ORDER
R.P. Garg, Vice President
1. The President, Income-tax Appellate Tribunal has constituted this Special Bench to consider and dispose of the appeal with the following question :
Whether, the expenditure incurred by the assessee on the issuance of convertible debentures is allowable as a revenue expenditure?
2. The assessee has offered to the public 17,33,000 convertible debentures for subscription at the rate of Rs. 75 per debenture. This was in two parts; Part-A of Rs. 35 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 25 per share on the date of allotment of the debenture and Part-B of Rs. 40 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 30 per share on the expiry of 15 months from the date of allotment of the debenture. Part-B debenture was to carry an interest at the rate of Rs. 14 per annum till the date of conversion payable half yearly on 30th June and 31st December each year and on conversion. As per Clause 6 of the prospectus, the debentures till the period of conversion were transferable and transmittable in the same manner and to the same extent and subject to the same restrictions and limitations as were applicable to the existing equity shares of the company. The provisions relating to transfer and transmission in respect of the equity share as provided in the Articles of Association of the company are made to apply mutatis mutandis to the debentures as well. It further provides that the debenture-holders would not be entitled to any rights and privileges available to the shareholders of the company and the debentures were not conferred upon the holders thereof a right to receive notice or to attend and vote at any general meetings of the company or to receive annual reports of the company. The objects of the issue are stated in Part IV under the head “Particulars of the Issue – Objects of the Issue” as under:
The present issue of Debentures is being made :
1. To part finance the cost of setting up a 100 per cent EOU project for the manufacture of Grey Cotton Fabrics with an installed capacity of 38.04 lakh metres per annum.
2. To meet the requirement of funds for the existing activities of the company.
3. To have the equity shares of the company enlisted in the Slock Exchanges.
3. The project and location are stated in the prospectus as: “The Company is setting up a 100 per cent Export Oriented Unit for Manufacture of Grey Cotton Fabrics with an installed capacity of 38.04 lakh metres per annum at Karannagar Village, Distt. Mehsana, State of Gujarat, which is a Notified category II backward area. The project is being established at ASL’s existing complex. The project site has well developed infrastructural facilities viz. power, transportation, parking, insurance, communication etc. The location is also well connected to the National Highway and railway network. The availability of skilled/unskilled manpower at and around the location is adequate. The site being part of a notified backward Area, the company is eligible for benefits like electricity tariff exemption and sales tax exemption.”
4. A sum of Rs. 77,26,999 was incurred by the assessee for issuing these debentures. It was set off against the share premium in the books of account but was claimed in the computation of income as a deduction by relying upon the Supreme Court decision in the case of India Cements Ltd. v. CIT . The Assessing Officer disallowed the claim of the assessee by stating that the facts of that case are quite different. In that case, the expenditure pertained to obtaining of loan which was subsequently to be repaid whereas in the instant case, the issue expenses pertained to fully convertible debentures which shall never be repaid but shall add to the equity capital of the assessee company on conversion into shares. On the contrary, the criterion for an expenditure to be of capital nature as set out in the case law is that the assessee should obtain some assets on advantage of enduring nature and this criterion is satisfied in the assessee’s case. He observed that convertible debentures issued by the assessee were to be fully converted into equity shares on allotment or after certain period and this money received by the assessee in the form of application money was never to be repaid to the subscribers thereof. This money, in fact, permanently becomes part of the funds of the company in the form of equity and thus, the assessee company gained an advantage of enduring nature. He further observed that the Supreme Court decision relates to a period when instruments like convertible debentures were not in vogue which is a recent phenomena and, therefore, the decision or the ratio as obiter dictum given by the Supreme Court were in respect of such debentures which were not to be converted into equity share and which were to be redeemed to the debenture holders on or after a specified period. According to him, convertible debentures cannot be equated with loans as they are not to be repaid to the subscribers and it becomes part of its funds on permanent basis.
5. The CIT (A) upheld the disallowance by observing in paragraph 2.2 as under:
2.2 The appellant has relied on the decision of the Supreme Court in the case of India Cements Ltd. v. CIT in support of its contention that the expenditure is allowable as revenue expenditure. The Assessing Officer, in the order of assessment, has discussed the aforesaid decision in detail and has come to the conclusion that since the assessee, by the issue of convertible debentures, has created an asset of enduring nature (since the loan was to be converted into equity), the expenditure on the issue of such debentures cannot be treated as revenue expenditure. The conclusion reached at by the Assessing Officer is correct, as in the case of India Cements Ltd. a loan was obtained by means of ordinary debentures and no asset of enduring nature was created. The Supreme Court had held that the expenditure incurred on the issue of such debentures was an expenditure for securing the use of money for a certain period in the case of India Cements Ltd., the Supreme Court had a distinction between obtaining capital and obtaining loans, appellant, on the other hand, had issued convertible Debentures which, partly immediately and partly after a period of time (15 months), were converted into equity. Therefore, the expenditure incurred on the issue of such debentures was an expenditure to create an asset of enduring nature and the Assessing Officer has correctly disallowed it. I, therefore, agree with the Assessing Officer as also my predecessor that the debenture issue expenses of Rs. 77,26,999 could not be claimed as revenue expenditure.
6. The Id. counsel of the assessee Shri S.N. Soparkar, submitted that debenture is a loan or a borrowing and, therefore, the expenditure incurred in issuing the debentures would be an expenditure for raising a loan or borrowing and consequently, allowable deduction in view of the Supreme Court decision in the case of India Cements Ltd. (supra). He further submitted that the fact that debenture is convertible does not make any difference in law to determine the nature of the loan. Similarly, the conversion on allotment itself also is not relevant because it was originally a loan/debt. Alternatively, he submitted that proportionate expenditure to convert the same be allowed as the second debenture convertion was after 15 months which expired in 1995-96. He referred to in this connection the decision of Calcutta High Court in the case of CIT v. East India Hotels Ltd. , Bombay High Court in the case of CIT v. Mahindra Ugine and Steel Co. Ltd and in the case of Premier Automobiles Ltd. v. CIT , Supreme Court decision in the case of India Cements Ltd. v. CIT , decision of Jaipur Bench of the Tribunal in the case of Dy. CIT v. Modern Syntex (India) Ltd. [2005] 95 TTJ (Jp.) 161 3 SOT 27 and Bombay ITAT decision in the case of JM Shares & Stock Brokers Ltd. v. Dy. CIT [2004] 83 TTJ (Mum.) 1052, in the case of Dy. CIT v. A.T.V. Projects India Ltd. [2003] 84 ITD 470 and in the case of Tata Chemicals Ltd. v. Dy. CIT [2000] 72 ITD 1.
7. Shri Jagdeo, the Id. CIT -DR and Dr. Banwari Lal, DR, appearing for the revenue on the other hand, submitted that the funds were raised through convertible debentures with a view to raise capital and, therefore, the expenditure for that it would be capital expenditure in view of the two Supreme Court decisions in the case of Brooke Bond (India) Ltd. v. CIT and in the case of Punjab State Industrial Development Corporation. Ltd. v. CIT Referring to the decision of the Supreme Court in the case of India Cements Ltd. (supra) he submitted that it was a case of loan that was held to be not an asset and it was to secure finance for a certain period. A loan has to be repaid but a case of a debenture on conversion into a share, the money is never repaid but appropriated towards capital. Therefore, convertible debenture is not a loan. He referred to in this connection the decision in the case of Pepsu Road Transport Corporation. v. CIT . He also referred to the provisions of Interest Tax Act and the decision in the case of CIT v. Lakshmi Vilas Bank Ltd. . He then referred to the Bombay High Court decision in the case of CIT v. United Western Bank Ltd. , and submitted that intention in this case was to raise share capital and not to raise the money by way of a loan. He then referred to the difference of a convertible debenture and share by stating that the procedure is same for issue of convertible debenture and the share. Money received is not to be refunded in both the cases. Both are in the nature of securities listed in the Stock Exchanges. In both the cases intention is not to get back the money but investment by the subscribers. No option is given for conversion after allotment of debenture. Shares are part pasu to other shares. The object was to raise the money to finance the project which is a permanent structure without any liability to repay. The dale and manner of conversion is settled. Both can be issued at premium, which is not possible in case of a simple loan. These are the features, which distinguish a convertible debenture from a loan. He further submitted that real nature of the transaction is to be seen and in this connection, he referred to the Accounting Standard AS-21 stating the calculation of income from share and debenture recognizing the fact that it was potentially a share. He also referred in this connection to the decisions of the Supreme Court in the case of Sundaram Finance Ltd. v. State of Kerala , in the case of Juggilal Kamlapat v. CIT , in the case of Sunil Siddharthbhai v. CIT and in the case of CIT v. B.M. Kharwar . He referred to the decision of the Tribunal in the case of Sona Steering Systems Ltd. v. Dy. CIT [2003] 129 Taxman 152 (Delhi) (Mag.); Dy. CIT v. Ranbaxy Laboratories Ltd. [2004] 88 ITD 283 (Delhi); Banco Products (India) Ltd. v. Dy. CIT [1997] 63 ITD 370 (Ahd.) wherein proportionate expenditure as was relatable to convertible debentures was not allowed as a deduction. Referring to the decision in the case of Network Ltd. v. Dy. CIT [2003] 84 ITD 67 (Delhi) (TM), he submitted that it was a case of surrender of debenture and allotment of shares wherein the decision of Calcutta High Court in the case of East India Hotels Ltd. (supra) was considered and upheld the disallowance for convertible portion of debentures. Referring to the prospectus he submitted that major part of the debenture amount was adjusted as part of the premium for allotment of the shares also shows that it was issue of capital. He then referred to the provisions of Section 37(1) wherein the expenditure to be allowed is to be wholly and exclusively for the purpose of carrying on the business of the assessee and if there is a mixed purpose, then the expenditure would not be allowable. The fact that conversion is repayment is not considered in East India Hotels Ltd. ‘s case (supra) decision cannot be and is not a ground for distinction.
