Issue for Consideration
The term ‘interest’ has been defined in section 2(28A) of the Income
tax Act as under:
“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 utilised.
The term has been exhaustively defined and in its scope it includes the
service fee or other charges in respect of the borrowings, debts and even
unutilized credit facilities. It not only includes interest, as understood
generally, which is payable on any kind of borrowing or debt, but also includes
payment on a deposit, claim or other similar right or obligation. This
extensive definition of ‘interest’ has been a subject matter of controversy,
more particularly from the point of view of the applicability of section 194A
to various types of payments for deduction of tax at source.
By applying the extensive definition, the Madras High Court considered
the payment of guaranteed return at a particular percentage to the investors,
under an investment scheme, to be an ‘interest’, though not captioned as
interest otherwise by the parties. On the other hand, the Calcutta High Court
took a view that the payment of an amount due to delay in delivering the plots,
though termed as interest in the letter of allotment, did not fall within the
ambit of the definition of ‘interest’. Though the facts of the cases before the
Madras High Court and the Calcutta High Court were materially different, the
issue arising therefrom was similar i.e. when does a payment made in respect of
a particular ‘obligation’ constitute interest.
Viswapriya Financial Services & Securities Ltd.’s case:
The issue regarding the interpretation of the definition of the term
‘interest’ first came up, before the Madras High Court, in the case of Viswapriya
Financial Services & Securities Ltd. vs. CIT 258 ITR 496.
In this case, the assessee had floated an innovative scheme of
investment which enabled individual investors to entrust their funds for
management to the assessee, with a guarantee from the assessee that it would so
manage the funds as to ensure a minimum return of 1.5 percent per month to the
investor. The salient features of the scheme operated by the assessee were as
follows:
– The offer memorandum was issued inviting the
investors to contribute and to entrust their money to the assessee for what had
been referred to as fund management. The offer memorandum formed the contract
between the investors and the assessee for the management on the investors’
behalf of the funds provided by the investors under the memorandum for
deployment in any investment.
– The investor, under that memorandum, was to
pay the amount to the assessee by cheques or drafts drawn in the name of
“Viswapriya Funds Management Account-Bank Guaranteed Investments”.
The investors’ money were not made part of the funds of the assessee-company’s
accounts but were kept in a separate account.
– A firm of chartered accountants had
been appointed to function as fiduciary and custodian of the scheme and the
accounts of that fund were also separately audited.
– The investments made in the course of the
management were fully secured and were backed by bank guarantees. However, the
money entrusted under the scheme was to be managed by the assessee, and the
investor was not required to be informed as to the specific investments made
from the fund and the particular investment in which the investor’s amount was
utilised.
– The investors were assured a guaranteed
return of 1.5 percent per month of the amount invested.
– The assessee was entitled to a management
fee of 6 percent per annum from all the funds invested on behalf of the
investors, but with a condition to forgo a part of that management fee if the
returns on the investment were insufficient to ensure the stipulated distribution
at the rate of 1.5 percent per month to the investors.
– If the return from the investments was in
excess of the amount of management fee and the minimum guaranteed return for
the investor, the assessee would become entitled to a performance incentive of
10 percent of such excess.
– The investor had been promised the return of
his investment at the end of the agreed period of three years.
– The investment made by the investor was
transferable. It was possible to be assigned or pledged with prior intimation
to the assessee. In the event of the death of the investor, the amount was to
be transferred to his nominee, if any, and in the absence of nomination, to his
legal heirs.
In the backdrop of these facts, for the assessment years 1993-94 and
1994-95, the assessing officer had passed an order u/s. 201(1) holding that the
assessee was liable to deduct tax at source u/s. 194A on the payments made to
the investors. The Tribunal upheld the order of the assessing officer and held
that the money received by the assessee from the investors created an
‘obligation’ and that the return on that investment at the guaranteed minimum
payment of 1.5 percent per month was covered by the definition of ‘interest’ as
provided in section 2(28A).
Before the High Court, on behalf of the assessee, it was submitted that
the income received by the assessee from the investments made by it did not
attract the liability for deduction of tax at source. Therefore, when the
amounts were distributed among the investors, no tax was deducted at source, as
the returns of the investments made from the fund were received by the
fiduciary and the custodian. It was also submitted that the scheme did not
bring about a relationship of debtor and creditor or borrower and lender and,
therefore, the definition of ‘interest’ in section 2(28A) did not apply to the
facts of the scheme.
