Income Tax Officer vs VXL India Limited

K.S. Radhakrishnan, J.—Following substantial question of law arises for our consideration in these appeals and therefore, we dispose of both these appeals by a common judgment.

Whether the Appellate Tribunal is right in law and on facts in allowing the claim of the assessee for amounts incurred for the issue of convertible debenture?

Assessee company is engaged in the manufacture of woolen fabrics and also engaged in job-work of woolen tops. We are in these cases concerned with the Assessment Years 1984-85 and 1985-86. For the assessment year 1984-85, return of income was filed on 26.6.1984 declaring a total income of Rs. 44,63,351/-, whereas for the assessment year 1985-86, the return of income was filed on 23.12.1985 declaring a total income of Rs. 21,84,440/-. Income Tax Officer computed the income for Assessment Year 1984-85 at Rs. 40,47,870/- and for the year 1985-86 at Rs. 6,50,740/-. Assessee claimed that company had issued convertible debentures of Rs. 125/- each of which Rs. 45/- each was to be converted into three shares on 1.7.1983 during the accounting year in respect of assessment year 1984-85 and stated that assessee had incurred expenses to the tune of Rs. 19,00,925/-. Assessee company had also got interest from bank on application money kept in short term deposits of Rs. 2,45,613/- and the same was adjusted against the expenses incurred in respect of issuance of convertible debentures. For the assessment year 1985-86, assessee had incurred an expenditure of Rs. 16,156/- for conversion of debentures into shares and had claimed the said amount as revenue expenditure. The Assessing Authority noticed that the assessee for the assessment year 1984-85 had incurred a total expenditure of Rs. 19,16,923/- for issuing debentures. It was also noted that out of which Rs. 16,000/- was paid to Amarchand and Mangaldas and Hiralal Shroff & Co., Bombay which had not been debentures. The Assessing Authority disallowed Rs. 6,90,093/- out of legal expenditure of Rs. 19,16,925/- incurred for issuing debentures. For the assessment year 1985-86, the assessee claimed that it had incurred an expenditure of Rs. 16,156/- for conversion of debentures into shares and claiming the same as revenue expenditure. Assessing Authority, on verification found out that major items of Rs. 15,156/- was the stamp duty paid for issuance of equity shares and also a sum of Rs. 1,000/- being conversion charges paid to Controller of Capital Issues, New Delhi. The Assessing Authority therefore, disallowed the claim for deduction holding that the expenses incurred for conversion of debentures into equity shares would have an enduring effect and the same has to be treated as capital expenditure and hence the claims for deduction made u/s 35D for both the years were disallowed.

Assessee took the matter in appeal before the Commissioner (Appeals) stating that Income Tax Officer has erred in law as well as in facts in treating a part of the gross expenditure on issue of debentures as capital expenditure. According to the assessee the real nature of expenditure was revenue expenditure and the conversion of part value of debenture into equity shares in the next accounting year was a mode of repayment of borrowed funds. According to the assessee, borrowing funds for the purpose of business and subsequent conversion of part of value of debentures into equity shares is a mode of repayment of borrowed funds, and that the mode of repayment, namely conversion into equity shares has no relevance in deciding allowability of expenditure incurred when borrowing was made. Commissioner (Appeals) did not accept the claim of the assessee, after having noticed that a portion of convertible debentures was converted into equity shares and company had got enduring benefits. Commissioner (Appeals) placed reliance on the decision of the Apex Court in India Cements Ltd. Vs. Commissioner of Income Tax, Madras, took the view that expenditure incurred by the assessee company on convertible debentures has to be treated as capital expenditure. Holding so, appeal preferred by the assessee was dismissed.

Assessee took up the matter in appeal before the Tribunal. Tribunal, however, allowed the appeals for both the assessment years, stating that the assessee had treated the expenditure incurred for convertible debentures as loan in the balance-sheet and their part conversion into equity shares would be in the nature of repayment of loan. The Tribunal therefore took the view that it is in the nature of revenue expenditure and hence the claim for deduction was allowed. Revenue is aggrieved by the said order and has approached this Court with these appeals.

