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Income Tax Appellate Tribunal, “B” BENCH, MUMBAI
Before: SHRI SAKTIJIT DEY, HONBLE & SHRI NARENDRA KUMAR BILLAIYA, HONBLE
ORDER \nPER NARENDRA KUMAR BILLAIYA, AM:\nI.T.A. No. 1418/Mum/2025 & are\ncross-appeals by the assessee and the revenue preferred against the\norder dated 18/12/2024 by NFAC, Delhi [hereinafter “the ld.CIT(A)"],\npertaining to AY 2017-18.\n2\n2. We first take up the assessee's appeal in ITA No.\n1418/Mum/2025.\n3. The solitary grievance of the assessee is that the ld. CIT(A) erred\nin sustaining the disallowance of Rs.11,56,72,935/- made u/s 36(1)(iii)\nof the Act by the AO.\n4. Briefly stated the facts of the case are that the assessee filed its\nreturn of income on 31/10/2017 declaring total income at\nRs.3,57,13,060/-. The return was selected for scrutiny assessment and\naccordingly statutory notices were issued and served upon the assessee.\nThe assessee is engaged in the business of operation and maintenance\nof an information technology Park. During the course of scrutiny\nassessment proceedings and on perusal of the notes to the accounts, the\nAO found that during the year under consideration pursuant to the\napproval of the Hon'ble Bombay High Court, the assessee has been\npermitted to reduce its capital by cancelling up to a maximum of 2 lakhs\npreference shares of Rs.100/- each fully paid up and returning the said\ncapital to the preference shareholders of an aggregate amount not\nexceeding Rs.70 crores/-. Accordingly, the assessee reduced the\nnumber of preference shares from 253185 by cancelling 165433\nredeemable optionally convertible shares of Rs.100/- each and\nreturning capital to the preference shareholders at Rs.4050/- per\nredeemable optionally convertible preference shares of Rs.100/- each\naggregating to Rs.67,00,03,650/- as per the scheme sanctioned by the\nHon'ble High Court of Bombay.\n4.
1. The premium of Rs.3950/- per share payable on capital reduction\nof 165433 redeemable OCPs, aggregating to Rs.65,34,60,350/- was\n3\npartly adjusted to the extent of Rs.16,89,73,947/- against the balance in\nthe surplus in the statement of profit and loss account and balance\namounting to Rs.48,44,86,403/- was adjusted against the balance in the\nrevaluation reserve and both the accounts stood reduced to that effect.\n4.
1. 1. The AO further found that the assessee has borrowed funds to be\nutilised for payment to shareholders on capital reduction and\nquestioned the interest thereon. The AO was of the opinion that the\ninterest thereon should be treated as capital expenditure in nature. The\nAO based his belief that the loan has been used for the purpose of capital\nreduction undertaken by the company on which interest expenditure of\nRs.11,56,72,935/- has been incurred. The assessee has claimed this\ninterest as revenue expenditure. Accordingly, the assessee was issued a\nshowcause notice as to why the same should not be disallowed u/s\n36(1)(iii) of the Act. The assessee filed detailed reply claiming that\nsection 36(1)(iii) of the Act is a self-contained code and it has to be read\nin its own terms. It was explained that the borrowing of the loan and\nactual application thereto are two separate transactions. The provisions\nof Section 36(1)(iii) of the Act attracts the transaction of the borrowing\nand not transaction of investment. It does not distinguish whether the\nloan is borrowed for the revenue purpose or the loan is borrowed for a\ncapital purpose and the assessee is entitled to claim interest paid on\nborrowed loan provided the loan is used for the purpose of business\nirrespective of what may be the result of using the loan which the\nassessee had borrowed. It was strongly contended that the assessee has\nsatisfied all the prescribed conditions u/s 36(1)(iii) of the Act.\n4\n4.
The submissions made by the assessee did not find any favour\nwith the AO who continue his belief that the assessee has borrowed\nfunds to repay shareholders and it is well established that expenditure\nincurred for payment of owners' fund does not tantamount to\nexpenditure incurred for the purpose of business and profession. The\nAO reiterated that u/s 36(1)(iii) of the Act, interest can be allowed only\nif the assessee proves that the same is for the business purpose.\nReferring to various judicial decisions the AO disallowed interest paid\nof Rs.11,56,72,935/-.\n4.
