2005 (4) TMI 610 - HC - Income Tax

Summary

Issues Involved:
1. Taxability of interest income in the hands of the individual assessee.
2. Deduction of liability in the hands of the company.
3. Applicability of Section 36(1)(iii) of the Income-tax Act, 1961.
4. Applicability of the Supreme Court decision in Madras Industrial Investment Corporation Limited.
5. Accounting treatment under mercantile system.
6. Proportionate taxation of interest income.

Issue-Wise Detailed Analysis:

1. Taxability of Interest Income in the Hands of the Individual Assessee:
The individual assessee invested in debentures and declared proportionate interest income for the accounting period. The Assessing Officer added the entire interest income based on the tax deduction certificate. The CIT (Appeals) upheld this addition, stating the entire interest income had accrued and was received during the accounting period. The Tribunal, however, ruled that only proportionate interest income was taxable, aligning with the principles of commercial accounting and the nature of Deep Discount Bonds.

2. Deduction of Liability in the Hands of the Company:
The payer company claimed a deduction for the total interest paid on debentures as revenue expenditure under Section 36(1)(iii) of the Income-tax Act, 1961. The Assessing Officer allowed only a proportionate deduction, treating the upfront interest payment as an advance for the entire period of six years. The CIT (Appeals) and the Tribunal upheld this proportionate deduction, referencing the Supreme Court decision in Madras Industrial Investment Corporation Limited.

3. Applicability of Section 36(1)(iii) of the Income-tax Act, 1961:
The payer company argued that it satisfied the conditions under Section 36(1)(iii) for deduction of interest paid on borrowed capital for business purposes. The court agreed, stating the company had paid the interest as per the contract terms and was entitled to the deduction in the year of payment, rejecting the proportionate deduction approach taken by the lower authorities.

4. Applicability of the Supreme Court Decision in Madras Industrial Investment Corporation Limited:
The court distinguished the present case from Madras Industrial Investment Corporation Limited, noting the latter dealt with Section 37(1) of the Act, while the current case involved Section 36(1)(iii). The court held that the principles of Section 37(1) could not be applied to Section 36(1)(iii), thus allowing the payer company's full deduction claim.

5. Accounting Treatment under Mercantile System:
The court clarified that under the mercantile system, both actual cash receipts and liabilities incurred are considered. The individual assessee's argument that only proportionate interest income should be taxed was rejected, as the entire interest amount had been received and accounted for during the relevant period.

6. Proportionate Taxation of Interest Income:
The court held that the entire interest income received by the individual assessee in the year of allotment was taxable in that year, rejecting the Tribunal's decision to tax it proportionately over six years. The court emphasized that the terms of the contract dictated the tax treatment, and the entire interest payment made upfront could not be spread over subsequent years.

Conclusion:
Both Tax Appeal No. 157 of 2000 and Tax Appeal No. 328 of 2000 were allowed. The payer company was entitled to the full deduction of interest paid in the year of payment, and the entire interest income was taxable in the hands of the individual assessee in the year of receipt. The court directed that any proportionate tax paid in subsequent years should be refunded, ensuring no double taxation.