The Madras High Court has held that shares allotted to settle accrued interest can amount to receipt of taxable value even when the taxpayer receives no cash. The ruling separates the tax treatment of interest from the capital-gains treatment of converting debentures into shares, and it upheld a remand for the tax officer to examine the interest component—not a final assessment fixing the taxpayer’s ultimate liability.
What the Madras High Court decided
In Sanjjay Saumyha v. Principal Commissioner of Income Tax, T.C.A. No. 151 of 2026, the Madras High Court dismissed the taxpayer’s appeal and affirmed the Income Tax Appellate Tribunal’s order. The judgment, delivered on 21 September 2026 by Chief Justice Sushrut Arvind Dharmadhikari and Justice G. Arul Murugan, upheld a revision under Section 263 of the Income-tax Act and a direction to determine the matter afresh.
The central point was that allotment of valuable shares to settle an interest obligation can constitute receipt of economic value. The court stated: “Receipt of income need not take the form of physical cash; settlement through allotment of valuable shares constitutes constructive receipt in law.” The decision concerns this taxpayer’s assessment and does not itself determine the final amount payable.
How the debenture conversion generated the dispute
The taxpayer was a director and shareholder of AVR Swarna Mahal Jewellery Pvt. Ltd. The company issued zero-coupon convertible debentures in 2009, each with a nine-year tenure and a stated redemption value of ₹6,400. The taxpayer held 5,006 debentures. They were converted in September 2012, and shares were allotted in October 2012 against the face value and accrued interest.
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- The initial face value was ₹1,00,12,000.
- Accumulated interest through conversion was ₹75,46,082.
- The total value of shares allotted was ₹1,75,58,082.
- Of the accumulated interest, ₹61,97,169 accrued in earlier years and had not been offered to tax.
- For FY 2012–13, ₹12,23,689 was the interest portion on which the company deducted tax at source. The taxpayer reported total interest income of ₹13,48,913 after gross-up and claimed credit for the TDS.
These amounts are case-specific figures recorded in the court’s judgment, not general tax thresholds or estimates for other investors.
Why shares can count as receipt when no cash changes hands
The court focused on what the taxpayer received economically, rather than whether the company transferred money into a bank account. The debentures carried an implicit interest component, and the shares allotted on conversion represented both the underlying face value and accumulated interest. Accepting shares in satisfaction of the debt therefore provided value in settlement of the interest obligation.
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The taxpayer’s reliance on the cash method under Section 145 did not, in the court’s view, necessarily postpone tax when valuable shares had already been received. The decision treats settlement in an asset as potentially different from an unpaid book entry: the relevant question is whether the taxpayer received value by having the obligation discharged.
Section 47(x) does not decide the tax treatment of interest
The court distinguished two parts of the transaction. Section 47(x) excludes conversion of debentures into shares from being treated as a transfer for capital-gains purposes. That treatment of the conversion does not, according to the judgment, change the character of interest embedded in the transaction or exempt it from tax under Section 56.
The court also addressed the concern that taxing interest when shares are allotted could tax the same value again when those shares are later sold. It referred to Section 49(2A): where interest is taxed on conversion, the amount so taxed forms part of the cost basis of the converted shares. The eventual tax treatment of a later sale is a separate event and depends on the applicable facts and rules.
Why the Section 263 revision was upheld
The dispute reached the High Court through a procedural challenge. The Principal Commissioner of Income Tax had invoked Section 263 to set aside a reassessment and require fresh determination. The ITAT upheld that order.
The High Court accepted that an assessment can be erroneous in law when it is completed without necessary inquiry or proper application of relevant provisions. Here, the Assessing Officer had not made the necessary inquiry into the interest component of the shares allotted on conversion. The court held that this failure made the reassessment erroneous and prejudicial to the Revenue, supporting the PCIT’s jurisdiction to revise it.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.What the ruling does—and does not—settle
- It does establish: for this dispute, shares received in discharge of an interest obligation could represent constructive receipt of value despite no cash payment.
- It distinguishes: the exclusion of a debenture-to-share conversion from capital-gains treatment under Section 47(x) from the separate tax character of interest under Section 56.
- It upholds: a Section 263 revision where the initial assessment lacked a necessary inquiry into the interest component.
- It does not fix: the taxpayer’s final assessment or ultimate tax liability. The matter was remanded for fresh determination, and the judgment says the taxpayer may raise issues before the Assessing Officer.
The judgment text is reproduced by Indian Kanoon. This is a report of a court decision, not individualized tax advice.
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