|
A. Facts of the Case
1. A company, engaged in the business of providing health and
beauty solutions, has almost 100 centers all over the country and
expanding further by opening new centers in various other locations.
For starting up a center, the company invests in leasehold
improvements and slimming and beauty equipments that are
necessary for providing services, and other electrical fittings,
furniture and office equipments.
2. The company takes the premises on rent, pays security deposit
which is equivalent to 6-10 months’ rent, develops the center within
a span of 3-5 months with the aesthetic interiors, cabins, beauty
salon area, gym floorings, etc. and thereafter, installs the necessary
equipments which are affixed with the specific workstation requirement, air conditioner and ducting plants, etc. According to
the querist, each project is being completed with the project period
of 3-5 months and with an investment ranging from Rs. 60 lakh to
Rs. 100 lakh depending upon the size of the carpet area covered
ranging from 2500 sq.ft to 5000 sq.ft. The capital expenditure has
been incurred on premises which are generally taken for nine
years’ lease with the extendable option with the lessee (the
company). The querist has informed that the capital expenditure
on leasehold improvements and equipments are capitalised and
allowed by auditors.
3. The querist has stated that the company develops 20 centers
in a year by investing almost Rs. 15-20 crore on fixed assets, such
as, leasehold improvements, equipments, etc. To fund these capital
additions, the company borrows from a bank by availing term loan,
the disbursement of which is based on the capital outlay/security
deposit paid by the company during the period. The term loan is
being disbursed on producing a Chartered Accountant’s certificate
certifying the assets introduced during the period. The company
pays a coupon rate of 10-13% (PLR linked) for the term loan
facility. Thus, the company has 20 projects during the year with a
gestation period of 3-5 months each and is spending 60-100 project
months with the capital outlay of Rs. 15-20 crore (emphasis supplied
by the querist).
4. The querist has informed that the company does not get the
disbursement in excess of the capital outlay and thus, does not
hold unutilised borrowed funds at any point of time and hence,
does not earn any interest/ return on the unutilised borrowed funds.
5. The querist has also stated that there is a practical difficulty
of not capitalising the interest. As per proviso to section 36(1)(iii)
of the Income-tax Act, 1961 (the Act), which reads thus:
“Provided that any amount of the interest paid, in respect of
capital borrowed for acquisition of an asset for extension of
existing business or profession (whether capitalised in the
books of account or not); for any period beginning from the
date on which the capital was borrowed for acquisition of the
asset till the date on which such asset was first put to use,
shall not be allowed as deduction.”
Thus, as per the querist, if the interest on borrowings for the
qualifying assets as per Accounting Standard (AS) 16, ‘Borrowing
Costs’, is not capitalised, the same shall be disallowed for the
purpose of income tax computation as per section 36(1)(iii) of the
Income-tax Act. Further, if interest on qualifying assets is not
capitalised as per AS 16, then there is disparity between the book
profit and profit for the purpose of income tax computation. Also,
arriving at the amount that is to be added back to the cost of asset
(as it is not allowed as deduction) to claim depreciation shall be
disputed by the Income-tax Department, as the calculation of the
same is not certified by the auditors and there is high risk that the
income-tax department shall disallow all the interest cost on the
term loans (i.e., interest expenses incurred for acquiring the assets
even after the assets were put to use).
6. The querist has informed that the query is only related to
capitalisation of interest cost on borrowings (till the centers are
operational) which is specifically raised for fixed assets additions.
B. Query
7. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(i) whether the capital addition of lease hold improvements
and equipments installed in 20 medium scale projects
with the capital outlay of Rs. 60-100 lakh each shall be
considered as ‘qualifying assets’ as defined under AS 16.
(ii) whether the project period of 3-5 months for developing
the centers shall be considered as ‘Substantial Period
of Time’ under the Accounting Standards Interpretation
(ASI) 1, Substantial Period of Time (Re. AS 16)2.
(iii) whether the interest cost on the amount borrowed for
payment of security deposit during the project period shall
be considered as ‘activity that is necessary to prepare
the asset for its intended use or sale in progress’ under
AS 16 and should be capitalised in the books of account.
C. Points considered by the Committee
8. The Committee notes from the Facts of the Case that the
basic issue raised in the query relates to whether the period of 3-
5 months taken for developing the centers can be considered as
‘substantial period of time’ as per the provisions of AS 16 and,
accordingly, whether, on that basis, an asset can be called as a
qualifying asset. The Committee has, therefore, answered only
this issue and has not touched upon any other issue arising from
the Facts of the Case, such as, allocation of borrowing costs over
various qualifying assets, etc. The opinion of the Committee
contained hereinafter is from the accounting point of view only,
and not from the point of view of income-tax considerations.
9. The Committee notes from the Facts of the Case that the
company is incurring various types of expenditure on development
of the centers. In the view of the Committee, the first and foremost
issue in the query is whether the expenditure results into creation
of an asset. In this regard, the Committee notes the definition of
the term ‘asset’ as contained in the Framework for the Preparation
and Presentation of Financial Statements, issued by the Institute
of Chartered Accountants of India, which states as follows:
“An asset is a resource controlled by the enterprise as a
result of past events from which future economic benefits are
expected to flow to the enterprise.”
