Inter-Corporate Deposits in India: A Legal and Taxation Analysis

Inter-Corporate Deposits in India: A Legal and Taxation Analysis

Introduction

Inter-Corporate Deposits (ICDs) are a significant financial instrument in the Indian corporate sector, representing unsecured borrowings by one corporate entity from another. These transactions facilitate short-term liquidity management, allowing companies with surplus funds to lend to those in need of temporary finance. Despite their prevalence, the legal nature and tax treatment of ICDs have been subjects of considerable judicial scrutiny. This article seeks to provide a comprehensive analysis of ICDs under Indian law, focusing on their regulatory framework under the Companies Act, 2013, the critical distinction between ICDs and loans/advances, and their implications under various taxation statutes, particularly the Income Tax Act, 1961. The analysis will draw heavily upon statutory provisions and judicial pronouncements, including those provided in the reference materials, to delineate the current legal landscape governing ICDs in India.

Regulatory Framework under the Companies Act

The Companies Act, 2013 ("Companies Act"), along with the rules promulgated thereunder, provides the primary regulatory framework for the acceptance of deposits by companies. Section 2(31) of the Companies Act defines "deposit" to include any receipt of money by way of deposit or loan or in any other form by a company, but does not include such categories of amount as may be prescribed in consultation with the Reserve Bank of India.

Crucially, the Companies (Acceptance of Deposits) Rules, 2014 ("Deposit Rules, 2014"), specifically exclude certain amounts from the definition of "deposit." Rule 2(1)(c)(vi) of the Deposit Rules, 2014, states that "deposit" does not include "any amount received by a company from any other company." This exclusion is pivotal as it effectively places ICDs outside the stringent regulatory regime applicable to deposits accepted from the public or members, such as requirements related to credit rating, deposit insurance, and maintenance of liquid assets (Sections 73 and 76 of the Companies Act).

The Bombay High Court in Ashish Mahendrakar v. State Of Maharashtra And Others (2019 SCC ONLINE BOM 1364) and AJAYKANT RUIA AND ANR. v. THE STATE OF MAHARASHTRA AND ORS. (2019 SCC ONLINE BOM 1365) observed this exclusion. It was noted that "under the Old Companies Act as well as the Companies Act, 2013 and the Rules framed thereunder, the amounts received by one company from any other company were excluded from the term 'deposit' for the purpose of regulation of acceptance thereof." This led to arguments that the field concerning ICDs is occupied by Central legislation (the Companies Act), potentially limiting the applicability of state-level statutes like the Maharashtra Protection of Interest of Depositors (in Financial Establishments) Act, 1999 (MPID Act) to such transactions, especially when the object of the MPID Act was primarily to protect small depositors.

The distinction between a "deposit" and a "loan" under company law was elaborated in Pennwalt India Ltd. And Others v. The Registrar Of Companies And Others (1986, Bombay High Court, (1987) 62 Comp. Cas. 112). The Court observed that while both involve a debtor-creditor relationship, "in the case of a deposit the delivery of money is usually at the instance of the giver and it is for the benefit of the person who deposits the money... In the case of a loan however, it is the borrower at whose instance and for whose needs the money is advanced." This conceptual distinction is vital for understanding the nature of ICDs.

Distinction between Inter-Corporate Deposits and Loans/Advances

The differentiation between an ICD and a "loan or advance" is not merely academic; it has significant implications under various statutes, particularly tax laws. While ICDs are a form of borrowing, courts have often carved out a distinction based on the nature, intent, and typical characteristics of these transactions.

The Income Tax Appellate Tribunal (ITAT) in Bombay Oil Industries Ltd. v. Deputy Commissioner of Income-tax (2009 SOT MUMBAI 28 383) provided a detailed exposition on this distinction. The Tribunal noted:

"By issuing prospectus of a company invites offer for making deposit and that is not offer to receive deposit whereas in case of loan the assessee prays for a loan. It offers to borrow money and once that offer is accepted, the lender is bound to give money to the borrower on terms settled... Inter-corporate deposit can neither be a loan not an advance."

This perspective emphasizes the initiative in the transaction: a deposit is typically an offer made by the depositor to place funds, whereas a loan originates from the borrower's request. The ITAT, Delhi Special Bench, in Housing & Urban Development Corpn. Ltd. v. Joint Commissioner of Income-tax (2006 SOT DELHI SB 5 918), while dealing with the Interest Tax Act, also affirmed that investments made by way of short-term deposits are distinct from "loans and advances."