The High Court held that the definition of interest, after referring to
the interest payable in any manner in respect of any money borrowed or debt
incurred, included the deposits, claims
and ‘other similar right or obligation’ and observed that the statutory
definition included amounts which might not otherwise be regarded as interest
for the purpose of the statute. Even amounts payable in transactions where
money had not been borrowed and debt had not been incurred were brought within
the scope of the definition, as in the case of a service fee paid in respect of
a credit facility which had not been utilised. Even in cases where there was no
relationship of debtor and creditor or borrower and lender, if payment was made
in any manner in respect of any money received as deposits or on money claims
or rights or obligations incurred in relation to money, such payment was, by
the statutory definition, regarded as interest.
The scheme operated by the assessee imposed an obligation on the
assessee to repay the investor at the end of the period of 36 months, and also
to ensure a monthly payment of 1.5 percent to the investor during that period.
This obligation to repay, in the opinion of the High Court, was an obligation
akin to a claim or a deposit, to which reference was made in the definition of
interest. The payment made by the assessee being a payment made in respect of
an obligation incurred under the terms of the offer memorandum, was regarded as
interest falling within the scope of section 2(28A). The fact that the assessee
did not choose to characterise such payment as interest was not considered as
relevant by the High Court.
West
Bengal Housing Infrastructure Development Corpn. Ltd.’s case
The issue of the interpretation of the definition of the term
‘interest’, in the contest of section 194A, again came up before the Calcutta
High Court in the case of Pr. CIT vs. West Bengal Housing Infrastructure
Development Corpn. Ltd. 96 taxmann.com 610.
The assessee was a
company engaged in the business of development of land, housing and
infrastructural facilities in New Town Projects, Kolkata. For assessment year
2005-06, it claimed a deduction of expenditure amounting to ` 9,71,17,977 which was in the nature of compensation for delay in
delivery of plots. As per the offer for allotment of plot of land developed by
the assessee, the assessee was under an obligation to hand over physical
possession of the plot to the allottees on payment of the entire cost of the
land and registration of sale deed.
If possession of
the plot was delayed for more than six months from the scheduled date of
possession, the assessee had to pay interest on installments already paid by
the allottee during such extended period, at the prevailing fixed term deposit
rates, for similar period offered by the State Bank of India. According to the
assessee, although the relevant clause of the allotment letter used the
expression “interest”, the actual nature of payment was in the nature
of damages for delayed allotment of a plot and not in the nature of interest.
Rejecting the explanation of the assessee, the assessing officer viewed
the payment to be in the nature of interest, and disallowed the expenditure
claimed by the assessee u/s. 40(a)(ia), on account of the failure of the
assessee to deduct tax at source u/s.194A. The CIT (A) confirmed the order of
the assessing officer. Upon further appeal, the Tribunal held that the amount
in question could not be characterised as interest within the meaning of
section 194A, and hence there was no obligation on the part of the assessee to
deduct tax at source. Accordingly, it deleted the disallowance made by the
assessing officer and confirmed by the CIT(A).
Before the High Court, on behalf of the revenue, it was argued that the
amount in question was covered by the definition of interest as provided in
section 2(28A). Reliance was placed on the decision of the Madras High Court in
the case of Viswapriya Financial Services & Securities Ltd. (supra). Reliance
was also placed on the decision in the case of CIT vs. Dr. Sham Lal Narula
50 ITR 513 (Punj), for the proposition that the amount paid in lieu of
delayed payment of compensation to which a person was entitled on the
acquisition of his land was in the nature of interest1.