8. Shri Soparkar, the Id. counsel of the assessee, in reply, submitted that the repayment was by conversion and reference was invited to the decision of Supreme Court in the case of J.B. Boda &Co. (P.) Ltd. v. CBDT stating that debentures were repaid by issue of shares. He also referred to the Gujarat High Court decision in the case of CIT v. Maganlal Mohanlal Panchal (HUF) [1984] 210 ITR 580 stating that if a solitary decision is there, it is binding. He then referred to the provisions of Section 81 of the Companies Act wherein both loan and debentures are covered by Section 81(3). The cases cited by the Id. Departmental Representative, he submitted have not considered the Calcutta High Court decision. In the fourth case, however, the Calcutta High Court has considered but wrongly and shall be applicable only for Part-A of the debentures which was converted on allotment itself.
9. We have heard the parties and considered their rival submissions. There is no specific section dealing with this type of expenditure except, perhaps, Section 35D for amortization of expenditure incurred before the commencement of business or after the commencement of business but for expansion of the unit or setting up a new unit. We have to examine the case in the light of the general provisions of Section 37 allowing expenditure, except capital expenditure and personal expenditure and not covered specifically by any earlier sections, incurred wholly and exclusively for the purpose of business of the assessee and the specific provisions of Section 35D dealing with amortization of expenses. Section 37(1) reads as under:
37. (1) Any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession.
10. On a fair reading of this section it is evident that an expenditure of capital expenditure does not qualify for deduction even if incurred for the purpose of carrying on of business wholly or exclusively. Similarly if the expenditure were of personal nature it would not qualify for deduction. We find two decisions on the capital nature of the expenditure. One is in the case of Punjab State Industrial Development Corpn. (supra) and the other being Brooke Bond (India) Ltd. (supra).
11. In the case of Punjab State Industrial Development Corpn. Ltd. (supra), before the Supreme Court, the question was whether the amount paid to the Registrar of Companies as filing fee for enhancement of capital was revenue or capital expenditure. After taking into consideration the decision in the case of India Cements Ltd. (supra) and Empire Jute Co. Ltd, v. CIT , the Supreme Court held that the fee paid to the Registrar of Companies as filing fee for enhancement of capital was not a revenue expenditure by observing as under:
We do not consider it necessary to examine all the decision in extenso because we are of the opinion that the fee paid to the Registrar for expansion of capital base of the company was directly related to the capital expenditure incurred by the company and although incidentally that would certainly help in the business of the company and may also help in profit-making, it still retains the character of a capital expenditure since the expenditure was directly related to the expansion of the capital base of the company. We are, therefore, of the opinion that the view taken by the different High Courts in favour of the revenue in this behalf is the preferable view as compared to the view based on the decision of the Madras High Court in Kisenchand Chellaram’s case .
12. In the case of Brooke Bond (India) Ltd. (supra), the matter again came up for consideration before the Supreme Court and an argument was raised that the object of enhancement of capital was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. The court held that though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making, the expenses in that connection still retains the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company.
13. One thing is thus clear and certain that if the expenditure is for raising capital base it would be capital expenditure even if the funds so received have been used for business purposes and also for helping profit-making or required for more working capital needs of the company. The argument that capital was raised for enhanced requirement of working capital and for capital project or was a help in profit-making was not accepted by the Supreme Court to take out the expenditure from being capital in nature. This is because every capital expenditure also would certainly be for the purposes of business of the assessee and would help directly or indirectly in profit-making by an assessee.
14. On the other hand, the expenditure incurred for raising a loan simpliciter has been allowed as deduction under Section 36(1)(iii) if it was interest and under Section 37 if it were other expenditure. The decision on this aspect is India Cements Ltd.’s case (supra). In this case, the assessee obtained a loan of Rs. 40 lakhs from Industrial Finance Corporation by a charge on the fixed assets of the company. The proceeds of this loan was utilized to pay off a prior debt of Rs. 25 lakhs due to M/s. A.F. Harvey Ltd. and Madurai Mills Ltd. and the balance was used towards working funds. The assessee incurred a sum of Rs. 84,633 in connection with this loan by way of stamp duty, registration fee and other charges including the legal fees. The Tribunal held that the expenditure was an allowable deduction but the High Court reversed the order of the Tribunal and it observed that there can be no doubt that at least to the extent of Rs. 25 lakhs that amount was expended for purposes of a capital nature and there was no material for the utilization of the other sum of Rs. 15 lakhs. The Supreme Court referred to in this connection the decision of Bombay High Court in the case of S.F. Engineer v. CIT wherein the Bombay High Court held that the expenditure incurred for raising loan for the carrying on of a business cannot in all cases be regarded as an expenditure of a capital nature. On the facts of the case, they held that as construction and sale of the building was the sole business of the firm and the building was its stock-in-trade, and the loan was raised and used wholly for the purpose of acquiring this stock-in-trade and not for obtaining any fixed assets or raising any initial capital or for expansion of the assessee’s business, the expenditure incurred for the raising of loan was not an expenditure of capital nature but revenue expenditure. Although the conclusion of the High Court was held to be correct, the Supreme Court expressed a decent with the principle that the nature of the expenditure incurred in raising a loan would depend upon the nature and purpose of the loan. It observed that a loan may be intended to be used for the purchase of raw material when it is negotiated, but the company may, after raising the loan, change its mind and spend it on securing capital assets. It then posed a question “Is the purpose at the time the loan is negotiated to be taken into consideration or the purpose for which it is actually used? Further suppose that in the accounting year the purpose is to borrow and buy raw material but in the assessment year the company finds it unnecessary to buy raw material and spends it on capital assets. Will the Income-tax Officer decide the case with reference to what happened in the accounting year or what happened in the assessment year?” In the opinion of the Court, it was rightly held by the Nagpur Judicial Commissioner in Nagpur Electric Light and Power Co. v. CIT 6 ITC 303 that the purpose for which the new loan was required was irrelevant to the consideration of the question whether the expenditure for obtaining the loan was revenue expenditure or capital expenditure. It observed finally as “To summarise this part of the case, we are of the opinion that: (a) the loan obtained is not an asset or advantage of an enduring nature; (b) that the expenditure was made for securing the use of money for a certain period; and (c) that it is irrelevant to consider the object with which the loan was obtained. Consequently, in the circumstances of the case, the expenditure was revenue expenditure within Section 10(2)(xv).”
15. In another case of Mahindra Ugine & Steel Co. Ltd. (supra), the Bombay High Court dealt with the issue of stamp duty on debenture issues and held that it was an allowable deduction. It was contended on behalf of the Department that payment of stamp duty on debenture was not an allowable deduction but the Tribunal rejected the contention and the High Court agreed with the Tribunal by stating “the expression in connection with the issue of public subscription of the debentures of the company essentially for the expansion of the business is a very wide expression and it would certainly include the stamp duty payable by the assessee on the debenture issue. It was held in this case that the judgment of the Supreme Court in the case of India Cements Ltd. v. CIT , applies in respect of expenditure on account of s tamp duty even after introduction of Section 35D. Under the circumstances, the Tribunal was right in allowing the same.
