2021 (8) TMI 520 - SC - Income Tax

Scope of Explanation 3C of Section 43B - Actual payment of interest or not - Issuance of debenture in lieu of Interest - Funding of the interest amount by way of a term loan amounts to actual payment as contemplated by Section 43B - whether interest can be said to have been actually paid by the mode of issuing debentures? - HELD THAT - 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. 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 This Court found that Explanation 3C was squarely attracted in that outstanding interest had not actually been paid, but instead a new credit entry of loan now appeared, bringing the case within the express language of Explanation 3C. Consequently, 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.

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. Applicability of Explanation 3C to the facts of the case.
4. Retrospective effect and interpretation of Explanation 3C.
5. The correctness of the High Court's framing of the question of law.

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 and its Explanation 3C. Section 43B mandates that certain deductions are only permissible on actual payment, overriding the mercantile system of accounting. Explanation 3C clarifies that converting interest into a loan does not constitute actual payment.

2. Whether the issuance of debentures in lieu of interest constitutes "actual payment" under Section 43B:
The Appellant issued debentures to financial institutions in lieu of outstanding interest, claiming this as an actual payment under Section 43B. The CIT and ITAT found that the issuance of debentures effectively discharged the interest liability, thus constituting actual payment. The ITAT emphasized that the conversion of interest liability into debentures was agreed upon by both parties and should be considered as an effective discharge of the liability.

3. Applicability of Explanation 3C to the facts of the case:
The High Court, relying on Explanation 3C, held that converting interest into a loan does not amount to actual payment, thus denying the deduction. However, the Supreme Court found that the facts of the case indicated that the debentures were issued under a rehabilitation plan to extinguish the interest liability, not to convert it into a loan. Therefore, Explanation 3C, aimed at preventing misuse by converting interest into loans, did not apply.

4. Retrospective effect and interpretation of Explanation 3C:
Explanation 3C, inserted retrospectively, was intended to curb the misuse of Section 43B by converting interest into loans. The Supreme Court clarified that retrospective provisions should not alter the law as it stood unless explicitly stated. The Court held that Explanation 3C was clarificatory and did not add new conditions retrospectively. The Court cited principles from cases like K.P. Varghese v. ITO and Sedco Forex International Drill. Inc. v. CIT to support this interpretation.

5. The correctness of the High Court's framing of the question of law:
The Supreme Court noted that the High Court framed the question incorrectly by omitting the term "debenture," which led to an erroneous conclusion. The correct question should have been whether the issuance of debentures amounted to actual payment under Section 43B. The Supreme Court found that the High Court's misframing of the question led to a misapplication of Explanation 3C.

Conclusion:
The Supreme Court set aside the High Court's judgments and restored the ITAT's order. It concluded that the issuance of debentures under the rehabilitation plan constituted actual payment of interest, and Explanation 3C did not apply to the facts of this case. The appeals were allowed, affirming that the debentures effectively discharged the interest liability, qualifying for the deduction under Section 43B.

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