TMI Blog2003 (9) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... , is directed against the order of the Income-tax Appellate Tribunal, Jodhpur Bench, Jodhpur, dated January 28, 2003, at the instance of the Commissioner of Income-tax. It relates to the assessment year 1992-93. The issue relates to the claim of the assessee regarding deduction of liability to pay premium on non-convertible debentures issued by it during the assessment year in question. The facts are that the assessee is a limited company, which is registered under the Indian Companies Act, 1956. It has issued non-convertible debentures of Rs. 3 crores in favour of the LIC and the State Bank of India Mutual Fund on premium. As per the terms of issue of the debentures, the assessee was to redeem those debentures at a premium of 5 per cent, of the face value of the debentures in three equal instalments at the end of the 7th, 8th and 9th years by paying Rs. 35 per year. The payment of Rs. 105 was to be made against the issue amount of Rs. 100 per debenture. Thus, against the receipt of Rs. 3 crores of finance, the assessee agreed to Rs. 3,15,00,000. The assessee maintains its books of account as per the mercantile system. Though no entries have been made regarding this liability in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any provision in the books of account, notwithstanding that it is maintaining the accounts as per the mercantile system, no deduction can be allowed, was not sustained by the Tribunal on the anvil of the decision of the Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT [1997] 227 ITR 172. About the other contentions raised in the said appeal for the assessment year 1993-94, we are not concerned. Aggrieved with the aforesaid allowance of deduction of the liability to pay premium on redemption of debenture issue, this appeal has been preferred by the Revenue and the following questions of law were framed at the time of admission: "1. Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is justified in law in holding that the premium payable on debentures was not a contingent liability and that it is allowable revenue expenditure? 2. Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is justified in law in directing to allow the claim of premium though proportionately over the period of redemption?" Both the questions pertain to the basic issue whether the li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cts and in the circumstances of the case, the Tribunal was justified in holding that the assessee had incurred an expenditure of Rs. 3,00,000 during the relevant previous year by way of discount paid to the persons who had subscribed to the debentures issued by it for Rs. 1.5 crores during the relevant previous year and the same was allowable as a revenue expenditure?" The first question formulated by the Madras High Court was answered in favour of the assessee holding that it was permissible for the Tribunal to allow the assessee to raise this issue in appeal. However, on the second issue, it was held that discount of Rs. 3 lakhs did not represent any payment made to any one so as to constitute expenditure. It was further held that no expenditure was laid out or incurred by the assessee/appellant-company which could be allowed as a deduction. This led to appeal before the Supreme Court. The Supreme Court posed the following question for its consideration in the first instance: "We have first to consider whether the discount of Rs. 3,00,000 on debentures which were issued by the appellant-company is expenditure incurred by the appellant-company for the purposes of its business. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... debentures, is a liability which has been incurred by the company for the purposes of its business in order to generate funds for its business activities. The amount so obtained by issue of debentures are used by the company for the purposes of its business. This would, therefore, be expenditure." Thus, the Supreme Court held that the difference between the amount actually received on issue of debenture and the liability to pay a higher sum by way of principal for the purpose of business activities is an expenditure incurred at the time when funds are generated. The court also held that the expenditure so incurred for generating funds for the purpose of its business activities is not a capital expenditure, but a revenue expenditure. Relying on its earlier decision in Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 (SC) in which the court held that the loan obtained is not an asset or advantage of an enduring nature; that the expenditure was made for securing the use of money for a certain period; and that it is irrelevant to consider the object with which the loan was obtained, it was laid down that in the circumstances of the case, the expenditure was rev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uoted above, the liability undertaken by the appellant cannot be said to be incurred unqualifiedly. It becomes a contingent liability because it depends on the event that is to say that if the company does not decide to repurchase the debentures before its maturity. Learned counsel relies on a decision of the Calcutta High Court in Tungabhadra's case [1994] 207 ITR 553. In Tungabhadra's case [1994] 207 ITR 553 (Cal), learned counsel for the Revenue pointed out, a like condition which was there subject to which debentures were issued in 1983, namely that debentures were to be redeemed after the expiry of the 7th year from the date of allotment with accrued interest thereon at the premium of 5 per cent, at the face value of debenture. The company has also reserved its right to repurchase and reissue the debentures. Construing the aforesaid condition, the Calcutta High Court held