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TMI Blog2003 (9) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... entures at a premium of 5 per cent, of the face value of the debentures in three equal instalments at the end of the 7th, 8th and 9th years by paying Rs. 35 per year. The payment of Rs. 105 was to be made against the issue amount of Rs. 100 per debenture. Thus, against the receipt of Rs. 3 crores of finance, the assessee agreed to Rs. 3,15,00,000. The assessee maintains its books of account as per the mercantile system. Though no entries have been made regarding this liability in the books, in its return, the assessee claimed deduction of this additional amount of Rs. 15,00,000 as revenue expenditure against the profits of the previous year relevant to the assessment year 1992-93. One of the terms of the debenture issue was as under: "The company shall have a right to repurchase (from the market) some or all of the debentures at any time prior to the redemption date(s) and re-issue the same at its discretion from time to time in accordance with the provisions of section 121 and other applicable provisions, if any, of the Companies Act, 1956. Upon such re-issue, the persons entitled to the debentures shall have and shall be deemed always to have had the same rights and priorities ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the case, the Income-tax Appellate Tribunal is justified in law in holding that the premium payable on debentures was not a contingent liability and that it is allowable revenue expenditure? 2. Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is justified in law in directing to allow the claim of premium though proportionately over the period of redemption?" Both the questions pertain to the basic issue whether the liability to pay premium on the issue price of debentures by a company is a contingent liability and if not, when such liability is to be allowed as a deduction. The later aspect of the question is whether it is to be allowed as one time expenditure at the time it is incurred or is to-be spread over proportionately lover the entire h period of redemption "t debentures or is to be allowed at the time of redemption. In its simple manifestation, the issue is no more res integra and is settled by the decision of the Supreme Court in Madras Industrial Investment Corporation Ltd.'s case [1997] 225 ITR 802. It was a case in which the assessee-company had issued redeemable debentures on discount, instead of at a premium that i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r held that no expenditure was laid out or incurred by the assessee/appellant-company which could be allowed as a deduction. This led to appeal before the Supreme Court. The Supreme Court posed the following question for its consideration in the first instance: "We have first to consider whether the discount of Rs. 3,00,000 on debentures which were issued by the appellant-company is expenditure incurred by the appellant-company for the purposes of its business. The appellant-company actually received Rs. 1.47 crores as against which it incurred a liability to return a sum of Rs. 1.50 crores with interest at the end of 12 years (the date of redemption). This liability which the assessee incurred, to pay the amount of Rs. 3,00,000 in addition to what it actually received, is being written off over the period of 12 years. Can it be treated as expenditure?" The Supreme Court laid down the following propositions: "1. The difficulty in the estimation of liability did not convert the accrued liability into a conditional one. This court said that the expression 'profits or gains' in section 10(1) of the Indian Income-tax Act, 1922, had to be understood in its commercial sense; and there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture. Relying on its earlier decision in Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 (SC) in which the court held that the loan obtained is not an asset or advantage of an enduring nature; that the expenditure was made for securing the use of money for a certain period; and that it is irrelevant to consider the object with which the loan was obtained, it was laid down that in the circumstances of the case, the expenditure was revenue expenditure under section 10(2)(xv). The ratio of the above decision was applied in the case of Madras Industrial Investment Corporation Ltd. [1997] 225 ITR 802 (SC). Coming to the question whether the entire amount should be allowed as an expenditure in the year of issue of debentures or should be spread over during the period until redemption of debentures, the court approved the principle stated by Batliboi's Principles and Practice of Auditing which reads as under: "'When debentures are issued at discount, an account styled "Discount on Debentures Account", will be debited with the discount allowed on the issue. The debentures account will be credited in the books at their nominal value and will appear at that value as a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company has also reserved its right to repurchase and reissue the debentures. Construing the aforesaid condition, the Calcutta High Court held as under: "On a construction of the aforesaid clauses it appears to us that the premium is payable to the debenture holders at the rate of 5 per cent, of the face value of the debentures on the expiry of the seventh year from the date of allotment It is true that the company shall have the right to reissue debentures which are repurchased by it from time-to-time in accordance with the provisions of section 121 and other applicable sections of the Companies Act, 1956, and upon such reissue, the person entitled to the debentures shall have, and shall be deemed always to have had, the same rights and priorities as if the debentures had never been redeemed. But