Income Tax Appellate Tribunal - Bangalore
The Deputy Commissioner Of Income-Tax vs Insotex (India) Ltd. on 1 August, 2005
Equivalent citations: [2006]103ITD211(BANG), [2006]287ITR11(BANG), (2006)104TTJ(BANG)1022
ORDER
Deepak R. Shah, Accountant Member
1. All these appeals by the Revenue are directed against the various orders of the learned Commissioner of Income Tax(A)-I, Bangalore dated 12.07.2002, 16.10.2002 & 11.03.2003.
2. The only issue in all these appeals is regarding the deletion of disallowance of interest payable on deep discount bonds issued by the assessee Company.
3. To understand the controversy the facts relevant to assessment year 1995-96 is described. The assessee is a company. While concluding the assessment the assessing officer disallowed the claim for an expenditure in a sum of Rs. 2,79,76,Q80/-. This expenditure related to the incremental amounts payable by the assesse on: the deep discount bonds (DDB Bonds) issued by it and figuring under head 'unsecured loans' in its balance sheet. As per the terms of the Bonds which are tenable for a period of 25 years on maturing over and above the issue price of Rs. 10,000/- a bond fetches a total value of Rs. 6,70,000/-. The amounts borrowed under the bond scheme are admittedly used for the purpose of business of the assessee. The bonds which are encashable by the Bond Holder at the end of the maturity period can be redeemed of its option by the assessee at the end of every 5 years. The redemption value of these bonds at intervals is as below:
a) at the end of 5 years for Rs. 23,200/-
b) at the end of 10 years for Rs. 55,200/-
c) at the end of 15 years for Rs. 1,27,000/-
d) at the end of 20 years for Rs. 2,89,000/-
The incremental amount available to the Bond Holder works out to yearly compounding at the rate of 18.33%. Having regard to the permissible redemption at the end of 5 years period the asscssee had provided in its books for the incremental amount payable and relating to the year. The claim for the assessment year in question amounting to Rs. 2,79,76,080/-, was rejected on the ground that it is a contingent liability. Similar disallowance has been made for the assessment years 1997-98 and 1999-2000. It may be mentioned that for the assessment year 1994-95, which is the first year of borrowal, the interest as claimed by the assessee has been allowed in an assessment made under Section 143(3) dated 4.10.96. For the assessment years. 1995-96 and 1998-99 the claim of the assessee has been allowed by accepting the return under Section 143(1)(a) of the Act. For the assessment year 1997-98 the assessing officer discussed the issue in detail. The assessing officer held that the deep discount bonds and regular bonds are two distinct instruments. It was held that interest payable is not specified in the bonds. He further held that unlike the case of fixed: deposits where the interest rate is specified and well defined, the interest accruing is correctly quantifiable and compounded year after year until maturity. Such features are absent in the bonds issued by the Company. It was also held that there is no question of premature redeemability as only the company has the option to redeem the bonds at the end of 5 years but the subscriber cannot opt for early redemption. The interest do not accrue till the end of 5 years and since this assessment being before the end of 5th year, the accounting entry is merely a provision and provisions are not allowable under the Act. He therefore, concluded that the liability is merely contingent and not ascertained or accrued liability. It was held that for an expenditure to be deductible, it can be only in respect of actually existing liability and not contingent upon happening of an event. He accordingly disallowed the provision for interest payable on such bonds.
3.1 Learned CIT(A) while deleting the disallowance held as under:
4. I have carefully considered the facts submitted by AR and the ratio of the decision of Supreme Court relied on by him. In the case of Madras Industrial Investment Corporation Ltd., v. CIT, reported in 225 ITR 802, it was issue of debentures redeemable after 12 years. The discount allowed to the debenture holders of Rs. 3 lakhs was equally divided over a period of 12 years and the proportionate amount was claimed in the assessment years concerned Assessing Officer disallowed the claim on the ground that there was no expenditure. The Supreme Court has observed that the expenditure is not necessarily confined to money which has been actually paid out, it covers a liability which is accrued or which has been incurred although it may have to be discharged. at a future date. However, a contingent liability which may have to be discharged in future cannot be considered. The Supreme Court observed that the expenditure also covers a liability which the assessee has incurred in the present although it is payable in future. A contingent liability that may arise in future is however not expenditure. It would also cover not just one time payment but a liability spread out over a number of years. In this judgment the Supreme Court specifically approved the decision of the Madhya Pradesh High Court reported in 165 ITR 765. In that case the MP High Court has held that the term 'expenditure' includes discount on bonds issued by it. The High Court has held that the amount of discount in effect represents deferred interest and an assessee would not be justified in claiming deduction of the entire amount of discount in the accounting year in question. But it would be entitled to proportionate deduction spread over a period for which the bonds remained outstanding. The Supreme Court have held that discount amount may be equally spread over the years during which the debenture was redeemable. AR argued that similar consideration must prevail in the case of the appellant and that the Bonds are treated at par with Debentures.