The Bombay High Court in Pennwalt India Ltd. (1986) further clarified that "ordinarily though not always in case of a deposit it is the depositor who is the prime-mover while in case of a loan it is the borrower who is the prime-mover." The Court also pointed to provisions in the erstwhile Companies Act, 1956, such as Section 58A (which included borrowed amounts within "deposit" for that section's purpose) and Section 227(1-A)(d) (auditor's inquiry whether loans and advances have been shown as deposits), as indicative that the terms are not always interchangeable unless the context dictates.

In Dr. Fredie Ardeshir Mehta And Others v. The Union Of India And Others (1989 SCC ONLINE BOM 161), the Bombay High Court, while considering whether deferred payment of purchase price constituted a "loan" to a director under Section 295 of the Companies Act, 1956, held it did not. Though the context differs (director's loan v. ICD), the underlying principle of scrutinizing the true nature of a financial accommodation beyond its label is relevant.

Taxation of Inter-Corporate Deposits

The tax treatment of ICDs involves several aspects, including the characterization of interest income, the applicability of deemed dividend provisions, and the scope of the Interest Tax Act.

Interest Income from ICDs

The nature of interest income earned from ICDs – whether it is "Business Income" or "Income from Other Sources" – depends on the facts and circumstances of each case, particularly the purpose for which such deposits are made and the business of the assessee.

In Commissioner Of Income-Tax v. Indo Swiss Jewels Ltd. And Another (2005 SCC ONLINE BOM 1673), the Bombay High Court upheld the Tribunal's finding that interest earned on ICDs was business income. The assessee had placed surplus funds, earmarked for importing machinery, into ICDs to earn a higher return pending utilization. The Court noted, "the funds were kept by the assessee in the various companies for short-terms for payment for imported machinery... the balance-sheet for the next year also showed that all these deposits were withdrawn and paid for the machinery." This linkage to business operations was crucial.

Similarly, in Azimuth Investments Ltd. v. ACIT (2016 SCC ONLINE ITAT 2948), the assessee company, a Non-Banking Financial Company (NBFC), was engaged in the business of Inter-Corporate deposits and investments of surplus funds, implying that interest from such ICDs would naturally be part of its business income.

Applicability of Deemed Dividend Provisions (Section 2(22)(e) of the Income Tax Act, 1961)

A significant area of litigation concerning ICDs has been their potential classification as "deemed dividends" under Section 2(22)(e) of the Income Tax Act, 1961. This provision treats any payment by a company (not being a company in which the public are substantially interested) by way of "loan or advance" to a shareholder having substantial interest, or to a concern in which such shareholder has substantial interest, as a dividend.

The consistent view of various Tribunals and some High Courts has been that genuine ICDs, which are distinct from loans or advances, do not fall within the ambit of Section 2(22)(e). The ITAT in Bombay Oil Industries Ltd. (2009) explicitly held:

"Section 2(22)(e) enacts a deeming fiction whereby the scope and ambit of the word dividend has been enlarged... Such a deeming fiction would not be given a wider meaning than what it purports to do. The provisions would necessarily be accorded strict interpretation... The requisite condition for invoking section 2(22)(e) of the Act is that payment must be by way of loan or advances. Since there is a clear distinction between the inter-corporate deposits vis-a-vis loans/advances, according to us the authorities below were not right in treating the same as deemed dividend under section 2(22)(e) of the Act."

This reasoning was echoed in DCIT, New Delhi v. M/s. Sindhu Realtors Pvt. Ltd. (ITAT Delhi), which relied on Bombay Oil Industries Ltd. (2009). The ITAT, Kolkata, in Cit v. P.C. Chandra Holdings Pvt. Ltd. (2013), also held that ICDs received for a specific period with specified interest rates could not be considered loans and advances for Section 2(22)(e), distinguishing them from unsecured loans. The Delhi High Court in Commissioner Of Income Tax Del v. M/S. Bharat Hotels Ltd. (2018 SCC ONLINE DEL 11199), while analyzing payments from subsidiary companies, examined the nature of the transactions to determine if they constituted loans or advances for Section 2(22)(e), underscoring the importance of the transaction's substance.

Furthermore, for Section 2(22)(e) to apply, the recipient company must be a shareholder in the paying company. The Gujarat High Court in Commissioner Of Income Tax-I v. Daisy Packers Pvt. Ltd. (2012 SCC ONLINE GUJ 4116) held that if the assessee company (recipient of ICD) does not hold shares in the company from which it received the deposit, the amount cannot be treated as a deemed dividend under Section 2(22)(e).

Applicability of Interest Tax Act, 1974

The Interest Tax Act, 1974 (now repealed, but relevant for past periods) imposed a tax on the total amount of interest (other than interest on loans and advances made to other credit institutions) arising to a credit institution. The question arose whether interest on ICDs was taxable under this Act.

