How to ascertain Actual Cost of Asset under Income Tax [Part-1]

Section 43 of the Income Tax Act is one of the most important provisions under the Act as it helps the assessee in deciding the ‘Actual Cost’ of any asset which in turn is a necessary factor for calculating depreciation as per Section 32. Our study in this article will not only be restricted to section 43 but simultaneously cover sections 43A, 43AA, and ICDS relating to foreign currency exchange fluctuations and their impact on the actual cost of assets. Let’s start…

Section-43(1) of the Income Tax Act

Meaning of Actual Cost

“Actual Cost” means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority.

Analysis:

Point-1:

According to section 43(1) for ascertaining ‘Actual Cost’, we have to look into the actual cost of the asset. It is also important that it should be the actual cost to the assessee.

For example, suppose a car has a fair market value of Rs. 5 Lakhs which Ram purchases from Shyam at a discounted price of Rs. 3 Lakhs. Thus, for the purpose of Income Tax, the actual cost of the asset (car) to Ram will be Rs. 3 Lakhs and not Rs. 5 Lakhs. The Fair Market Value of the asset is not relevant for deciding the actual cost of any asset u/s 43(1).

Point-2:

There might be a situation where a part of the cost of the asset is borne by any other person directly or indirectly. In such a case, the actual cost of the asset will be the value derived after deducting that part of the cost which is borne by any other person.

For example Ram purchased machinery for its newly set up factory for Rs. 10 Lakhs. Out of this, Ram got an investment grant against the machinery from the Government of Rajasthan equal to 25% of the cost of machinery. Therefore, the actual cost of the machinery to Ram will be Rs. 7,50,000 [10 Lakhs -25%].

Proviso to Section 43(1)

Provided further that

Where the assessee incurs any expenditure for the acquisition of any asset or part thereof
In respect of which a payment or aggregate of payments made to a person in a day,
Otherwise than by an account payee cheque drawn in a bank or an account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed exceeds Rs. 10,000
Such expenditure shall be ignored for the purposes of determination of actual cost.

Analysis:

The restrictions over cash payments in respect of revenue expenditures were already there in the Income Tax Act. This proviso has been introduced to discourage cash transactions even in the case of capital expenditure. The effect of the proviso is that the assessee cannot make a payment in cash of an amount exceeding Rs. 10,000 in a single day in respect of the acquisition of any asset.

Example: Ram purchases from Shyam machinery costing Rs. 5 Lakhs for use in his business. He makes payments in cash Rs. 150,000 on 01-01-2022, Rs. 180,000 in cash on 02-01-2022, Rs. 170,000 in cash on 03-01-2022.

In this example, the entire payment of Rs. 5 Lakhs has been made in cash exceeding Rs. 10,000 on a single day. Therefore, the actual cost of machinery shall be taken as ‘Nil’ for the purpose of the ‘Block of Assets’.

Further, you must know that accepting cash more than Rs. 2 Lakhs in respect of any transaction attracts a penalty u/s 271DA equal to 100% of the amount. Therefore, Shyam in this example will be liable for a penalty of Rs. 5 Lakhs (100% of cash accepted) u/s 271DA. Thus, the above transaction will have a tax impact on both Ram and Shyam as Ram will not be able to claim any depreciation on the machinery acquired and Shyam will be penalized u/s 271DA.

Let’s further elaborate the above example. Suppose Ram makes payment of Rs. 5 lakhs as below:

01-02-2022: Rs. 12,000 (5 times on same day)- Total Rs. 60,000

02-02-2022: Rs. 10,000 (5 times on same day)- Total Rs. 50,000

03-02-2022: Rs. 10,000

04-02-2022: Rs. 10,000

05-02-2022: Rs. 2,70,000 by account payee cheque

06-02-2022: Rs. 50,000 by self cheque

07-02-2022: Rs. 50,000 by NEFT

Solution:

Date	Admissibility of payment as a part of the actual cost
01-02-2022	Payment on a single day exceeding Rs. 10,000 is not allowed
02-02-2022	Though each payment is up to Rs. 10,000 but the aggregate payment in cash is Rs. 50,000 which is above the limit of Rs. 10,000- Hence not allowed
03-02-2022	Allowed as a part of the actual cost- Rs. 10,000
04-02-2022	Allowed as a part of the actual cost- Rs. 10,000
05-02-2022	Allowed as payment made by Account Payee Cheque- Rs. 2,70,000
06-02-2022	Payment by self cheque not allowed
07-02-2022	Payment by electronic modes allowed- Rs. 50,000
Hence, Actual cost of machinery in case of Ram shall be: 10,000 + 10,000 + 270,000 + 50,000 = Rs. 3,40,000

What are the ‘Other Electronic Modes’ allowed under section 43(1)?

According to Rule 6ABBA, the following are the electronic modes permissible u/s 43(1):

Credit Card	Debit Card	Net Banking
IMPS (Immediate Payment Services)	UPI (Unified Payment Interface)	RTGS (Real Time Gross Settlement)
NEFT (National Electronic Funds Transfer)	BHIM Aadhar Pay

Impact of Proviso to Section 43(1): The assessee who acquires an asset and makes payment in cash exceeding Rs. 10,000 in a single day will not be able to take benefit of depreciation u/s 32 as the cost of the asset will be considered as ‘Nil’.

Now, we will have a reading of Income Computation and Disclosure Standard (ICDS)- V relating to Tangible Fixed Assets for better understanding of the manner ‘Actual cost’ could be determined.

ICDS-V: Tangible Fixed Assets

Scope: ICDS is applicable only in respect of the computation of income under the head “Profits & Gains from Business & Profession” & “Income from Other Sources” and not for the purpose of maintenance of accounts. Further, in case of conflict between the ICDS and the Act, the provisions of the Act shall prevail.

According to ICDS-V, the following shall be the component of the cost of the tangible fixed assets:

Purchase Price less trade discounts and rebates
Import duties and other duties excluding those subsequently recoverable like GST
Directly attributable expenditure on making the asset ready for use such as site preparation costs, initial delivery costs, and handling charges, installation expenses, professional fees such as architect fees, etc.
Expenditure on employees and supervisors engaged in construction work including salaries, welfare contributions, and expenses
Insurance charges and vehicle expenses relating to construction
Interest on borrowed capital (discussed separately)
Price adjustments & exchange fluctuations

Administration and other general overhead expenses:

Administration and other general overhead expenses are to be excluded from the cost of tangible fixed assets if they do not relate to a specific tangible fixed asset.
Expenses that are specifically attributable to the construction of a project or to the acquisition of a tangible fixed asset or bringing it to its working condition, shall be included as a part of the cost of the project or as a part of the cost of the tangible fixed asset.

Start-up & commissioning expenditure

The expenditure incurred on the start-up and commissioning of the project, including the expenditure on test runs and experimental production, shall be capitalized.
The expenditure incurred after the plant has begun commercial production i.e. production intended for sale or captive consumption shall be treated as revenue expenditure.

Should Interest on Borrowed Capital be capitalized as the cost of asset?

For this purpose, we will first read section 36(1)(iii) & Explanation -8 to section 43(1) and then have a detailed discussion:

Section 36(1)(iii) of the Income Tax Act

Explanation-8 to Section 43(1) of the Income Tax Act

Interest paid in respect of borrowed capital for the purposes of the business or profession shall be allowed:

Provided that:

The amount of interest paid in respect of capital borrowed for acquisition of an asset (whether capitalized in the books of accounts 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.

Where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first PUT TO USE shall not be included and shall be deemed never to have been included, in the actual cost of such asset.

Analysis:

The combined reading of both the provisions makes it clear that interest incurred on borrowed capital till the asset is put to use shall be capitalized as a part of the cost of the asset and it will not be allowed a deduction as revenue expenditure. In other words, we can say that interest on borrowed money for the purposes of acquiring a capital asset, pertaining to the period after the asset is put to use has to be claimed as a deduction under section 36(1)(iii).