10. From the above, the Committee is of the view that only that
expenditure in respect of which future economic benefits are
expected to arise and over which the enterprise has a control can
be considered as an asset. Accordingly, the expenditure that does
not result into creation of an asset (e.g., repair charges) should be
expensed and, therefore, it can not be considered as a qualifying
asset in the context of capitalisation of borrowing costs as per AS
16.
11. As far as the issue relating to determination of qualifying
asset is concerned, the Committee notes that in the context of the
query, there can be broadly two types of assets:
(i) assets which are ready to use when acquired, e.g., airconditioners, furniture, certain slimming and beauty
equipments, etc.
(ii) self-constructed assets, such as, cabins.
12. As far as the first type of assets, i.e., those which are ready to
use when acquired are concerned, in the view of the Committee,
these cannot be considered as qualifying assets within the meaning
of AS 16, although there may be some time lag between their
acquisition and actual use, in view of the definition of the term
‘qualifying asset’ and paragraph 5 of AS 16, as reproduced below:
“A qualifying asset is an asset that necessarily takes a
substantial period of time to get ready for its intended
use or sale.”
“5. Examples of qualifying assets are manufacturing plants,
power generation facilities, inventories that require a substantial
period of time to bring them to a saleable condition, and
investment properties. Other investments, and those
inventories that are routinely manufactured or otherwise
produced in large quantities on a repetitive basis over a short
period of time, are not qualifying assets. Assets that are ready
for their intended use or sale when acquired also are not
qualifying assets.”
13. As regards second type of assets, i.e., self-constructed assets,
the Committee notes that these can be considered as qualifying
assets only if these take substantial period of time to get ready for
intended use or sale thereof. In this context, the Committee notes
that the consensus portion of ASI 1 issued by the Institute of
Chartered Accountants of India, has been included as an
Explanation to the definition of the term ‘qualifying asset’ in AS 16,
‘Borrowing Costs’, notified by the Central Government under the
Companies (Accounting Standards) Rules, 2006, which provides
as follows:
Explanation:
“What constitutes a substantial period of time primarily
depends on the facts and circumstances of each case.
However, ordinarily, a period of twelve months is considered as substantial period of time unless a shorter
or longer period can be justified on the basis of facts and
circumstances of the case. In estimating the period, time
which an asset takes, technologically and commercially,
to get it ready for its intended use or sale is considered.”
14. On the basis of the above, the Committee is of the view that
ordinarily, 3-5 months cannot be considered as a substantial period
of time. The company should itself evaluate what constitutes a
substantial period of time considering the pecularities of facts and
circumstances of its case, such as nature of the asset being
constructed, etc. In this regard, time which an asset takes,
technologically and commercially to get it ready for its intended
use should be considered. Accordingly, the assets concerned may
be considered as ‘qualifying assets’ as per the provisions of AS
16.
15. As regards the borrowing costs incurred in relation to security
deposit made to acquire the premises on lease, the Committee is
of the view that the security deposit is made in respect of the
lease transaction and, accordingly, it is not directly attributable to
the activities necessary to make various assets ready for their
intended use, and accordingly, the payment of security cannot be
considered as ‘the activity necessary to prepare the assets for its
intended use or sale’ under AS 16 as is being argued by the
querist in paragraph 9(iii) above. In this connection, the Committee
also notes paragraph 6 of AS 16 which states as follows:
“6. Borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying
asset should be capitalised as part of the cost of that
asset. The amount of borrowing costs eligible for
capitalisation should be determined in accordance with
this Standard. Other borrowing costs should be
recognised as an expense in the period in which they are
incurred.”
Thus, in order to be capitalised, borrowing costs should be directly
attributable to acquisition, construction or production of a qualifying
asset. The test of directly attributable borrowing costs is that these
borrowing costs would have been avoided if the expenditure on the qualifying asset had not been incurred. In the present case,
the Committee notes that the security deposit would have to be
made to acquire the leasehold property irrespective of the fact
whether the improvements on the leasehold property had been
made or not. Thus, in the view of the Committee, the borrowing
costs incurred in relation to the security deposits cannot be
capitalised.
16. As far as the querist’s contention regarding practical difficulties
of not capitalising borrowing costs on account of proviso to section
36(1)(iii) of the Income-tax Act, as argued by the querist in
paragraph 5 above, is concerned, the Committee has not examined
that issue as in accordance with Rule 2 of the Advisory Service
Rules of the Expert Advisory Committee, the Committee does not
answer issues involving legal interpretation of various enactments,
such as, the Income- tax Act, 1961.
D. Opinion
17. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 7 above:
(i) The assets that are ready for their intended use when
acquired cannot be considered as ‘qualifying assets’.
However, self-constructed assets can be considered as
qualifying assets provided these take substantial period
of time as per the provisions of AS 16 as discussed in
paragraph 14 above.
(ii) Ordinarily, the project period of 3-5 months cannot be
considered as ‘substantial period of time’. However,
keeping in view the various factors peculiar to the facts
and circumstances of the case of the company it may
be considered as substantial period of time, as discussed
in paragraph 14 above.
(iii) The payment of security deposit cannot be considered
as the activity that is necessary to prepare the asset for
its intended use or sale. Moreover, the borrowing costs
incurred in relation to security deposit are not directly
attributable to the construction/acquisition/development of assets in the present case and, accordingly, the same
incurred during the project period cannot be capitalised,
as discussed in paragraph 15 above.
|