TMI Blog2006 (3) TMI 188X X X X Extracts X X X X X X X X Extracts X X X X ..... not an incentive for debenture but a prelude to issue of shares. We, therefore, hold that the raising of funds by issue of convertible debentures was to raise capital by ultimately converting debentures into equity share without giving an option to debenture holder to get repayment or a say in conversion. Substance of the transaction is issue of equity capital partly on the date of allotment of debentures. The contention of the assessee that expenditure relating to conversion partly after 15 months can at least be held as revenue has no force as the nature of such retention is akin to share application money pending allotment of shares. In the result, the appeal of the assessee is dismissed. - HON'BLE R.P. GARG, VICE PRESIDENT, R.P. TOLANI, JUDICIAL MEMBER AND A.L. GEHLOT, ACCOUNTANT For the Appellant : S.N. Soparkar, Adv. For the Respondent : Jagdeo and Banwari Lal, Advs. ORDER R.P. Garg, Vice President. 1. The President, Income-tax Appellate Tribunal has constituted this Special Bench to consider and dispose of the appeal with the following question: Whether, the expenditure incurred by the assessee on the issuance of convertible debentures is allowable as a revenue expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ASL's existing complex. The project site has well developed infrastructural facilities viz. power, transportation, parking, insurance, communication etc. The location is also well connected to the National Highway and railway network. The availability of skilled/unskilled manpower at and around the location is adequate. The site being part of a notified backward Area, the company is eligible for benefits like electricity tariff exemption and sales tax exemption. 4. A sum of Rs. 77,26,999 was incurred by the assessee for issuing these debentures. It was set off against the share premium in the books of account but was claimed in the computation of income as a deduction by relying upon the Supreme Court decision in the case of India Cements Ltd. v. CIT [1966] 60 ITR 52. The Assessing Officer disallowed the claim of the assessee by stating that the facts of that case are quite different. In that case, the expenditure pertained to obtaining of loan which was subsequently to be repaid whereas in the instant case, the issue expenses pertained to fully convertible debentures which shall never be repaid but shall add to the equity capital of the assessee company on conversion into sha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing loans, appellant, on the other hand, had issued convertible Debentures which, partly immediately and partly after a period of time (15 months), were converted into equity. Therefore, the expenditure incurred on the issue of such debentures was an expenditure to create an asset of enduring nature and the Assessing Officer has correctly disallowed it. I, therefore, agree with the Assessing Officer as also my predecessor that the debenture issue expenses of Rs. 77,26,999 could not be claimed as revenue expenditure. 6. The ld. counsel of the assessee Shri S.N. Soparkar, submitted that debenture is a loan or a borrowing and, therefore, the expenditure incurred in issuing the debentures would be an expenditure for raising a loan or borrowing and consequently, allowable deduction in view of the Supreme Court decision in the case of India Cements Ltd. He further submitted that the fact that debenture is convertible does not make any difference in law to determine the nature of the loan. Similarly, the conversion on allotment itself also is not relevant because it was originally a loan/debt. Alternatively, he submitted that proportionate expenditure to convert the same be allowed as the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Both are in the nature of securities listed in the Stock Exchanges. In both the cases intention is not to get back the money but investment by the subscribers. No option is given for conversion after allotment of debenture. Shares are part pasu to other shares. The object was to raise the money to finance the project which is a permanent structure without any liability to repay. The date and manner of conversion is settled. Both can be issued at premium, which is not possible in case of a simple loan. These arc the features, which distinguish a convertible debenture from a loan. He further submitted that real nature of the transaction is to be seen and in this connection, he referred to the Accounting Standard AS-21 stating the calculation of income from share and debenture recognizing the fact that it was potentially a share. He also referred in this connection to the decisions of the Supreme Court in the case of Sundaram Finance Ltd. v. State of Kerala AIR 1966 SC 1178, in the case of Juggilal Kamlapat v. CIT [1969] 73 ITR 702 (SC), in the case of Sunil Siddharth bhai v. CIT [1985] 156 ITR 509(SC) and in the case of CIT v. B.M. Kharwar [1969] 72 ITR 603. He referred to the decisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore the commencement of business or after the commencement of business but for expansion of the unit or setting up a new unit. We have to examine the case in the light of the general provisions of section 37 allowing expenditure, except capital expenditure and personal expenditure and not covered specifically by any earlier sections, incurred wholly and exclusively for the purpose of business of the assessee and the specific provisions of section 35D dealing with amortization of expenses. Section 37(1) reads as under:- 37.