The assessee challenged the addition before the ld. CIT(A) but\nwithout any success.\n5. Before us, the ld. Counsel vehemently stated that there is no\ndispute regarding the reduction of the capital which scheme has been\napproved by the Hon'ble High Court of Bombay. The assessee had\nborrowed money for the payment to the shareholders which has also\nnot been doubted by the AO. The only reason given by the AO is that\ninterest paid on the money borrowed for reduction of capital is not for\nthe purpose of business. The ld. Counsel placed reliance on the\ndecisions of the Hon'ble High Court of Gujarat in the case of Deputy\nCommissioner Of Income-Tax vs Core Healthcare Ltd [2001]251 ITR 61(Guj)\nand the Hon'ble Supreme Court in the case of Eastern Investments\nLimited v. Commissioner of Income-tax (1951) 20 ITR 1 (SC).\nThe ld. D/R placed strong reliance on the assessment order and\nthe order of the ld. CIT(A) and read the operative part.\n6. We have carefully considered the orders of the authorities below\nand the judicial decisions relied upon by the ld. Counsel. The\n5\nundisputed facts are that the articles of association of the assessee\ncompany authorises the assessee company which can from time to time,\nby special resolution, reduce its capital in any manner authorised by\nlaw. Pursuant to such powers conferred upon it, the board passed\nspecial resolution to reduce its capital and the said resolution has been\napproved by the Hon'ble High Court of Bombay. In order to reduce its\ncapital as approved by the Hon'ble High Court of Bombay, the assessee\nutilized the borrowed funds and paid interest thereon and claimed it as\nrevenue expenditure. The entire quarrel revolves around the\nallowability of such interest payment u/s 36(1)(iii) of the Act, which\nprovides as under:-\n“36(1) The deductions provided for in the following clauses shall be allowed in\nrespect of the matters dealt with therein, in computing the income referred to in\nSection 28 -\n(i) and (ii)******\nII the amount of the interest paid in respect of capital borrowed for the purposes of\nthe business or profession :-\nProvided that any amount of the interest paid, in respect of capital borrowed for\nacquisition of an asset for extension of existing business or profession (whether\ncapitalized in the books of account or not); for any period beginning from the date on\nwhich the capital was borrowed for acquisition of the asset till the date on which such\nasset was first put to use, shall not be allowed as deduction.\nExplanation. - Recurring subscriptions paid periodically by shareholders, or\nsubscribers in Mutual Benefit Societies which fulfill such conditions as may be\nprescribed, shall be deemed to be capital borrowed within the meaning of this clause.\"\n7.\nIn light of the aforementioned provisions, the assessee is required\nto fulfil the following conditions:-\n(i) the assessee must have borrowed money.\n(ii) the borrowing must be for the purpose of business &;\n(iii) the assessee must have paid interest on the borrowed amount\nwhich he has shown as an item of expenditure.\n6\n7.
1. There is no dispute that the assessee has borrowed money and\nthere is no dispute that the assessee has paid interest thereon. The only\ndispute is that whether the money so borrowed has been utilized for the\npurpose of business. Now, the moot question which needs our\nconsideration is whether reduction of share capital amounts to \"for the\npurpose of business”.\n8. The Hon'ble Gujarat High Court in the case of Core Healthcare Ltd.\n(supra), has observed as under :-\n“There is an inherent indication in the Act that any expenditure which is in the\nnature of capital expenditure would not be allowable as a deduction while computing\nthe income chargeable under the head \"Profits and gains of business or profession\"\nas laid down in Section 37 of the Act ; but in the same section the portion in\nparenthesis lays down that such expenditure has to be \"not being expenditure of the\nnature described in Sections 30 to 36\". Therefore, there is a specific provision dealing\nwith interest paid/payable in respect of the borrowings incurred for the purposes of\nbusiness and hence the general provision viz., Section 37 of the Act cannot come into\nplay. Therefore, whether the interest is paid for a borrowing which is utilised for\nacquisition of capital asset or which is utilised for a revenue purpose loses its\ndistinction and if that be so the stand adopted by the Revenue that in respect of\ninterest which is capitalised, after the commencement of the business but before an\nasset is first put to use cannot be allowed as a revenue deduction under Section\n36(1)(iii) of the Act is against the plain language of the provisions of the Act.\"\n8.
