3 As mentioned in Part I of this write-up (BCAI-June, 2015), the Bombay
High Court rejected the claim of the assessee for deduction of upfront
payment of interest on debenture in the first year itself and instead,
accepted the action of the AO in spreading over the deduction over the
five years, being the life of the debentures. For this purpose, the High
Court relied on the judgment of the Apex Court in Madras Industrial
Investments case (referred to in para 1.4 of the Part I of the write-up)
wherein the Court had upheld the spread over of deduction of borrowing
cost of debentures on the ground that there is a continuing benefit to
the business of the company during the tenure of the debentures. While
deciding the issue against the assessee, the Bombay High Court took the
view that although ordinarily revenue expenditure incurred for the
purpose of business must be allowed in its entirety in the year in which
it is incurred but, in the present case, the fact justifies the AO to
spread over the deduction during the life of the debentures as allowing
the expenditure in the first year itself gives a distorted picture of
the profit of that year when the funds collected through the issue of
debentures give a continuing benefit to the business of the assessee
over the entire period of the debentures. For this, the High Court
applied the ‘Matching Concept’ referred to in para 2.8 of Part I of the
write-up. While doing so, the High Court did not accept the contention
of the assessee that this amounts to re-writing of the terms of issue of
debenture. For this, the High Court largely relied on the accounting
treatment of the expenditure given by the assessee in its accounts and
also rejected the contention of the assessee that good accounting is not
necessarily correct law.
Taparia Tools Ltd. vs. Jcit – 276 ctr 1 (sc)
4.1
The judgment of the Bombay High Court in the above case came-up for
consideration before the Apex Court for its decision at the instance of
the assessee and accordingly, the issue referred to in para 1.3 of Part I
of the write-up came-up before the Apex Court for its consideration.
Before the Apex Court, three assessment years [1996-97 to 1998-99]
involving identical issue had come-up for decision.
4.2
Referring to the details of the appeals involving identical issue for
the assessment year 1996-97, the Court stated that the question of law
which has arisen for consideration is whether the liability of the
assessee to pay the interest upfront to the debenture holders is
allowable as deduction in the first year itself or it has to be spread
over a period of five years, during the life of the debentures?
4.3
For the purpose of deciding the issue, the Court noted the relevant
facts [as mentioned in paras 2.1 to 2.3 of Part I of the write-up] and
also noted that the assessee was unsuccessful in appeal before the
Bombay High court. The Court noted that the view taken by the Tribunal
as well the High Court was that for theentire amount paid by the
assessee in the particular assessment year, full deduction is not
available and this deduction is spread over a period of five years.
Thus, the question is as to whether deduction of the entire amount of
interest paid should be allowed in the first year itself or the stence
of the Revenue need to be affirmed.
4.4 For the purpose of deciding the issue at hand, the Court referred to the following relevant factual position [page 7]:
“As
pointed out above, the assessee maintains its accounts on mercantile
basis. Further, the entire amount for which deduction was claimed was,
in fact, actually paid to the debenture-holder as upfront interest
payment. It is also a matter of record that this amount became payable
to the debenture-holder in accordance with the terms and conditions of
the non-convertible debenture issue floated by the assessee, on the
exercise of option by the aforesaid debenture-holders, which occurred in
the respective assessment years in which deduction of this expenditure
was claimed.”
4.5 The Court then noted the provisions of section 36(1)(iii) of the Act and explainedthe effect thereof as under [page 8]:
“…………It
is clear that as per the aforesaid provision any amount on account of
interest paid becomes an admissible deduction u/s.36 if the interest was
paid on the capital borrowed by the assessee and this borrowing was for
the purpose of business or profession. There is no quarrel, in the
present case, that the money raised on account of issuance of the
debentures would be capital borrowed and the debentures were issued for
the purpose of the business of the assessee. In such a scenario when the
interest was actually incurred by the assessee, which follows the
mercantile system of accounting, on the application of this statutory
provision, on incurring of such interest, the assessee would be entitled
to deduction of full amount in the assessment year in which it is paid.
While examining the allowability of deduction of this nature, the AO is
to consider the genuineness of business borrowing and that the
borrowing was for the purpose of business and not an illusionary and
colourabale transaction. Once the genuineness is proved and the interest
is paid on the borrowing, it is not within the powers of the AO to
disallow the deduction either on the ground that rate of interest is
unreasonably high or that the assessee had himself charged a lower rate
of interest on the monies which he lent………………….”