16. In the case of Premier Automobiles Ltd, (supra) before the Bombay High Court, the amount spent for stamp duty, registration fees, lawyer’s fees, etc. in respect of the issue of debentures to secure a loan was claimed as a business expenditure and was held to be an amount spent not in the nature of capital expenditure and was laid out and expended wholly and exclusively for the purpose of assessee’s business and was, therefore, allowable as a deduction under Section 10(2)(xv) of the Act. The court observed that the act of borrowing money was incidental to the carrying on of business, the loan obtained was not an asset or an advantage of enduring nature, the expenditure was made for securing the use of money for a certain period and it was irrelevant to consider the object with which the loan was obtained.
17. The decision of the Supreme Court in India Cements Ltd.’s case (supra) and the aforesaid two decisions of Bombay High Court are in connection with the expenditure on the raising a simple loan or by issue of debentures simpliciter and not cases of raising money by issue of the convertible debentures. In the case of convertible debenture, it is nothing but raising capital by issue of equity shares increasing the capital base via media being issue of convertible debentures. The loan or borrowings are not to be repaid but retained by converting into equity shares, therefore, it cannot be said to be a borrowing or a loan. The expenditure for raising the same could not be held allowable deduction. Interest if not paid on borrowings but on capital of the assessee was held to be not allowable in the case of Pepsu Road Transport Corpn. (supra) by the Punjab and Haryana High Court. In this case the question was whether interest paid to the Northern Railway and the Punjab Government in respect of the capital borrowed for purposes of the assessee’s business was allowable under Section 36(1)(iii) of the Act and in that connection, the term ‘borrowing’ came up for consideration and it was held that the term borrow has not been defined in the statute and, therefore, its dictionary meaning has to be looked up. The meaning of the word ‘borrow’ as given in the Shorter Oxford Dictionary (3rd Edition) is “to take (a thing) on security given for its safe return. To take a thing on credit on the understanding of returning it or an equivalent”. A reference was made to the Calcutta High Court decision in the case of CBDT v. Bhartia Electric Steel Co. Ltd. wherein it was held that there has to be a positive act of lending coupled with acceptance by the other side of the money, as a loan. Thus, it is clear that an element of refund or repayment is inherent in the concept of borrowing. The assessee was incorporated under the Road Transport Corporations Act, 1950. Section 23 of the said Act incorporated that the Central Government or State Government to provide to the Corporation any capital that may be required for the purpose of carrying on the undertaking or for purpose connected therewith on such terms and conditions not inconsistent with the provisions of the Act and where the capital of the Corporation is not provided by the Central or State Government, the Corporation was to raise capital as may be authorized in this behalf by the State Government. The Corporation may at any time, with the previous approval of the State Government, redeem the shares issued to parties other than the State Government and Central Government. As per Section 28 of the Corporations Act, where the capital of a Corporation is provided by the Central Government or State Government, the Corporation was to pay interest on such capital at such rate as may, from time to time, be fixed by the State Government in consultation with the Central Government and such interest shall be deemed to be part of the expenditure of the Corporation, In view of this provision, the capital was provided by the Union of India through the Northern Railway and Punjab Government and the assessee paid interest to both of them and claimed the same as deduction. The question was whether the interest paid was an allowable deduction. The court held that there is no provision in the Act which contemplates the repayment of the capital so provided under Section 23 of the Act and apart from that, Section 23 provided that the Central Government and the State Government may provide any capital. In other words, it was not by virtue of any agreement, etc. between the parties, but because of the statutory provision that the Governments are obliged to provide the capital and that by making provision, the Corporation may borrow money in the open market for the purpose of raising its working capital. A distinction was made in the Act itself between the “capital provided” under Section 23 and the “capital borrowed” under Section 26. After noticing the fact that in the event of a Corporation being placed in liquidation and the assets of the Corporation, after meeting the liabilities, if any, shall be divided among the Central and the State Governments and such other parties as may have subscribed to the capital in proportion to the contribution made by each of them to the capital of the Corporation. The court held that there was no obligation to refund the capital provided by the Governments and in this view of the matter, the capital provided under Section 23 of the Act by the two Governments cannot be said to be capital borrowed as contemplated under Section 36(1)(iii) of the Act and, therefore, it was not an allowable deduction. On the basis of this decision, we uphold the contention of the Revenue that debentures in this case are fully convertible and there being no liability to repay but retained as capital by conversion into equity shares it was not a borrowing and consequently the expenditure on issue would not be allowable as deduction.
18. Certain decisions dealing with a question as to whether the interest received on debenture was interest received on loans and advances and, therefore, chargeable under Interest Tax Act also are relied upon. Under this Act the interest received on loans and advances are chargeable and the courts have held that interest received on debenture is not an interest on loans and advances and therefore not chargeable to tax. The first case is the case of Lakshmi Vilas Bank Ltd. (supra) before the Madras High Court, and a contention was raised by the counsel of the assessee by relying upon the Circular of the Central Board of Direct Taxes No. 665, dated 5th October, 1993 in order to show that amounts invested in purchasing the debentures would amount to investment made in approved securities. The court considered the concept of debenture as appearing in Law Lexicon at page 290 and noted that “debenture” is a document or a certificate signed by the officer of a Corporation or company acknowledging indebtedness for money lent and guaranteeing repayment with interest; a security for a loan of money issued by a public company, usually creating a charge on the whole or a part of the company’s stock and property though not necessarily in the form of a mortgage. Section 137 of the Transfer of Property Act was also noted wherein a debenture is regarded as a subject-matter of transfer and not as constituting a transfer by itself. A debenture, it was observed, means a document which either creates a debt or acknowledges it, and any document which fulfils either of these conditions is a debenture. Although the instruments called debentures may be described with comparative ease, a judicial definition of a debenture – or at any rate an accurate one has not been obtained and is perhaps not urgently required. The meaning of debenture in the Accountancy Text Book by William Pickles was also noted to mean as a document acknowledging a loan to a company and is generally executed under the seal of the company usually (but not necessarily) containing provisions as to payment of interest and the repayment of the principal and giving a charge on the assets of such company, and may give security for the payment over some or all of the debts and undertakings of the company. Halsbury’s Law of England, 4th Edition, 7th Volume page 813 is also noted to have defined the debenture to mean “A debenture is a document which either creates or acknowledges a debt. A document may be a debenture although under its terms, the debt is only to be repaid out of a part of the profits. The term ‘debenture’ is usually associated with a company of some kind, and most debentures are securities given by companies, but they are often granted by clubs and occasionally by individuals.” The definition of the term ‘debenture’ as appearing in the Companies Act in Section 2(12) was also noted as including debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. In view of the definitions given by the various authorities with regard to debenture, the court held that debentures are also in the nature of securities and in these circumstances, the finding of the Tribunal that interest on debentures is interest on investment was accepted and consequently, the payment of interest on debentures was held to be not an interest on loans and advances.
19. The second case cited is of United Western Bank Ltd, (supra) of the Bombay High Court. Here again, the question whether interest on securities, bonds and debentures was interest on loans and advances within the meaning of Interest Tax Act, 1974 came up for consideration and it was held that Interest Tax Act will not apply to interest received by the assessee bank on securities/debentures held by the assessee under the category “permanent”. The court, however, made it clear that the securities or debentures held under the caption “current” is not being considered by them and their decision was only with respect to the securities and debentures held under the category “permanent”.
