TMF HOLDINGS LTD,MUMBAI vs. ACIT CIRCLE 1(3)(2), MUMBAI

The assessee had a call option on the NCDs after 10 years from the date of issue and at the end of every month thereafter, which may be exercised only with the prior approval of the Reserve Bank of India. There was aslo a step-up option of 50 basis points (0.5%) in the event that the call option is not exercised by the assessee. It has been stated before us that debentures have been redeemed on completion of 10 years from the date of issue and therefore, there was no requirement to seek TMF Holdings Ltd. approval from the RBI. Though the perpetual debentures have been issued in F.Y.2010-11 i.e. A.Y.2011-12 onwards, it has been pointed out before us that assessee‟s claim for interest thereon had been accepted in the earlier years. During the year under consideration, i.e., A.Y.2015-16 assessee has incurred an expenditure amounting to Rs.39,86,33,662/- being interest paid on perpetual debentures which the assessee has claimed the same as a deductible expenditure under section 36(1)(iii) of the Act.

The ld. AO has disallowed the said claim on the following reasons:- “What is allowable u/s 36(1) (iii) of the IT act is amount of interest in respect of capital borrowed for the purpose of business on profession. So the moot issue to be examined is whether the capital raised by issues of perpetual debentures qualifies as "borrowings The perpetual debentures being a hybrid instrument, many corporations raise funds by way of issuing perpetual debentures with periodic coupon payments similar to u debt instrument with a fixed term. Whilst perhaps redeemable at a certain point of time at the option of the issuer perpetual debentures by definition have no fixed maturity date. This feature would bestow on the perpetual debentures elements suggestive of an equity instrument.

The ld. CIT (A) too has confirmed the said addition on the following grounds:- (i) For loan, there should be a loan agreement which specifies that the monies loaned would be paid back either on demand or on directions of the creditor and particular interest/ no interest would be paid on said sum. (ii) The assessee has not been able to prove any commercial expediency and whether it is for business purposes. (iii) Interest on debentures is an expense and has to be paid irrespective of any profits in a particular financial year or not. It creates a charge against the profits of the organization and is thus, debited to the Profit & Loss Account. Since it has to be paid irrespective or profit or loss, this only indicates it has nothing to do with business activity or commercial expediency, hence not allowable as business expenditure.

We have heard both the parties at length, perused relevant finding given in the impugned orders as well as material referred to before us. The case of the department before us is that – Firstly, a perpetual debenture does not have any fixed  maturity date which is suggestive of an equity instrument.  Secondly, in the case of perpetual debenture, the instrument does not provide the investor with any means to enforce the payment of distribution and repayment of the principal amount, which suggests that the instrument is an equity instrument.

Although the term 'borrowing' is not defined under the provisions of the Income Tax Act, however, what is understood in general parlance, 'capital borrowed‟ means money which a person has received from another party under an agreement with an intention to repaу. As against this, 'equity capital‟ is capital provided and is not intended to be repaid in the normal course of business. It represents a kind of risked capital where the returns to the investors are dependent on the performance of the company. On the contrary, interest on capital borrowed is payable at a fixed rate or agreed rate. The essence of interest is that it is a payment which becomes due because the creditor/lender has given the money which is no longer at his disposal and therefore, he is entitled to be compensated for the

Now what is “Perpetual Debentures”? To understand this, first it would be worthwhile to refer to Section 120 of the erstwhile Companies Act 1956 which defined the term „Perpetual Debentures' as under. "A condition contained in any debentures or in any deed for securing any debentures, whether issued or executed before or after the commencement of this Act, shall not be invalid by reason only that thereby, the debentures are made irredeemable or redeemable only on the happening of a contingency, however remote, or on the expiration of a period, however long"

Further, the Reserve Bank of India vide circular on Basel III Capital Regulation for Banks has included the perpetual debt instruments or perpetual bonds under the Additional Tier 1 Capital for banks. As per the RBI circular of 1 July 2015, the return on investment in perpetual bond (included in Additional Tier-1 Capital) is referred to as 'interest' and issue of such bonds is treated as debt raised and accordingly reported by the issuer.

