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Discounting charges of Bill of Exchange or factoring charges of sale cannot be termed as interest for TDS U/s. 194A

Interest is a term relating to a pre-existing debt, which implies a debtor creditor relationship. According to us, unpaid consideration gives rise to a lien over goods sold and not for money lent. This interpretation of ours is supported by the decision of Hon’ble Supreme Court

Interest is a term relating to a pre-existing debt, which implies a debtor creditor relationship. According to us, unpaid consideration gives rise to a lien over goods sold and not for money lent. This interpretation of ours is supported by the decision of Hon’ble Supreme Court in the case of Bombay Steam Navigation Co. Pvt. Ltd. Vs. CIT (1963) 56 ITR 52 (SC), wherein it is held that, where interest on unpaid purchase price was not treated as interest on loan. It is clear from the definition that before any amount paid is construed as interest, it has to be established that the same is payable in respect of any money borrowed or debt incurred. According to us, discounting charges of Bill of Exchange or factoring charges of sale cannot be termed as interest.

The assessee in the present case is acting as an agent. Now what is this is to be seen. According to us, a Del Credere is an agent, who, selling goods for his principal on credit, undertakes for an additional commission to sell only to persons for whom he can stand guarantee. His position is thus that of a surety who is liable to his principal should the vendee make default. The agreement between him and his principal need not be reduced to or evidenced by writing, for his undertaking is a guarantee. A Del Credere Agent is an agent who not only establishes a  privity of contract between his principal and the third party, but who also guarantees to his principal the due performance of the contract by the third party. He is liable, however, only when the third party fails to carry out his contract, e.g., by insolvency. He is not liable to his principal if the third party refuses to carry out his contract, for example, if the buyer refuses to take delivery.

In the present case before us the assessee has assessed the income as Del Credere being trading in goods and merchandise and also dealing in securities and which is assessed as income from business and not income from other sources. The expenditure incurred is also on account of business expenditure and not interest expenditure in the nature of interest falling u/s. 194A of the Act. Accordingly, these discount/factoring charges do not come within the purview of section 194A and assessee is not liable to TDS on these charges. Hence, CIT(A) has rightly deleted this disallowance and we confirm the same.

INCOME TAX APPELLATE TRIBUNAL: KOLKATA

I.T.A No. 729/Kol/2011

Assessment Year: 2007-08

Income-tax Officer Vs. M/s. M K J Enterprises Ltd.

Date of pronouncement: 27.01.2014

ORDER

Per Shri Mahavir Singh, JM: This appeal by revenue is arising out of order of CIT(A)-VI, Kolkata in Appeal No. 881/ CIT(A)-VI/09-10/Cir-6/Kol dated 31.01.2011. Assessment was framed by DCIT, Circle-6, Kolkata u/s. 143(3) r.w.s. 115WE(3) of the Income-tax Act, 1961 (hereinafter referred to as “the Act”) for Assessment Year 2007-08 vide his order dated 29.12.2009.

2. At the outset, it is noticed that this appeal by revenue is delayed by 24 days and revenue has filed con donation petition. On query from the Bench, Ld. AR fairly conceded that the appeal can be admitted. As the Ld. counsel has not raised any objection, we, going through the small delay, condone the delay and admit the appeal.

3. The first issue in this appeal of revenue is as regards to the order of CIT(A) restricting the dis allowance at 1% of exempted income u/s. 14A of the Act. For this, revenue has raised following ground no.1:

“1. That on the facts and circumstances of the case, Ld. CIT(A)-VI, Kolkata has erred in law in directing the A.O. to restrict the dis allowance u/s. 14A of the I. T. Act to 10% of total exempted income at Rs. 7,85,71 7/- which comes to Rs. 7,857/-.”

4. We have heard rival submissions and gone through facts and circumstances of the case. We find that the relevant assessment year involved is 2007-08 and Hon’ble Bombay High  Court in the case of Godrej & Boyce Mfg. Co. Ltd. vs. DCIT [2010] 328 ITR 81 (Bom.), wherein it is held that Rule 8D of the Rules as inserted by the I. T (Fifth Amendment) Rules, 2008 w.e.f. 24.3.2008 is prospective and not retrospective. The CIT(A) restricted the dis allowance at 1% of the exempted income u/s. 14A of the Act by observing as under:

“I find that the decision of Daga Capital has been reversed by Hon ’ble Bombay High Court in their above mentioned order dtd. 12.08.2010. In this order Hon’ble Court has held that Rule 8D shall be applicable from assessment year 2008-09 on wards. Here, since the assessment year involved is 2007-08 therefore I hold that Rule 8D will not apply. However, in certain recent decisions Hon’ble ITAT Kolkata has held that out of the administrative expenses, expenses to the tune of 1% of the exempt income can be disallowed u/s. 14A. Following these decisions I hold that an amount of Rs. 7,857/- shall be dis allowable u/s. 14A.”