On behalf of the
assessee, it was argued that the amount payable by the assessee on account of
delay in delivering the plots was not interest within the meaning of section
2(28A), since the contract, in the instant case, was for sale of land by the
assessee to the allottee; the assessee did not borrow any money or incur any
debt; and no money was due by the assessee to the allottee. There was no
debtor-creditor relationship between the parties. The ‘right’ must be to a sum
of money and the ‘obligation’ must also be in respect of a sum of money. The
right of an allottee to obtain possession of land and the obligation of the
assessee to deliver possession therefore did not fall within the purview of the
definition. Reliance was also placed on the decision of the Himachal Pradesh
High Court in the case of CIT vs. H.P. Housing Board 340 ITR 388
wherein, on an almost identical set of facts, it was held that the amount paid
by the assessee (H.P. Housing Board, in that case) was not payment of interest,
but payment of damages to compensate the allottee for the delay in the
construction of his house and the harassment caused to him.
Additionally, the assessee also contended that taxing statutes must be
strictly construed and any doubt must be construed against the taxing
authorities and in favour of the taxpayer.
As far as the definition of ‘interest’ was concerned, the High Court
held that the term ‘interest’ had been made entirely relatable to money
borrowed or debt incurred, and various gradations of rights and obligations
arising from either of the two. The parenthesis in the section was in the
nature of a qualification of the borrowing of money/incurring of debt and what
it included.
On the facts of the case, the High Court held that the payment made by
the assessee to the allottee was in terms of the agreement entered between
them, where the liability of the assessee would arise only if it failed to make
the plots available within the stipulated time. Hence, the payment made under
the relevant clause of the letter of allotment was purely contractual and in
the nature of compensation or damages for the loss caused to the allottee in
the interregnum for being unable to utilise or possess the flat. It had the
flavour of compensation and the expression ‘interest’ used in the concerned
clause might be seen merely as a quantification of the liability of the
assessee in terms of the percentage of interest payable by the State Bank of
India. Since there was neither any borrowing of money nor incurring of debt on
the part of the assessee, it was held that the interest as defined u/s. 2(28A)
had no application to such payments.
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While holding so, the High Court preferred to rely upon the decision of
the Himachal Pradesh High Court in the case of H.P. Housing Board (supra) over
the decision of the Madras High Court in the case of Viswapriya Financial
Services & Securities Ltd (supra).
Observations
From the features of the scheme operated in Viswapriya’s case as
presented before the High Court, it appears that the scheme was similar to the
portfolio management scheme. In the case of portfolio management scheme, the
fund manager invests the funds of the investors and the gains generated by it
accrue to the investors. The fund manager receives the management fees for
managing the portfolio.
In Viswapriya’s case, the assessee had guaranteed a minimum
return with the condition that its management fees would get reduced to the extent
it failed to provide the guaranteed return. Therefore, as per the facts as
presented before the High Court, the only consequence of inability to provide
the guaranteed return was forgoing of the management fee to the extent of
shortfall and nothing more. Had it been the obligation of the assessee to
compensate the shortfall out of its own capital, then perhaps the view taken by
the High Court would have been justified.
In a similar case of chit funds, where the funds belong to the
contributors, various High Courts have taken a view that the bid discount and
dividend to contributors does not amount to interest. The logic is that bid
amount which is distributed among all the subscribers/members is not in respect
of any money borrowed by the chit fund company or any debt incurred by it.
Reference may be made to the following decisions in this regard:
CIT vs. Sahib Chits (Delhi) Pvt Ltd 328 ITR 342
(Del)
CIT vs. Avenue Super Chits (P) Ltd 375 ITR 76
(Kar)
CIT vs. Panchajanya Chits (P) Ltd 232 Taxman 592
(Kar)
The similar logic should have applied equally in Viswapriya’s
case. It appears that these cases have not been cited before the Madras High
Court nor the distinction between the interest, a definite liability, and the
return of gain to the one on whose behalf it was earned has been appropriately
highlighted.
A careful analysis of the definition of ‘interest’ as provided in
section 2(28A) reveals that, in order that a particular payment is regarded as
‘interest’ the following conditions should be satisfied –
1. The payment should be
interest, service fee or other charge.
2. It should be in respect of any
money borrowed or debt incurred including a deposit, claim or other similar
right or obligation and credit facility which has not been utilised.
3. It is payable in any manner.
Not all payments can be considered as ‘interest’, unless the payment
can be termed as the interest, service fee or other charge. The legislature in
its wisdom has used the words “interest” and not just “any amount”.
