Income Tax Appellate Tribunal - Pune
Taparia Tools Ltd. vs Joint Cit on 3 October, 2000
Equivalent citations: (2002)74TTJ(PUNE)229
ORDER
B.L. Chhibber, A.M. Since common issues are involved in these three appeals by the assessee, these were heard together and are disposed to by an common order for the sake of convenience.
2. First we take up ITA No. 944/Pn/1999 relating to assessment year 1996-97. The mains grievance projected in this appeal by the assessee is that the learned Commissioner (Appeals) is not justified in confirming the disallowance of the up-front fee of Rs. 2,72,25,000 paid by the assessee on the NCDs subscribed by M/s. Maliram Makharia Stock Brokers (P) Ltd.
3. The assessee is a public limited company and is engaged in the manufacture and sale of hand tools and forgings. In the assessment year 1996-97, the company resolved to issue non-convertible debentures (NCDs) aggregating to Rs. 6 crores on a private placement basis. The debentures issued carried the following terms and conditions :
(a) The face value of the debenture is Rs. 100 each.
(b) As regards payment of interest on debentures, the debenture-holder had the option of either periodically receiving interest half yearly at the rate of 18 per cent per annum for five years or a one time up-front payment of Rs. 55 per debenture. The option in respect of the payment of interest was to be exercised within 30 days of the date of allotment.
(c) The debentures could be redeemed at par along with 10 per cent redemption premium at any time after the end of the 5th year but not beyond the 7th year.
(d) The debentures shall be secured by way of second charge on the assets of the company.
Ultimately, the debentures were allotted to the following parties on the date indicated against each :
Party Amount (in lacs) Date of allotment
1.
Maliram Makharia Stock Brokers (P) Ltd.
495.00 29-3-1996
2. Orient Corporation 1.25 19-6-1996
3. Suyok Agencies 1.25 19-6-1996
4. Kyasap Enterprises 1.25 19-6-1996
5. Suraj Agencies 1.25 19-6-1996
6. Sharp Knife Co. (P) Ltd.
100.00 19-6-1996 600.00 The debentures at serial No. 1 were allotted in the accounting year 1995-96 relevant to the assessment year 1996-97 (under appeal) and the orders in the accounting year 1996-97 relevant to assessment year 1997-98.
4. The parties at serial Nos. 1 and 6, namely, Maliram Makharia Stock Brokers (P) Ltd. and Sharp Knife Co. (P) Ltd., respectively, opted for one time up-front payment of Rs. 55 per debenture payable immediately on allotment, a term which was modified at the instance of debenture-holders. Accordingly, one time up-front interest payment of Rs. 2,72,25,000 was made to Maliram Makharia Stock Brokers (P) Ltd. and Rs. 55,00,000 to Sharp Knife Co. (P) Ltd. respectively.
5. The parties at serial Nos. 2 to 5 opted for payment of interest at the rate of 18 per cent per annum payable half-yearly. A trust deed was executed with SBI on 29-6-1996, after having previously made enquiries with various banks to act as trustees. In its return for assessment year 1996-97, the assessee claimed the entire upfront interest payments of Rs. 2,72,25,000 to Maliram Makharia (P) Ltd. as fully deductible expenditure, the reasons given before the assessing officer were as follows :
(i) the amount of Rs. 2,72,25,000 was accrued as a liability and paid accordingly. Therefore, it constituted an allowable deduction for the year because the assessee had followed mercantile system of accounting.
(ii) Secondly, the debentures were issued and proceeds thereof were utilised for the purpose of business and hence such up-front fee is an allowable deduction.
(iii) Spreading of amount of Rs. 2,72,25,000 for 5 years, i.e., linking of the same with period of redemption of the debentures is not proper and has no base.
(iv) If the period of debenture redemption is reduced or increased, amount which is actually spent cannot be reduced/increased on that basis when amount is actually accrued/due and paid for, it has to be allowed as a deduction from the total income.
6. The assessing officer did not accept the above contentions and disallowed the claim of the assessee for the following reasons :
(i) The assessee has borrowed Rs. 100 per N.C.D. On it he has paid an interest of Rs. 52. The net amount of Rs. 45 will be utilised by the assessee in his business for five years. At the end of five years, the assessee will return Rs. 100 plus premium of Rs. 10, i.e., Rs. 110. By paying Rs. 55 in one stroke, the assessee is absolved of the liability to pay Rs. 18 per year as interest on Rs. 100.
(ii) The funds have come in on 29-3-1996. The year has ended on 31-3-1996. The fund will actually be used for subsequent five years, income will be generated by the use of this fund in the succeeding five years, each years income, corresponding to the utilisation of this fund, will be taxed in the succeeding five years. In fact, the assessee debits, the entire interest of Rs. 2,72,25,000 in this financial year (FY) by the same yardstick it should offered for taxation in this financial year, the probable income charged to tax in the succeeding five years which is generated by the utilisation of this fund.
(iii) In the final accounts, the assessee has not claimed the amount of Rs. 2,72 crores as the deduction in profit & loss account. It has duly debited to a debenture interest deferred account of Rs. 2,72,25,000 for the year ended on 31-3-1996. In fact, for premium on redemption of debentures even though the same is payable after five years when the debentures will be due for redemption, the assessee has claimed that the matching amount of Rs. 11,53,726 for the year ended on 31-3-1997, and Rs. 12 lakhs for the year ended on 31-3-1998. Why the same concept was not followed for the payment of NCDs, which, in fact accrues at 18 per cent p.a. payable half-yearly, beats the common logic. Surely discretion is always better part of valour.
(iv) Assessees claim to deduction of the entire interest of Rs. 2.72 crores would have merited consideration had, it credited to the profit & loss account, say amount equal to its G.P. on the amount of total funds (Rs. 4.95 crores) for each of the succeeding 5 years. Just as it would be too far-fetched to tax in this year, the income of succeeding 5 years corresponding to the funds borrowed (Rs. 4.95 crores) it is equally far-fetched to claim the entire expenses pertaining to the cost of fund for the succeeding 5 years.