(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head Profits and gains of business or profession. 10. On a fair reading of this section it is evident that an expenditure of capital expenditure does not qualify for deduction even if incurred for the purpose of carrying on of business wholly or exclusively. Similarly if the expenditure were of personal nature it would not qualify for de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenditure is for raising capital base it would be capital expenditure even if the funds so received have been used for business purposes and also for helping profit-making or required for more working capital needs of the company. The argument that capital was raised for enhanced requirement of working capital and or capital project or was a help in profit-making was not accepted by the Supreme Court to take out the expenditure from being capital in nature. This is because every capital expenditure also would certainly be for the purposes of business of the assessee and would help directly or indirectly in profit-making by an assessee. 14. On the other hand, the expenditure incurred for raising a loan simpliciter has been allowed as deduction under section 36(1)(iii) if it was interest and under section 37 if it were other expenditure. The decision on this aspect is India Cements Ltd.'s case. In this case, the assessee obtained a loan of Rs. 40 lakhs from Industrial Finance Corporation by a charge on the fixed assets of the company. The proceeds of this loan was utilized to pay off a prior debt of Rs. 25 lakhs due to M/s. A.F. Harvey Ltd. and Madurai Mills Ltd. and the balanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . CIT 6 ITC 303 that the purpose for which the new loan was required was irrelevant to the consideration of the question whether the expenditure for obtaining the loan was revenue expenditure or capital expenditure. It observed finally as To summarise this part of the case, we are of the opinion that: (a) the loan obtained is not an asset or advantage of an enduring nature; (b) that the expenditure was made for securing the use of money for a certain period; and (c) that it is irrelevant to consider the object with which the loan F was obtained. Consequently, in the circumstances of the case, the expenditure was revenue expenditure within section 10(2)(xv). 15. In another case of Mahindra Ugine Steel Co. Ltd., the Bombay High Court dealt with the issue of stamp duty on debenture issues and held that it was an allowable deduction. It was contended on behalf of the Department that payment of stamp duty on debenture was not an allowable deduction but the Tribunal rejected the contention and the High Court agreed with the Tribunal by stating the expression in connection with the issue of public subscription of the debentures of the company essentially for the expansion of the business ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for consideration and it was held that the term borrow has not been defined in the statute and, therefore, its dictionary meaning has to be looked up. The meaning of the word 'borrow' as given in the Shorter Oxford Dictionary (3rd Edition) is to take (a thing) on security given for its safe return. To take a thing on credit on the understanding of returning it or an equivalent . A reference was made to the Calcutta High Court decision in the case of CBDT v. Bhartia Electric Steel Co. Ltd. [1954] 25 ITR 192 wherein it was held that there has to be a positive act of lending coupled with acceptance by the other side of the money, as a loan. Thus, it is clear that an element of refund or repayment is inherent in the concept of borrowing. The assessee was incorporated under the Road Transport Corporations Act, 1950. Section 23 of the said Act incorporated that the Central Government or State Government to provide to the Corporation any capital that may be required for the purpose of carrying on the undertaking or for purpose connected therewith on such terms and conditions not inconsistent with the provisions of the Act and where the capital of the Corporation is not provided b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this decision, we uphold the contention of the Revenue that debentures in this case are fully convertible and there being no liability to repay but retained as capital by conversion into equity shares it was not a borrowing and consequently the expenditure on issue would not be allowable as deduction. 