Introduction
When the Government securities are acquired between two due dates, the admissibility of interest attributable to the period from the last due date to the date of acquisition in computing the income from interest on securities has been a point of consideration both before and after the deletion of section 18.
Rajasthan High Courts decision in Bank
of Rajasthan
In CIT v. Bank of Rajasthan [IT Appeal Nos. 12, 117, 119 and 120 of 2005, dated 24-3-2008] the bank had purchased Government securities after the dates of issue and the next due dates or between two due dates, paying a composite sum consisting of the issue price and accrued interest for the intervening period. The question for the assessment years 1990-91 to 1992-93 was the admissibility of interest for the aforesaid intervening period while computing income from interest on securities, and whether the deletion of sections 18, 19 and 20 made any difference to the result when income was required to be computed under the head Business or other sources. On these facts, the Court held :
In our view, so far as taxability of income from interest by the assessee, as also entitlement to claim deduction, is a matter, with regard to which there is no material or significant difference, consequent upon deletions of the provisions of sections 18 and 19; obviously sections 20 and 21 are not relevant for the present purpose. That being the position, the ratio propounded in Vijaya Bank Ltd. v. CIT [1991] 187 ITR 541 (SC), even though it proceeds on consideration of the then provisions of sections 18 and 19, still holds good.
Observing that they felt bound by the ratio laid down in Vijaya Bank Ltd. v. CIT [1991]
There have been numerous decisions on the nature of the interest attributable to the broken period and its deductibility which have been almost invariably against the assessee. 187 ITR 541 (SC), the decision in American Express International Banking Corpn. v. CIT [2002] 258 ITR 601/125 Taxman 488 (Bom.), was dissented from observing :
. . . we do not find ourselves able to agree with the reasoning, inasmuch as, if carried to logical conclusion, it permits a post-mortem of the purchase component of the asset, and permits deduction of interest element paid, as business expenditure. We are afraid on the face of the judgment in Vijaya Banks case (supra) this cannot be said to be permissible.
Some decisions of the Supreme Court
The words accrue and arise are used to contradistinguish the word receive. Income is said to be received when it reaches the assessee; when the right to receive the income becomes vested in the assessee, it is said to accrue or arise. Income becomes taxable on the footing of accrual only after the right of the taxpayer to the income accrues or arises - CIT v. Ashokbhai Chimanbhai [1965] 56 ITR 42 (SC).
A claim for deduction against securities can be sustained only when the assessee is in a position to show that any reasonable expenditure has been incurred for realizing the interest on securities. Where the assessee purchases securities at a price determined with reference to their actual value as well as the interest accrued thereon till the date of purchase, the entire price paid for them would be in the nature of a capital outlay and no part of it can be set off as an expenditure against the income by way of interest received on securities - Vijaya Bank Ltd.s case (supra).
Some decisions of High Courts
Interest on Government securities does not accrue from day to day but on certain fixed days and, where securities are purchased at a price expressed as a capital sum plus interest computed de die in diem from the last due date to the date of sale; interest, thus, paid to the vendor is not deductible from the interest actually received by the purchaser on the next due date, in assessing the purchaser under section 8 of the Indian Income-tax Act, 1922. The mere quotation in the bargain of estimated accrued interest does not establish a separate contract in respect of the estimated accrued interest, and even if it were considered to be a separate contract, it would remain part and parcel of the whole purchase consideration and would not be deductible (Haveli Shah Sardari Lal v. CIT [1936] 4 ITR 297 (Lahore), also Ranjit Prasad Singh v. CIT (Punjab) [1930] 4 ITC 264.
Having assessed the broken period interest received at the time of sale under section 28, the department disallowed the broken period interest paid at the time of purchase. The limited dispute (for the assessment years 1975-76 to 1977-78) was whether the adjustments made in the method of accounting adopted by the bank should be discarded. The contention that even if the securities are held as trading assets, income from securities can only be assessed under section 18, is not sustainable for the following reasons: firstly, the decision in Vijaya Bank Ltd.s case (supra) is not applicable on the facts of this case; secondly, the Tribunal had found that the securities were held as trading assets; thirdly, it has been held by the Supreme Court in CIT v. Cocanada Radhaswami Bank Ltd. [1965] 57 ITR 306 that income from securities can also be assessed as business income under section 28. Having taxed the broken period interest received, the department should have allowed the broken period interest paid (American Express International Banking Corpn. v. CIT [2002] 258 ITR 601/125 Taxman 488 (Bom.).