in the case of repurchase of debentures, no premium is payable. We are, therefore, unable to hold that the liability for payment of the premium was created at the time of issue of the debentures or the liability to pay the premium is in unqualified terms. The liability to pay the premium, in our view, clearly arise is at the expiry of the seventh year from the date of allotment and ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liability which is incurred in future, but a liability which is incurred in praesenti to be discharged in future. The distinction drawn by learned counsel for the Revenue was also founded on the premise that the entire liability is liable to deduction in one year only. In that event the liability has been allowed as deduction only when the repayment becomes due. It was pointed out by Mr. Kothari on both the issues, that the decision of the Supreme Court in Madras Industrial Investment Corporation Ltd.'s case [1997] 225 ITR 802 impliedly overrules the ratio of the Calcutta decision. To understand the effect of such term of right to repurchase and reissue needs understanding the gamut of debenture, redemption, repurchase and reissue of the redeemable debentures by the company in its proper perspective. The term "debenture" is not a technical term nor a term of art but in its ordinary sense denotes one of the modes for borrowing money by any Company in exercise of its borrowing powers. However, in the ordinary business sense, a "debenture" is generally under-stood to be a document usually but not necessarily wider seal, acknowledging a debt and securing repayment thereof by mort ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd undertaking were subjected to mortgage or charge with repayment of loan which came to be identified as floating charge. Towards the end of the last century instead of creating mortgage or charge with the company's assets in favour of the debenture-holders, the trust deed was introduced by which trustees were appointed to represent the interests of the lenders and the trust deed created legal mortgages over the company's fixed assets and a floating charge over its other assets and its undertaking in favour of the trustees. The trust deed additionally empowered the trustees to consent on the lenders behalf to minor deviations by the company from the terms of the collective loan and to minor variations in the security for it. This system also underwent a change during the earlier period of the twentieth century. Palmer said: "In a modern trust deed the company covenants with the trustees to repay the total amount secured by an issue of debentures (that is the total amount subscribed by the debenture holders), together with yearly or half yearly interest until the principal is repaid, and payment of these amounts is to be made either to the trustees on behalf of the debenture-holde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies with listed debenture stock, but may be used by others when there is an opportunity of acquiring debentures for redemption at less than their nominal value. The aforesaid different modes of repayment of debenture only show that a redemption is a method by which the company obliterates its obligation to repay its debt either by paying its debt to the debenture-holders or debenture stackers or by itself repurchasing the debentures. Discharging the liability to the debenture-holder who has sold his debentures and since a company cannot be its own debtor, in effect such purchase amounts to repayment of the loan. However, in the ordinary course unless otherwise required by law or contract the discharge of the debt results in discharge of mortgage charge or trust which is created for the purpose of borrowing money by issue of debentures. It was held in George Routledge and Sons Ltd., In re [1904] 2 Ch 474 and in W. Tasker and Sons Ltd., In re [1905] 1 Ch 283 that debenture once paid off was extinguished and could not be reissued and results in discharge of the mortgage charge or the trust when such discharge takes place. Obviously the same debenture cannot be reissued for rais ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... where a payment in addition to the principal and interest of a loan is secured on mortgaged property, it forms part of the mortgage debt, and unless equity can set the bargain aside because it is harsh and unconscionable, the mortgagor cannot redeem at all unless he pays the whole amount secured on his property. In the second place, it is clearly contemplated by the Companies Act, 1985, that premiums may be paid on the redemption of debentures, and bonuses are indistinguishable from premiums.....It would seem, therefore, that provisions for premiums or bonuses to be paid to debenture or debt security holders are valid and may be included in the total amount secured, unless they can be set aside by the court in exercise of its equitable jurisdiction to give relief from unconscionable and oppressive bargains." The aforesaid view of the gamut of issuing debentures redeemable on premium shows that premium of repayment is a matter of contract by the terms of issue and forms the part of the sum which the company agrees to repay at the time of redemption/repayment or repurchase. It also explains that premium may be payable as part of the terms of debenture issue both at the time of pre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure is also not discharged and is kept alive with debentures has received statutory recognition. The provisions of the Companies Act relating to issue of debentures do envisage that where repayment of debenture is secured by creating a charge on the company's assets of hot, a trust is required to set for the purpose of securing repayment of debentures by the company. In this connection, section 117 of the Companies Act ordains that