
ELT 395 (SC) was cited to point out that, in
paragraph 11 of the judgement, after considering
its earlier decision in Madras Rubber Factory,
the Supreme Court held that when goods were sold
on credit and interest is received, that does not
form part of the price on which excise duty is
payable.
[n] Decision in Devidas Vithaldas & Co. v.
Commissioner of Income Tax, Bombay City I,
reported in 84 ITR 272 was cited for the
proposition that if the transaction is embodied
in a document, the liability to tax depend upon
meaning and content of the language used in it
accordance with the ordinary rules of
construction.
[o] Decision in K.P.Subbarama Sastri v.
K.S.Raghavan, reported in (1987) 2 SCC 424, was
cited for the proposition that, where a contract
provides for payment of money in installments and
contains also a stipulation that on default being
committed in paying any of the installments the
whole sum shall become payable at once, the true
test for determining whether the said condition
is in the nature of a penalty is to find out
whether the amounts referred to in the agreement
were debita in praesenti although solvenda in
futuro or whether they were to become due to the
promisee only on the respective dates when the
installments were payable. It was held that if
on a proper construction of a contract it is
found that the real agreement between the parties
was to the effect that the whole amount was on
the date of the bond a debt due but the creditor
for the convenience of the debtor allowed it to
be paid by installments intimating that if
default should be made in the payment of any
installment, he would withdraw the concession,
then the stipulation as to the whole amount of
the balance becoming payable would not be penal.
[p] Decision of the Bombay High Court in Narsee
Nagsee & Co. v. Commissioner of Income Tax,
Bombay City I, reported in 35 ITR 134, which was
rendered in context of the provisions of section
18(3A) and (3C) of the Indian Income Tax Act,
1922 was cited for the proposition that where the
non-resident had indicated only the mode of
payment by nominating an agent to whom the amount
is to be paid, it was held that it was the
responsibility of the assessee to the
non-resident and that responsibility remained and
therefore, the assessee was under a duty to
deduct income tax and super-tax under the said
provisions and was responsible for the tax.
[q] The decision of the Supreme Court in Standard
Triumph Motor Co. Ltd. v. Commissioner of
Income Tax, reported in 201 ITR 391, which was
rendered in context of sections 5(2) and 145 of
the said Act, was cited to point out that, where
there was a collaboration agreement between a
non-resident and an Indian Company and the
appellant was entitled to a royalty of 5%
thereunder, on all sales effected by the Indian
company, the royalty less the Indian tax had to
be remitted to the appellant in pounds sterling,
it was held that the credit entry of the royalty
to the account of the appellant in the books of
the Indian company amounted to receipt of the
royalty by the appellant and it was accordingly
taxable. It was held that it was immaterial when
the appellant actually received it in the U.K.
and the method of accounting adopted by the
appellant was irrelevant, and, therefore, the
order of remand made by the Tribunal was
unnecessary.
[r] The decision of the Hon'ble Supreme Court in
Hyderabad Industries Ltd. v. Union of India,
reported in 1995 ELT 641 was cited for the
proposition that the asbestos fibre that is
removed from the parent rock is in every respect
the asbestos that was embedded in it. No process
of manufacture can be said to have been employed
by the appellants, nor was a new or distinct
commodity released therefrom, as held by the
Supreme Court. It was held that such asbestos
fibre was, therefore, not liable to excise duty.
[s] The decision of the Bombay High Court in
Commissioner of Sales Tax v. Delhi Iron & Steel
Company Pvt. Ltd., reported in 1995 S.T.Cs. 202
was cited to point out that, in a case where the
ship was condemned and unserviceable at the time
of sale and under the agreement, it was sold for
breaking and scraping purposes, the Bombay High
Court held that the condemned and unserviceable
ship purchased by the dealer was not a ship but a
re-rollable scrap in the form of an old ship for
dismantling. In effect, the dealer acquired only
the old material and articles contained therein
which were sold by it in the form in which they
were acquired and no process whatsoever was
applied to the goods, much less any process of
manufacture. It was held that the question of
using the goods purchased in the manufacture of
other goods, therefore, did not arise and section
13 of the Bombay Sales Tax Act, 1959 was not
applicable.
[t] The decision in Collector of Central Excise,
Madras v. M/s Kutty Flush Doors & Furnitures Co.
(P) Ltd., reported in 1988 (supp) SCC 239 was
cited for the proposition that "manufacture"
implies a change, but every change is not
manufacture, yet every change of an article is
result of treatment, labour and manipulation.
But something more was necessary and there must
be transformation; a new and different article
must emerge having a distinct name, character or
use. (See para 5 of the judgement).
[u] Decision of the Supreme Court in Lucky Minmat
Pvt. Ltd. v. Commissioner of Income Tax,
reported 245 ITR 830 which was rendered in
context of the provisions of section 80HH of the
said Act, was cited to point out that the Supreme
court held therein that the conversion into lime
and lime dust or concrete by stone crushers could
legitimately be considered to be a manufacturing
process while mere mining of lime stone and
marble and cutting the same before it was sold in
the market could not be so considered.
[v] Decision in Divisional Deputy Commissioner of
Sales Tax v. Bherhaghat Mineral Industries,
reported in 246 ITR 230, the Supreme Court held
that the crushing of dolomite lumps into chips
and powder was not a process of manufacture that
brings about a new commodity.
IV CONTENTIONS AND CASES CITED FOR THE ASSESSEES:
8. The two learned Senior Counsel and other counsel,
who appeared for the assessees in all these appeals,
contended that the assessees had not made any payment to
the non-residents from whom the ships were purchased,
because, in view of the independent contract between the
assessees and their bankers for taking out irrevocable
letters of credit, the assessees had made payment of the
amounts to the bank in India and not to the
non-residents. They were, therefore, not liable to
deduct tax at source under section 195(1) of the Act. It
was then argued that the amount in question though
described as interest in the MOA was not "interest"
within the meaning of section 2(28A) of the said Act, or
within the meaning of the definition of "interest" in the
Article concerning taxation of interest in the Double
Taxation Avoidance Agreements. It was argued that the
amount though described as interest was, in fact, part of
the purchase price of the ship, because, it was payable
with the purchase price at the end of the usance period
of 180 days. It was submitted that the accounting
entries reflecting that the amount was paid by way of
interest were irrelevant for deciding the taxability of
the item and that mere nomenclature attributed to the
amount was not decisive. It was then contended that in
view of the provisions of the DTAAs, the amount in
dispute was not chargeable to tax in India because it was
not interest within the meaning of definition of interest
under the D.T.A.A. It was therefore part of the business
profit which was required to be taxed abroad and not in
India under the Article concerning taxation of business
profits contained in the Agreement. It was submitted
that the amount of purchase price was not a debt because
what was paid to the seller was one price at the end of
the usance period which was an incremental or deferred
price. According to the counsel, reading the provisions
of the Income Tax Act and the DTAA, the amount received
by the seller could only be profit arising out of
business and taxable abroad. It was also contended that
the obligation of the buyer was discharged on the date
when the L.C. was released and the obligation was taken
over by the Indian bank as the principal obligor which
was to be honoured by the bank at the end of the usance
period of 180 days. It was submitted that if the issuing
bank failed, the seller could have no remedy against the
buyer. It was argued that unpaid purchase price is not a
debt and payment for unpaid purchase price was not a
claim for a debt, but it remained to be a claim for
unpaid purchase price. It was also submitted that the
DTAA for Indonesia in 1989 and Philippines in 1980 which
are reproduced in 177 ITR (Statutes) and 299 ITR
(Statutes) respectively included in the definition of
interest, the words "including interest on deferred
payment sales" after the words "debt claims" which shows
that in other Agreements where these words were not put
into parenthesis, the idea was not to include interest on
deferred payment sales within the meaning of the
expression debt claims. It was submitted that the buyer
had no option to pay the amount of purchase price earlier
and that by itself showed that the interest amount
payable alongwith the price at the end of the usance
period of 180 days was a part and parcel of the price of
the ship bought by the assessees. It was also argued
that the customs authority would levy the duty on the
value of the goods of import as may have been disclosed
and the fact that the customs duty was charged on the
purchase price of the ship and not on the interest amount
considering the later to be part of the price would not
be conclusive for holding that the interest amount was
not a part of the purchase price. The learned counsel
have also contended that shipbreaking was an activity for
manufacture of production of new articles or things
because the raw material that was ship was converted into
totally different articles mainly steel plates.
8.1 In support of their contentions, the learned
counsel for the assessees relied upon the following
decisions :
[a] The decision of the Supreme court in Federal Bank
Ltd. v. V.M.Jog Engineering Ltd. and another,
reported in (2001) 1 SCC 663 was cited for the
proposition that the contract of the bank
guarantee or the letter of credit is independent
of the main contract between the seller and the
buyer. This is also clear from Articles 3 and 4
of the Uniform Commercial Practice of Documentary
Credits (1983). In case of an irrevocable bank
guarantee or letter of credit, the buyer cannot
obtain injunction against the banker on the
ground that there was a breach of the contract by
the seller. On the basis of this decision, it
was argued that since as per the Uniform
Commercial Practice, the negotiating bank pays
the seller when satisfied that the documents
appear on their face to be in accordance with the
terms and conditions of the credit and the
issuing bank is bound to reimburse the
negotiating bank, it cannot be said that the
issuing bank is making payment to the seller, who
was the non-resident.
[b] The decision of the Supreme Court in United
Commercial Bank v. Bank of India, reported in
AIR 1981 SC 1426 was cited for the proposition
that the credit contract is independent of the
sales contract on which it is based, unless the
sales contract is in some measure incorporated.
Unless documents tendered under a credit are in
accordance with those for which the credit calls
and which are embodied in the terms of the paying
or negotiating bank, the beneficiary cannot claim
against the paying bank and it is the paying
bank's duty to refuse payment. The Supreme Court
held that the rule was well established that a
bank issuing or confirming a letter of credit is
not concerned with the underlying contract
between the buyer and the seller. The duties of
a bank under a letter of credit are created by he
document itself, but in any case, it has the
power and is subject to the limitations which are
given or imposed by it, in the absence of the
appropriate provisions in the letter of credit.
(paragraph 38).
[c] The decision of the Supreme Court in M/s Tarapore
and Co., Madras v. Tractoroexport Moscow and
another, reported in AIR 1970 SC 891 was referred
to for the same proposition that the letter of
credit is independent of and unqualified by the
contract of sale or underlying transaction. The
Court held that the autonomy of an irrevocable
letter of credit is entitled to protection. As a
rule, the Courts refrain from interfering with
that autonomy.
[d] The decision in A.D.Sasoon & Co. Ltd. v.
C.I.T. Bombay City, reported in XXXVI ITR 27 was
cited for the proposition that a debt must have
come into existence and a right must have been
acquired to receive the payment. It was held
that unless and until assessee's contribution or
parenthood is effective in bringing into
existence a debt or a right to receive the
payment or in other words a debitum in praesenti,
solvendum in futuro, it cannot be said that any
income has accrued to him. The Supreme Court
held that income may accrue to an assessee
without the actual receipt of the same. If the
assessee acquires a right to receive the income,
the income can be said to have accrued to him,
though it may be received later on its being
ascertained. The basic conception is that he
must have acquired a right to receive the income.
There must be a debt owed to him by somebody.
Unless and until there is created in favour of
the assessee a debt due by somebody, it cannot be
said that he has acquired a right to receive the
income or that income has accrued to him. The
matter related to managing agency commission
which was at an annual payment calculated upon
the annual net profit of the company, and was to
be due to the managing agents yearly on the 31st
March in each and every year. In that context,
the Supreme Court held that the amount of such
commission did not become a debt owing by the
company to the managing agents until the 31st
March in each and every year and was to be paid
immediately after the annual accounts of the
company have been passed by the shareholders.
It was held that the managing agency agreement
was an entire and indivisible contract
stipulating a payment of remuneration or
commission per year and enjoined upon the
managing agents the duty and obligation of
rendering the services through the company for
the whole year by way of condition precedent
through their earning any remuneration or
commission for the particular accounting year.
[e] The decision of the Supreme Court in Tuticorin
Alkali Chemicals v. C.I.T. reported in 227 ITR
172 which was referred lays down that income tax
is attracted at the point when the income is
earned. The Court held that the application or
destination of income has nothing to do with its
accrual or taxability, and that it was also well
settled that interest income is always of revenue
nature unless it is received by way of damages or
compensation.
[f] The decision of the SC in Dr. Shamlal Narula v.
C.I.T. reported in 53 ITR 151 was cited to point
out that, in context of the provisions of section
34 of the Land Acquisition Act, 1894, the Supreme
Court held that the statutory interest paid under
the said provision on the amount of compensation
awarded for the period from the date the
Collector has taken possession of land
compulsorily acquired, is interest paid for the
delayed payment of the compensation and is
therefore a revenue receipt liable to tax under
the Income Tax Act. The Supreme Court observed
that interest pertains to the domain of payment
after the compensation has been ascertained. It
is a consideration paid either for the use of
money or for forbearance from demanding it after
it has fallen due. The Court held that the Land
Acquisition Act itself makes a clear distinction
between the compensation payable for the land
acquired and the interest payable on the
compensation awarded. The Court approvingly
cited the observations of Lord Wright in
Westminster Bank Ltd. v. Riches (1947) (28) Tax
Cases 159 at 189] which indicate that interest,
whether it is statutory or contractual,
represents the profit the creditor might have
made if he had the use of the money or the loss
is suffered because he had not that used. The SC
held that it is something in addition to the
capital amount, though it arises out of it.
[g] In TNK Govindraju Chetty v. CIT Madras, reported
in 66 ITR 465, the Supreme Court held that the
principle in Shamlal Narula's case [supra] that
if the source of the obligation imposed by the
statute to pay interest arises, because, the
claimant is kept out of his money, the interest
received is chargeable to tax as income, will
apply if interest is payable, under the terms of
an agreement, expressed or implied and the court
or the arbitrator gives effect to the terms of
the agrement and awards interest which has been
agreed to be paid.
