Income Tax

Premium on Redemption of Convertible Debentures is Revenue Expenditure

The Karnataka High Court in the case of Nitesh Housing Developers (P.) Ltd. v. Deputy Commissioner of Income-tax 2022 has allowed that the premium on redemption of convertible debentures payable by assessee-Company is a revenue expenditure and it cannot be allowed as a capital expenditure. Henceforth, the Karnataka high court dismissed the impugned order of the ITAT and allowed the appeal of the assessee-company. The present article will discuss in detail the facts of the case, grounds of appeal, issues and contentions of both the parties.

Facts of the Case

The facts of the case are:

1. The assessee company is a Private Limited Company engaged in the business of the Development of Real Estate and execution of Engineering Contracts.
2. The assessee company filed its returns for the annual year 2011-2012 on 30.09.2011, which declared total income as Rs 12, 23, 66,760.
3. The assessee company then filed a revised return on 29.09.2012 claiming a loss of Rs 15,71,45,958 and processed the same under Section 143(1) of the IT Act^[1] 1961.
4. The case was taken up for scrutiny by the assessing officer. An explanation was sought from the assessee company in regard to the difference between the tax liability arising out between the original return & the revised return.
5. The assessee company states that the difference is due to the non-deduction of premium on redemption of convertible debentures to an amount of Rs 28, 82, 17,552.
6. The assessing officer rejected the contentions of the assessee company and disallowed the claim for taking a deduction on the premium on redemption of convertible debentures.
7. Being aggrieved by the order of the assessing officer, the assessee company filed an appeal before the CIT (Appeal), which has allowed the deduction of premium on redemption of convertible debentures as revenue expenditure, which the company would claim in the 3 consecutive years.
8. Being aggrieved by the CIT (A) order, the revenue department prefers an appeal before the ITAT, which has reserved the order of the CIT (A) and upheld the earlier findings of the assessing officer.
9. Being aggrieved by the order of ITAT, the assessee company filed the present appeal before the Karnataka High Court.

Decision of the Assessing officer/Revenue Department

The assessing officer held that the premium on redemption of convertible debentures shall arise out of the reserves & surplus and would constitute capital expenditure arising out of the accumulated surplus. Therefore, the premium on redemption of convertible debentures payable by the assessee is not a revenue expenditure. Further, while disallowing the expenditure of Rs 28, 83, 17, 552, the assessing officer observed that such expenditure is contingent upon the issue of IPO.

Decision of the CIT (A)

The CIT (A) held that the according to the agreement on 15.05.2010 the assessee company is eligible to adjust the premium payable on redemption of convertible debentures in the following years 2010-2011, 2011-2012 & 2012-2013 and allowed such expenditure as revenue expenditure.

Decision of the ITAT

The ITAT has held that there is no dispute that the premium on redemption of convertible debentures is revenue expenditure and allowed for claiming debenture during the debenture period. The ITAT, while disallowing the appeal, has observed that the contentions of the assessee that the terms of the agreement are changed to suit the parties is not sustainable and it is a make-belief story in order to claim the deduction. It is further observed that since the liability has not been crystallized, the genuineness of the transaction could not be proved beyond doubt.

Issue of the case

Whether the premium on redemption of convertible debentures payable by the assessee-Company is a revenue expenditure?

Submissions of appellant

The appellant has taken the following points in order to conclude that the order of the ITAT is sustainable in law:

• The appellant has entered into a Debenture Subscription Agreement on 25-09-2009 with HDFC Asset Management Company Ltd. wherein the HDFC has agreed to subscribe the optionally convertible debentures for an amount of Rs 62 crore, which will be redeemable on 20-09-2012.
• The appellant has agreed to redeem the debenture at a price that would entitle the HDFC to a post-tax internal rate of return (IRR) of 25%. In case, if the Initial public offer is not completed till the redemption date, in that case, the debenture would be redeemed at a pre-tax IRR of 18%.
• The subscription agreement was modified on 15.05.2010 and it was agreed by the parties that the debentures should be compulsorily converted into preference shares, which would enable the HDFC to claim post IRR of 25% on the subscription amount.
• The agreement was then again modified on 12.11.2012 wherein it was agreed that the HDFC has the option to convert the debenture to preference shares.
• Therefore, the assessee–company claimed the deduction of premium on redemption of preference shares in its revised returns.
• The revised returns were filed before the date of the second modification. Hence, the tribunal was not justified in upholding the disallowance of premium on redemption of preference shares.
• As per the act, the revenue expenditure shall be allowed for business purposes in the year in which it occurs.

Submissions of the Respondent

The submissions of the respondent are:

1. The assessee company has not claimed the deduction for the annual year 2011-2012 when the revised returns were filed. It is claimed by the respondent that the assessee company has created a make-belief story for claiming deduction and hence the tribunal is correct in the findings for disallowing the deduction of premium on redemption of convertible debentures.
2. The assessee company cannot claim the deduction of premium on redemption of convertible debentures as the liability for the assessment year has not been crystallized.

Observations of the High Court

The High Court observed that the principle adduced by the Income-tax Tribunal that the premium on redemption of convertible debentures is revenue expenditure. It is observed that the restoration of the HDCFC’s right to restore the option of converting debentures into preference shares under the modified agreement dated 12.11.2012 conforms with the original agreement. Henceforth, the HDFC can make the assessee company to redeem all the debentures upon its maturity. The court observed that the assessee company has also made a provision for premium payment and the requisite TDS.

Decision of the Court

The high court has allowed the appeal of the assessee and upheld its contentions that the deduction of premium on redemption of convertible debentures is allowed as revenue expenditure and the findings of the ITAT that it’s a make-believe story and the parties have changed the agreement to suit their convenience is not sustainable by any reason.

Conclusion

The High Court, in the appeal, has allowed that the assessee company is allowed to claim deduction of premium on redemption of convertible debentures as revenue expenditure under Section 37 (1) of the IT Act 1961. The assessee company can claim the deduction for the assessment year in which the premium was to be paid. However, if the amount is greater, then the deduction can be claimed in the following assessment years, just like as happened in the present case wherein the CIT (A) has allowed the assessee to claim a deduction of the amount in the consecutive assessment years.

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