Flash Alert: Ruling of the Hon’ble Mumbai ITAT in the case of Khushaal C. Thackersey
- Posted by kalyani
- On May 22, 2024
- 0 Comments
The Hon’ble Mumbai ITAT, in a recent ruling in the case of Khushaal C. Thackersey[1], has held that the surplus received by the taxpayer on redemption of zero coupon non-convertible debenture is taxable as interest income under the head ‘Income from other sources’ and not as ‘Capital gains.’
A summary of the Ruling is provided below:
Facts
- For the Financial Year (‘FY’) 2004-05, two Indian Companies, Bhishma Realty Limited (‘BRL’) and Capricorn Realty Limited (‘CRL’), issued redeemable Non-Convertible Debentures (‘NCD’) on a private placement basis to a nationalised bank.
- The NCDs were to be redeemed within a period of five years along with a redemption premium to yield an IRR. No interest was required to be paid by the companies on the debentures during the tenure of the instrument.
- In 2006, the taxpayer, being one of the directors of CRL, purchased the NCDs from the nationalised bank.
- In FY 2009-10, NCDs were redeemed, and the entire surplus received on redemption of NCDs was offered to tax by the taxpayer as long-term capital gains. Further, the taxpayer invested the amount received on maturity of NCDs for acquiring a house under construction and claimed a deduction under Section 54F of the Income-tax Act, 1961 (‘the Act’).
- During appellate proceedings, the Revenue Authorities treated the surplus received on redemption of NCDs as interest income under Income from Other Sources (‘IFOS’) and consequently rejected the deduction claim under Section 54F of the Act as made by the taxpayer.
- Aggrieved by the order of the learned Commissioner of Income Tax Appeals, the taxpayer filed an appeal before the Mumbai ITAT.
Ruling of Hon’ble Mumbai ITAT
The ITAT, while considering the question of whether surplus arising to the taxpayer on redemption of NCDs is ‘interest income’ or ‘capital gains’ made the following observations:
- As per the Companies Act, “debentures” include debenture stock, bonds, or any other instruments of a company evidencing a debt, whether constituting a charge on the assets of the company or not. Hence, although debentures fall under the definition of “securities,” they are essentially an “instrument,” evidencing a debt.
- There is a fundamental difference between shares and debentures, with each instrument having different rights and liabilities. A shareholder is an owner of the company, while a debenture holder is a financial creditor entitled to interest and principal but not surplus on liquidation, available to shareholders. Hence, the ratio of rulings rendered in the context of equity/preference shares cannot be applied to debt instruments like debentures.
- The redemption proceeds on redemption of NCDs is akin to repayment of the debt, and the same cannot be considered as ‘extinguishment’ within the definition of transfer under Section 2(47) of the Act. Consequently, the difference between the NCDs’ sale value and purchase cost must be assessed as interest income under IFOS.
- In the case of Deep Discount bonds (‘DDBs’), the face value of the bonds is discounted by applying a particular interest rate, ensuring that the maturity proceeds equal the face value. Conversely, in the case of NCDs redeemable at a premium, the premium amount is determined by applying a particular interest rate. Therefore, both the discount in the case of DDBs and the premium in the case of zero coupon NCDs effectively represent “interest amounts”. Also, companies issuing bonds or debentures typically claim the discount/premium as interest expenditure, and Revenue Authorities have in the past allowed such claims.
- The legal fiction of Section 50AA of the Act, wherein surplus arising on transfer/redemption of Market Linked Debentures(‘MLD’) is taxable as short-term capital gains, cannot be applied in the facts of this case as the NCDs differ materially from MLDs.
In conclusion, the ITAT ruled in favour of Revenue Authorities and opined that the surplus/premium received by the taxpayer on redemption of the NCDs is in the nature of interest income and not capital gains. Consequently, it was concluded that the taxpayer would not be entitled to any deduction under Section 54F of the Act.
KNAV Comments
The taxability of premiums on redemption of NCDs are a contentious issue. Typically, interest paid on a debt instrument represents a commercial rate of return, and any premium thereon is toward the capital risk borne by the instrument’s holder.
In this case, the ITAT post, considering the terms of the instrument, concludes that the redemption premium is taxable as interest since no periodic interest payment was made to the recipient of the NCDs and the entire payment, is made in the form of a premium on redemption / maturity of the NCDs. In light thereof, the ITAT has recharacterised the premium on redemption as interest and taxed the same as ‘IFOS’ and not as ‘Capital gains.’
Taxpayers may want to take note of this ruling on the specific facts of their cases while dealing with NCDs.
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