Mumbai Tribunal holds perpetual debentures as debt and allows interest deduction

In the case of TMF Holdings Ltd.^[1] , the Taxpayer was a Non-Deposit taking Non-Banking Financial Company (ND-NBFC) registered with the Reserve Bank of India (RBI) . It was engaged in the business of financing vehicles manufactured by its parent company, Tata Motors Ltd. (TML), and it was also a captive financing arm of TML. The Taxpayer raised funds by issuing Non-Convertible Subordinate Perpetual Debentures (NCPDs) with a call option exercisable (a) at end of 10 years (without RBI approval) and (b) at the end of every month thereafter (subject to RBI approval). During the tax year (TY) 2014-15, the Taxpayer claimed interest expenditure on NCPDs as a deduction under Section (S.) 36(1)(iii) of the Income Tax Act (ITA).

The Tax Authority disallowed interest deduction on the ground that NCPDs lacked the characteristics of a debt, such as pre-determined maturity, principal protection and no profit participation. Further, features of perpetuity of NCPDs supported it to be equity instrument. The first appellate authority upheld the disallowance on the ground that commercial expediency was not demonstrated.

On further appeal by Taxpayer, the Mumbai Tribunal observed that NCPDs holders had no voting or profit participation rights (comparable to equity shares) in the Taxpayer company. The interest payment on NCPDs is fixed and cumulative with call option evidencing repayment obligations of debt after stipulated time. It further observed that repayment of equity would require National Company Law Tribunal (NCLT) approval which is not the case for NCPDs repayment. Even from regulatory perspective, the Securities and Exchange Board of India (SEBI) and RBI treated NCPDs as debt and it is traded on stock exchange under ‘debt segment’. Considering the above features, the Tribunal held NCPDs to be a debt instrument and not equity.

The Tribunal observed that the Taxpayer was into financing business and debt was borrowed in the regular course of its business. Further, NCPDs prospectus evidences the purpose of borrowing was for the Taxpayer’s financing activities, repayment of loans and for working capital requirements. Accordingly, Tribunal held that interest expense was allowable as business expenditure under s.36(1)(iii).

[1] [TMF Holdings Ltd v. Commissioner of Income-Tax, National Faceless Centre Income Tax Dept. [TS-801-ITAT-2024(Mum)]