The exempted income is to the extent of Rs.7,85,717/- and CIT(A) has directed the AO to restrict he dis-allowance at 1% of the exempted income. We find no infirmity in the order of CIT(A) and this issue of revenue’s appeal is dismissed.

5. The next issue in this appeal of revenue is against the order of CIT(A) deleting the dis allowance made by AO on account of discounting/factoring charges as interest expenses for non-deduction of TDS u/s. 194A of the Act, thereby disallowed by invoking the provisions of section 40(a)(ia) of the Act. For this revenue has raised following ground no.2:

“2. That on the facts and circumstances of the case, Ld. CIT(A) has erred in law as well as on the facts by deleting the dis allowance u/s. 40(a)(ia) though the assessee has treated the payment as interest in its books of account.”

6. Briefly stated facts are that during the relevant FY the assessee paid a sum of Rs.56,33,112/- to M/s. Lalji Financial on account of discounting/factoring charges without deducting TDS. According to AO, these factoring /discounting charges are interest expenses as per the provisions of section 2(28A) of the Act and assessee is liable to deduct TDS u/s. 194A of the Act. According to AO, as the assessee failed to deduct TDS, these expenses cannot be allowed in term of section 40(a)(ia) of the Act. Accordingly, he made dis allowance. Aggrieved, assessee preferred appeal before CIT(A), who allowed the claim of the assessee by observing in para 6.3 as under:

“6.3. I have carefully considered all the facts and circumstances of this issue. It is seen that the assessee is a agent of M/s. Mukand Ltd. and the steel products of this company are sold through the assessee. The sale bills are issued by Mukand Ltd. in the name of the customers but on them it is mentioned that the payment for the bills is guaranteed and underwritten by the assessee M/s. MKJ Enterprises Ltd. under a arrangement. As per this arrangement the payment to Mukund Ltd. is to be made by the assessee and the assessee collects the payment from the clients who have purchased the goods from  Mukand Ltd. through the assessee. The bills of purchase for which payment is to be received by the assessee are discounted with a financing firm named M/s. Lalji Financials. When the bills are discounted, M/s. Lalji Financials pays to the assessee the bill amount after deducting its discounting or factoring charges. These discounting / factoring charges are claimed by the assessee as expenditure. In thìs process of bill discounting the responsibility to collect the bill amount from the customers passes on to M/s. Laljì Financials. Whether the payment of the bill amount is received or not received or received late or a less amount is received by Lalji Financials it is not a concern of the assessee. This shows that in this transaction actually the assessee has sold its assets to M/s. Lalji Financials and the ownership of the assets, in the form of debtors, has now passed on to M/s. Laljì Financials. In this kind of transactions it cannot be said that M/s. Lalji Financials has advanced any loan to the assessee or the assessee has incurred any debt. The amount paid by M/s. Lalji Financials to the assessee in view of the bill discounted by it is in the nature of sale proceeds of the debt purchased by Lalji Financials from the assessee. Therefore, it cannot be said that the discounting/factoring charges paid to Lalji Financials are in the nature of interest as defined in section 2(28A) of the I. T. Act. From section 2(28A) it can be seen that one important requirement of this section is that there should be any money borrowed or debt incurred or any credit facility utilized by the assessee. Here, the assessee has not done any of these three things because the money paid by M/s. Lalji Financials ìn view of the bill discounted by it, is not to be repaid by the assessee. Therefore, any charges paìd by the assessee in respect of such money received after bill discounting cannot be termed as interest u/s. 2(28A). In its submission the assessee has referred to CBDT Circular No. 65 dated 2.9.71 and has claimed that this supports their stand. The A. O. has rejected this contention of the assessee on the ground that this was related to discounting charges paid to banks and not to private parties. In this respect the relevant content of the above CBDT circular is reproduced below:

“I am directed to invite a reference to the Board’s Circular No. 48, dated 7th November, 1970 [F. 275/195/70-ITJ]. The Board has been requested to reconsider the views given in that Circular. After a careful examination of the legal position the Board is of the view that to, the following extent the earlier views need a modification. Where the supplier of goods makes over the usance bill/hundi to his bank which discounts the same and credits the net amount to the supplier’s account straightaway without waiting for realization of the bill on due date, the property in the usance bill/hundi passes on to the bank and the eventual collection on due date is a receipt by the bank on its own behalf of the supplier. For such cases of immediate discounting the net payment made by the bank to the suppliers in the nature of a price paid for the bill. Such a payment cannot technically be held as including interest and therefore no tax need be deducted at source from such payments by the bank. Further, the buyer need not deduct any tax from the payment made by him on due date to the bank in respect of such discounted bill inasmuch as these payments are to a bank or a banking co¬operative society, confirming to the exemption granted by section 194A(3)(iii)(a) of the income-tax Act, 1961.”

