Issue Involved/Facts – Whether expenditure incurred for preparing prospectus, payment of underwriting commission and brokerage for issue of redeemable preference shares is deductible as Revenue Expenditure?
Arguments in against –
1) Hindustan Gas & Industries Ltd. v. CIT [1979] 1 Taxman 546 (Cal.):
Facts of the case:
The assessee-company incurred expenditure for payment of solicitor fees, underwriting commission and prospectus in connection with issue of RPS and claimed deduction of the expenditure in return. The ITO disallowed the claim on ground that the expenditure was not revenue in nature. Before ITAT, the assessee-company contended that there was hardly any difference between RCPS and debentures. Further, they had also relied on the decision in case of India Cements Ltd v. CIT [1966] 60 ITR 52 (SC), wherein it was held that a loan was not an asset or advantage of an enduring nature and that there was no distinction between interest paid on loan and an expenditure incurred for obtaining a loan, the expenses for issue of RPS were allowable as deduction.
Held as under:
‘’Share capital including RPS capital could not be equated with loan or debentures in as much as a debenture-holder could sue a company whereas the shareholder could not. The assessee-company failed to discharge its onus of proving that the expenditure incurred was not of a capital nature. Therefore, the expenditure was not allowable as deduction.’’
2) Section 37 of the Income-tax Act, 1961:
(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
Explanation 1.—For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.
Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.
(2B) Notwithstanding anything contained in sub-section (1), no allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or the like published by a political party.
Arguments in favour –
1) India Cements Ltd v. CIT (Supra)
2) Indian Accounting Standard (Ind AS) 32 – Financial Instruments
A financial liability is any liability that is:
(a) a contractual obligation :
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or
(b) a contract that will or may be settled in the entity’s own equity instruments and is:
(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments;
or
(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Apart from the aforesaid, the equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency. Also for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.
As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D.
3) Substance over form
The substance of a financial instrument, rather than its legal form, governs its classification in the entity’s balance sheet. Substance and legal form are commonly consistent, but not always. Some financial instruments take the legal form of equity but are liabilities in substance and others may combine features associated with equity instruments and features associated with financial liabilities. For example: A preference share that provides for mandatory redemption by the issuer for a fixed or determinable amount at a fixed or determinable future date, or gives the holder the right to require the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount, is a financial liability
4) CIT v. Secure Meters Ltd [2008] 175 Taxman 567 (Rajasthan)
Held, that expenses incurred in relation to issue of debentures (debt) are allowable as revenue expenditure.
5) Other arguments regarding- Recent developments
With the introduction of IBC and NCLT, it has become approachable for filing complaints against the company
Further, GAAR has been introduced with intention of classifying a transaction with regards to the substance over its form.
Conclusion –
Based on above, expenses incurred on issue of RPS ought to be considered as revenue in nature as against capital and accordingly, ought to be allowed as a deduction
Assumptions –
- The dividend payable on RPS issued by the company is of cumulative in nature
- Ind As is applicable in Company case
- Company has recorded the preference shares as a debt in books of accounts
- Company is regularly paying dividend on the preference shares
Scope Limitations –
The comments in this opinion are based on the applicable laws and regulations in force as on the date of this opinion and current practice and interpretation of such applicable laws and regulations that have been discussed in this opinion.
Unless specifically requested, we have no responsibility to update our opinion for events, developments and circumstances occurring after the date of this opinion.
These views are not binding on the Indian Revenue Authorities and there can be no assurance that the Indian revenue authorities will not take a position contrary to our views.
This opinion is solely for your information and for the purposes stated in this opinion and should not be used for any other purpose, disclosed or made available to any other party or referred to in any document without our prior written consent. In no event, regardless of whether consent has been provided, shall we assume any responsibility to any other party to which this opinion is disclosed or otherwise made available or is used for any purpose other than that indicated in the opinion.
Author Bio