In the case of the assessee, the perpetual debentures, which has been issued does not contain the characteristic of equity which has been explained before the authorities below and also before us in the following manner:-

Nature of interest a. Perpetual Debentures do acquired in the not fall within the definition of company. "shares" under the Companies Act. On the contrary. they fall under the definition of 'debentures'. b. Holders of the securities are not reflected in the Register of members/shareholders but instead in the Register of Debenture Holders. c. Perpetual Debenture holders are not entitled to the proportion of ownership of the company unlike equity shareholders.

Voting Rights The perpetual debenture holders have no voting rights in present or future in the company.

3. Participation in The perpetual debenture holders profits of the have no right to participate in company the profits on the company unlike equity shareholders.

Fixed periodic The perpetual debentures bear a payment of fixed periodic payment of Interest. Interest. Although the company has the right to defer payment of interest in certain cases, the interest payments are cumulative in that case.

Nature of returns Interest on perpetual debentures is fixed and regular unlike payment of dividends to shareholders which is variable and irregular.

Interest on Return to equity shareholders is perpetual NCDs called dividend which is an is a charge appropriation of profits Whereas, against the the interest payment on profits perpetual debentures is a charge against the profits of the company. It is submitted that the assessee has debited the interest on Perpetual Debentures to the Profit & Loss Account

Obligation to The Perpetual Debentures are repay the repayable to the investors in principal amount. terms of the Investor agreement. Such Debentures have a call option for repayment which may be exercised by the assessee after a period of 10 years. Further, where such debentures are not redeemed by the assessee after the expiry of 10 years, the rate of interest increases by 0.5%. The step-up feature results in higher cost for the issuer to keep the instrument, thus incentivizing the assessee to exercise the Call option to redeem the perpetual NCDs. Further, in a continuously lowering interest rate scenario in our country, it is more likely

Ranking for In the event of dissolution or repayment in the liquidation, the perpetual event of debentures shall rank liquidation of subordinate to the claim of other dissolution creditors but superior to the claim of preference shares and equity shares.

Listing on Debt The listing of Perpetual segment of Stock Debentures is regulated by the Exchange SEBI (Issue and Listing of Debt Securities) Regulations, 2008; while listing of equity shares is regulated by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009.

Thus, merely the subscriber to the Perpetual Debentures cannot redeem such debentures, it can be reckoned that Perpetual Debentures is a „borrowing‟, because consideration paid by the subscriber is not be able to have such amounts at their disposal and therefore, he is entitled to a fixed rate of coupon.

It is brought on record and also it is an undisputed fact that perpetual debentures issued by the assessee are to be repaid alongwith interest. Under the arrangement between the assessee and subscribers to the perpetual debenture, assessee TMF Holdings Ltd. acknowledges that the monies received by way of issue of perpetual debentures have to be repaid and this is evident from the fact that a 'call option' exists in the Agreement permitting the assessee to redeem the perpetual debentures after a stipulated time. If assessee does not redeem the debentures within the stipulated time, the subscribers are entitled to an additional 0.5% rise in the coupon rate of interest. This is evident from the documents submitted before us. The fixed coupons are to be treated as consideration for a subscriber's commercial expediency to lend capital to the assessee for perpetual time and as against this, a shareholder of the assessee does not get any consideration for granting capital to the assessee. It is only entitled to a share in his own profits which cannot be considered as a consideration for a capital. Further, under the arrangement between the assessee and the subscribers to the Perpetual NCDs, the assessee acknowledges that the monies received by way of issue of perpetual NCDs have to be repaid because the 'call option' exists in the Agreement permitting the assessee to redeem the Perpetual NCDs after a stipulated time.

Now the issue is, whether the interest paid on perpetual debentures is allowable u/s.36(1)(iii) of the Act or not. Section 36(1)(iii) of the Act provides that the amount of interest paid is respect of capital borrowed for the purpose of business is allowed as a deduction in computing the business income. Thus, for claiming deduction, the twin conditions which are to be specified; firstly, there must be capital which is borrowed and TMF Holdings Ltd. secondly, interest expenditure must have been incurred for the purpose of business. Though, before us many judgments have been cited of the Co-ordinate Bench, wherein on similar issue the interest has been allowed u/s. 36(1)(iii). However, as discussed above, once assessee has paid fixed coupon rate of interest on such perpetual debentures, the same is on account of consideration paid for capital borrowed which is in the nature of interest and hence, allowable u/s.36(1)(iii).