Therefore, an amount paid, which is not an interest in form and in substance,
cannot be brought into the definition of the term to deem it as interest. The
very fact that the definition, in its second limb, has specifically included
‘any service fee or other charge’ within its scope suggests that the ‘interest’
in its extended meaning includes service fee and other charge and nothing else.
If the first limb was capable of including any type of payment within its
scope, which is in respect of money borrowed or debt incurred, then the second
limb would become otiose. Such an interpretation is against the basic rule of
harmonious construction, whereby an interpretation which reduces one of the
provisions to a dead letter should be avoided. In short, unless the payment can
be classified as an ‘interest’ in its ordinary meaning of the term, it would
not be termed as ‘interest’ u/s. 2(28A) unless of course, the payment
represents the service fee or charge of the specified kind.
In the case of Viswapriya Financial Services & Securities Ltd.,
the amount paid by the assessee under the investment scheme floated by it can
also not be characteriSed as interest as per its general meaning. Interest is
something which is paid from one’s own income or capital. In the kind of
investment scheme operated by the assessee, the money was received from the
investors and retained by it in its fiduciary capacity. The assessee did not
become the owner of that money. The accumulated money was invested by the assessee
on behalf of the investors and the return earned by investing such money had
been distributed back to the investors who were entitled to it.
The Madras High Court was also swayed by the fact that the assessee had
guaranteed a certain percentage of return on investment made by the investors.
However, there may be several such arrangements under which the minimum return
has been guaranteed. For instance, a builder may assure a guaranteed repurchase
price to the investors. A life insurance policy may also have a minimum sum
assured on maturity to the policyholder. The differential amount in such cases
cannot be considered as an ‘interest’ merely because there is an obligation to
pay the amount with a pre-determined rate of return.
In the context of the certificates of deposit and the commercial paper
which are issued at a discount, the CBDT vide its Circular No. 647 dated
22-3-1993 has clarified that the difference between the issue price and the
face value is to be treated as ‘discount allowed’ and not as ‘interest paid’
and, therefore, the provisions of section 194A are not applicable to it. Thus,
the payment, even though in respect of the borrowing, has not been treated as
interest, as it is understood to be the discount and not the interest.
Guidance can be obtained from the decision of the High Court of Punjab
in the case of CIT vs. Sham Lal Nerula 50 ITR 5132 for
understanding the general meaning of interest as quoted below:
“Interest” in general terms is the return or compensation
for the use or retention by one person of a sum of money belonging to or owed
to another. In its narrow sense, “interest” is understood to mean the
amount which one has contracted to pay for use of borrowed money.
“Interest” in this sense may be placed broadly in three categories.
The first kind is interest fixed by the parties to the bargain or contract,
that is, “interest'” ex pacto or ex contractu. The second kind of
“interest” is conventional interest, determined by the accepted
usage, prevalent in a trade or a mercantile community. This is also called ex
mora. In the third category may be placed the legal interest allowed by law or
where the court is empowered by the statute to grant interest generally or at a
fixed rate, that is, ex lege.
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The High Court of Punjab relied upon the decision of the House of Lords
in Westminster Bank Ltd. vs. Riches [1947] A.C. 390 / 28 Tax Cas. 159.
It was a case where a decree was passed against the Westminster Bank for £
36,255 as representing a debt due to Riches. In the exercise of its statutory
powers, the court also awarded a further sum of £ 10,028 as representing
interest due on the debt from the date when the cause of action arose. The
issue before the House of Lords was whether the additional sum of £ 10,028 was
taxable, being in the nature of income. The appellant contended that the
additional sum of £ 10,028, though awarded under a power to add interest to the
amount of the debt, and though called interest in the judgment, was not really
interest attracting income tax, but was damages.
In this context, Lord Wright observed:
“The appellant’s contention is in any case
artificial and is, in my opinion, erroneous, because the essence of interest is
that it is a payment which becomes due because the creditor has not had his
money at the due date. It may be regarded either as representing the profit he
might have made if he had had the use of the money, or conversely the loss he
suffered because he had not that use. The general idea is that he is entitled to
compensation for the deprivation. From that point of view it would seem
immaterial whether the money was due to him under a contract express or
implied, or a statute, or whether the money was due for any other reason in
law. In either case the money was due to him and was not paid or, in other
words, was with-held from him by the debtor after the time when payment should
have been made, in breach of his legal rights, and interest was a compensation,
whether the compensation was liquidated under an agreement or statute, as for
instance under section 57 of the Bills of Exchange Act, 1882, or was
unliquidated and claimable under the Act as in the present case. The essential
quality of the claim for compensation is the same, and the compensation is
properly described as interest.”
