The Supreme Court of India, in a crucial ruling, has clarified that broken period interest paid by banks while purchasing government securities is a deductible revenue expenditure and not a capital outlay. The judgment was delivered by a bench comprising Justice Abhay S. Oka and Justice Pankaj Mithal in the case of Bank of Rajasthan Ltd. v. Commissioner of Income Tax and several related appeals (Civil Appeal Nos. 3291-3294 of 2009).
The court held that broken period interest — the interest paid by a bank when purchasing government securities between coupon payment dates — should be treated as revenue expenditure and deductible in the year of purchase. This decision has significant implications for banks’ tax liabilities, particularly concerning how they treat securities held as part of their statutory liquidity ratio (SLR) obligations.
Background of the Case
The case arose from a dispute over the tax treatment of broken period interest paid by banks. When a bank purchases government securities between two coupon dates, it pays the accrued interest for the period between the last coupon payment and the purchase date, referred to as the “broken period.” This interest is recouped when the next coupon payment is made.
The appellant, Bank of Rajasthan Ltd., along with other banks, argued that this broken period interest should be treated as a revenue expenditure, deductible from their taxable income. The Income Tax Department, however, contended that such payments constituted capital expenditure, which cannot be deducted.
The Income Tax Appellate Tribunal (ITAT) had ruled in favor of the banks, but the department appealed the decision, citing earlier rulings such as Vijaya Bank Ltd. v. Additional Commissioner of Income Tax (1991), where broken period interest was not allowed as a deduction.
Key Legal Issues
1. Revenue vs. Capital Expenditure: The core issue was whether the broken period interest paid by banks is a capital outlay or revenue expenditure. The classification affects whether banks can deduct this amount from their taxable income.
2. Stock-in-Trade vs. Investment: The court examined whether the securities held by banks, particularly for meeting SLR requirements, were part of their stock-in-trade (trading assets) or investments. This distinction is vital for determining the treatment of the interest payments.
3. Application of Past Judgments: The bench also had to address the applicability of the 1991 Vijaya Bank Ltd. judgment, which ruled against deducting broken period interest under the old provisions of the Income Tax Act, Sections 18 to 21, which have since been repealed.
Supreme Court’s Observations
Justice Abhay S. Oka, writing the judgment, highlighted the evolution of the legal framework since the Vijaya Bank Ltd. case. He emphasized that post-repeal of Sections 18 to 21 of the Income Tax Act in 1989, the context of broken period interest has shifted. The court ruled that under the current legal provisions, broken period interest should be classified as a revenue expenditure when securities are held as part of a bank’s stock-in-trade.
The court referred to earlier cases, including Citi Bank NA and American Express International Banking Corporation, which upheld the deduction of broken period interest as revenue expenditure. Justice Oka noted:
“Broken period interest paid on the purchase of securities should not be considered part of the purchase price and should be allowed as revenue expenditure in the year of purchase of securities.”
The bench further observed that securities held by banks to comply with the statutory liquidity ratio (SLR) requirements are part of their stock-in-trade. Thus, broken period interest paid while acquiring these securities is deductible from the bank’s taxable income as a business expense.
Decision and Conclusion
The Supreme Court dismissed the appeals filed by the Income Tax Department and upheld the ITAT’s decision allowing banks to deduct broken period interest as revenue expenditure. The court also clarified that the reliance on Vijaya Bank Ltd. was misplaced, as that judgment was based on a different legal framework, which no longer applies after the repeal of the relevant sections of the Income Tax Act.
In concluding, Justice Oka stated that treating broken period interest as capital expenditure would be inconsistent with established principles for calculating profits and gains from business. Therefore, the court held that the interest payments are legitimate business expenses and should be deducted accordingly.
Case Details:
– Case Title: Bank of Rajasthan Ltd. v. Commissioner of Income Tax and related appeals
– Case Numbers: Civil Appeal Nos. 3291-3294 of 2009 and connected appeals
– Bench: Justice Abhay S. Oka and Justice Pankaj Mithal
– Legal Representation: Senior counsel represented the appellant banks, while the Additional Solicitor General represented the Income Tax Department.