4.6 While
dealing with the principle of deduction of such expenditure, the Court
noted that the AO did not dispute that the expenditure on account of
interest was genuinely incurred. It is also not in dispute that the
amount of interest was actually paid in the relevant year. Since the
assessee was following mercantile system of accounting, the amount of
interest could be claimed as deduction even if it was not actually paid
but simply incurred. While staggering and spreading the interest over a
period of five years, the AO was mainly persuaded by two reasons viz.,
(i) the term of debenture was five years; and (ii) the assessee had
itself given this very treatment in the books of account (i.e.,
spreading it over a period of five years in its final accounts by not
debiting the entire amount in the first year to the P&L account).
The Court also noted that the High Court has based its reasoning on the
second aspect and applied the principle of ‘Matching Concept’ to support
its conclusion.
4.7 Dealing with the first reason adopted by
the AO i.e., the debentures were issued for the period of five years,
the Court took the view that this is clearly not tenable. For this, the
Court stated as under [page 9]:
“………….While taking this view, the AO clearly erred as he ignored by ignoring the terms on which debentures were issued. As noted above, there were two methods of payment of interest stipulated in the debenture issued. Debenture- holder was entitled to receive periodical interest after every half year @ 18% per annum for five years, or else, the debenture-holder could opt for upfront payment of Rs. 55 per debenture towards interest as one-time payment. By allowing only 1/5th of the upfront payment actually incurred, though the entire amount of interest is actually incurred in the very first year, the AO, in fact, treated both the methods of payment at par, which was clearly unsustainable. By doing so, the AO, in fact, tampered with the terms of issue, which was beyond his domain. It is obvious that on exercise of the option of upfront payment of interest by the subscriber in the very first year, the asessee paid that amount in terms of the debenture issue and by doing so he was simply discharging the interest liability in that year thereby saving the recurring liability of interest for the remaining life of the debentures because for the remaining period the assessee was not required to pay interest on the borrowed amount.”
4.8 Having dealt with the first reason on which the AO based his order, the Court proceeded to consider the second reason of the AO and stated that whether the assessee was estopped from claiming deduction for the entire interest paid in the same year merely because it had spread over this interest in its books of account over a period of five years. The Court then noted, in brief, the contentions raised on behalf of the assessee in this context (which are broadly on the line raised before the High Court). In substance, on behalf of the assessee, it was contended that the accounting treatment in the books of account is not relevant for the purpose of determining the deductibility of an expenditure and thathas to be decided in accordance with the provisions of the Act when the claim is made by the assessee on that basis and for that purpose, terms of issue of debentures are relevant. For this, the assessee had relied on the provisions of section 36(1)(iii) of the Act. The Court noted that the High Court has dealt with this provision and explained implications thereof in following words [page 10]:
“……The term ‘interest’ has been defined u/s. 2(28A) of the Act. Briefly, interest payment is an expense u/s. 36(1)(iii). Interest on monies borrowed for business purposes is an expenditure in a business [see M.L.M. Muthiah Chettiar & Ors. vs. CIT (1959) 35 ITR 339 (Mad)]. For claiming deduction under s. 36(1)(iii), the following conditions are required to be satisfied viz. the capital must have been borrowed; it must have been borrowed for business purpose and the interest must be paid. The word ‘paid’ is defined in section 43(2). It means payment in accordance with the method followed by the assessee. In the present case, therefore, the word ‘paid’ in section 36(1)(iii) should be construed to mean paid in accordance with the method of accounting followed by the assessee i.e. Mercantile System of accounting… ”
4.8.1 The Court then stated that notwithstanding the aforesaid implications of the provisions of section 36(1)(iii) noted by the High Court, the High Court chose to decline the whole deduction in the year of payment and thereby, affirmed the orders of lower authorities by invoking the ‘Matching Concept’. In the opinion of the High Court, this ‘Matching Concept’ is required to be done on accrual basis and in High Court’s view, in this case, payment of Rs. 55 per debenture towards interest made by the assessee pertained to five years, and thus, this interest of five years was paid in the first year. The Court then opined that it is here that the High Court has gone wrong and this approach resulted in wrong application of ‘Matching Concept’. In this context the Court further opined as under [pages 10 & 11]:
“… However, in the second mode of payment of interest, which was at the option of the debenture- holder, interest was payable upfront, which means insofar as interest liability is concerned, that was discharged in the first year of the issue itself. By this, the assessee had benefited by making payment of lesser amount of interest in comparison with the interest which was payable under the first mode over a period of five years. We are, therefore, of the opinion that in order to be entitled to have deduction of this amount, the only aspect which needed examination was as to whether provisions of section 36(1)(iii) r/w section 43(2) of the Act were satisfied or not. Once these are satisfied, there is no question of denying the benefit of entire deduction in the year in which such an amount was actually paid or incurred.”
