SC approves deduction of interest paid via debentures

The Supreme Court (SC) has allowed MM Aqua Technologies to deduct interest paid via issue of debentures from its income for the purpose of income tax calculation. The judgment, which came this week, may provide relief to a number of companies that want to restructure their interest liability into payments by securities.

The court held that the interest was “actually paid” by the assessee through issuance of debentures, which has extinguished its liability to pay interest. To reach this conclusion, the court relied on the fact that the accounts of the bank reflected the amount received by way of debentures as its business income for the assessment year in question.

Yashesh Ashar, partner, Bhuta Shah & Co, said: “The judgment could pave the way for corporates under stress in the current environment to restructure their interest payment as debentures or other instruments, and deduct the same for income tax purposes. This is provided the lender recognises such interest payment in its books and pays tax on it.”

The court relied on Explanation 3C to section 43B(d) of the Income Tax Act given by the government for this purpose. It said that the explanation is “clarificatory” in nature and does not add a new condition retrospectively.

“A retrospective provision in a tax act which is ‘for the removal of doubts’ cannot be presumed to be retrospective, even where such language is used, if it alters or changes the law as it earlier stood,” the Bench of Justices RF Nariman (now retired) and BR Gavai observed.

Section 43B provides a list of expenses allowed as deduction under the head ‘Income from business and profession’. It states that some expenses can be claimed as deduction from business income only in the year of actual payment and not in the year when the liability to pay such expenses is incurred.

According to Ashar, the ruling makes it clear that explanation 3C is merely a clarification and should not impact genuine transactions of acceptance of a debenture in lieu of interest due in case of defaults.

However, the court also came down on the practice of introducing retrospective changes to the tax law under the garb of clarifications. “Certainty in tax law is nonnegotiable, and the court has reinforced this principle with its judgment,” said Abhay Sharma, partner, Shardul Amarchand Mangaldas & Co.

MM Aqua Technologies was in default of the payment of principal and interest on loan from ICICI Bank. So, the two parties agreed that the interest be paid through issue of ‘debentures’ by the assessee to the lender. The assessee, after the conversion of interest into debentures, claimed the interest under Section 43B of the IT Act as paid.

Ashar said, “The ruling upholds the doctrine of ‘substance over form’ and reiterates that the income tax authorities cannot rewrite the transaction entered into by the two parties”.

Earlier, the deduction claimed by the company was disallowed by the assessing officer. However, it was allowed by the Commissioner of Income Tax (Appeals) as well as the Income Tax Appellate Tribunal.

The matter went to the Delhi High Court, which relied on the Explanation 3C to the section 43B(d) of the IT Act to disallow the deduction.