TMI Blog2005 (4) TMI 546X X X X Extracts X X X X X X X X Extracts X X X X ..... any while filing its return of income claimed deduction of the total amount of interest paid on the ground that the interest paid was a revenue expenditure and could not be disallowed as the same was paid by way of rent for use of capital. It was further contended that deduction of interest under Section 36(1)(iii) of the Income-tax Act, 1961 (the Act) only required that interest is paid in respect of capital borrowed for the purposes of business of the borrower. That the payer company had in fact satisfied the requirements of the said provision and once payment had been made there was no question of disallowing the interest. Reliance was also placed on the provisions of Section 43(2) of the Act which define the term 'paid'. The Assessing Officer did not accept the contentions of the payer company and held that interest payment Rs. 62/- per debenture payable up front on the date of allotment was nothing but advance payment for the entire period of six years and that interest @ Rs. 62/- per debenture having face value of Rs. 100/- could not be interest for a period of seven days of the accounting period. He, therefore, held that the payer company cannot state that the entire interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ence to the terms of debenture. Inviting attention to Condition No. 2 which deals with interest rate and manner of payment it was contended that the payer company was bound by the terms of the covenants and accordingly in discharge of such obligation it had made payment of interest to the debentureholder and was entitled to the deduction of the said amount. 7. As against that Mr. M.R. Bhatt learned Senior Standing Counsel appearing on behalf of the respondent Revenue, submitted that the impugned order of the Tribunal did not call for any interference as the same was based on the Apex Court decision. According to Mr. Bhatt, issuance of debenture by the payer company was nothing but raising of funds by way of loan on which interest was payable to the debentureholder, but as per commercial accounting principles, interest was for user of the said fund and would accrue or arise on a day-to-day basis as and when the funds were employed for the purposes of business. He, therefore, supported the order made by the Tribunal with a plea that the same may be upheld. 8. As the facts narrated hereinbefore go to show the case of the respondent - assessee in Tax Appeal No. 328 of 2000 and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bligation arising from the contract between the parties. As already reproduced hereinbefore the Company had agreed and undertaken to duly and punctually pay, observe and perform the Financial Covenants and Conditions endorsed on the debenture certificate. It has done so. The limited question that would then survive is whether the Company is entitled to deduction of such amount while computing its taxable income. 11. Section 36(1) of the Act lays down that the deduction provided in the clauses that follow shall be allowed in respect of the matters dealt with in the respective clauses while computing the income referred to in Section 28 i.e. income from profits and gains of business or profession. Clause (iii) of sub-section (1) of Section 36 reads "The amount of interest paid in respect of capital borrowed for the purposes of the business or profession". The Proviso and the Explanation thereunder are not reproduced as they are not relevant for the present. Therefore, on a plain reading for an assessee to become entitled to deduction under Section 36(1)(iii) of the Act while computing income under the head 'Profits and gains of business and profession' the assessee has to establish ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expended wholly and exclusively for the purposes of business. Therefore, once it is shown that an expenditure is of the nature described in any of the specified Sections i.e. Sections 30 to 36, the same cannot fall within Section 37(1) of the Act. In the circumstances, the assessee's claim being under Section 36(1)(iii) of the Act, there is no question of applying principles on the basis of which deduction of an expenditure is permissible under provisions of Section 37(1) of the Act. 14. There is one more aspect of the matter. The Company issuing the debenture, under which the borrowing is made, has entered into a contract with the debentureholder. It is nobody's case that the contract is sham or not acted upon. In the circumstances, the parties are bound by the terms of the contract and it is not open to any third party, including Revenue or the Court, to rewrite the terms of the contract. During course of hearing, on behalf of Revenue, attention was invited to observation made by the Assessing Officer regarding applicability of ratio of McDowell and Co. Ltd. v. Commercial Tax Officer, [1985] 154 ITR 148 (S.C.) to contend that there was a transaction entered into between the par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt to the impugned order of Tribunal if any claim is made by each of the payer companies in any of the subsequent years on the basis of proportionate payment in accordance with the order of the Tribunal, the respective assessee companies shall have no objection if the claims which might have been allowed are withdrawn and additions made to the said extent considering that the entire claim of deduction of interest paid is allowed in Assessment Year 1995-96. TAX APPEAL NO. 328 OF 2000 18. The following substantial question of law has been formulated at the time of admission of the appeal on 8th November, 2000: "Whether, the Appellate Tribunal is right in law and on facts in holding that the interest income in the hands of the assessee who was allotted debentures by the Companies is required to be taxed only on proportionate basis and that the Commissioner of Income Tax (Appeal) was not justified in sustaining the addition of the whole amount of interest at the rate of Rs. 62/- per debenture in the accounting year in question ?" 19. The appellant of this Tax Appeal is an individual. The individual assessee made investment to the tune of Rs. 2,15,00,000/- by way of subscribing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rther held that accounting treatment of an item of expenditure in hands of the payer company can be different from the accounting treatment of the same item by way of corresponding receipt in hands of the payee. The contention raised by the assessee that the debentures were in the nature of Deep Discount Bonds was also rejected. 22. Being aggrieved, the assessee filed second appeal before Tribunal. The Tribunal passed a consolidated order on 20th October, 1999 in case of three individuals including the present assessee as the issue was common in all the three cases. The Tribunal took into consideration the terms and conditions of the debentures which were described as Financial Covenants and Conditions. As per the condition relatable to payment of interest, namely, Condition No. 2 whereby interest was payable at the rate of Rs. 62/- per debenture up front on the date of allotment, it was observed by the Tribunal that merely because by contract interest is received in a lump-sum manner much before the interest accrues cannot lead to a conclusion that the whole receipt is taxable in case of an assessee who maintains his accounts on mercantile basis. That interest was in the nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ords, the contention was that receipt per se would not assume characteristic of income. That interest was nothing else but compensation for user of the monies advanced and in commercial world interest would accrue or arise or become due only on an de diem basis. That if substance of the transaction was taken into consideration it was apparent that interest was payable by way of rent for user of the funds advanced and agreement between the parties, though relevant, would not determine the characteristic of receipt. In other words, the receipt would assume colour of income only in accordance with the principles of commercial accounting and law. He, in this context, invited attention to the instructions issued by CBDT in case of Deep Discount Bonds, [2002] 254 ITR (Statute) 241 as well as Page 533 of Vol. (1) of Income Tax Law by Chaturvedi Pithisaria 5th Edition. 25. In relation to the taxability of corresponding receipt in hands of the individual payee, it is necessary to note that entire amount of interest paid by company had been received during the relevant accounting period accompanied by certificate showing tax deducted at source. In these circumstances, it was not open to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y is posted as of the date of sale, although no cash is received immediately in payment of such goods; and a debit entry is similarly posted when a liability is incurred although payment on account of such liability is not made at the time. There may have to be appropriate variations when this system is adopted by an assessee who carries on a profession. Whereas under the cash system no account of what are called the outstandings of the business either at the commencement or at the close of the year is taken, according to the mercantile method actual cash receipts during the year and the actual cash outlays during the year are treated in the same way as under the cash system, but to the balance thus arising, there is added the amount of the outstandings not collected at the end of the year and from this is deducted the liabilities incurred or accrued but not discharged at the end of the year." Therefore, to contend that cash receipts would not partake characteristic of income only on the basis of system of accounting is an incorrect proposition of law as held by the Apex Court. Even in a mercantile system of accounting cash receipts and cash out goings are to be taken into consid ..... X X X X Extracts X X X X X X X X Extracts X X X X
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