Date of judgment:
August 11, 2021
Judges:
RF Nariman, J.
BR Gavai, J.
Parties:
Appellant: M.M. AQUA TECHNOLOGIES LTD.
Respondents: COMMISSIONER OF INCOME TAX, DELHI-III
Subject
Whether interest can be said to have been actually paid by the mode of issuing debentures and can the deduction be claimed for the same under Section 43B of IT Act, 1961?
Overview
- In November 1996, the appellant filed for income tax returns with a loss of Rs.1,03,18,572/- for the assessment year 1996-1997 and claimed deduction of Rs.2,84,71,384/- under Section 43B based on the issue of debentures in exchange of interest to him and payable to financial institutions.
- In 1998, the assessing officer rejected the contention of the appellant on the ground that it was contrary to Section 43B (d) of the IT Act, 1961 and ineligible for the deduction.
- The appellant filed an appeal before the Commissioner of Income Tax (Appeals) (CIT) which was allowed by the CIT and it stated that the creditor of the appellant had accepted the debentures in lieu of the liability for the outstanding interest, which was no longer payable by the appellant and it was equal to actual payment under Section 43B of the Act.
- The CIT allowed the deductions under Section 43B of the IT Act.
- In an appeal by the Income Tax Department, the order of the CIT was upheld by Income Tax Appellate Tribunal and it was held that Section 43B was introduced in order to prevent tax evasion by way of not paying interest and also claiming the deduction.
- The ITAT held that where the two parties have agreed that interest will be paid in the form of converted debenture, such agreement will be taken as the actual discharge of liability and the order to invoke the provisions of Section 43B cannot be invoked in this case.
- The order of the ITAT was challenged by the Revenue Department before the High Court and the question that came before the HC was whether the funding of the interest amount by way of a term loan is equal to actual payment as mentioned under Section 43B of the Act.
- The High Court accepted the plea of the Revenue Department and it dismissed the review petition of the assessee/appellant by referring to Explanation 3C of Section 43B and holding that it had a retrospective effect and will be applicable to FY 1996-1997.
- The Senior Advocate appearing on behalf of the Appellant before the Supreme Court submitted that the question framed by the HC was wrong and therefore it led to the wrong conclusion.
- He also brought the court’s attention to the fact that Explanation 3C will not be applicable in this case as interest had not been converted into any loan or borrowing.
Legal Provisions
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Section 43B of IT Act, 1961
Section 43B of the Income Tax Act lays down a list of expenses that are allowed as deduction from the income under income from business and profession. It allows some expenses that can be claimed as deduction only in the present year and not in the year when liability arises towards those expenses.
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Explanation 3C to Section 43B
Explanation 3C was added to Section 43B in 2006 to curb the practice of tax evasion, where the assesses were claiming deduction under Section 43B by converting the interest payable on an existing loan into a new loan and misusing the Section and this explanation allowed certain deductions only on actual payments.
Judgment Analysis
- The Court first and foremost looked into the meaning and purpose of Section 43B and Explanation 3C under the Income Tax Act.
- It remarked into the object of Section 43B and stated that this Section allows certain deductions on actual payment and that incurring of liability cannot allow a deduction, but only “actual payment” can allow claiming the deduction.
- The Court referred to the orders passed by the CIT and the ITAT and remarked that the appellant paid the interest by issuing debentures, which extinguished his liability to pay interest.
- It was also observed that there was no misuse found of Section 43B and the Court agreed with the observations of the CIT and the ITAT and Explanation 3C cannot be applied to this case.
- The Court aimed to clear the ambiguity of the retrospective nature of Explanation 3C by laying down three major interpretations.
- Firstly, Explanation 3C was added in 2006 with the aim to remove the loopholes in Section 43B but it was not meant to affect bonafide transactions.
- Secondly, a retrospective provision in a Tax Act, which is "for the removal of doubts", cannot be presumed to be retrospective, even where such language is used.
- Thirdly, if there is any ambiguity as to the language of Explanation 3C, it will always be in the favour of the assessee as per the case of Brandy Syndicate v. Inland Revenue Commissioner.
- The Court noted that the judgement of the High Court, that concluded that the interest was converted into, was errored and not as per the facts of the case.
- The bench allowed the appeal and set aside the impugned judgement of the High Court and restored the judgement and order of the ITAT.
Conclusion
The Supreme Court looked into the meaning and definition of Section 43B of the Income Tax Act, 1961 and the purpose of Explanation 3C that was added to the Section in 2006. According to the Court’s findings, the Explanation was added to the Section to prevent the loopholes in the said Section and stop people from evading tax by turning the interests into fresh loans. The Court also cleared the ambiguity in the language of Explanation 3C and laid down three interpretations to understand the language of the said provision.
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