In support of the above, the assessing officer placed reliance on the judgment of the Honble Supreme Court in Madras Industrial Investment Corporation Ltd. v. CIT (1997) 225 ITR 802 (SC).
7. The assessee appealed to the Commissioner (Appeals) who confirmed the action of the assessing officer. He held that no prudent businessman will pay a sum of Rs. 55 to raise a loan of Rs. 45 and that the whole transaction with Maliram Makharia Stock Brokers (P) Ltd. was a colourable device, as the assessee-company during the year had earned more profits and Maliram Makharia Stock Brokers (P) Ltd. had incurred losses and the whole arrangement was made to benefit each other. The learned Commissioner (Appeals) accordingly held that the above payment of interest of Rs. 2,72,25,000 by the assessee to Maliram Makharia Stock Brokers (P) Ltd. is nothing but repayment of capital out of the total borrowings of Rs. 2,95,00,000 and consequently, the net result is that for the purpose of section 36(1)(iii) capital actually borrowed is Rs. 2,72,25,000 (Rs. 4,95,00,000 minus Rs. 2,72,25,000). He accordingly allowed interest at the rate of 18 per annum on the reduced capital borrowed amount of Rs. 2,72,25,000 for three days from 29-3-1996, to 31-3-1996. To support this conclusion, he held that the whole scheme of debentures issue was a colourable device to avoid tax and in this connection relied on the decision of the Honble Supreme Court in the case of McDowell & Co. Ltd. v. CTO (1985) 154 ITR 148 (SC). This aspect of the matter is discussed by him at per page 15, 16, 17 and 18 his order.
8. Aggrieved by the above orders of the authorities below, the assessee is in appeal before us, Shri S.E. Dastur, the learned counsel for the assessee, submitted that the assessee follows mercantile system of accounting and, therefore, the liability to pay debenture interest has been incurred and arisen in the first year itself and consequently, the liability to pay the lump-sum interest has accrued on exercise of the option by the debenture-holders to pay the discounted value of the interest up-front on the date of allotment, i.e., 29-3-1996. According to the learned counsel, the liability in the case of the assessee has not only undoubtedly and irrecovably accrued, but has also been irretrievably paid out from its pocket. Consequently, the one time lump-sum discounted up-front payment is fully deductible in its entirety in the first year itself, i.e., assessment year 1996-97. In this context, he drew our attention to the provisions of section 36(1)(iii) and submitted that it is clearly stated therein that the deduction in, computing the income, will be allowed of the amount of interest paid on the borrowings. in the case of the assessee, as the up-front fee was actually paid, the deduction of the same was allowable in view of the above provisions and there was no reason for the revenue to disallow the same. Secondly, in support of the proposition that the up-front fee is the interest on the borrowings, the learned counsel drew our attention to the definition of the word "interest" in section 2(28A) which states that "interest" means interest payable in any manner, in respect of money borrowed. He submitted that in view of this definition, the up-front fee constituted interest under section 36(1)(iii) and hence, it was allowable in the year of payment. In support of this contention, he placed reliance on the decision of the Madras Tribunal in EID Parry (India) Ltd. v. Dy. CIT (1993) 46 ITD 387 (Mad).
9. According to the learned counsel, the decision of the Honble Supreme Court in Madras Industrial Investment Corporation Ltd. (supra) is not applicable to the assessees case on the following counts :
(a) In that case, the Supreme Court was concerned with the deductibility of discount on debentures, having a life of 12 years and where the discount amount was payable after twelve years, whereas in the assessees case, the assessee was claiming deduction of one time actual lump-sum payment of discounted interest, involving surrogation of the annual interest, that would have been payable had the debenture-holders not opted for the up-front option. What has been paid, in substance, by the assessee by making one-time upfront payment is the discounted value of deferred interest, its basic and fundamental nature, which does not change because it was paid up-front.
(b) The Honble Supreme Court was not concerned with up-front payment of interest, but with an issue of debenture at a discount. The discount was not treated as deferred interest. At page 811 to 225 ITR 802, it stated that it was leaving open the question whether discount is deferred interest and it further observed that that would depend upon the terms of debenture issue and other circumstances. In the present case, one is concerned with actual payment of interest.
(c) In (1997) 225 ITR 802 (SC) (supra), the assessee itself initially claimed the deduction of discount on spread-over basis and it is only at the Tribunal stage that the assessee claimed the deduction in its entirety, whereas the assessee in the present case has always, since inception contended, that the up-front payment of discounted interest is fully deductible in the first year itself.
(d) The most vital, primary and glaring distinction is that though liability in both the cases has been incurred and accrued in the first year itself, in the assessees case, the liability has not only accrued and arisen in the first year itself, but has been paid out to debenture-holders and has gone out to them irrestrievably in the first year itself, whereas, the discount portion of debentures in (1997) 225 ITR 802 (SC) will be paid out only at the end of the life of the debentures, i.e., 12 years and is, therefore, continuing liability stretched over a period of 12 years as held by the Supreme Court at page 812 to 225 ITR 802 (SC).
(e) Discounted interest paid up-front in the first year by the assessee is not a continuing liability inasmuch as the liability has been liquidated in the first year itself by way of payment of the one-time up-front payment. By virtue of the said payment, the liability ceases to exist and the liability exhausted in the first year itself. It is for this very reason that the assessee has adopted the ratio of the Supreme Court in (1997) 225 ITR 802 (SC) (supra) for the purpose of claiming the deduction of 10 per cent premium payable on redemption of its debentures on a spread over basis stretched over five years, inasmuch as, just as discount in the case before the Supreme Court, premium is a continuing liability and has to be discharged at the time of redemption. The assessee submits for foregoing to bring out the uniformity and consistency in the assessees stand.
