1988 PLP 10 (PTD)

Rs.2,65,580 Rs.2,74,554 Interest on debentures to customs Rs.3,00,800 Rs.6,53,067 Disallowance by the assessing officer. Rs.6,66,380 Rs.9,27,621

3. The, assessing officer disallowed the aggregate of interest on both the debentures at Rs.6,66,380 in 1982-83 and at Rs.9,27,921 in 1983-84 for, according to him, although the arrangement and the quantum stood proved, the expense was not covered under clause (vii) of subsection of section 23(1) of the Ordinance. With this reasoning the learned AAC in the first year and the learned CIT(A) in the second year, concurred. The learned CIT(A) in his order referred to clause.(vii) of section 23(1) also and held that the customs debentures (etc) represented interest on deferment of import duty hence expenditure incurred in respect of import of capital goods constituted capital expenditure not having a revenue character. Moreover, it was not in nature of interest on "capital borrowed".

4. The learned counsel for the Appellant referred to the definition of "interest" as per cruse (29), of section 2 of the Income Tax Ordinance to contend that the two appellate authorities at the first stage, were not correct in holding that the expense was recompense for late payment. According to the A.R a debt was incurred to the Customs Department and to ICP/scheduled banks and the additional expense was covered b3 the definition of "interest" hence allowable under the provisions of section 23(1)(vii) of the Ordinance. The learned counsel was however, not in a position to explain as to what was the definition of "capital borrowed" about which a specific querry was made by us in view of the wording of section 23(1)(vii) which reads as under:- "any interest paid in respect of capital borrowed for the purposes of the business or profession."

5. Before we proceed to adjudicate upon the dispute it would be beneficial to analyse and understand as to:- What are debentures? Does the debentures issued by the Appellant fulfil the criteria? What accounting treatment was given to the interest paid on the Debentures issued by the Appellant. What is meant by Capital or Capital borrowed?

6. What is Debenture? It is well-known in commercial circles, especially in the corporate sector, that Debenture is a document acknowledging a loan to a company and is generally executed under of the company usually (but not necessarily) containing provision the payment of interest and the repayment of the principal and charge over the assets of such company. Not infrequently a charge may be conferred on some specified assets or undertaking of company. Debentures may be classified as (i) Mortgage or specific security Debentures; or (ii) Floating Charge Debentures. A company may issue debentures as collateral security for a loan, or for a bank over-draft, by way of total or partial security, therefore. A collateral security is one, which could be realised in the event of the original loan not being repaid at the due date or it the event of breach of agreement between the parties on repayment of the loan, the collateral security is at once released. Thus, in the case of debentures issued by a company as collateral, these are normally withdrawn if the loan is repaid by the due date.

7. It is thus evident that debentures are one of the popular and convenient ways of raising money. I', may be particularly favoured for certain projects that require finance for a limited period more so' because the debentures (unlike shares) can be redeemed by the company. Under established and accepted accounting principles, interest paid on debentures is treated deductable in computing taxable profits, whereas dividends are not.

8. Does the debentures issued by the Appellant fulfil the criteria ? The CBR issued Circular C.No.4(35)SS(CB)/65 pt on 27-7-1976 laying down procedure for deferred payment of custom duty. Under this circular certain categories of machinery and spare parts thereof (for approved projects) were made eligible for the grant of concession of deferred payment of half of custom duty on import. The procedure in the circular envisaged that the deferred amount would be paid within a period of three years in six equal half-yearly instalments and interest at to above the bank rate would be payable during the currency of the debenture on six monthly basis. The custom officials were authorised to allow the concession of deferred payment of custom duties for which debentures were to be issued after proper Resolution by the Board of Directors of the company and after affixing the seal of the company on such debentures. Specific guarantees were to be given by the company and undertaking furnished on non-judicial paper for which purposed different forms were prescribed by the CBR. It is thus manifest that the debentures so issued were an obligation of the company in respect of the payment of the Customs Duty and interest, thereon, in the same manner as another loan obtained in the ordinary course of business.

9. What accounting treatment was given to the interest paid on the debentures issued by the Appellant?-- It may be borne in mind that in the books o accounts entries in respect of the debentures are mutatis mutandis similar to those for shares issued by a company. It is not in dispute that the Appellant company availed the concession for deferred payment of custom duty under CBR Circular dated 22-7-1976 (ibid) and took the prescribed steps towards that end. In addition, to the custom debentures (covering 50% of the customs duty) the Appellant raised cash for payment of the other 50% custom by issuing debentures to ICP/scheduled Banks. In the Balance Sheet these two debenture issues were listed under "Long Terms Loans and Deferred Liabilities". The interest paid was capitalized till such time as the production had not commenced whereafter it was charged to the Profit and Loss Account.

10. What is meant by Capital or Capitals Borrowed?-- Capital stock and capital are synonymous terms. In the general sense, it is money invested in business operations, whether that business be conducted by single individual, a partnership a corporation or a Government and it makes no difference how the money is obtained whether by labour, by borrowing, or otherwise. If the money is borrowed it is presented in the hands of the lender, by bonds, notes or papers. In such situations the lender is not a stock-holder in the business far as the party itself is concerned, if the money borrowed, or otherwise obtained, is invested in its business it is capital, or (more correctly capital borrowed).

11. On careful appraisal of all aspects of the issue to the examination, of which we have addressed ourself, we have no difficulty in holding that Customs Debentures by the appellant were a method of raising loan, which clearly fell within the scope of the expression "capital borrowed for the purpose of business or profession". It is to be remembered that there is no controversy about the import of machinery, about its installation and commissioning for the purpose of business. It also is settled that it was in respect of this very machinery that payment of custom Duty was deferred, hence claim for interest expense. .

12. Looking at the controversy from yet another angle we notice' that the assessing officer, as also the learned AAC never doubted the revenue nature of the interest expense nor did they dispute its payment. Therefore, in our view the claim represents" ....expenditure (not being in nature of capital expenditure or personal expenses of assessee) laid out or expanded wholly and exclusively for the purposes of such business or profession".

13. On the basis of the foregoing discussion whichever way we look having in mind both clause (vii) and clause (xviii) of subsection (1) of section 23 of the Ordinance, we find the interest paid on Debentures to Custom; and to ICP/scheduled banks, deducting for computing income under the head 'income from Business or Profession'. The two officers below clearly erred in making the impugned disallowances, which cannot be sustained in any of the years under consideration.

14. Depreciation.-- A sum of Rs.48, 41,198 was claimed as depreciation in the year 1982-83. On appeal the learned AAC set aide the issue for the reasons that the claim arose due to allocation of expenses on installation of Plant and Machinery besides construction of Building etc. The learned AR contends that instead of setting aside the issue the learned A. A. C. should have ordered that the claim be admitted. We do not agree with this contention, as it is not possible at this stage to allocate the expenses with accuracy without undertaking detailed examination of the record. We, therefore maintain the, order by the learned AAC on this issue. Needless to say consequential effect would follow in the year 1983-84.

15. No other ground was pressed. M.B.A./434/7 Order accordingly.