Case Law Details

Case Name : Commissioner of Income Tax vi Vs m/s Virat Investment & Mercantile co. (Delhi High Court)
Appeal Number : ITA Nos.709/2004, 37/2005 & 636/2004
Date of Judgement/Order : 19/01/2017
Related Assessment Year : 1992-93

The brief facts are that the assessee, an investment company had reported for the assessment years 199293, a loan transaction to fund its subscription to the tune of  Rs. 1,50,00,000/- in Shreyans Industries Ltd. The assessee was a shareholder in that company and wished to subscribe to certain debentures which had both convertible and non-convertible elements. The assessee was an existing shareholder with 28% equity holding in the company. The LIC Mutual Funds which financed these debentures, through an agreement, required the assessee to ensure that the debentures were subscribed in its name; the advance carried an interest of 19.5% annually. Upon the repayment of the principal and liquidation of all liabilities, the converted shares (being part of the convertible portion) were to be registered and made over to the assessee. It is not in dispute that during the first assessment year 1992-93, after allotment of the debentures to the assessee, it ensured the sale of the non-convertible portion of the debentures at 11% discount. Concededly, the AO accepted this transaction – as is evidenced by the acceptance of the capital loss reported in that regard. The assessment was finalized under Section 143 (3) for AY 1992-93 as well as later years. On 07.04.1997, during the course of regular assessment, the AO was of the opinion that the interest component should not have been allowed and, therefore, not only proceeded to bring that to tax for the concerned period/year but also issued notice for reassessment. In the reassessment proceedings, the AO disallowed the interest paid to the creditor, i.e., LIC Mutual Funds Corporation on the ground that the assessee had wrongly claimed it and that it was inadmissible by virtue of Section 57 (iii) of the Income Tax Act, 1961 (hereafter referred to as “Act”). The assessee’s appeals were accepted by the CIT (A) for all the years in which the reassessments were concluded. The Revenue’s appeal was rejected by the ITAT by different orders In these circumstances, the Revenue had approached this Court.

Revenue contends that object of the expenditure ultimately was to retain control of the 28% share holding and in that sense it had to be treated on the capital side. Learned counsel relies upon the judgment of the Bombay High Court in Commissioner of Income Tax v. Amritaben R. Shah, (1999) 238 ITR 777 (Bom) and submits that under similar circumstances where the Revenue had to deal with interest on loans borrowings by the assessee for acquiring shares with the intention to retain or acquire control, the Court had categorically ruled that the expenditure lay properly in the capital side and, therefore, had to be disallowed under Section 57 (iii). He also relied CIT (1994) 206 ITR 616 (Bom). Learned counsel further relied upon the judgment of the Supreme Court reported as Brooke Bond India Ltd. v. Commissioner of Income Tax, W.B.III, Calcutta, (1997) 10 SCC 362 as well as Punjab State Industrial Development Corpn. Ltd. v. CIT (1997) 10 SCC 184.

On this aspect, the CIT (A) found as follows:

“5.3 It is also seen that whatever service charges were paid by the appellant were debited to interest expenditure account after reducing interest/dividend received from debentures/shares. This fact was duly mentioned by the auditors in the audited statement of accounts for the financial years 1991-92 to 1994-95. A copy of these accounts has been filed by the appellant company and this has been verified. Thus, it would be seen that the treatment given in the accounts both by the buyers (appellant company) and the subscribers (LIC Mutual Fund) suggests clearly that for all practical purposes the appellant company was the de-facto buyer of these debentures.

5.4 To view the matter in its proper perspective it would be necessary to examine what have been the effect in accountancy terms, had the appellant company raised a normal loan from some other source to make the said investment. It is very clear that in such a case interest paid on such borrowings would have been allowable straightway as a revenue expenditure. Therefore, the allowability of the interest paid to LIC Mutual Fund cannot be disputed merely because the LIC had subscribed to the shares under a buy back agreement. In fact, by entering into such an agreement the LIC Mutual Fund has only protected its interest by subscribing to these debentures/shares instead of giving a loan to the appellant company to invest in the said debentures. Thus the substance of the contract makes it clear that the LIC Mutual Fund did not wish to advance a straight loan to the appellant company but intended to give it in an indirect manner with checks and balances, as per the terms of the agreement.

5.5 It is very clear that had the appellant company not subscribed through LIC Mutual Fund to the right offer the holdings of the promoters would have fallen below 28% in M/s Shreyans Industries Limited. Therefore, the business exigencies demanded that the promoters, including the appellant company, get the right offer subscribed and this compulsion became the genesis of the said buy back agreement, which was necessary because the appellant-company was facing a paucity of funds.”

In light of the above findings, the CIT (A) granted relief for AY 1995- 96 which appears to be the main order that was followed in all other years. The ITAT had the following to say on the subject: –

“16. After examining the rival contentions, we are of the view that there is no merit in the submissions made by the ld. DR on behalf of the Revenue. The CIT (A) has aptly set out relevant facts of the case and has relied on relevant case law to initially come to the conclusion that it is the substance of the agreement with the LIC Mutual Fund, which is to be examined in proper perspective rather than its form. He has thereafter referred to relevant causes of the agreement to ultimately come to the conclusion that for all practical purposes, the Respondent company was the de-facto buyer of the debentures. The treatment given in their respective accounts by the Respondent company and the LIC Mutual Fund has also been taken into account to reach the same conclusions.”

Held by Delhi HIgh Court

Interest expenditure in the present case is not of the kind that went into capital stream. In Brooke Bond (supra) as well as Punjab State Industrial Development Corporation (supra) – both cited by the Revenue, the expenditure was not towards interest but rather towards expenses which was the integral part of the capital raising activity. In both cases, the assessee had issued offers to the public and expenditure laid out was towards such capital generation. The conclusions of the Court that such expenditure could not be allowed since they were capital in nature was logical. However, in this case, the expenditure clearly is not towards acquisition of the capital nor is it an integral part of it, it is only the service alone. It is of a similar kind that would otherwise have been permitted under Section 37 of the Income Tax Act. Since this expenditure does not pertain to the stream of income covered by Section 37 and is not excluded by Section 57 (3), it had to be and was correctly allowed.

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