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Explanation 3C of Section 43B of Income Tax Act, 1961 is clarificatory

In M.m. Aqua Technologies Ltd vs Commissioner Of Income Tax, on 28th November, 1996, the Appellant filed a return of income declaring a loss of Rs.1,03,18,572/- for the assessment year 1996-1997. In the return filed by it, the Appellant claimed a deduction of Rs.2,84,71,384/- under Section 43B based on the issue of debentures in lieu of interest accrued and payable to financial institutions. By an order dated 29th October, 1998, the Assessing Officer rejected the Appellants contention by holding that the issuance of debentures was not as per the original terms and conditions on which the loans were granted, and that interest was payable, holding that a subsequent change in the terms of the agreement, as they then stood, would be contrary to Section 43B(d), and would render such amount ineligible for deduction. The Commissioner of Income Tax (Appeals) [CIT] allowed the appeal which was overturned by the High Court.

The Supreme Court first looked into the section of the act which said -

43B. Certain deductions to be only on actual payment – 

Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of— 

xxx xxx xxx 

(d) any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or 

xxx xxx xxx 

shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him: 

Provided that nothing contained in this section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return. 

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Explanation 3C.—For the removal of doubts, it is hereby declared that a deduction of any sum, being interest payable under clause (d) of this section, shall be allowed if such interest has been actually paid and any interest referred to in that clause which has been converted into a loan or borrowing shall not be deemed to have been actually paid. 

The appellants argued before the SC that the debentures that were issued were not towards any future payment of liability, but towards actual payment of interest that was due and owed to the financial institution in question. Explanation 3C, which was introduced with retrospective effect, would have no application in the facts of this case as interest had not been converted into any loan or borrowing.

The SC observed that both the CIT and the ITAT found, as a matter of fact, that as per a rehabilitation plan agreed to between the lender and the borrower, debentures were accepted by the financial institution in discharge of the debt on account of outstanding interest. Thus, it is clear that interest was actually paid by means of issuance of debentures, which extinguished the liability to pay interest.

Explanation 3C, which was introduced for the removal of doubts, only made it clear that interest that remained unpaid and has been converted into a loan or borrowing shall not be deemed to have been actually paid and to prevent misuse of the provisions of Section 43B by not actually paying interest, but converting such interest into a fresh loan. On the facts found in the present case, the issue of debentures by the assessee was, under a rehabilitation plan, to extinguish the liability of interest altogether. No misuse of the provision of Section 43B was found as a matter of fact by either the CIT or the ITAT. Explanation 3C, which was meant to plug a loophole, cannot therefore be brought to the aid of Revenue on the facts of this case.

Setting aside the High Court order and restoring the order of the ITAT, the SC held that the Explanation 3C is clarificatory – it explains Section 43B(d) as it originally stood and does not purport to add a new condition retrospectively, as has wrongly been held by the High Court.

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