Conversion of outstanding interest into equity shares treated as actual payment under Section 43B, extinguishing liability

HC held that conversion of outstanding interest into equity shares extinguished the liability and, following the Supreme Court's interpretation of section 43B, amounted to "actual payment" for purposes of deduction. Because Revenue did not dispute that the liability ceased on issuance of shares, the assessee was entitled to the benefit of section 43B. The substantial question of law was answered in favour of the assessee.

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Issues Involved:

1. Whether the conversion of interest liability into equity shares amounts to "actual payment" under Section 43B of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Conversion of Interest into Equity Shares as "Actual Payment" under Section 43B:

The primary issue in this case was whether the conversion of interest liability into equity shares could be considered "actual payment" under Section 43B of the Income Tax Act, 1961. The assessee, a software development company, had converted unpaid interest of Rs.75,75,000/- to Andhra Pradesh Industrial Development Corporation Limited (APIDC) into equity shares. The Assessing Officer disallowed this conversion under Section 43B, which mandates actual payment for deduction eligibility. The assessee argued that constructive payment amounted to actual payment, citing precedents from the Supreme Court and High Courts.

The court examined the provisions of Section 43B, which was introduced to curb practices where liabilities were claimed as deductions without actual payment. Explanation 3C, inserted by the Finance Act, 2006, clarifies that conversion of interest into a loan or other instruments does not constitute actual payment. The Supreme Court in M.M. Aqua Technologies Limited had previously ruled that the actual payment requirement is met if the liability to pay interest is extinguished, as was the case when debentures were issued to discharge the interest liability.

The High Court noted that the Revenue did not dispute the cessation of the liability to pay interest upon the issuance of equity shares. Referring to the Supreme Court's interpretation, the court concluded that the liability's cessation due to share issuance equated to actual payment under Section 43B. Consequently, the assessee was entitled to the deduction benefit.

Conclusion:

The High Court ruled in favor of the assessee, determining that the conversion of interest into equity shares constituted actual payment under Section 43B. The court set aside the Tribunal's order, allowing the assessee to claim the deduction. The appeal was allowed, with no order as to costs.

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