From the above it can be seen that this circular does not deal with the bill discounting charges directly. It is actually related to the amount which is paid by the banks to their customers after deducting the bill discounting charges from the bill amount. The circular says that no interest component is involved in this amount paid by banks to the sellers who discount their bills with the banks. However in thís círcular it has been clarified that when in a transaction of bill discounting the net amount of the bill, after deducting the discounting charges, is paid to the discountee, the property in the bill passes to the  discounter and the collection on the due date is a receipt by the discounter on its own behalf and not on behalf of the discountee. Thus the amount which is paid by the bill discounter to the discountee is not a loan but a purchase price. Since in this transaction no loan is borrowed by the assessee therefore any charges paid in respect of the same cannot be treated as interest u/s. 2(28A).

In hìs order the A.O. has referred to a decision of Madras High Court in the case of Viswapriya Financial & Securities Ltd. vs. CIT(200) 258 ITR 496 (Mad.). First of all it is seen that this case ís not related to bill discounting charges but related to amount paid by the assessee to its customers at a fixed rate on the amount deposited by them with the assessee. Secondly, the observations of Hon ’ble Court will not apply to the case of bill discounting because as described above in such transactions undertaken by the assessee no money has been borrowed by it from the bill discounter. Therefore, the above decision of Madras High Court will not apply to the case of the assessee. The A. O. has also referred to two more circulars of the CBDT. I find that the issue discussed in circular dated 23.09.1968 is not relevant to the issue under consideration here. Similarly it is seen that the issue discussed in circular 48 has been modified by the CBDT, subsequently in the Circular No.65 discussed above. In the above discussion it has been pointed out that even as per this Circular 65 the discounting charges cannot be termed as interest as per section 2(28A) of the I.T. Act.

In view of the above discussion I hold that the discounting charges of Rs.56,33,112/- paid by the assessee cannot be termed as interest u/s. 2(28A) and therefore the assessee was not required to deduct TDS on them u/s. 194A of the I. T. Act. Hence the dis allowance of these discounting charges made by the AO u/s. 40(a)(ia) is deleted.”

Aggrieved, revenue came in appeal before us.

7. We have heard rival submissions and gone through facts and circumstances of the case. We find that the assessee is a Del Credere agent of Mukund Ltd. Mukund Ltd. is a company producing steel and assessee is selling steel products produced by Mukund Ltd. as a Del Credere agent. From the facts of the case, it is clear that the sale bills are issued by Mukund Ltd. in the name of the customers but on them it is mentioned that the payment for bill is guaranteed and under-written by the assessee MKJ Enterprises Ltd., as per Del Credere arrangement/agreement. As per this arrangement, the payment to Mukund Ltd. is to be made by the assessee after collecting from the clients, who have purchased steel of Mukund Ltd. through assessee. In such circumstances, the bill of purchase for which payment is to be received by the assessee are to be discounted with a finance from Lalji Financial. When the bills are discounted, M/s. Lalji Financial passed the same to the assessee after deducting its discounting/factoring charges. These discounting/factoring charges are claimed by the assessee as expenditure. Whether this expenditure of discounting/factoring charges is in the nature of interest or not? The provision of section 2(28A) of the Act defines the definition of interest, which reads as under:

“28A. 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.”

