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M.P Financial Corporation v. Commissioner Of Income-Tax
Structured Summary of the Opinion (Reference under Section 256(1) of the Income-tax Act, 1961)
Factual and Procedural Background
The Income-tax Appellate Tribunal, Indore Bench, referred two questions of law to this Court under Section 256(1) of the Income-tax Act, 1961. The assessee is a corporation established under the State Financial Corporations Act, 1951. For the assessment year 1978-79, the assessee issued 6 1/4% 1981 Bonds (II Series) to the public at a discount, raising Rs. 82.50 lakhs. The discount aggregated to Rs. 94,875 (Rs. 1.15 per hundred), which the assessee debited to its profit and loss account and claimed as a deduction for the relevant accounting year.
The Inspecting Assistant Commissioner (Assessment) allowed the deduction. On some other points the assessee's contentions failed and it preferred an appeal; the appellate authority allowed the appeal but did not disturb the allowance of the Rs. 94,875 discount. The Commissioner of Income-tax, Bhopal, examined the assessment record and considered the Inspecting Assistant Commissioner's order to be erroneous and prejudicial to the Revenue because the discount was not, in his view, an admissible deduction in computing total income. The Commissioner issued a notice under Section 263 and subsequently passed an order directing the Inspecting Assistant Commissioner (Assessment) to modify the assessment by rejecting the claim for the Rs. 94,875 deduction.
The assessee appealed to the Tribunal. Before the Tribunal the assessee contended that the Commissioner wrongly assumed jurisdiction under Section 263 in respect of the Inspecting Assistant Commissioner's order and that the deduction was allowable. The Tribunal overruled the jurisdictional objection and held that no liability to pay the sum of Rs. 94,875 had accrued to the assessee in the previous year, concluding the discount was not an allowable expenditure. The assessee sought the reference to this Court, resulting in the two questions of law referred by the Tribunal.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the Commissioner of Income-tax was competent to revise under Section 263 an order passed by the Inspecting Assistant Commissioner (Assessment)?
- Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that a sum of Rs. 94,875 allowed as discount to the subscribers of the bond issued by the assessee-Corporation was not an allowable expenditure?
Arguments of the Parties
Assessee's Arguments
- The Commissioner of Income-tax had erroneously assumed jurisdiction under Section 263 in respect of an order of assessment passed by the Inspecting Assistant Commissioner (Assessment).
- The sum of Rs. 94,875, representing discount on bonds issued, was properly allowed as a deduction by the Inspecting Assistant Commissioner (Assessment) and should not have been disallowed by the Commissioner under Section 263.
Revenue's / Commissioner's Position
- The Commissioner treated the Inspecting Assistant Commissioner's order as erroneous and prejudicial to the interests of the Revenue and therefore issued a notice under Section 263 to revisit the allowance of the Rs. 94,875 discount.
