Bonafide issue of debentures under rehabilitation plan, to extinguish liability of interest, is not misuse of Sec 43B of I-T Act: Supreme Court

Read Judgment: M.M. Aqua Technologies Ltd vs. Commissioner of Income Tax, Delhi

Pankaj Bajpai

New Delhi, August 12, 2021: The Supreme Court has ruled that Explanation 3C to Section 43B of the Income Tax Act, which was introduced for “removal of doubts”, only made it clear that interest that remained unpaid and has been converted into a loan or borrowing shall not be deemed to have been actually paid.

A Division Bench of Justice Rohinton Fali Nariman and Justice B R Gavai observed that the issue of debentures by the assessee was, under a rehabilitation plan, to extinguish the liability of interest altogether and no misuse of the provision of Section 43B was found as a matter of fact by either the CIT or the ITAT. 

The case pertains to the assessee filing a return claiming a deduction u/s 43B based on the issue of debentures in lieu of interest accrued and payable to financial institutions. The AO however rejected the claim by holding that the issuance of debentures was not as per the original terms and conditions on which the loans were granted, and that interest was payable, holding that a subsequent change in the terms of the agreement, as they then stood, would be contrary to Section 43B(d), and would render such amount ineligible for deduction.

The matter went in appeal before the Income Tax Appellate Tribunal (ITAT) which observed that when both the creditor and debtor agree that the conversion of the outstanding interest liability into fully paid debentures would be accepted by them as discharge of the liability, then to hold that notwithstanding the contract between the two it was open to the income tax authorities to say that the interest liability had not been discharged, would not only be opposed to the contextual perspective of section 43B but would also do violence to the language used. 

Not satisfied, the Revenue Department approached the High Court, which held that the clear purport of the statute i.e. Section 43-B (d) was that any amount payable towards interest liability would qualify for deduction; however Explanation 3C acts to insist on a rider.

After considering the provision of Section 43B and its rider Explanation, the Supreme Court noted that both the CIT and the ITAT found, as a matter of fact, that as per a rehabilitation plan agreed to between the lender and the borrower, debentures were accepted by the financial institution in discharge of the debt on account of outstanding interest. 

“This is also clear from the expression “in lieu of” used in the judgment of the CIT. That this is so is clear not only from the accounts produced by the assessee, but equally clear from the fact that in the assessment of ICICI Bank, for the assessment year in question, the accounts of the bank reflect the amount received by way of debentures as its business income,” said Justice Nariman.

The Top Court said that it is clear that interest was “actually paid” by means of issuance of debentures, which extinguished the liability to pay interest. Explanation 3C, which was introduced for the “removal of doubts”, only made it clear that interest that remained unpaid and has been converted into a loan or borrowing shall not be deemed to have been actually paid. 

At the heart of the introduction of Explanation 3C is misuse of the provisions of Section 43B by not actually paying interest, but converting such interest into a fresh loan, added Justice Nariman. 

On the facts in the present case, the Top Court found the issue of debentures by the assessee was, under a rehabilitation plan, to extinguish the liability of interest altogether and no misuse of the provision of Section 43B was found as a matter of fact by either the CIT or the ITAT. 

“Explanation 3C, which was meant to plug a loophole, cannot therefore be brought to the aid of Revenue on the facts of this case. Indeed, if there be any ambiguity in the retrospectively added Explanation 3C, at least three well established canons of interpretation come to the rescue of the assessee in this case,” observed the Division Bench. 

The Apex Court therefore concluded that Explanation 3C is clarificatory in nature and it explains Section 43B(d) as it originally stood and does not purport to add a new condition retrospectively, as has wrongly been held by the High Court.