Discharge of interest payable to financial institutions by way of issue of debentures amounts to actual payment of interest and allowed as deduction u/s 43B : SC
Case Law : M.M. Aqua Technologies Ltd. v. Commissioner of Income Tax (Supreme Court)
Legal Provisions involved
As per Section 43B(d) of Income Tax Act, 1961, interest on loan or borrowing from any public financial institution or State Financial Corporation or State Industrial Investment Corporation shall be allowed as deduction while computing business income of that previous year in which such interest is actually paid.
As per Explanation 3C to Section 43B of Income Tax Act, 1961, if the interest payable under clause (d) has been converted into a loan or borrowing then it shall not be deemed that such interest have been actually paid.
Explanation 3C disallows deduction of interest on loan paid by way of conversion of such interest into new loan.
Facts of the Case
In the return filed by it, the assessee claimed a deduction of interest under section 43B based on issue of debentures in lieu of such interest payable to financial institution. Such debentures were issued in lieu of interest payable to financial institutions. Debentures were issued by assessee under a rehabilitation plan, to extinguish liability of interest altogether.
The assessee was not in a position to pay the interest and liquidated damages. It approached the lead Financial Institutions which on behalf of all the institutions approved the Rehabilitation Plan. According to the Rehabilitation Plan, the assessee issued convertible debentures of Rs.100 each in lieu of outstanding interest and other charges.
Disallowance of claim of deduction by Assessing Officer
Assessing Officer disallowed the appellant’s claim of deduction by holding that the issuance of debentures was not as per the original terms and conditions on which the loans were granted. He held that a subsequent change in the terms of the agreement would be contrary to Section 43B(d) and would render such amount ineligible for deduction.
Contentions of assessee
The assessee contended that the original terms and conditions of the borrowings provided for the revision of terms and conditions of payment at the time of each default. On the assessee’s request, the lead institution acting as trustee of all the lenders agreed to the Rehabilitation Plan and accepted debentures of Rs. 100 each in discharge of the outstanding interest. The discharge of the liability of interest through issue of debentures as mutually agreed between the assessee and the lenders was therefore in accordance with the terms and conditions governing the borrowings.
It was argued by the assessee that payment of the outstanding interest by issue of debentures tantamount to actual payment of interest as envisaged u/s 43B of the Income Tax Acr,1961. Since the lender had admitted receipt of interest, there was no dispute about the payment.
Findings of CIT (Appeals)
CIT (Appeals) directed that the said deduction should be allowed u/s 43B of Income Tax Act. It held that debenture is not a piece of paper. The issue of debentures in lieu of interest merely postponed the payment of liability. Financial institutions had accepted the debentures in effective discharge of the liability for the outstanding interest which was no longer payable by the assessee. It tantamount to actual payment for the intent of section 43B of the Income Tax Act.
Findings of Income Tax Appellate Tribunal (ITAT)
ITAT confirmed with the findings of CIT (Appeals). The ITAT held that when both the creditor and debtor agree that the conversion of the outstanding interest liability into fully paid debentures would be accepted by them as discharge of the liability then to hold that notwithstanding the contract between the two, it is open to the income tax authorities to say that the interest liability has not been discharged, would not only be opposed to the contextual perspective of section 43B, but would also do violence to the language used.
The assessee has not claimed the interest as a deduction again in the year in which the debentures were redeemed. It has thus been proved in the present case that the payment of interest by conversion of the outstanding liability into convertible debentures, is a real substantial and effective payment, meeting the requirement of the word “actual” and is not a fictional or illusory payment. The parties have understood it as an effective discharge by the assessee of the interest liability. Further such interest amount is reflected as business income in the assessment of financial institution.
Disallowance by High Court
High Court based on Explanation 3C to section 43B disallowed deduction under section 43B. It held that to claim deduction under section 43B, actual payment is essential and any interest which had been converted into loan or borrowing could not be deemed to have been actually paid.
Decision of Supreme Court
Supreme Court upheld the decision of CIT (Appeals) and ITAT. The apex court held that interest was actually paid by means of issuance of debentures, which extinguished the liability to pay interest. It was found that issue of debentures by assessee was, under a rehabilitation plan, to extinguish liability of interest altogether. No misuse of provision of section 43B was found.
Explanation 3C is clarificatory in nature. It explains section 43B(d) as it originally stood and does not purport to add a new condition retrospectively, as has wrongly been held by High Court. High Court was clearly in error in concluding that ‘interest’, on facts of instant case had been converted into a loan.
Nobody has the right to intervene and rewrite the arrangement for the parties and say that the parties cannot agree between themselves that this will be taken as actual discharge of the liability to pay interest.
The impugned judgments of the High Court are set aside and the judgment and order of the ITAT is restored.
Supreme Court directed the Assessing Officer to delete the disallowance of deduction of interest claimed by assessee u/s 43B by way of issue of debentures.
INCOME TAX : Assessee, claimed deduction under section 43B based on issue of debentures in lieu of interest accrued and payable to financial institutions which was disallowed by Assessing Officer but allowed by Commissioner (Appeals) and said order was confirmed by Tribunal. High Court based on Explanation 3C to section 43B disallowed deduction under section 43B and held that to claim deduction under section 43B, actual payment is essential and any interest which had been converted into loan or borrowing could not be deemed to have been actually paid
- However, it was found that issue of debentures by assessee was, under a rehabilitation plan, to extinguish liability of interest altogether.No misuse of provision of section 43B was foundas a matter of fact by either Commissioner or Tribunal. Explanation 3C, which was meant to plug a loophole, could not therefore be brought to aid of revenue on facts of instant case. Indeed, if there be any ambiguity in retrospectively added Explanation 3C, at least three well established canons of interpretation come to rescue of assessee in this case. First, since Explanation 3C was added in 2006 with object of plugging a loophole – i.e. misusing section 43B by not actually paying interest but converting interest into a fresh loan, bona fide transactions of actual payments are not meant to be affected. Second, a retrospective provision in a tax act which is ‘for removal of doubts’ cannot be presumed to be retrospective, even where such language is used, if it alters or changes law as it earlier stood. This being case, Explanation 3C is clarificatory – it explains section 43B(d) as it originally stood and does not purport to add a new condition retrospectively, as has wrongly been held by High Court. Third, any ambiguity in language of Explanation 3C shall be resolved in favour of assessee.
- Thus, High Court was clearly in error in concluding that ‘interest’, on facts of instant case had been converted into a loan.There was no basis for this finding – as a matter of fact, it was directly contrary to finding on facts of authorities below.
- [Commissioner of Income-tax, Delhiv. M.M. Aqua Technologies Ltd.[2016] 72 taxmann.com 171 (Delhi) – Set aside]
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