26 March 2015 EY Tax Alert Supreme Court rules on year of deductibility of debenture interest paid upfront Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Supreme Court (SC), in the case of Taparia Tools Ltd. [1] (Taxpayer), wherein the issue was whether a taxpayer can be permitted full deduction under the provisions of the Indian Tax Laws (ITL) for upfront payment of debenture interest, though such payment has been amortised over the tenure of the debenture in the books of account. The SC, based on the facts, held that since the Taxpayer had claimed deduction for the full amount of upfront interest payment, the same should be allowed in the year of payment and should not be spread over the term of the debentures. The SC reiterated that there is no concept of deferred revenue expenditure under the ITL. Furthermore, the SC also ruled that the treatment given in the books of account is not an estoppel against the statute to claim deduction. [1] [TS-134-SC-2015]
Facts of the case The Taxpayer, an Indian company, issued non-convertible debentures which provided for two options as regards payment of interest: Half-yearly payment of interest @ 18% p.a. for five years. Or One-time upfront payment of INR55 per debenture. The debentures were redeemable at premium. Based on the terms of the debenture issue, few debenture holders opted for upfront payment of interest and the same was, accordingly, paid by the Taxpayer. The Taxpayer accounted the upfront interest as deferred revenue expenditure in its books of account and the same was written off over a period of five years i.e., the tenure of the debentures issued. However, for tax purposes, the entire upfront interest payment was claimed as a deductible expenditure in the year of payment. The Appellate Authorities and the Bombay High Court ruled in favor of the Tax Authority. The Bombay High Court upheld the Tax Authority s view on the following grounds: The Taxpayer itself had, in its books of account, spread the interest expenditure over a period of five years. As per matching concept under the mercantile system of accounting, the income shown for the year has to match with the expenditure incurred for the purpose of such income. In the facts, interest paid in the first year actually pertained to five years, being the term of the debentures and, accordingly, deduction in respect of the same shall be spread over a period of five years. For this proposition, reliance was placed on the SC ruling in the case of Madras Industrial Investment Corporation Ltd. (supra) in which the SC allowed deduction for discount on the debentures on amortised basis over the tenure of the debentures. Aggrieved, the Taxpayer appealed before the SC. SC s ruling The premium payable on redemption, however, was claimed on a spread-over basis over five years, on which there was no dispute. The Tax Authority, based on the SC decision in the case of Madras Industrial Investment Corporation Ltd. [2], treated the upfront interest amount as deferred revenue expenditure and allowed deduction proportionately over the tenure of the debentures (1/5th of the total interest amount each year) i.e., in line with the treatment provided in the books of account of the Taxpayer. Based on the below reasoning, the SC held that the Taxpayer was entitled to full deduction of upfront interest in the year of payment and the deduction should not be spread over the term of the debentures in the absence of the concept of deferred revenue expenditure under the ITL. As per the provisions of the ITL, interest paid on borrowed capital for the purposes of business or profession is deductible. In the present case, the following facts were not in dispute: The debenture proceeds were used for business purpose. The borrowing was genuine and not an illusory or colorable transaction. The clause permitting the option of upfront payment of interest was genuine and upfront interest expenditure was genuinely incurred. [2] [(1997) 4 SCC 666] Once the genuineness of the borrowing and upfront interest payment is accepted, it is not within the powers of
the Tax Authority to disallow the deduction either on the ground that the rate of interest is unreasonably high or that the taxpayer had itself charged a lower rate of interest on the monies which it lent. The term paid is defined under the ITL to mean actually paid or incurred according to the method of accounting. In case of the mercantile system of accounting, the amount actually incurred, though not paid, would still be treated as paid. In the present case, the Taxpayer has not only incurred but also paid the interest amount in the relevant tax year in which the deduction was claimed. Reliance was placed on the SC decision in the case of Bharat Earth Movers [3] wherein it was ruled that if a business liability has arisen in the accounting year, the deduction should be allowed even if such a liability may have to be quantified and discharged at a future date. In the present facts, liability had not only arisen but was also discharged in the relevant tax year. Once the option of upfront interest payment is exercised by the debenture holder, liability of the Taxpayer to honor the payment arises. The fact that the debentures were issued for a period of five years does not justify the spread-over of the upfront interest payment. The debenture terms clearly allowed two options to the holders viz., upfront payment and periodic payment. Allowing 1/5th of the upfront interest actually paid would be tantamount to treating both the modes of interest payment at par, which is not sustainable. The Tax Authority cannot tamper with the terms of issue of the debentures, which is beyond its domain. Upfront interest payment saved the Taxpayer recurring liability of interest for the remaining life of the debentures. Furthermore, there is no concept of deferred revenue expenditure, except where specific provisions are provided in the ITL (e.g., preliminary expenditure). [3] [(2000) 6 SCC 645] The case of Madras Industrial Investment Corporation Ltd (supra) is distinguishable. In that case, the taxpayer itself had opted for amortised deduction of discount on the debentures over the tenure of the debentures, though the liability for discount was actually incurred in the year of issue of the debentures itself. The SC found that the taxpayer could still be allowed to spread the expenditure since the taxpayer could utilize the monies collected under the said debentures and secure benefit over a number of years. The SC, while being conscious of the principle that, normally, revenue expenditure is to be allowed in the same year in which it is incurred, permitted spread-over at the instance of the taxpayer since there was a continuing benefit to the business over the entire period. What follows from the above ruling is that, normally, revenue expenditure incurred in a particular year has to be allowed in the same year. If a taxpayer claims such expenditure in that year, the Tax Authority cannot deny the same. However, in those cases, where a taxpayer itself 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, up to now, has been restricted to the cases of debentures. In the present facts, the Taxpayer exercised its option to claim the entire interest expenditure in the year in which it was incurred. It is true that the Taxpayer may have initially intended to claim the expenditure over the period of five years by giving such treatment in its books of account. However, it abandoned the same before reaching the crucial stage of furnishing return of income and chose to claim the whole expenditure as deduction in the year of incurrence. Once the return was filed in such a manner, the Tax Authority was bound to carry out the assessment by applying the statutory provisions. There is no estoppel against the statute and the ITL enables and entitles the Taxpayer to claim the entire expenditure in the manner it is claimed.
Merely because a different treatment is given in the books of account, it would not deprive the Taxpayer from claiming the entire expenditure as deduction. It is well-settled that entries in the books of account are not determinative or conclusive and the matter is to be examined on the touchstone of the provisions contained in the ITL [4]. Comments This decision of the SC is a welcome ruling and upholds that the concept of deferred revenue expenditure is not relevant under the ITL and, hence, revenue expenditure should ordinarily be allowed in full in the year of incurrence. However, if the revenue expenditure grants a continuing benefit over a number of years, a taxpayer has the option to either claim full deduction in the year of incurrence or claim amortised deduction on a spreadover basis. In this regard, the SC has reiterated the well-settled principle that entries in the books of account are not determinative or conclusive and the matter is to be examined on the touchstone of statutory provisions. A taxpayer is free to claim deduction as per its option in the return of income and the Tax Authority is bound to allow the same if it is otherwise allowable under the law. [4] Illustratively, Kedarnath Jute Manufacturing Co. Ltd. [(1972) 3 SCC 252], Tuticorin Alkali Chemicals and Fertilizers Ltd. [(1997) 6 SCC 117], Sutlej Cotton Mills Ltd. [(1978) 4 SCC 358], United Commercial Bank [(1999) 8 SCC 338]
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