2024 (4) TMI 1152 - AT - Income Tax

LTCG - Exemption u/s 54F and 54EC - Incidence of capital gain may arise in the case of debentures - surplus realized by the assessee on surrender of Non Convertible Debenture (NCD) upon its redemption on maturity - whether the gain arising to the assessee on redemption of debentures is in the nature of Capital gains as claimed by the assessee or it is in the nature of interest income as held by CIT(A)? - HELD THAT - Shares and debentures stand on different footing. In our view, the decisions with regard to redemption of preference shares and reduction of capital in case of equity shares have been rendered considering the rights and liabilities attached to shares. Hence, in our view, the ratio of decisions rendered in the case of equity shares/preference shares cannot be applied to debt instruments. We notice that the decision in the case of Mrs. Perviz Wang Chuk basi 2005 (10) TMI 214 - ITAT BOMBAY-G was related to Capital investment Bond issued by Government of India and not the case of debenture issued on private placement basis. Accordingly, the redemption of debentures is nothing but repayment of debt and the same, in our view, cannot fall under the category of extinguishment as interpreted by the Courts in the case of Shares/Preference shares. The market value of debentures would depend upon the fluctuation in the prevailing general interest rates. We may explain this with an example. Let us assume that a debt instrument having face value of Rs.1000/- was issued and it carried interest rate of 12% p.a. Let us further assume that the market rate of interest has fallen to 6% subsequently. In that case, the market forces will recognize the higher interest yield available in the above said debt instrument. Accordingly, the market value of debt instrument may increase to say Rs.1300/-. If the holder of the said debt instrument having face value of Rs.1000/- sells it for Rs.1300/-, then the gain of Rs.300/- obtained by that person is assessable as Capital gain. So far as the company which had issued the debt instrument is concerned, the above said market value is irrelevant. It would be paying interest on the face value of Rs.1000/- only and further, at the time of redemption of the same, the said company would be redeeming the debt instrument at its face value of Rs.1000/- only. We have held earlier that such kind of redemption will not give rise to any capital gains. In the instant case, the NCDs under consideration are privately placed debentures and they are not listed in the stock exchange. Further, the assessee herein has not sold the NCDs in the open market. Assessee has only surrendered the NCDs to the SPVs, viz., M/s Bhishma Realty Ltd and M/s Capricorn Realty Ltd, for redemption. Thus, it is a case of realization of money advanced by a creditor, since debentures are debt instruments only. Thus, the question of generation of capital gains will not arise, when the debentures are redeemed by the issuing companies. What is received by the assessee in the form of premium is nothing but interest income only. CIT(A) was legally correct in holding that the premium/surplus received by the assessee is interest income assessable under the head Income from Other Sources. We noticed earlier, the cost of purchase of debentures to the assessee was Rs.1451.32 lakhs and the redemption value was Rs.2359.62 lakhs. Hence the actual interest that has accrued to the assessee was Rs.908.30 lakhs only. Accordingly, we modify the order passed by CIT(A) and direct the AO to assess the above said interest income of Rs.908.30 lakhs only. Since we have held that the surplus/premium received by the assessee is in the nature of interest income, the contention of the assessee that the same was in the nature of capital gain is rejected. Hence the assessee will not be entitled for any deduction u/s 54F and 54EC of the Act in the absence of any capital gains income.

Summary

Issues Involved:
1. Classification of surplus on redemption of Non-Convertible Debentures (NCDs) as Long Term Capital Gains or Income from Other Sources.
2. Determination of the correct surplus amount if classified as Income from Other Sources.
3. Eligibility for deductions under Section 54F and 54EC if the surplus is classified as Long Term Capital Gains.

Issue-wise Detailed Analysis:

1. Classification of Surplus on Redemption of NCDs:

The primary issue is whether the surplus realized by the assessee on the redemption of NCDs should be classified as Long Term Capital Gains or Income from Other Sources. The assessee claimed the surplus as Long Term Capital Gains, arguing that debentures are capital assets and their redemption constitutes a transfer, resulting in capital gains. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] disagreed, classifying the surplus as interest income under the head Income from Other Sources. The CIT(A) held that the redemption of NCDs does not fall under the definition of "transfer" as per the Income Tax Act, and thus, the surplus should be treated as interest income. The Tribunal upheld the CIT(A)'s decision, stating that debentures are debt instruments, and their redemption is akin to the repayment of debt, not a transfer of capital assets. Therefore, the surplus received on redemption is interest income.

2. Determination of the Correct Surplus Amount:

If the surplus is classified as Income from Other Sources, the next issue is determining the correct surplus amount. The CIT(A) directed the AO to assess a sum of Rs.12.59 crores as interest income, which was the difference between the sale value and the face value of the NCDs. However, the Tribunal noted that the correct surplus amount should be the difference between the redemption value and the purchase cost of the NCDs, which is Rs.9.08 crores. The Tribunal corrected this error and directed the AO to assess Rs.9.08 crores as interest income.

3. Eligibility for Deductions under Section 54F and 54EC:

The third issue concerns the eligibility for deductions under Section 54F and 54EC if the surplus is classified as Long Term Capital Gains. Since the Tribunal upheld the classification of the surplus as interest income, the question of deductions under Section 54F and 54EC does not arise. The Tribunal noted that deductions under these sections are available only against capital gains, and since the surplus is not capital gains, the assessee is not entitled to these deductions.

Conclusion:

The Tribunal concluded that the surplus realized by the assessee on the redemption of NCDs is interest income and not Long Term Capital Gains. The correct surplus amount to be assessed as interest income is Rs.9.08 crores. Consequently, the assessee is not entitled to deductions under Section 54F and 54EC. The appeal filed by the assessee was partly allowed, with the Tribunal modifying the CIT(A)'s order to correct the surplus amount.