[h] The decision of the Supreme Court in Kedarnath
Jute Mfg. Co. Ltd. v. C.I.T., Calcutta,
reported in 82 ITR 363 was cited for the
proposition that, whether the assessee is
entitled to a particular reduction or not will
depend on the provisions of law relating thereto
and not on the view which the assessee might take
of his rights; nor can the existence or absence
of entries in his books of account be decisive or
conclusive in the matter.
[i] In the decision of the Court of Appeal, in Re
Charg Card Services Ltd. reported in (1988) 3
All E.R. 702, which was rendered in context of
payments in respect of sale of goods by credit
card transaction, it was held that there was no
general principle of law that, whenever a method
of payment was adopted which involved a risk of
non-payment by a third party, there was a
presumption that the acceptance of payment
through the third party was conditional on the
third party making the payment, and that, if he
fails to pay, the original obligation of the
purchaser remained. Each method of payment had
to be considered in the light of the consequences
and other circumstances attending that type of
payment.
[j] The decision of the Supreme Court in Ferro Alloys
Corporation Ltd. v. A.P. State Electricity
Board, reported in AIR 1993 SC 2005, where the
Supreme court was concerned with the question of
payment of interest on security deposit by high
tension consumers of electricity shows that, in
that context, it was held by the SC that the word
"interest" would apply only to cases where there
is a relationship of a debtor and creditor. A
lender of money who allows the borrower deprives
himself of the use of those funds. He does so
because he charges interest which may be
described as kind of rent for the use of the
fund. It was held that, in the case before it,
there was no relationship of debtor and creditor.
The SC held that the deposit made cannot be
equated to a fixed deposit because in the case of
Delhi Supply of Electricity, there was a
consequential liability on the consumer to pay
for each day's consumption of electricity and to
ensure that payment, the security deposit was
furnished.
[k] The decision of the Supreme Court, in Radha
Kissen Chamria and others v. Keshardeo Chamria
and another, reported in AIR 1957 SC 743, which
was rendered in context of the provisions of
section 30 of the Bengol Money Lenders Act, 1940,
was cited to point out that the SC held that the
purchasers could not claim any benefit under
Section 30 inasmuch as they were neither
borrowers nor were they being made to pay in
respect of a "loan" as those terms were defined
in the Act; the fact that under the compromise
decree, the moneys were payable in a number of
installments instead of at once would not show
that the price had become a loan, nor was there
anything to show that the parties had treated the
purchase money as paid off in its entirety and
the amount equivalent to the purchase money as
being due by the purchasers to the vendor by way
of a loan on which basis the transaction might in
substance be a loan. Section 2(12) of that Act
defined loan so as to mean an advance, whether of
money or any kind, made on condition of
re-payment with interest and included any
transaction which was in substance a loan. The
SC observed that the case before it admittedly
was not a case of an advance in kind, nor was it
a case in which there was an actual advance of
money.
[l] The decision in Vijay Bank Ltd. v. Commissioner
of Income Tax, reported in 187 ITR 541 was cited
to point out that, in a case where the assessee
purchased securities at a price determined with
reference to their actual value as well as the
interest accrued thereon till the date of
purchase, the entire price paid for them would be
in the nature of a capital outlay and no part of
it can be set off as an expenditure against the
income by way of interest received on the
securities. It was contended before the SC that
the price paid for the securities was determined
with reference to their actual value as well as
the interest which had accrued on them till the
date of purchase. But the fact was, whatever was
the consideration which prompted the assessee to
purchase the securities, the price paid for them
was in the nature of a capital outlay and no part
of it could be set off as expenditure against the
income accruing on those securities. It was held
that subsequently when the securities yielded
income by way of interest, such income attracted
section 18 of the said Act. The Court held that
a claim for deduction can be sustained only when
the assessee is in a position to show that any
reasonable expenditure had been incurred for the
purpose of realizing with interest on securities.
[m] The decision of the Lahore High Court in Haveli
Shah Sardarilal v. Commissioner of Income Tax,
Punjab, reported in 4 ITR 297 was cited for the
proposition that the mere quotation in the
bargain, of estimated accrued interest, does not
establish a separate contract, in respect of the
interest. Even if it were considered to be a
separate contract, it would remain part and
parcel of the whole purchase consideration and
would not be deductible. In that case, the
assessee had purchased securities at a price
expressed as a capital sum plus interest computed
de die in diem from the last due date to the date
of sale, and the question was whether the said
computed interest was deductible from the
interest actually received by the assessee, in
assessment under Section 8 of the Indian
Income-Tax Act, 1922.
[n] The decision of the Court of Session (Scotland),
First Division, in the Commissioners of Inland
Revenue v. Ballantine, reported in VIII Tax
Cases 595, was cited for the proposition that,
where the award was substantially one of damages,
the sum added in the name of interest was merely
part of the damages, and was not "interest of
money" chargeable to Income Tax under Case III of
Schedule - D to the Income Tax Act, 1918. It was
held that the interest awarded in that case truly
constituted that part of the compensation
discerned for which it is attributable to the
fact that the claimant had been kept out of his
due for a long period of time. The Court held
that the form of award in the case before it
seemed to make it impossible to distinguish the
character of the so-called interest between the
4th of November 1981 and the date of the award,
from its character between the date of the award
and the date of payment.
[o] The judgement of the High Court of Justice
[King's Bench Division] in Wigmore v. Thomas
Sommerson & Sons. Ltd., reported in 9 Tax Cases
577 was a case where a company sold a holding of
5% war-stock on the 10th April 1923. The sale
was with interest rights, such stock not being
dealt in "ex-interest" until the 1st May 1923.
An assessment to income tax was made upon the
vending company for the year 1923-24 in respect
of the amount of interest deemed to have accrued
on the stock in the period between the last
payment of interest and the sale of the stock, it
being contended that the price received by the
company on sale of the stock included this
interest. The Court found that the stock was
sold for a sum for principal and accrued and
accruing interest; and it was not true to say in
fact that in the purchase price there was
necessarily to be found a sum as purchase money
of the accrued interest exactly equivalent to the
amount of interest which had accrued. It was
therefore held that the company was not
assessable in respect of the interest accrued at
the date of the sale of the stock and the appeal
was dismissed.
[p] In the decision of the High Court of Justice
[King's Bench Division] reported in XIV Tax Cases
580, the question involved was whether
compensation under Prize Chitty computed on the
basis of interest was income. It was held that
the income in question arose when received by the
banks and that the compensation was not income
for income tax purposes. Lord Hanworth M.R.
held that the way to estimate compensation or
damages - sensible way no doubt would be by
calculating a sum in terms of what interest it
would have earned. That had been done but the
sum that was paid had not been turned into
interest so as to attach income tax to it. It
remained compensation and for these reasons, it
was not a sum which attracted or attached income
tax to it. It was held that the judgement of Mr.
Justice Rowlatt was right and the appeal must be
dismissed. Justice Rowlatt had held that sum
first came into existence by the Award and no
previous history or anterior character can be
attributed to it.
[q] In Commissioners of Inland Revenue v. Pilcher, a
decision of the Court of Appeals, reported in 31
Tax Cases 314, was a case in which a fruit-grower
and fruit-salesman purchased for 5500 Pounds the
free-hold of a cherry orchard inclusive of the
year's fruit crop, which was nearly ripe for
picking. Before the sale, he had valued the
growing crop at 2500 pounds, and subsequently it
was picked and sold for 2903 Pounds, which sum
was brought into accounts as a trading receipt.
On appeal against assessment to income tax under
Schedule-D and to excess profit taxes, it was
contended that sum of 2500 Pounds should be
charged in the accounts as the purchase price of
the cherries sold either on the ground that the
cherries did not form part of the fructus
industriales and not fructus naturales or on the
ground that it should be so charged on proper
commercial principles. The Crown contended that
the cherries formed part of the land and the
purchase was a single operation resulting in the
acquisition of a single capital asset. The
Special Commissioner held that a deduction
representing the costs of the cherries was
permissible. The Court held that no part of the
purchase price of the land could be deducted for
arriving at the profit from the sale of the crop.
[r] The decision of the Andhra Pradesh High Court in
the Commissioner of Income Tax, Andhra Pradesh v.
Vishakhapatanam Port Trust, reported in 144 ITR
146 on which the reliance was placed by the
Tribunal was referred to for the proposition
that, under Article VIII of the Double Taxation
Avoidance Agreement between the Federal Republic
of Germany and India, interest would be
assessable in India if it arises out of
"indebtedness", and that an agreement to pay the
balance of consideration due by the purchaser
does not give rise to a loan. The Court held
that when the payment of interest is part and
parcel of the agreement to pay the unpaid
purchase money on a deferred payment basis, there
is no indebtedness. If there is no agreement
initially or by way of novation to treat balance
of sale consideration as paid off in full and no
novation to treat the balance of consideration as
a loan, the amount received by the seller cannot
be regarded as interest on money lent. It was a
matter where a German company tendered contract
for the supply of the equipment and an agreement
was entered into between the German company and
the Port Trust whereby the German Company
undertook to supply the equipment and to delegate
an engineer to supervise its installation under
Clause 10(a) of the contract. The purchase price
for the equipment was payable in German currency
in Germany. Part of it was payable on conclusion
of the contract and the balance was payable in 20
semi annual installments. For the credit
remaining after payment of each of the
installments, interest was to be paid by the port
trust at 6% per annum. The port trust paid the
installments in Germany currency in Germany. The
I.T.O. held that the port trust should have
deducted tax at source on the interest u/s 195(2)
of the Act. When the matter reached the
Tribunal, the assessee for the first time raised
the question whether the tax was deductible in
view of the Indo-German Double Taxation Avoidance
agreement, the Tribunal considered the
applicability of the agreement and found that the
actual installation work was not done by the
German company and the German company had no
permanent establishment in India within the
meaning of the agreement and interest did not
arise out of "indebtedness" within the meaning of
the agreement. On reference, the High Court
held, as noted above, that interest would be
taxable if it arose out of indebtedness. The
Court noted that the expression "debt" may take
colour from the provision of the concerned Act.
It also noted that when interest is paid not as
part of compensation but is given for the
depreciation of the use of the money, it is an
independent source of income and is taxable,
referring to the decision of the apex Court in
Dr. Shamlal Narulal's case (supra). It also
held that if the right to interest arises because
the person is kept out of his money, the interest
received is chargeable to tax as income and that
the same principle would apply if interest is
payable under the terms of an agreement and the
court or arbitrator gives effect to the terms of
the agreement and awards interest and in this
regard, it referred to the decision of the Apex
Court in TNK Govindraj Chetty (supra). It,
however, held where the interest is merely in
name but constitutes part of the compensation or
part of the damages, it is not "interest"
chargeable to income tax. As an integral part of
such compensation, it may be either slumped up
with the other elements in the gross sum or may
be separately stated but treated as a part of the
gross sum. On this, the Court referred to
Valentine (supra). It then proceeded to observe
that mere description of the amount as interest
which in fact is part of the compensation does
not have the effect of altering the true
character of the compensation and for this, it
referred to Samsung (supra). After referring the
ratio of various decisions approvingly, the Court
observed that the same was the position with
regard to unpaid purchase money coupled with a
liability to pay interest alongwith each of the
installments. It was held that where as was the
case before it , parties entered into an
agreement to accept a portion of the purchase
money immediately and the balance to be paid in
certain installments alongwith interest on the
installment of purchase money, the agreement
though it vested the property agreed to be sold
in the purchaser, does not have the effect of
converting the price due into a loan. The
intrinsic nature of the money due to the vendor
is as unpaid purchase money and not as debt. It
was observed that the parties may however agree
to convert the unpaid purchase money as a debt,
referring to Radha Kissen v. Keshavdeo (supra).
[s] The decision of this Court in Commissioner of
Income Tax, Gujarat v. Saurashtra Cement &
Chemical Industries Ltd., reported 101 ITR 502
was cited to point out that the Court, in context
of the provisions of section 9(1)(i) of the
Income Tax Act, held that since most of the
elements of the contract were found to be densely
grouped with the other country which was Italy
where the non-resident company was carrying on
its business of supplying plant and machinery and
the debt which the assessee company owned to the
non-resident company was not an asset held by the
non-resident company in India, the interest which
was payable in respect of the debt was not income
arising from or through any asset held by the
non-resident company in India. As regards the
alternative argument made on behalf of the
Revenue that income accruing or arising through
from any money lent on interest and brought into
India, in cash or in kind, was taxable in India,
it was held that, in view of the decision of the
Supreme Court in Bombay Steel Navigation Company
v. C.I.T. reported in 56 ITR 52, obviously the
amount of unpaid price could never have been said
to be a loan advanced by the non-resident company
to the assessee company. It was held that since
the non-resident company could not be said to
have lent the amount of the unpaid purchase price
to the assessee company either in cash or in
kind, there was no question of the interest
payable by the assessee company to the
non-resident company being deemed to be income
accruing or arising from any money lent at
interest and brought into India in kind. The
Court, therefore, held that the amount payable by
the assessee to the company by way of interest on
the unpaid purchase price so far as the amount
represented by the bills of exchange was
concerned, was not taxable in the hands of the
assessee as agent of the non-resident company
under Section 9(1)(i) of the Act. It will be
seen that this decision was rendered on 23rd
September 1974, much prior to the insertion of
the provisions of clause (v) in section 9(1) of
the Act by the Finance Act, 1976 w.e.f.
1-6-1976.]