(f) In (1997) 225 ITR 802 (SC) (supra), the Supreme Court itself has observed as under at page 813 :
"Ordinarily revenue expenditure, which is incurred wholly and exclusively for the purpose of business must be allowed in its entirety in the year in which it is incurred. It cannot be spread over a number of years even if the assessee has written it off in his books over a period of years."
In fact, if the assessee had not claimed the deduction in the first year it may not, in law, be entitled for deduction in the subsequent years on the score that the liability for payment cannot be said to have arisen in the subsequent years as it was neither paid in such subsequent year nor any such event has taken place in the subsequent year which would give rise to its accrual in the subsequent year. In this connection, attention was invited to the decision of the Bangalore Tribunal in Bangalore Tools Works (P) Ltd. v. ITO (1993) 47 ITD 604 (Bang) where the Tribunal observed that in such a case the assessee can be said to have "missed the bus" if he does not claim it in the year of accrual.
10. Shri Dastur further submitted that there is no concept of deferred revenue expenditure in income-tax law and in support of this contention, he relied upon Hindustan Commercial Bank, In re (1952) 21 ITR 353 (All); CIT v. Bongaigaon Refinery and Petro Chemical Ltd. (1996) 222 ITR 208 (210) (Gau) and Bangalore Tool Works (P) Ltd. v. ITO (supra). He, therefore, submitted that revenue expenditure is to be allowed in its entirety in the year of its incurrence/accrual.
11. Shri Dastur also submitted that the rate of interest agreed is at 18 per cent per annum and this fact has also been accepted by the assessing officer, inasmuch as, the assessing officer himself in his orders for assessment years 1996-97, 1997-98 and 1998-99 calculated interest on debenture at the rate of 18 per cent per annum and consequently, that position is undisputed and unchallenged. As regards the period of debentures being five years and other terms and conditions, the learned counsel submitted that nothing turns on these facts and these are businessmans decisions not liable to interfered with by the department relying on CIT v. Bombay Samachar Ltd. (1969) 74 ITR 723 (Bom).
12. The learned counsel further submitted, that there a lump-sum one-time payment of discounted interest relieves the assessee or secures him the advantage of obtaining an absolution or immunity incurring that recurring revenue interest expenditure, the lump-sum payment so made is also deductible in its entirety as revenue expenditure. In other words, when a lumpsum amount is paid to get rid of an annual recurring expenditure, such lumpsum outgo is fully deductible in the year in which it is incurred. For this proposition, the learned counsel relied upon the following judgments :
(a) CIT v. Associated Cement Companies Ltd. (1988) 172 ITR 257 (SC);
(b) Hancock v. General Reversionary 7 Tax Cases 358, 370, 371, 372 (KB);
(c) Green v. Cravens (32 Tax Cases 359, 363);
(d) Nocil v. CIT (1993) 203 ITR 410 (Bom);
(e) CIT v. HMT (1993) 203 ITR 820 (Karn);
(f) R.K. Swami Advertising Associates (P) Ltd. v. IAC (1993) 44 ITD 99, 112, 113, 114 (Mad);
(g) Addl. CIT v. Buckau Wolf (1986) 157 ITR 751 (Bom); and
(h) Addl. CIT v. Bajaj Tempo Ltd. (Pune Tribunal) in ITA Nos. 271 to 272/Pn/85.
13. Coming to the comments of the assessing officer about the entries made in the books of account, the learned counsel submitted that entries concerning a particular expenditure in the books of an assessee is not conclusive or decisive of the matter regarding deductibility for income-tax purposes. Merely because the assessee has treated the up-front payment as deferred revenue expenditure in its account, it cannot be denied deduction of the said expenditure in its entirety in the first year of its incurrence/accrual. In support of this contention, he relied upon the following judgments :
(a) Kedarnath Jute Mfg. Co. v. CIT (1971) 82 ITR 363 (SC);
(b) CIT v. Chunilal Mehta & Sons (P) Ltd. (1971) 82 ITR 54 (SC);
(c) India Cements Ltd. v. CIT (1966) 60 ITR 52, 55 (SC);
(d) Sultej Cotton Mills v. CIT (1978) 116 ITR 1 (SC);
(e) United Commercial Bank v. CIT (1999) 240 ITR 355 (SC);
(f) CIT v. Gujarat Mineral Development Corpn. (1981) 132 ITR 377 (Guj); and
(g) CIT v. Nagarjuna Investment Trust Ltd. (1998) 65 ITD 17 (Hyd) (SB).
14. The learned counsel further submitted that by treating the up-front payment made by the assessee to the debenture-holders as refund/repayment of capital, the learned Commissioner (Appeals) has sought to rewrite the agreement with the debenture-holders, which is not possible in law in view of CIT v. Khaitan & Co. (1962) 45 ITR 170 (Cal), CIT v. Bibuti Bhushan Dutt (1963) 48 ITR 233 (Cal).
15. Coming to the decision of the Honble Supreme Court in the case of McDowell & Co. Ltd. (supra), the learned counsel submitted that the same is not applicable to the assessees case, inasmuch, as the ratio of McDowell cannot be invoked in case of a single transaction where there are no series of transaction, (Ramsay v. IRC 54 Tax Cases 101, 198. IRC v. Burmah Oil 54 Tax Cases 200, 214, and Fumiss v. Dawson 55 Tax Cases 324, 392 referred to at page 19 (Note 19) of Kanga and Palkhiwala, Eighth Edn. Vol. 1.] In other words, it applies only to a preordained series of transaction-McDowell & Co. Ltd. v. CTO (supra); Craven v. White (1990) 183 ITR 216, 224, 246, 264 (HL). The real ratio and meat of the matter concerning tax avoidance, vis-a-vis, tax planning as laid down in McDowell & Co. (supra) is embodied and contained in the main judgment rendered by four Judges, led by Justice Ranganath Mishra commencing from page 161 of the report. When viewed thus, the ratio that can be culled from the said main judgment is that tax planning within the framework of law is legitimate and it is only colourable devices and dubious methods that are to be discouraged (page 171 of 154 ITR 148). With respect, it was submitted that the judgment Justice Chinappa Reddy on tax avoidance refers to the development of the law in England from time to time, whereas the judgment of the other 4 learned Judges lays down its application in the Indian context. It may be noted that whereas Chinappa Reddy J. seems to cast some doubt on the earlier decisions of the Supreme Court in CIT v. Raman & Co. (1968) 67 ITR 11 (SC) and CIT v. B.M. Kharwar (1969) 72 ITR 603 (SC) (page 159), the 4 learned Judges have referred to the said decisions with approval at per page 170 and 171.