Though interest has been interpreted as including the damages or
compensation for deprivation in the aforesaid decision, it may not be true in
every case, in view of the subsequent insertion of the specific definition in
the Act. As per the definition, the interest should be one which is payable in
respect of –
– any moneys borrowed
– debt incurred
– deposit
– claim
– other similar right or obligation
– Credit facility, utilised or not.
Something which is not payable in respect of any of the above, cannot
be regarded as interest for the purpose of the Act, though can be regarded or
called as interest otherwise as per the principles laid down in the aforesaid
decisions.
The first item in the above list is borrowing of money, which is simple
to understand, and there cannot be any debate with regard to it. The second
item refers to the ‘debt incurred’ and the term ‘debt’, though not defined
further in this section, has been defined in section 94B as follows:
“debt” means any loan, financial instrument,
finance lease, financial derivative, or any arrangement that gives rise to
interest, discounts or other finance charges that are deductible in the
computation of income chargeable under the head “Profits and gains of
business or profession”.
The term ‘deposit’ is defined in section 269T as follows:
“loan or deposit” means any loan or
deposit of money which is repayable after notice or repayable after a period
and, in the case of a person other than a company, includes loan or deposit of
any nature.
Though both the above definitions have limited applicability to the
relevant Sections, it will have a persuasive value in order to understand their
meaning in the context of the definition of the term ‘interest’.
It can be seen that the common feature of all of the above items is
that there should be an involvement of money. As far as the borrowing is
concerned, the reference to ‘any moneys’ makes it clear that it cannot include
borrowing of non-monetary assets, for instance, borrowing of securities under
Securities Lending and Borrowing Scheme. As far as incurring of debt is
concerned, it can be a monetary debt or even a non-monetary debt. However, in
the context of this definition and considering the other preceding and
succeeding terms, it should be read in the narrow sense by applying the
principles laid down by the Supreme Court in the case of CIT vs. Bharti
Cellular Ltd. 330 ITR 239. In this case, the words “technical
services” have been interpreted in the narrower sense by applying the rule
of Noscitur a sociis, because the words “technical services”
in section 9(1)(vii) read with Explanation 2 comes in between the words
“managerial and consultancy services”. Therefore, incurring of a debt
not having monetary involvement should not be considered for the purpose of
interpreting the definition of the term ‘interest’.
Apart from borrowing of money and incurring of debt, the definition
also includes “deposit, claim or other similar right or obligation” in
parenthesis. As involvement of money is regarded as essential criteria, the
right must be to a sum of money and the obligation must also be in respect of a
sum of money. The Madras High Court has interpreted the term ‘obligation’ as
including the obligation to repay the money received. However, the definition
refers to a ‘similar’ right or obligation. Therefore, any and every obligation
in respect of money does not get covered unless it is similar to the borrowing
of money or incurring of debt. For instance, preference share capital cannot be
considered as a ‘similar obligation’.
Reference can also be made to CBDT’s Instruction O.P. No.
275/9/80-IT(B) dt. 25-1-1981 which dealt with the issue of applicability of
s/s. 94A to the hire purchase instalment paid by a hirer to the owner under a
hire purchase contract. The relevant portion of the circular is reproduced
below:
4. It has to be considered whether the payment of any instalment or
instalments under a hire purchase agreement can be said to be by way of
interest in respect of any moneys borrowed or debt incurred. In this context,
it has to be borne in mind that a hire purchase agreement is a composite
transaction made up of two elements bailment and sale. In such an agreement,
the hirer may not be bound to purchase the thing hired. It is a contract
whereby the owner delivers goods to another person upon terms on which the
hirer is to hire them at a fixed periodical rental. The hirer has also the
option purchasing the goods by paying the total amount of the agreed hire at
any time or of returning before the total amount is paid. What is involved in
the present reference is the real nature of the fixed periodical rental payable
under a hire purchase agreement.
