Facts

The assessee issued debentures giving the debenture holders two options as regards to the payment of interest. They could either receive interest periodically

i.e. half yearly at the rate of 18% per annum over a period of five years or opt      for one time upfront receipt of discounted interest of Rs. 55  per  debenture. In   the second alternative, discounted interest of Rs. 55 per debenture was to be paid upfront. At the end of five years period, the debentures were to be redeemed at    the face value of Rs. 100. Two of the debenture holders opted for the upfrontpayment of interest. In the books of account the said upfront payment of interest  on debentures was recorded as deferred revenue expenditure and was  written  off over a period of five years. For the purpose of income-tax, entire payment of interest was claimed as a deduction under section 36(i)(iii) of the Act in the year   of payment itself. However, the AO, CIT(A), ITAT and High Court rejected the assessee’s claim and held that though the amount was paid upfront, the same   was only allowable as a deduction over the tenure of the debentures i.e. over the period of five years.

Issue

Whether the upfront payment of interest to the debenture holders is allowable as    a deduction in the year in which it is incurred and paid  or it is to be spread over  the life of the debentures?

View

In the case of Bharat Earth Movers v. CIT (2000) 245 ITR 428 (SC) the Supreme Court has held that if a business liability has arisen in the accounting year, the deduction should be allowed in that year even if such a liability may have to be quantified and discharged at a future date.

Held

The Supreme Court held that in accordance with the terms and conditions of the issue of non-convertible debenture floated by the assessee the amount of interest became payable to the debenture holders on the exercise of option by them which occurred in the current assessment year in which deduction of the expenditure  was claimed. As per section 36(1)(iii) of the Act, any interest expenditure paid      by the assessee for the purpose of its business is allowable as a deduction. Further, ‘paid’ as per section 43(2) means actually paid or  incurred. Therefore, the Supreme Court held that when the interest was actually incurred and paid      by the assessee, the assessee would be entitled to deduction of the upfront payment of discounted interest on debenture in the assessment year in which it     is paid. The Supreme Court held that normally revenue expenditure incurred in     a particular year has to be allowed in that year itself and if the assessee claims    that expenditure in that year,  the  department cannot deny the same. There is  no concept of deferred revenue expenditure in the Income-tax Act, 1961, except where the section specifically provides for the same. Further, the treatment in the books of account do not determine the allowability or taxability of any item of expenditure or income. The deduction of any expenditure is permissible as per the provisions of the Act. The matching concept also does not come in the way of the assessee. If an assessee follows mercantile system of accounting, the expenditure becomes allowable once the liability to  pay  is  incurred by  the  assessee. Even if the assessee treats such expenditure as deferred revenue expenditure in the books of account, then same shall not estop the assessee from claiming the entire deduction for the purpose of the Act. (AY. 1996-97, 1997-98, 1998-99) (CA Nos. 6366-6368of 2003 and 6946-6948 of 2004 dt. 23-3-2015)

Editorial: The order of the Bombay High Court in Taparia Tools Ltd. v. JCIT (2003) 260 ITR 102/126 Taxman 544 (Bom) (HC) has been reversed. The principle laid down in this judgment that once the liability is incurred by the assessee it    has to be allowed as an expenditure has been followed by the Supreme Court in CIT v. Modern Spinners Ltd. (2016) 382 ITR 472/243 Taxman 437 (SC). This principle has been followed in the following judgments as well: CIT v. Oil & Natural Gas Corporation Ltd. (2016) 387 ITR 710 (Uttarakhand) (HC) Prithvi Associates v. ACIT (2016) 240 Taxman 621 (Guj.)(HC)

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– Mahatma Gandhi