The bank claimed in the returns filed for the assessment years 1989-90 and 1990-91 that accrued interest for the periods till March 31, 1989 and March 31, 1990 has to be excluded in respect of the securities held by it on the ground that it did not become due in the respective previous years and even after the omission of section 18, the interest on securities could be charged only when it becomes due for payment as it did not accrue on a day-to-day basis. It was held that even though section 18 was deleted, the assessee was taxable for interest on securities only on specified dates when it became due for payment, in view of the third proviso to section 145(1) of the Act [CIT v. Tamilnadu Mercantile Bank Ltd. [2007] 291 ITR 137 (Mad.); also CIT v. City Union Bank Ltd. [2007] 291 ITR 144/163 Taxman 495 (Mad.)].
Due and payable
The expression due under Explanation 1 to section 7 of the 1922 Act is followed by the qualifying clause whether paid or not and it shows that there shall be an obligation on the part of the employer to pay the amount and a right on the employee to claim the sameCIT v. L.W. Russel [1964] 53 ITR 91 (SC).
Due as a noun is an existing obligation; a debt ascertained and fixed though payable in future. As an adjective capable of being justly demanded; claimed as of right. (Concise Law Dictionary, P Ramanathan Aiyar 1997 Edn.)
Government securities and goods
Under section 2(2) of the Public Debt Act, 1944 Government security means :
(a) a security, created and issued by the Government for the purpose of raising a public loan, and having one of the following forms, namely:
(i) stock transferable by registration in the books of the bank; or
(ii) a promissory note payable to order; or
(iii) a bearer bond payable to bearer; or
(iv) a form prescribed in this behalf;
(b) any other security created and issued by the Government in such form and for such of the purposes of this Act as may be prescribed.
Section 2(a) of the Indian Securities Act, 1920, defines Government security to mean promissory notes (including treasury bills), stock-certificates, bearer bonds and all other securities issued by the Central Government at any time. . . .
Under section 2(6) of the Sale of Goods Act, future goods means goods to be manufactured or produced or acquired by the seller after making of the contract of sale and goods in section 2(7) means every kind of movable property other than actionable claims and money; and includes stocks and shares. . . . . Under section 4(1) A contract of sale of goods is a contract whereby the seller transfers or agrees to transfer the property in goods to a buyer for a price. . . . . . section 6(1) says the goods which form the subject of a contract of sale may be either existing goods, owned or possessed by the seller, or future goods.
A Government security in the form of stock or a stock-certificate which is transferable either by registration or otherwise is a kind of movable property, falling within the definition of goods under the Sale of Goods Act.
The Securities Contracts (Regulation) Act, 1956 adopts the meaning of Government securities in section 2(2) of the Public Debt Act. This Act is concerned mainly with regulation of Stock Exchanges. It only declares transactions prohibited by the Central Government under sections 13 and 16 of that Act as illegal.
Nature of the interest attributable to
the broken period and its deductibility
Under section 29 of the Banking Companies Act, the Form of balance sheet prescribed in Annexure A, requires Government securities to be shown at Line 4(i) under the head Investments stating the mode of valuation, e.g., cost or market. The form of income and expenditure account prescribed in Annexure B requires all types of interest to be shown under the head Income in Line 1 as Interest and Discount. The said securities fall under the general head Investments, but since they need to be valued, and no distinction is made in the income and expenditure account between interest from depositors, etc., and the Government securities, it appears that the expectation, if not the intention, is that such securities are generally held as trading assets. The Reserve Bank requires banks to maintain a cash reserve ratio by holding the Government securities, cash and gold with reference to demand liabilities for financial prudence as well as liquidity. Thus, the bulk of Government securities would be held to satisfy the required ratio; a minor part of such holding may be traded if it is found to be profitable.
When a Government security is purchased for a composite consideration made up of its face value and interest computed de die in diem, from the last due date to the date of purchase falling before the next due date, the nature of the said interest (attributable interest hereafter) is the issue.