[t] Decision of the Supreme Court in Central Bank of
India v. Ravindra and others, reported in AIR
2001 SC 3095 was cited to point out that, in
paragraph 37 of the judgement, the Supreme Court
referred to the definition of "interest" in
Black's Law Dictionary (7th Edition), in which it
was defined, inter alia, as the compensation
fixed by agreement or allowed by law for the use
or detention of money, or for the loss of money
by one who is entitled to its use; especially,
the amount owed to a lender in return for the use
of the borrowed money. The meaning of word
"interest" from Stroud's Judicial Dictionary of
Words and Phrases (5th Edition) was also referred
and it was defined therein to mean, inter alia,
compensation paid by the borrower to the lender
for deprivation of the use of his money. The
opinion of Lord Wright, in Riches v. Westminster
Bank, Ltd. was also referred, as per which, the
essence of interest was that it is a payment
which becomes due because the creditor has not
had his money at the due date. It may be
recorded either as representing the profit he
might have made if he had the use of the money,
or, conversely, the loss he suffered because he
had not that use. The Court observed that the
general idea is that he is entitled to
compensation for the deprivation; the money due
to creditor, was not paid, or, in other words,
was withheld from him by the debtor after the
time when payment should have been made, in
breach of his legal rights, and interest was a
compensation whether the compensation was
liquidated under an agreement or statute.
[u] The decision of the High Court in Commissioner of
Income Tax, West Bengal IV v. Smt. Asrafi Devi
Rajgharia, reported in 142 ITR 380 was cited to
point out that the Court accepted the contention
on behalf of the assessee that none was entitled
to payment of interest unless the amount on which
the interest was claimed was quantified and was
payable to him (page 399 of the Report).
[v] In the decision of the Supreme Court in
K.S.Krishna Rao v. Commissioner of Income Tax,
Andhra Pradesh, reported in 181 ITR 408 which was
rendered in context of the provisions of section
28 of the Land Acquisition Act, in which the
Court followed its earlier decision in Rama Bai
v. CIT [1990] 181 ITR 400, it was held that the
interest on enhanced compensation for land
compulsorily acquired under that Act awarded by
the Court on a reference under Section 18 or on
further appeals, had to be taken to have accrued
not on the date of the order of the court
granting enhanced compensation but as having
accrued year after year from the date of delivery
of possession of the land till the date of such
order, and such interest cannot be assessed to
income tax in one lumpsum in the year in which
the order was made, and that interest paid on
compensation awarded was of the nature of income
and not capital.
[w] The decision of the Supreme Court in Keshav Mills
Ltd. v. Commissioner of Income Tax (Bom.),
reported in 23 ITR 230 was cited for the
proposition that merely because the goods have
been supplied and the price thereof has been
debited to the purchaser, the rights and
obligations of the vendor as purchaser inter se
are not in any manner affected. The Supreme
Court held that the vendor is bound to fulfill
all his obligations under the contract and
continues to be liable for all the consequences
of his default including rejection of his goods
by the purchaser or a claim for damages for
breach of warrantee by him. It was held that the
purchaser is equally entitled to reject the goods
or to claim the damages as on breach of warrantee
by the vendor and all these rights and
obligations have got to be worked out inspite of
the fact that the entries are made in the books
of account by the vendor in accordance with the
mercantile system of accounting adopted by him.
The vendor could not say that he is under no
further obligation to the purchaser and that the
purchaser must pay the price of goods debited to
him as a debit arising out of the book entry. It
was held that the count in any action filed by
the vendor against the purchaser would be a count
for the price of goods sold and delivered and
would not be a count on an assumpsit or for
recovery of a debt due by the debtor to him. In
the same judgement, the Supreme Court referring
to the nature of the mercantile system of
accounting, has held that the mercantile system
brings into credit what is due, immediately
becomes legally due and before it is actually
received and it brings into debit expenditure the
amount for which a legal liability has been
incurred before it is actually disbursed. The
profits or gains of the business which are thus
credited are not realised but having been accrued
are treated as received though in fact there is
nothing more than an accrual or arising of the
profits at that stage. They are book profits.
Receipt being not the sole test of chargeability
and profits and gains that have accrued or arisen
or are deemed to have accrued or arisen are also
liable to be charged for income tax, the
assessibility of these profits which are thus
credited in the books of account arises not
because they are received but because they have
accrued or arisen.
[x] The decision of this Court in Meteor Satellite
Ltd. v. I.T.O., Companies Circle IX, Ahmedabad,
reported in 121 ITR 311 was cited to point out
that, while rejecting the preliminary objection
against the maintainability of the petition in
view of the alternative remedies available to the
petitioner under the Act, the Court held that in
order to facilitate the remittance of the amount
of the first two installments payable to the
collaborator in sterling, the petitioner was
entitled, if it were right in law, to have a tax
clearance certificate from the I.T.O. It could
not, in view of the terms of the agreement, wait
for the long process of having the matter
assessed and then tested by way of an appeal etc.
under the provisions of the Income Tax Act, 1961.
It was held that, under the circumstances, the
existing machinery by way of regular assessment
was totally inadequate and unsuitable for the
problems that were faced by the petitioner. It
was held that, in order to enable the petitioner
to get the approval of the Reserve Bank of India,
it was obligatory on the respondent to issue a
certificate to that effect. The Court ordered
certificate to be issued within four weeks. It
will be noted that, in the present case, the
assessee did not make any such application for
obtaining any certificate from the assessing
officer on the ground that no deduction of tax at
source was required to be made by them in respect
of the payments made to the sellers.
[y] The decision of the Bombay High Court in
Porbandar State Bank v. Commissioner of Income
Tax, Bombay city, reported in 18 ITR 134 was a
case where the assessee Porbandar State Bank as
ordinary resident in British India was assessed
to income tax under the provisions of the
Government Trading Taxation Act, 1926. It had
received deposits in Porbandar State and claimed
that interest paid to the depositors on such
deposits was an allowable deduction under Section
10(2)(iii) of the Indian Income Tax Act, 1922.
The assessee did not deduct tax at source under
Section 18(3)(a) of the Act of 1922. Income Tax
authorities disallowed the deduction under the
proviso to section 10(2)(iii) of that Act on the
ground that as the interest was chargeable under
Section 42 and was paid outside British India,
the assessee could have deducted tax at source
under Section 18(3)(a). The court held that, in
order to deprive the assessee of the deduction
under section 10(2)(iii), it must be found that
the persons who deposited moneys with the
assessee and earned interest on the deposits knew
as a part of the integral transaction of the
deposit that the assessee would take this money
to British India and utilize it for the purpose
of earning income on it. It was held that since
it was not established that there was any
knowledge on the part of the lender that his
deposit would be transferred to British India for
the purposes of earning income on it, the
interest earned by the depositors was not
chargeable under the Indian Income Tax Act and
there was no obligation upon the assessee to
deduct tax under Section 18(3)A. The assessee
was therefore entitled to the deduction under
Section 10(2)(iii) of the Act.
[z] In Commissioner of Income Tax, Bombay City I v.
Cooper Engineering Ltd., reported 68 ITR 457, the
Court, in context of the provisions of section
4(1) and 18(3B) of the Indian Income Tax Act,
1922, held that unless any payment of interest is
such that the interest is chargeable under the
Act, the liability upon the person responsible
for paying such interest to deduct the tax at
source is not there. The Court found upon the
facts that the amount of interest payable to M/s
Tata Ltd., London, was not an amount chargeable
under the Act. It was therefore held that there
was no obligation upon the assessee to deduct the
amount of interest at source. The Court held
that the words "chargeable under the provisions
of this Act" in section 18(3B) apply to
"interest" as well as "any other sum" and
consequentially a person paying interest to a
non-resident is not liable to deduct tax on the
said interest if it is payable to the
non-resident in respect of the money payable to
him for service rendered without the taxable
territories, which, u/s 4(1) of the Act of 1922,
was not chargeable to tax under the Act.
[z-1] The decision of Kerala High Court in United
Construction Contractors v. C.I.T., reported in
208 ITR 914 was a case where the assessee was a
contractor under the Public Works Department.
The dispute regarding payment for his bills was
referred to arbitration and under the award, he
was entitled for an amount for the work done for
which the bills were pending and also an amount
by way of interest, as also future interest. The
assessee contended that the interest payable by
the Public Works Department was neither under a
statute nor under a contract and so it was only
on an exgratia basis, and could not be taken as a
revenue receipt. This contention was rejected by
the revenue authorities and the Tribunal. The
High Court held that the interest paid to the
assessee partook of the same character and the
receipts, the payment of which he was otherwise
entitled to under the contract and which payment
was delayed as a result of certain disputes. It
was held that the interest amount of the revenue
receipts liable to be taxed for the Assessment
Year 1979-80. It was a finding recorded by the
Tribunal that the assessee was following the cash
system of accounting.
[z-2] In the decision of the Supreme Court in
Commissioner of Income Tax, A.P. v. Toshoku
Ltd. reported in 125 ITR 525, dealing with the
question where the commission earned by a
non-resident sales agent could be taxed in India
treating "B" to whom the sale price received on
the sale in Japan was remitted wholly in India
and who debited his commission account and
credited the amount of commission payable to the
Japanese company in his account book and later
remitted the amount to the Japanese company, it
was held that it could not be said that the
making of entries in the books of "B" amounted to
receipt, actual or constructive, by the
non-resident sales agents as the amounts was
credited in their favour were not at their
disposal or control; they could not therefore be
charged to tax on the basis of the receipt of
income, actual or constructive, for the taxable
territories. It was held that a credit balance,
without more, only represents the debt and a mere
book entry in the debtor's own books does not
constitute payment which will secure a discharge
from the debt.
[z-3] The decision of the Calcutta High Court in C.I.T.
v. Davy Ashmore India Ltd. reported in 190 ITR
626 which was rendered in context of the
provisions of sections 9 and 90 of the Act and
the Double Taxation Avoidance between Indian and
U.K. was cited for the proposition that in case
of inconsistency between the terms of the Double
Taxation Avoidance Agreement and the taxation
statute, the Agreement alone would prevail.
[z-4] The decision of the Calcutta High Court in Cosi,
Agent Stock Company v. I.T.O. reported in 81
ITR 162, while considering the provisions of
section 195(2) of the said Act, held that the
said provision pre-supposes that the person
responsible for making the payment to the
non-resident is in no doubt that tax is payable
in respect of some part of the amount to be
remitted to a non-resident, but is not sure what
should be the portion so taxable or the amount of
tax to be deducted. He can then make an
application to the I.T.O. for determining the
amount. It was held that it is only when these
conditions were satisfied and an application is
made to the Income Tax Officer that the question
of making an order under Section 195(2) will
arise. Where the I.T.O. is only approached for
a certificate that no tax was due in respect of
freight charges for goods unloaded at an India
Port as such a certificate was required by the
Reserve Bank, it cannot be said that an
application has been made under Section 195(2) of
the Act and any order under Section 195(2) in
such case would be in excess of the jurisdiction
conferred by the Act.
[z-5] The decision of the Allahabad High Court in CIT
v. Meerut Biri Factory reported in [1998] 146
CTR (Allahabad) 489 was cited for the proposition
that when interest is credited in the books of
the assessee in India, it is not payable outside
India within the meaning of Section 49 (a)(I) and
hence, not disallowable under that Section.
[z-6] The decision of the Hyderabad High Court in CIT,
Hyderabad v. Nagaria Oil Mills, reported in 25
ITR 258 was cited to point out that in context of
the provisions of Section 24 (4) of the Hyderabad
Income Tax Act which corresponded to Section
18(3A) of the Indian Income Tax Act, 1922, it was
held that it was open to the Income Tax
authorities not to allow the deduction when they
found that interest was in fact deducted or no
interest was paid to the non-resident entitled to
receive the amounts. It was held that the word
"payment" in Section 24 (12) of the Hyderabad Act
should be interpreted as meaning "actual payment"
and, therefore, crediting of interest amounts to
the accounts of the lenders could not be deemed
to be payment within the meaning of that
sub-section so as to attract Income Tax at the
maximum rate under Section 24(12) of the Act.
[z-7] The judgement of the Bombay High Court in Ship
Scraps traders c. CIT (BOM) reported in 251 ITR
806 was cited to show that the question whether
the ship breaking activities in which the
assessees were engaged amounted to manufacture or
production activities for the purposes of
deductions under Sections 80 HHA and 80-I of the
Act was decided in favour of the assessees
holding that they were entitled to claim
deductions under these provisions. Relying upon
the earlier decision of the Court in C.S.T. v.
Indian Metal Traders, reported in (1978) 41 STC
169 in which it was held that scrap iron and
steel which were obtained by the respondents by
dismantling and breaking up of the ship must be
regarded as a different commercial commodity from
their ship itself, and hence, the activity would
amount to manufacture, the Court held that
considering the peculiar nature of ship breaking
activity, it gives rise to manufacture and
production of altogether new commercial articles
or things which were commercially identifiable in
the commercial world as other than the ship and
therefore, the assessees should be entitled to
claim deductions under the said provisions. The
Court held that the input of the ship breaking
industry, namely ship, covered by Chapter 89, is
used to manufacture its output, namely metal
scrap covered by Chapter 72 to 81 of the Customs
and Central excise Tariff Act. It was held that
in the course of breaking activity, the ship
loses its identity and results into production of
the items ferrous metals and non-ferrous metals
as well as non-metalic material enumerated in the
judgement.
[z-8] Decision in Commissioner of Income Tax v.
Ashwinkumar Gordhanbhai and Bros. Pvt. Ltd.,
reported in 212 ITR 614 which was rendered in
context of section 104(4) of the Act, was cited
for the proposition that the activities of the
assessee in cutting the tobacco leaves into small
leaves or pieces and after removing the dust and
unwarranted stems of the tobacco leaves, selling
them to the bidi manufacturers, involved
"processing" of goods.
[z-9] Decision of the Supreme Court in Ujagar Prints v.
Union of India, reported in 179 ITR 317 was cited
for the proposition that the processes of
bleaching, dyeing, printing, sizing,
shrink-proofing, water-proofing, rubberising and
organdie processing carried on in respect of
cotton or man-made grey fabric amount to
"manufacture" for the purpose and within the
meaning of section 2(f) of the Central excises
and Salt Act, 1944.
[z-10] Decision of the Madras High Court in Commissioner
of Income Tax, Madras v. M.R.Gopal, reported in
58 ITR 598 which was rendered in context of
section 15(c) of the Indian Income Tax Act, 1922,
was cited for the proposition that the process
employed in converting boulders into small stones
with the aid of machinery is a manufacturing
process and the undertaking is an "industrial
undertaking" and as such entitled to the
exemption under Section 15C. The Court referred
to the definition of "manufacture" from Webster's
Dictionary, where it is defined to mean;
"Anything made from raw materials by the hand, by
machinery, or by art, as clothes, iron utensils,
shoes, machinery, etc.; a manual occupation or
trade; to produce by labour especially now,
according to an organised plan and with division
of labour and usually with machinery."
