2021 (8) TMI 1404 - SC - Income Tax

Deduction u/s 43B - issue of debentures in lieu of interest accrued and payable to financial institutions - AO rejected the Appellant s contention by holding that the issuance of debentures was not as per the original terms and conditions on which the loans were granted, and that interest was payable, holding that a subsequent change in the terms of the agreement, as they then stood, would be contrary to Section 43B(d), and would render such amount ineligible for deduction - CIT(A) allowed assessee appeal - question recorded by HC - Whether the funding of the interest amount by way of a term loan amounts to actual payment as contemplated by Section 43B of the Income-tax Act, 1961? HELD THAT - The object of Section 43B, as originally enacted, is to allow certain deductions only on actual payment. This is made clear by the non-obstante clause contained in the beginning of the provision, coupled with the deduction being allowed irrespective of the previous years in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by it. In short, a mercantile system of accounting cannot be looked at when a deduction is claimed under this Section, making it clear that incurring of liability cannot allow for a deduction, but only actual payment , as contrasted with incurring of a liability, can allow for a deduction. Interestingly, the sum payable referred to in Section 43B(d), with which we are concerned, does not refer to the mode of payment, unlike Proviso 2 to the said Section, which was omitted by the Finance Act, 2003 w.e.f. 1st April, 2004. This being the case, it is important to advert to the facts found in the present case. Both the CIT and the ITAT found, as a matter of fact, that as per a rehabilitation plan agreed to between the lender and the borrower, debentures were accepted by the financial institution in discharge of the debt on account of outstanding interest. This is also clear from the expression in lieu of used in the judgment of the learned CIT. That this is so is clear not only from the accounts produced by the assessee, but equally clear from the fact that in the assessment of ICICI Bank, for the assessment year in question, the accounts of the bank reflect the amount received by way of debentures as its business income. This being the fact-situation in the present case, it is clear that interest was actually paid by means of issuance of debentures, which extinguished the liability to pay interest. Explanation 3C, which was introduced for the removal of doubts , only made it clear that interest that remained unpaid and has been converted into a loan or borrowing shall not be deemed to have been actually paid. As has been seen by us hereinabove, particularly with regard to the Circular explaining Explanation 3C, at the heart of the introduction of Explanation 3C is misuse of the provisions of Section 43B by not actually paying interest, but converting such interest into a fresh loan. On the facts found in the present case, the issue of debentures by the assessee was, under a rehabilitation plan, to extinguish the liability of interest altogether. No misuse of the provision of Section 43B was found as a matter of fact by either the CIT or the ITAT. Explanation 3C, which was meant to plug a loophole, cannot therefore be brought to the aid of Revenue on the facts of this case. Indeed, if there be any ambiguity in the retrospectively added Explanation 3C, at least three well established canons of interpretation come to the rescue of the assessee in this case. First, since Explanation 3C was added in 2006 with the 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. In similar circumstances, in K.P. Varghese v. ITO, ( 1981 (9) TMI 1 - SUPREME COURT ) this Court construed Section 52 of the Income Tax Act as applying only to cases where understatement is be found an understatement is not to be found in the literal language of Section 52, but was introduced by this Court to streamline the provision in the light of the object sought to be achieved by the said provision. Second, a retrospective provision in a tax act which is for the removal of doubts cannot be presumed to be retrospective, even where such language is used, if it alters or changes the law as it earlier stood. This being the 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 the High Court. The question decided in this case is far removed from the question to be decided in the facts of the present case and has no application to these facts whatsoever. The question in the present case does not depend upon what can, in law, be stated to be a debenture and/or whether it is convertible or non-convertible or payable immediately or in the future. The question in the present case is only whether interest can be said to have been actually paid by the mode of issuing debentures. The impugned judgments of the High Court are set aside and the judgment and order of the ITAT is restored. These appeals are allowed in the aforesaid terms.

Summary

Issues Involved:
1. Interpretation of Section 43B Explanation 3C of the Income Tax Act, 1961.
2. Whether the issuance of debentures in lieu of interest constitutes "actual payment" under Section 43B.
3. The applicability and retrospective effect of Explanation 3C.
4. The relevance of judicial precedents and statutory interpretation principles.

Detailed Analysis:

1. Interpretation of Section 43B Explanation 3C of the Income Tax Act, 1961:
The core issue revolves around the interpretation of Section 43B, particularly Explanation 3C, which was inserted by the Finance Act, 2006, with retrospective effect from 1.4.1989. The explanation clarifies that any interest converted into a loan or borrowing shall not be deemed to have been "actually paid."

2. Whether the issuance of debentures in lieu of interest constitutes "actual payment" under Section 43B:
The appellant claimed a deduction under Section 43B for interest discharged by issuing debentures. The Assessing Officer rejected this, but the CIT (Appeals) and ITAT allowed the deduction, holding that the issuance of debentures constituted actual payment. The ITAT emphasized that both creditor and debtor agreed that converting the outstanding interest liability into fully paid debentures effectively discharged the liability, thus meeting the requirement of "actual payment."

3. The applicability and retrospective effect of Explanation 3C:
The High Court, relying on Explanation 3C, concluded that converting interest into a loan does not amount to actual payment, thus disallowing the deduction. However, the Supreme Court noted that Explanation 3C was introduced to curb the misuse of Section 43B by converting interest into loans without actual payment. The Court found that in this case, the issuance of debentures extinguished the interest liability, and no misuse was found by the CIT or ITAT. Therefore, Explanation 3C, intended to plug a loophole, did not apply to bona fide transactions like the one in question.

4. The relevance of judicial precedents and statutory interpretation principles:
The Supreme Court highlighted several principles of statutory interpretation, including the need to strictly construe fiscal statutes and the presumption against retrospective application of provisions that alter existing law. The Court cited precedents like Cape Brandy Syndicate v. Inland Revenue Commissioner and K.P. Varghese v. ITO to support its interpretation. The Court emphasized that any ambiguity in Explanation 3C should be resolved in favor of the assessee.

Conclusion:
The Supreme Court concluded that the High Court erred in its interpretation and application of Explanation 3C. The issuance of debentures in this case constituted "actual payment" of interest under Section 43B. The judgments of the High Court were set aside, and the order of the ITAT was restored, allowing the appellant's deduction claim.