4.8.2 The Court then dealt with the issue of deferred revenue expenditure and stated as under [page 11]:
“The High Court has also observed that it was a case of deferred interest option. Here again, we do not agree with the High Court. It has been explained in various judgments that there is no concept of deferred revenue expenditure in the Act except under specified sections, i.e. where amortisation is specifically provided, such as section 35D of the Act.”
4.8.3 Dealing with the facts of the assessee’s case, the Court then stated that the moment second option was exercised by the debenture-holder to receive the upfront payment, liability of the assessee to make the payment in that very year has arisen and this liability was to pay interest @ Rs. 55 per debenture. To support this position, the Court noted the following passage from the judgment of the Apex Court in the case of Bharat Earth Movers [245ITR 428]:
“The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesentithough it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.”
4.1.1.1 Having referred to the above passage, the Court stated that the present case is even on a stronger footage in as much as not only the liability had arisen in the relevant year, it was even quantified and discharged as well in that very year.
4.1.2 The Court then dealt with the effect of Madras Industrial Investments case (supra) and stated that, in that case, the Court categorically held that the general principle is to allow the revenue expenditure incurred for business purposes in the same year in which it is incurred. However, some exceptional cases can justify spreading the expenditure and claim it over a period of ensuing years. In that case, the assessee wanted spreading the expenditure over a period of time and had justified the same. By raising money through the said debentures, the assessee could utilise the said amount and secure the benefit over number of years. On this basis, the Court found that the assessee could be allowed to spread over the expenditure over a period of five years, at the end of which the debentures were to be redeemed.
4.1.2.1 After referring to the relevant passage from the judgment in the case of Madras Industrial Investments case (supra), the Court observed as under [pages12 &13]:
“Thus, the first thing which is to be noticed is that though the entire expenditure was incurred in that year, it was the assessee who wanted the spread over. The Court was conscious of the principle that normally revenue expenditure is to be allowed in the same year in which it is incurred, but at the instance of the assessee, who wanted spreading over, the Court agreed to allow the assessee that benefit when it was found that there was a continuing benefit to the business of the company over the entire period.”
4.8.4.2 Explaining the effect of the above judgment, the Court further stated as under [page 13]:
“What follows from the above is that normally the ordinary rule is to be applied, namely, revenue expenditure incurred in a particular year is to be allowed in that year. Thus, if the assessee claims that expenditure in that year, the IT Department cannot deny the same. However, in those cases where the assessee himself wants to spread the expenditure over a period of ensuing years, it can be allowed only if the principle of ‘Matching Concept’ is satisfied, which upto now has been restricted to the cases of debentures.”
4.8.5 Having explained the effect of the judgment in the case of Madras Industrial Investments case (supra), the Court dealt with the case of the assessee and stated that, in this case, the assessee did not want spread over of this expenditure and it had claimed the entire interest paid upfront as deductible expenditure in the same year in its return of income. When this course of action was permissible in law to the assessee, merely because a different treatment was given in the books of account cannot be a factor which would deprive the assessee from claiming the entire expenditure as a deduction. This Court has repeatedly held that entries in the books of account are not determinative or conclusive and the matter is to be examined in the context of the provisions contained in the Act. Having referred to this settled position, the Court, finally, held as under [page 13]: “At the most, an inference can be drawn that by showing this expenditure in a spread over manner in the books of accounts, the assessee had initially intended to make such an option. However, it abandoned the same before reaching the crucial stage, inasmuch as, in the IT return filed by the assessee, it chose to claim the entire expenditure in the year in which it was spent/ paid by invoking the provisions of section 36(1)(iii) of the Act. Once a return in that manner was filed, the AO was bound to carry out the assessment by applying the provisions of that Act and not to go beyond the said return. There is no estoppel against the statute and the Act enables and entitles the assessee to claim the entire expenditure in the manner it is claimed.”
4.9 Based on the above,the Court concluded that the High Court and the authorities below did not law down correct position in law. The assessee would be entitled to a deduction of the entire interest expenditure in the year in which the amount was actually paid. As such, the appeals of the assessee were allowed.
Conclusion
5.1 (i) From the above judgment of the Apex Court, it is clear that the upfront payment of interest on debenture in one year is eligible for deduction u/s. 36(1)(iii) in that year itself whenliability to pay the same is incurred in that year.
(ii) In such cases, if the assessee has spread over the interest expenditure in accounts and if the claim of deduction is made on that basis on the ground that there is a continuing benefit to the business, he can choose to do so.
(iii) As such, in mercantile system of accounting, in such cases, the assessee has an option either to claim deduction in the year in which the liability to pay interest is incurred or to spread over the same during the life of the debentures.
