SC disapproves of retrospective adjustments to tax legal guidelines by means of clarifications

In an interesting ruling last week that could have more far-reaching implications, the Supreme Court (SC) disapproved of the practice of making retrospective changes to tax laws by adding additional clarifications.

In its judgment last week in favor of the complainant MM Aqua Technologies, the Supreme Court ruled that Explanation 3C to Section 43B (d) of the Income Tax Act is “clarifying” and does not retroactively add any new condition.

“A retrospective provision in a tax law that is used” to resolve doubts “cannot be considered retroactive, even if such wording is used in amending or amending the law as it was previously amended,” Judge RF Nariman and BR Gavai observed.

Section 43B contains a list of deductible expenses under the heading “Income from trade and work”. This lists some expenses that can only be deducted from operating income in the year in which they are actually paid and not in the year in which the obligation to pay these expenses arises.

“The court has abandoned the practice of making retrospective changes to tax law under the guise of clarifications. Tax certainty is non-negotiable, and the court confirmed that principle in its judgment, ”said Abhay Sharma, Partner, Shardul Amarchand Mangadas & Co.

“The ruling affirms the ‘substance over form’ doctrine and affirms that the income tax authorities are unable to rewrite the transaction completed by the two parties,” added Yashesh Ashar, partner, Bhuta Shah & Co. added.

Assesee MM Aqua Technologies was in arrears with the payment of principal and interest on loans from ICICI Bank. Therefore, the two parties agreed that the interest would be paid to the lender through the issuance of “bonds” by the Assesse. After converting interest into bonds, the Assesse claimed interest as paid in accordance with Section 43B of the IT Act.

The above deduction was rejected by the assessor. However, the same has been approved by the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal.

In its appeal, the High Court relied on Note 3C to Section 43B (d) of the IT Act that any amount payable on the interest liability would be deductible if that interest were actually paid. However, interest converted into a loan or bond is not deemed to have actually been paid.

For its part, the SC concluded last week that the interest was “actually paid” by the Assesse by issuing bonds, thereby nullifying its obligation to pay interest. In order to reach this conclusion, the court relied on the fact that the bank’s accounts show the amount that the bank received as its operating income from bonds for the tax year in question.

According to Bhuta, the ruling makes it clear that Statement 3C is merely a clarification and should not affect real transactions to accept a bond in lieu of the interest due in the event of default.

“The ruling could pave the way for companies under stress in the current environment to restructure their interest payments into bonds or other instruments and deduct them for income tax purposes. Provided the lender recognizes these interest payments on their books and pays taxes on them, “said Bhuta.

Important observations from the SC

  • At the heart of the introduction of Note 3C is the abuse of the provisions of Section 43B by not actually paying interest but converting it into a new loan.

  • Explanation 3C is used for clarification; it explains Section 43B (d) in its original form and does not purport to add a new condition retrospectively.

  • A retroactive provision in a tax law that serves to “eliminate doubt” cannot be accepted as retroactive if it changes or changes the previous law.

  • According to a restructuring plan agreed between the lender and the borrower, bonds were accepted by the bank to settle the debts due to outstanding interest.

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