20. The assessee however relied in the case of East India. Hotels Ltd. (supra). In this case, the assessee had incurred a sum of Rs. 67,18,758 on the issue of 7,50,000 debentures of Rs. 100 each for a total value of Rs. 7.50 crores and 20 per cent of that amount was converted at the end of the three years from the date of allotment of debentures by way of issue of equity shares and out of the balance 20 per cent each thereafter at the end of the 8th, 9th, 10th and 11th years from the date of allotment of debentures by payment in cheques. This 20 per cent conversion into equity shares was taken to be the repayment of debenture by the court. This according to the Id. Counsel of the assessee is a proposition that act of conversion of debenture into equity share is an act of repayment of debenture by such conversion. On a close scrutiny of the case we, however, find that it was not a finding of the court but an admission of the situation as even according to the Commissioner of Income-tax 20 per cent loan was payable by issue of shares and this along with repayment of loan within 11 years, was amounting to taking the loan not for a certain and limited period, therefore, the decision of the Supreme Court in the case of India Cements Ltd, v. CIT was held not applicable. In appeal before the Tribunal, the Tribunal has taken the view that even after insertion of Section 35D in the Act of 1961, the expenses on the issue of debentures cannot be disallowed as the decision of the Supreme Court in the case of India Cements Ltd. (supra) still holds the field and, therefore, the expenditure on the issue of debentures for short-term loan can be allowed as revenue expenses. The court, therefore, held that “Admittedly, here the loan has to be repaid within eleven years from the date of allotment of debentures. If 20 per cent of that loan is payable by the end of three years from the date of issue of debentures by way of issue of shares to make the debentures more lucrative/attractive that does not change the character of repayment of loan within eleven years. Therefore, in view of this admitted fact we find no reason to interfere in the order of the Tribunal allowing the claim of the assessee.” The court noted the observations in the case of India Cements Ltd. (supra): “To summarise this part of the case, we are of the opinion that: (a) the loan obtained is not an asset or advantage of an enduring nature; (b) that the expenditure was made for securing the use of money for a certain period; and (c) that it is irrelevant to consider the object with which the loan was obtained. Consequently, in the circumstances of the case, the expenditure was revenue expenditure within Section 10(2)(xv).” After quoting the aforesaid extract of the Supreme Court, the Calcutta High Court held in the aforesaid case that when the money is secured for certain period the expenditure is revenue expenditure within the meaning of Section 10(2)(xv) of the Act as held by the Apex Court in the case of India Cements Ltd (supra).
21. In the case of Modern Syntex (India) Ltd. (supra) the Tribunal considered the concept of debenture and observed that it was nothing more than an acknowledgement of indebtedness. It is a statement that company will pay a certain sum of money on given day and will also pay interest on the same. Debenture means a document acknowledging a loan made to the company and providing for the payment of interest on the sum borrowed until debenture is redeemed, namely, payment of principal sum. The characteristic features of the debentures are – (i) it is issued by the company and it is in the form of certain indebtedness; (ii) it provides for repayment of principal and interest at specified date or dates. With regard to convertible debenture, it was observed that an option is given to the debenture holders to convert them into equity or preferential share at stated rate of exchange after certain period which is also another form of loan for a specified period till they are converted into shares. In that case, the company issued 1,52,67,350 secured fully convertible debentures at Rs. 120 each at par aggregating to Rs. 183.2 crores. The debentures consisted of two parts of Rs. 60 each – Part-A was to be compulsorily and automatically converted into shares of Rs. 10 each at a premium of Rs. 20 each after six months and part-B was also to be converted into 2 shares of Rs. 10 each at a premium of Rs. 20 each after 18 months. The expenditure incurred on the issue of debentures compulsorily convertible into shares was allowed as a deduction.
22. In the case of Banco Products (India) Ltd. (supra) before the Ahmedabad Bench of the Tribunal, the assessee company issued 3 lakhs equity shares of Rs. 10 each and 1 lakh 15 per cent partly convertible debentures of Rs. 100 each to the public with the object specified in the prospectus – (z) to finance the capital expenditure of the company; (ii) to supplement the company’s long-term resources for working capital; and (iii) to obtain listing of the equity shares and debentures of the company on the stock exchange. A sum of Rs. 8 lakhs was incurred on these public issues and was claimed as a deduction on the basis of the ratio of the amount of shares and debentures i.e. 77 per cent for debentures. The Assessing Officer disallowed the debentures issue expenses claimed by the assessee on the ground that the expenditure was incurred to increase the share capital of the company and hence the same was not allowable as deduction. The CIT (A) held that the expenditure incurred on convertible portion of Rs. 30 each was in the nature of capital expenditure because 30 per cent of the debenture issue would go to augment the share capital of the company and the balance 70 per cent could be treated as loan. The assessee was in appeal. In paragraph 5 of the order, the Tribunal discussed the basic requirement of a debt visa-vis the convertible debenture as under:
6. We have considered the rival submissions and perused the facts on record. Basic Requirement of a debt is repayability. Broadly stated, a debt is a liquidated money obligation for the recovery of which an action will lie. It is an ascertained liquidated quantified obligation enforceable in praesenti or in futuro. A debt must be a debitum that is due. Debitum in praesenti solvendum in futuro is vital conception of a debt. Viewed from this angle, convertible portion of the debenture cannot be termed as a debt because in our considered view convertible debentures have characteristics of equity shares; these are equity shares in embryo. The conversion of such debentures on the stipulated date leads to augmentation of the equity base of the company. In the case before us convertible debentures were clearly identifiable as Equity capital. The conversion was mandatory. Hence, it cannot be said that convertible part had the characteristics of loan funds. The dale and manner of conversion was certain and nothing was left to chance and in any case when the return of income of the company was due to be filed on 30-6-1987 and was actually filed on that date, the factum of conversion was a dead certainty.
23. It distinguished the decision of the Supreme Court in the case of India Cements Ltd. (supra) by observing that the Supreme Court was dealing with a case where loan was raised and the loan was in the nature of debt. It was neither a case where issue of equity shares or convertible/partly convertible debenture was involved and, therefore, held that that decision would not be applicable in deciding the issue. The Tribunal also observed that the expenditure incurred on issue of shares would not be an allowable deduction. It, however, observed that none of the cases of the High Courts referred to before the Bench dealt with the issue of convertible/partly convertible debentures. It, therefore, held that the proportionate expenditure on the convertible part of the debentures is for the augmentation of equity base of the company and as such has to be treated as capital expenditure. It, therefore, upheld the order of the CIT (A).
24. Nature of debentures is an acknowledgement of liability to repay in cash or through bank or in any other manner as agreed to by the holder. Option was there with the holder of the debenture to get it converted or retain or get repaid as noted in decision of Lakshmi Vilas Bank Ltd.’s case (supra) and United Western Bank Ltd’s case (supra). Nature of convertible debentures could be only an advance or deposit akin to or like share of application money as there is no repayment of money but the amount received is adjusted towards shares compulsorily and interest is paid on that, also until shares are allotted and the amount is adjusted. No option is for the holder as debentures are compulsorily converted into shares. No action on the part of holder of debenture to get it converted as it is converted automatically on a specified date. Section 81 of the Companies Act deals with both in the like manner. Even the prospectus says transfer/transmission has to be carried like equity share J.B. Boda & Co. (P.) Lld.’s case (supra) was a case of liability to be discharged by the agents to remit the sale proceeds which was discharged partly by payment and partly by adjustment against expenses incurred by them and it was held that entire receipts be deemed to have been received by the assessee and the amount retained for expenses incurred by them was to be taken as a payment by the assessee. It is not a case of remittance of by payment but remittance by adjustment.
25. We find that various decisions have discussed the issue of allowability of the expenses incurred on issue of debentures in the following cases the claim of the assessee has been allowed.
(a) In the case of Modern Syntex (India) Ltd. (supra) before the Tribunal, the expenditure incurred on the issue of debentures compulsorily convertible into shares was allowed as a deduction. In that case, the company issued 1,52,67,350 secured fully convertible debentures at Rs. 120 each at par aggregating to Rs. 183.2 crores. The debentures consisted of two parts of Rs. 60 each – Part-A was to be compulsorily and automatically converted into shares of Rs. 10 each at a premium of Rs. 20 each after six months and part-B was also to be converted into 2 shares of Rs. 10 each at a premium of Rs. 20 each after 18 months. The Tribunal observed that debenture was nothing more than an acknowledgement of indebtedness. It is a statement that company will pay a certain sum of money on given day and will also pay interest on the same. Debenture means a document acknowledging a loan made to the company and providing for the payment of interest on the sum borrowed until debenture is redeemed, namely, payment of principal sum. The characteristic features of the debentures are – (i) it is issued by the company and it is in the form of certain indebtedness; (ii) it provides for repayment of principal and interest at specified date or dates. With regard to convertible debenture, it was observed that an option is given to the debenture holders to convert them into equity or preferential share at stated rate of exchange after certain period which is also another form of loan for a specified period till they are converted into shares. Referring to Section 35D and the Board’s Circular, the Tribunal held that in majority of the cases, the Tribunal had allowed the expenditure except the solitary decision in the case of Banco Products (India) Ltd. (supra) where the decision of the Calcutta High Court in the case of East India Hotels Ltd. (supra) was not available to the Ahmedabad Bench that decided the case.
