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TMI Blog2005 (4) TMI 610X X X X Extracts X X X X X X X X Extracts X X X X ..... , in the facts and circumstances of the case, the ITAT was right in law in holding that the assessee was not entitled to the deduction of interest paid by it on the debentures issued by it ? 3. In this Tax Appeal the payer company is the appellant. The payer company while filing its return of income claimed deduction of the total amount of interest paid on the ground that the interest paid was a revenue expenditure and could not be disallowed as the same was paid by way of rent for use of capital. It was further contended that deduction of interest under Section 36(1)(iii) of the Income-tax Act, 1961 (the Act) only required that interest is paid in respect of capital borrowed for the purposes of business of the borrower. That the payer company had in fact satisfied the requirements of the said provision and once payment had been made there was no question of disallowing the interest. Reliance was also placed on the provisions of Section 43(2) of the Act which define the term 'paid'. The Assessing Officer did not accept the contentions of the payer company and held that interest payment ₹ 62/- per debenture payable up front on the date of allotment was nothing b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at source on the entire payment made in the relevant accounting period and the said tax had been deposited with the Central Government. He, therefore, submitted that the Tribunal had incorrectly applied the ratio of the Hon'ble Supreme Court decision without appreciating the facts of the case, with special reference to the terms of debenture. Inviting attention to Condition No.2 which deals with interest rate and manner of payment it was contended that the payer company was bound by the terms of the covenants and accordingly in discharge of such obligation it had made payment of interest to the debentureholder and was entitled to the deduction of the said amount. 7. As against that Mr.M.R.Bhatt learned Senior Standing Counsel appearing on behalf of the respondent Revenue, submitted that the impugned order of the Tribunal did not call for any interference as the same was based on the Apex Court decision. According to Mr.Bhatt, issuance of debenture by the payer company was nothing but raising of funds by way of loan on which interest was payable to the debentureholder, but as per commercial accounting principles, interest was for user of the said fund and would accrue or aris ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 24th March, 1995. There is no dispute that the Company has in fact made payment of interest to the debentureholder on the date of allotment, deducted tax at source on such payment in accordance with the provisions of the Act, and paid over such tax to the credit of Central Government. Therefore, the payer company has fulfilled its part of obligation arising from the contract between the parties. As already reproduced hereinbefore the Company had agreed and undertaken to duly and punctually pay, observe and perform the Financial Covenants and Conditions endorsed on the debenture certificate. It has done so. The limited question that would then survive is whether the Company is entitled to deduction of such amount while computing its taxable income. 11. Section 36(1) of the Act lays down that the deduction provided in the clauses that follow shall be allowed in respect of the matters dealt with in the respective clauses while computing the income referred to in Section 28 i.e. income from profits and gains of business or profession. Clause (iii) of sub-section (1) of Section 36 reads The amount of interest paid in respect of capital borrowed for the purposes of the business or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion 37(1) of the Act. Section 37(1) of the Act specifically states that any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee) shall be allowed in computing the income chargeable under the head 'Profits and gains of business or profession' if it is laid out or expended wholly and exclusively for the purposes of business. Therefore, once it is shown that an expenditure is of the nature described in any of the specified Sections i.e. Sections 30 to 36, the same cannot fall within Section 37(1) of the Act. In the circumstances, the assessee's claim being under Section 36(1)(iii) of the Act, there is no question of applying principles on the basis of which deduction of an expenditure is permissible under provisions of Section 37(1) of the Act. 14. There is one more aspect of the matter. The Company issuing the debenture, under which the borrowing is made, has entered into a contract with the debentureholder. It is nobody's case that the contract is sham or not acted upon. In the circumstances, the parties are bound by the terms of the contract and it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... these circumstances, the question raised in Tax Appeal No.157 of 2000 is answered in the negative. The Tribunal was not right in holding that the assessee i.e. the payer company was not entitled to deduction of interest paid by it on the debentures issued by it in the assessment year under consideration. 