There are several imponderables relating to such attributable interest. As interest on Government securities does not accrue from day-to-day, but only on the due dates set in the issue, it cannot be computed for the intervening period from the last due date to the date of purchase; therefore, during the aforesaid intervening period the attributable interest is inchoate, and does not exist; it is, therefore, not an existing good under section 2(6) read with section 6(1) of the Sale of Goods Act; it is also not a future good under section 2(7), ibid because the seller cannot acquire it when interest from the last due date to the next due date actually falls due, as at that time he would not be the owner of the said security. Under section 6(1) ibid only existing or future goods, which can be owned or possessed can be the subject of a contract of sale under section 4(1) ibid.
If a single composite consideration is stipulated for the purchase of the face value of the Government security and the attributable interest, as the said consideration for one of the objects, viz., the attributable interest is unlawful under section 4(1) read with section 6(1), the entire contract is void under section 24 of the Contract Act, which says: If any part of a single consideration for one or more objects, or any part of any one of several considerations for a single object, is unlawful, the agreement is void. However, the general rule is that, where you cannot sever the illegal from the legal part of a covenant, the contract is altogether void; but where you can sever them, whether the illegality be created by statute or by the common law, you may reject the bad part and retain the good [Pikering v. Ilfracombe Ry. Co, [1868] LR 3 CP 235/250]. On the other hand, if the consideration is stated to be based on the market value of the Government security (of which the dominant part of the difference between the face value and the market price is the attributable interest) no fault can be found with the contract. In both types of transactions, the bank does not, because it cannot acquire the attributable interest because it is an inchoate/non-existing good/asset.
The issue which arises in cases like the instant one, is the admissibility of the payment made for attributable interest in the purchase of one or more Government securities, in the computation of income from interest on securities which accrues on the due dates falling within the previous year. If the transaction is one in which a composite market price is paid or claimed to be paid, even though the difference between the face value and the market price is based mainly on the attributable interest, the assessee cannot even claim a deduction for the attributable interest. If, on the other hand, the consideration paid is severable between the face value and the attributable interest, the issue of admissibility would arise. Taking the case of a bank, it would be not only impractical but impossible, for it to purchase and sell Government securities only on the due dates prescribed in each scrip; it has to buy and sell them as the need arises. The bank can legitimately argue that the expenditure on the attributable interest is necessitated by commercial expediency which has to be judged from the point of view of a businessman (CIT v. Panipat Woollen & General Mills Co. Ltd. [1976] 103 ITR 66 (SC), CIT v. Sales Magnesite (P.) Ltd. [1995] 214 ITR 1/81 Taxman 334 (Bom.); a narrow and technical view ignoring ground realities is impractical and causes undue hardship. The aforesaid expenditure is required to be incurred for running the business or working it with a view to produce profits [Assam Bengal Cement Co. Ltd. v. CIT [1955] 27 ITR 34/45 (SC)] and it is so related to the carrying on or conduct of the business, that it may be regarded as an integral part of the profit-earning process [Bombay Steam Navigation Co. (1953) (P.) Ltd. v. CIT [1965] 56 ITR 52/59/60 (SC)], and so has to be allowed as revenue expenditure under section 37. The revenue would contend on the other hand, that attributable interest is neither an existing good or a future good under the Sale of Goods Act; it cannot be owned and possessed, and therefore can neither be lawfully sold by the seller nor purchased by the bank under that Act. If in any transaction, the consideration paid for attributable interest is severable, the contract would be void to the extent of the consideration paid for the said interest, and payment made for such an unlawful transaction is not deductible [Maddi Venkataratnam & Co. (P.) Ltd. v. CIT [1998] 229 ITR 534/96 Taxman 643/539-40 (SC)].
Conclusion
The decisions on this issue have been almost invariable against the assessee. Here has been analysed the nature of attributable interest and its deductibility. If the consideration for acquisition of a Government security between say, any two due dates set in it, is claimed to be based on its market value, an assessee cannot even claim a deduction for the attributable interest though it may in effect be the dominant component of the difference between the face value of the said security and its purported market price. But where the consideration is severable between the face value of the security and the attributable interest, there is an arguable case for contending that the expenditure on the attributable interest is necessitated by commercial expediency based on ground realities, and is, therefore, admissible under section 37.
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