(b) In the case of J.M. Shares & Stock Brokers Ltd. (supra) before the Bombay Bench of the Tribunal, the assessee issued certain convertible debentures during the year at the face value of Rs. 50 which was to be converted into five shares of Rs. 10 each and as a matter of fact, these debentures got converted into equity shares, during the year itself. The Assessing Officer treated the expenditure on the issue of convertible debentures as expenditure incurred on the issue of shares. The CIT (A) upheld the disallowance. When the matter came up before the Tribunal, the matter was decided in favour of the assessee by observing as under:
Now, limited question before us to adjudicate upon, is whether the conversion of PCD into shares in the same year or after the end of the relevant year has got any bearing on the allowability of the expenses incurred on the issue of convertible portion of the debentures. The addition by the Assessing Officer is based on this consideration alone and on this consideration only the learned CIT (A) confirmed the action of the Assessing Officer. The argument of learned Departmental Representative is also on this consideration that since conversion took place in the same year itself, it shall be treated as issue of shares, whereas the learned Authorised Representative’s argument is that the conversion was effected after six months of the issue which in this case fell within the same year but if the timing of issue had been different, the date of conversion after six months might have fallen in the next year also. There is force in the arguments of the learned Authorised Representative that at the time of issue of debentures, the convertible portion was also debentures only and only because the date of conversion after six months has fallen within the same year, it cannot be considered as issue of shares. On this count, we agree with the arguments of learned Authorised Representative and once we agree on this basic argument that the expenses were incurred for issue of debenture, the issue stands covered in favour of the assessee by the various judgments relied upon by the learned Authorised Representative and respectfully following the same, we are of the considered opinion that the disallowance of Rs. 11,01,379 towards expenses on convertible portion of partly convertible debentures is allowable as revenue expenditure.
(c) In the case of Tota Chemicals Ltd. (supra) before the Bombay Tribunal, the assessee incurred the expenditure of Rs. 16,99,497 on issue of non-convertible and partly convertible debentures. The Tribunal held that the fertilizer division of the assessee was part of the business and that was being carried on by the assessee during the relevant previous year and, therefore, the debentures issue expenses are allowable as a deduction.
(d) In the case of Fag Precision Bearings Ltd. in [IT Appeal No. 4652 (Ahd.) of 1992], the Ahmedabad Bench vide order dated 26-5-2003 held that the expenditure incurred by the assessee was for raising loan by issue of convertible debentures and the fact that ultimately the convertible debentures have been converted into shares in the subsequent year would not be of any consequence. The expenditure would remain to be an expenditure incurred for raising of finance for the purpose of business of the assessee and would, therefore, be an allowable deduction.
26. We also find that in the following cases the claim was allowed proportionately to the time the debenture was not converted in the share.
In the case of Essar Steel Ltd. v. Dy. CIT [2005] 97 ITD 125 (Ahd.) (TM), the assessee issued fully convertible debentures in the year 1989 which were converted into shares partly on allotment in 1990 and fully by 1992. The assessee incurred a sum of Rs. 6,51,95,614 for the issue of debentures and claimed the same to be revenue, even though this amount was capitalized by the assessee being expenditure incurred in connection with rights issue of debentures during the relevant accounting year. The Assessing Officer noted the object of issue to be – (i) to part-finance the steel project and related investments; (ii) to meet the expenditure of the issue, (iii) to repay the bridge loan, if any, taken against the loan issue; and (iv) to meet the normal capital expenditure of working capital needs. He observed that the entire issue went to increase the paid up capital and share premium account because the entire debenture was fully convertible into shares within a period of 15 months. He, therefore, held that the expenditure was in the nature of expenditure mentioned in Section 35D and only 10 per cent was allowed. The CIT (A) upheld the disallowance by observing that after a period of 15 months equity funds and the same fund was available as equity funds and the amount raised, therefore, was available with the assessee on a permanent basis. Reliance on the decision of the Ahmedabad Bench of the Tribunal in the case of VXL India Ltd. [IT Appeal Nos. 5382 and 5383 (Ahd.) of 1989, dated 16-6-1999] was also placed. After considering the case of the assessee, the Division Bench of Tribunal held in paragraph 39 as under:
39. We have heard the parties and considered the rival submissions. In the case of VXL India Ltd. (supra), the assessee issued convertible debentures of Rs. 125 each out of which Rs. 45 each is to be converted into three shares on 1-7-1983. The expenditure was disallowed by the Assessing Officer on the ground that portion of the convertible debenture is converted into equity shares. The Tribunal referred to the decision of the Supreme Court in the case of India Cements Ltd. (supra) the decision of the Tribunal in the case of Voltas Ltd. v. Dy. CIT [1998] 61 TTJ (Mum.) 543 as well as in the case of Telco [In IT Appeal No. 1154 (Bom.) of 1985] wherein it was held that the question of convertibility arrives at the time of repayment which is a mode of repayment only. The expenditure was incurred for raising the loan and, therefore, it was an allowable deduction. In the present case, right share of debentures were issued which were to be converted into shares within a period of 15 months. The expenditure when it was incurred was for raising loan and as held by the Tribunal in the case of VXL India Ltd. (supra) and decisions referred to therein, the conversion was only a mode of repayment of loan raised by issue of debentures. The expenditure was thus for raising the loan and, therefore, in view of the Supreme Court decision in the case of Madras Industrial Investment Corpn. (supra), the proportionate expenditure has to be allowed during the period of 15 months of the debenture. The proportionate expenditure pertaining to the year under consideration may thus be allowed to the assessee in the light of the aforesaid Supreme Court decision. The observation of the revenue authorities that it was in the nature of expenditure under Section 35D is not warranted because at the time when the expenditure was incurred, it was for right issue of debentures and not capital. We direct accordingly.
27. We further find contrary decisions on this issue. In the cases the Tribunal had upheld the disallowance of expenses for issue of the debentures, which were to be converted into shares.
(i) In the case of A.T.V. Projects India Ltd. (supra), a case before the Bombay Tribunal, 9/10th of the expenditure amounting to Rs. 53.29 lakhs was claimed as a revenue expenditure for raising loan through convertible debentures issued by treating the same expenditure as preliminary expenses and restricted the deduction to 1/10th thereof under Section 35D. Referring to the Circular of the Board and the decision of the Supreme Court in the case of India Cements Ltd. (supra), the Tribunal held that if the company incurs expenditure on issue of debentures, when it is already in business, it is not covered either under Section 35D(1)(i) or (ii) of the Income-tax Act because what is contemplated under Section 35D is an expenditure incurred before commencement of the business or after the commencement of business but in connection with the expansion of the undertaking or in connection with setting up a new unit. On the other hand, the assessee has specifically made a claim for amortization and, therefore, such expenditure will not qualify for deduction under any other provision of the Income-tax Act. Referring to the observation of the High Court “but how a deduction which is allowable otherwise as revenue expenses can be denied after the insertion of Section 35D, the learned Counsel failed to explain.”, the Tribunal observed that the Circular has nowhere stated that expenditure allowable under Section 35D should be considered under Section 37(1) of the Act. On the other hand, it merely clarifies that an expenditure which is otherwise allowable under Section 37(1) should not be disallowed merely because it does not fall under Section 35D of the Act. The Tribunal, therefore, held that the assessee was entitled to l/10th of the expenditure under Section 35D and thus restored the order of the Assessing Officer.
(ii) In the case of Sona Steering Systems Ltd. (supra) before the ITAT, Delhi Bench, the assessee claimed deduction of expenditure incurred on the issue of partly convertible debentures by way of rights issue. It was not allowed by the Assessing Officer considering the expenditure to be of capital in nature. The CIT (Appeals) allowed the claim of the assessee by holding that the expenditure was for the rights issue partly convertible debentures and not towards shares. The Tribunal, however, referring to the decision of the Supreme Court in the case of India Cements Ltd. (supra) held that the expenditure on public issue of debentures would be allowable as a revenue expenditure since the issue of debentures is made for obtaining loan whereas the expenditure incurred on the public issue of shares would be a capital expenditure not allowable under Section 37. It however, observed that the public issue in that case was of partly convertible debentures. The object of the issue was to raise the finance for expansion and diversification of the business. One debenture was issued to every shareholder holding two equity shares. Part-A was convertible part of Rs. 25 which was compulsorily and automatically to be converted into one share of Rs. 10 each at the end of six months from the date of allotment and consequently, face value of the debenture was to be reduced to Rs. 15. The equity shares allotted as a result of conversion to rank pari passu in all respects with the existing equity shares. The Tribunal observed that the same result could have been achieved by the assessee by public issue of shares and debentures separately. It was only because of convenience and from economic point of view that a combined public issue was made. In that context, it was observed by the Tribunal that it is settled legal position that nomenclature of a document is not relevant. What is relevant is the true nature of the transaction. It was apparent from the scheme that the assessee had incurred expenditure for raising capital of the company as well as loans. The Part A of debentures was to become permanent part of the capital structure of the company within a short period of 6 months from the date of allotment. It was only Part-B which was to be returned on redemption. Merely because single issue was made for shares and debentures in the guise of debenture, the entire expenditure did not partake the character of revenue expenditure. The Tribunal held that the proportionate expenditure should be allowed as revenue expenditure.