18. Certain decisions dealing with a question as to whether the interest received on debenture was interest received on loans and advances and, therefore, chargeable under Interest Tax Act also are relied upon. Under this Act the interest received on loans and advances are chargeable and the courts have held that interest received on debenture is not an interest on loans and advances and therefore not chargeable to tax. The first case is the case of Lakshmi Vilas Bank Ltd. before the Madras High Court, and a contention was raised by the counsel of the assessee by relying upon the Circular of the Central Board of Direct Taxes No. 665, dated 5th October, 1993 in order to show that amounts invested in purchasing the debentures would amount to investment made in approved securities. The court considered the concept of debenture as appearing in Law Lexicon at page 290 and noted that debe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n investment was accepted and consequently, the payment of interest on debentures was held to be not an interest on loans and advances. 19. The second case cited is of United Western Bank Ltd. of the Bombay High Court. Here again, the question whether interest on securities, bonds and debentures was interest on loans and advances within the meaning of Interest Tax Act, 1974 came up for consideration and it was held that Interest Tax Act will not apply to interest received by the assessee bank on securities/debentures held by the assessee under the category permanent . The court, however, made it clear that the securities or debentures held under the caption current is not being considered by them and their decision was only with respect to the securities and debentures held under the category permanent . 20. The assessee however relied in the case of East India Hotels Ltd. In this case, the assessee had incurred a sum of Rs. 67,18,758 on the issue of 7,50,000 debentures of Rs.100 each for a total value of Rs.7.50 crores and 20 per cent of that amount was converted at the end of the three years from the date of allotment of debentures by way of issue of equity shares and out of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held in the aforesaid case that when the money is secured for certain period the expenditure is revenue expenditure within the meaning of section 10(2)(xv) of the Act as held by the Apex Court in the case of India Cements Ltd. 21. In the case of Modern Syntex (India) Ltd. the Tribunal considered the concept of debenture and observed that it was nothing more than an acknowledgement of indebtedness. It is a statement that company will pay a certain sum of money on given day and will also pay interest on the same. Debenture means a document acknowledging a loan made to the company and providing for the payment of interest on the sum borrowed until debenture is redeemed, namely, payment of principal sum. The characteristic features of the debentures are - (i) it is issued by the company and it is in the form of certain indebtedness; (ii) it provides for repayment of principal and interest at specified date or dates. With regard to convertible debenture, it was observed that an option is given to the debenture holders to convert them into equity or preferential share at stated rate of exchange after certain period which is also another form of loan for a specified period till they are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le portion of the debenture cannot be termed as a debt because in our considered view convertible debentures have characteristics of equity shares; these are equity shares in embryo. The conversion of such debentures on the stipulated date leads to augmentation of the equity base of the company. In the case before us convertible debentures were clearly identifiable as Equity capital. The conversion was mandatory. Hence, it cannot be said that convertible part had the characteristics of loan funds. The dale and manner of conversion was certain and nothing was left to chance and in any case when the return of income of the company was due to be filed on 30-6-1987 and was actually filed on that date, the factum of conversion was a dead certainty. 23. It distinguished the decision of the Supreme Court in the case of India Cements Ltd. by observing that the Supreme Court was dealing with a case where loan was raised and the loan was in the nature of debt. It was neither a case where issue of equity shares or convertible/partly convertible debenture was involved and, therefore, held that that decision would not be applicable in deciding the issue. The Tribunal also observed that the expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tures at Rs.120 each at par aggregating to Rs. 183.2 crores. The debentures consisted of two parts of Rs. 60 each - Part-A was to be compulsorily and automatically converted into shares of Rs. 10 each at a premium of Rs. 20 each after six months and part-B was also to be converted into 2 shares of Rs. 10 each at a premium of Rs. 20 each after 18 months. The Tribunal observed that debenture was nothing more than an acknowledgement of indebtedness. It is a statement E that company will pay a certain sum of money on given day and will also pay