[z-11] Decision of the Gauhati High Court in
Commissioner of Income Tax v. R.C.Construction,
reported in 222 ITR 658 was referred in order to
point out that it was held that making chips out
of big boulders would amount to a manufacturing
process and, therefore, the assessee was entitled
to investment allowance as envisaged under
Section 32A of the Income Tax Act, 1961.
[z-12] Decision of the Madras High Court in Commissioner
of Income Tax, Madras v. Perfect Liners,
reported in 142 ITR 653, which was rendered in
context of the provisions of section 33 of the
Act, was cited to point out that it was held
therein that the word "manufacture" was used in a
wide sense. After the rough casting was
polished, the product was a new product which was
utilised as a component in internal combustion
engines. It was held that the Tribunal having
found that the component parts were essential
parts for internal combustion engines, the grant
of higher development rebate was justified.
[z-13] The decision of the Supreme Court in C.I.T. v.
N.C.Budharaja and Company, reported in 204 ITR
412 was cited for the proposition that the word
"production" has a wider connotation than the
word "manufacture". While every manufacture can
be characterized as production, every production
need not amount to manufacture. It was held that
the word "production" or "produce", when used in
juxtaposition with the word "manufacture" takes
in bringing into existence new goods by a process
which may or may not amount to manufacture. It
also takes in all the by-products, intermediate
products and residual products which emerge in
the course of manufacture of goods. The Supreme
Court held that the principle of adopting a
liberal interpretation which advances the purpose
and object of beneficial provisions cannot be
carried to the extent of doing violence to the
plain and simple language used in the enactment.
[z-14] Decision of the Bombay High Court in C.I.T. v.
Sterling Foods (Goa) reported in 213 ITR 851 was
referred for pointing out that the Court held
that the word "production" has a wider
connotation than the word "manufacture". The
Court followed the decision of the Supreme Court
in Budharaja (supra) and observed that three
expressions "production", "manufacture" and
"produce" used in various taxing statutes are not
interchangeable expressions. It will be seen
that the Court held on merits that by subjecting
of prawns to processing for the purpose of
export, they do not lose their original character
and no new commodity or article emerges as a
result of such processing. That being the
position, the provision of section 80HH of the
I.T. Act would not apply to the undertaking of
the assessee which was engaged in the processing
of prawns for making them fit for the market.
This decision came to be approved by the Supreme
Court in C.I.T. v. Relish Foods, reported in
237 ITR 59 in which it was held that when raw
shrimps and prawns are subjected to the
provisions of cutting of heads and tails, piling,
divining, cleaning and freezing, they do not
cease to be shrimps and prawns and do not become
other distinct commodities. It was therefore
held that the assessee was not entitled to the
special deduction under Section 80HH for the A.Y.
1977-78.
[z-15] A series of judgments in context of the
provisions like Section 2 (17) of the Bombay
Sales Tax Act, 1959 which defined "manufacture"
were cited. In Mohammedali Ismail v.
Commissioner of Sales Tax (Bombay), reported in
82 STC 50, it was held that the definition of
manufacture as contained in Section 2(17) of the
Bombay Sales Tax Act, 1959 was wide. The Court
held that the process of converting raw hides and
skin into tanned or traced hides and skins will,
thus, be covered by the word "manufacture".
[z-16] Rajasthan High Court in CTO v. Bhonri Lal Jain,
reported in 94 STC 118 held that the blocks and
stones had different commercial names in common
and commercial parlance and the dealer was a
manufacturer entitled to avail of the benefit of
the notification.
[z-17] In Deputy Commissioner of Sales Tax v.
Mohammedali, reported in 90 STC 174, the Supreme
Court held that the lifeless meat was by any
standard of other goods different from goat and
sheep for the purpose of purchase tax under
Section 5A of the Kerala General Sales Tax Act,
1963. The Court followed its earlier decision in
Deputy Commissioner of Sales Tax v. Ismail,
reported in (1986) Suppl. Supreme Court Cases,
218.
[z-18] In Ashirvad Ispat Udhyog and others v. State
Level Committee and others, 112, Sales Tax Cases,
207, the Supreme Court held in context of the
provisions of Section 2 (j) and (12) of the
Madhya Pradesh General Sales Tax Act, 1958 that
when the appellants treated iron and steel scraps
of considerable bulk by cutting it down by
mechanical processes into pieces that might be
conveniently utilized in rolling mills and
foundries, such treatment making saleable goods
fell within the wide definition of "manufacture"
under Section 2 (j) of the said Act and the
appellants were entitled to the relief granted to
industrial units under the notification issued
under Section 12 of the Act.
[z-19] In Shri Balaji Mineral Grinding Industries v.
State of Madhya Pradesh, reported in 117 STC,
page 117, the Madhya Pradesh High Court held that
making of marble powder by manufacturing process
was an activity covered within the special
definition of "manufacture" given in Section 2
(j) of the Madhya Pradesh General Sales Tax Act,
1958.
[z-20] In ACTO v. Girrota Silica Udhyog, reported in 93
STC, page 280, the Rajasthan High Court held that
in view of the findings of the Tribunal that the
mineral was excavated from the mine in the form
of lumps, that red or yellow colour on the sides
of the lumps was removed and then they were
grinded, that the mineral water was thereafter
screened and graded etc., the assessees were
rightly considered to be manufacturers.
[z-21] In Deputy Commissioner of Sales Tax v. Coco
Fibres, reported in 80 STC 249, where green
coconut husk was soaked in saltish water for days
together and after decomposition, it was
subjected to beating by mechanical or manual
process, the coconut fibre produced in the
process was a distinct commodity known in
commercial parlance. It was held that the
respondent, a registered dealer was converting
coconut husk into fibre and, therefore, was
liable to tax at 4% on the purchase turnover of
coconut husk under Section 5A of the Kerala
General Sales Tax Act, 1963.
[z-22] In Kumar Rolling Mills Ltd. v. Commissioner of
Sales Tax, reported in 87 STD 222, the Madhya
Pradesh High Court held that conversion of one
category of iron and steel to another was
manufacture within the meaning of Section 2 (j)
of the Madhya Pradesh General Sales Tax Act,
1958.
V REASONING:
9. The controversy centres around the liability of
the assessees to deduct tax at source under Section
195(1) of the said Act on the usance interest as
stipulated in the Memorandum of Agreement between the
assessee, who was the buyer of the ship, and the
non-resident seller, who was the owner of the ship, as
mentioned in the contract. The question arose when the
assessee deducted the interest amount while computing its
income chargeable under the head "profits and gains of
business or profession" and on noticing that the interest
was paid under the written contract to the non-resident,
the assessing officer raised the issue and held under
Section 40(a) that such deduction of interest in
computing the income under the head "profits and loss of
business or profession" was not permissible since the sum
was payable outside India and no tax was paid thereon,
nor any deduction of tax made at source as required by
Chapter XVII-B of the Act. The provision of section 40
of the Act, to the extent relevant, reads as follows :
"Sec.40 Amounts not deductible.
40. Notwithstanding anything to the contrary
in sections 30 to 38, the following
amounts shall not be deducted in
computing the income chargeable under the
head "Profits and gains of business or
profession",--
[a] in the case of any assessee--
[i] any interest (not being interest
on a loan issued for public subscription
before the 1st day of April, 1938),
royalty, fees for technical services or
other sum chargeable under this Act,
which is payable outside India, on which
tax has not been paid or deducted under
chapter XVII-B:
Provided that where in respect of any
such sum, tax has been paid or deducted
under Chapter XVII-B in any subsequent
year, such shall be allowed as a
deduction in computing the income of the
previous year in which such tax has been
paid or deducted.
xxx xxx xxx xxx"
Thus, if interest expenditure in respect of which
deduction in computing income is claimed is payable
outside India, such interest expenditure can be claimed
only when the deduction of tax at source is made in
respect thereof.
9.1 Section 9 of the Act enumerates the income which
shall be deemed to accrue or arise in India. Clause
(v)(b) of sub-section (1) of section 9, which came to be
inserted with retrospective effect from 1-4-1982 by the
Taxation Laws (Amendment) Act, 1984, laid down that the
income by way of interest payable by a person who is
resident shall be deemed to accrue or arise in India,
except where the interest is payable in respect of any
debt incurred or moneys borrowed and used, for the
purposes of a business or profession carried on by such
person outside India. Therefore, in all cases, where the
income by way of interest payable by a resident does not
relate to carrying on business outside India or earning
of income from outside India, such income payable by way
of interest would be deemed to accrue or arise in India.
In other words, whereever income by way of interest may
be payable by the resident, it shall be deemed to accrue
or arise in India, that is the source of such income will
be from India even if it is payable outside India, and
this is the deeming fiction adopted to make such income
payable by way of interest by the resident to a
non-resident outside India as if it had accrued or arisen
in India. Such interest income which is deemed to accrue
or arise to the non-resident in India in a previous year
will be a part of the total income of that previous year
of such non-resident by virtue of section 5(2)(b) of the
said Act. Under sub-section (2) of section 5, not only
income received or deemed to be received in India by or
on behalf of the non-resident, but also income that
accrues or arises or is deemed to accrue or arise to him
in India during the previous year is to be included in
the total income of the non-resident for such previous
year. Explanation 2 to section 5 makes it clear that
income which has been included in the total income of a
person on the basis that it has accrued or arisen or is
deemed to have accrued or arisen to him, shall not again
be so included on the basis that it is received or deemed
to be received by him in India. Thus, all income from
whatever source derived whether actually received or
deemed to have been received or whether actually accrued
or arisen or deemed to have accrued or arisen to a
non-resident in India in a previous year, will be
considered to be a part of his "total income" in respect
of which income tax shall be charged for that year, as
envisaged by section 4(1) of the Act. Section 4(2)
specifically provides that, in respect of the income so
chargeable under sub-section (1), income tax shall be
deducted at source or paid in advance where it is so
deductible or payable under the provisions of the said
Act.
9.2 The provisions of section 9(1)(v)(b) read with
section 5 (2) and section 4(1)(2) leave no room for doubt
that the income payable by way of interest by a resident
to a non-resident (which is not payable for the purpose
of carrying on the business of such resident outside
India or for earning income from any source outside
India) would be deemed to have accrued or arisen to such
non-resident in India, and will be part of his total
income that would be chargeable to income tax which shall
be deducted at source or paid in advance when it is so
deductible at source or payable in advance under the
provisions of the Act. If the controversy that the
interest payable under the MOA to the non-resident by the
assessee is not interest but a part of the price of the
ship purchased by the resident is kept apart for the
time-being and the amount specified as interest in the
MOA is treated as interest payable under the contract by
the resident - assessee to the non-resident in respect of
deferred payment of price, such interest payable to the
non-resident would be income deemed to have accrued or
arisen to the non-resident in India under Section
9(1)(v)(b) and would be chargeable to income tax under
Section 4(1) read with section 5(2) of the Act. If that
be so, income tax thereon would be deductible at source
under Section 195(1) of the Act which, inter alia,
provides that any person responsible for paying to such
non-resident any interest chargeable under the provisions
of the Act (not being the income chargeable under the
head "salaries"), shall, at the time of credit of such
income to the account of the payee or at the time of
payment in cash or by the issue of a cheque or draft or
by any other mode, whichever is earlier, deduct income
tax thereon at the rates in force.
9.3 Under the MOA, the assessee was responsible for
paying to the seller non-resident, the amounts specified
therein for the purchase of the ship for demolition
purposes. The assessee was responsible for paying both
the amounts of the two separate invoices, one of the
purchase price of the ship and the other of the interest
amount. The amounts payable under the MOA were payable
to the seller of the ship and not to the issuing bank of
the assessee that had issued the letter of credit, as per
the mode of payment stipulated in the MOA by the seller
and the buyer. The liability to deduct the tax at source
in such case would be of the assessee by whom the
interest was payable and not of the issuing bank that
issues the letter of credit. Such liability would arise
when credit entry is made on accrual basis in favour of
the non-resident in respect of such payable interest even
before the actual payment which is yet to follow. The
liability of the person responsible for the payment to
deduct the tax at source arises when credit entry is made
or when payment is made by cash or any other mode of
payment, whichever is earlier. The liability of the
assessee to deduct the tax from the interest so payable
cannot, therefore, depend upon any particular mode that
may be adopted by the buyer for making the payment. It
would not, therefore, be correct to argue, as has been
done, that, the assessee had paid the amount to the
issuing bank, which was not a non-resident, and
therefore, there was no obligation on the part of the
assessee to deduct the tax at source. No such automatic
shifting of responsibility in respect of interest payable
to the non-resident under the MOA entailing duty to
deduct tax at source and thereby shifting the obligation
to deduct such tax to the bank which issued the letter of
credit as a mode of payment of the amount by the
assessee, is contemplated by section 195(1) of the Act.
The amount was payable by the assessee as per the M.O.A.
and therefore, the liability to deduct the tax was that
of the assessee while making payment through the letter
of credit facility provided to the assessee by its bank.
If a person responsible for paying to the non-resident
the amount of interest chargeable under the Act considers
that the whole sum would not be chargeable, he has to
make an application to the assessing officer under
Section 195(2) of the Act. As held by the Supreme Court
in Transmission Corporation (supra), the provision of
section 195 under which the payer should deduct income
tax on the amount paid to a non-resident is for a
tentative deduction of income tax thereon, subject to
regular assessment and by the deduction of income tax,
the rights of the parties are not, in any manner,
adversely affected. The rights of the payee or recipient
are fully safeguarded under Section 195(2), 195(3) and
197 of the Act.
