Whether Upfront Payment of Interest on Debentures Allowed as Deduction in the Year of Payment

INCOME TAX QUESTIONS & ANSWERS SERIES PART-X

Whether upfront payment of interest on debentures will not be allowed as deduction during the year of payment

We are going to analyze a problem in which a company has paid upfront interest on an option exercised by debenture holders and claim the whole payment as an expenditure in the same previous year. But the AO has disallowed the same and spread the expenditure over a period of five years due to different treatment given in the books of accounts of assessee.

PROBLEM: M/s. ABC Ltd., has issued debentures in previous year 2020-21 ,where were to be matured at the end of five years from the date of issue. The debenture holders were given an option of one time upfront payment of Rs. 60.00 per debenture on account of interest which was to be immediately paid by the company. As per option exercise by debenture holders , company paid interest upfront to them in the first year itself and same was claimed as expenditure in the year of payment. But in the books of accounts of the ABC Ltd., the same expenditure was shown as “ Deferred Revenue Expenditure “ and same will be deductible over a period of five years during the terms of debentures.

The Assessing Officer spread the upfront paid interest over a period of five years and allowed one fifth(1/5) of interest to be claimed during the previous year under consideration. Analyze the decision of AO.

LET'S FIRST CONSIDER APPLICABLE PROVISIONS OF THE INCOME TAX ACT, 1961

SECTION 36(1)(iii) PROVIDES THAT

(i) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28.

(ii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession.

Explanation

Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed shall be deemed to be capital borrowed within the meaning of this clause.

DEFERRED EXPENSES, also known as deferred charges, fall in the long-term asset category. When a business pays out cash for a payment in which consumption does not immediately take place or is not planned within the next 12 months, a deferred expense account is created to be held as a non current asset on the balance sheet. Full consumption of a deferred expense will be years after the initial purchase is made. The deduction is allowed in case of Deferred Expenses over the time period during which their benefits received by the company. In above case the debentures were issued and same will be redeemable over a period of five years and hence interest accrued in each year is supposed to claim as expenditure.

ANSWER

The facts of the case were similar to the case of Taparia Tools Ltd., Vs. JCIT(2015) 372 ITR 605, wherein the Supreme Court observed that under Section 36(1)(iii) , the amount of interest paid in respect of Capital Borrowed for the purpose of business or profession , is allowable as deduction.

The moment the option of upfront payment of interest was exercise by the debenture holders , the liability to make payment interest by ABC Ltd, has raised. In the bone case not only the liability of payment of interest has arisen but also it was qualified and paid during concerned previous year by the ABC Ltd.

The fact that a different treatment was given in the books of accounts could not be the factor which would bar the company for claiming full expenditure as deduction in he same previous year in which payment was made.

Accordingly, the action of Assessing Officer in spreading the upfront payment of interest over period of five years and restriction the deduction during FY 2020-21 only one fifth of the same is not correct.

The company is eligible to claim the whole amount of interest paid as upfront interest during FY 2020-21 and the same will be allowed as deduction under Section 36(1)(iii) of the Income Tax Act, 1961.

DISCLAIMER: The above write up is an attempt to share information and knowledge with our readers. The view expressed here are the personal views of the author and same should not be considered as a professional advice. It is advisable to consult with your tax consultant before acting on any part of this article.