The Supreme Court ruled that the conversion of outstanding interest into debentures by the assessee company qualified for deduction under Section 43B of the Income Tax Act. The conversion was done under a rehabilitation plan agreed with institutional creditors to extinguish the interest liability. The Court observed that Section 43B was not meant to affect bona fide transactions, and debentures were different than loans/borrowings under Explanation 3C. It set aside the High Court's decision and allowed the assessee's claim for deduction, noting the conversion was an actual payment of interest rather than postponing the liability.
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ALLOWABILITY OF OUTSTANDING INTEREST CONVERTED INTO DEBENTURES AS AN EXPENSE U/S 43B OF THE INCOME TAX, 1961
1. M.M. AQUA TECHNOLOGIES LTD.
V.
COMMISSIONER OF INCOME-TAX, DELHI-III
[2021] 129 TAXMANN.COM 145 (SC)
ALLOWABILITY OF OUTSTANDING
INTEREST CONVERTED INTO
DEBENTURES AS AN EXPENSE U/S 43B
OF THE INCOME TAX, 1961
2. LEGENDS USED
AO Assessing Officer
AY Assessment Year
CIT Commissioner of Income Tax
CIT(A) Commissioner of Income Tax (Appeals)
HC High Court
ITAT Income tax Appellate Tribunal
PFI Public Financial Institution
PY Previous Year
SC Supreme Court
SFC State Financial Corporation
the Act Income Tax Act, 1961
u/s under section
3. PRESENTATION SCHEMA
Facts of the Case and Issue
for Consideration
Extract of the Section and
Rationale behind its
Insertion
Rulings of Lower
Jurisdictional Authorities
Rival Submissions before the
Hon’ble SC
Observations made by the
Hon’ble SC and Final Ruling
Way Forward
5. ISSUE FOR CONSIDERATION
Assessee-Company M M Aqua, was
heavily indebted to its institutional
creditors (PFIs) and due to financial
troubles, was unable to discharge its
interest obligations.
As facilitated under a Rehabilitation
Plan and agreed upon by the
institutional creditors, the assessee,
in PY 1995-96, issued debentures in
lieu of the outstanding interest due
to them.
Consequently, assessee claimed
deduction u/s 43B of the Act,
explaining that interest was actually
paid by it.
AO rejected the assessee's claim for deduction, on the premise that the debenture issue only resulted in
postponement of the interest liability and hence, the interest could not be considered as having been "actually
paid“ as required by Section 43B of the Act.
FACTS OF THE CASE
7. EXTRACT OF SECTION 43B OF THE
INCOME TAX ACT, 1961
43B. Certain deductions to be only on actual payment.
“Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable
under this Act in respect of—
(d) any sum payable by the assessee as interest on any loan or borrowing from any public financial
institution or a State financial corporation or a State industrial investment corporation, in accordance
with the terms and conditions of the agreement governing such loan or borrowing
shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the
assessee according to the method of accounting regularly employed by him) only in computing the income
referred to in section 28 of that previous year in which such sum is actually paid by him.
*Explanation 3C.—For the removal of doubts, it is hereby declared that a deduction of any sum, being
interest payable under clause (d) of this section, shall be allowed if such interest has been actually paid and
any interest referred to in that clause which has been converted into a loan or borrowing shall not be
deemed to have been actually paid.”
Section 43B, to the extent relevant for the present case, reads as follows:
*Explanation 3C was inserted by the Finance Act, 2006
8. RATIONALE BEHIND INTRODUCTION OF
SECTION 43B
Taxpayers claimed their
statutory liabilities (excise duty,
employer’s contribution to PF,
ESI, etc.,) as a deduction on the
ground that they maintained
accounts on accrual basis.
On the other hand, they
disputed the liability and did not
discharge the same
Before analysing the proceedings before the Hon’ble SC, let us try to understand the rationale behind the introduction of Section
43B. Prior to the introduction of the section, there were several instances where:
Later, Finance Act 2006 introduced Explanation 3C to the Section 43B (retrospectively from 01.04.1989), to curb the misuse of the
provisions of the section by claiming deduction against conversion of interest into a fresh loan, without any constructive discharge
of interest liability.
To curb this practice, section 43B was introduced vide Finance Act 1983, to provide that any statutory liability be allowed as a
deduction only in the previous year in which such sum is actually paid by the assessee.
Further, Finance Act, 1989 inserted clause (d) in section 43B to bring interest on loan or borrowing from any PFI or SFC or a State
Industrial investment corporation within the ambit of section 43B of the Act.
10. DECISIONS BY THE LOWER JURISDICTIONAL
AUTHORITIES
CIT(A):
As the Financial institutions had
accepted the debentures in
effective discharge of the
liability for the outstanding
interest which was no longer
payable by the appellant, it was
tantamount to actual payment
for the intent of section 43B of
the Act.
ITAT:
Section 43B was introduced to curb
the mischief of withholding tax
payment by the assessee, while at the
same time claiming deduction thereof.
When both the parties agree that the
conversion of outstanding interest
liability into fully paid debentures
would be accepted as discharge of
the liability, then to hold that the
interest liability has not been
discharged would be opposed to the
contextual perspective of section
43B.