9.4 The effect of the deeming fiction that the income
by way of interest payable by a person who is resident
would be that the income deemed to accrue or arise in
India, as envisaged by clause (v)(b) of section 9(1),
will be treated to be arising in India irrespective of
its being paid any where outside India. Simply by virtue
of its becoming payable by the resident, the interest
income of the type covered by clause (v)(b) of section
9(1) will be deemed to be accruing or arising in India,
even if it is actually received by the non-resident
outside India. If it is permissible for a non-resident
receiving such interest income from a resident of India
to contend that he has actually been disbursed the amount
outside India and, therefore, such interest income did
not accrue or arise in India, the provisions of section
9(1)(v)(b) will become wholly redundant. Such income is
deemed to accrue or arise in India wherever it is payable
by a resident. This means that irrespective of its being
paid to the non-resident in the country of his residence
or else where outside India, it is deemed to have accrued
or arisen to him in India. Therefore, even if the sum
which was payable to the non-resident by the resident
assessee is paid by the mode of releasing a letter of
credit and received by the non-resident outside India
from the negotiating / intermediatory bank, such sum
would be nonetheless income deemed to be accruing or
arising to the non-resident in India. There is,
therefore, no substance in the contention of the two
learned Senior Counsel for the assessees that they had
paid the money to the banks issuing the letters of credit
and therefore, the assessees had not paid the sum to the
non-residents and hence, no deduction was required to be
made by the assessees under Section 195(1) of the said
Act.
10. It was argued by the learned Senior Counsel for
the assessees that the letter of credit is an independent
contract whereunder the issuing bank becomes the
principal obligor to the seller in respect of the payment
by letter of credit, and that the obligation of the buyer
gets discharged on the day L.C. is delivered and such
obligation taken over by the issuing bank is to be
discharged by it as a principal on the 180th day at the
end of the usance period. It was contended that if the
issuing bank fails to pay, the seller can have no remedy
against the buyer. In short, the interest amount was
paid by the buyer to the issuing bank and not to the
foreign bank or the seller which means no interest income
arose or accrued in India and the buyer was not obliged
to deduct tax therefrom under Section 195(1) of the Act.
The contention was that the issuing bank was not acting
as an agent of the buyer in effecting the payment under
the L.C. and was acting as a principal. These
contentions overlook the real nature of payment by a
letter of credit which is one of the internationally
recognized mode of payment through the banking medium for
paying the consideration for purchase of goods. The
letter of credit is a document issued by a bank as per
instructions by a buyer of the goods, authorizing the
seller to draw a specified sum of money under specified
terms, usually receipt by the bank of certain documents,
within a given time. In the present case, the MOA
between the buyer and the seller stipulated that the
payment was to be made by irrevocable letter of credit.
The letter of credit issued complied with the conditions
laid down in the MOA. The MOA did not specifically
provide that mere issue of credit shall be absolute and
final payment. Acceptance by the seller of a commercial
credit constituting absolute payment which would debar
him from his ordinary right to pursue the buyer if the
seller did not receive payment under the credit has to be
expressed in clear terms in absence of which the seller's
rights against the buyer are not exhausted by the issue
of credit (See "The Law of Bankers' Commercial Credit
(7th Edition) by H.L. Guttridge & Maurice Megrah at pp.
35 and 36). The purpose of the system of confirmed
irrevocable Documentary Credits developed in the
international trade is "to give to the seller an assured
right to be paid before he parts with control of the
goods" (See Lord Diplock's Speech in United City
Merchants (Investments) Ltd. and Glass Fibres and
Equipment Ltd. v. Royal Bank of Canada, Vitrorefuerzos
SA and Banco Continental SA, reported in (1982) 2 Llyod's
Report 1 H.L.) Thus, in absence of a specific "absolute
payment" clause when the letter of credit is issued and
accepted by the seller, it operates as a conditional
payment of the price (Lord Denning M.R. in W.L. Alan &
Co. (supra)). The buyer is not entitled to claim that
he has performed his entire bargain by furnishing the
required letter of credit and by remitting to the issuing
banker the funds necessary for making payment. He is not
discharged from his duty to pay the price to the seller,
because, the buyer promises to pay by letter of credit
and not just to provide by a letter of credit merely a
source of payment which does not pay. (See para 34.425
of Chitty on Contracts, 28th Edition, Volume 2 at page
354, citing Marun Road Saw Mill v. Austin Taylor Co. &
Ltd., reported in [1975]1 Lloyd's Report 156, 159; and
E.D. & F.. Man Ltd. v. Nigerian Sweets and
Confectionery Co. Ltd. reported in [1972] 2 Lloyd's
Report 50). When it is agreed in the contract of sale
that payment should be made by furnishing of a commercial
credit, the seller has to claim payment from the bank in
the first instance and only on the default being
committed by the bank, from the buyer. "Authorities both
in London and in the United States indicate that the
buyers' obligation to pay the price of goods is not
absolutely discharged by opening of the credit and that
upon the banker's default, the seller can claim payment
from the buyer" - (See para 34.423 at page 354 of Chitty
on Contracts, 28th Edition, Volume 2). The commercial
credit is addressed to the seller and states that, on the
instructions of the buyer, the banker authorizes the
seller to draw bills of exchange upto the stated amount.
The opening of a confirmed letter of credit constitutes a
bargain between the banker and the vendor of the goods,
which imposes upon the banker an obligation to pay on the
basis of mercantile usage recognized all over the world.
Irrevocable credit constitutes an independent contract
between the issuing banker and the seller, and it is not
qualified by or subject to the terms of the contract of
sale or the contract between the issuing banker and the
buyer. The autonomy of banks undertaking is usually
upheld by the courts' reluctance to interfere with the
banking arrangement except under the fraud rule or
illegality of the letter of credit itself, which
constitute exceptions to the autonomy doctrine. (See,
Chitty on Contracts paragraphs 34.433 to 34.437).
10.1 In order to avoid hard results from refusal to
recognize contracts for the benefits of third parties as
creating rights in the later, English Courts, as also
American Courts have been and are increasingly straining
to get away from the exclusive bargain theory and the
requirement of consideration. Dean Roscoe Pound in his
Jurisprudence, Volume III in Chapter 14 places fifteen
such exceptions under four different heads. Under
heading IV "Intention to be bound in a business
transaction" at page 212, in context of letters of
credit, points out that letters of credit though not upon
consideration are given effect when acted on, on the
theory of estoppel or sometimes on a theory of
consideration moving from a third person and the attitude
of the courts not to interfere with them having regard to
the norms adopted by the substantive institution of law
merchant, in the following terms;
"Letters of credit not under seal and not upon
consideration are given effect when acted on.
Sometimes this is done on a theory of estoppel,
sometimes on a theory of consideration moving
from a third person, and sometimes on a theory of
an independent transaction of the law merchant
requiring no consideration except between the
immediate parties. As has been well said,
"Throughout the cases we may note the courts
feeling, more or less subconsciously, that we
have here a substantive institution of the law
merchant, which ought to be sustained on its own
basis; and that whatever common law theories may
be convenient for the purpose are to be resorted
to in order to fortify it. It is significant
that no deliberate written promise of a business
man or commercial entity, made as a business
transaction, to answer for credit extended on the
basis of the writing has failed of enforcement in
our courts."
11. The letter of credit, in the present case, as is
usual, states that; "This credit is subject to the
Uniform Customs and Practice for Documentary Credits
(1993 Revision) - International Chamber of Law
Publication No. 500". Under Article 2 of the U.C.P.
(which applies to all Documentary Credits), Documentary
Credit means any arrangement, however named or described,
whereby the issuing bank at the request and on the
instructions of a customer-applicant, is to make a
payment to the third party beneficiary or to accept pay
bills of exchange (Drafts) drawn by the beneficiary, or
authorizes another bank to effect such payment or to
accept such Drafts, or to negotiate against stipulated
documents, provided that the terms and conditions of the
credit are complied with. By Article 3, it is made clear
that credits, by their very nature, are separate
transactions from the sale or other contracts on which
they may be based and banks are in no way concerned with
or bound by such contracts even if a reference whatsoever
to such contract is included in the credit.
Consequently, the undertaking of a bank to pay, accept
and pay drafts or negotiate and/or fulfill any other
obligation under the letter of credit is not subject to
claims or defences by the Applicant (buyer in the present
case), resulting from his relationship with the issuing
bank or the beneficiary (seller in the present case).
Under Article 9 of the U.C.P., an irrevocable letter of
credit constitutes a definite undertaking of the issuing
bank, provided stipulated documents are presented to the
nominated bank or the issuing bank, and that the terms
and conditions of the credit are complied with to pay, as
provided by sub-clause (a) of Article 9, on the maturity
dates determinable in accordance with the stipulations of
the credit, if the credit provides for deferred payment
(as in the present case), or to pay as per the
contingencies mentioned in other clauses. Under Article
18(a)(b) of the U.C.P., banks utilizing the services of
another bank for the purpose of "giving effect to the
instructions of the Applicant" (the assessee - buyer in
the present case), do so "for the account and at the risk
of such Applicant", and banks assume no liability or
responsibility should the instructions they transmit not
be carried out, even if they have themselves taken the
initiative in the choice of such other banks. By Article
18(d) of the U.C.P., it is made clear that the Applicant
- customer (the assessee - buyer in the present case),
shall be bound by and liable to indemnify the bankers
against all obligations and responsibility imposed by
foreign laws and usages. Even under the Uniform Rules
for Collection (ICC No.322), the customer entrusting the
operation of collection (which means handling by banks,
on instructions received, of documents as defined in the
definition clause which includes commercial documents),
is the "principal" under whose instructions the remitting
bank to whom the principal has entrusted the operation of
collection, will utilize the collecting bank "for giving
effect to the instructions of the principal" (i.e. the
customer) as provided in Article 3, and, "banks utilizing
the service of other banks for the purpose of giving
effect to the instructions of the principal do so for the
account of and the risk of the later". Under Article 4
of these Rules, banks concerned with collection assume no
liability or responsibility for the consequences arising
out of delay and / or loss in transit of letters or
documents.
11.1 The buyer, therefore, does not get absolved from
his contractual liabilities under the contract of sale or
from his statutory liabilities, such as, of making
deduction of tax at source under Section 195(1) of the
Act while making payment by the mode of a letter of
credit. The seller, in absence of any contrary
stipulations, accepts the mode of payment by a letter of
credit on an understanding that the Drafts drawn by him
on the letter of credit will be honoured. Issuance of
the confirmed irrevocable letter of credit is an
assurance to him that he will get the payment for the
goods sold by drawing on the letter of credit, but it
would be only a conditional payment, the condition of its
acceptance being that the amount will be realised on the
basis of the credit released in his favour. There was no
stipulation in the MOA that the letter of credit by
itself was accepted by the seller as an "absolute
payment". It was therefore a conditional payment and in
such a case, when by reason of the dishonour of the
drafts drawn by the seller on the letter of credit or the
failure of the letter of credit, the condition on which
the letter of credit was received by the seller is not
fulfilled, the seller would be an "unpaid seller" within
the meaning of section 45(1)(b) of the Indian Sale of
Goods Act (similar to section 38(1)(b) of the U.K. Sale
of Goods Act, 1979), and be entitled to claim the price
from the buyer under Section 55 of the Indian Act
(similar to section 49 of the U.K.Act), and his remedies
against the goods would revive.
11.2 The issuing bank acts at the request and on the
instructions of the buyer and thereby acts on behalf of
the buyer to pay the seller the amount on presentation of
the documents as per the stipulations in the letter of
credit. It is only a banking arrangement to effect
payment and has nothing to do with the statutory
obligations of the buyer which continue to bind the buyer
in respect of the income by way of interest and other
sums that are deemed to accrue or arise in India in
favour of the non-resident seller. The contention that
obligation of the buyer was taken over by the issuing
banker when the letter of credit was delivered and
therefore, there was no duty on the part of the buyer to
make deduction at source of the tax under Section 195(1)
of the said Act is, therefore, misconceived and
unwarranted.
12. Then comes the contention that if the sum paid by
release of the letter of credit to the non-resident is to
be deemed to be income accrued or arisen to him in India,
then it was not in fact "interest" and was part of the
price of the ship purchased and therefore, no tax was
required to be deducted from such amount under Section
195(1) by the buyer. The argument runs thus: The amount
of usance interest though described as interest in the
MOA was not interest as contemplated by section 2(28A) of
the Act. The price of the goods would consist of costs
of material, labour costs, costs of finance and profit.
Though price would be the sum total of these items,
payment made for the goods is not payment towards any of
the components that go in to the fixation of the price.
It is submitted that the MOA itself recognizes interest
as a part of the purchase price by making the whole
amount payable thereunder, including the so called
interest, at the end of the usance period of 180 days.
When the principal amount of the price of the ship itself
was payable at the end of 180 days from the date of
delivery, no price was due and payable on the date of
delivery and therefore, there could arise no question of
interest to start running from that date, argued the
learned Senior Counsel. The interest amount was fixed
and made payable alongwith the price of the ship at the
end of the usance period and the buyer had no option to
pay it earlier and therefore also, it was, in fact, not
interest and was part of the full purchase price, which
was for convenience sake, split-up into two invoices, one
of the purchase price and the other of the usance
interest, according to the learned Senior Counsel.
Moreover, in the event of breach of contract on the part
of the buyer, for computing damages, the measure
stipulated was the basis of the entire amount payable as
purchase price, which according to the learned counsel,
showed that the interest was part of the price of the
ship.
12.1 The MOA dated 14th July 1994 by which the ship
"Global Hope" was purchased by the buyer for demolition
from the non-resident seller incorporates the following
conditions as regards the price and its payment in
clauses (1) and (2) :
"1. PRICE : U.S. $ 66.06 per long ton
(excluding of interest for 180 days from the date
of tendering NOR) of light displacement tunnage
excluding permanent ballast, net L.D.T. being
18483.78 long tons excluding permanent ballast.
Total price : US $ 30,69,416.51 (United States
Dollars Three Million Sixty Nine Thousand Four
Hundred Sixteen and Cents Fifty One Only) and
interest for 180 days from the date of NOR
7.25% per annum, separate invoice and drafts to
be prepared for the original price and for the
interest amount.