5. It may be pointed out that part of the amount
of the hire purchase price is towards the hire and part towards the payment of
price. The agreed amount payable by the hirer in periodical instalments cannot
be characterised as interest payable in any manner within the meaning of
section 2(28A) of the Income-tax Act. It is in the nature of a fixed periodical
rental under which the hire purchase takes place.
6. It is true that the definition of the hire
purchase price in section 2(d) of the Hire Purchase Act, 1972, also refers to
any sum payable by the hirer under the hire purchase agreement by way of
deposit or other initial payment or credit or amounts to be credited to him
under such agreement on account of any such deposit or payment. But such
deposit or payment is not in respect of any money borrowed or debt incurred
within the meaning of section 2(28A) of the Income-tax Act.
7. In view of the above, it would appear that the
provisions of section 194A will not be attracted in the case of payment of
periodical instalments under a hire purchase agreement.
Thus, deposit not in the nature of
money borrowed or debt incurred has been considered to be not relevant for the
purpose of interpreting the definition of the term ‘interest’. It strengthens
the view that “deposit, claim or other similar right or obligation” in
parenthesis should also have the element of borrowing of money or incurring of
debt. Similarly, in the case of bill discounting and factoring, where the bill
or debt is assigned to the bank/financial entity, various High Courts have
taken the view that the discount or factoring charges in such cases does not
amount to interest, given that such transactions amount to assignment of the
bill or debt, and discounting or factoring charges paid were not in respect of
any debt incurred or money borrowed. Reference may be made to the following
cases:
CIT vs. MKJ Enterprises Ltd 228 Taxman 61
(Cal)(Mag)
Principal CIT vs. M Sons Gems N Jewellery (P.)
Ltd 69 taxmann.com 373 (Del)
CIT vs. Cargill Global Trading (P) Ltd 335 ITR 94
(Del) – affirmed by the Supreme Court in 21 taxmann.com 496
Attention is also invited to the decision of the Allahabad High Court
in the case of CIT vs. Oriental Insurance Co. Ltd. 211 Taxman 369. The
High Court was dealing with the applicability of section 194A on delayed
payment of compensation for accident under the Motor Vehicle Act. The relevant observations of the Court are
reproduced here:
37. The necessary ingredients of such interest are
that it should be in respect of any money borrowed or debt incurred. The award
under the Motor Vehicle Act is neither the money borrowed by the insurance
company nor the debt incurred upon the insurance company. As far as the word
“claim” is concerned, it should also be regarding a deposit or other
similar right or obligation. The definition of Section 2(28A) of the Income Tax
Act again repeats the words “monies borrowed or debt incurred” which
clearly shows the intention of the legislature is that if the assessee has
received any interest in respect of monies borrowed or debt incurred including
a deposit, claim or other similar right or obligation, or any service fee or
other charge in respect of monies borrowed or debt incurred has been received
then certainly it shall come within the definition of interest.
38. The word “claim” used in the
definition may relate to claims under contractual liability but certainly do
not cover the claims under the statutory liability. The claim under the Motor
Vehicle Act regarding compensation for death or injury is a statutory
liability.
In the case of West Bengal Housing Infrastructure Development Corpn.
Ltd. 96 taxmann.com 610, the Calcutta High Court was dealing with
altogether different facts as compared to Viswapriya’s case. The High
Court rightly held that the rights and obligation referred in the definition
should be arising either from borrowing of money or incurring of debt.
Therefore, the interest payable on account of failure to deliver a particular
asset on the scheduled date as per the agreed terms does not fall within the
definition of the term ‘interest’ under the Act. Though such compensatory
payment could have been regarded as interest as per the principles laid down in
the case of CIT vs. Sham Lal Nerula and Westminster Bank Ltd. vs. Riches,
the statutory definition does not recognise it as interest in the absence of
any borrowing of money, incurring of (monetary) debt or other such similar
arrangements having monetary involvement in respect of which the payment has
been made. Perhaps for similar reasons, the interest payable under the Real
Estate (Regulation and Development) Act, 2016 on account of the failure of the
promoter as envisaged in Section 18 of that Act may also not be regarded as
interest for the purpose of the Act.
This
analysis is restricted to the interpretation of the term ‘interest’ mainly from
the point of view of applicability of section 194A.
