TMI Blog2000 (10) TMI 204X X X X Extracts X X X X X X X X Extracts X X X X ..... b) As regards payment of interest on debentures, the debenture holder had the option of either periodically receiving interest half-yearly @ 18% p.a. 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 alongwith 10% 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 Date of (in Lacs) allotment ---------------------------------------------------------------------------------------------- 1. Maliram Makharia Stock 495.00 29-3-1996 Brokers (P.) Ltd. 2. Orient Corporation 1.25 19-6-1996 3. Suyok A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 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. 55. The net amount of Rs. 45 will be utilised by the assessee in this 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 year 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Hon'ble Supreme Court in the case of McDowell Co. Ltd. v. Commercial Tax Officer [1985] 154 ITR 148. This aspect of the matter is discussed by him at pages 15, 16, 17 and 18 of 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 irrevocably 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ances. In the present case, one is concerned with actual payment of interest. (c) In Madras Industrial Investment Corpn. Ltd's case, 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 assessee's 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 irretrievably in the first year itself, whereas the discount portion of debentures in Madras Industrial Investment Corpn. Ltd.'s case will be paid out only at the end of the life of the debentures ie., 12 years and is, therefore, continuing liability stretched over a period of 12 years as held by the Supreme Court at page 812 in Madras Indus trial Investment Corpn. Ltd's case. (e) Discounted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rety in the year of its incurrence/accrual. 11. Shri Dastur also submitted that the rate of interest agreed is at 18% 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 @ 18% 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 business-man's decisions not liable to be interfered with by the department relying on CIT v. Bombay Samachar Ltd. [1969] 74 ITR 723 (Bom.). 12. The learned counsel further submitted that where a lump sum one time payment of discounted interest relieves the assessee or secures him the advantage of obtaining an absolution or immunity of 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 lump sum amount is paid to get rid of an annual recurring expenditure, such lump sum outgo is fully deductible in the y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f McDowell Co. Ltd. cannot be invoked in case of a single transaction where there are no series of transactions. W. T. Ramsay Ltd. v. IRC54 TC 101, 198 (HL); IRC v. Burmah Oil Co. Ltd. 54 TC 200,214 (HL); Fumiss v. Dawson 55 TC 324, 392 (HL) 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 transactions (McDowell Co. Ltd 's case at p. 156; Craven (Inspector of Taxes) v. White (Stephen) [1990] 183 ITR 216, 224, 246, 264 (HL). The real ratio and meet of the matter concerning tax avoidance vis-a-vis tax planning as laid down in McDowell Co. Ltd.'s case 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 frame-work of law is legitimate and it is only colourable devices and dubious methods that are to be discouraged in McDowell Co. Ltd. 's case. 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sion was made by the learned counsel that if for any 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 CIT(A) 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 DR. strongly supported the orders of the authorities below. First he specifically highlighted the facts given on pages 4 5 of the CIT(A)'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 CIT(A)'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 D.R. emphasised that the assessee had debited only proportion ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d counsel that the ratio laid down by the Supreme Court in the aforesaid judgment is not applicable cannot be accepted. The learned D.R. further brought to our notice that the decision of the Supreme Court in the case of Madras Industrial Investment Corpn. Ltd. was interpreted by the Calcutta High Court in National Engg. Industries Ltd. v. CIT [1999] 236 ITR 577 and the Hon'ble 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 D.R. 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 Hon'ble Supreme Court in McDowell Co. Ltd.'s case is squarely applicable and he placed reliance on the decision of the CIT(A) on pages 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... roportionate amount of discount for the period of six months ending with June 30, 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 ITO disallowed the claim, but the Appellate Asstt. 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 that order of the Tribunal. On further appeal, the Hon'ble 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 beer 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 pe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ars ranging from issue to redemption. Further on page 579, it has been observed by the Hon'ble 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 Indian Jute Mills' case [1982] 134 ITR 68, 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's case [1987] 165 ITR 765. The references are given in the Supreme Court judgment." In other words, the Hon'ble High Court has interpreted the decision of the Apex Court in the case of Madras Industrial Investment Corpn. Ltd 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 to redemption, irrespective of the method of accounting adopted by the assessee for paym ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scount 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 Hon'ble Supreme Court in the case of Kedarnath Jute Mfg. Co. 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 National Engg. Industries Ltd's case the said decision of the Hon'ble Supreme Court in Madras Industrial Investment Corpn. Ltd's case 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 assessee's 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 debe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 business-man 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, the Hon'ble 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, the Hon'ble 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 circum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w, because it was against the letter of spirit of the judgment of the Hon'ble Supreme Court in the case of Madras Industrial Investment Corpn. Co. 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 Hon'ble Supreme Court in McDowell Co. Ltd.'s case squarely applies to the facts of the present case. 32. In the light of above discussion, we direct that Assessing Officer to allow interest at the rate of 18% 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 CIT(A) 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/99 -Assessment year 1997-98 33. The first grievance of the assessee is that the learned CIT(A) is not justified in c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 in the pocket of the assessee comes back to him indirectly through such transactions. Such contention of assessee's counsel in my opinion cannot be accepted. In the case of McDowell Co. Ltd., 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%, then the Sales Tax would have been leviable on the total amount of Rs. 130. If the rate of Sales Tax was 10%, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er 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 upon 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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