2. The total amount with interest shall be
payable :-
By means of 100 per cent confirmed
irrevocable 180 days usance letter of
credit with confirmation charges at
seller's cost and acceptable to sellers
through any nationalised Indian bank
(hereinafter called the Opening Bank) to
be established in favour of the sellers
for the nett amount by 19th September,
1994."
Thus, original price of the ship fixed was US $
30,69,416.51 (excluding interest). The interest for 180
days from the date of tendering the Notice of Readiness
(NOR) was calculated at the rate of 7.25% on the said
original price of the ship from the date of the NOR. The
invoices and drafts of the original price and the
interest amount were to be separately prepared and were
in fact separately prepared. The commercial invoice
certified the details of the vessel and its purchase
price at US $ 30,69,016.51 as per the MOA dated 14-7-1994
(See page 30 of the appellant's paper book - similar
commercial invoice of two other ships at pp. 33 and 34
of paper book 1 in Tax Appeal No. 348 of 2002). It will
also be seen that, admittedly, the buyers paid customs
duty on the purchase price of the ship excluding the
interest amount. Thus, not only the invoices of the
purchase price of the ship and the interest amount were
to be separately prepared, the customs duty which was
payable for the buyers account as per clause (21) of the
MOA was paid on the purchase price of the ship excluding
interest. The intention of the parties to the contract
was, thus, clear and the price of the ship was considered
to be separate as certified in the invoice, which
reflected its price agreed in the MOA, and, the buyer in
lieu of the credit facility of 180 days from the date of
the NOR was required to pay interest at the rate
stipulated in the MOA and worked out thereunder for which
a separate invoice was prepared. It is also significant
to note that the price of the ship was separately
calculated on the basis of US $ 166.06 per long ton in
the MOA relating to `Global Hope' and the total price of
net L.D. Tonnage of 18,483.78 was worked out at that
rate to be US $ 30,69,416.51. The interest amount was
worked out on that total price and the interest rate and
time of 180 days fixed for the credit facility. This
means that there was no nexus between the interest amount
and fixation of the price of the ship which was on
tonnage basis. The nexus of interest was only with the
period from which the purchase price of the ship became
due on Notice of Readiness or Delivery. In clauses 15(D)
to 15(E) of the MOA, measure of damages due to default of
the buyer in payment or the seller in the execution of
the bill of sale or in delivery was fixed at 20% of the
purchase price of the ship, which as per the commercial
invoice dated 22-9-1994 was US $ 30,69,416.51 as per the
MOA dated 14-7-1994 and as certified by the seller in
that invoice. This clearly indicates that interest
amount covered under the separate invoice was not a part
of the purchase price though it was payable alongwith the
purchase price by means of 180 days usance confirmed
irrevocable letter of credit. The plea that the usance
interest amount should be treated as part of the price
is, therefore, clearly an afterthought of these buyers
and cannot be countenanced being against their positive
conduct and terms of the contract of sale.
13. As per clause (2) of the MOA, the total amount
with interest was payable by confirmed irrevocable 180
days usance letter of credit with confirmation charges at
seller's costs and acceptable to sellers through any
Nationalized Indian Bank, to be established in favour of
the sellers for the net amount by 19-9-1994. The letter
of credit was to be released to the sellers "immediately
after the Notice of Readiness had been given by the
buyers and upon presentation to the negotiating bank of
the documents mentioned in clause (3), which included
signed commercial invoice certifying details of the
vessel and the purchase price of US $ 30,69,416.51 and a
signed invoice for the interest amount of US $
1,09,742.15 for 180 days usance from the date of NOR, as
was stipulated in the MOA dated 14-7-1994. In clause (6)
of the MOA, it was stipulated that the vessel with
everything belonging to "Her" shall be at seller's risk
and expenses, until she is delivered to the buyer. If
before delivery the vessel became "total constructive
loss", the contract was to be considered as null and void
and the letter of credit to be immediately released to
the buyers as per clause (14) of the MOA. These
stipulations show that the purchase price became payable
on the delivery being effected as per the NOR when the
risk passed to the buyer. Under Section 20 of the U.K.
Sale of Goods Act, 1979 (similar to section 26 of the
Indian Act), the property in the ship was transferred to
the buyer, prima facie with the passing of the risk.
14. The definition of "interest" in section 2(28A) of
the Act was inserted w.e.f. 1-6-1976 by the Finance Act,
1976. `Interest' means interest payable in any manner in
respect of any moneys borrowed or debt incurred
(including a deposit, claim or other similar right or
obligation) and includes any service fee or other charge
in respect of the moneys borrowed or debt incurred or in
respect of any credit facility which has not been
utilized. The meaning of the word "interest" is, thus,
very wide and would include interest on unpaid purchase
price payable in any manner which would include payable
by means of irrevocable letter of credit. The claim of
the seller to the price of the goods sold normally arises
when the property is transferred to the buyer. The
seller gets a right to get the price of the goods and the
buyer has a corresponding obligation to pay it, both as
per the contract of sale and under the law. Therefore,
debt is incurred by the buyer of the purchase price which
he is obliged to pay. The debt arises from the
unwillingness or inability to pay cash down when the
purchase price becomes payable against delivery, and the
engagement to pay it at a later date or by installments.
(See Jurisprudence by Roscoe Pound, Part III, at p.
176).
14.1 Under Section 28 of the U.K. Sale of Goods Act,
1979 (corresponding to Section 32 of the Indian Act),
unless otherwise agreed, delivery of goods and payment of
the price are concurrent conditions. The seller gets a
right to sue for the price when property in goods has
passed under Section 49 of the English Act (similar to
section 55 of the Indian Act). Thus, when the price
became payable on transfer of the property in the ship
when the risk passed on delivery, the seller became
entitled to the purchase price payable by the buyer to
him and in respect of such debt incurred, interest at the
stipulated rate for the usance period was calculated from
the date of the transfer of the property in the ship to
the buyer till the end of the period of credit facility
of 180 days given to the buyer for effecting the payment
of the purchase price. When the price of the ship which
became due on the property being transferred was to be
paid under the contractual arrangement at the end of the
usance period of 180 days and interest was calculated
thereon, by the very nature of such contractual
arrangement, both the principal amount and interest
calculated for the credit period fixed were required to
be paid together as per the usance letter of credit.
When payment is made by negotiable instrument or by a
letter of credit which is normally regarded as
conditional payment, only the remedy of the seller to sue
for price is suspended and not his right or claim to the
price of the goods, which arises on the transfer of
property in the goods.
14.2 In England, statutory interest may be payable
under the Late Payment of Commercial Debts (Interest)
Act, 1998 on debt created by virtue of obligation to pay
the whole or part of the contract price. Under Section 1
of the Act, it is provided that it is an implied term in
a contract to which the Act applies that any qualifying
debt created by the contract carries simple interest.
Such statutory interest shall be treated, for the purpose
of any rule of law or enactment relating to interest on
debts, in the same way as interest carried under an
expressed contractual term. That Act applies to a
contract of sale of goods and section 3 thereof provides
that a debt created by virtue of an obligation under such
contract to pay the whole or any part of the contract
price is a "qualifying debt" for the purposes of the Act.
Even under Article 78 of the United Nations Conventions
on Contracts for the International Sale of Goods Act,
1980 (CISG), if a party fails to pay the price or any
other sum that is in arrears, the other party is entitled
to interest on it without prejudice to any claim for
damages recoverable under Article 74 thereof. Under
Article 53 of that Convention, the buyer must pay the
price for the goods and take delivery of them as required
by the contract and the said Convention. By Article 54,
it is provided that the buyer's obligation to pay the
price includes taking such steps and complying with such
formalities as may be required under the contract or any
laws and regulations to enable payment to be made. Under
Article 59, the buyer must pay the price on the date
fixed by or determinable from the contract and the
Convention, without the need for any request or
compliance with any formality on the part of the sellers.
By Section 54 of the English Sale of Goods Act and
Section 61 of the Indian Act, the right of the buyer or
the seller to recover the interest is saved. Under
Section 61(2), in absence of a contract to the contrary,
the Court may award interest at such rate as it thinks
fit on the amount of the price to the seller in a suit by
him for the amount of the price, from the date of the
tender of goods or from the date on which the price was
payable. We may note that the word "debt" is defined in
section 2(c) of the Interest Act, 1978, inter alia, to
mean any liability for an ascertained sum of money. The
price payable under the MOA for the ship was an
ascertained sum of money which the buyer had undertaken
to pay for the purchase of the ship. Thus, it would be
too farfetched to urge that unpaid purchase price of sale
of goods is never a debt incurred and no interest can
accrue thereon. Here, the contract of sale itself has
considered the purchase price of the ship as payable on
delivery after Notice of Release, and that is why the
interest is computed at the rate agreed for the usance
period of 180 days being the credit facility given to the
buyer. Such contractual arrangement is perfectly valid
and the parties have themselves stipulated payment of
interest on the purchase price of the ship considering it
to be a debt incurred by the buyer from the date of
delivery when the risk passed to the buyer and with it,
the property in the ship.
15. Furthermore, as per the Accounting Standards,
revenue from sale of goods is recognized when the seller
transfers the goods to the buyer for consideration.
Under the International Accounting Standard 18 relating
to revenue recognition, revenue should be recognized in
sale of goods when:
(i) Significant risks and rewards of ownership are
transferred to the buyers,
(ii) Managerial involvement and control have passed,
(iii) The amount of revenue can be measured thereby,
and,
(iv) the costs of the transaction (including future
costs) can be measured reliably.
Interest revenue is recognized on a time
proportionate basis using the effective interest rate.
Accounting Standard 9 issued by the Institute of
Chartered Accountants of India of "revenue recognition"
relating to transactions involving sale of goods as
contained in paragraphs 10 and 11 read as under :
"10. Revenue from sales or service
transactions should be recognised when
the requirements as to performance set ut
in paragraphs 11 and 12 are satisfied,
provided that at the times of performance
it is not unreasonable to expect ultimate
collection. If at the time of raising of
any claim it is unreasonable to expect
ultimate collection, revenue recognition
should be postponed.
11. In a transaction involving the sale of
goods, performance should be regarded as being
achieved when the following conditions have been
fulfilled:
(i) the seller of goods has transferred to
the buyer the property in the goods for a
price or all significant risks and
rewards of ownership have been
transferred to the buyer and the seller
retains no effective control of the goods
transferred to a degree usually
associated with ownership; and
(ii) no significant uncertainty exists
regarding the amount of the consideration
that will be derived from the sale of the
goods.
xxx xxx xxx"
Interest revenue is to be recognized on the
following basis as per para 13 of Accountant Standard 9 :
"13. Revenue arising from the use by others of
enterprise resources yielding interest,
royalties and dividends should only be
recognised when no significant
uncertainty as to measurability or
collectability exists. These revenues
are recognised on the following bases.
(i)Interest: on a time proportion
basis taking into account
the amount outstanding
and the rate applicable;
xxx xxx xxx"
15.1 It is obvious that if the payment of the sale
price of the ship which was revenue to be recognized at
the time of transfer of "significant risks and rewards of
ownership" to the buyer was to be made at the deferred
date, the buyer would be entitled to use the amounts due
to the seller for the usance period, and interest accrued
thereon on the time basis determined by the amount of the
price outstanding and the rate applicable which were duly
worked out in the contract itself. The parameters, that
is, time proportion, the amount of the purchase price of
the ship which became outstanding when the property in
the ship was transferred to the buyer on delivery with
all risks and the rate of interest were all agreed
between the parties and interest amount was specifically
worked out on the purchase price of the ship for the
usance period. These are not the cases where the total
amount payable under the MOA included a mere estimate of
interest loss made as an integral part of the purchase
price on incremental basis. These are the cases in which
there exist conscious and deliberate stipulations of
purchase price of the ship and the interest amount
specifically calculated at the agreed rate for the period
fixed. Thus, there is absolutely no scope for contending
that the outstanding price of the ship was not a "debt
incurred" within the meaning of section 28A of the said
Act or not a "debt claim" under the Article concerning
taxation of interest in the Double Taxation Avoidance
Agreements, on the date of delivery or that the interest
payable thereon under the contract was part of the
purchase price or incremental price of the ship, as
contended on behalf of the assessees.
15.2 The observations of the Supreme Court in Keshav
Mills Ltd. (supra), to the effect that the relationship
of the vendor and the purchaser is not metamorphosed in
to that of creditor and vendor cannot be construed to
mean that outstanding unpaid purchase price of the goods,
is not a debt. All that the Supreme Court has said is
that the vendor vendee relationship is not metamorphosed
into creditor and debtor, meaning thereby, that it is not
totally transformed into a creditor and debtor
relationship. This only means that their rights and
liabilities as vendor and vendee continue to exist even
after the debt becomes outstanding. That is why, it was
held that the vendor could not say that he is under no
further obligation to the purchaser and that the
purchaser must pay the price of the goods debited to him
as a debt arising out of the book entry. The Supreme
Court, while explaining the mercantile system of
accounting held that it brings into credit, what is due,
immediately becomes legally due and before it is actually
received and it brings into debit expenditure amount for
which a legal liability has been incurred before it is
actually disbursed. Distinguishing Keshav Mills Ltd.
(supra), the Supreme Court in Standard Triumph Motor
Company Ltd. v. C.I.T., reported in 201 ITR 391, held
that the credit entry to the account of the non-resident
assessee in the books of account of the Indian Company
would amount to receipt by the non-resident company and
is accordingly taxable.