1. This decision of the Hon'ble Gujarat High Court has been upheld\nby the Hon'ble Supreme Court in Core Health Care Ltd. 298 ITR 194 (SC).\n9.\nThe Hon'ble Supreme Court in the case of Eastern Investments\nLimited v. Commissioner of Income-tax (supra) had the occasion to consider\na situation where the company agreed to reduce its share capital by ₹ 50\nlakhs and the shareholder agreed to forgo cash payment and agreed\ninstead to receive debentures of face value of ₹ 50 lakhs carrying interest\nat 5% per annum. The claim of interest paid on such debenture as\nexpenditure was the subject matter of the quarrel before the Hon'ble\nCourt. The Hon'ble Supreme Court observed as under:-\n7\n“The next point on which some stress was placed was that there was complete\nidentity of person between the person whose shares were sold and the person who\ntook the debentures and that the transaction resulted in considerable benefit to him.\nIn the absence of a suggestion of fraud this is not relevant at all for giving effect to\nthe provisions of section 12(2) of the Income tax Act. Most commercial transactions\nare entered into for the mutual benefit of both sides, or at any rate each side hopes to\ngain something for itself. The test for present purposes is not whether the other party\nbenefitted, nor indeed whether this was a prudent transaction which resulted in\nultimate gain to the appellant, but whether it was properly entered into as a part of\nthe appellant's legitimate commercial undertakings in order indirectly to facilitate\nthe carrying on of its business.\"\n9.
1. And further observed as under:-\n“On a full review of the facts it is clear that this transaction was voluntarily entered\ninto in order indirectly to facilitate the carrying on of the business of the company\nand was made on the ground of commercial expediency. It therefore falls within the\npurview of section 12(2) of the Income-tax Act, 1922 before its amendment in 1939.”\n9.
2. The Hon'ble Supreme Court has set at rest the allegations made\nby the AO/ld. CIT(A) that the impugned transaction is not carried out\nfor the purpose of business. The Hon'ble Supreme Court has clearly laid\ndown the following test :-\n“The test for present purposes is not whether the other party benefitted, nor\nindeed whether this was a prudent transaction which resulted in ultimate\ngain to the appellant, but whether it was properly entered into as a part of\nthe appellant's legitimate commercial undertakings in order indirectly to\nfacilitate the carrying on of its business.”\n[Emphasis supplied]\n10. Considering the facts of the case in totality in light of the decisions\ndiscussed hereinabove, the disallowance of interest u/s 36(1)(iii) of the\nAct is uncalled for and is directed to be deleted.\n11. We now take up the revenue's appeal in I.T.A. No.\n1025/Mum/2025,\n12. The grievance of the revenue reads as under:-\n\"1. \"Whether on the facts and in the circumstances of the case and in law, the\nLd. CITYA) erred in deleting the tax levied under Section 115QA of the Income-fax\nAct, 1961, on the capital reduction undertaken by the assessee, failing to appreciate\nthat the said transaction amounts to buyback of shares and distribution of profits,\n8\nand is therefore liable to tax as per the provisions of the said section 115QA of the\nAct?\"\n2. \"Whether on the facts and in the circumstances of the case and in law, the Ld,\nCIT(A) erred in ignoring Explanation fil) to Section 115QA, which defines\n'distributed income' and mandates that tax be levied on the excess consideration paid\nover the issue price, thereby incorrectly holding that the capital reduction in question\ndoes not result in any buyback' as contemplated under the Act?\"\n3.\n\"Whether on the facts and in the circumstances of the case and in law, the\nLd. CITA) erred in failing to appreciate the principle laid down by the Hon'ble\nSupreme Court in the case of K.P, Varghese v. ΤΟ /(1981) 131 IR 597 (SC), which\nemphasizes that the substance of a transaction must he considered over its form, and\nthereby overlooking that the capital reduction was, in effect, a buyback of shares?\"\n4.