16. Shri Dastur further submitted that the transaction of the assessee with M/s Maliram Makharia Stock Brokers (P) Ltd. is within the four corners of law and falls within the ken of tax planning laid down in the main judgment of four Judges delivered by Justice Ranganath Mishra. According to him, this line of thinking has been reiterated by the Honble Supreme Court in CWT v. Arvind Narottam (1988) 173 ITR 479 (SC), Union of India v. Playworld Electronics (1990) 184 ITR 308 (SC) quoting, observations from (1988) 173 ITR 479 (SC) with approval. In similar vein, the learned counsel drew our attention to the decision of the Gujarat High Court in Banyan & Berry v. CIT (1996) 222 ITR 831 (Guj) and M. Valliappan v. ITO (1988) 170 ITR 238 (Mad).
17. Shri Dastur submitted that the mode of raising finance, employed by the assessee is commercially acceptable and recognised in the financial market and is also employed by National Housing Bank, ICICI and IDBI. He drew our attention to a sample copy of schemes. of NHB and ICICI which was duly furnished during the course of hearing. According to the learned counsel, this by itself establishes and lends the much needed commercial angle to the whole transaction under scrutiny.
18. Coming to the observation of the learned Commissioner (Appeals) that the assessee-company had made huge profits this year and M/s Maliram Makharia Stock Brokers (P) Ltd. had incurred losses and the transaction was made in a colourable manner for the mutual benefit, the learned counsel submitted that it may be true that M/s. Maliram Makharia Stockbrokers (P) Ltd. had losses, but the department ignores the fact that by setting off the interest income against the losses, Maliram has lost the right to carry forward losses which otherwise it would be entitled to, had it not offered the interest income for tax and in fact such a set off has resulted in Maliram, offering an income of Rs. 34,91,164 for tax in assessment year 1996-97.
19. An alternative submission was made by the learned counsel that if for reason the Tribunal comes to the conclusion that the entire up-front interest payment is not fully and entirely deductible in the first year itself as claimed by the assessee, it may restore the order of the assessing officer in view of the submissions hereinabove as the Commissioner (Appeals) has enhanced the income by Rs. 40,838 without even giving a statutory opportunity of showing cause against such enhancement as required under section 251(2) of the Act.
20. Shri Naresh Kumar, the learned senior Departmental Representative, strongly supported the orders of the authorities below. First he specifically highlighted the facts given on per page 4 and 5 of the Commissioner (Appeals)s order, where it is mentioned that the assessee-company is following mercantile system of accounting, wherein liability is allowable as deduction, the moment it is incurred for business. On page 6 in para 8 of the Commissioner (Appeals)s order, it has been observed that the entire interest was not debited in the books of account, but only the portion pertaining to this year was debited and balance would be written off over the period of debenture. Thus, the learned Departmental Representative emphasised that the assessee had debited only proportionate interest in the books of account, and this factor cannot be ignored. The learned Departmental Representative further pointed out that Rs. 55 paid by the assessee cannot represent the discounted value of the interest, payable by the assessee for the five years. He drew our attention to the terms and conditions of the NCDs mentioned at page 2 of the paper book and submitted that the calculation of interest is dependent upon the prime lending rate. It is not possible to foresee what would be the prime lending rate after 4 or 5 years. Therefore, the liability of the assessee to pay interest cannot be computed in advance and, hence the discounted value of interest cannot be computed.
Therefore, according to the learned Departmental Representative, Rs. 55 cannot represent the discounted value of interest, and it has to be held that Rs. 55 represents the return value of the debenture and the value of the debenture gets reduced to Rs. 45. He submitted that it is interesting to note that the assessee received Rs. 100 per debenture on 29-3-1996, and refunded Rs. 55 on the same day. According to the learned Departmental Representative in other words, the assessee received only Rs. 45. Therefore, the assessee raised a loan of Rs. 45 which is used for the purpose of business. The sum total of the transaction entered into by the assessee on 29-3-1996, is that the assessee received only Rs. 45. Therefore, as has been held by the Madras High Court in CIT v. Harveys Ltd. (1940) 8 ITR 307 (Mad), the interest need not be paid on the notional value of the debenture. The learned Departmental Representative emphasised that in the present case, real value of the debenture is only Rs. 45 and, therefore, interest has to be calculated only at Rs. 45.
21. The learned Departmental Representative relied upon the judgment of the Honble Supreme Court in the case of Madras Industrial Investment Corporation Ltd. (supra) relied upon by the authorities below and submitted that in this case it has been held that interest on debenture is payable only on accrual basis. Therefore, the composite payment of interest for 5 years cannot be said to be the payment of an amount, which was payable by the assessee and hence the provisions of section 36(1)(iii) are not applicable. The learned Departmental Representative read extensively from the judgment of the Supreme Court referred to supra and submitted that the ratio laid down by the Apex Court in the said judgment squarely applies to the facts of the present case and that the contention of the learned counsel that the ratio laid down by the Supreme Court in the aforesaid judgment is not applicable, cannot be accepted. The learned Departmental Representative further brought to our notice that the decision of the Supreme Court in the case of Madras Industrial Investment Corporation Ltd. was interpreted by the Calcutta High Court in National Engineering Industries Ltd. v. CIT (1999) 236 ITR 577 (Cal) and the Honble Calcutta High Court has held that liability to pay debenture premium is to be spread over years between the date of issue and the date of redemption. The learned Departmental Representative further submitted that the assessee and M/s. Maliram Makharia Stock Brokers (P) Ltd. entered into a colourable device and accordingly, the ratio laid down by the Honble Supreme Court in McDowell (supra) is squarely applicable and he placed reliance on the decision of the Commissioner (Appeals) on per page 13 to 20.