(iii) In the case of Ranbaxy Laboratories Ltd. (supra), a case before the Delhi Bench of the Tribunal, the Allowability of expenditure on fully convertible as well as partly convertible debentures came up for consideration. There, the assessee company had offered 12.5% secured convertible debentures of Rs. 300 each on rights basis and has incurred a sum of Rs. 47,54,541 on the issue of debentures. The issue of debentures was in two parts, one of Rs. 200 each which was convertible into shares after a prescribed period and the other was of Rs. 100 each non-convertible and redeemable at par at the end of 7 years from the date of allotment. The Assessing Officer allowed 1/3rd expenditure as revenue and disallowed the balance to be considered under the provisions of Section 35D. The CIT (A) allowed the entire expenditure. The Tribunal observed that the transaction is not to be understood by its nomenclature but by the real intent of such document/ transaction in view of the decision of the Supreme Court in the cases of Sunil Siddharthbhai v. CIT Taxman 14W and CIT v. B.M. Kharwar . It held that at the initial stage itself both the assessee as well as potential investors knew well in advance that a major part of the fund or the entire fund as the case may be would be converted into share capital and in such a case, the entire expenditure could not be held to be a revenue expenditure as otherwise it would be lead to absurd result and may render the judgment in the case of Brooke Bond India Ltd. (supra) as redundant. The assessee had issued fully convertible debentures in assessment year 1994-95 and after some time and ultimately the entire amount was converted into equity share capital. Following its earlier decision in Sona Steering Systems Ltd’s case (supra) the Tribunal set aside the order of the CIT (A) and restored that of the Assessing Officer.
(iv) In the case of Banco Products (India.) Ltd. (supra) before the Ahmedabad Bench of the Tribunal, the assessee company issued 3 lakhs equity shares of Rs. 10 each and 1 lakh 15% partly convertible debentures of Rs. 100 each to the public with the object specified in the prospectus -(i) to finance the capital expenditure of the company; (ii) to supplement the company’s long-term resources for working capital; and (iii) to obtain listing of the equity shares and debentures of the company on the stock exchange. A sum of Rs. 8 lakhs was incurred on these public issues and was claimed as a deduction on the basis of the ratio of the amount of shares and debentures i.e. 77 per cent for debentures. The Assessing Officer disallowed the debentures issue expenses claimed by the assessee on the ground that the expenditure was incurred to increase the share capital of the company and hence the same was not allowable as deduction. The CIT (A) held that the expenditure incurred on convertible portion of Rs. 30 each was in the nature of capital expenditure because 30 per cent of the debenture issue would go to augment the share capital of the company and the balance 70 per cent could be treated as loan. The assessee was in appeal. The Tribunal upon discussing the basic requirement of a debt vis-a-vis the convertible debentures being the repayability; that broadly stated, a debt being a liquidated money obligation for the recovery on which an action would lie; that it being an ascertained liquidated quantified obligation enforceable in praesenti or in future. A debt must be a debitum that is due; that Debitum in praesenti solvendum in futuro is vital conception of a debt and, therefore, viewed from this angle, convertible portion of the debenture could not be termed as a debt because the convertible debentures have characteristics of equity shares; these are equity shares in embryo and that the conversion of such debentures on the stipulated date leads to augmentation of the equity base of the company, the Tribunal held that convertible debentures were clearly identifiable as Equity capital, the conversion was mandatory and hence, it cannot be said that convertible part had the characteristics of loan funds. The dale and manner of conversion was certain and nothing was left to chance and in any case when the return of income of the company was due to be filed on 30-6-1987 and was actually filed on that date, the factum of conversion was a dead certainty. The Tribunal distinguished the decision of the Supreme Court in the case of India Cements Ltd. (supra) by observing that the Supreme Court was dealing with a case where loan was raised and the loan was in the nature of debt. It was neither a case where issue of equity shares or convertible/ partly convertible debenture was involved and, therefore, held that that decision would not be applicable in deciding the issue. The Tribunal also observed that none of the cases of the High Courts referred to before the Bench dealt with the issue of convertible/partly convertible debentures. It, therefore, held that the proportionate expenditure on the convertible part of the debentures is for the augmentation of equity base of the company and as such has to be treated as capital expenditure. It, therefore, upheld the order of the CIT (A).
(v) In the case of Network Ltd. (supra) before the Delhi Bench of the Tribunal, the assessee company had incurred an expenditure on the issue of partly convertible debentures and claimed it as a deduction. He Assessing Officer allowed proportionate expenditure being the amount towards non-convertible portion of the debenture and balance which related to the portion convertible into share capital was disallowed. The CIT (A) confirmed the view taken by the Assessing Officer. In the Tribunal, there was a difference of opinion between the two Members and the Third Member held in paragraphs 24, 25 and 26 as under:
24. I have considered the rival submissions and have also perused the orders passed by the learned Members constituting the Division Bench, along with the authorities relied upon before the Division Bench and now before me in the present reference. As rightly contended by the learned Departmental Representative, there is no dispute between the learned Members of the Division Bench that the expenditure pertaining to issue of share capital is not to be allowed on Revenue account. The parties before me have very aptly and have in fact clearly understood the impact of the judgment of the Hon’ble Supreme Court in the case of India Cements Ltd. (supra), but at the outset, I must observe that the reliance by the learned Judicial Member on the judgment of the Hon’ble Supreme Court in the case of Rajasthan State Warehousing Corporation (supra) is not at all appropriate since it does not deal with the point at issue as it is on the question of apportionment of expenditure between taxable items and non-taxable items of income. As against this, the judgment of the Hon’ble Supreme Court in the case of Punjab State Industrial Development Corpn. Ltd. (supra) is direct taking the view that expenditure on issue of share capital is to be treated as capital expenditure. This has been relied upon by the learned Departmental Representative and very aptly. The judgment of the Hob’ble Calcutta High Court in the case of East India Hotels Ltd. (supra) relied upon by the learned Counsel is not at all applicable since in that case an expenditure of Rs. 67,00,000 and odd was incurred on the issue of debentures and the repayment in the form of issue of equity shares over a period of time was not found to be relevant by Their Lordships who opined that the expenditure pertained to the issue of debentures and was, therefore, allowable. In the present case, it has been aptly highlighted by the learned Accountant Member and thereafter by the learned Departmental Representative that the issue of debentures and equity shares was a simultaneous act on the same date.
25. It clearly emerges from a perusal of the record that whatever be the nomenclature indicated in the various documents, the issue was of debentures and shares simultaneously and an applicant when making payment of application money and subsequently the allotment amount was in no doubt that on payment of a stipulated amount he would be issued a debenture of a stipulated value and equity shares once again of a specified value and as rightly noted by the learned Accountant Member, nothing more was required to be done on the part of the applicant and the issue of debentures and shares was simultaneous and automatic there being no intervening period of even a minute to be quite precise and accurate. The learned Accountant Member has referred to the prospectus and other relevant documents very aptly highlighting that the issue was of debentures and shares and since the intention of the assessee was manifest right at the beginning and all along, then there could be no two opinions that the total expenditure incurred on the issue was required to be bifurcated on a pro rata basis treating a part thereof to be capital in nature being related to the issue of share capital. The learned Departmental Representative has also referred to relevant portions of the prospectus and other connected documents to emphasize relevant facts of the case and her reliance on the unreported decision of the Delhi Benches of the Tribunal in the case of Sona Steering Systems Ltd, (supra) is apt and in fact direct and this would also be my observation in respect of the reported decision of the Ahmedabad Bench of the Tribunal in the case of Banco Products (India) Ltd, (supra). That was a case in which the assessee-company had incurred certain expenditure on issue of partly convertible debentures and claimed the same as Revenue expenditure by treating the same as pertaining to borrowing of funds. It was submitted before the Assessing Officer that in respect of each debenture of the face value of Rs. 100, Rs. 30 was convertible into three shares of Rs. 10 each on 30th June, 1987 and the balance of Rs. 70 was non-convertible and was redeemable in the 6th, 7th and 8th years of issue. The Assessing Officer disallowed the claim treating the same to be towards increase of share capital. On appeal, the Commissioner of Income-tax (Appeals) held that the expenditure incurred on the convertible portion i.e, 30 per cent was in the nature of capital expenditure as it would go to augment the share capital of the company and the balance was to be treated as loan. On further appeal the Tribunal confirmed the view taken by the CIT (Appeals) noting that the convertible part of the debenture was clearly identifiable and the conversion was mandatory and, therefore, it could not be said that the convertible part had the characteristics of loan funds. The Tribunal further observed that the date and manner of conversion was certain and nothing was left to chance. It is observed that in taking the aforesaid view the Tribunal in addition to numerous other judgments referred to the case of India Cements Ltd (supra) as also the judgment of the Hon’ble Calcutta High Court in the case of Brooke Bond India Ltd. v. CIT which ultimately came to be affirmed by the Hon’ble Supreme Court in Brooke Bond India Ltd. v. CIT . The view of Their Lordships of the Supreme Court was that expenditure incurred in connection with the issue of shares with a view to increase the share capital was directly related to the expansion of the capital base of the company and was, therefore, a capital expenditure. The Supreme Court followed its earlier judgment in the case of Punjab State Industrial Development Corpn. Ltd (supra).