Here, in this case, ld. CIT(A) has upheld the action of the ld. AO on the ground that for a loan there should be a loan agreement which specified that monies owned would be paid back and assessee is not able to prove any commercial expediency and whether it is for business purposes. Further, interest on debenture is an expense and has to be paid irrespective of any profits in a particular financial year or not and it creates a charge against the profits. Since it has to be paid irrespective or profit or loss, this only indicates that it has nothing to do with business activity or commercial expediency, hence not allowable as business expenditure.

One very important fact which has not been appreciated by the Ld. First Appellate authority is that assessee is being business of vehicle financing and it has to meet its day-to-day capital expenditure for which it requires substantial funds. The assessee has raised funds by way of issue of perpetual debentures and objects of the issues have been stated in the TMF Holdings Ltd. debenture disclosure document that it has to be used for various financing activities; Repay existing loans; Business expenditure including capital expenditure and working capital requirements, etc. Here in this case, it is a fact that perpetual debentures carry a 'call-option' which may be exercised by the assessee after the end of 10 years and also a step-up option of 50 basis points (0.5%) in the event that the call option is not exercised by the assessee. The assessee did exercised this call option on the completion of 10 years and redeemed the debenture, which goes to show that assessee has viewed the perpetual debentures as the debt of the Company which needs to be re-paid within a fixed period of time rather than equity. Thus, it is in the nature of debt borrowed which cannot be questioned and accordingly, we hold that it is a borrowing and interest paid on such borrowing is allowable as „business expenditure.‟

Ld. AO has claimed heavy reliance on the decision of Punjab & Haryana HC in the case of Pepsu Road Transport Corpn (supra). In that case, assessee-corporation, incorporated under the Road Transport Corporation Act, 1950, (the RTCA) was engaged in the business of plying passenger buses Its capital was provided by the Union of India, under section 23 of the RTCA through the Northern Railway and the Punjab Government. For the assessment year 1965-66, it paid interest of Rs. 36,91,781 to both the Northern Railway and the Punjab Government and claimed the deduction of the same under section 36(1)(iii). Eventually, the Tribunal disallowed the TMF Holdings Ltd. assessee's claim on the grounds, inter alia, that though the interest was payable in respect of the capital provided to the assessee for its business, the said capital could not be said to have been borrowed by the assessee because;  there was no written agreement of loan and neither the assessee, being a body corporate. nor the Government could be a party to a verbal agreement of loan, and  that the RTCA contained no provision for the repayment of the impugned loan. On reference to the Hon'ble High Court, it was held that "the assessee was provided capital not because of any agreement between the parties, but because of a statutory obligation of the Government Moreover, under the RTCA, in the event of the assessee being placed in liquidation, the assets of the assessee, after meeting the liabilities, if any, were to be divided among the Central Government and State Government and such other parties, if any, as may have subscribed to the capital in proportion to the contribution made by each of them to the total capital in the light of these facts, the impugned interest could not be held to be deductible under section 36(1)(iii)".

Thus, the ratio of the aforesaid case is not applicable in the present case because the payment of interest is pursuant to a written agreement between the parties for borrowing of certain monies. It contains an express provision to call the perpetual debentures for redemption after the expiry of 10 years and at the end of every month thereafter with the option price being the face TMF Holdings Ltd. value of debentures. In event of liquidation, the debenture holders are entitled to assets only up-to the amount of borrowings and that the debenture holders are not entitled to any excess assets after meeting all the liabilities. While the High Court emphasized on the rationale that an element of repayment must exist in order to be characterized as debt, however in the present case, under the existing agreements for perpetual debentures, an element of repayment does exist in the form of call option by the assessee for redemption of perpetual debentures. This is unlike of in the case of subscription for equity shares. Accordingly, the aforesaid judgment is not applicable and the claim of the assessee on payment of interest on such debenture is allowed.

In the result, the grounds raised by the assessee are allowed.

Lastly, in the issue of short grant of TDS credit, it has been stated that assessee has claimed TDS credit amounting to Rs 26,08,34,800/-. As against this, the learned AO has allowed TDS credit amounting to Rs 25,67,09,067/- and thereby, leading to short grant of TDS credit amounting to Rs. 40,35,731/-. As per the Form 26AS for the captioned AY as on 03/07/2024, the assessee is eligible for Rs. 26,06,70,547/-. Accordingly, we direct the ld. AO to grant TDS credit as claimed by the assessee in revised return after verification.

In the result, appeal of the assessee is partly allowed.