2007 (3) TMI 294 - AT - Income Tax

Appeal Granted: Deduction for Debenture Expenses Allowed, Direction to AO for Part-A Expenses

The Tribunal partially allowed the appeal, permitting the deduction of debenture issue expenses related to Part-B until conversion into equity shares, ... Deduction under section 36(1)(iii) for interest on borrowed capital - debenture as borrowed capital until repayment or conversion - treatment of convertible debentures - pre-conversion revenue, post-conversion capital - amortisation of issue expenses under section 35D(2) - substance of transaction governs characterisation of expenditureDeduction under section 36(1)(iii) for interest on borrowed capital - debenture as borrowed capital until repayment or conversion - treatment of convertible debentures - pre-conversion revenue, post-conversion capital - Allowability of interest and related issue expenses in respect of the pre-conversion period of partly/fully convertible debentures - HELD THAT: - The Tribunal held that a debenture remains borrowed capital until it is repaid or discharged and that conversion into equity is a mode of repayment or discharge. The impugned debentures (Part B and non-convertible portions) were used for business purposes until their conversion; consequently interest paid in respect of those debentures for the pre-conversion period is deductible under the statutory provision dealing with interest on capital borrowed for business. The fact that the debentures were ultimately converted into equity during the relevant period does not defeat the character of the debenture as borrowed capital for the pre-conversion period. On these facts the Revenue's grounds seeking denial of deduction were dismissed and the AO was directed to allow deduction for interest/issue expenses attributable to the pre-conversion period of Part B and the non-convertible portions. [Paras 11, 12]Deduction under section 36(1)(iii) allowed for interest/issue expenses attributable to the pre-conversion period of Part B of the convertible debentures and for the non-convertible portion until conversion/discharge.Amortisation of issue expenses under section 35D(2) - treatment of convertible debentures - pre-conversion revenue, post-conversion capital - substance of transaction governs characterisation of expenditure - Treatment of issue expenses relating to the portion of debentures converted into equity on the date of allotment (Part A) - HELD THAT: - The Tribunal affirmed that expenses relating to those debentures (Part A) which stood converted into equity on the date of allotment are capital in nature. Those capitalised issue expenses qualify for amortisation under the statutory provision dealing with capitalised issue expenditure. As the lower authorities had not examined the quantification and allowance under that provision, the matter was remitted to the assessing officer for verification of facts and computation of the deductible portion in accordance with the statutory amortisation scheme. [Paras 14]Expenses relating to the portion of debentures converted into equity on allotment are capital and are to be amortised; the AO is directed to verify facts and allow deduction as per section 35D(2).Final Conclusion: The appeal is partly allowed: interest and issue expenses attributable to the pre-conversion period of Part B and non-convertible portions of the debentures are allowable as deduction under section 36(1)(iii); expenses relating to the portion converted into equity on allotment are capital and are remitted to the AO for amortisation and allowance under section 35D(2). Issues involved:1. Confirmation of disallowance of debenture issue expenditure amounting to Rs. 5,21,22,533 on the ground that it is capital in nature.Issue-wise Detailed Analysis:Issue 1: Confirmation of disallowance of debenture issue expenditure amounting to Rs. 5,21,22,533 on the ground that it is capital in nature.The assessee, a public limited company, claimed debenture issue expenses of Rs. 5,21,22,533 as an allowable deduction while computing income under the head profit and gains of business/profession. The AO disallowed this claim, treating the expenses as capital in nature, arguing that the debentures were converted into equity shares within one year of their issuance, thus not qualifying as revenue expenditure.Assessee's Arguments:- The debentures, though convertible, were secured loans in nature, carrying a 14% interest rate, which was paid from the date of application.- The assessee relied on the Supreme Court judgment in India Cement Ltd. vs. CIT and the Bombay High Court judgment in Dhrangadhra Chemical Works Ltd., arguing that debentures are debt instruments and expenses on raising funds through them are allowable as revenue expenditure.Revenue's Arguments:- The AO and CIT(A) rejected the assessee's contentions, maintaining that the debenture expenses were capital in nature.- The learned Departmental Representative cited the Special Bench decision in Ashima Syntex Ltd. vs. Asstt. CIT, arguing that the debentures were issued to increase the capital base of the company, making the expenses capital in nature.Tribunal's Analysis:- The Tribunal considered the assessee's reliance on the Supreme Court's observations in India Cement Ltd. vs. CIT, which distinguished between obtaining capital by issuing shares and obtaining loans by debentures.- The Tribunal noted that debentures are acknowledged as debt instruments, and any expenditure on raising funds through them is allowable under s. 36(1)(iii) of the Act.- The Tribunal also referred to the Madras High Court's decision in CIT vs. Laxmi Vilas Bank Ltd., which elaborated on the distinction between debentures and shares, emphasizing that debentures are loans that must be repaid, unlike shares.Precedent and Consistency:- The Tribunal found that in the preceding assessment year (1996-97), a similar issue was decided in favor of the assessee, treating the issuance of convertible debentures as raising a loan and allowing the deduction of interest expenses.- The Tribunal emphasized the importance of consistency, noting that the facts of the current year were identical to those of the previous year.Special Bench Decision Consideration:- The Tribunal examined the Special Bench decision, which categorized cases into three groups: fully in favor of the assessee, partially in favor (allowing expenses for the pre-conversion period), and against the assessee.- The Tribunal highlighted that the Special Bench decision focused on the substance of the transaction, determining whether the expenditure was for raising the capital base.Conclusion:- The Tribunal concluded that the debenture issue expenses related to Part-B of the debentures (convertible after one year) should be allowed as revenue expenses until their conversion into equity shares.- For Part-A of the debentures (convertible on the date of allotment), the expenses were treated as capital in nature, and the Tribunal directed the AO to grant deduction under s. 35D(2) of the Act.Result:- The appeal was partly allowed, granting the assessee deduction for expenses related to Part-B of the debentures and directing the AO to verify and grant deduction under s. 35D(2) for Part-A expenses.