2003 (1) TMI 83 - HC - Income Tax

Upfront interest on non-convertible debentures treated as deferred revenue expenditure, spread over five-year life and deduction upheld

Taparia Tools Ltd. Versus Joint Commissioner of Income-Tax, Commissioner of Income-Tax Versus Taparia Tools Ltd.

The HC held that the upfront interest liability on non-convertible debentures constituted deferred revenue expenditure and could be spread over the ... Deductibility of Up-Front Payment of Interest on Non-Convertible Debentures - Matching concept - mercantile system of accounting - double entry system of accounting - Whether, the Tribunal was right in holding that even though, the liability of payment of interest stood liquidated in the first year itself, such liability had to be allowed on a spread over basis over the life of the debentures? - HELD THAT:- It is important to note that the deferred revenue expenditure is of revenue nature but, because of its special features, it is spread over a number of years during which the benefit of expenditure is expected to arise to the business. On the facts, we hold that the liability was a continuing liability to pay interest spread over for a period of five years. In this case, therefore, the Assessing Officer was right in spreading the deduction over the period of five years which was the life of the debenture. The Assessing Officer has not re-written the contract. Whether the deduction should be calculated at 18 per cent. per annum or 11 per cent. per annum is not in issue. In any event, it is a pure finding of fact. In the circumstances, we do not see any reason to interfere with the order passed by the Assessing Officer as confirmed by the Tribunal. We do not see any reason to discuss various authorities cited on behalf of the assessee as we are concerned with the application of law laid down by the Supreme Court in various cases cited. Lastly, we may mention that in this case, the deduction has been calculated at 18 per cent. per annum whereas, if one goes by the books, it is at 11 per cent. per annum. Therefore, the assessee has got higher deduction. Consequently, the above question framed by this court is answered in the affirmative, i.e., in favour of the Department and against the assessee. In this case, we are concerned with deferred revenue expenditure, which is a special type of asset. In this case, we are not concerned with the nature of profits. In this case, we are concerned with the ascertainment of true profits under the Income-tax Act and in order to ascertain such profits, we have to follow the true accounting principles and we have to apply those principles in the light of the method of accounting followed by the assessee. In cases involving special types of assets, where profits cannot be deduced by following the method adopted by the assessee, the Assessing Officer is free to make adjustments as done in this case. Lastly, as stated above, in this matter, we are concerned with computation of taxable income and, therefore, the true accounting principles will have to be taken into account. Issues Involved:1. Deductibility of up-front payment of interest on non-convertible debentures.2. Application of the matching concept in accounting for deferred revenue expenditure.3. Determination of whether the up-front payments represent revenue or capital expenditure.4. Application of appropriate discount rate for estimating expenditure.Issue-Wise Detailed Analysis:1. Deductibility of Up-Front Payment of Interest on Non-Convertible Debentures:The primary issue was whether the up-front payment of Rs. 55 per debenture (totaling Rs. 2,72,25,000) should be allowed as a deductible expenditure in the first year of allotment (1996-97) or spread over the life of the debentures (five years). The assessee argued that the liability to pay interest was incurred and discharged in the first year, thus entitling them to claim the entire amount as a deduction in that year. The Assessing Officer (AO) disallowed this claim, treating the payment as deferred revenue expenditure (DRE) and spreading it over five years. The High Court upheld the AO's decision, emphasizing the matching concept and stating that allowing the entire expenditure in one year would distort the profits of that year.2. Application of the Matching Concept in Accounting for Deferred Revenue Expenditure:The court explained that under the mercantile system of accounting, profits are matched with expenses incurred during the same period, irrespective of actual cash flow. This matching concept is crucial in cases involving DRE. The court cited the Supreme Court's judgment in Madras Industrial Investment Corporation Ltd. v. CIT [1997] 225 ITR 802, which recognized that spreading expenditure over the period of benefit prevents distortion of profits. The court noted that the assessee's annual accounts showed Rs. 2,72,25,000 as deferred revenue expenditure, to be written off over five years, thus supporting the AO's approach of spreading the deduction.3. Determination of Whether the Up-Front Payments Represent Revenue or Capital Expenditure:The AO and the Tribunal found that the up-front payments were on revenue account, not capital. The High Court did not disturb this finding. The court noted that the nature of the expenditure was not in dispute; the issue was the manner of allowing such expenditure under the Income-tax Act. The court held that the AO was correct in treating the up-front payments as deferred revenue expenditure and spreading the deduction over five years.4. Application of Appropriate Discount Rate for Estimating Expenditure:The AO applied a discount rate of 18% per annum to estimate the expenditure, taking a clue from the interest rate applicable to another option under the terms of the debenture issue. The court upheld this approach, rejecting the assessee's argument that the AO had rewritten the contract. The court explained that the discount rate was a yardstick for estimating the expenditure and that the AO's application of 18% was appropriate given the circumstances.Conclusion:The High Court upheld the AO's decision to spread the deduction of up-front interest payments over five years, emphasizing the importance of the matching concept in accounting for deferred revenue expenditure. The court found no merit in the assessee's arguments and dismissed their appeals. The court also noted that the AO's approach did not rewrite the contract but appropriately applied a discount rate to estimate the expenditure. Consequently, the Department's appeals were not addressed as the primary issue was resolved in favor of the AO's approach.