- The Commissioner held that the deduction of Rs. 94,875 (the entire discount) was not an admissible deduction in computing total income and directed modification of the assessment to reject that claim.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| CIT v. Madras Industrial Investment Corporation Ltd. [1980] 124 ITR 454 (Mad) | Held that "expenditure" in Section 37 should be construed as paying out money irretrievably from the pocket of the assessee; thus issue of debentures at a discount did not involve such payment. | The Tribunal had followed this decision. The Court in the present opinion criticized that decision for not recognizing the real nature of discount on issue (deferred interest) and did not accept its restrictive construction of "expenditure." |
| CIT v. Indian Jute Mills Association [1982] 134 ITR 68 (Calcutta) | Considered the Madras decision and examined the Supreme Court's treatment of "expenditure incurred" (distinction between present liability and liability de futuro). | The present Court referred to this decision as having considered the Madras judgment and the Supreme Court authority, and relied on observations in Indian Jute Mills to support a broader understanding of "expenditure." |
| Indian Molasses Co. (Pvt.) Limited v. CIT [1959] 37 ITR 66 (SC) | Considered meaning of "expenditure incurred" while dealing with distinction between present liability (in praesenti) and liability de futuro; contains observations on contextual interpretation of "expenditure." | The Court extracted and relied upon observations from this case (as quoted by the Calcutta High Court) to support that "expenditure" in Section 37 can include amounts which are effectively losses or liabilities not necessarily resulting in immediate cash outflow. |
| Nash (Inspector of Taxes) v. Tamplin & Sons Brewery Brighton Ltd. [1951] 2 All ER 869 (House of Lords) | Held that "rent forgone" in the facts of that case amounted to money wholly and exclusively laid out or expended for the purposes of trade — i.e., non-cash losses can amount to expenditure. | The Court cited this authority to support the proposition that "expenditure" may include non-cash items like deferred interest (discount on issue) and therefore such amounts can fall within Section 37 in appropriate circumstances. |
| Usher's Wiltshire Brewery Limited v. Bruce [1915] AC 433 | Earlier authority on the proposition that non-cash items (e.g., rent forgone) can qualify as expenditure for trade purposes. | Referenced as precedent followed in Nash; used to bolster the broader proposition that "expenditure" is not confined to cash outflows. |
| Jones v. Carmarthen Corporation [1841] 10 LJ Exch. 401 | Illustrated a contextual construction where "expenses" meant actual disbursements in the Parliamentary Voters Registration Act context (used in judicial dictionary discussion quoted in Indian Molasses). | Appears in the quoted material to show that interpretation of "expenses" or "expenditure" depends on statutory context; relied upon indirectly through the Indian Molasses discussion. |
| R. v. Marsham [1892] 1 QB 371 | Illustrated that "money expended" may include moneys the person is bound to pay (i.e., liabilities), again showing context matters for meaning of "expenditure." | Used in the quoted material to demonstrate that "expenditure" may extend beyond actual payments; the Court accepted this contextual approach as instructive. |
Court's Reasoning and Analysis
The Court addressed the two referred questions sequentially.
(1) Jurisdiction under Section 263 (first question): The Court examined Section 125A(4) of the Act, which provides that when an Inspecting Assistant Commissioner exercises the powers or performs the functions of an Income-tax Officer pursuant to an order of the Commissioner under Section 125A(1), any reference in the Act to the Income-tax Officer shall be construed as a reference to the Inspecting Assistant Commissioner. Using that statutory construction, the Court reasoned there is no doubt that orders passed by an Inspecting Assistant Commissioner under such delegation are orders of an Income-tax Officer and therefore are amenable to revision by the Commissioner under Section 263. On that basis the Court held the Tribunal was correct in upholding the Commissioner’s competence to invoke Section 263 in respect of the Inspecting Assistant Commissioner’s assessment order.
(2) Allowability of the bond-issue discount (second question):
- The Court first established the undisputed factual matrix: the bonds were issued at a discount totalling Rs. 94,875.
- It examined accounting authorities (Spicer & Pegler; Batliboi) describing discount on issue as in substance "deferred interest" or a loss which need not be written off wholly in the year of issue but written off proportionately over the period the debentures/bonds remain outstanding.
- Applying the accounting principle, the Court inferred that the same reasoning applicable to debentures at a discount applies to bonds issued at a discount: the discount is in effect deferred interest and therefore a proportionate annual charge to revenue over the life of the bonds is appropriate.
- The Court considered the Tribunal's reliance on the Madras High Court decision (CIT v. Madras Industrial Investment Corporation Ltd.) which treated "expenditure" in Section 37 as confined to cash paid out irretrievably. The Court found that approach to be unduly restrictive and noted that the Madras decision did not adequately recognize the real nature of a discount on issue.
- The Court drew on subsequent consideration of the issue by the Calcutta High Court (CIT v. Indian Jute Mills Association) and the Supreme Court's observations in Indian Molasses to support the contextual and broader interpretation of "expenditure" — i.e., that "expenditure" under Section 37 can, in appropriate circumstances, include amounts which are essentially losses or liabilities that have not resulted in immediate cash outflow.