16. The last limb of the argument that the assessee
was not liable to deduct tax at source on the interest
payable to the non-resident under the MOAs, was that such
amount was not interest within the meaning of the DTAAs
and was part of business profit of the non-resident and
therefore, taxable in the other contracting States. The
DTAAs, between India and Great Britain, and, India and
Singapore, copies of which are at items 8 and 9 of the
paper book of the appellant in Tax Appeal No. 273 of
2002 and which appear in 209 ITR (Statutes) at page 1
(with Singapore); and 206 ITR (Statutes) at page 235
(with United Kingdom of Great Britain, (Similar DTAAs are
with U.S.A. in 178 ITR (Statutes) 44, Germany in 223 ITR
(Statutes) 130, United Arab Emirates 205 ITR (Statutes)
49, Cypress in 218 ITR (Statutes) 70, and Belgium in 228
ITR (Statutes) 79), provided in the Article concerning
the taxation of business profits that the business
profits of an enterprise of a contracting State shall be
taxable in that State unless non-resident carries on
business in the other contracting State through a
permanent establishment situated therein. It is,
however, specifically mentioned that "where profits
include items of income which are dealt with separately
in other Articles of the Agreement, then the provisions
of those Articles shall not be affected by the provisions
of this Article". Article 11 of the DTAA with Singapore
and Article 12 of the DTAA with the U.K. deal with
"Interest" and provide in Clauses (1) and (2) that
interest arising in a contracting State and paid to a
resident of the other contracting State may be taxed in
that other State. However, such interest may also be
taxed in the contracting State in which it arises, and
according to the laws of that State, but if the
beneficial owner of interest is resident of the other
contracting State, the tax so charged shall not exceed
the percentage of the gross amount of the interest
specified therein. The term "interest" as used in these
Articles of the said two Agreements means "income from
debt claims of every kind, whether or not secured by
mortgage and whether or not carrying a right to
participate in the debtor's profits." (emphasis added).
The relevant part of the said Article concerning taxation
on interest contained in the DTAAs reads as under :
"Art.11: Interest:
1. Interest arising in a Contracting State
and paid to a resident of the other
Contracting State may be taxed in that
other State.
2. However, such interest may also be taxed
in the Contracting State in which it
arises, and according to the laws of that
State, but if the beneficial owner of the
interest is a resident of the other
Contracting State, the tax so charged
shall not exceed:
(a) 10 per cent of the gross amount
of the interest if such interest
is paid on a loan granted by bank
carrying on a bona fide banking
business or by a similar
financial institution (including
an insurance company);
(b) 15 per cent of the gross amount
of the interest in all other
cases.
3. The term "interest" as used in this
Article means income from debt-claims of
every kind, whether or not secured by
mortgage and whether or not carrying a
right to participate in the debtor's
profits; and in particular, income from
Government securities and income from
bonds or debentures, including premiums
and prizes attaching to such securities,
bonds or debentures. Penalty charges for
late payment shall not be regarded as
interest for the purpose of this Article.
xxx xxx xxx"
17. The DTAAs follow the pattern of the Organization
of Economic Cooperation and Development (OECD) Model
Convention. The Model Convention has been used by the
covenanting States as a basic document of reference while
entering into such bilateral treaties. Such double
taxation avoidance treaties are international agreements.
Section 90 of the said Act enables the Central Government
to enter into such Agreement with the government of
another country, inter alia, for relief where income tax
is paid in both countries or for avoidance of double
taxation. Under sub-section (2) of section 90, it is
provided as under :
"Agreement with foreign countries :
"90.
(1) xxx xxx
(2) Where the Central Government has entered
into an agreement with the Government of
any country outside India under
sub-section (1) for granting relief of
tax, or as the case may be, avoidance of
double taxation, then, in relation to the
assessee to whom such agreement applies,
the provisions of this Act shall apply to
the extent they are more beneficial to
that assessee."
By virtue of sub-section (2) of section 90, the
provisions of the Income Tax Act will apply to the extent
they are more beneficial to the assessee. This would
mean that the provisions of the Agreement will apply and
if the provisions of the Act are more beneficial than the
provisions of the DTAA, then those more beneficial
provisions will apply. Impact of this provision is to
make treaty prevail over the Act with an additional
advantage of applying more beneficial provisions of the
Act.
17.1 A formula reserving the exclusive taxation of
interest to one State, whether the State of the
beneficiary's residence or the State of source was not
sure of general approval. Therefore, Article 11 of the
Model Convention concerning the taxation of interest
adopted a compromise solution providing that interest may
be taxed in the State of residence but leaves to the
State of source of income the right to impose a tax, if
its laws so provide, it being implicit in this right that
the State of source is free to give up all taxation on
interest paid to non-residents. Its exercise of this
right will however be limited by a ceiling which its tax
cannot exceed. (See OECD Commentary on Article 11 of the
Model Convention - Preliminary remarks in para 11C.03).
18. As per OECD Commentary (para 11C.06), the term
"paid" in paragraph 1 of the Article concerning taxation
of interest has a very wide meaning "since the concept of
payment means fulfilment of the obligation to put funds
at the disposal of the creditor in the manner required by
contract or by custom". Payment would therefore mean the
fulfilment of the claim to receive interest in whatever
form it may actually occur (See Klans Vogel on Double
Taxation Convention, 3rd Edition at page 714). Thus,
payment of interest by means of irrevocable letter of
credit by the buyer will be considered as an interest
paid to the seller. Article 11(2) of the Model
Convention lays down nothing about the mode of taxation
in the State of source. This Article does not deal with
procedural aspects of tax collection. It therefore
leaves that State free to apply its own laws and, in
particular, to levy tax either by deduction at source or
by individual assessment. Referring to the definition of
"interest" in para 3 of Article 11 of the Model
Convention, which is the definition adopted in the DTAAs
between India on one side and U.K. and Singapore and
other countries on the other, the OECD Commentary in para
11C.21 records that the definition of `interest' is, in
principle, exhaustive and covers practically all the
kinds of income which are regarded as interest in the
various domestic laws and that the formula employed
offers greater security from the legal point of view and
ensures that Conventions would be unaffected by future
changes in any countries in domestic law." The expression
"debt claims of every kind" cannot, therefore, be
whittled down to mere debt claim in form of loans. The
addition of the words "including interest on deferred
payment of sales", in the parenthesis after the words
"debt claim of every kind" in the DTAAs with Indonesia
(reproduced in 171 ITR (Statutes) 27 at page 35) or the
words to the same effect in the DTAA with Philippines
(reproduced in 219 ITR (Statutes) 60, relevant page 71),
is, in our view, only explanatory and makes explicit that
what is implicit in the phrase "debt claims of every
kind", to prevent unnecessary arguments of the type
raised by these assessees. Even the Model Convention did
not contain such words that amplify the meaning of the
expression "debt claims of every kind". In the present
case, the purchase price of the ship became outstanding
on the date of its delivery and since it was not being
actually paid cash down against delivery, interest was
contractually charged thereon at the specified rate for
the usance period. Thus, by the very intention of the
parties reflected in the MOA and their conduct, the
interest amount was agreed to be paid treating the
purchase price as a debt claim that arose when the
purchase price became payable against delivery. The
contractual interest on the debt in the form of the
outstanding purchase price of the ship, which revenue was
to be recognized, as per the MOA and the provisions of
the Sales of Goods Act as well as Accounting Standards,
from the date of delivery of the ship, was the amount
that would aptly fall in the expression "debt claims of
every kind". This was not a case where the vendor gave
the goods to the buyers on credit at a lumpsum price to
be paid in future in which the interest element could not
be definitely identified, but it is a case where the
price became outstanding under the MOA on the date of
delivery and the interest was agreed to be paid on the
debt that was incurred in form of the unpaid purchase
price that was treated as debt outstanding. The
interest, in the present case, having regard to the
nature of contract and the intention of the parties
reflected from their conduct of treating purchase price
and interest separate for all purposes including payment
of customs duty and accounts, has no element whatsoever
of the selling price of the ship. The contention that
the interest payable to the non-resident under the MOAs
was part of the purchase price of the ship, therefore,
fails both on facts and in law.
19. The decision of the Andhra Pradesh High Court in
C.I.T. (A.P.) v. Vishakhapatanam Port Trust (supra) was
rendered in the context of liability to pay tax on the
basis of DTAA and the case of the German Company was that
it had no "permanent establishment" in India and
therefore, since section 9(1)(i) of the said Act was
subject to the DTAA, it was not taxable in India, but in
the other contracting State. The assessments in that
case related to the years prior to the introduction of
section 9(1)(v) in the Act w.e.f. 1-6-1976 under which
by a deeming fiction interest, such as usance interest
payable by a resident, would be deemed to accrue and
arise in India. Therefore, the said decision of the
Andhra Pradesh High Court cannot assist the assessees.
It will be noticed that Article VIII concerning taxation
on interest in the DTAA with Germany existing at that
time was worded differently from the Article concerning
taxation of interest of the revised Model Convention 77
and the DTAAs relevant to the present cases followed that
Model Convention which included the expression "debt
claim of every kind" in the Article concerning taxation
of interest which expression was absent in the said
clause VIII of the Agreement with Germany. The decision
of the Andhra Pradesh High Court was, therefore, rendered
in a different context. We are, however, for the
foregoing reasons unable to subscribe to the view that
the outstanding purchase price of goods is not a debt.
20. The Article of the DTAAs concerning the taxation
of interest does not deal with the procedural aspects of
tax collection. The mode of tax collection including by
deduction at source as provided under Section 195(1) read
with section 4(2) of the Act which enjoin a duty on these
assessees who were responsible for paying to the
non-residents usance interest, to deduct income tax
thereon at the time of credit to the payee's account or
at the time of payment by means by irrevocable letter of
credit whichever was earlier could be validly enforced
against them and having failed in making deduction of
income tax on the interest paid by them to the
non-residents, they cannot claim any deduction of the
amount in respect of such interest which was payable
outside India, in view of the provisions of section 40 of
the said Act. The finding of the Tribunal that the
assessees were not liable to deduct tax at source from
the said payment of interest and that disallowance of
interest under Section 40(a)(i) of the Act was not
warranted, is, therefore, obviously erroneous.
21. The reasoned order of the Tribunal on the
question whether ship breaking activity gives rise to
manufacture and production of altogether different
articles or things and hence, the applicant is entitled
to deduction under Section 80HH and 80I of the Act, which
has been followed by it in other cognate matters, is
contained in Tax Appeal No. 196 of 2001. The Tribunal
followed the decision of the Bombay High Court in Ship
Scraps Traders (supra) holding that the ship breaking
activity gives rise to manufacture and production of
altogether new commercial articles or things which are
commercially identifiable in the commercial world other
than the ship, and therefore, the assessees should be
held entitled to claim of deductions under Sections 80HH
and 80I of the Act. The Bombay High Court distinguished
its earlier judgement in C.S.T. v. Delhi Iron & Steel
Co. (supra) in which it was held that no process of
manufacture was involved when after purchase of an old
ship, the assessee dismantled the same and sold the scrap
material obtained from the dismantled ship. Even in ship
scraps Traders Case (supra), an old ship was bought for
the purpose of demolition and the ship was dismantled.
The Bombay High Court, however, distinguished its earlier
judgement on the ground that the ship was in that case
condemned and unserviceable. The Tribunal relied upon
the above judgement of the Bombay High Court, observing
that since the ships were new and in good working
condition because they remained afloat, it followed the
said decision.
22. New ships are not meant for demolition or
breaking. It is after the operative and useful life of
the ship is over that they are scheduled to be sold for
demolition. The procedure for demolition of a ship is
not just a private affair and involves permission of the
authorities under the law to transfer them for
demolition. Merely because the ship is able to sail on
its own upto the shore where it is to be demolished, it
cannot be said that such ship which is sold for
demolition is a new ship. Remaining afloat is not a sure
test for a ship to be called new, because, a condemned
ship is not always a sunk ship. An old ship sold for
demolition that manages to remain afloat cannot be said
to be a new ship. The distinction made on that count is
a distinction attempted without any real difference
between the old ships which are sold for demolition, for
the purpose of considering whether the ship breaking
activity is a manufacturing or production activity. The
contention of the learned counsel for the assessees was
that the activity of the ship breaking was a production
activity by which new articles came into existence by
dismantling the ship which was a systematic process
requiring skill and expertise and expensive machinery was
used for demolition of a ship. It was also attempted to
argue that ship breaking was a manufacturing activity and
for this, reliance was placed on several decisions in
Sales tax Cases which centered around the definition of
"manufacture" in the sales tax laws of various States.
Reference was also made to the Factories Act, 1948 to
point out that "breaking up or demolishing" any article
with a view to its use, sale etc. was, "manufacturing
process" as defined in section 2(k) of that Act.
Literature was shown for pointing out the type of
articles and things that come out of the broken old
ships. An ingenious argument was canvassed by the
intervening learned counsel that if by assembling
different articles (parts) one is said to manufacture an
automobile, then why should it not be considered as
manufacture when by the reverse process of disassembling
the automobile its parts are brought into existence. In
short, both the "birth" and the "death" of a ship should
be construed as manufacture or production activity. One
of integration into a ship and the other of its
disintegration into the articles that went into its
making. The assessees have the advantage of making these
arguments, because, the expression "manufacture and
production" of articles or things is not defined for the
purposes of sections 80HH or 80I of the Act. The cases
based upon sales tax, factory or excise laws where there
is definition of `manufacture' or `manufacturing process'
will have to be viewed in the context of and purposes
underlying those laws and in light of the definition of
manufacture tailored to achieve those purposes.
23. By the nature of its very setting, one has to
construe the expression "manufacture or produce articles"
in sub-section (2)(i) of section 80HH and the expression
"manufactures or produces any article or thing not being
any article or thing specified in the list in the
Eleventh Schedule", appearing in section 80I(2)(iii) in
the context of the fact that the deduction under Section
80HH is meant to encourage establishment of new
industrial undertakings in backward areas when such
industrial undertaking `has begun or begins to
manufacture or produce articles' and in context of the
fact that section 80I is designed to encourage industrial
undertakings to manufacture or produce "any article or
thing, not being article or thing specified in the list
in the Eleventh Schedule". The Eleventh Schedule
enumerates articles such as steel furniture, office
machines and apparatus, gramophones, toilet preparations
etc. and things like aerated waters with blended
concentrations, confectionary or chocolates. The
excluded items give an idea of what is meant by the
legislature when it refers to "articles and things" in
section 80I(2) of the Act. If the contention of the
deceased is tested in context of an article of steel
furniture, such as, steel table which would fall in the
list of the excluded items in the Eleventh Schedule, the
result would be that the benefit of section 80I will not
be available while making a new steel table, but will be
claimed when that steel table is dismantled and cut into
scrap, on a specious plea that by the process of cutting
the table, new articles such as handles, rods and sheets
from which the table was made are brought into existence.