AR has given a comparison between the deep discount bonds issued by the assessee and the IDBI Flexi bonds that these bonds issued by the assessee are also deep discount bonds. The issue price is much below the face value. The maturity period is 25 years. The yield is about 15.5%. IDBI has the option to redeem the bonds at the intervals of 5 years. AR has relied on the clarification issued by the CBDT dated 23.5.1996 to the effect that the difference between the issue price and the redemption price is to be treated as interest in the hands of the bond holder. Therefore it is argued that its character cannot be different in the hands of the issuer. It is urged that it is beyond dispute that the difference represents interest payable by the issuing company namely the assessee herein to the bond holder and on the basis of the decision of Supreme Court cited, it has to be spread over the years concerned.
Keeping in view the principles laid down by the Supreme Court in the case: reported in 225 ITR 802, and having regard to the fact that deep discount bonds issued by appellant are comparable with Debentures, I hold that the claim made by appellant of interest payable of Rs. 2,79,76,080/- is an admissible deduction under Section 37. Assessing Officer is directed to delete the addition accordingly.
4. Learned CIT- OR Shri Arun Bhatnagar heavily relied upon the assessment order. He submitted that from the terms of issue it can be held that no interest is payable till the expiry" of 5 years from the date of issue. Though the interest may be quantifiable, the assessee is under no obligation to pay such interest. If the subscriber to bond ask for pre-payment, the assessee is not obliged to pay any interest thereon. The decision of Supreme Court in Madras Industrial Investment Corporation Ltd. (supra) relied by Learned CIT(A) does not apply to the assessee's case since the factual position is totally different. In Madras Industrial Investment Corporation Ltd. (supra), the assessee issued debentures at a discount on the issue price which was claimed as an ascertained liability and hence deductible. In the assessec's case the bonds are not issued at discount. The option is with the assessee to redeem the bonds at the end of 5 years, 10 years, etc., and till the assessee exercises that option there is no liability to pay any amount to the bond holders. The liability claimed by the assessee is therefore a contingent liability. He further submitted that only such expenditure are allowable in respect of which the liability is crystallized or ascertained and not a contingent one. He therefore, pleaded that the interest is not allowable.
5. Learned Counsel for assessee Shri Sanjay Dave relied upon the appellate order. He submitted that as per the terms of borrowal and considering the total length of period for which the bond is issued, the assessee has to pay Rs. 6.60 lakh towards interest. Such interest has been computed on the face of the bond itself. If the amount is redeemed at the end of 5th year, the assessee has to pay Rs. 13,200/-towards interest. If such amount is equally spread, Rs. 2,640/-becomes the interest payable for every year. The assessee has provided only such amount payable at the end of 10th, 15th, 20th and 25th year. He also filed before us the basis of computation of interest which is as under:
A. Number of bonds 10008 10008 10008 10008 10008
Terms in years 25 20 15 10 5
Issue Price 10,000 10,000 10,000 10,000 10,000
Face value 670,000 280,000 127,000 55,000 23,200
B Total
issue Price 100,080,000 100,080,000 100,080,000 100,080,000 100,080,000
Total face
value 6,705,360,000 2,802,240,000 1,271,016,000 550,440,000 232,185,600
Tota Interest 6,605,280,000 2,702,160,000 1,170,936,000 450,360,000 132,105,600
Annual interest 780,624,000 306,244,800 144,115,200 63,650,880 26,421,120
C Interest
Component 660,000 270,000 117,000 45,000 13,200
Incremental interest 390,000 153,000 72,000 31,800 13,200
Annua interest 26,400 13,500 7,800 4,500 2,640
Annual incremental
interest 78,000 30,600 14,400 6,360 2,640
D Interest
Component 6,605,280,000 2,702,160,000 1,170,936,000 450,360,000 132,105,600
Incremental
interest 3,903,120,000 1,531,224,000 720,576.000 318,254,400 132,105,600
End of Years From To Annual Total - 5 Yrs.
Interest-claim-first 5 years 5 1994 1998 26,421,120 132,105, 600
Interest-claim-next 5 years 10 1999 2003 63,650,880 318,254,400
Interest-claim-next 5 years 15 2004 2008 144,115,200 720,576,000
Interest-claim-next 5 years 20 2009 2013 306,244,800 1,531,224,000
Interest-claim-next 5 years 25 2014 2018 780,624,000 3,903,120,000
6,605,280,000
On Full term - Annual Charge is 254,211,200
Average Rate of Return 18.32%
He, thereafter submitted that if the total interest payable is considered, the annual interest payable comes to @ 18.31%. This was the prevailing market rate of borrowal at the relevant time. Similar bonds were issued by other financial institutions including Government companies like GNFC, IDBI, ICICI, etc. It is also an admitted fact that the amount has been' borrowed by the assessee by issue of bonus' amount repayable on maturity or on early redemption is also fixed. Thus by discounting the interest at present rate, the liability is ascertained and not contingent. He accordingly submitted that the order of Learned CIT(A) is to be upheld.