- The Court further relied on the House of Lords decision in Nash v. Tamplin & Sons (and the earlier Usher's Wiltshire Brewery authority) to illustrate that non-cash items such as "rent forgone" can, in proper circumstances, be treated as expenditure for trade purposes.
- Drawing these strands together, the Court concluded that while the entire discount of Rs. 94,875 was not properly deductible in the accounting year in question, a proportionate part of that discount spread over the period for which the bonds remain outstanding is allowable. Thus the Commissioner was not justified in disallowing any and all recognition of the discount as deductible over time; rather, the discount should be amortized and allowed pro rata in the relevant years.
The Court therefore disagreed with the Tribunal's categorical conclusion that no liability had accrued and that the full amount was not allowable; instead it formulated the correct tax treatment as amortisation of discount over the life of the bonds.
Holding and Implications
Holding:
Answer to Question 1: In the affirmative and against the assessee — the Commissioner of Income-tax was competent to revise under Section 263 the order passed by the Inspecting Assistant Commissioner (Assessment).
Answer to Question 2: Though the entire discount of Rs. 94,875 was not an allowable deduction in the assessment year in question, the amount represents deferred interest and must be spread proportionately over the number of years for which the bonds would remain outstanding; the proportionate amount attributable to the assessment year in question is an allowable expenditure.
Direct consequences for the parties: The reference is answered in the terms above; the Commissioner was competent to revise under Section 263, and the assessee is not entitled to deduct the whole discount in the single year but is entitled to proportionate deduction over the bond period. The Court ordered that parties shall bear their own costs of the reference.
Broader implications: The opinion adopts a contextual and substantive approach to the meaning of "expenditure" under Section 37, recognizing non-cash liabilities (such as discount on issue) as capable of constituting expenditure when amortised appropriately. The opinion did not purport to lay down a novel general principle beyond the application to the facts of this case.
1. By this reference under Section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as "the Act"), the Income-tax Appellate Tribunal, Indore Bench, has referred the following questions of law to this court for its opinion :
"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the Commissioner of Income-tax was competent to revise under Section 263 an order passed by the Inspecting Assistant Commissioner (Assessment) ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that a sum of Rs. 94,875 allowed as discount to the subscribers of the bond issued by the assessee-Corporation was not an allowable expenditure?"
2. The material facts giving rise to this reference, briefly, are as follows :
The assessee is a corporation established under the State Financial Corporations Act, 1951. The assessment year in question is 1978-79. During the relevant previous year, the assessee, with the object of increasing its working capital, issued bonds for public subscription described as 6 1/4% 1981 Bonds (II Series of the face value of Rs. 100 each) for a sum of Rs. 82.50 lakhs. As the said bonds were issued at a discount, the assessee debited to its profit and loss account for the assessment year 1978-79, the amount of Rs. 94,875 representing discount at Rs. 1.15 per hundred and claimed it as deduction. The Inspecting Assistant Commissioner (Assessment) allowed this claim. As certain other contentions of the assessee were not upheld, the assessee preferred an appeal. While allowing that appeal, the appellate authority did not set aside the finding of the Inspecting Assistant Commissioner (Assessment) with regard to the claim of the assessee for deduction of the amount of Rs. 94,875. Subsequently, the Commissioner of Income-tax, Bhopal, while examining the record of the assessment of the assessee for the assessment year in question found that the order of the assessment passed by the Inspecting Assistant Commissioner (Assessment) was erroneous in so far as it was prejudicial to the interests of the Revenue on the ground that though the deduction of Rs. 94,875 representing the difference between the face value of the bonds and their issue price was not an admissible deduction in computing the total income, it was nevertheless allowed by the Inspecting Assistant Commissioner (Assessment). The Commissioner of Income-tax, therefore, issued a notice to the assessee under Section 263 of the Act to show cause why the discount of Rs. 94,875 allowed to the assessee be not withdrawn. The Commissioner of Income-tax thereafter passed an order under Section 263 of the Act directing