5.2 In the above case, in the context of the mercantile system of accounting, the Apex Court has reiterated following settled positions under the Act:-
(i) Ordinarily the revenue expenditure incurred for the purpose of the business of the assessee is eligible for deduction in its entirety in the same year in which it is incurred.
(ii) In the absence of any specific provision in the Act, deductible revenue expenditure cannot be treated as deferred revenue expenditure and on that basis, the deduction of such expenditure cannot be spread over.
(iii) The claim of deduction of any expenditure should be examined on the basis of the relevant provisions contained in the Act and in that context, the accounting treatment given by the assessee in the books of account is irrelevant.
(iv) The conditions to be satisfied for claiming deduction of interest on capital borrowed u/s. 36(1)
(iii) [refer para 4.5]. This should be subject to other specific provisions contained in the proviso and Explanation to section 36(1)(iii).
5.3 (i) Section 145(2) has been amended by the Finance (No. 2) Act, 2014 from assessment year 2015-16. Under these amended provisions, the Central Government is authorised to notify Income Computation and Disclosure Standards (ICDS) to be followed by the any class of assessees or in respect of any class of income.
(ii) Under these provisions, the Government has notified 10 ICDS by notification dated 31st March, 2015 [applicable from assessment year 2016-17]. ICDS-IX deals with the borrowing costs. The impact of this should now also be borne in mind.It is also worth noting that every ICDS specifically provides that in case of conflict between the provisions of the Act and the ICDS, the provisions of the Act shall prevail to that extent.
(iii) Arguably, even in post ICDS era, this judgment should continue to hold good. At the same time, in all probability, the Revenue is likely to contest this position. As such, on this position,which is settled by the Apex Court after nearly two decades, fresh round of litigation is likely to start. Instead, if the Government does not wish to accept this position, although it would be unfair as well as improper as the Court, in this case, has only re-iterated the settled position, it can consider to make appropriate amendment.
(iv) Similar could be the impact of most of the ICDS as, almost all the major assessees, for the purpose of maintenance of books of account, will have to follow either the accounting standards [including Ind AS] prescribed under the Companies Act, 2013 or the accounting standards issued by the ICAI [Statutory AS]. At macro level, the Government is showing it’s preparedness to address all genuine concerns of the business community on tax issues. But, unfortunately, at micro level, things are not encouraging. Need of the hour is to provide clarity at the micro level and encourage change of mind- set in the tax administration. The ICDS will certainly not make it easy for doing business in India. This will lead to further uncertainty in determination of annual tax liability.
(v) In our view, there is absolutely no need to keep suchelaborate ICDS for the purpose of computation of income. In a good tax system, there should be minimum possible gap between the accounting profit and the taxable profit. The ICDS have gone completely against this basic canon of taxation. The ICDS will only widen this gap. A common thread noticed in the ICDS is an attempt to accelerate the taxation either by advancing the taxation of income before it is recorded in accounts or by postponing the deduction of expenses/ losses recognised in the books of account based on well settled accounting principles. As such, for tax purpose also, the Revenue Department should have accepted the commercial profit determined in accordance with the Statutory AS and in cases of disagreement, if any, on treatment of some items, the Government could have amended few provisions in the Act itself. In fact, effectively, this was the recommendation of the earlier Committee formed in the year 2002 in it’s report submitted in November, 2003. This could have achieved the object of ICDS,provided certainty and also relieved the business community from the unwarranted huge compliance burden. Statutory ASsare mandatory for maintenanceof books of account for most of the assessees. Effectively, under ICDS regime, the assessees will have to maintain either one more set of books of account or detailed records for the purpose of reconciling the commercial profit with the taxable income. In this process, we are almost assured of new era of litigation in this respect for atleast two more decades, if not more. It is difficult to believe that the Revenue Department is unaware of this ground reality. BCAS had made elaborate representation explaining why ICDS should not be introduced, but no impact.
(vi) In view of the notification of the ICDS, the damage has already been done. Best way is to withdraw the same. But this is doubtful as the Government will not have courage to do so. Therefore, now, only the extent of this damage can be restricted. For this, the only one action is required and that is to restrict the applicability of ICDS only to corporate entities which are mandatorily required to followInd-AS. This will be also in line with the object of ICDS as the idea of prescription of ICDS had originatedonly on account of requirement of introduction of Ind AS. This will restrict the impact of ICDS to largecorporate assesseesand will also help to mitigate the hardships of the smaller and medium size assessees, who lack requisite competence and infrastructure needed for such compliance. This will substantially save the nation from the potential long term protected litigation on the issues which are not worth litigating. There are many other constructive and better things to do to build the nation. We may also mention that if the ICDS continue to apply to all assessees, the profession may benefit but the nation will not. The Government has to make a choice.
