Finance Bill, 2022 has proposed to amend the provisions of section 43B to clarify that conversion of interest payable under section 43B(d)/(da)/(e) of the Income-tax Act, 1961 (‘Act’) into debenture or any other instrument by which liability to pay is deferred to a future date, shall not be deemed to have been actually paid.
Background
With a view to allowing certain deductions only on ‘actual payment basis’, Finance Act, 1983 introduced Section 43B in the Act. This is irrespective of the method of accounting followed by the assessee.
Over the years, the subsequent Finance Acts have enlarged the scope of Section 43B of the Act.
Section 43B of the Act provides for certain deductions to be allowed only on actual payment. Explanation 3C, 3CA and 3D of this section provides that a deduction of any sum, being interest payable on loan or borrowing from specified financial institution/NBFC/scheduled bank or a co-operative bank under clause (d), clause (da), and clause (e) of this section respectively, shall be allowed if such interest has been actually paid and any interest referred to in these clauses which has been converted into a loan or borrowing or advance shall not be deemed to have been actually paid.
Finance Act, 1989 inserted clause (d) in section 43B to bring interest on loan or borrowing from any public financial institution or State Financial Corporation or a State Industrial investment corporation within the ambit of section 43B.
Similarly, clause (da) in the said section was inserted by the Finance (No. 2) Act, 2019 to provide for deduction of interest on any loan or advances from deposit-taking NBFCs only on payment basis.
Finance (No. 2) Act, 1996 amended the provisions of section 43B to include interest on any term loan from a scheduled bank within its ambit by inserting clause (e) in the said section.
Subsequently, the Finance Act, 2006 inserted two Explanations, namely, Explanation 3C (with retrospective effect from 1.4.89) and Explanation 3D (w.r.e.f. 01.04.1997) to clarify that if the interest on loan or borrowing or advance is converted into a loan or borrowing or advance, the interest so converted and not 'actually paid', shall not be deemed as 'actual payment' and, hence, not allowed as a deduction in the computation of income under section 43B. These two Explanations cover clauses (d) and (e) of section 43B.
Explanation 3CA which covers clause (da) was inserted by the Finance (No. 2) Act, 2019 itself to provide for non-deduction of conversion of interest amount into loan or borrowings under this section.
Proposed Amendments to Section 43B
It is proposed to amend Explanation 3C, Explanation 3CA and Explanation 3D of section 43B to provide that conversion of interest payable under clause (d), clause (da), and clause (e) of section 43B, into debenture or any other instrument by which liability to pay is deferred to a future date, shall also not be deemed to have been actually paid.
Clause 14 of the Finance Bill, 2022 amends section 43B as under-
Amendment of section 43B.
14. In section 43B of the Income-tax Act, with effect from the 1st day of April, 2023,––
(i) in Explanation 3C, after the words “loan or borrowing”, the words “or debenture or any other instrument by which the liability to pay is deferred to a future date” shall be inserted;
(ii) in Explanation 3CA, after the words “loan or borrowing”, the words “or debenture or any other instrument by which the liability to pay is deferred to a future date” shall be inserted;
(iii) in Explanation 3D, after the words “loan or advance”, the words “or debenture or any other instrument by which the liability to pay is deferred to a future date” shall be inserted.
Explaining the provisions of the proposed amendments
Clause 14 seeks to amend section 43B of the Income-tax Act relating to certain deductions to be allowed only on actual payment.
Explanations 3C, 3CA and 3D of the said section provide that a deduction of any sum, being interest payable under clauses (d), (da), and (e) of the said section, shall be allowed if such interest has been actually paid and any interest referred to in the said clauses which has been converted into a loan or borrowing or advance shall not be deemed to have been actually paid.
It is proposed to amend the said Explanations 3C, 3CA and 3D of the said section to provide that conversion of interest payable under clauses (d), (da), and (e) of the said section, into debenture or any other instrument by which liability to pay is deferred to a future date, shall also not be deemed to have been actually paid.
These amendments will take effect from 1st April, 2023 and will, accordingly, apply in relation to the assessment year 2023-2024 and subsequent assessment years.
Rationale of the Proposed Amendments in Section 43B
The Memorandum states that certain taxpayers are claiming deduction under section 43B on account of conversion of interest payable on an existing loan into a debenture on the ground that such conversion is a constructive discharge of interest liability and, therefore, amounted to actual payment which has been upheld by several Courts.
