CONVERTIBLE DEBENTURES |
Business income ID – 29 (JBC-041) |
Since there is no specific provision for such expenditure it has be claimed under section 37(1) as general deduction. Also related question are expenditure on issue of share capital, additional share capital, discount on debentures, expenditure on issue of debentures and of course the most vital question expenditure on convertible debentures. All this is discussed here in brief based on the light of some decided case. The general principles applicable in determining whether a particular expenditure is capital or revenue expenditure are as follows:
Outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment;
Expenditure may be treated as properly attributable to capital when it is made not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. If what is got rid of by a lump sum payment is an annual business expense chargeable against revenue, the lump sum payment should equally be regarded as a business expense, but if the lump sum payment brings in a capital asset, then that puts the business on another footing altogether
Whether for the purpose of the expenditure, any capital was withdrawn, or, in other words, whether the object of incurring the expenditure was to employ what was taken in as capital of the business. Again, it is to be seen whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital.
[1966] 060 ITR 0052A India Cements Ltd. v/s. CIT (S C)
The act of borrowing money is incidental to the carrying on of business, the loan obtained is not an asset or an advantage of enduring nature, the expenditure made for securing the use of money for a certain period, and it was irrelevant to consider the object with which the loan was obtained. The appellant obtained a loan of Rs. 40 lakhs from the Industrial Finance Corporation secured by a charge on its fixed assets. In connection therewith it spent a sum of Rs. 84,633 towards stamp duty, registration fees, lawyer's fees, etc., and claimed this amount as business expenditure Held that the amount spent was not in the nature of capital expenditure and was laid out or expended wholly and exclusively for the purpose of the assessee's business and was therefore allowable as a deduction.
In principle, apart from any statutory provisions, there is no distinction between interest in respect of a loan and an expenditure incurred for obtaining the loan. The nature of the expenditure incurred in raising a loan would not depend upon the nature and purpose of the loan. The purpose for which the loan was required is irrelevant to the consideration of the question whether the expenditure for obtaining the loan is revenue expenditure or capital expenditure
225 ITR 0798- BROOKE BOND INDIA LTD. VS. CIT (S C)
When an expenditure is made not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital. But this is not a strait-jacket formula and the question will have to be determined in the backdrop of the facts of each case. The test laid down can at best be a guide for determining whether a particular expenditure forms part of revenue expenditure or capital expenditure.
Where the object of incurring an expenditure is to affect the capital structure as a result of which certain incidental advantage flows, the expenditure will be of capital nature. Expenditure incurred by a company in connection with issue of shares, with a view to increase its share capital, is directly related to the expansion of the capital base of the company, and is capital expenditure, even though it may incidentally help in the business of the company and in the profit-making.
[1997] 225 ITR 0802B Madras Industrial Investment Corpn. Ltd. vs. CIT (S C)
The question whether a particular expenditure is revenue expenditure incurred for the purpose of business must be determined on a consideration of all the facts and circumstances, and by the application of principles of commercial trading. When a company issues debentures at a discount, it incurs a liability to pay a larger amount than what it has borrowed. The liability to pay the discounted amount over and above the amount received for the debentures, is a liability which has been incurred by the company for the purposes of its business in order to generate funds for its business activities. The amounts so obtained by issue of debentures are used by the company for the purposes of its business. This would, therefore, be expenditure. Section 37(1) further requires that the expenditure should not be of a capital nature.
The appellant-company issued debentures in December, 1966, at a discount. The total discount on the issue of Rs. 1.5 crores amounted to Rs. 3 lakhs. For the assessment year 1968-69, the appellant-company wrote off Rs. 12,500 out of the total discount of Rs. 3 lakhs being the proportionate amount of discount for the period of six months ending with June 30, 1967, taking into account the period of 12 years which was the period of redemption and dividing the discount of Rs. 3 lakhs over the period of 12 years.
In other words ordinarily, revenue expenditure which is incurred wholly and exclusively for the purpose of business must be allowed in its entirety in the year in which it is incurred. It cannot be spread over a number of years even if the assessee has written it off in his books over a period of years. However, the facts may justify an assessee who has incurred expenditure in a particular year to spread and claim it over a period of ensuing years. Issuing debentures at a discount is one such instance, where although the assessee has incurred the liability to pay the discount in the year of issue of debentures, the payment is to secure a benefit over number of years. There is a continuing benefit to the business of the company over the entire period. The liability should, therefore, be spread over the period of the debentures
[1997] 063 ITD 0370- Banco Products (India) Ltd. vs. Deputy Commissioner of Income-tax (ITAT)
The assessee company offered 3 lacs Equity Shares of Rs. 10 each and 1,00,000 15% Partly Convertible Debentures of Rs. 100 each to the Public during the year under appeal. The objects of the public issue specified in the Prospectus issued by the assessee company were as follows
Finance the capital expenditure of the company; Supplement the company's long term resources for working capital; and obtain listing of the Equity Shares and Debentures of the company on the stock exchange.
Assessee submitted that :
It was true that part of the borrowed funds were going to be converted into equity shares at a future date. That by itself, however, cannot change the characteristics of the receipts. Borrowings continued to remain borrowings till the end of the year. If that be so, expenditure incurred by the assessee would certainly' be regarded as expenditure incurred on borrowing the funds. What might happen at a future date is an issue which is not relevant for the purpose of deciding this controversy.
Following facts emerge from the case that was notified and officers point of view:
The Debenture issued as per terms of issue itself was liable to be converted into Equity Shares automatically and compulsorily without any further act or application on the part of such debenture holder.
The debenture holder or any subsequent transferee, before the date of conversion, has to hold such shares with the aforesaid condition of automatic and compulsory conversion having no choice or option in the matter.
The date and manner of such conversion was pre-determined and final at the date of issue of such debentures itself.
Further, although the date of conversion was a subsequent date, such convertible portion had characteristics of Equity Shares which becomes further clear from stipulation regarding augmentation of number of such shares by conversion in the event of issue of bonus shares prior to such conversion.
The further restriction on repurchase of such debenture prior to conversion makes it abundantly clear as such restriction was obviously self-imposed in view of provisions of section 77 of the Companies Act, 1956 prohibiting repurchase of its share capital from open market.
According to the officer it was clear that funds so obtained through the issue of Convertible Debentures were clearly identifiable as Equity Capital and loan funds from the very beginning and for all the time thereafter. The mere fact that such funds, temporarily for a brief period of about 6 months from the time of completion of formalities of allotment, were treated as raised against debenture with a mandatory condition of convertibility will not bestow on the entire funds, the characteristics of loan funds.
Held that :
The conversion of such debentures on the stipulated date leads to augmentation of the equity base of the company. In the case before us convertible debentures were clearly identifiable as Equity capital and issue relates to the expenditure on issue of partly convertible debentures and for the reasons discussed above, we hold that the proportionate expenditure on the convertible part of the debentures is for the augmentation of equity base of the company and as such has to be treated as capital expenditure.
Conclusion:
Exately opposite decision exist of the Mumbai ITAT, that is of the opinion that in present assessee has acquired the loan in form of debentures and thus it is an expenditure in connection with raising of finance and must be regarded as revenue expenditure. What is expected to happen at a future date is of no relevance for the previous year in question.
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