22. We have considered, the rival submissions and perused the facts on record. There is no dispute that the assessee follows mercantile system of accounting and hence, under such an accounting system, only a liability which accrues during the course of an accounting year is allowable. During the year under appeal, the assessee issued NCDs of the face value of Rs. 100 to be redeemed after 5 years and the debenture-holder had two options : (a) either periodically receiving interest half-yearly at the rate of 1.8 per cent per annum for five years, or (b) a one-time up-front payment of Rs. 55 per debenture. While the first option conforms to accepted accounting principles and legal position, the second option is not the correct option both in the eyes of principles of accounting and provisions of law. In Batlibois "Principles and Practice of Auditing", following treatment has been given to the allowance of interest on debentures :
"When debentures are issued at discount, an account styled Discount on Debenture Account, will be debited with the discount allowed on the issue. The debentures account will be credited in the books at their nominal value and will appear that that value as a liability in the balance sheet. The loss, thus arising need not be completely written off in the year, in which the debentures are issued, since the benefit to be derived from the amount borrowed will continue, till the debentures are redeemed. Where the debentures are redeemable at the end of a fixed period, a proportionate amount of discount should be written off out of revenue every year, during which the debentures are outstanding."
23. Following passage in Spicer and Peglers Book-keeping and Accounts (seventeenth edition) at page 240 further fortifies the above position :
"The discount on the issue is, in effect, deferred interest, and should accordingly be written off over the period having the use of the money raised by the debentures, unless a sinking fund is created to accumulate the full redemption price, including the discount."
Relying upon the above accepted principles of accountancy, we see no justification in the action of the assessee in giving one-time up-front part payment of Rs. 55 per debenture.
24. As far as the legal position is concerned, the issue stands squarely covered against the assessee and in favour of the department by the judgment of the Honble Supreme Court in the case of Madras Industrial Investment Corporation Ltd. (supra). In this case, the assessee-company issued debentures in December, 1966, at a discount. The total discount on the issue of Rs. 1.5 crores amounted to Rs. 3 lakhs. For the assessment year 1968-69, the assessee-company wrote off Rs. 12,500 out of the total discount of Rs. 3 lakhs being the proportionate amount of discount for the period of six months ending with 30-6-1967, taking into account the period of 12 years, which was the period of redemption and dividing the discount of Rs. 3 lakhs over the period of 12 years. The Income Tax Officer disallowed the claim, but the Appellate Assistant Commissioner allowed the deduction of Rs. 12,500. The Tribunal held that the entire expenditure of Rs. 3,00,000 was allowable as expenditure incurred for the purpose of business. On appeal, the High Court upheld the order of the Tribunal. On further appeal, the Honble Supreme Court, reversing the findings of the Tribunal and High Court, held at page 812 of the judgment as under :
"The Tribunal, however, held that since the entire liability to pay the discount had been incurred in the accounting year in question, the assessee was entitled to deduct the entire amount of Rs. 3,00,000 in that accounting year. This conclusion does not appear to be justified looking to the nature of the liability. It is true that the liability has been incurred in the accounting year. But the liability is a continuing liability which stretches over a period of 12 years. It is, therefore, a liability spread over a period of 12 years. Ordinarily, revenue expenditure which is incurred wholly and exclusively for the purpose of business must be allowed in its entirety in the year, in which it is incurred. It cannot be spread over a number of years even if the assessee has written it off in his books over a period of years. However, the facts may justify an assessee who has incurred expenditure in a particular year to spread and claim it over a period of ensuing years. In fact, allowing the entire expenditure in one year might give a very distorted picture of the profits of a particular year. Thus in the case of Hindustan Aluminium Corporation Ltd. v. CIT (1983) 144 ITR 474 (Cal), the Calcutta High Court upheld the claim of the assessee to spread but a lump sum payment to secure technical assistance and training over a number of years and allowed a proportionate deduction in the accounting year in question."
The Honble Supreme Court further observed :
"Issuing debentures at a discount is another such instance, where although the assessee has incurred the liability to pay the discount in the year of issue of debentures, the payment is to secure a benefit over a number of years. There is continuing benefit to the business of the company over the entire period. The liability should, therefore, be spread over the period of the debentures."
25. As stated above, the assessee issued debenture for a period of 5 years. The loan raised by way of debentures was to be utilised by the assessee for a period of 5 years and accordingly, the assessee was to get a benefit for 5 years. Applying the aforesaid ratio laid down by the Honble Supreme Court, the action of authorities below in allowing proportionate interest is justified. The above decision of the Honble Supreme Court has been interpreted by the Honble Calcutta High Court in National Engg. Industries Ltd. v. CIT (supra). On page 578, it has been observed by the Honble High Court as under :
"On the basis of the Supreme Court decision given in the case of Madras Industrial Investments case (1997) 225 ITR 802 (SC), in our opinion, it is not longer possible to take a second view in this matter. The Supreme Court had made observations which are quite clear to this effect that when a debenture carries a payment clause, say in the nature of a discount, that payment clause is to be spread over as a liability of the issuing assessee-company over the years ranging from issue to redemption."