6. We have carefully considered rival submissions and relevant facts of the case. The Institute of Chartered Accountants of India (ICAI) is the premier Institute regulating the accountancy profession in India established under an Act of Parliament, has prescribed certain Accounting Standards. Section 145(2) of the Income Tax Act empowers the Central Government to notify the Accounting Standards. However, till date the Central Government has notified the Accounting Standards only relating to disclosure of accounting policies and relating to disclosure of prior period and extra-ordinary items. Under the Companies Act, 1956, the Central Government is authorised to issue Accounting Standards in consultation with the ICAI. Under the Companies Act, 1956, it is also provided that if no Accounting Standard has been prescribed by the Central Government, the Accounting Standards prescribed by the ICAI shall prevail. Hon'ble Supreme Court in the case of Challapalli Sugars Ltd. v. CIT (98 ITR 167) has accepted the accounting principles and standards laid down by the ICAI as bench mark for computing the income under the Act. The ICAI has notified the Accounting Standard No. 4 on contingencies and events occurring after the balance sheet date. In the said standard, a contingency has been defined as:
a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain future events.
In this regard, a distinction should be made between a contingency and an accounting estimate. For example, a provision for the estimated amount payable for services received is not a contingency even though the exact amount to be paid in future may be uncertain. This is because, even though estimation is involved in making the provision, there is certainty about the obligation to pay. For the word 'Provision' we can make useful reference to Accounting Standard 29 issued by ICAI and as defined in the Companies Act. A provision is defined in Part III of Schedule VI to the Companies Act, as any amount written off, or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. AS 29 presents a slimmed down version of this definition and states that a provision is a liability which can be measured only by using a substantial degree of estimation. The Standard prescribes three conditions, all of which are required to be cumulatively met, if a provision is to be recognized. These are:
a. An enterprise has a present obligation as a result of a past event, b. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and c. A reliable estimate can be made of the amount of the obligation.
6.1 It is also necessary to understand what is contingent liability. As per the Accounting Standard 4 and Accounting Standard 29, a contingent liability is defined to include two separate situations, of it being either a possible obligation, or a present obligation.
Situation I: A contingent liability is:
A possible obligation that arises from past events and The existence of which Will be confirmed only by The occurrence, or non-occurrence of one or more future uncertain events, Not wholly within the control of the enterprise.
Situation II: A contingent liability is:
A Present obligation that arises from past events But is not recognized because-
a) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or
b) A reliable estimate of the amount of the Act the obligation cannot be made.
6.2 The above principle can be applied here. In the present case, the amount has been borrowed by issue of deep discount bonds. The amount has been utilized for the purpose of business. As per the terms of issue, if the bonds are redeemed at the end of 5 years, the assessee is obliged to pay interest of Rs. 13,200/-. Dividing equally the sum, the liability for the year is Rs. 2640/- per bond. Even considering the total liability payable on maturity, the liability comes very near to the provisions made by the assessee. We also find that the provisions made is scientific and acceptable. The liability is not contingent upon happening or not happening of an event. Hon'ble Supreme Court in the case of BEML v. CIT 245 ITR 428 analyzed the difference between the accrued liability and contingent liability. At page 431, Hon'ble Supreme Court held thus:
The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being-estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.
In Metal Box Company of India Ltd. v. Their Workmen . the appellant company estimated its liability under two gratuity schemes framed by the company and the amount of liability was deducted from the gross receipts in the Profit & Loss Account. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability not all at once but spread over a number of years. The practice followed by the company was that every year the company worked out the additional liability incurred by it on the employees putting in every additional year of service. The gratuity was payable on the termination of an employee's service either due to retirement death or termination of service - the exact time of occurrence of the latter two events being not determinable with exactitude before hand. A few principles were laid down by this Court, the relevant of which for our purpose are extracted and reproduced as under:
(i) For an assessee maintaining his accounts on the mercantile system, accrued liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in the case of amounts actually expended or paid;
(ii) Just as receipts though not actual receipts but accrued due are brought in for Income Tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business;
(iii) A condition subsequent, the fulfillment of which may result in the reduction or even extinction of the liability, would not have the effect of converting that liability into a contingent liability;
(iv) A trader computing his taxable profits for a particular year may properly deduct not only the payments actually made to his employees but also the present value of any payments in respect of their services in that year to be made in a subsequent year if it can be satisfactorily estimated.
So is the view taken in Calcutta Co Ltd. v. CIT wherein this Court has held that the liability on the assessee having been imported, the liability would be an accrued liability and would not convert into a conditional one merely because the liability was to be discharged at a future date. There may be some difficulty in the estimation thereof but that would not convert the accrued liability into a conditional one; it was always open to the tax authorities concerned to arrive at a proper estimate of the liability having regard to all the circumstances of the case.
6.3 The decision referred by Hon 'ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd. v. CIT reported in 225 ITR 802 relied by Learned CIT(A) will also apply to the present set of facts. In the said case, the discount though ultimately accruing at the end of maturity, was allowed to be spread evenly over the period of such deep discount bonds issued. In the present case, the, liability to pay interest is evenly and rationally spread over as per the terms of issue. Applying the above said settled principles, we find that the provisions made by the assessee for meeting the liability incurred by it under the terms of issue of deep discount bonds is accrued liability and is therefore allowable.
In the result, the appeals are dismissed.