Such interpretation is against the intent of legislation. The section was introduced to curb the mischief of claiming deduction by the assessee, without paying interest to financial institutions/NBFC/scheduled bank or a co-operative bank. Section 43B makes a departure from other sections in the Act, as indicated by its non-obstante clause. Under the provisions of this section conversion of the outstanding interest liability into debentures is not an actual payment and cannot be claimed as a deduction.
In other words, a mercantile system of accounting cannot be looked at when a deduction is claimed under this section, as actual payment would have to be made.
Concluding Remarks
Often, under a loan restructuring plan with the lenders i.e. banks and financial institutions, the borrower may issue debentures or other securities in favour of the lender towards the settlement of outstanding interest on loans and borrowings.
In such a situation, a question generally arises as to whether settlement of such outstanding interest can be regarded as ‘actually paid’ and thereby deductible under section 43B of the Act or not.
In this regard, the decision of the Supreme Court in the case of M.M. Aqua Technologies Ltd. vs. CIT (Civil Appeal No. 4742-4743 of 2021) is noteworthy.
The proposed amendment to section 43B seeks to overrule the decision of the Supreme Court in the case of M.M. Aqua Technologies case (supra). In this case, it was held that issue of debentures against the outstanding interest liability as the final discharge of liability would be treated as actual payment of interest and such amount need not be disallowed under Section 43B.
Thus with the proposed amendment, settlement of outstanding interest liability with debentures will never be allowed as a deduction in the hands of the borrower even though there is a complete extinguishment of interest liability. It appears the deduction will be allowed in the year in which the debenture will be repaid. [Refer CBDT Circular No. 7/2006 dated 17.07.2006]
This time the amendment in Explanations 3C, 3CA and 3D of section 43B is proposed to apply prospectively from AY 2023-24.
Alternative Interpretation
Hon’ble Supreme Court distinguished the case of CIT vs. Gujarat Cypromet Ltd. (Civil Appeal No. 5347/2010) decided on 21.02.2019 in the M.M. Aqua Technologies case (supra).
In Gujarat Cypromet’s case (supra) it was held that the conversion of outstanding interest into loan does not amount to "actual payment" of the interest in order to qualify for deduction in view of the retrospective insertion of Explanation 3C to section 43B.
Whereas in the M.M. Aqua Technologies case (supra) it was held that if there is the extinguishment of interest liability and there is no liability to pay the same at a future date, it amounts to ‘actual payment’ of interest and thus is deductible under section 43B.
In para 27 of the Order, the apex court expressly stated that the question is not what is debenture and whether it is convertible or non-convertible or paybale immediately or in future. Thus the case was not distinguished on the basis of ‘loan’ and ‘debenture’.
It was argued before the court that in the case of Gujarat Cypromet’s case (supra) the outstanding interest was converted into a ‘loan’ whereas in the M.M. Aqua Technologies case (supra) unpaid interest was converted into ‘debentures’ and Explanation 3C to section 43B covers ‘loan’ and not debentures.
This is why the Apex Court has stated that the question is whether interest is actually paid by issuing debentures.
Further, in para 30 of the Order of M.M. Aqua Technologies case (supra) the Court has distinguished the case of Gujarat Cypromet. According to their Lordships, in Gujarat Cypromet’s case, outstanding interest had not been actually paid instead a new credit entry of loan appeared.
Thus, interest remains unpaid and with the conversion in loan, the interest payment is deferred to a future date.
In the amendment, the language used is ‘loan or borrowing or debenture or any other instrument by which the liability to pay is deferred to a future date’. The expression, the liability to pay interest is deferred to a future date still suggests that if there is a deferment of interest payment by conversion of outstanding or unpaid interest into loan or borrowing or debenture or any other instrument, then only the Explanations 3C, 3CA and 3CD will trigger and disallowance under section 43B will persist.
If there is the extinguishment of liability to pay interest with the conversion and there is no deferment to a future date, it will still be covered by the M.M. Aqua Technologies case (supra) as it amounts to ‘Actual Payment’ of interest and the proposed amendment of inclusion of ‘debenture’ may not hold good.
It is not necessary that ‘actual payment’, for the purpose of section 43B, must be in cash only. It may be in other modes also. The essence is that there must be an extinguishment of liability and is not deferred to be payable in future.
Though the wordings of the proposed amended provisions indicate so, it may not be the intention of the legislator and this is not what they intend to do.
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