26. In the final analysis, considering the facts of the present case as also the legal position on the subject, I in the ultimate analysis, opine that the view taken by the learned Accountant Member to treat the sum of Rs. 18,17,680 as capital expenditure was justified and proper. The file may now be placed before the learned Members constituting the Division Bench for passing an order in conformity with the majority opinion,
28. We have, therefore, to examine to which category of cases the claim of the assessee falls. To determine that, we have to first understand the real nature of the transaction in the light of the three decisions of the Supreme Court (i) in the case of Juggilal Kamlapat v. CIT ; (ii) in the case of Sunil Siddharthbhai v. CIT and (iii) in the case of CIT v. B.M. Kharwar . These cases have laid down a rule that it is the substance of the transaction which matters ignoring the nomenclature. In the case of Juggilal Kamlapat before the Supreme Court (supra), the assessee was a registered firm in which the three Singhania brothers held 51 per cent and one Bushir held 49 per cent. The firm floated a company in which the three Singhania brothers and their wives held a majority of the shares. That company appointed the assessee firm as its managing agents for a period of 25 years. The directors of the managed company wrote a letter to the financiers of the company asking for repayment of advances made by them in excess of Rs. 5 lakhs and it was resolved to call upon the assessee firm to arrange for advances of such sums of money as would be necessary to pay off the loan of the financiers. The assessee firm stated that it had no obligation to make any advances nor had it any assets on the security of which it could raise the money. The company, therefore, decided to terminate the managing agency and in turn agreed with the newly formed company for taking over the managing agency of the firm. It received a sum of Rs. 2 lakhs on the termination of the agreement. The Tribunal held that the termination of the managing agency was a collusive device practiced for the purpose of evading income-tax, that the partners of the firm continued to enjoy the benefit of the managing agency as shareholders and directors of the new managing agency company, that there was only a change in the personnel in the managing agency and not a change in office, and that the sum of Rs. 2 lakhs was received by the assessee by virtue of its office and that it was a receipt in the course of its managing agency business. The matter reached the Supreme Court and the Supreme Court held as under:
Held, (i) that in cases such as this the income-tax authorities were entitled to pierce the veil of corporate personality and look at the reality of the transaction. It was true that from the juristic point of view the company was a legal personality entirely distinct from its members and the company was capable of enjoying rights and being subjected to duties which were not the same as those enjoyed or borne by its members. But in certain exceptional cases, the court was entitled to pierce the veil of corporate entity and pay regard to the economic realities behind the legal facade. The court had power to disregard the corporate entity if it was used, for tax evasion or to circumvent tax obligations or to perpetrate fraud.
(ii) That there was proper material before the Tribunal in support of in finding that the receipt of Rs. 2 lakhs was a receipt in the course of its managing agency business and hence a revenue receipt. The managing agency business carried on by the appellant firm was not destroyed or lost to the four individual partners who constituted the firm. What happened was that the individuals who constituted the appellant firm became the directors of the newly formed company, viz. the J.K. Commercial Corporation, and in this new capacity they undertook the conduct of the managing agency business and as shareholders continued to benefit from the profits of that business flowing the them in the shape of dividend instead of as a share of profits from the assessee-firm. In other words, the managing agency asset was enjoyed by the four individual partners in different capacity with the same object of profit-making. There was, therefore, no destruction of the apparatus of the profit-making asset, i.e., managing agency contract.
29. In the case of Sunil Siddharthbhai (supra), while considering a case of a partner making over capital asset which are held by him to a firm as his contribution towards capital whether amounts to transfer of capital asset, the Supreme Court observed as under:
If the transfer of the personal asset by the assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on capital gain, it will be open to the income-tax authorities to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, whether the transaction of transferring the personal asset to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert the personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain. The Income-tax Officer will be entitled to consider all the relevant indicia in this regard, viz, whether the partnership is formed between the assessee and his wife and children or substantially limited to them, whether the personal asset is sold by the partnership firm soon after it is transferred by the assessee to it, whether the partnership firm has no substantial or real business or the record shows that there was no real need for the partnership firm for such capital contribution from the assessee. All these and other pertinent considerations may be taken into regard when the Income-tax Officer enters upon a scrutiny of the transaction, for in the task of determining whether a transaction is a sham or an illusory transaction or a device or ruse, he is entitled to penetrate the veil covering it and ascertain the truth.
30. In case of B.M. Kharwar (supra) before the Supreme Court while dealing with the transfer of asserts from a firm to the company observed as under:
It is now well-settled that the taxing authorities are not entitled, in determining whether a receipt is liable to be taxed, to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as ‘the substance of the matter’. The taxing authority is entitled, and is indeed bound, to determine the true legal relation resulting from a transaction the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the ‘substance of the transaction’.
This principle applies alike to cases in which the legal relation is recorded in a formal document, and to cases where it has to be gathered from evidence – oral and documentary – and conduct of the parties to the transaction.
Where machinery of a factory belonging to a firm is transferred to a private limited company, assuming that thereby readjustment of the business relationship was intended, the liability to be taxed under the second proviso to Section 10(2)(vii) of the Indian Income-tax Act, 1922, in respect of the readjustment has to be determined according to the strict legal form of the transaction. The company is a legal entity distinct from the partnership under the general law, the transfer of the machinery is by the firm to the company, and the legal effect of the transaction is to convey for consideration the rights of the firm in the machinery to the company. If the transaction results in excess realisation over the written down value of the machinery to the firm, the liability to tax, if any, arising under the Act cannot be avoided merely because in consequence of the transfer the interest of the partners in the machinery is substituted by the interest in the shares of the company which owned the machinery.
By virtue of the amendment made in the second proviso to Section 10(2)(vii) by Section 11 of the Taxation laws (Extension to Merged States and Amendment) Act, 1949, even under a ‘realisation sale’, the excess over the written down value not exceeding the difference between the original cost and the written down value is liable to be brought to tax.
31. The decisions of the Tribunal in the cases of sona Steering Systems Ltd v. Dy. CIT [2003] 129 Taxman 152 (Delhi) (Mag.); CIT v. Ranbaxy Laboratories Ltd. [2004] 88 ITD 283 (Delhi); Banco Products (India) Ltd v. Dy. CIT [1997] 63 ITD 370 (Ahd.) have also been decided by looking into the substance of the matter and held that the expenditure as was relatable to non-convertible debentures alone was allowable as a deduction. Accounting Standard AS-20 issued by the Institute of Chartered Accountants of India have also understood the convertible debenture as an equity share while determining the earnings per share where the basic earnings per share is required to be calculated by dividing the net profit or loss for the period attributable to equity shareholders by the weighed average number of equity shares outstanding during the period. In that connection, a potential equity share is required to be taken into consideration which is defined to mean “a financial instrument or other contract that entitles, or may entitle, its holder to equity shares”. In Clause 7, one of the examples of potential equity shares is stated to be “debt instruments or preference shares, that are convertible into equity shares”.
