The Delhi High Court has ruled that issue of bonds to public financial institutions in lieu of overdue interest payments do not amount to actual payment as contemplated by Section 43B of the Income-tax Act, 1961 read with Explanation 3C.

Case Details:
Income Tax Appeal (ITA) : 110/2005
Judgment Reserved on: 30.04.2015 Pronounced on: 18.05.2015
Commissioner Of Income Tax, Delhi …Appellant    Vs    M.M. Aqua Technologies Ltd. …Respondent
Coram: Hon'ble Mr. Justice S. Ravindra Bhat and Hon'ble Mr. Justice R. K. Gauba

The Question:
“Whether the funding of the interest amount by way of a term loan amounts to actual payment as contemplated by Section 43B of the Income-tax Act, 1961?”

Important Case Law Referred:
Andhra Pradesh High Court in CIT v. Mahindra Nissan Allywin Ltd., 233 ITR 493
Subhra Motel (P.) Ltd., 64 ITD 134 (Delhi Bench of the ITAT)
J.B. Boda Co. (P.) Ltd. v. Central Board of Direct Taxes, 223 ITR 271 (SC)
Salendra Narain Bhanj Dev v. Asstt. Agricultural Incometax Orissa, 30 ITR 801 (Patna High Court)
Kalpana Lamps and Components Ltd. v. DCIT, (2001) 255 ITR 491 (Madras High Court)
Vinir Engineering (P) Ltd. v Deputy Commissioner of Income Tax 313 ITR 154
Commissioner of Income Tax v Shakti Spring Industries (P) Ltd, [2013] 219 Taxman 124
Eicher Motors Ltd. v. Commissioner of Income Tax, 315 ITR 312 (MP)
Commissioner of Income Tax v. Pennar Profiles Limited, (ITA No. 289 of 2003

Facts of the Case:
The respondent assessee was heavily indebted to its institutional creditors and was unable to discharge this interest liability due to its financial hardship. The accumulated interest on the overdue principal was Rs. 3,00,14,900/-. ICICI was the lead manager of those creditors. In settlement, the ICICI, waived part of the compound interest and commitment charges and the assessee on 15-03-1996 issued 3,00,149 convertible debentures of  Rs. 100 each, amounting to Rs. 3,00,14,900/- in lieu of the outstanding interest. The assessee, in its income-tax return, claimed interest of Rs. 2,84,71,384 (rest of the interest was capitalized as preproduction expenditure) as deductible expenditure, claiming that it was actually paid in the relevant accounting period.

However, the Assessing Officer held that issue of debentures resulted only in postponement of the interest liability and that the interest could not be considered as having been "actually paid" as required by Section 43B of the Income Tax Act, 1961 and thus the claim was disallowed.

Excerpts from the Judgment:

From the AO‟s order, it is evident that the loans, in respect of which the assessee claims deduction of interest under Section 43B, were taken from ICICI, IDBI and IFCI. These entities are included within the definition of „public financial institution‟ set out in Section 4A of the Companies Act, 1956 (applicable for the purposes of the instant case as it relates to AY 1996-97). Consequently, by virtue of Explanation 4(a) to Section 43B, these entities would also constitute public financial institutions for the purposes of Section 43B and the interest on loan taken by the assessee from these entities would fall within the purview of Section 43B(d) of the Act.

Now, Explanation 3C, having retrospective effect with effect from 01.04.1989, would be applicable to the present case, as it relates to AY 1996-97. Explanation 3C squarely covers the issue raised in this appeal, as it negates the assessee‟s contention that interest which has been converted into a loan is deemed to be „actually paid‟. In light of the insertion of this explanation, which, as mentioned earlier, was not present at the time the impugned order was passed, the assessee cannot claim deduction under Section 43B of the Act.

In so concluding, this Court is supported by the decision of the Madhya Pradesh High Court in Eicher Motors Ltd. v. Commissioner of Income Tax, 315 ITR 312 and subsequently, the judgment of the High Court of Telangana and Andhra Pradesh in Commissioner of Income Tax v. Pennar Profiles Limited, (ITA No. 289 of 2003, decided on 11.02.2015). In Eicher Motors, the Court noted:

“7. As observed supra, the Expln. 3C has now in clear terms provided that such conversion of interest amount into loan shall not be deemed to be regarded as "actually paid" amount within the meaning of Section 43B. In view of clear legislative mandate removing this doubt and making the intention of legislature clear in relation to such transaction, it is not now necessary for this Court to interpret the unamended Section 43B in detail, nor it is necessary for this Court to take note of facts in detail as also the submissions urged in support of various contentions except to place reliance on Expln. 3C to Section 43B and answer the questions against the assessee and in favour of Revenue.”

The Court in Pennar Profiles Limited (supra) considered the decisions in Mahindra Nissan (supra), Vinir Engineering (supra) and Eicher Motors (supra) and held as follows:

“8. In this backdrop, we have perused the provisions contained in Section 43B of the Act, in particular, Explanation 3C thereof, which was inserted by the Finance Act, 2006 with retrospective effect from 01.04.1989. This provision was inserted in 2006 and hence, this Court in Mahindra Nissans case, had no occasion to deal with the case in the light of this provision. Insofar as the Karnataka High Court is concerned, though this provision was existing on the date of judgment, it appears that it was not brought to the notice of learned Judges and hence, the Division Bench proceeded to consider and decide the appeal of the assessee without referring to Explanation 3C appended to Section 43B of the Act.

9. As a matter of fact, from reading of Explanation 3C, in our opinion, the question as raised in the present appeals stands answered without further discussion. This provision was inserted for removal of doubts and it was declared that deduction of any sum, being interest payable under clause (d) of Section 43B of the Act, 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. Thus, the doubt stands removed in view of Explanation 3C. This provision was considered by the Madhya Pradesh High Court in Eicher Motors Limited v. Commissioner of Income Tax to hold that in view of the Explanation 3C appended to Section 43B with retrospective effect from 01.04.1989, conversion of interest amount into loan would not be deemed to be regarded as actually paid amount within the meaning of Section 43B of the Act.”

In light of the introduction of Explanation 3C, this Court does not consider it necessary to discuss the precedents relied upon by the assessee delivered prior to the enactment of Finance Act, 2006….

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