WHETHER THE DISCOUNTING CHARGES AMOUNT TO INTEREST AND LIABLE FOR TDS?

[Mr. M. GOVINDARAJAN]

Section 2(7) of the Interest Tax Act defines the term ‘interest’ as interest on loans and advances made in India and includes-

(a)    Commitment charges on unutilized portion of any credit sanctioned for being availed of in India; and

(b)   Discount on promissory notes and bill of exchange drawn or made in India. 

Thus, where the legislature was conscious of the fact that even the discount of bill of exchange is to be included within the definition of interest, the same was basically so provided for. 

Section 2(28A) of the Income tax Act defines the term ‘interest’ as interest payable in any manner in respect of any money borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debit incurred or in respect of any credit facility which has not been utilized.  From this definition it is clear that before any amount paid is construed as interest, it has to be established that the same in respect of any money borrowed or debt incurred.

The Central Board of Direct Taxes has issued vide Circular No. 65 dated 02.09.1971 clarifying the position in respect of income by way of interest under Section194A read with Section 197(1) and (2) of the Act as under:

1. …..Where the supplier of goods makes over the usance bill/hundi to his bank which discounts the same and credits the net amount to the supplier’s account straightaway without waiting for realization of the bill on due date, the property in the usance bill/hundi passes on to the bank and the eventual collection on due date is a receipt by the bank on its own behalf and not on behalf of the supplier. For such cases of immediate discounting the net payment made by the bank to the supplier is in the nature of a price paid for the bill.   Such a payment cannot technically be held as including interest and, therefore, no tax need be deducted at source from such payments by the bank.   Further the buyer need not deduct any tax from the payment made by him on due date to the bank in respect of such discounted bill inasmuch as these payments to a bank or a banking co-operative society, conforming to the exemption granted by Section 194A(3)(iii)(a) of the Income Tax Act, 1961.
2. On the other hand, where there is no immediate discounting and the bank merely acting as agent receives on the expiry of the period the payment for the bill from the buyer on behalf of the supplier and credits it to him accordingly, the bank receives interest on behalf of the supplier and the instructions contained in the Board’s abovementioned circular dated 7.11.1970 would apply and the buyer will have to deduct the tax from the interest.

Another circular No. 647, dated 22.03.1998 is on the point as it relates to TDS on interest other than ‘interest on securities’. In this circular the Board has clarified the issue in the following manner:

3. A question has been recently raised as to whether the difference between the issue price and face value of these instruments should be treated as ‘interest’ in which case it would be liable to deduction of tax at source under Section 194A of the Income Tax Act, 1961, or it should be treated as ‘discount’ which is not liable to deduction of tax at source.
4. It is clarified for the information of all concerned that the difference between the issue price and the face value of the commercial papers and the certificates of deposits is to be treated as ‘discount allowed’ and not as ‘interest paid’. Hence, the provisions of the Income Tax Act relating to deduction of tax at source are not applicable in the case of transactions in these two instruments.

In ‘Commissioner of Income Tax V. Cargill Global Trading P. Limited’ – (2011) 335 ITR 94 (Delhi) the assessee is in the export business. On the exports made by him to its best buyers outside India, the assessee draws bills of exchange on those buyers located outside India. These bills of exchange are discounted by the assessee from CFSA who on discounting the bills immediately remits the discounted amount to the assessee. Thereafter, it is the obligation of CFSA to realize the amounts from those buyers to whom the goods are exported and bills are drawn by the assessee.  For the assessment year 2004-05 the assessee filed the income tax return declaring the income at Rs.1.14 crores.  The Assessing Officer noticed that the assessee had paid a sum of Rs.3.97 crores on account of discounted charges for getting the export sale bills discounted.   The view of the Assessing officer was that the discounting charges were nothing but interest with the ambit of Section 2(28A) of the Income Tax Act, 1961.   Since the assessee had not deducted tax at source under Section194 of the Act, he invoked the provisions of Section 40(a)(i) of the Act and disallowed the sum of Rs.3.97 crores claimed by the assessee under Section 37(1) of the Act.

The Commissioner of Income Tax Appeals, on the appeal of the assessee, deleted the addition holding that the discount paid by the assessee to CFSA cannot be held to be interest and therefore, the provisions of Section 40(a)(i) of the Act would not apply.  The Revenue aggrieved against this order filed an appeal before the Tribunal.   The Tribunal found that the purchase of bill of exchanges on ‘without recourse’ basis implies that-

• The appellant sells the bill of exchanges to CFSA, typically, on ‘without recourse’ basis, i.e., CFSA purchases the bill of exchanges on its own behalf;
• CFSA collects the payment from the sale/settlement of the bill of exchanges on its own behalf, and not on behalf of the Indian companies;
• CFSA has no right to proceed against the appellant in case of a default by the foreign buyer. 

The Tribunal observed that the discounting charges were not in the nature of interest paid by the assessee, rather the assessee had received the net amount of bill of exchange accepted by the purchaser after deducting the amount of discount. Since CFSA was having no permanent establishment in India, it was not liable to tax in respect of such amount earned by it and, therefore, the assessee was not under an obligation to deduct tax at source under Section 195 of the Act.  The Tribunal further held that the said discounting charges could not be disallowed by the Assessing Officer by invoking Section 40(a)(i) of the Act.

The Revenue not satisfied with the order of the Tribunal filed the present appeal to the High Court. The High Court concluded that the discounting charges paid by the assessee are not interest as is neither any money borrowed nor is any debt incurred.  The discounting charges are not in the nature of interest paid by the assessee.   Rather after deducting the discount the assessee received the net amount of the bill of exchange accepted by the purchaser.   CFSA, not having any permanent establishment in India, is not liable to tax in respect of such discount earned by it and, hence, the assessee is not under obligation to deduct tax at source under Section 195 of the Act.   According the same cannot be disallowed by invoking Section 40(a)(i) of the Act.