17. At this stage, it is stated by learned Advocate for the appellant company that pursuant to the impugned order of Tribunal if any claim is made by each of the payer companies in any of the subsequent years on the basis of proportionate payment in accordance with the order of the Tribunal, the respective assessee companies shall have no objection if the claims which might have been allowed are withdrawn and additions made to the said extent considering that the entire claim of deduction of interest paid is allowed in Assessment Year 1995-96. TAX APPEAL NO.328 OF 2000 18. The following substantial question of law has been formulated at the time of admission of the appeal on 8th November, 2000: Whether, the Appellate Tribunal is right in law and on facts in holding that the interest income in the hands of the assessee who was allotted debentures by the Companies is re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s) held that the entire interest income had become due to the assessee, had accrued to the assessee and had also been received during the accounting period relevant to Assessment Year 1995-1996. He also turned down the plea of the assessee that on the system of accounting regularly employed by the assessee, namely, mercantile system of accounting, only proportionate interest was taxable in hands of the debentureholder. It was further held that accounting treatment of an item of expenditure in hands of the payer company can be different from the accounting treatment of the same item by way of corresponding receipt in hands of the payee. The contention raised by the assessee that the debentures were in the nature of Deep Discount Bonds was also rejected. 22. Being aggrieved, the assessee filed second appeal before Tribunal. The Tribunal passed a consolidated order on 20th October, 1999 in case of three individuals including the present assessee as the issue was common in all the three cases. The Tribunal took into consideration the terms and conditions of the debentures which were described as Financial Covenants and Conditions. As per the condition relatable to payment of interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lation to the entire interest income, be upheld. 24. As against that, Mr.S.N.Soparkar, learned Senior Advocate appearing on behalf of the respondent assessee, submitted that the individuals were following mercantile system of accounting. That as per such system of accounting entire interest income did not accrue during the accounting period but only a proportion had accrued despite the fact that there might be receipt which may be equivalent to the total amount of interest receivable. In other words, the contention was that receipt per se would not assume characteristic of income. That interest was nothing else but compensation for user of the monies advanced and in commercial world interest would accrue or arise or become due only on an de diem basis. That if substance of the transaction was taken into consideration it was apparent that interest was payable by way of rent for user of the funds advanced and agreement between the parties, though relevant, would not determine the characteristic of receipt. In other words, the receipt would assume colour of income only in accordance with the principles of commercial accounting and law. He, in this context, invited attention to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -keeping. There is firstly, the cash system in which a record is maintained of actual receipt and actual disbursements, entries being posted when money or money's worth is actually received, collected or disbursed. There is, secondly, the mercantile system, in which entries are posted in the books of account on the date of the transaction, i.e., on the date on which rights accrue or liabilities are incurred, irrespective of the date of payment. For example, when goods are sold on credit, a receipt entry is posted as of the date of sale, although no cash is received immediately in payment of such goods; and a debit entry is similarly posted when a liability is incurred although payment on account of such liability is not made at the time. There may have to be appropriate variations when this system is adopted by an assessee who carries on a profession. Whereas under the cash system no account of what are called the outstandings of the business either at the commencement or at the close of the year is taken, according to the mercantile method actual cash receipts during the year and the actual cash outlays during the year are treated in the same way as under the cash system, but ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in holding that interest income in hands of the assessee who was allotted debentures by the companies was required to be taxed only on proportionate basis. In fact the Commissioner of Income-tax (Appeals) was justified in sustaining the addition of whole amount of interest ₹ 62/- per debenture in the accounting year in question. The question is, therefore, answered as aforesaid. 31. Before parting it is necessary to take note of the fact that the individual assessee viz. the recipients have returned the proportionate interest income in subsequent assessment years in consonance with the income returned for the year under consideration and upheld by the Tribunal. However, in light of the fact that this Court has held that the entire interest income is taxable in Assessment Year 1995-96 the same income cannot be proportionately brought to tax in any of the subsequent years. In the circumstances it will be open to each individual assessee to move an appropriate application and seek refund, if any, of the proportionate tax relatable to the interest income in each of the subsequent years in question. Needless to state that, in case any such application is moved revenue shall no ..... X X X X Extracts X X X X X X X X Extracts X X X X
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