after the commencement of the Companies Act, the debenture-holder will not have any voting rights at any meeting of the company, whether generally or in respect of particular classes of business. Thus made it clear that the debenture-holders are not the shareholders in the company having its shares in the management. Further, pointer to this aspect of the matter is that vide the Companies (Amendment) Act, 2000, sections 117A and 117B were inserted making it clear that no company shall issue a prospectus or a letter of offer to the public for subscription of its debentures, unless the company has, before such issue, appointed one or more debenture trustees for such debentures and the company has, on the face of the prospectus or the letter of offer, st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is discharged whether it is obtained by creating charge on property by way of mortgage or otherwise or by appointing trustees. In the latter case, the trust stands discharged and the trustee's obligation to administer the trust comes to an end. In the aforesaid context section 121 is required to be considered, which reads as under: "121. Power to re-issue redeemed debentures in certain cases.-(1) Where either before or after the commencement of this Act, a company has redeemed any debentures previously issued, then,- (a) unless any provision to the contrary, whether express or implied, is contained in the articles, or in the conditions of issue, or in any contract entered into by the company; or (b) unless the company has, by passing a resolution to that effect or by some other act, manifested its intention that the debentures shall be cancelled ; the company shall have, and shall be deemed always to have had, the right to keep the debentures alive for the purposes of re-issue, and in exercising such a right, the company shall have, and shall be deemed always to have had, power to re-issue the debentures either by reissuing the same debentures or by issuing other debentures i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es or the securities for the same." The aforesaid provision clearly provides that unless any provision to the contrary is made whether express or implied, is contained in die articles, or as a condition of issue of debentures or any other contract entered into by the company or unless the company has passed the resolution to that effect or by some other act, manifested its intention that the debentures shall be cancelled, the company shall have, and shall be deemed always to have had, the right to keep the debentures alive for the purpose of re-issue. This only suggests that even if redeemed debt to the holders of debenture scrip/ it will not discharge any security or a trust, on the basis of which, the debentures have been issued and their repayment has been secured. It gives power to the company to re-issue the same debentures or by issuing other debentures in their place on the same terms and conditions on which the earlier debentures have been issued for which charge or security has been created or trustees have been appointed. Therefore, the term "redemption" strictly comes into play where repayment of debt would result in discharging the security or surety. If the debentures ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reissue subject to the same terms and conditions in future as and when it wants to secure loan from the public, flows from section 121 in the absence of any agreement contrary to the articles of association. In the present case, the company has chosen to go along with the provision of section 121 without surrendering its rights to keep the debenture alive for reissue which will not discharge the trustees or the security on redemption of loan or repayment. Therefore, by the expression "repurchase" used as the term of issue of debenture does not alter the position as if the issue has been made without such condition. Since in the present case no such expression has been used as buy-back, we need not to go into the finer distinction of the word between right to "repurchase" or right to "buy-back". Suffice it to state that prima facie right to repurchase may refer to repurchase at the time of maturity and right to buy-back may refer to redemption of loan before the due date to the debtor. Else both the expression deal with repayment of debt. Be that as it may, the aspect, which is clear from the facts, is that the company has issued debentures redeemable on premium to secure funds f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liability to pay Rs. 105 against receipt of Rs. 100 was a contingent liability so as to consider that the liability has not been incurred in the year in which it has been created as liability in respect of the company on receipt of debenture issue price, though, the liability was to be discharged in future. The decision rendered in Madras Industrial Investment Corporation's case [1997] 225 ITR 802 (SC) governs the facts of the present case on all fours and no distinction can be found on the basis of Tungabhadra's decision [1994] 207 ITR 553 (Cal). In CIT v. S. M. Holding and Finance P. Ltd. [2003] 264 ITR 370, the Bombay High Court was required to consider the same question. The assessee-company had issued unsecured redeemable debentures of Rs. 100 each redeemable after ten years at a premium of 100 per cent. The assessee claimed 10 per cent, of the total amount of premium in the first year. The Assessing Officer found that the terms of debenture could be altered before maturity and did not allow the claim by holding that the liability was not ascertainable and was contingent. The decision of the Supreme Court in Madras Industrial Investment Corporation [1997] 225 ITR 802 was rel ..... X X X X Extracts X X X X X X X X Extracts X X X X
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