interest on the same. Debenture means a document acknowledging a loan made to the company and providing for the payment of interest on the sum borrowed until debenture is redeemed, namely, payment of principal sum. The characteristic features of the debentures are - (i) it is issued by the company and it is in the form of certain indebtedness; (ii) it provides for repayment of principal and interest at specified date or dates. With regard to convertible debenture, it was observed that an option is given to the debenture holders to convert them into equity or preferential share at stated rate of exchange after certain period which is also another ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic-argument that the expenses were incurred for issue of debenture, the issue stands covered in favour of the assessee by the various judgments relied upon by the learned Authorised Representative and respectfully following the same, we are of the considered opinion that the disallowance of Rs. 11,01,379 towards expenses on convertible portion of partly convertible debentures is allowable as revenue expenditure. (c) In the case of Tata Chemicals Ltd. before the Bombay Tribunal, the assessee incurred the expenditure of Rs. 16,99,497 on issue of non-convertible and partly convertible debentures. The Tribunal held that the fertilizer division of the assessee was part of the business and that was being carried on by the assessee during the relevant previous year and, therefore, the debentures issue expenses are allowable as a deduction. (d) In the case of Fag Precision Bearings Ltd. in [IT Appeal No. 4652 (Ahd.) of 1992], the Ahmedabad Bench vide order dated 26-5-2003 held that the expenditure incurred by the assessee was for raising loan by issue of convertible debentures and the fact that ultimately the convertible debentures have been converted into shares in the subsequent year wou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the Supreme Court in the case of India Cements Ltd. the decision of the Tribunal in the case of Voltas Ltd. v. Dy. CIT [1998] 61 TTJ (Mum.) 543 as well as in the case of Telco [In IT Appeal No. 1154 (Bom.) of 1985] wherein it was held that the question of convertibility arrives at the time of repayment which is a mode of repayment only. The expenditure was incurred for raising the loan and, therefore, it was an allowable deduction. In the present case, right share of debentures were issued which were to be converted into shares within a period of 15 months. The expenditure when it was incurred was for raising loan and as held by the Tribunal in the case of VXL India Ltd. and decisions referred to therein, the conversion was only a mode of repayment of loan raised by issue of debentures. The expenditure was thus for raising the loan and, therefore, in view of the Supreme Court decision in the case of Madras Industrial Investment Corpn., the proportionate expenditure has to be allowed during the period of 15 months of the debenture. The proportionate expenditure pertaining to the year under consideration may thus be allowed to the assessee in the light of the aforesaid Supreme Cour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture incurred on the issue of partly convertible debentures by way of rights issue. It was not allowed by the Assessing Officer considering the expenditure to be of capital in nature. The CIT (Appeals) allowed the claim of p the assessee by holding that the expenditure was for the rights issue partly convertible debentures and not towards shares. The Tribunal, however, referring to the decision of the Supreme Court in the case of India Cements Ltd. held that the expenditure on public issue of debentures would be allowable as a revenue expenditure since the issue of debentures is made for obtaining loan whereas the expenditure incurred on the public issue of shares would be a capital expenditure not allowable under section 37. It however, observed that the public issue in that case was of partly convertible debentures. The object of the issue was to raise the finance for expansion and diversification of the business. One debenture was issued to every shareholder holding two equity shares. Part-A was convertible part of Rs. 25 which was compulsorily and automatically to be converted into one share of Rs. 10 each at the end of six months from the date of allotment and consequently, fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... investors knew well in advance that a major part of the fund or the entire fund as the case may be would be converted into share capital and in such a case, the entire expenditure could not be held to be a revenue expenditure as otherwise it would be lead to absurd result and may render the judgment in the case of Brooke Bond India Ltd. as redundant. The assessee had issued fully convertible debentures in assessment year 1994-95 and after some time and ultimately the entire amount was converted into equity share capital. Following its earlier decision in Sona Steering Systems Ltd's case the Tribunal set aside the order of the CIT(A) and restored