This article is based on the long debated taxability of share issue expenses incurred by a company.
One of the major sources of funding company is infusion of equity. A company may incur a host of expenses such as professional consultation, underwriting commission, legal expenses, printing expenses, listing expenses etc., when it opts for issue of share capital.
Taxation of such expenses can be analysed with reference to Section 35D, Section 32 and Section 37 of the Income Tax Act.
Section 35D allows amortisation of certain specified preliminary share issue expenses incurred by an Indian company or a person other than a company incurred before the commencement of his business or after the commencement of his business, in connection with the extension of his undertaking or in connection with his setting up a new unit.
Prior to 2008, this section was applicable only industrial undertakings. Later by an amendment through Finance Act 2008, the word “Industrial” was removed from this Section, thereby extending the applicability of this provision to non-industrial undertakings as well.
However, the benefit of provisions of Section 35D cannot be availed in the following cases:-
1. When the issue of share capital is not made for public subscription.
2. When expenses other than those specified in Section 35D are incurred such legal fees paid to ROC, professional consultation, and share valuation expenses etc.
3. When the share issue is not for the purpose of establishment of new business or expansion of existing business or setting up of a new unit and for other purpose such as to meet the working capital requirements, repayment of debt, streamline debt-equity ratio etc.
In the case of CIT Vs Ashok Leyland Ltd (2012) 349 ITR 663, the Madras High Court has defined the meaning of the phrase “being” as mentioned in section 35D (2)(c)(iv) and held that expenditure incurred in connection with the issue of shares and debentures of the company to public subscription, which qualify for consideration under Section 35D, are underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus and nothing more.
In the case of International Computers India Manufacture Limited Vs CIT (2015) 230 Taxman 428 the assesse who has incurred expenditure for issue of shares and had it capitalised to various heads of plant and machinery and factory equipment relying on the decision of Chellapalli Sugars Vs CIT 98 ITR 167 was denied depreciation as according to Commissioner of Income Tax Appeals the case was a different one when compared to Chellapalli Sugars.
Generally, the common premise or understanding on the above subject is that any expenditure incurred on the public issue to raise capital for expansion of business would fall under the ambit of Section 35D and the assesse would be entitled for the benefit of Section 35D.
Similar view was held in the cases of Autolite India Ltd Vs CIT 264 ITR 117 and CIT Vs Mahindra Ugine and Steel Co Ltd (2001) 250 ITR 84 (Bom) where the Courts have denied depreciation on such expenses which were capitalised.
However, there may be certain expenditure which may fall under the definition of actual cost u/s 43, but not under provision of Section 35D and vice versa like:-
1. Expenditure specified in Section 35D and not falling within the ambit of Section 43 definition of actual cost.
It was held in CIT Vs Polychem Ltd 98 ITR 574 that printing and stationery which has no connection with the acquisition and installation of machinery could not be allowed.
1. Expenditure incurred purely for the purpose of business after the commencement of business in connection with extension of the business undertaking or setting up of new unit but not covered under Section 35D for claiming deduction.
In most of the cases, such expenditure incurred in connection with the issues of shares of company being underwriting commission, brokerage was not entitled to be benefit of Section 35D as that section was in applicable having regard to the increase in share capital being subsequent to the establishment of the business and the assesse had not established any new industrial unit nor had it expanded the existing industrial undertaking as mentioned in the case of Sakthi Finance Ltd Vs CIT (2002) 256 ITR 488 (Mad) by Madras High Court.
Similar view was also spelt out in the case of CIT Vs Ennar Steel and Alloy Pvt Ltd (2003) 261 ITR 347 wherein it was held that the Board need to include items of expenditure and items which are not included cannot be claimed under the same section. More magnanimous view need to be taken to include expenditure prior to commencement of production for eligibility.
The revenue nature of any business expense determines whether such expense can be claimed as deduction under section 37.
Lord Viscount Clave LC in the case of British Insulated and Helsby Cables Ltd Vs Atherton has given a reliable basis for determining whether an expense is of capital or revenue in nature.
