A 'Clarificatory' Provision In Tax Laws Cannot Impose A New Condition Retrospectively: Supreme Court

A retrospective provision in a tax act which is "for the removal of doubts" cannot be presumed to be retrospective, even where such language is used, if it alters or changes the law as it earlier stood, the Supreme Court observed while holding that Explanation 3C to Section 43B(d) of the Income Tax Act is 'clarificatory' and does not add a new condition retrospectively.

The bench of Justices RF Nariman and BR Gavai observed that Explanation 3C was introduced to curb the misuse of the provisions of Section 43B by not actually paying interest, but converting such interest into a fresh loan.

Section 43B(d) reads as follows: Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of— xxx xxx xxx (d) any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or xxx xxx xxx shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him: Provided that nothing contained in this section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return.

Finance Act, 2006 inserted Explanation 3C w.e.f. 1st April, 1989, which reads as follows: ""Provided further that no deduction shall, in respect of any sum referred to in clause (b), be allowed unless such sum has actually been paid in cash or by issue of a cheque or draft or by any other mode on or before the due date as defined in the Explanation below clause (va) of sub-section (1) of section 36, and where such payment has been made otherwise than in cash, the sum has been realised within fifteen days from the due date.""

In this case, the Assessee claimed a deduction under Section 43B based on the issue of debentures in lieu of interest accrued and payable to financial institutions. Assessing Officer rejected the claim holding that the issuance of debentures was not as per the original terms and conditions on which the loans were granted, and that interest was payable, holding that a subsequent change in the terms of the agreement, as they then stood, would be contrary to Section 43B(d), and would render such amount ineligible for deduction. The Commissioner of Income Tax (Appeals) ["CIT"] allowed the appeal, which order was was upheld in appeal by the Income Tax Appellate Tribunal. Before the High Court, Revenue filed appeal raising the question "Whether the funding of the interest amount by way of a term loan amounts to actual payment as contemplated by Section 43B of the Income-tax Act, 1961?" The High Court upheld Revenue's contention holding that Explanation 3C, having retrospective effect with effect from 01.04.1989, would be applicable to the present case, as it relates to AY1996-97.

In appeal, the Court first noted that the object of Section 43B, as originally enacted, is to allow certain deductions only on actual payment.

"This is made clear by the non-obstante clause contained in the beginning of the provision, coupled with the deduction being allowed irrespective of the previous years in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by it. In short, a mercantile system of accounting cannot be looked at when a deduction is claimed under this Section, making it clear that incurring of liability cannot allow for a deduction, but only "actual payment", as contrasted with incurring of a liability, can allow for a deduction."

 observed that Explanation 3C, which was introduced for the "removal of doubts", only made it clear that interest that remained unpaid and has been converted into a loan or borrowing shall not be deemed to have been actually paid.

As has been seen by us hereinabove, particularly with regard to the Circular explaining Explanation 3C, at the heart of the introduction of Explanation 3C is misuse of the provisions of Section 43B by not actually  paying interest, but converting such interest into a fresh loan. On the facts found in the present case, the issue of debentures by the assessee was, under a rehabilitation plan, to extinguish the liability of interest altogether. No misuse of the provision of Section 43B was found as a matter of fact by either the CIT or the ITAT. Explanation 3C, which was meant to plug a loophole, cannot therefore be brought to the aid of Revenue on the facts of this case.

The court observed that if there be any ambiguity in the retrospectively added Explanation 3C, there are three well established canons of interpretation come to the rescue of the assessee in this case

1. Since Explanation 3C was added in 2006 with the object of plugging a loophole – i.e. misusing Section 43B by not actually paying interest but converting interest into a fresh loan, bona fide transactions of actual payments are not meant to be affected.
2. A retrospective provision in a tax act which is "for the removal of doubts" cannot be presumed to be retrospective, even where such language is used, if it alters or changes the law as it earlier stood. 
3. Any ambiguity in the language of Explanation 3C shall be resolved in favour of the assessee as per Cape Brandy Syndicate v. Inland Revenue Commissioner.

The bench, therefore, taking note of other facts of the case, set aside the High court judgment and restored the orders of ITAT.

Case: M.M. Aqua Technologies Ltd vs. Commissioner of Income Tax, Delhi-III ;  CA 4742-4743 OF 2021
Citation: LL 2021 SC 373
Coram: Justices RF Nariman and BR Gavai
Counsel: Sr. Adv Biswajit Bhattacharya, ASG  Balbir Singh

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