The Supreme Court examined the issue relating to the tax treatment of interest paid for the broken period on the purchase of government securities by banking companies. The core question was whether such broken period interest is allowable as a deduction when the securities are held by banks as stock-in-trade in the course of their banking business.

The Court noted that banks are statutorily required under the Banking Regulation Act, 1949 and the guidelines issued by the Reserve Bank of India to invest in government securities for maintaining the Statutory Liquidity Ratio. Such securities are routinely purchased and sold by banks and constitute an integral part of banking operations. The interest on these securities is uniformly assessed as business income under the head “Profits and Gains of Business or Profession”.

The Court explained that when a bank purchases a security between two coupon dates, it pays the seller interest accrued up to the date of purchase, commonly referred to as broken period interest. Upon the next due date, the bank receives interest for the entire period, including the broken period. In commercial and accounting practice, banks debit the broken period interest to the profit and loss account and offer the entire interest received to tax as business income.

Distinguishing the earlier decision in Vijaya Bank Ltd. v. Additional Commissioner of Income Tax, the Court held that the said judgment was rendered in the context of the pre-1989 statutory regime when interest on securities was taxed under a separate head and governed by Sections 18 to 21 of the Income Tax Act. After the repeal of those provisions, interest on securities held as trading assets is taxable as business income under Section 28, and the principles laid down in Vijaya Bank Ltd. have no application to such cases.

The Court relied upon and reaffirmed the decisions in American Express International Banking Corporation v. Commissioner of Income Tax and Commissioner of Income Tax v. Citi Bank NA, wherein it was held that broken period interest paid by banks on securities held as stock-in-trade is a revenue expenditure allowable in the year of purchase. The Court also reiterated that government securities held by banks form part of their trading assets, as consistently recognised in earlier decisions such as Cocanada Radhaswami Bank Ltd. and United Commercial Bank Ltd.

It was further observed that the method of accounting followed by banks in claiming deduction of broken period interest does not result in any loss of revenue to the tax department and is revenue-neutral. Once the income from securities is assessed as business income, the corresponding expenditure incurred for earning such income must also be allowed in accordance with settled principles of commercial accounting.

Accordingly, the Supreme Court held that interest paid for the broken period on the purchase of government securities held by banks as stock-in-trade is allowable as a revenue deduction, and the appeals were decided in favour of the assessees.

Source Link - https://api.sci.gov.in/supremecourt/2008/19950/19950_2008_6_1501_56387_Judgement_16-Oct-2024.pdf

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