Nirma Industries’ Pro-Rata Deep-Discount Bond Interest Deduction Stands Though Payable At Maturity: Gujarat HC

The Revenue appealed under Section 260A of the Income-tax Act, 1961, against the Tribunal’s decision allowing Nirma Industries Ltd. a proportionate deduction for discount/interest accruing on Deep Discount Bonds (DDBs) and optionally convertible premium notes (OFCPNs) during Assessment Year 2004–05.

The Tribunal followed its earlier decision for Assessment Year 2002–03, which had allowed proportionate deduction by spreading the liability over the debentures’ term.

The bonds’ discount was payable at maturity, but the assessee claimed the corresponding expense on an accrual basis over the period of the bonds

1. Whether the Tribunal was right in law and on the facts in reversing the CIT(A)’s order and deleting the disallowance of ₹10,98,52,704 in interest on various DDBs/OFCPNs

2. Whether the assessee could deduct, on a proportionate basis for the relevant year, the discount/interest liability payable on maturity of the bonds

Sections 36(1)(iii) and 37 of the Income-tax Act govern deductions for interest on capital borrowed for business and business expenditure, respectively; Section 145 concerns the method of accounting.

In Madras Industrial Investment Corporation Ltd. v. CIT, (1997) 225 ITR 802 (SC), the Supreme Court held that although liability for discount on debentures is incurred in the year of issue, where it secures a continuing benefit over the debenture period, the discount may be spread over that period and deducted proportionately.

Taparia Tools Ltd. v. Joint Commissioner of Income-tax, (2015) 372 ITR 605 (SC), states that revenue expenditure is ordinarily deductible in the year incurred, while spreading over may be appropriate where the assessee seeks it and the matching principle is satisfied

The Court noted that the bond terms created a contractual liability in the year of issue, even though payment was deferred until maturity, and that the liability related to a continuing business benefit over the bonds’ term.

The assessee had claimed the discount/interest proportionately, rather than seeking to deduct the entire amount in the year of issue.

Applying Madras Industrial Investment Corporation, the Court accepted that the proportionate amount related to the relevant accounting period and that deferred payment did not defeat deduction under the accrual method.

It therefore found no legal infirmity in the Tribunal’s application of the matching principle

It held that the Tribunal was justified in allowing the proportionate deduction for discount/interest on the DDBs/OFCPNs and dismissed the Tax Appeal