32. Reference was invited to Section 35D wherein the expenditure on the issue of shares and/or debentures is dealt with and contention raised by the Revenue is that the expenditure covered under this section could not be allowed under the residuary Section 37 of the Act. This section reads as under:
35D. (1) where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in Sub-section (2),-
(i) before the commencement of his business, or
(ii) after the commencement of his business, in connection with the extension of his industrial undertaking or in connection with his setting up a new industrial unit, the assessee shall, in accordance with and subject to the provisions of this section, be allowed a deduction of an amount equal to one-tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation.
(2) The expenditure referred to in Sub-section (1) shall be the expenditure specified in any one or more of the following clauses, namely:
(a) expenditure in connection with–
(i) preparation of feasibility report;
(ii) preparation of project report;
(iii) conducting market survey or any other survey necessary for the business of the assessee;
(iv) engineering services relating to the business of the assessee:
Provided that the work in connection with the preparation of the feasibility report or the project report or the conducting of market survey or of any other survey or the engineering services referred to in this clause is carried out by the assessee himself or by a concern which is for the time being approved in this behalf by the Board;
(b) legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee;
(c) where the assessee is a company, also expenditure–
(i) by way of legal charges for drafting the Memorandum and Articles of Association of the company;
(ii) on printing of the Memorandum and Articles of Association;
(iii) by way of fees for registering the company under the provisions of the Companies Act, 1956 (1 of 1956);
(iv) in connection with the issue, for public subscription, of shares in or debentures of the company, being underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus;
(d) such other items of expenditure (not being expenditure eligible for any allowance or deduction under any other provision of this Act) as may be prescribed.
33. This section basically applies to the expenditure incurred before commencement of business. It also applies to the expenditure incurred after commencement if there was expansion of industrial undertaking or setting up of a new industrial unit. The object of the issue of debentures is stated to be three-one of which is financing the new 100 per cent EOU project of gray cotton fabrics at Karnanagar, Mehsana District in Gujarat; the other being to have the equity shares enlisted in the stock exchange which was possible when there is a large equity base and the third being financing the existing business. Thus, one of the objects falls in Section 35D, sure and certain, as there is setting up a new industrial unit. l/3rd of the expenditure falls sure and certain under Section 35D(2)(c)(iv) as both the shares and debentures are included in the said clause. As regards the enabling enlisting of equity shares at Stock Exchange, that may also fall in Section 35D, if a connection is established that the higher equity was necessary or had a connection for setting up the 100 per cent EOU unit. In any case the object for issue as is evident from the prospectus the debentures are to be fully converted into equity shares and thus expansion of capital base as such cannot fall in Section 35D unless as aforesaid it has a relation to or it was for setting up the new unit of 100 per cent EOU, The third object namely, financing the existing business cannot fall in Section 35D but in the light of the Supreme Court decision it would normally be expenditure covered under Section 37 if it was a simple raising of loan by issue of debentures unless that is ultimately found to have been a prelude to and be for the object to increase the capital base. The last 2 categories depend upon the intention of the assessee. If the intention was to issue the shares and via route of convertible debentures is adopted the expenditure would be capital. That intention in second case is evident as the issue of debentures was to enable it to enlist the equity shares in stock exchange. For the second also, when the debentures are compulsorily to be converted into equity shares the intention is implicit that they were issued for increasing the capital base of the company. It is true that part-B debentures were to be converted after 15 months and during those 15 months the money received on the issue of debentures was only as a loan or advance or deposit pending allotment of shares like application money. But it being towards allotment of shares ultimately no allowance on proportionate can also be allowed to the assessee.
34. Certain cases dealing with the provisions of Section 35D vis-a-vis Section 37 were referred to. First decision is in the case of East India Hotels Ltd. (supra), the Calcutta High Court considered the provisions of Section 35D and the Board’s Circular No. 56, dated 19-3-1971 held that Section 35D has been introduced to give benefit to the assessees in cases of capital expenses and that the Board had clarified that the provision for amortization is not intended to supersede any other provision of the Income-tax Law under which such expenditure is admissible as a deduction or deduction allowable by virtue of the decision of the Supreme Court in India Cements Ltd’s case (supra). In the another decision in the case of Mahindra Ugine & Steel Co. Ltd. (supra), the Bombay High Court dealt with the issue of stamp duty on debenture issues and held that it was an allowable deduction de hors provisions of Section 35D of the Act. It was contended on behalf of the Department that payment of stamp duty on debenture was not an allowable deduction but the Tribunal rejected the contention and the High Court agreed with the Tribunal by stating “the expression in connection with the issue of public subscription of the debentures of the company essentially for the expansion of the business is a very wide expression and it would certainly include the stamp duty payable by the assessee on the debenture issue”. Section 35D would apply only in respect of expenditure which is otherwise not allowable under the law, for example, capital expenditure. Therefore, in this case, the judgment of the Supreme Court in the case of India Cements Ltd. v. CIT , applies in respect of expenditure on account of stamp duty even after introduction of Section 35D. Under the circumstances, the Tribunal was right in allowing the said deduction. In the yet another case of Premier Automobiles Ltd. (supra) before the Bombay High Court, the amount spent for stamp duty, registration fees, lawyer’s fees, etc. in respect of the issue of debentures to secure a loan was claimed as a business expenditure and was held to be an amount spent not in the nature of capital expenditure and was laid out and expended wholly and exclusively for the purpose of assessee’s business and was, therefore, allowable as a deduction under Section 10(2)(xv) of the Act. The court observed that the act of borrowing money was incidental to the carrying on of business, the loan obtained was not an asset or an advantage of enduring nature, the expenditure was made for securing the use of money for a certain period and it was irrelevant to consider the object with which the loan was obtained. In the case of Modern Syntex (India) Ltd. (supra), referring to Section 35D and the Board’s Circular, the Tribunal held that in majority of the cases, the Tribunal had allowed the expenditure except the solitary decision in the case of Banco Products (India) Ltd. (supra) where the decision of the Calcutta High Court in the case of East India Hotels Ltd. (supra) was not available to the Ahmedabad Bench that decided the case. In the case of ATV Projects India Ltd. (supra), a case before the Bombay Tribunal, 9/10th the expenditure amounting to Rs. 53.29 lakhs was claimed as revenue expenditure for raising loan through convertible debentures issued by treating the same expenditure as preliminary expenses and restricted the deduction to 1/10th thereof under Section 35D. Referring to the Circular of the Board and the decision of the Supreme Court in the case of India Cements Ltd (supra), the Tribunal held that if the company incurs expenditure on issue of debentures, when it is already in business, it is not covered either under Section 35D(1)(i) or (ii) of the Income-tax Act because what is contemplated under Section 35D is an expenditure incurred before commencement of the business or after the commencement of business but in connection with the expansion of the undertaking or in connection with setting up a new unit. On the other hand, the assessee has specifically made a claim for amortization and, therefore, such expenditure will not qualify for deduction under any other provision of the Income-tax Act. Referring to the observation of the High Court “but how a deduction which is allowable otherwise as revenue expenses can be denied after the insertion of Section 35D, the learned Counsel failed to explain”, the Tribunal observed that the Circular has nowhere stated that expenditure allowable under Section 35D should be considered under Section 37(1) of the Act. On the other hand, it merely clarifies that an expenditure which is otherwise allowable under Section 37(1) should not be disallowed merely because it does not fall under Section 35D of the Act. The Tribunal therefore, held that the assessee was entitled to 1/10th of the expenditure under Section 35D and thus restored the order of the Assessing Officer. We, however, need not express any opinion on the applicability of Section 35D as that is not an issue directly before us and only an indirect reference has been made.
35. Maganlal Mohanlal Panchal (HUF)’s case (supra) – Gujarat High Court decision, states that a solitary decision is to be followed but only when it is applicable to the facts and circumstances of the case. It has a persuasive value and not a binding decision like that of Supreme Court. This is with regard to decision of Calcutta High Court in the case of East India Hotels Ltd (supra). In this case, the debenture was held to be loan and 20 per cent repaid by allotment of shares was found to be an incentive for debentures subscription. There is nothing in the present case of that nature. Intention was to issue shares, partly on allotment of debenture itself and partly after 15 months. Here, the intention is thus was otherwise. The conversion is not an incentive for debenture but a prelude to issue of shares.
36. We, therefore, hold that the raising of funds by issue of convertible debentures was to raise capital by ultimately converting debentures into equity share without giving an option to debenture holder to get repayment or a say in conversion. Substance of the transaction is issue of equity capital partly on the date of allotment of debentures. The contention of the assessee that expenditure relating to conversion partly after 15 months can at least be held as revenue has no force as the nature of such retention is akin to share application money pending allotment of shares.
37. In the result, the appeal of the assessee is dismissed.