2006 (3) TMI 188 - AT - Income Tax

Expenditure from Convertible Debentures Deemed Capital, Not Revenue: Tribunal Dismisses Appeal, Upholds Enduring Asset View.

The Tribunal concluded that the expenditure incurred by the assessee on issuing convertible debentures, which were eventually converted into equity ... Convertible debentures for subscription - Expenditure incurred on the issuance of convertible debentures is 'capital or revenue' expenditure? - HELD THAT - Maganlal Mohanlal Panchal (HUF)'s [1993 (9) TMI 20 - GUJARAT HIGH COURT], states that a solitary decision is to be followed but only when it is applicable to the facts and circumstances of the case. It has a persuasive value and not a binding decision like that of Supreme Court. This is with regard to decision of Calcutta High Court in the case of East India Hotels Ltd. [2001 (8) TMI 102 - CALCUTTA HIGH COURT], In this case, the debenture was held to be loan and 20 per cent repaid by allotment of shares was found to be an incentive for debentures subscription. There is nothing in the present case of that nature. Intention was to issue shares, partly on allotment of debenture itself and partly after 15 months. Here, the intention is thus was otherwise. The conversion is not an incentive for debenture but a prelude to issue of shares. We, therefore, hold that the raising of funds by issue of convertible debentures was to raise capital by ultimately converting debentures into equity share without giving an option to debenture holder to get repayment or a say in conversion. Substance of the transaction is issue of equity capital partly on the date of allotment of debentures. The contention of the assessee that expenditure relating to conversion partly after 15 months can at least be held as revenue has no force as the nature of such retention is akin to share application money pending allotment of shares. In the result, the appeal of the assessee is dismissed. Issues Involved: Whether the expenditure incurred by the assessee on the issuance of convertible debentures is allowable as a revenue expenditure.Issue-Wise Detailed Analysis:1. Nature of Convertible Debentures:The primary issue was to determine if the expenditure on issuing convertible debentures can be classified as revenue expenditure. The assessee issued 17,33,000 convertible debentures, which were to be converted into equity shares. The Assessing Officer disallowed the claim, stating that the expenditure was capital in nature as it created an asset of enduring nature. The CIT(A) upheld this view, distinguishing it from the Supreme Court's decision in India Cements Ltd. v. CIT, where the expenditure was for obtaining a loan, not creating an enduring asset.2. Arguments by the Assessee:The assessee argued that debentures are loans or borrowings and hence, the expenditure should be deductible as revenue expenditure, relying on the Supreme Court decision in India Cements Ltd. The counsel also cited various High Court and Tribunal decisions supporting the deduction of such expenditures.3. Arguments by the Revenue:The Revenue contended that funds raised through convertible debentures aimed to increase capital, making the expenditure capital in nature. They cited Supreme Court decisions in Brooke Bond (India) Ltd. v. CIT and Punjab State Industrial Development Corpn. Ltd. v. CIT, which held that expenditures related to capital expansion are capital expenditures.4. Tribunal's Analysis:The Tribunal examined the nature of convertible debentures, noting that they are essentially equity shares in embryo, as they are converted into shares, thus augmenting the capital base. The Tribunal differentiated between raising loans and raising capital through convertible debentures, concluding that the latter is not a loan but a capital-raising mechanism.5. Applicability of Section 35D:The Tribunal considered Section 35D, which deals with the amortization of preliminary expenses, including expenses for issuing shares or debentures. The Tribunal noted that one of the objects of the debenture issue was to finance a new industrial unit, making it fall under Section 35D. However, the Tribunal did not express a definitive opinion on this, focusing instead on the nature of the expenditure.6. Precedents and Judicial Interpretations:The Tribunal reviewed various judicial precedents. It noted that decisions allowing such expenditures as revenue were based on the specific nature of the debentures and their conversion terms. The Tribunal distinguished these from the present case, where the debentures were fully convertible, indicating an intention to raise capital.7. Substance Over Form:The Tribunal emphasized the principle of looking at the substance of the transaction over its form. It concluded that the real nature of the transaction was to raise equity capital via convertible debentures, making the expenditure capital in nature.Conclusion:The Tribunal held that the expenditure incurred on issuing convertible debentures, which were ultimately converted into equity shares, was capital in nature and not allowable as revenue expenditure. The appeal of the assessee was dismissed.