that of the Assessing Officer. (iv) In the case of Banco Products (India) Ltd. before the Ahmedabad Bench of the Tribunal, the assessee company issued 3 lakhs equity shares of Rs. 10 each and 1 lakh 15% partly convertible debentures of Rs. 100 each to the public with the object specified in the prospectus -(i) to finance the capital expenditure of the company; (ii) to supplement the company's long-term resources for working capital; and (iii) to obtain listing of the equity shares and debentures of the company on the stock exchange ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... observed that none of the cases of the High Courts referred to before the Bench dealt with the issue of convertible/partly convertible-debentures. It, therefore, held that the proportionate expenditure on the convertible part of the debentures is for the augmentation of equity base of the company and as such has to be treated as capital expenditure. It, therefore, upheld the order of the CIT(A). (v) In the case of Network Ltd. before the Delhi Bench of the Tribunal, the assessee company had incurred an expenditure on the issue of partly convertible debentures and claimed it as a deduction. He Assessing Officer allowed proportionate expenditure being the amount towards non-convertible portion of the debenture and balance which related to the portion convertible into share capital was disallowed. The CIT(A) confirmed the view taken by the Assessing Officer. In the Tribunal, there was a difference of opinion between the two Members and the Third Member held in paragraphs 24, 25 and 26 as under:- 24. I have considered the rival submissions and have also perused the orders passed by the learned Members constituting the Division Bench, along with the authorities relied upon before the Di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applicant and the issue of debentures and shares was simultaneous and automatic there being no intervening period of even a minute to be quite precise and accurate. The learned Accountant Member has referred to the prospectus and other relevant documents very aptly highlighting that the issue was of debentures and shares and since the intention of the assessee was manifest right at the beginning and all along, then there could be no two opinions that the total expenditure incurred on the issue was required to be bifurcated on a pro rata basis treating a part thereof to be capital in nature being related to the issue of share capital. The learned Departmental Representative has also referred to relevant portions of the prospectus and other connected documents to emphasize relevant facts of the case and her reliance on the unreported decision of the Delhi Benches of the Tribunal in the case of Sona Steering Systems Ltd. is apt and in fact direct and this would also be my observation in respect of the reported decision of the Ahmedabad Bench of the Tribunal in the case of Banco Products (India) Ltd. That was a case in which the assessee-company had incurred certain expenditure on issu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... opinion . 28. We have, therefore, to examine to which category of cases the claim of the assessee falls. To determine that, we have to first understand the real nature of the transaction in the light of the three decisions of the Supreme Court (i) in the case of Juggilal Kamlapat v. CIT [1969] 73 ITR 702; (ii) in the case of Sunil Siddharthbhai v. CIT [1985] 156 ITR 509 and (iii) in the case of CIT v. B.M. Kharwar [1969] 72 ITR 603. These cases have laid down a rule that it is the substance of the transaction which matters ignoring the nomenclature. In the case of Juggilal Kamlapat before the Supreme Court, the assessee was a registered firm in which the three Singhania brothers held 51 per cent and one Bushir held 49 per cent. The firm floated a company in which the three Singhania brothers and their wives held a majority of the shares. That company appointed the assessee firm as its managing agents for a period of 25 years. The directors of the managed company wrote a letter to the financiers of the company asking for repayment of advances made by them in excess of Rs. 5 lakhs and it was resolved to call upon the assessee firm to arrange for advances of such sums of money as wou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nued to benefit from the profits of that business flowing the them in the shape of dividend instead of as a share of profits from the assessee-firm. In other words, the managing agency asset was enjoyed by the four individual partners in different capacity with the same object of profit-making. There was, therefore, no destruction of the apparatus of the profit-making asset, i.e., managing agency contract. 