The ITAT Special Bench in Housing & Urban Development Corpn. Ltd. (HUDCO) (2006) held that "investments made by way of short-term deposits and also in the form of securities and bonds cannot be considered as loans and advances and as such interest thereon shall be outside the scope of 'interest' defined under section 2(7) of the Act." This was based on a strict interpretation of "loans and advances."

The ITAT in Bombay Oil Industries Ltd. (2009), referencing the HUDCO decision, reiterated: "In these circumstances we hold that interest on inter-corporate deposits is not an interest on loan or advance and therefore would not be includible in the chargeable interest under the Interest-tax Act."

Deductibility of Interest Paid on ICDs

Interest paid by a company on ICDs taken for business purposes would generally be deductible as a business expenditure under Section 36(1)(iii) (interest on capital borrowed for the purposes of the business or profession) or Section 37(1) (general deduction for expenditure laid out wholly and exclusively for the purposes of the business) of the Income Tax Act, 1961. The allowability would depend on satisfying the conditions of these sections, primarily the nexus with the business. The Madras High Court in Commissioner Of Income-Tax v. South India Corporation (Agencies) Ltd. (2006 SCC ONLINE MAD 1324), while dealing with interest on borrowings from subsidiaries and loans for acquiring bonds, upheld the deductibility where business necessity was established, reinforcing general principles applicable to interest expenditure.

Judicial Interpretation and Key Principles

The judiciary has played a crucial role in interpreting the legal and fiscal status of ICDs. Several key principles emerge from the referenced case law:

  • Distinction between Deposits and Loans: Courts consistently recognize a distinction between "deposits" (particularly ICDs) and "loans/advances," based on factors like who initiates the transaction, the purpose, and the customary practices (Pennwalt India Ltd. (1986); Bombay Oil Industries Ltd. (2009)).
  • Strict Interpretation of Taxing Statutes: When interpreting provisions like Section 2(22)(e) of the Income Tax Act or the Interest Tax Act, a strict construction is favored. Deeming fictions are not to be extended beyond their explicit scope (Bombay Oil Industries Ltd. (2009)). As stated, "a taxing statute has to be strictly construed and the subject cannot be taxed unless comes within the letter of law. The argument that a particular income falls within the spirit of the law cannot be availed of by the revenue."
  • Substance over Form: While the label "Inter-Corporate Deposit" is used, the actual nature of the transaction, evidenced by terms, tenure, interest, and conduct of parties, is critical, especially in tax assessments (Cit v. P.C. Chandra Holdings Pvt. Ltd. (2013)).
  • Regulatory Exclusion under Companies Act: The specific exclusion of amounts received by a company from another company from the definition of "deposit" under the Deposit Rules, 2014, significantly shapes their regulatory treatment (Ashish Mahendrakar (2019); AJAYKANT RUIA (2019)).
  • Commercial Reality: Courts often acknowledge ICDs as a common and legitimate mode of corporate finance for managing surplus funds and meeting short-term requirements (Commissioner Of Income-Tax v. Indo Swiss Jewels Ltd. (2005)). However, as hinted in In The Matter Of v. Xenitis Infotech Pvt. Ltd (2010 SCC ONLINE CAL 187), if transactions claimed as ICDs lack essential features like consideration for interest, or are part of illegal schemes, they may face scrutiny and censure.

Conclusion

Inter-Corporate Deposits represent a flexible and widely utilized financial instrument in the Indian corporate landscape. Legally, they are carved out from the more stringent regulations applicable to general "deposits" under the Companies Act, 2013, by virtue of the specific exclusion in the Companies (Acceptance of Deposits) Rules, 2014. This distinct status is further reinforced by judicial interpretations that differentiate ICDs from conventional "loans and advances" based on the genesis and nature of the transaction.

From a taxation perspective, this distinction has profound consequences. The prevailing judicial view, particularly from appellate tribunals and high courts, is that genuine ICDs do not constitute "loans or advances" for the purpose of invoking the deemed dividend provisions of Section 2(22)(e) of the Income Tax Act, 1961. Similarly, interest on ICDs has been held to be outside the purview of the (now repealed) Interest Tax Act, 1974. Interest income from ICDs may be treated as business income if a sufficient nexus with the company's business operations or fund management strategy is established.

The consistent application of principles like strict interpretation of taxing statutes and consideration of the substance of transactions has provided a degree of clarity. However, companies engaging in ICD transactions must ensure that these are genuinely structured and documented as such, reflecting commercial terms, to avoid adverse regulatory or tax consequences. The evolving jurisprudence continues to shape the understanding and treatment of ICDs, underscoring their unique position in Indian corporate finance.