(Emphasis, here italicised in print, supplied) Further on page 579, it has been observed by the Honble High Court as follows :
"It was specifically observed by the Supreme Court that any other view of deduction,; like taking the entire liability as amassed in the year of issue or in the year of redemption would give a distorted picture of the profits of that particular year of assessment. In saying this, the Supreme Court referred with approval to the case of CIT v. Indian Jute Mills Association (1982) 134 ITR 68 (Cal), a decision of Justice Sabyasachi Mukharji when his Lordship was taking up the Reference Bench at the Calcutta High Court. The Supreme Court also approved of the decision of the Madhya Pradesh High Court in M.P. Financial Corporation v. CIT (1986) 51 CTR (MP) 249 : (1987) 165 ITR 765 (MP). The references are given in the Supreme Court judgment."
In other words, the Honble High Court has interpreted the decision of the Apex Court in the case of Madras Industrial Investment Corporation Ltd.s case (supra) to mean that whenever a debenture carries a payment clause, such liability has to be allowed by spreading over a number of years ranging from the issue of redemption, irrespective of the method of accounting adopted by the assessee for payment. Therefore, the payment of liability of interest has to be allowed only by spreading over the same over the years ranging from issue to redemption, any other form of deduction would give a distorted picture of profits. Therefore, the decision of the Honble Supreme Court is squarely applicable to the facts of the present case and, accordingly, the authorities below are justified in allowing only proportionate interest, at the rate of 18 per cent per annum and not the up-front payment.
26. We do not find any merit in the contentions of the learned counsel summarized in para 9 (supra) where he has tried to distinguish the judgment of the Honble Supreme Court in Madras Industrial Investment Corporation Ltd. (supra), His first contention was that Supreme Court was concerned with the deductibility of discount on debentures having a life of 12 years, where the discount amount was payable after twelve years, whereas in the assessees case, the assessee was claiming deduction of one-time actual lump-sum payment of discounted interest involving surrogation of the annual interest, that would have been payable had the debenture-holders not opted for the up-front option. In our view, the period whether it is 12 years or 5 years is immaterial and the Honble Supreme Court has laid down the general proposition that interest payable on debentures has to be spread over period of debenture. His second point was that the Honble Supreme Court was not concerned with upfront payment of interest, but with an issue of debenture at a discount and that the Supreme Court was leaving open the question whether discount is deferred interest and, therefore, the ratio of (1997) 225 ITR 802 (SC) (supra) is not applicable. We have pointed out to the observations of the Honble Calcutta High Court in National Engg. Industries Ltd. (supra) where the High Court has held that the Supreme Court was concerned with any payment in respect of debentures. The High Court has observed, "The Supreme Court has made observations which are quite clear to this effect that when a debenture carries a payment clause, say in the nature of a discount, that payment clause is to be spread over as a liability of the issuing assessee-company over the years ranging from issue to redemption." His third contention was that in (1997) 225 ITR 802 (SC) (supra), the assessee itself initially claimed deduction of discount on spread over basis and it is only at the Tribunal stage that the assessee claimed the deduction in its entirety, whereas the assessee in the present case has always since the very beginning contended that the up-front payment of discounted interest is fully deductible in the first year itself. Here, we must quote the celebrated decision of the Honble Supreme Court in the case of Kedarnath Jute Manufacturing Co. v. CIT (supra) where the Apex Court has held that the allowability of the deduction does not depend upon the treatment given by the assessee in its books of account. Further, as has been held by the Calcutta High Court in (1999) 236 ITR 577 (Cal), the said decision of the Honble Supreme Court in (1997) 225 ITR 802 (SC) is applicable, irrespective of the fact, whether the assessee maintains the books of account on mercantile basis or on cash basis.
27. The next distinction drawn by the learned counsel was that in the assessees case the liability had not only accrued and arisen in the first year itself, but had been paid out to the debenture-holders and had gone out to them irretrievably in the first year itself, whereas the discount portion of the debentures in (1997) 225 ITR 802 (SC) (supra) will be paid out only at the end of the life of the debentures, i.e., 12 years. This distinction drawn by the learned counsel has no meaning, because the assessee had paid out the entire interest which was not as per the accounting principles. In fact, the assessee had not paid the discounted value of the interest, but part of the face value of the debenture itself. The assessee got the debenture of the face value of Rs. 100 and paid on the same day Rs. 55 out of the same. This was, in any case, not a prudent decision and this one-sided action, on the part of the assessee cannot lead to the conclusion that the judgment of the Honble Supreme Court (1997) 225 ITR 802 (SC) is distinguishable in facts.
28. As regards the argument of the learned counsel that discounted interest paid up-front in the first year by the assessee is not a contingent liability, inasmuch as, the liability has been liquidated in the first year itself by way of payment of one-time up-front payment, we do not find any merit in this contention, because as has been held by the Calcutta High Court in Hindustan Aluminium Corpn. Ltd. v. CIT (1983) 144 ITR 474 (Cal), the decision which has been approved by the Supreme Court in (1997) 225 ITR 802 (SC), even though the liability might have been liquidated in the first year itself, yet the liability has to be allowed and spread over a number of years.
29. In view of the above discussion, we do not agree with the learned counsel that the judgment of the Honble Supreme Court in Madras Industrial Investment Corporation Ltd. (supra) is distinguishable on facts from the case of the assessee.
