Sanjjay Saumyha Vs PCIT (Madras High Court)
Summary: The Madras High Court dismissed the assessee’s appeal for AY 2013-14 and upheld the PCIT’s exercise of revisionary jurisdiction under Section 263 concerning accumulated interest on zero-coupon convertible debentures. The assessee, a director and shareholder of AVR Swarna Mahal Jewellery Pvt. Ltd., held 5,006 debentures with an initial face value of Rs.1,00,12,000/-. These were prematurely converted into equity shares during FY 2012-13, with the allotment value of Rs.1,75,58,082/- including accumulated interest of Rs.75,46,082/-. The assessee reported interest income of Rs.13,48,913/- but did not offer the remaining Rs.61,97,169/- to tax. The Assessing Officer accepted her explanations during reassessment, whereas the PCIT set aside that order for fresh determination, holding that the interest component had not been properly examined.
The assessee argued that she followed the cash system of accounting under Section 145, received no cash on conversion and was protected by Section 47(x), which excludes conversion of debentures into shares from “transfer” for capital gains purposes. She also contended that the Assessing Officer had adopted a plausible view after inquiry, that the Tribunal had exceeded the scope of the revision appeal by addressing taxability, and that taxing interest on conversion could result in double taxation when the shares were subsequently sold.
The Court held that allotment of valuable equity shares in discharge of an identified interest liability constituted receipt of economic value, even without physical cash. It distinguished the exclusion from capital gains under Section 47(x) from the taxability of the embedded interest income under Section 56. The Court also observed that the assessee could not claim credit under Section 199 while disclaiming taxability of the underlying income in the same assessment year. Addressing the double-taxation objection, it stated that interest taxed on conversion would form part of the cost basis of the shares. The reassessment order was held erroneous and prejudicial to the Revenue because of inadequate inquiry and incorrect application of law. While affirming the revision, the Court left the assessee to raise her issues before the Assessing Officer in the fresh proceedings, taking account of the Tribunal’s rectification order. No substantial question of law arose, and the appeal was dismissed without costs.
Cases Discussed
- Sanjjay Saumyha Vs PCIT, ITA No.392/Chny/2024, order dated 5.11.2024, ITAT Chennai Bench ‘A’, AY 2013-14 — The underlying appellate order challenged before the High Court upheld revision under Section 263 concerning accumulated debenture interest settled through equity shares. The source also records a subsequent rectification order expunging an observation concerning taxability. The High Court affirmed the Tribunal’s order and directed that the fresh assessment take account of that rectification.
FULL TEXT OF THE JUDGMENT/ORDER OF MADRAS HIGH COURT
This Tax Case Appeal filed by the assessee under Section 260A of the Income-tax Act, 1961 [for brevity, “the Act”] challenges the order dated 5.11.2024, passed by the Income Tax Appellate Tribunal, Chennai Bench ‘A’, in ITA No.392/Chny/2024 for the Assessment Year (AY) 2013-14. By the said order, the Tribunal upheld the revisionary order dated 21.12.2023, issued by the Principal Commissioner of Income Tax (PCIT), Coimbatore-1, under Section 263 of the Act.
2. The present appeal, according to this court, proposes the following four substantial questions of law centering on whether the PCIT validly invoked Section 263 of the Act to set aside a reassessment order passed under Section 147 read with Section 144B of the Act:
i. Whether the Appellate Tribunal was justified in upholding the revisionary jurisdiction exercised by the PCIT under Section 263 of the Act, despite the Assessing Officer having accepted the appellant’s explanations during reassessment proceedings?
ii. Whether the Appellate Tribunal erred in not adjudicating the ground regarding assumption of jurisdiction under Section 263 of the Act where two views were alleged to be possible?
iii. Whether the Appellate Tribunal exceeded its scope by making observations on the merits of taxability of accrued interest in an appeal concerning revision under Section 263 of the Act?
iv. Whether conversion of zero-coupon debentures into equity shares, exempted under Section 47(x) of the Act, gives rise to taxable interest income under Section 56 or any other provision of the Act?
3.1. The facts in a nutshell are that t he appellant is an individual taxpayer and was a director and shareholder in AVR Swarna Mahal Jewellery Pvt. Ltd. (SMJPL). During Financial Year (FY) 2009-10, SMJPL issued zero-coupon debentures with a face value of Rs.2,000/- per debenture to nine of its directors. The appellant received 5,006 zero-coupon convertible debentures on 2.9.2009. These debentures had a nine-year tenure, maturing on 1.9.2019, with a redemption value of Rs.6,400 per debenture. The company periodically amortized this discount in its books as interest expense.
3.2. On 30.9.2012 (during FY 2012-13, relevant to AY 2013- 14), SMJPL prematurely converted these debentures into equity shares, which were allotted to the debenture holders on 31.10.2012. The shares were allotted against the initial face value of the debentures plus total accrued interest up to the date of conversion. For the appellant’s 5,006 debentures, the breakdown stood as follows: Initial Face Value: Rs.1,00,12,000/- Total Accumulated Interest (2.9.2009 to 30.9.2012): Rs.75,46,082/- Total Allotment Value of Equity Shares: Rs.1,75,58,082/-
3.3. During FY 2012-13, SMJPL deducted Tax Deducted at Source (TDS) on the interest portion of Rs.12,23,689/- accruing for that specific financial year. In her return of income for AY 2013-14, the appellant reported total interest income of Rs.13,48,913/- (reflecting the single-year accrued interest grossed up for TDS) and claimed full credit for the TDS deducted by SMJPL. However, she did not offer the balance accumulated interest of Rs.61,97,169/- (accrued across FY 2009-10 to FY 2011-12) to tax.
