CIT vs Insotex India Ltd.

A common question of law is involved in all these three appeals between the same parties for different assessment years and therefore, it is taken for consideration together and disposed of by this common judgment. The assessee is carrying on business in manufacture of electrical insulation tapes. In respect of the assessment year 1999-00, he filed a return of income declaring NIL income. A notice u/s 148 of the Income Tax Act, 1961 was issued for reopening assessment. The assessing officer took up the matter for scrutiny assessment. The assessing officer found that the assessee had invited ''Deep Discount Bonds''. The holder of this bond had the option of obtaining equity shares by converting 60% of the value of the bonds at the end of 25 years. This option was provided only at the instance of the assessee company. On examination, the assessing officer found that the bonds did not disclose payment of any interest. The right of redemption, which was with the company, could be exercised at the end of 5th, 10th, and 15th years. The assessee had created provision for a sum of Rs. 2,82,79,950 as interest payable on the redemption of the bonds. The assessing officer found that there was no contract to pay interest and on redemption, which was at the instance of the assessee company only shares had to be issued. Therefore, no such interest accrued. According to him it was a mere contingent liability, which cannot be treated as expenditure and the same was disallowed. Aggrieved by the same, the assessee preferred an appeal. The Commissioner (Appeals-I) relying on the accountancy practice recognised by the institute of Chartered Accountants at India and also following the judgment of the Apex Court in the case of Bharat Earth Movers Vs. Commissioner of Income Tax, Karnataka, and also in the case of Metal Box Company of India Ltd. v. Their Workmen (1969) 72 ITR 53 (SC) as well as the judgment of Apex Court in the case of M/s. Madras Industrial Investment Corporation Ltd. Vs. The Commissioner of Income Tax, Tamil Nadu-I, Madras, held that the assessing authority is not justified in disallowing the deduction claimed by the assessee on the ground that it is contingent liability. Accordingly, the addition of Rs. 2,79,76,080 was deleted. Aggrieved by the same the revenue preferred an appeal to the appellate Tribunal. The appellate Tribunal relied on the very same judgments on which the reliance was placed by the appellate Commissioner, was of the view that the discount though ultimately accruing at the end of maturity, was allowed to be spread evenly, over the period of such deep discount bonds issued. Therefore, the provision made by the assessee for meeting the liability incurred by in on the terms of issue of deep discount bonds is the accrued liability and therefore, dismissed the appeal. Aggrieved by these orders, the revenue is in appeal. The appeal was admitted on 26-3-2007 to consider the following substantial questions of law.

(i) ...Whether the assessing officer was correct in disallowing the sum of Rs. 2,82,79,950 provision made for interest on Deep Discount Bonds when the same had neither accrued nor was it payable during the current assessment year?

(ii) ...Whether the appellate authorities were correct in not taking into consideration that as per the Deep Discount Bonds no interest was contemplated and redemption takes place only once in 5 years that to at the instance of the assessee company and on redemption only equity shares were being issued and consequently recorded a perverse finding by holding that interest had accrued without basing such conclusion on any relevant material?

The learned counsel for the revenue assailing the impugned order contends that the liability to pay interest is a contingent liability, which may arise in future and therefore, it is not expenditure. More over, the terms of the contract make it very clear at the end of the period agreed upon the assessee has to issue shares and not pay money and therefore, the assessee was not justified in spreading the interest payable for each financial year and in claiming deduction under the heading of expenditure.

Per contra, the learned counsel appearing for the assessee supported the impugned order. The Apex Court in the case of Madras Industrial Investment Corp. Ltd. v. CIT (supra) after referring to various judgments has held as under :

...thus the expenditure is not necessarily confined to money which has been actually paid out, it covers a liability which is accrued or which has been incurred although it may have to be discharged at a future date. However, a contingent liability which may have to be discharged in future cannot be considered as expenditure.

Thereafter, they proceeded to hold as under :

Therefore when a company issues debentures on discount, it incurs liability to pay a larger amount within what it has borrowed at a future date.

We need not go into the question whether this additional liability is equivalent to the discount, which is incurred in present but it is payable in future represents additional interest or not they may depend upon the totality of the circumstances relating to the issue of debenture including its items. The liability, however, to pay the discount amount over and above the amount received by debentures is a liability, which has been incurred by the company for the purpose of its business in order to generate funds for its business activities. The amount was obtained by issue of debentures are used by the company for the purpose of its business. This would therefore, be expenditure.

Issuing debentures on discount is another such instance where although the assessee has incurred the liability to pay the discount in the year or issue of debentures, the payment is to source a benefit over a number of years. There is a continuing benefit to the business of the company over the entire period. The liability should, therefore, be spread over beyond period of debentures.

In the instance case, the assessee issued deep discount bonds and it figures under the head Unsecured loans in its balance sheet. As per the terms of the bonds, which are tenable for a period of 25 years on maturing over and above the issue price of Rs. 10,000 a bond fetches a total value of Rs. 6,70,000. The amounts borrowed under the bond scheme are admittedly used for the purpose of business of the assessee. The bonds, which are encashable by the bondholder at the end of the maturity period, can be redeemed of its option by the assessee at the end of every five years. The redemption value of these bonds at intervals is as below:

(a) ...At the end of 5 years for Rs. 23,200

(b) ...At the end of 10 years for Rs. 55,200

(c) ...At the end of 15 years for Rs. 1,27,000

(d) ...At the end of 20 years for Rs. 2,89,000. The incremental amount available to the bondholder works out to yearly compounding at the rate of 18.33%. Having regard to the permissible redemption at the end of five years period, the assessee had provided in its books for the incremental amount payable and the issue price represents the discount enjoyed by the bondholder and given by the assessee. Therefore, the finding of the assessing authority that there is no contract to pay interest and after the expiry of the period, the assessee is entitled to share runs contrary to the terms of the deep discount bond. Once the liability to pay interest accrues every year and the money is utilized by the assessee for its business, he is entitled in law to spread over the said liability during the period of the life of those bonds. It is a liability, which the assessee has incurred for the purpose of his business or generate funds for his business activities. Therefore, the said amount would constitute expenditure as the expenditure is not necessarily confined to be money, which has been actually paid out and as it includes or covers a liability, which has accrued but it may have to be discharged at a future date. It cannot be construed as a contingent liability. The liability to pay interest is certain, though it accrues every year the payment is postponed. The liability accrues in present year but the discharge is on a future date. In view of this legal position the order passed by the appellate authority is strictly in accordance with law and does not call for any interference. Therefore, the substantial questions of law framed in these appeals are answered in favour of the assessee and against the revenue.