Entire interest expenditure is to be allowed in the year in which it is incurred and paid – SC
While computing the profit and gains from business or profession, there are certain expenditures which are disallowed. This means that the income tax department does not allow the benefit of such expenditures and the assesses are required to pay taxes on such expenditures by adding it back to the net profits. Section 36(1)(iii) allows deduction of the amount of interest paid in respect of capital borrowed for the purposes of business. The deduction is granted under the section, once it is established that the borrowing is for the purposes of business and that the interest is paid on such borrowings.
Section 36(1)(iii) has to be read on its own terms. It is a code by itself. Section 36(1)(iii) is attracted when the assessee borrows the capital for the purpose of his business. It does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all that the section requires is that the assessee must borrow the capital for the purpose of his business. There by meaning that the transaction of borrowing is not the same as the transaction of investment.
Interest is an award that all debenture holders receive for investing in the debentures of a company. Usually, the company pays the interest at the regular interval at the pre-set rate of interest on its face value. the treatment of interest is that it is a charge on profit. When a company issues the debentures, it is under the obligation to pay the debenture holder the interest at the pre-set rate at regular interval until the company pays off the debentures. The percentage is a part and the parcel of the name of debenture such as 6% debenture, 12% debenture, etc., and the interest that is payable we calculate it at the nominal value of debenture.
Let us refer to the case of Taparia Tools Ltd. v. JCIT (2015), where the issue under consideration was whether the upfront payment of interest to the debenture holders is allowable as a deduction in the year in which it is incurred and paid or it is to be spread over the life of the debentures?
Facts of the Case:
- The assessee issued debentures giving the debenture holders two options as regards to the payment of interest.
- They could either receive interest periodically i.e. half yearly at the rate of 18% p.a over 5 years or opt for one-time upfront receipt of discounted interest of Rs. 55 per debenture.
- In the second alternative, discounted interest of Rs. 55 per debenture was to be paid upfront.
- At the end of five years period, the debentures were to be redeemed at the face value of Rs. 100.
- Two of the debenture holders opted for the upfront payment of interest.
- In the books of accounts, the said upfront payment of interest on debentures was recorded as deferred revenue expenditure and was written off over 5 years.
- For the purpose of income-tax, entire payment of interest was claimed as a deduction under section 36(i)(iii) in the year of payment itself.
- However, the AO, CIT(A), ITAT and High Court rejected the assessee’s claim and held that though the amount was paid upfront, the same was only allowable as a deduction over the tenure of the debentures i.e. over the period of five years.
Observations of the Supreme Court (SC)
- SC held that in accordance with the terms and conditions of the issue of non-convertible debenture floated by the assessee the amount of interest became payable to the debenture holders on the exercise of option by them which occurred in the current assessment year in which deduction of the expenditure was claimed.
- As per section 36(1)(iii), any interest expenditure paid by the assessee for the purpose of its business is allowable as a deduction.
- Further, ‘paid’ as per section 43(2) means actually paid or incurred.
- Therefore, SC held that when the interest was actually incurred and paid by the assessee, the assessee would be entitled to deduction of the upfront payment of discounted interest on debenture in the assessment year in which it is paid.
- SC held that normally revenue expenditure incurred in a particular year had to be allowed in that year itself and if the assessee claimed that expenditure in that year, the department could not deny the same.
- There was no concept of deferred revenue expenditure in the Income-tax Act, 1961, except where the section specifically provided for the same.
- Further, the treatment in the books of account did not determine the allowability or taxability of any item of expenditure or income.
- The deduction of any expenditure was permissible as per the provisions of the Act.
- The matching concept also did not come in the way of the assessee. If an assessee follows mercantile system of accounting, the expenditure becomes allowable once the liability to pay is incurred by the assessee.
- Even if the assessee treated such expenditure as deferred revenue expenditure in the books of account, then same shall not stop the assessee from claiming the entire deduction for the purpose of the Act.
Entire interest expenditure is to be allowed in the year in which it is incurred and paid and treatment in the books of account not determinative of the allowability of interest expenditure.