[Income tax deductions] Explanation 3C to Section 43B(d) of Income Tax act clarificatory, does not add new condition: Supreme Court

The Supreme Court on Wednesday had occasion to observe that Explanation 3C to Section 43B of the Income Tax Act, 1961 is only clarificatory and meant to curb the misuse of Section 43B, which lays down that income tax deductions on certain transactions can only be claimed after actual payment and not merely on accrual basis (MM Aqua Technologies Ltd. v. Commissioner of Income Tax, Delhi-III).Disagreeing with a 2015 Delhi High Court judgment in the matter, Justices RF Nariman and BR Gavai opined, ."Explanation 3C is clarificatory – 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.”.In the course of the ruling, the Bench also found that the issue of certain debentures, in this case, constituted a discharge of the liability to pay interest on loans availed by the assesee, or actual payment of the interest by the assesee. .Therefore, the assesee is entitled to claim deduction under Section 43B of the Income Tax Act for the payment of such interest, the top Court held. .Case background.The Court was dealing with an appeal against a Delhi High Court order that had ruled against a tax assessee (MM Aqua Technologies Ltd.) which sought to claim certain income tax deductions in the year 1996-97..The deduction it sought to claim was with respect to the payment of interest on loans from a bank. Instead of paying the interest directly, the assessee had arrived at an agreement with the bank to issue debentures instead which would act to discharge its liability to pay the interest..The Assessing Officer however declined to view the issue of debentures as having discharged the assesee's liability to pay interest and said that the assessee was not entitled to get the deduction. On appeal, the Commissioner of Income Tax (CIT) and the Income Tax Appellate Tribunal (ITAT) ruled in the assessee’s favour. The Delhi High Court, however, ruled against it..The Law in focus.Section 43B (d) of the Income Tax Act and Explanation 3C to this section were in focus. .Section 43B deals with certain kinds of deductions that can be claimed under the head of “Profits and gains of business or profession”. As per Section 43B, certain deductions can be claimed only if the amount referred to is “actually paid” and not just accrued (or the liability to pay incurred). Section 43B (d) refers to interest on loans..Explanation 3C to this Section was inserted by the Finance Act of 2006 and made retrospectively applicable from 1989 when Section 43B (d) was inserted. .Explanation 3C stated that the conversion of interest on a loan into another loan would not constitute the discharge of the liability to pay interest or constitute actual payment of interest as required under Section 43B to claim an income tax deduction..Explanation 3C was inserted to curb the misuse of 43B as it was found that many were claiming deductions on the ground that they maintain accounts on mercantile or accrual basis, but not actually paying the amount later on..Issue involved and Supreme Court verdict.The issue before the Supreme Court ultimately boiled down to whether the issuance of debentures would amount to “actual payment” of interest on a loan, entitling the assessee to avail a deduction under Section 43B..The Delhi High Court had treated the matter as a case where the assessee had converted the interest on the loan into another loan. As such, applying Explanation 3C, High Court ruled against the asessee..The Supreme Court, however, agreed with the assessee that the issue of the debentures “in lieu” of the interest on its loan was a discharge of the liability to pay that part of the interest on loan. In other words, the issue of debentures was not the creation of a fresh loan as referred to under Explanation 3C. ."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 learned 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. This being the fact-situation in the present case, it is clear that interest was “actually paid” by means of issuance of debentures, which extinguished the liability to pay interest", the judgment explained..This was evident from the fact that the bank had also agreed to treat the issue of debentures as a means of discharging the liability to pay interest, the Court noted. .In this backdrop, the top Court further noted that the assessee had advantage on at least three counts:1. Bona fide transactions of actual payments were not meant to be affected by the Explanation 3C, which was only meant to “plug a loophole” under Section 43B of the Income Tax Act, 1961. 2. Explanation 3C, which was introduced for the retrospective "removal of doubts" cannot be viewed as retrospectively altering the law as it stood earlier.3. Any ambiguity in the language of Explanation 3C should be resolved in favour of the assessee.."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. As has been seen by us hereinabove, particularly with regard to the Circular explaining Explanation 3C, 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. On the facts found in the present case, the issue of debentures by the assessee was, under a rehabilitation plan, to extinguish the liability of interest altogether. 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", the Court ruled..Having made these observations, the Court proceeded to allow the appeal by MM Aqua Technologies Ltd..[Read Judgment]