29. In the case of Sunil Siddharthbhai, while considering a case of a partner making over capital asset which are held by him to a firm as his contribution towards capital whether amounts to transfer of capital asset, the Supreme Court observed as under:- If the transfer of the personal asset by the assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on capital gain, it will be open to the income-tax authorities to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, whether the transaction of transferrin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness relationship was intended, the liability to be taxed under the second proviso to section 10(2)(vii) of the Indian Income-tax Act, 1922, in respect of the readjustment has to be determined according to the strict legal form of the transaction. The company is a legal entity distinct from the partnership under the general law, the transfer of the machinery is by the firm to the company, and the legal effect of the transaction is to convey for consideration the rights of the firm in the machinery to the company. If the transaction results in excess realisation over the written down value of the machinery to the firm, the liability to tax, if any, arising under the Act cannot be avoided merely because in consequence of the transfer the interest of the partners in the machinery is substituted by the interest in the shares of the company which owned the machinery. By virtue of the amendment made in the second proviso to section 10(2)(vii) by section 11 of the Taxation laws (Extension to Merged States and Amendment) Act, 1949, even under a 'realisation sale', the excess over the written down value not exceeding the difference between the original cost and the written down va ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion or operation. (2) The expenditure referred to in sub-section (1) shall be the expenditure specified in any one or more of the following clauses, namely:- (a) expenditure in connection with- (i) preparation of feasibility report; (ii) preparation of project report; (iii) conducting market survey or any other survey necessary for the business of the assessee; (iv) engineering services relating to the business of the assessee: Provided that the work in connection with the preparation of the feasibility report or the project report or the conducting of market survey or of any other survey or the engineering services referred to in this clause is carried out by the assessee himself or by a concern which is for the time being approved in this behalf by the Board; (b) legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee; (c) where the assessee is a company, also expenditure- (i) by way of legal charges for drafting the Memorandum and Articles of Association of the company; (ii) on printing of the Memorandum and Articles of Association; (iii) by way of fees for registeri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pital. That intention in second case is evident as the issue of debentures was to enable it to enlist the equity shares in stock exchange. For the second also, when the debentures are compulsorily to be converted into equity shares the intention is implicit that they were issued for increasing the capital base of the company. It is true that part-B debentures were to be converted after 15 months and during those 15 months the money received on the issue of debentures was only as a loan or advance or deposit pending allotment of shares like application money. But it being towards allotment of shares ultimately no allowance on proportionate can also be allowed to the assessee. 34. Certain cases dealing with the provisions of section 35D vis-a-vis section 37 were referred to. First decision is in the case of East India Hotels Ltd., the Calcutta High Court considered the provisions of section 35D and the Board's Circular No. 56, dated 19-3-1971 held that section 35D has been introduced to give benefit to the assesses in cases of capital expenses and that the Board had clarified that the provision for amortization is not intended to supersede any other provision of the Income-tax La ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... where the decision of the Calcutta High Court in the case of East India Hotels Ltd. was not available to the Ahmedabad Bench that decided the case. In the case of ATV Projects India Ltd., a case before the Bombay Tribunal, 9/10th the expenditure amounting to Rs. 53.29 lakhs was claimed as revenue expenditure for raising loan through convertible debentures issued by treating the same expenditure as preliminary expenses and restricted the deduction to 1 /10th thereof under section 35D. Referring to the Circular of the Board and the decision of the Supreme Court in the case of India Cements Ltd, the Tribunal held that if the company incurs expenditure on issue of debentures, when it is already in business, it is not covered either under section 35D(1)(i) or (ii) of the Income-tax Act because what is contemplated under section 35D is an expenditure incurred before commencement of the business or after the commencement of business but in connection with the expansion of the undertaking or in connection with setting up a new unit. On the other hand, the assessee has specifically made a claim for amortization and, therefore, such expenditure will not qualify for deduction under any other ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
