Clarification by CBDT fails to win over experts

A recent clarification issued by the Central Board of Direct Taxes, stating that unpaid interest converted into loan would be allowed as a deduction while computing income, has still not convinced some tax experts.

Mrugen Trivedi and Girish Mistry of RSM and Co have pointed out that the circular does not address conversion of interest into redeemable preference shares or equity shares of the borrower company instead of a loan.

"Many times, banks or financial institutions enter into an arrangement whereby unpaid interest is converted into redeemable preference or equity shares of the borrower company instead of loan.

In such a situation, the income tax department may disallow payment of interest which has been converted into redeemable preference or equity shares. Even Section 43B of the Income Tax Act does not deal with this situation," RSM Co Manager Trivedi said.

Mistry, a partner with the firm, added that looking at the objective for which the circular has been issued, such conversions should be allowed as deductible expenditure. However, in the absence of a clarification, there could be some litigation, he said.

Last month, the CBDT had issued a circular clarifying that such unpaid interest converted into loan, whenever actually paid to the bank or financial institution would be in the nature of revenue expenditure and the interest so converted shall be allowed as deduction while computing income under the Income Tax Act.

The nomenclature of the sum of converted interest would make no difference, as the sum of converted interest whenever actually paid would represent repayment of interest and not principal, the circular said.

The circular had been issued following an amendment in the Finance Act, 2006 which stated that if the interest on any loan, borrowing, etc payable by the assessee is converted into a loan or borrowing or advance, such conversion would not be considered as actual payment of the interest.

Accordingly, interest so converted would not be allowed as deduction while computing the total income.

Under the Income Tax Act, 1961 (IT Act) the income is computed after excluding deductible expenditure, however, subject to the provisions of the Act.

Section 43B of the IT Act disallows certain statutory liabilities and interest on loans, borrowings, etc from banks/ financial institutions, if it is not actually paid before the due date of filing return of income.