Delhi HC:
Explanation 3C, inserted
retrospectively with effect from 01-
04-1989, would be applicable to
the present case, as it relates to AY
1996-97.
Because of Explanation 3C to
Section 43B, any adjustment other
than actual payment does not
qualify for deduction under the
section.
It shall be noted that the ruling of CIT(A) and the ITAT came prior to the introduction of Explanation 3C vide Finance Act, 2006.
12. RIVAL SUBMISSIONS BEFORE THE
HON’BLE SC
Contentions of the Assessee
• The debentures that were issued were
not towards any future payment of
liability, but towards actual payment of
interest that was due and owed to the
financial institution in question.
• Explanation 3C would have no
application in the facts of this case as
interest had not been converted into any
loan or borrowing but debentures,
which are actionable claims and can be
sold in the market as such.
• It is well established that fiscal and tax
statutes have to be strictly construed.
Since the word "debenture" is not
specified in Explanation 3C, it cannot be
read into it.
Contentions of the Revenue
• Section 43B makes a departure from
other sections in the Act, as indicated
by its non-obstante clause. The section
was introduced so that no deductions
could be claimed based on a mercantile
system of accounting as actual payment
would have to be made.
• A debenture is nothing but a loan.
Interest had, in fact, been converted
into a loan on the facts of this case and
squarely attracted the latter part of
Explanation 3C.
14. OBSERVATIONS MADE BY THE
HON’BLE SC
Both the CIT and the ITAT found that as per a rehabilitation plan agreed to
between the lender and the borrower, debentures were accepted by the
financial institution in discharge of the debt on account of outstanding
interest.
Reliance placed on the use of the expression "in lieu of" by the learned CIT
It is clear that interest
was "actually paid" by
means of issuance of
debentures, which
extinguished the
liability to pay interest.
For the AY in question, the accounts of the bank for income tax purposes,
reflect the amount received by way of debentures as its business income.
At the heart of the introduction of Explanation 3C is misuse of the provisions of section 43B by not actually
paying interest, but converting such interest into a fresh loan.
The issue of debentures by the assessee was, under a
rehabilitation plan, to extinguish the liability of
interest altogether.
No misuse of the provision of section 43B was found
as a matter of fact by either the CIT or the ITAT.
1
2
15. INTERPRETING EXPLANATION 3C TO
SECTION 43B
The Hon’ble SC laid down the following canons of interpretation to resolve the ambiguity in interpreting the
provisions of Explanation 3C :
Bonafide Transactions are not
affected by the provision
Since Explanation 3C was inserted
with the object of curbing the
misuse of section 43B by not
actually paying interest but
converting interest into a fresh
loan, bona fide transactions of
actual payments are not meant to
be affected.
A retrospective provision cannot
be presumed to be retrospective,
if it changes the law as it earlier
stood
•Explanation 3C, which is "for the
removal of doubts" is clarificatory
in nature - it explains section
43B(d) as it originally stood and
does not purport to add a new
condition retrospectively, as has
wrongly been held by the HC.
Ambiguity, if any, shall be resolved
in favour of the assessee
Any ambiguity in the language of
Explanation 3C shall be resolved in
favour of the assessee
16. FINAL RULINGS BY THE HON’BLE SC?
The Court noted that the HC was clearly in error in concluding that interest, on
the facts of this case, has been converted into a loan as there was no basis for
such finding.
Where reliance was placed by the Revenue on a case pertaining to conversion
of outstanding interest to loan, the Hon’ble SC clearly distinguished the facts
of the case relied upon from the facts of the present case, thereby
establishing that debentures were different from loan/borrowings.
Thus, the Court ruled in favour of the assesee, allowing the conversion of
outstanding interest into debentures as a deduction u/s 43B, setting aside
the judgement of the HC.
18. WAY FORWARD
Owing to the financial difficulties on account of the pandemic, several borrowers have entered into
various forms of restructuring arrangements with the respective lenders. The ruling of the Hon’ble
SC, in the present case, could have an impact on their claim of deduction.
This ruling of the Hon’ble SC further clearly distinguishes debentures from loans or borrowings and
accordingly prescribes the interpretation of the various other provisions of law.
The ruling places emphasis on the intent of the law and the mischief it seeks to curb, thereby
excluding bonafide transactions from the ambit of the section. This could be useful in interpreting
other sections, the intent of which, is to prevent malafide transactions.
![M.M. AQUA TECHNOLOGIES LTD.
V.
COMMISSIONER OF INCOME-TAX, DELHI-III
[2021] 129 TAXMANN.COM 145 (SC)
ALLOWABILITY OF OUTSTANDING
INTEREST CONVERTED INTO
DEBENTURES AS AN EXPENSE U/S 43B
OF THE INCOME TAX, 1961](https://image.slidesharecdn.com/mmaqua-211023110013/85/ALLOWABILITY-OF-OUTSTANDING-INTEREST-CONVERTED-INTO-DEBENTURES-AS-AN-EXPENSE-U-S-43B-OF-THE-INCOME-TAX-1961-1-320.jpg)