30. Coming to the argument of the learned counsel, that no colourable device was adopted by the assessee and, accordingly, the ratio of the judgment of the Honble Supreme Court in the case of McDowell & Co. Ltd. (supra) is not applicable, we do not again find any merit in this contention. It is a queer case. The assessee raised a loan of Rs. 100 on 29-3-1996 and on the same day, it returned a sum of Rs. 55 by way of up-front fee. In other words, the assessee got only Rs. 45. Thus in the process, the assessee is not raising any loan, but giving Rs. 10 from its own pocket. No prudent businessman can refund more than 50 per cent of the borrowed capital on one go, i.e., on the same day, without using the funds for business. In the year under appeal, the assessee utilised borrowed funds for a period of only three days and paid huge up-front fee of Rs. 2,72,25,000. As per normal and prudent accounting practices, only interest accrued as on last day of the financial year is allowable. It is not a commercial prudence to return part of the borrowed capital on the same day in the form of huge up-front fee as it defeats the very purpose of raising capital. No doubt, it is the prerogative of the businessman to run his business, but decisions have to be in tune with accepted accounting principles and within the four corners of law. In CIT v. Durga Prasad More (1971) 82 ITR 540 (SC), the Honble Supreme Court has held as under :
"Taxing authorities were not required to put blinkers while looking at the document produced before them, They were entitled to look into the surrounding circumstances to find out the reality of the recitals made in those documents."
Again in Sumati Dayal v. CIT (1995) 214 ITR 801 (SC), the Honble Supreme Court has observed that considering the surrounding circumstances and applying the test of human probabilities is a must. If we look at the surrounding circumstances, we find that the assessee and M/s Maliram Makharia Stock Brokers (P) Ltd. entered into a colourable device for their mutual benefit. As pointed out in para (iii) on page 16 in the learned Commissioner (Appeals)s order, during the year under appeal, the assessees turnover had increased to Rs. 36.84 crores from Rs. 28.09 crores over the last year and the profit increased to Rs. 1.86 crore from Rs. 0.50 crore representing growth of 70.53 per cent. At the same time, M/s. Maliram Makharia Stock Brokers (P) Ltd. had suffered losses. Looking to the surrounding circumstances, the assessee approached M/s. Maliram Makharia Stock Brokers (P) Ltd. and by mutual benefit, the assessee reduced its profit by up-front fee of Rs. 2,72,25,000 and M/s. Maliram Makharia Stock Brokers (P) Ltd. showed nominal income. As pointed out in sub-para (iv), though M/s. Maliram Makharia Stock Brokers (P) Ltd. claimed to have shown an amount of Rs. 2,72,25,000 (received as up-front fee on 29-3-1996, from the assessee) as its income for the year under consideration, but as evidenced from record, it has returned its taxable income only at Rs. 34,91,164 for the assessment year 1996-97 as against Rs. 2.72 crores received from the assessee. Thus, M/s. Maliram Makharia Stock Brokers (P) Ltd. adjusted their losses in one stroke by readily agreeing to and becoming party to the said scheme conceived by the assessee.
31. Shri Dastur admitted that M/s. Maliram Makhania Stock Brokers (P) Ltd. had losses, but stated that the department ignores the fact, that by setting off the interest income against the losses, M/s Maliram has lost right to carry forward losses, which otherwise it would be entitled to, had it not offered the interest income for tax. We do not find merit in this contention because where is the guarantee that M/s Maliram Makharia Stock Brokers (P) Ltd. will earn only profits in the years to come so as to set off their losses. Thus, there was a collusion between the assessee and M/s Maliram Makharia Stock Brokers (P) Ltd. and such connivance cannot be called a valid tax planning. We do agree with the learned counsel that in McDowell & Co. (supra), the judgment is that tax planning within the framework of law is legitimate and it is only colourable devices and dubious methods that are to be discouraged. But in the case before us, as pointed out above, tax planning was not within the framework of law, because it was against the letter of spirit of the judgment of the Honble Supreme Court in the case of Madras Industrial Investment Co. (supra) and also against the accepted principles of accounting. From the facts, it is evident that it was a colourable device out and out to evade tax and accordingly, the judgment of the Honble Supreme Court in McDowell & Co. squarely applies to the facts of the present case.
32. In the light of above discussion, we direct the assessing officer to allow interest, at the rate of 18 per cent, per annum on the capital borrowed by way of NCDs for a period of 3 days during the year under appeal. We do not find any merit in the action of the Commissioner (Appeals) in enhancing the income by an amount of Rs. 40,838 as agitated by the assessee in ground No. 1.
32A. The next ground relates to interest charged under sections 234A, 234B and 234C. This ground is consequential in nature. The assessing officer is directed to recompute interest under the above sections after taking into consideration the relief allowed by this order.
ITA No. 945/Pn/1999Assessment year 1997-9833. The first grievance of the assessee is that the learned Commissioner (Appeals) is not justified in confirming the disallowance of up-front fee of Rs. 55,00,000 paid by the assessee on NCDs and further the Commissioner (Appeals) is not justified in enhancing income by an amount of Rs. 47,85,225, without giving a statutory opportunity of showing cause against such enhancement as required under section 251(2) of the Act.
34. The facts and arguments of the parties are same as those discussed in the assessees appeal relating to assessment year 1996-97 above. Accordingly, our decision given above for assessment year 1996-97 will apply mutatis mutandis for assessment year 1997-98 also and the assessing officer is directed to allow interest at the rate of 18 per cent per annum on the capital borrowed for a period of 12 months.
35. We do not find any merit in the action of the Commissioner (Appeals) in enhancing the income by an amount of Rs. 47,85,225, as agitated by the assessee in ground No. 1.
36. The next ground relates to interest charged under sections 234A, 234B and 234C. This ground is consequential in nature. The assessing officer is directed to recompute interest under the above sections after taking into consideration, the relief allowed by this order.
ITA No. 946/Pn/1999Assessment year 1998-9937. The first grievance of the assessee is that the Commissioner (Appeals) is not justified in confirming the disallowance of up-front fee, paid by the assessee on NCDs and further the Commissioner (Appeals) is not justified in enhancing income by an amount of Rs. 58,90,500, without giving a statutory opportunity of showing cause against such enhancement, as required under section 251(2) of the Act.
38. The facts and arguments of the parties are same as those, discussed in the assessees appeal relating to assessment year 1996-97 above. Accordingly, out decision given above for assessment year 1996-97 will apply mutatis mutandis for assessment year 1997-98 also and the assessing officer is directed to allow interest at the rate of 18 per cent per annum on the capital, borrowed for a period of 12 months.