As per section 2(28A) of the Act interest payable in any manner in respect of any moneys borrowed or debt incurred includes any service, fee or other charges in respect of moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized. It is, thus, seen that interest either means sum payable in respect of any money borrowed or debt incurred. In the instant case, it was not a case of debt incurred or moneys borrowed. In fact, it was a case where the assessee had merely discounted sale consideration receivable on sale of goods. It was not a case where any money had been borrowed or debt had been incurred. It was also not a case where any service, fee or either charge had been paid in respect of money borrowed or debt incurred or in respect of any credit facility which had not been utilized. It was not a case where section 2(28A) of the Act could be invoked. Further, we can deal with this issue from another angle i.e. the Interest Tax Act, 1974. As per section 2(7) of the Interest Tax Act, interest means interest on loans and advances made in India and includes – (a) commitment charges on unutilized portion of any credit sanctioned for being availed of in India; and (b) discount on promissory notes and BE drawn or made in India. Thus, where the Legislature was conscious of the fact that even the discount of bills of exchange was to be included within the definition of interest, the same was basically so provided for. However, under the scheme of the Act, the word interest defined under section 2(28A) does not include the discounting charges on discounting of BE. Though the Circular No. 65 was rendered in relation to deduction of tax under section 194A of the Act, yet in respect of payment to a resident, the same would be relevant even for the purpose of considering whether the discount should be treated as interest or not. The CBDT had opined that where the supplier of goods makes over the usance of bill/hundi to his bank which discounts the same and credits the net amount to the supplier s account straightaway without waiting for realization of the bill on due date, the property in the usance of bill/hundi passes on to the bank and the eventual collection on due date is a receipt by the bank on its own behalf and not on behalf of the supplier. For such cases of immediate discounting, the net payment made by the bank to the supplier is in the nature of a price paid for the bill. Such payment cannot technically be held as including any interest and, therefore, no tax need to be deducted at source from such payment by the bank.

8. The process adopted in the present case was explained by the assessee before the AO,before CIT(A) and even now before us, which is as under:

“Now, our case, which should be properly termed as reversed factoring or non-recourse or without recourse, wherein credit cover is provided to the purchaser and in the event of failure of the customer to pay, the factor will bear the bad debt risk.

Such arrangements are made for the purpose of maintaining the production – sales realization cycle in a smooth manner.

Please understand our process of purchase, Sale and Bill Discounting from Lalji financials.

We are the Selling Agent and Agent of Mukund Limited in respect of stainless steel industrial grade produced by them. In respect of sell. Mukund Limited raises directly bill on our customers and endorsement on the invoice “Payment of the Invoice is guaranteed and underwritten by MKJ Enterprises Ltd. as per arrangement/agreement. Under such process, Lalji Financials , a Proprietorship Firm discounts the Purchase Bills, after drawing and acceptance of Bills of “Exchange/Hundi by and between Purchaser and Seller, and make us the net payment of Bill after deducting Discount Charges (pre- payment basis or call it upfront charges). As soon as the said Lalji Financials, discounts the Bills, property in the bills passes to Lalji Financials. On due date or an earlier date, payment made to Lalji Financials, cannot technically be held as including interest and therefore as per the aforesaid rationale provided by the said Circular, the payment of discounting charges by the MKJ Enterprises Limited, of bills, would not be liable for TDS under section 194A of the Income Tax Act, 1961.”

From the above explanation of the assessee it is clear that interest is a term relating to a pre- existing debt, which implies a debtor creditor relationship. According to us, unpaid consideration gives rise to a lien over goods sold and not for money lent. This interpretation of ours is supported by the decision of Hon’ble Supreme Court in the case of Bombay Steam Navigation Co. Pvt. Ltd. Vs. CIT (1963) 56 ITR 52 (SC), wherein it is held that, where interest on unpaid purchase price was not treated as interest on loan. It is clear from the definition that before any amount paid is construed as interest, it has to be established that the same is payable in respect of any money borrowed or debt incurred. According to us, discounting charges of Bill of Exchange or factoring charges of sale cannot be termed as interest. The assessee in the present case is acting as an agent. Now what is this is to be seen. According to us, a Del Credere is an agent, who, selling goods for his principal on credit, undertakes for an additional commission to sell only to persons for whom he can stand guarantee. His position is thus that of a surety who is liable to his principal should the vendee make default. The agreement between him and his principal need not be reduced to or evidenced by writing, for his undertaking is a guarantee. A Del Credere Agent is an agent who not only establishes a  privity of contract between his principal and the third party, but who also guarantees to his principal the due performance of the contract by the third party. He is liable, however, only when the third party fails to carry out his contract, e.g., by insolvency. He is not liable to his principal if the third party refuses to carry out his contract, for example, if the buyer refuses to take delivery. In the present case before us the assessee has assessed the income as Del Credere being trading in goods and merchandise and also dealing in securities and which is assessed as income from business and not income from other sources. The expenditure incurred is also on account of business expenditure and not interest expenditure in the nature of interest falling u/s. 194A of the Act. Accordingly, these discount/factoring charges do not come within the purview of section 194A and assessee is not liable to TDS on these charges. Hence, CIT(A) has rightly deleted this dis allowance and we confirm the same. This ground of appeal of revenue is dismissed.

9. In the result, appeal of revenue is dismissed.

10. Order is pronounced in the open court on 27.01.2014.

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