the Inspecting Assistant Commissioner (Assessment) to modify the assessment for the assessment year 1978-79 by rejecting the claim of the assessee for deduction of Rs. 94,875. Aggrieved by the order passed by the Commissioner of Income-tax under Section 263 of the Act, the assessee filed an appeal before the Tribunal. It was contended before the Tribunal that the Commissioner of Income-tax had erroneously assumed jurisdiction under Section 263 of the Act in respect of an order of assessment passed by the Inspecting Assistant Commissioner (Assessment) and that the Commissioner of Income-tax had erred in holding that the assessee was not entitled to the deduction of Rs. 94,875 as claimed by the assessee. The Tribunal overruled the objection with regard to the jurisdiction of the Commissioner of Income-tax. The Tribunal also held that no liability to pay the sum of Rs. 94,875 had accrued to the assessee during the previous year relevant to the assessment year 1978-79 and hence the Commissioner of Income-tax was justified in holding that the deduction of Rs. 94,875 made by the Inspecting Assistant Commissioner (Assessment) was not an allowable expenditure. Aggrieved by the order passed by the Tribunal, the assessee sought a reference and it is at the instance of the assessee that the aforesaid two questions of law have been referred to this court for its opinion.
3. Now, so far as the first question is concerned, it has to be noted that Sub-section (4) of Section 125A of the Act provides that where the Inspecting Assistant Commissioner exercises the powers or performs the functions of an Income-tax Officer, in pursuance of an order made by the Commissioner of Income-tax under Sub-section (1) of Section 125A of the Act, reference in the Act or in any rule made thereunder to the Income-tax Officer, shall be construed as reference to the Inspecting Assistant Commissioner. This provision leaves no room for doubt that the orders passed by the Inspecting Assistant Commissioner (Assessment), in exercise of powers conferred on him by virtue of an order made under Sub-section (I) of Section 125A of the Act, are subject to revision under Section 263 of the Act because the order passed by an Income-tax Officer is liable to be revised by the Commissioner under Section 263 of the Act, in accordance with the provisions of that section. Therefore, in our opinion, the Tribunal was justified in holding that the Commissioner of Income-tax was competent to revise under Section 263 of the Act, the order passed by the Inspecting Assistant Commissioner (Assessment). Our answer to the first question referred to us is in the affirmative and against the assessee.
4. Before we proceed to consider question No. 2, it is necessary to refer to certain facts having a bearing on that question. It is not disputed that during the relevant accounting year, the assessee had issued bonds for public subscription at a discount of Rs. 1.15 per hundred and that the amount of discount on the issue of bonds was Rs. 94,875. Now, when debentures are issued at a discount, the effect thereof is aptly described in Spicer & Pegler's Book-Keeping and Accounts (seventeenth edition) at page 240 as follows :
"The discount on the issue is, in effect, deferred interest, and should accordingly be written off over the period having the use of the money raised by the debentures, unless a sinking fund is created to accumulate ' the full redemption price, including the discount."
5. In Batliboi's Principles and Practice of Auditing, the effect of issue of debentures at a discount is stated thus :
"When debentures are issued at discount, an account styled 'Discount on Debentures Account', will be debited with the discount allowed on the issue. The debentures account will be credited in the books at their nominal value and will appear at that value as a liability in the balance-sheet. The loss thus arising need not be completely written off in the year in which the debentures are issued, since the benefit to be derived from the amount borrowed will continue till the debentures are redeemed. Where the debentures are remeedable at the end of a fixed period, a proportionate amount of discount should be written off out of revenue every year during which the debentures are outstanding."
6. In the case of issue of bonds at a discount, the same principles as are applicable in the case of issue of debentures at discount would be attracted. The amount of discount, in effect, represents deferred interest. Looked at as a loss, a proportionate amount of discount can be written off out of revenue every year during the period the bonds would remain outstanding. Therefore, though the assessee would not be justified in claiming deduction of the entire amount of discount amounting to Rs. 94,875 in the accounting year in question, it would nevertheless be entitled to proportionate deduction spread over the period for which the bonds would remain outstanding.