as under: "On a construction of the aforesaid clauses it appears to us that the premium is payable to the debenture holders at the rate of 5 per cent, of the face value of the debentures on the expiry of the seventh year from the date of allotment It is true that the company shall have the right to reis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on they will be redeemed at a premium, on the date of the receipt of amount of debenture by the company it has incurred liability to repay more amount than what the company has received to the debenture-holders and then the subsisting contract between the debenture-holders and the company which would remain unaltered unless something happens which may affect that right or liability, therefore, the liability is not a contingent on happening. Its avoidance depends on the volition of the company. Therefore, such avoidance is contingent on exercise of volition and not the honouring of agreement. Therefore, the liability to pay additional amount by the company to the lender underline term of borrowing, than what it has to pay on future date is not a liability which is incurred in future, but a liability which is incurred in praesenti to be discharged in future. The distinction drawn by learned counsel for the Revenue was also founded on the premise that the entire liability is liable to deduction in one year only. In that event the liability has been allowed as deduction only when the repayment becomes due. It was pointed out by Mr. Kothari on both the issues, that the decision of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bentures can be issued without constituting a mortgage or charge on the assets of the company. However, it does not intend to define what debenture is. In this connection, Pennington in his Chapter of Debenture and Debt Securities in his book Company Law discussed the property of debenture and placing historical evolution. It explained that the distinctive form of security which may be created by companies, however, is the debenture and its derivatives, namely, debenture stock, loan stock, loan notes and other varieties of debt securities. When the debentures first appeared during 1860s it envisaged that in addition to containing a covenant by the company to repay the loan, they mortgaged or charged the company's property or assets or its whole assets and undertaking were subjected to mortgage or charge with repayment of loan which came to be identified as floating charge. Towards the end of the last century instead of creating mortgage or charge with the company's assets in favour of the debenture-holders, the trust deed was introduced by which trustees were appointed to represent the interests of the lenders and the trust deed created legal mortgages over the company's fixed as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on date. Subject to the terms of issue, the sinking fund may be used for partial redemptions before the final redemption date as explained below. (3) By purchase in the market, by tender or private treaty. The terms of issue of debentures or debenture stock usually authorise a company, at its option, to redeem a part of the issue at any time by purchase in the market or by tender available to all holders and to utilise the sinking fund payments for this purpose. The maximum price payable for debentures so redeemed is normally restricted to their nominal value. When the market price is lower than par, most companies will take advantage of purchasing stock for redemption on these favourable terms. Purchases by tender or private treaty are rarely resorted to by companies with listed debenture stock, but may be used by others when there is an opportunity of acquiring debentures for redemption at less than their nominal value. The aforesaid different modes of repayment of debenture only show that a redemption is a method by which the company obliterates its obligation to repay its debt either by paying its debt to the debenture-holders or debenture stackers or by itself repurchasing t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... two different formats of terms as to payment of premium. These contingencies have been explained by Pennington in his Company Law as under: "Companies which reserve the right to repay long or medium term loans before the contractual date for payment, often undertake to pay a premium in addition to the principal or part of the principal which is repaid; the premium is calculated at a percentage rate on the amount repaid, and is usually charged at a graduated rate dependent on how early the repayment is made. Also companies in straitened circumstances have sometimes been compelled to promise to pay a substantial bonus or premium on redemption to induce investors to lend to them, and have charged their undertakings with payment of both the loan and the bonus or premium where a payment in addition to the principal and interest of a loan is secured on mortgaged property, it forms part of the mortgage debt, and unless equity can set the bargain aside because it is harsh and unconscionable, the mortgagor cannot redeem at all unless he pays the whole amount secured on his property. In the second place, it is clearly contemplated by the Companies Act, 1985, that premiums may be paid on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the statute or the term as to reserving the right of the company to reissue debentures only affects the security under which the debentures are issued. If the company's rights to reissue the debentures on the same terms after the present liability to repay is discharged, is not reserved, on repayment repurchase the debentures as such stood extinguished. So also the mortgage charge or trust created for the purpose of issue of debenture also stands discharged. As