2017 (11) TMI 63 - HC - Income Tax

Interest on Special Purpose Notes: Legitimate Business Expenditure under Income Tax Act

The High Court allowed the appeal, determining that the interest on Special Purpose Notes (SPNs) was a legitimate business expenditure under section ... Interest on Special Purpose Notes - Held that:- The assessee's claim of deduction arises out of section 36(1)(iii) of the Act under which while computing the income under section 28 of the Act, the deduction of the amount of interest paid in respect of capital borrowed for the purposes of the business or profession would be a deductible expenditure. The first objection of the Revenue is squarely covered by the judgment in case of Core health Care ltd.(2008 (2) TMI 8 - SUPREME COURT OF INDIA ). While confirming the decision of this Court, it was held that for the said deduction, all that was necessary was that the money i.e. capital must have been borrowed by the assessee, that it must have been borrowed for the purpose of business and lastly, that the assessee must have paid interest on the borrowed amount. All that is germane is whether the borrowing was, or was not, for the purpose of the business. It was held that the provision makes no distinction between money borrowed to acquire a capital asset or a revenue asset. Preoperative expenditure of interest - Held that:- As in the context of project interest expenses of the same two projects, this Court had confirmed the view of the Tribunal that the assessee through its existing administrative mechanism had started a new facility for production of soda ash and lab for its captive consumption for the purpose of its existing business of manufacturing soaps. The Court therefore, held that the expenditure was not in the nature of preoperative expenditure of interest. Accrual of interest liability - Held that:- In the present case, however, the vital fact is that the company, investors, banks and financial institutions and all and sundry were aware that the SPNs would be foreclosed and that the company would pay out a sum of ₹ 361/per SPN. The fact that NCDs and SPNs were both freely transferable is not in dispute. If the promoters SPN holders and the banks and financial institutions therefore, traded in such SPNs, the same would not indicate any colourable device of tax planning. Mere early redemption also would not be enough to hold that from the inception there was a device created by the company to defeat the Revenue's interests. Issues Involved:1. Whether the interest on Special Purpose Notes (SPNs) was required to be disallowed when it was in respect of the capital borrowed for the purposes of the business of the appellant.Detailed Analysis:Background and Nature of the Borrowing:The appellant, a public limited company engaged in the manufacturing of consumer products, decided to set up a soda ash manufacturing plant requiring significant capital investment. The company raised funds through various sources, including a rights issue of Non-Convertible Debentures (NCDs) and Special Purpose Notes (SPNs). The terms of these financial instruments were detailed in the prospectus, with SPNs carrying no interest for the first three years but offering a premium in subsequent years. The company's promoters and related entities subscribed predominantly to the SPNs.Assessing Officer's Disallowance:The Assessing Officer disallowed the interest expenditure claimed by the appellant, arguing that the entire transaction was a premeditated plan to avoid tax. The majority of SPNs were held by promoters and related entities who transferred them to financial institutions before early redemption, claiming capital gains while the company claimed the expenditure as an interest expense. The Assessing Officer viewed this as a device to defraud the Revenue.Commissioner (Appeals) Findings:The Commissioner (Appeals) formulated three key questions:1. Whether the capital borrowed was related to the same business.2. Whether the interest had accrued during the year.3. Whether the transaction was a colourable device.On the first issue, the Commissioner held that the expenditure was capital in nature and not for the same business, thus not allowable. On the second issue, the Commissioner viewed the liability as contingent. On the third issue, the Commissioner agreed with the Assessing Officer, citing unusual terms and the high premium as indicators of a sham transaction.Tribunal's Confirmation:The Tribunal confirmed the Revenue's view, emphasizing the overwhelming subscription to SPNs by promoters and the early redemption known only to them. The Tribunal did not opine on whether the project was part of the same business or if the interest liability had accrued, focusing instead on the transaction's non-genuine nature.High Court's Analysis:1. Capital vs. Revenue Expenditure:The High Court referred to the Supreme Court's decision in Core Health Care Ltd., which held that interest on borrowed capital is deductible irrespective of whether the capital was used for acquiring a capital or revenue asset. Thus, the first objection of the Revenue was not sustainable.2. Expansion of Existing Business:The Court noted its earlier decision in Nirma Ltd., which concluded that the soda ash and lab manufacturing plants were part of the existing business. Therefore, the expenditure was not preoperative but related to the expansion of the existing business.3. Accrual of Interest Liability:Referring to the Supreme Court's decision in Taparia Tools Ltd., the Court held that the interest liability accrued when the company resolved to redeem the SPNs prematurely. The liability was not contingent as the decision was publicly known, and the company avoided future payments by redeeming the SPNs early.4. Sham Transaction Allegation:The Court distinguished between legitimate tax planning and a sham transaction. The early redemption of SPNs was publicly announced, and all stakeholders, including banks and financial institutions, were aware of the redemption terms. The Court found no evidence of a hidden design or advantage exclusive to the promoters. The decision to redeem early was a business decision, influenced by falling interest rates, and did not constitute a sham transaction.Conclusion:The High Court allowed the appeal, holding that the interest on SPNs was a legitimate business expenditure under section 36(1)(iii) of the Income Tax Act. The transaction was not a colourable device, and the expenditure was allowable. The question was answered in favor of the assessee, and the tax appeal was disposed of accordingly.