2015 (3) TMI 853 - SC - Income Tax

Interest upfront to the debenture holder - AO treated it as the deferred revenue expenditure ,whether is allowable as a deduction in the first year itself or it is to be spread over a period of five years, being the life of the debentures? - assessee follows mercantile system of accounting - Held that - In the instant case, as noticed above, the assessee did not want spread over of this expenditure over a period of five years as in the return filed by it, it had claimed the entire interest paid upfront as deductible expenditure in the same year. In such a situation, when this course of action was permissible in law to the assessee as it was in consonance with the provisions of the Act which permit the assessee to claim the expenditure in the year in which it was incurred, merely because a different treatment was given in the books of accounts cannot be a factor which would deprive the assessee from claiming the entire expenditure as a deduction. has been held repeatedly by this Court that entries in the books of accounts are not determinative or conclusive and the matter is to be examined on the touchstone of provisions contained in the Act. See Kedarnath Jute Manufacturing Co. Ltd. v. Commissioner of Income Tax (Central), Calcutta 1971 (8) TMI 10 - SUPREME Court At the most, an inference can be drawn that by showing this expenditure in a spread over manner in the books of accounts, the assessee had initially intended to make such an option. However, it abandoned the same before reaching the crucial stage, inasmuch as, in the income tax return filed by the assessee, it chose to claim the entire expenditure in the year in which it was spent/paid by invoking the provisions of Section 36(1)(iii) of the Act. Once a return in that manner was filed, the AO was bound to carry out the assessment by applying the provisions of that Act and not to go beyond the said return. There is no estoppel against the Statute and the Act enables and entitles the assessee to claim the entire expenditure in the manner it is claimed. Thus the assessee would be entitled to deduction of the entire expenditure of 2,72,25,000 and 55,00,000 respectively in the year in which the amount was actually paid. - Decided in favour of assessee.

Issues Involved:
1. Whether the liability of the assessee to pay interest upfront to the debenture holder is allowable as a deduction in the first year itself or it is to be spread over a period of five years, being the life of the debentures.

Detailed Analysis:

1. Nature of the Interest Payment and Deduction under Section 36(1)(iii):
The appellant, Taparia Tools Limited, claimed deductions for upfront interest payments to debenture holders in the assessment years 1996-97 and 1997-98. The Assessing Officer (AO) treated these payments as 'deferred revenue expenditure' to be spread over five years, allowing only 1/5th of the payments each year. The core issue is whether this upfront interest payment should be deductible in the first year or spread over five years.

2. Terms of Debenture Issue:
The debenture issue provided two options for interest payment to subscribers: periodic half-yearly payments at 18% per annum over five years or a one-time upfront payment of Rs. 55 per debenture. The debenture holders opting for the upfront payment were paid Rs. 2,72,25,000 and Rs. 55,00,000 respectively.

3. Accounting Treatment vs. Tax Treatment:
The assessee follows the mercantile system of accounting. Although the upfront interest was shown as deferred revenue expenditure in the accounts, the assessee claimed the entire amount as a deductible expense in the respective assessment years. The AO denied this claim, spreading the deduction over five years. The Commissioner of Income Tax (Appeals), Income Tax Appellate Tribunal, and the High Court of Bombay upheld the AO's decision, applying the 'Matching Concept'.

4. Section 36(1)(iii) of the Income Tax Act:
Section 36(1)(iii) allows deductions for interest paid on capital borrowed for business purposes. The court noted that the entire amount of interest paid upfront in the first year should be deductible if the borrowing was for business purposes and the interest was genuinely incurred. The AO did not dispute the genuineness of the borrowing or the interest payment.

5. Concept of 'Paid' under Section 43(ii):
The term 'paid' includes amounts actually paid or incurred according to the method of accounting. Since the assessee follows the mercantile system, the interest payment, even if not actually paid but incurred, would be deductible. In this case, the interest was actually paid.

6. Matching Concept and Its Application:
The High Court applied the 'Matching Concept', suggesting that the interest payment should be spread over the debenture's life. However, the Supreme Court disagreed, stating that the upfront interest payment discharged the liability in the first year, saving recurring interest liability for the remaining period. The court emphasized that the treatment of entries in the books of accounts should not override statutory provisions.

7. Estoppel and Tax Returns:
The court rejected the argument that the assessee was estopped from claiming the entire deduction in the first year due to the accounting treatment. It held that the tax assessment should be based on the provisions of the Act, not on the entries in the books of accounts. The assessee's right to claim the deduction under Section 36(1)(iii) should be upheld.

8. Precedents and Legal Principles:
The court referred to Bharat Earth Movers v. Commissioner of Income Tax, which held that a business liability arising in the accounting year should be deductible even if discharged later. The court also distinguished the case from Madras Industrial Investment Corporation Limited v. Commissioner of Income Tax, where the assessee wanted to spread the expenditure over time.

Conclusion:
The Supreme Court concluded that the assessee is entitled to deduct the entire upfront interest payment in the year it was paid, aligning with the provisions of Section 36(1)(iii). The judgment and orders of the High Court and lower authorities were set aside, allowing the appeals with no orders as to costs.

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