39. The next ground relates to interest charged under sections 234A, 234B and 234C. This ground is consequential in nature. The assessing officer is directed to recompute interest under the above sections after taking into consideration the relief allowed by this order.
40. In the result, the appeals are allowed in part.
K.C. Singhal, J.M.
41. Agree with the conclusions arrived at by my learned brother in the proposed order. However, few words are added on the issue of colourable device.
42. The gist of the arguments advanced by Mr. Dastur, the learned senior counsel for the assessee is that the doctrine of colourable device can be invoked only in the case of circuitous transactions i.e., where the money passed from the pocket of the assessee comes back to him indirectly through such transactions. Such contention of assessees counsel in my opinion cannot be accepted. In the case of McDowell & Co. (1985) 154 ITR 148 (SC), the assessee was a manufacturer of liquor who was liable to pay excise duty on its manufacture and sales-tax on its sale. According to the relevant sales-tax legislation, the sales-tax was leviable on the total turnover which included the actual sale price of the liquor, as well as, the excise duty, charged by the assessee from its customers. For example, if sale price of liquor was Rs. 100 + excise duty of 30 per cent, then the sales-tax would have been leviable on the total amount of Rs. 130. If the rate of sales-tax was 10 per cent, then the sales-tax liability amounted to Rs. 13. In order to reduce the sales-tax liability, the assessee prepared a scheme, under which the purchaser of liquor was persuaded to pay the element of excise duty directly to the state exchequer. Accordingly, the assessee was not required to charge the excise duty in the invoice. Consequently, the sales-tax liability was reduced to Rs. 10. By adopting such method, the assessee was able to reduce its sales-tax liability from Rs. 13 to Rs. 10. But, the Sales Tax Department treated this method as a colourable device and, therefore, ignored the scheme of the assessee and consequently taxed the company on the turnover, including the excise duty element. This issue was disputed before the higher authorities, but finally the stand of the department was approved by the Supreme Court in the aforesaid case. Considering the facts of that case and the ruling, delivered by the Supreme Court, the argument advanced by Mr. Dastur cannot be accepted since there was no circuitous transaction in that case and still it was held that the scheme adopted by the assessee was a colourable device to evade the tax.
43. In this connection, it would be useful to refer to the following observations of the Supreme Court in the case of Sunil Siddharthbhai v. CIT (1985) 156 ITR 509, 523 :
"We have decided these appeals on the assumption that the partnership firm in question is a genuine firm and not the result of a sham or unreal transaction and that the transfer by the partner of his personal asset to partnership firm, represents a genuine intention to contribute to the share capital of the firm for the purpose of carrying on the partnership business. If the transfer of the personal asset by the assessee to a partnership, in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on a capital gain, it will be open to the income-tax authorities to go behind the transaction and examine, whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, the transaction of transferring the personal asset to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing, but a device or ruse to convert the personal asset into money, substantially for the benefit of the assessee, while evading tax on a capital gain. The Income Tax Officer will be entitled to consider all the relevant indicia in this regard, whether the partnership is formed between the assessee and his wife and children or substantially limited to them, whether the personal asset is sold by the partnership firm, soon after it is transferred by the assessee to it, whether the partnership firm has no substantial or real business or the record shows that there was no real need for the partnership firm for such capital contribution from the assessee. All these and other pertinent considerations may be taken into regard when the Income Tax Officer enters upto a scrutiny of the transaction, for, in the task of determining, whether a transaction is a sham or illusory transaction or a device or ruse, he is entitled to penetrate the veil covering it and ascertain the truth."
In view of the above discussions, two propositions emerge :
1. If the result of the normal transaction is tried to be achieved through a scheme, with the only intention to avoid the tax, then such scheme can be described as a colourable device even though such scheme may be within the framework of law.
2. If such scheme is adopted, then courts are entitled to pierce the veil and ascertain the real transactions behind the scheme and tax the same, in accordance with the law.
44. Let us consider the above legal position vis-a-vis, the facts of the present case. A normal transaction of borrowing of Rs. 45 by a prudent businessman with compound interest rate of 18 per cent per annum for five years would result in a liability of repayment of Rs. 102.94 on its maturity. If such normal transaction is adopted, then the assessee would be entitled to deduction, equal to the amount of interest accrued on such borrowings, in respect of all the five years. In the present case, the assessee issued debentures at the fag end of the year to a private person with face value of Rs. 100 giving option to the lender either to have interest at the rate of 18 per cent per annum with return of Rs 100 after five years or in the alternative to get back Rs. 55 as up-front fee immediately and to receive Rs. 100 after five years. From perusal of the scheme, it appears clearly that end result of the scheme is the same which would have been in the normal transaction, i.e., borrowing of Rs. 45 with an undertaking to return of Rs. 100 at the end of five years (on the basis of compound rate of interest of 18 per cent). By adopting this method, the sole purpose of the assessee was to claim one-time deduction to avoid the huge tax liability of the present year, which otherwise would have been payable by it. In the normal transaction, the assessee would have been entitled to deduction of very negligible amount, as money was utilised for the purpose of business only for 3 days, but by adopting that scheme, the assessee has tried to get huge deduction of Rs. 2,72,25,000, in order to avoid the tax liability of the year under consideration. Considering the facts, that profits of the assessee-company had suddenly increased enormously and the lender had incurred heavy losses in the year under consideration, such scheme can be described as a colourable device since it helped the assessee in reducing the heavy burden of liability on one hand and without affecting much the lender on the other hand. In such situation, it is the duty of the tax authority/Tribunal to pierce the veil and ascertain the real transaction, as held by the Supreme Court in the case of Sunil Siddharthbhai (supra). In view of this legal position, I concur with the finding of my learned brother, that colourable device was adopted by the assessee to avoid the tax.