In this respect, we will also refer to the landmark judgment of the Supreme Court in the case of Challapali Sugar Mills Limited in which it was held that the interest incurred on borrowed capital before the commencement of the production can be capitalized and added to the cost of the fixed asset which has been created as a result of such expenditure.

Take an example to understand the concept better: Suppose X Limited started construction of its plant having 3 units A, B & C on 01-01-2021. Construction of units A, B & C could be completed by 01-01-2022. However, commercial production actually started on 01-02-2022 when Unit ‘A’ is put to use. Unit ‘B’ was put to use on 01-03-2022 and Unit ‘C’ on 01-04-2022.

Solution:

Unit	Capitalization Period for interest on borrowed capital
A	01-01-2021 to 01-02-2022
B	01-01-2021 to 01-03-2022
C	01-01-2021 to 01-04-2022

Tips from Judiciary:

CIT vs. Anang Polyfil Pvt. Ltd.

Where machinery is purchased in installments, the interest payable on the installments pertaining to the period after the machinery is put to use cannot be included in the actual cost.

CIT vs. Hindustan Polymers Ltd.

It was held that during the period of construction of the building and installation of the plant where the assessee incurred expenses on salaries, maintenance of guest house for erection staff, and vehicle expenses in setting up the plant, the entire amount would form part of the actual cost.

Treatment of temporary interest income on surplus funds

The Revenue Authorities have been quite inconsistent on the issue of temporary investment income from surplus borrowed funds. On the one side, the authorities treat expenditure prior to commencement of business as a capital expenditure, and on another side, they tend to treat income earned during this period as revenue income in nature. On this issue, one must see the ratio laid down by the Hon’ble Supreme Court in the matter of Tuticorin Alkali Chemicals & Bokaro Steel Limited.

In the case of Tuticorin Alkali Chemicals, it was held that if the funds are surplus and then by virtue of that circumstance they are invested in fixed deposits, the income earned in the form of interest will be taxable under the head “Income from Other Sources”.

Interest earned on the advances given in connection with the construction/ installation work will reduce the cost of the assets but any interest earned on surplus funds available with the assessee will not reduce the cost of the asset but shall be taxable as income from other sources [Bokaro Steel Limited vs. CIT]

We may also refer to various other judgments on similar issues as below:

CIT vs. Karnal Co-operative Sugar Mills Ltd. (SC)
CIT vs. Karnataka Power Corporation (SC)
Bongaigaon Refinery and Petrochemicals Ltd. vs. CIT (SC)
Indian Oil Panipat Power Consortium Limited cs. ITO (Delhi HC)
CIT vs. Jaypee DSC Ventures Limited (Delhi HC)

Author’s Note:

In this regard, we should also refer to the Accounting Standards & ICDS. ICDS IX relating to Borrowing Costs is silent on the issue of treatment of interest income on surplus funds. However, AS-16 “Borrowing Costs” issued by ICAI states that income from temporary investment of surplus funds may be set off against interest expense incurred during the period (which will be ultimately capitalized). Thus, temporary interest income will go on reducing the actual cost of the asset. Thus, the accounting view gets differed from the above rulings. Please note that we will be guided by the provisions of law and not by accounting principles while discussing tax implications.

Thus, we can conclude the issue as below:

Interest and other similar incomes generated by the investment of surplus and idle funds, with a specific view of earning income during the pre-commencement period of business, are to be considered as revenue in nature and are taxable under the head “Income from Other Sources”.
Interest and other similar income which is earned through the temporary investment of borrowed funds, which ultimately is linked to the setting up of business infrastructure, is capital in nature and is required to be set off against pre-operative expenses (capitalized).

CIT vs. J.M.A. Industries

It was held that expenditure on traveling incurred for acquiring assets would be part of the actual cost.

CIT vs. Fort Gloster Industries Limited

Guarantee Commission paid to Bank in respect of the purchase of capital assets will be added to the actual cost.

Expenses on a test run:

Amount to be capitalized as part of actual cost = Expenses incurred on the trial run- Sale proceeds of trial run production

About Author: The above article is contributed by CA Naveen Goyal who is a passionate writer on Income Tax issues. He has an experience of over 15 years in the field of Direct & Indirect Taxation.

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