7. The Tribunal held, following the decision of the Madras High Court in CIT v. Madras Industrial Investment Corporation Limited [1980] 124 ITR 454, that the expression "expenditure" occurring in Section 37 of the Act has to be construed in the sense of paying out the money which goes out of the pocket of the assessee irretrievably and that in the case of issue of debentures at discount, there is no such paying out, as is contemplated by Section 37 of the Act. With respect we may say that the decision in CIT v. Madras Industrial Investment Corporation Ltd. [1980] 124 ITR 454 (Mad), does not take note of the real nature of the amount of discount, when debentures are issued at a discount. The decision in [1980] 124 ITR 454, came up for consideration before the Calcutta High Court in CIT v. Indian Jute Mills Association [1982] 134 ITR 68. Referring to the decision of the Supreme Court in Indian Molasses Co. (Pvt.) Limited v. CIT [1959] 37 ITR 66, on which reliance was placed by the Madras High Court, it was observed that the Supreme Court was, in that case, considering the meaning of the expression "expenditure incurred" while dealing with the question as to whether there was a distinction between the actual liability in praesenti and a liability de futuro. Sabyasachi Mukharji J. (as he then was), who delivered the judgment of the court, observed as follows (at pp. 75 and 76):
"The expression 'expenditure' is not denned in the Act, as such. In the context of different statutes, the expression 'expenses' have been construed. For example, in Stroud's Judicial Dictionary, third edn., vol. II, p. 1030, it is noted that in the case of Jones v. Carmarthen Corporation [ 1841] 10 LJ Exch. 401, the expression 'expenses' meant actual disbursements not allowances for loss of time. Therefore, a charge by a town clerk for preparing lists of parliamentary voters was not 'expense incurred' by him within the Parliamentary Voters Registration Act, 1843. But, again, in the case of R. v. Marsham [ 1892] 1 QB 371, 379 (CA), the Master of the Rolls, Esher, observed that the ' money expended ' by a local board and recoverable from the owners or occupiers were not confined to moneys actually paid but include the moneys expended in the sense, the owner or occupier was bound to pay it. It, therefore, appears that the expression must be understood in the context in which it is used."
8. The learned judge further observed as follows (at pp. 76 and 77):
"Reference in this connection may be made to Section 37 of the Act which enjoins that any expenditure not being expenditure of the nature described in Sections 30 to 36 laid out or expended wholly and exclusively for the purpose of the business or profession should be allowed in computing the income chargeable under the head 'Profits and gains of business or profession'. In Sections 30 to 36, the expressions 'expenses incurred' as well as 'allowances and depreciation' had been used. For example, depreciation and allowances have been dealt with in Section 32. Therefore, the Legislature was using the expression 'any expenditure' in Section 37 to cover both."
9. We respectfully agree with the aforesaid observations.
10. It would thus appear that the expression " expenditure " as used in Section 37 of the Act may, in the circumstances of a particular case, cover an amount which is really a loss and the said amount has not gone out from the pockets of the assessee. In Nash (Inspector of Taxes) v. Tamplin & Sons Brewery Brighton Ltd. [1951] 2 All ER 869, the House of Lords was considering the question as to whether the assessee was entitled to deduct the 'rent forgone' in the circumstances of that case. It was held, following the decision in Usher's Wiltshire Brewery Limited v. Bruce [1915] AC 433, that 'rent forgone' would, in the circumstances of that case, amount to money wholly and exclusively laid out or expended for the purposes of the trade of the assessee.
11. Therefore, our answer to question No. 2 is that though the entire amount of discount amounting to Rs. 94,875 was not an allowable expenditure in the assessment year in question, the said amount of discount has to be spread out proportionately over the number of years for which the bonds are issued and the proportionate amount of discount would be allowable expenditure in the assessment year in question.
12. Reference answered accordingly. In the circumstances of the case, parties shall bear their own costs of this reference.
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