“When an expenditure is made, not only once and for all but with a view to bringing into existence an asset or an advantage for the enduring benefit of trade, I think that there is a very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue, but to capital.”
In view of the above pronouncement, it can be construed that the expenses incurred in relation to further issue if share capital is of capital in nature.
It is a common analogy that any expenditure being incurred that will increase the capital base say, in the form of (a) Initial Public Offer or (b) Rights Issue which may introduce new influx of funds and thereby expansion of capital would be a capital expenditure.
Judgement given by the Supreme Court in the case of Punjab State Industrial Development Corporation Ltd Vs CIT (1997) 225 ITR 792 (SC) provided a guiding judgement in reference to expenses paid to ROC for enhancing the share capital. The Supreme Court has decided that expenses incurred in relation to increase in capital base is capital expenditure incurred by the company even though it certainly helps the company in profit making still retains the characteristic of a capital expenditure.
The same was held in the cases of in Brooke Bond India Ltd Vs CIT (1997) 225 ITR 798 (SC), where the Supreme Court held that share issue expenses are capital in nature and cannot be claimed as deduction.
In case of CIT Vs Motor Industries Ltd (1998) 229 ITR 137 (Kar) it was held that expenses incurred in relation to rights issue were of capital in nature and answered in favour of the Revenue disallowing such expenses.
On the other hand, expenditures which are contrary to the above say incurred on buy back will result in the contraction of reduction of capital base and are not of enduring benefit as mentioned in Motor Industries Company Ltd (TS-671-SC-2015).
However, no yardstick for determining whether the share capital issued was applied for the purpose of working capital requirements was laid out in any of the above judgements.
As mentioned rightly in the case Brahma Corp Hotels & Resorts Ltd [TS-740-ITAT-2014(PUN)] that “There is no hesitation in holding that the expenditure which was incurred in order to facilitate the smooth running of business by getting rid of a group of shareholders was an expenditure incurred out of business expediency and wholly and exclusively incurred in the course of carrying on the business.
Similar view was also extended in USV Ltd VS JCIT [TS-17-ITAT-2006(Mum)] wherein expenditure incurred for protection of business of assesse was allowed as revenue.
In CIT Vs Rajasthan Breweries Ltd (TS-75-SC-2014) SC dismissed SLP filed by revenue against Delhi High Court where the HC rejected section 35D invocation after allowing amortisation initially had held that business establishment expenses allowed to be spread over 10 years period by AO could not be interfered with in later years.
In recent Bangalore ITAT ruling in the case of Subex Ltd vs CIT. (TS-362-ITAT-2015(BANG)) it was held that share premium cannot be employed in the business of the assessee as share capital and distinguished it from JCIT vs Sirhind Steel Ltd. 97 ITD 502 (Ahd) where in the context of Sec.35D, the Bench took the view that Share premium has to be considered as part of "Issued Share capital. Bangalore ITAT further denied relief on the basis of "Cost of Project" u/s 35D(3)(a), as assessee chose the option u/s 35D(3)(b), moreover shares acquired cannot be treated as land or building, plant or machiner etc by any stretch of imagination, so as to be treated as "cost of project" for the purposes of Sec 35D.
Therefore based on the above various case laws it is a proven theory that only expenditure which are perfectly fit into the definition of section 43, 35D, 32 can be claimed as a deduction. The Act remains silent with respect to treatment of share issue expenses incurred wholly for the purpose of business that are outside the purview of these sections. Since the purpose of such issue of share capital are not covered under the ambit of Section 35D and are capital in nature these cannot be claimed as deduction under any Section.
With the raising impetus for Make in India and Start Up India, Stand Up India initiative by the Central Government calling for investments in India, it is vital to allow these expenses as deductions under Income Tax Act, in the best interest of the assessee who come forward to set up industrial establishments here. In light of the above case laws in can be construed that the taxability of such expenses requires reconsideration.