Provisions of Article 80HH or 80I are meant for the
benefit of industrial undertakings that carry out the
activity of manufacture or production of articles or
things and not for the scrap merchants who trade in
buying old articles or things and take out their parts to
sell them separately. All large scale junk dealers in
discarded old and scrapped vehicles who might fish out a
horn in working condition from such vehicle or pull out
its steering wheel or part of its engine that may have a
demand in the market of second hand spares will proclaim
themselves to be manufacturers or producers of articles
or things. No such startling result is intended by the
provisions of sections 80HH and 80I, having regard to
their underlying purpose of encouraging industries for
being set up for manufacture or production of new
articles or things. In fact, industrial undertaking
formed by transfer of machinery or plant previously used
for any purpose is disentitled to such benefits both
under sections 80HH (2)(iii) and 80I(2)(iii) of the Act.
24. Ship breaking is undoubtedly an industry in which
there is great earning potential despite environmental
hazards which have prompted the developed countries to
shun it and forward their vessels for demolition to the
countries where labour is cheap and concern for
environment and health hazards is yet to gather its due
momentum. The pollution aspects of ship breaking are
enumerated in para 2.13 of the Report of the Ferrous
Scrap Committee of the Government of India published in
August 1997 which was referred to by the learned counsel
for the assessees during their arguments. Recently,
criticism has been voiced in some rich OECD countries
that ship owners assume no responsibility for the often
very toxic substances long contained in their roughly 30
years old vessels. Instead, the owners sell the ship as
pure steel to Asia and make a good profit on this, while
fully aware that the unsuspecting people there will be
directly exposed to the hazardous substance; fully aware,
too, that the authorities there do not meet their
obligations to protect their citizens, be it out of
negligence or incapacity.(See "Ships for scrap steel and
toxic wastes for Asia. The health & environment hazards
in recepient States, fact finding mission to the Indian
Ship Breaking Yards in Alang and Bombay in October 1998"
Authors Dipl.-Ing, Judit Kanthak, Andreas Berrstorff,
published by Green Peace e.v. Hamburg, Germany).
24.1 The Regulations of the Gujarat Maritime Board
under the Gujarat Maritime Board Act, 1981, are the
regulations made for safety and welfare of workers as a
measure of precautions during the cutting operations in
the ship breaking yards and reliance on them does not
advance case of the assessees on the aspect of
manufacture or production. In fact, ship breaking
activities are defined in Regulation 2(viii) as, all
activities from beaching, cutting and other activities
till dismantling of the ship, and the despatch of the
dismantled materials from the ship breaking yard and not
as any manufacture or production activity.
25. The MOAs in the present matters clearly indicate
that the old ships were purchased by the assessees for
demolition purpose. The registration of the ships was
cancelled and the deletion certificate showing
cancellation of registration was to be forwarded to the
buyers as undertaken in para 3(viii) of the MOA dated
14-7-1994 of `Global Hope' and Part 3(vii) of the MOA
dated 15-10-1993 of Kraszovodsk. The vessels were sold
under these MOAs. "with everything belonging to her on
board" and for demolition. In para 24 of the MOA dated
14-7-1994, it was stipulated that "Buyers agreed and
warrant that vessel shall be broken up and not used for
further trading of any kind". Admittedly, all the
vessels purchased by the assessees of all these appeals
were for ship breaking activities i.e. for dismantling
them and removing dismantled material from the plots
allotted to them for the purpose.
26. The rates of customs duty payable on the vessels
imported for breaking up (which fall under item 8908 of
the Customs Tariff) was much lower (5%), than the rates
for other vessels (40%). The ships imported for breaking
up are obviously old ships, purchased to retrieve the
material, particularly steel plates, for disposal in the
market for re-rolling or re-cycling purposes which is not
the activity done by these ship breakers in the process
of ship breaking. The publication of Ferrous Scrap
Committee Report, Ministry of Steel, Government of India
entitled " Ship Breaking Industry present status in India
and its impact on environment", relied upon by the
learned counsel for the assessees (excerpts of which are
in the compilation in Tax Appeal No.196 of 2002) records
in para 02.05.02 that ship breaking consists essentially
the activities of preparation for breaking up (including
mouring / beaching), breaking down to big blocks, small
blocks and sections, with handling, hoisting, cutting and
shipping equipment. The sequence of ship breaking
activities generally followed in beaching methods is
enumerated in para 02.05.06, as under :
"Different methods of dismantling large ships and
for reclaiming metals from broken-up ships have
been evolved over the years in various countries
depending on the availability of
berthing/beaching facilities with a view to
achieve speed and ease of recovery.
xxx xxx xxx xxx xxx xxx"
02.06 THE SHIPBREAKING PROCESS AT ALANG :
xxx xxx xxx xxx xxx
The sequence of shipbreaking activities generally
followed in beaching method are :
* Ballast water, fuel oil and lubricants
that can be pumped out are removed.
* Super structure items like cabins,
furnitures, life boats, loose cables,
firefighting equipments, ladders, window
panes and frames, doors, fittings etc.
are dismantled.
* Stores and movable gears including
electrical navigation equipments nylon
and steel ropes shackles, pulley blocks,
tarpaulin, paint and lubricant tins,
machinery spares etc. are removed.
* Some of the winches, masts and derricks
which are useful to manipulate cutting
operations are removed.
* The ship hull is cut vertically into 3 to
10 ton blocks by oxygen-LPG torches. The
hull cutting area is first cleaned
manually by wire brushes and chippers
before cutting. If the plates are
rivetted, as in some ships aged more than
30 years, rivets are removed by
gas-cutting orches or hammer and chisels.
These blocks including those knocked down
on to the beach are removed to the shore
by winches.
* Auxilliary equipment of the prime mover
machinery like diesel generator sets,
boilers, air compressors, pumps, valves,
etc are dismantled and removed.
* The main engine is dismantled in parts
head, main block, piston, crankshaft and
base. Bigger chunks of the engine are
removed only when the engine room is
exposed after cutting bulkheads of the
hull.
* Bunker oil that cannot be pumped out in
the beginning and that is stored under
cargoholds is removed simultaneously with
the engine dismantling.
* The propeller is cut from its shaft and
removed.
* Large ships requiring deep draft even in
light displacement condition may need to
be rebeached by pulling the residual part
of hull closer to the shore during the
next high tide around the full moon day
or the new moon day.
xxx xxx xxx"
26.1 Under the heading Recovery of different items
from ship breaking, items obtained after breaking are
described as under :
02.08 RECOVERY OF DIFFERENT ITEMS FROM SHIP-BREAKING :
02.08.01 Items Obtained After Breaking
"Major items which are obtained after breaking
are rerollable scrap, melting scrap, cast iron
scrap, non ferrous metal, machinery, wooden
furnitures, etc. Though, the amount of these
items obtained on breaking varies with the size
(LDT) and type of ships, but an average figure
has been worked out based on questionnaire survey
and is given in Table 2-4.
Larger the size of the ship lesser will be the
percentage of non-ferrous metals, machinery,
wooden furniture and cast iron and accordingly
higher the percentage of re-rollable steel scrap.
Ships built from 1970s onwards will contain less
percentage of non-ferrous metals, machinery,
wooden furniture and cast steel and fibre glass."
27. Thus, there is nothing whatsoever in the process
of ship breaking activity which can be termed as
manufacture or production of any article or thing. The
dismantled material was already existing as a component
of the old ship. The process of extracting steel plates
from it while dismantling the ship will not make such
extraction of existing material an activity of
manufacture or production of such material nor will the
process of cutting extracted steel plates for convenient
disposal be manufacture or production of such steel
plates. Merely because the ship breaking is considered
as an industry, it would not be an industry engaged in
manufacture or production of any article or thing.
Benefit of the provisions of section 80HH and 80I is
clearly not intended for such ship breaking activities
which do not result in bringing into existence any new
article or thing. The word "manufacture" in the context
of sections 80HH and 80I of the Act would mean making of
articles or things. While dismantling the ship, steel
plates are not made but only removed which is not the
same thing as making of steel plates. The word
"production" in context of these provisions would mean
the action of making or manufacturing from components or
raw materials an article or thing and not just removing
existing article or cutting it. The Supreme Court in
Indian Poultry v. Commissioner of Income tax, reported
in (2001) 9 SCC 740, held, in context of section 80I,
that it was not possible to conclude that the dressing of
poultry is tantamount to manufacture. In Commissioner of
Income Tax v. Gem India Manufacturing Co., reported in
249 ITR 307, the Supreme Court held in context of Section
80I, that there can be little difficulty in holding that
the raw and uncut diamond is subjected to process of
cutting and polishing which yields the polished diamond,
but that is not to say that the polished diamond is a new
article or thing which is the result of manufacture or
production. In C.I.T. v. Venkateswara Hatcheries (P)
Ltd., reported in (1999) 3 SCC 632, the Supreme Court, in
context of sections 80HH, 80HHA, 80I and 80J, held that
the business of the assessee who was having poultry farms
and running a hatchery where eggs were hatched on a large
scale by adopting latest scientific and technological
methods was not an industrial undertaking nor was it
engaged in the business of producing "articles or things"
and therefore, the assessee was not entitled to
deductions under the said provisions. The Supreme Court
in paragraph 17 of the judgement demonstrated how
activity of the assessee was not an activity of
production of any article or thing in the following
terms;
"From a perusal of the self-stated steps taken by
the assessee for the alleged production of
chicks, it is clear that the assessee does not
contribute to the formation of chicks. The
formation of chicks is a natural and biological
process over which the assessee has no hand or
control. In fact, what the assessee is doing is
to help the natural or biological process of
giving birth to chicks. The chicks otherwise can
also be produced by conventional or natural
method and in that process also, same time is
taken when the chicks come out from the eggs.
What the assessee by application of mechanical
process does in the hatchery is to preserve and
protect the eggs at a particular temperature.
But the coming out of chicks from the eggs is an
event of nature. The only difference seems to be
that by application of mechanical methods, the
morality rate of chicks is less and the assessee
may get chicks more in number. This, however,
would not mean that the assessee produces chicks
and that chicks are "articles or things". We
are, therefore, of the opinion that the assessee
is neither an industrial undertaking nor does the
business of hatchery carried out by the assessee
fall within the meaning of section 32-A and
Section 80-J of the Act."
In the present case, application of mechanical
methods only removed the steel plates and other objects
which were existing on the ships, which would not mean
that the assessees produced those existing articles or
things by the process of removing and cutting them.
27.1 As held by the Supreme Court in C.I.T. v.
N.C.Budharaja (supra), the word "production" or "produce"
when used in juxtaposition with word "manufacture" takes
in bringing into existence new goods by a process which
may or may not amount to manufacture. It was held that
the principle of adopting a liberal interpretation which
advances the purpose and object of beneficial provisions
cannot be carried out to the extent of doing violence to
the plain and simple language of the enactment.
27.2 We are, therefore, unable to subscribe to the
view that ship breaking is an activity which gives rise
to manufacture and production of altogether new
commercial articles or things. We hold that the
assessees are, not entitled to claim deductions under
Sections 80HH and 80I of the Act and that the Tribunal
committed an error in upholding such deductions.
VI. DECISION:
28. For the foregoing reasons, we decide the above
questions of law formulated in these appeals as under:
[1] The usance interest paid by the assessees was not
any part of the purchase price of the ships and
was interest within the meaning of the definition
of the term `interest' under Section 2(28A) of
the Income Tax Act, 1961.
[2] The assessees who did not deduct tax at source
under section 195(1) of the Income Tax Act, 1961
on the usance interest payable outside India and
on which tax had not been paid, are not entitled
to deduct the amounts of such usance interest in
computing their income chargeable under the head
"profits and gains of business of profession".
The Tribunal was, therefore, wrong in deleting
the disallowance under Section 40(a)(i) of the
Act for failure on the part of the assessees to
deduct tax at source, from usance interest paid
to the non-residents, under Section 195(1) of the
Act.
[3] The assessees being responsible for paying to the
non-residents usance interest which was
chargeable under the provisions of the Income Tax
Act, 1961, were liable to deduct income tax
thereon under section 195(1) thereof. The
Tribunal was, therefore, wrong in holding that
the usance interest partook the character of
purchase price and therefore, not liable to
deduction at source under Section 195(1) of the
Act.
[4] Usance interest is `interest' within the meaning
of the Article concerning taxation of interest in
the relevant Double Taxation Avoidance
Agreements. The Tribunal was, therefore, wrong
in holding that usance interest was not
`interest' as envisaged in the Double Taxation
Avoidance Agreements.
[5] Ship breaking activity is not an activity for
manufacture or production of any article or thing
for the purposes of availing the benefit of
deductions under Sections 80HH and 80I of the
Income Tax Act, 1961. The Tribunal was,
therefore, wrong in holding that the ship
breaking activity gives rise to manufacture and
production of altogether new articles or things
and in allowing deductions under Sections 80HH
and 80I of the Act to the assessees.
29. The impugned orders of the Tribunal to the extent
they are challenged in these appeals are, therefore,
hereby set aside. All the appeals are accordingly
allowed with costs to be paid by the respondents
assessees to the appellants, quantified at Rs.10,000=00
for each appeal.
30. The learned counsel appearing for the assessees,
at this stage, pray for a Certificate of Fitness for
appeal to the Supreme Court under Section 261 of the
Income Tax Act, 1961. Though the learned counsel have in
this group of matters dilated the questions involved with
great emphasis, in our opinion, having regard to the
clear provisions of the Act, the D.T.A.As. and the facts
of the case there is no justification for issuance of any
such certificate. We, therefore, can not accede to the
request made by the learned counsel for the assessees for
certificate of fitness. The prayer made for staying the
operation of this order is not at all justified and is
rejected.
[R.K.ABICHANDANI, J.]
[A.L.DAVE, J.]
parmar*
|