\n\"Whether on the facts and in the circumstances of the case and in law, the\nLd. CIT(A) erred in disregarding the binding precedents laid down by the Hon'ble\nSupreme Court in. Vodafone International Holdings B.V. u. UOI (2012) 341 TR 1\n(SC) and the Hon'ble Delhi High Court in Cairn India Lid. v. DCIT (2019) 414 MR\n300 (Del), which categorically hold that capital reduction resulting in payments to\nshareholders is akin to a buyback and consequently liable to tax under Section\n115QAP\"\n5. \"Whether on the facts and in the circumstances of the case and in law, the\nLd. CIT(A) erred in deleting interest levied u/s 115QB of the Act which is chargeable\nas the company distributing profit failed to deposit tax payable w/s 115QA within\n14 days of the date of payment of consideration to the shareholders on buyback of\nshares.\n6.\n\"The appellant prays that the order of the CIT(A) on the grounds be set aside\nand confirms the order of the AO.\"\n7.\n\"The appellant craves leaves to add, amend or alter all or any of the grounds\nof appeal.\"\n13. Briefly stated, the facts of the case are that during the course of\nscrutiny assessment proceedings, on finding that there was a capital\nreduction by the assessee during the year, the AO issued the following\nshowcause notice to the assessee:-\n“It is observed from your submissions during assessment proceedings that during\nthe year, you have undertaken the process of capital reduction pursuant to Hon'ble\nBombay High Court Order, whereby you have cancelled 1,65,433 ROCPS\n(Redeemable Optionally Convertible Preference Shares) of Rs 100 each on\n19.05.2016 and you have paid Rs 67,00,03,650/- to the ROCPS holders on\n31.05.2016 i.e., @ Rs 4,050 per share. The said payment attracts the provisions of\nSection 115QA of the Income Tax Act 1961.\"\n14. The assessee was further asked to explain the following:-\n“1. Please explain when the above Equity shares were issued and at what price, with\nsupporting evidences? In case there has been any transfer of the same, please submit\n9\ncomplete details of transferor/ transferee, and the price at which such transfer taken\nplace, with supporting evidences.\n2. Please submit copy of the High Court Order, and relevant document evidencing\nthe cancellation of above Equity shares.\n3. Please submit copy of relevant Bank Statement showing the payments made to\nabove Equity shareholders.\n4. Please show cause as to why additional tax u/s 115QA r.w.r. 40BB should not be\nlevied in the case.\"\n15. The assessee filed a detailed reply stating that Section 115QA was\namended by Finance Act, 2016 w.e.f. 01/06/2016, to broaden the\ndefinition of buy-back to mean buy-back under any law and not just to\nbuy-back u/s 77 of the Companies Act, 1956. Since the scheme of\nreduction was 16/04/2016 which was prior to the amended law,\ntherefore, Section 115QA of the Act is not applicable on the facts of the\ncase in hand. This contention of the assessee was dismissed by the AO\nwho went on to apply the provisions of Section 115QA of the Act on the\ndistributed income of Rs.65,34,60,350/- and computed the tax liability\n@ 20% + surcharge & cess, determining the liability at Rs.15,07,66,372/-\nand also levied interest @ 1% per month u/s 115QB of the Act\namounting to Rs.6,48,29,540/-\n15.
The assessee challenged the additions before the ld. CTI(A) and\nreiterated its claim that the amendment is not applicable to the assessee\non the given facts of the case. After considering the facts and the\nsubmissions of the related amendment by the Finance Act, 2016 to the\nprovision of Section 115QA of the Act w.e.f. 01/06/2016, the ld. CIT(A)\nobserved that prior to the amendment, the provisions of Section 115QA\nof the Act were limited to buy-back of shares whereas the assessee has\nmade reduction in the share capital and since the assessee has made the\n10\npayment prior to 01/06/2016, the ld. CIT(A) directed the AO to verify\nwhether the payments were received by the investor/shareholders\nprior to 01/06/2016.\n16. Insofar as the dates of payment is concerned, there is no quarrel.\nThe only dispute relates to the applicability of the provisions of Section\n115QA of the Act after the amendment. There is no ambiguity that\nFinance Act, 2016 has made the amendment to Section 115QA w.e.f.\n01/06/2016 and since there is no quarrel insofar as the payment made\nby the assessee to its shareholder is concerned as the same is prior to\n01/06/2016, the amended provisions did not apply to the assessee.\nTherefore, there is not error or infirmity in the findings of the ld. CIT(A).\n17. In the result, appeal of the assessee is allowed and appeal of the\nrevenue is dismissed.\nOrder pronounced in the Court on 18th September, 2025 at Mumbai.\nSd/-\n(SAKTIJIT DEY)\nVICE PRESIDENT\nSd/-\n(NARENDRA KUMAR BILLAIYA)\nACCOUNTANT MEMBER\nMumbai, Dated 18/09/2025\n*SC SPS\nआदेश की प्रतिलिपि अग्रेषित/