Shri Manish R. Bhatt, learned Senior Counsel appearing for the Revenue submitted that the Tribunal was not justified in holding that the assessee was entitled to claim deduction of the expenditure u/s 35D of the Income Tax Act, stating that only convertible portion was a loan disallowed by the Assessing Officer since same would form part of the capital. Learned Counsel submitted that conversion of part of value of debentures into equity shares would be enduring in nature and therefore, it has to be treated as a capital expenditure, as rightly held by the Assessing Officer as well as by the Commissioner (Appeals). In support of his contention, reliance was placed on the judgment of the Apex Court in Brooke Bond India Limited Vs. Commissioner of Income Tax, West Bengal-III, Calcutta, Reliance was also placed on the decision of the Apex Court in Commissioner of Income Tax Vs. Kodak India Ltd.,

Shri Saurabh Soparkar, learned Senior Counsel appearing for the assessee submitted that so far as the present case is concerned, assessee has treated the convertible debentures in the nature of loan and those debentures were secured and details thereof were mentioned in the balance-sheet and their conversion into equity shares was only a mode of repayment of loan raised by way of issue of convertible debentures and till conversion into equity shares, they were in the nature of loan and interest was also payable thereon. Learned Counsel also placed reliance on the decision of India Cements Ltd. Vs. Commissioner of Income Tax, Madras, Reference was also made to the decision of the Apex Court in Deputy Commissioner of Income Tax, Ahmedabad Vs. Core Health Care Ltd., decision of the Punjab and Haryana High Court in Commissioner of Income Tax Vs. S.A. Builders (P) Ltd., decision of Calcutta High Court in Commissioner of Income Tax Vs. East India Hotels Ltd., and decision of Madras High Court in Commissioner of Income Tax Vs. First Leasing Co. of India Ltd., and submitted that the expenses incurred for issuing debentures is a revenue expenditure.

We heard learned Senior Counsel appearing for either side at length. Facts would clearly indicate that assessee company had issued convertible debentures of Rs. 125/- each of which Rs. 45/- each was to be converted into three shares on 1.7.1983 during the assessment year 1984-85 and had incurred expenses to the tune of Rs. 19,00,925/-. According to the assessee, the expenses incurred are in respect of issuance of convertible debentures. Facts would further clearly indicate that major portion of the convertible debentures was converted into equity shares, and thereby assessing company had got enduring benefit. Debenture under the Company law means a document which either creates or acknowledges a debt. Debentures, wholly secured or unsecured are also used as convertible debentures with the option of being subsequently converted into shares. Share is a right to a special amount of the Share Capital of a company. Capital can be raised by converting debentures into equity shares. Expenditure incurred by the assessee on conversion of convertible debentures into equity shares would have to be treated as capital expenditure. Normally, in a company there are two kinds of share capital; preferential share capital and equity share capital. Generally, all share capital not falling within the description of preference capital is equity capital. Equity share capital is that part of share capital which confers a right either to the whole or part of any residue of any profits or to the whole or part of any residue of any assets remaining for distribution after satisfying the claims of any other shareholders whose right to participate therein is limited. Equity share-holders are owners of the company, sharing its risks, profits, and losses and having a residual claim on the earnings and assets of a company and are paid their share of the company''s profit after all other claims are met, and in the event of liquidation of the company, they share whatever is left of the company after all its creditors have been paid. They enjoy limited liability i.e. liability only to the extent of their share-holding and they are only entitled to vote at the company''s meetings, thus controlling the management. If the company prospers, it is the equity shareholder who is the greatest gainer. Therefore, in our view, when the debentures are converted into equity shares, the assessing company has already got enduring benefit and the expenditure incurred by the conversion of equity shares has to be treated as capital expenditure.

Apex Court in India Cements Ltd. v. CIT, Madras (supra), held that the loan obtained is not an asset or advantage of an enduring nature, but obtaining capital by issuance of shares is different from obtaining loan by debentures. Above referred judgment was followed by the Apex Court in Brooke Bond India Ltd. v. CIT (supra) and took the view that expenditure incurred by the company in connection with issue of shares with a view to increase its share capital, is directly related to the expansion of the capital base of the company, and is capital expenditure, even though it may incidentally help in the business of the company and in the profit-making.

In view of the above position, decisions cited by the learned Counsel for the asessee have no application. Facts of the case clearly indicate that portion of the convertible debenture was converted into equity shares and assessee company had got enduring benefits and therefore, the expenditure incurred by the assessee on conversion of convertible debentures into equity shares has to be treated as capital expenditure. It may be noted that the Assessing Authority disallowed expenditure only to the extent pertaining to the convertible portion of the expenditure which formed part of the capital. As such disallowance made by the Income Tax Officer, which was confirmed by the Commissioner (Appeals) has to be sustained. The question of law raised by the Revenue, though not happily framed, is accordingly answered in the negative in favour of the Revenue and against the Assessee. Consequently, appeals are allowed and the order of the Tribunal is set aside.