3.4. The Assessing Officer reopened the assessment under Section 147 of the Act to examine the non-reporting of this Rs.61,97,169/-. In response, the appellant submitted two arguments, viz., (i) she maintained her accounts on a cash basis under Section 145 of the Act and received no actual cash upon conversion; and (ii) conversion of debentures into shares is exempt from being treated as a “transfer” under Section 47(x) of the Act.
3.5. The Assessing Officer accepted these explanations and passed a reassessment order on 14.9.2021, under Section 147 read with Section 144B of the Act, making no additions to the reported income.
3.6. The PCIT reviewed the assessment record and found the Assessing Officer’s acceptance of the return of income erroneous and prejudicial to the interests of the Revenue. After issuing a show-cause notice and considering the appellant’s written objections, the PCIT passed an order under Section 263 of the Act on 21.12.2023. The PCIT observed that the Assessing Officer failed to examine the interest component embedded in the conversion, noted that other directors who underwent scrutiny were assessed for their proportionate accrued interest, set aside the reassessment order, and remanded the matter to the Assessing Officer for a fresh determination.
3.6. Aggrieved by the order passed by the PCIT, the appellant appealed to the Income Tax Appellate Tribunal. The Tribunal dismissed the appeal by order dated 5.11.2024, holding that conversion into equity shares realized the accrued interest value, that claiming full TDS credit while omitting the underlying accumulated interest was legally unsustainable, and that the revision under Section 263 of the Act was valid.
3.7. It is seen from the records that the appellant had subsequently filed an application to rectify the order dated 5.11.2024 and the same was allowed by expunging the observation in the order dated 5.11.2024 to the following effect: “ However, here is question is of taxability of interest component of debenture that has accrued to the assessee up-to the date of conversion.”
4.1. Learned counsel appearing on behalf of the appellant submitted that the Assessing Officer made detailed inquiries during the reassessment proceedings under Section 147 of the Act and took a plausible view based on Section 145 of the Act. Exercise of power under Section 263 of the Act merely reflects an impermissible change of opinion.
4.2. It is further submitted that the appellant follows a cash system of accounting. Conversion into shares involved no cash inflow, so no income crystallized during the year. He added that conversion of debentures into equity shares is explicitly excluded from “transfer” under Section 47(x) of the Act. Any capital gain can only be evaluated upon the ultimate sale of the equity shares. Taxing the accrued interest during conversion while fixing the cost of acquisition under Section 49(2A) of the Act at original debenture cost would result in double taxation when the shares are eventually sold.
4.3. In any event, it is submitted that the Tribunal exceeded its jurisdiction by giving findings on the merits of taxability when the PCIT had only remanded the matter for fresh assessment.
5. We have heard learned counsel for the appellant and carefully considered the documents on record, including the impugned order.
6. The scope of Section 263 of the Act is well settled. An order passed by an Assessing Officer can be revised if it is both erroneous and prejudicial to the interests of the Revenue. Where an Assessing Officer accepts a claim without necessary inquiry or proper application of mind to the applicable legal provisions, the order is erroneous in law.
7. In this case, the zero-coupon debentures carried an implicit interest component payable upon redemption or settlement. Upon premature conversion on 30.9.2012, SMJPL discharged its obligation by issuing equity shares worth Rs.1,75,58,082/-, which explicitly included Rs.75,46,082/- towards accumulated interest. By accepting equity shares representing this accumulated interest, the appellant received economic value satisfying the debt.
8. The appellant’s reliance on the cash system of accounting under Section 145 of the Act cannot defer tax liability when an asset of clear monetary value (equity shares) is received in discharge of accrued interest. Receipt of income need not take the form of physical cash; settlement through allotment of valuable shares constitutes constructive receipt in law. Furthermore, the appellant claimed credit for the full TDS deducted on this interest income. A taxpayer cannot claim credit for tax deducted at source under Section 199 of the Act, while disclaiming taxability of the underlying income in the same assessment year.
9. Section 47(x) of the Act excludes conversion of debentures into shares from being treated as a “transfer” for computing capital gains under Section 45 of the Act. However, Section 47(x) of the Act does not alter or exempt the character of interest income embedded in the transaction, which remains taxable under Section 56 of the Act. The Assessing Officer failed to apply these statutory provisions and accepted the return of income without proper analysis.
10. On the argument of double taxation, the cost of acquisition of converted shares under Section 49(2A) of the Act must be interpreted alongside the tax treatment of the interest component. Once the interest component is brought to tax upon conversion, that taxed interest forms part of the cost basis of the shares acquired, eliminating double taxation upon subsequent sale.
11. The Assessing Officer’s failure to conduct proper inquiry and apply law correctly rendered the reassessment order erroneous and prejudicial to the Revenue. The PCIT correctly exercised jurisdiction under Section 263 of the Act. The Tribunal’s finding does not warrant interference. In as much as the PCIT has only remanded the matter to the Assessing Officer for fresh determination, it is for the appellant to raise all these issues before the Assessing Officer, which shall be considered by the Assessing Officer in the light of the order passed by the Tribunal in the miscellaneous application rectifying the said order, as indicated above.
12. We are, therefore, of the considered view that no substantial question of law arises for consideration in this appeal.
As a sequel, the Tax Case Appeal is dismissed. The order dated 5.11.2024, passed by the Tribunal is affirmed. No costs.