we shall see presenty unless the terms of contract otherwise provide, repayment or repurchase of debentures does not extinguish the company's right to reissue the same debentures and the debentures are kept alive for reissue, the mortgage charge or trust created for the purpose of borrowing money by issue of debenture is also not discharged and is kept alive with debentures has received statutory recognition. The provisions of the Companies Act relating to issue of debentures do envisage that where repayment of debenture is secured by creating a charge on the company's assets of hot, a trust is required to set for the purpose of securing repayment of debentures by the company. In this connection, section 117 of the Com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he rules framed thereunder for the purpose of ensuring to keep the trustees of debentures act within the bounds of such regulations and rules. We are not on the details of the gamut of debenture issue, but debentures are securities whether they are secured by a charge on the company's assets or secured by appointment of trustee or trustees as the case may be. Whether the charge on asset is created or trustee is appointed to secure repayment of debenture money, in the ordinary sense on the repayment of the amount payable on the debenture, such charge is discharged. Such security whether by way of charge or mortgage on the company's assets or by the trustees appointed for the purpose. The term "redemption" means that on repayment of debt, the security on which the debt is secured is discharged whether it is obtained by creating charge on property by way of mortgage or otherwise or by appointing trustees. In the latter case, the trust stands discharged and the trustee's obligation to administer the trust comes to an end. In the aforesaid context section 121 is required to be considered, which reads as under: "121. Power to re-issue redeemed debentures in certain cases.-(1) W ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unless he had notice or, but for his negligence, might have discovered, that the debenture was not duly stamped; but in any such case the company shall be liable to pay the proper stamp duty and penalty. (6) Nothing in this section shall prejudice- (a) the operation of any decree or order of a court of competent jurisdiction pronounced or made before the twenty-fifth day of February, 1910, as between the parties to the proceedings in which the decree or order was made; (b) where an appeal has been preferred against any such decree or order, the operation of any decree or order passed on such appeal, as between the parties to such appeal; or (c) any power to issue debentures in the place of any debentures paid off or otherwise satisfied or extinguished, reserved to a company by its debentures or the securities for the same." The aforesaid provision clearly provides that unless any provision to the contrary is made whether express or implied, is contained in die articles, or as a condition of issue of debentures or any other contract entered into by the company or unless the company has passed the resolution to that effect or by some other act, manifested its intention that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... estored free and clear of the mortgage; performance of the mortgage obligation being essential, for that purpose. Redemption has also been used in terms of imposing heavy fines as distinguished from confiscation of property in terms of imposition of penalties and the penal consequence of failure to abide by any provisions of law or to act in breach of certain Conditions. In the context, the condition to which the reference has been made by learned counsel as the condition of the debenture issue by the respondent company is nothing, but a manifestation of section 121 of (he Companies Act. It would otherwise be inherent under the terms of issue of debentures, had such condition not been specifically mentioned as term of the issue of the debentures. The company's right to keep the debentures alive for reissue subject to the same terms and conditions in future as and when it wants to secure loan from the public, flows from section 121 in the absence of any agreement contrary to the articles of association. In the present case, the company has chosen to go along with the provision of section 121 without surrendering its rights to keep the debenture alive for reissue which will not dis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rcise of option. It would not make the liability which is certain in praesenti to be contingent merely because on happening of certain event it could be avoided. The distinction drawn by learned counsel for the appellant on the basis of the term in the issue which was in consonance with the provisions of the Act does not exist. With great respect, the decision of the Calcutta High Court, in our opinion, does not take into account the relevant provisions of the Companies Act and the distinction between a liability, discharge of which is contingent on the happening of an event, on the one hand and the case on which happening of an event which is not certain, existing liability can be reduced, in which case avoidance of liability becomes contingent. Looking from any angle, it cannot be said that the term liability to pay Rs. 105 against receipt of Rs. 100 was a contingent liability so as to consider that the liability has not been incurred in the year in which it has been created as liability in respect of the company on receipt of debenture issue price, though, the liability was to be discharged in future. The decision rendered in Madras Industrial Investment Corporation's case ..... X X X X Extracts X X X X X X X X Extracts X X X X
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