2009 (11) TMI 25 - SC - Income Tax

Tax on Interest - credit institution - Section 2(7) of the Interest Tax Act, 1974 - held that - when assessee buys bonds and debentures of approved nature, they constitute investment and they cannot be treated as loans and advances. Therefore, interest on such investment cannot be taxed under the Interest Tax Act, 1974. - in order to constitute a miscellaneous finance company, it has to be a company which carries on exclusively two or more classes of business referred to in the preceding sub-clauses (i) to (v). In other words, if there is a company which is investment company and also finance company, it can fall under section 2(5B)(vi). Therefore, a residuary non-banking company cannot fall within sub-clause (vi) as contended by the Department as the said sub-clause specifically says that a miscellaneous financial company should carry two or more classes of business referred to in the preceding sub-clauses. Moreover, unlike residuary non-banking companies, none of the companies mentioned in sub-clauses (i) to (v) are empowered to accept 17 deposits - interest tax is not leviable

Summary

Issues Involved:
1. Taxability of interest earned on bonds and debentures under the Interest Tax Act, 1974.
2. Definition and scope of "chargeable interest" and "interest" under the Interest Tax Act, 1974.
3. Classification of the respondent as a "credit institution" under Section 2(5A) of the Interest Tax Act, 1974.
4. Applicability of the Interest Tax Act, 1974 to residuary non-banking companies.

Issue-Wise Detailed Analysis:

1. Taxability of Interest Earned on Bonds and Debentures
The primary issue for determination was whether the interest earned on bonds and debentures by the assessee was chargeable to tax under the Interest Tax Act, 1974. The court examined the definition of "interest" under Section 2(7) of the Act, which includes interest on loans and advances, commitment charges, and discounts on promissory notes and bills of exchange but excludes interest on bonds and debentures. The court concluded that "interest on investments" is not taxable as interest under Section 2(7) of the Act.

2. Definition and Scope of "Chargeable Interest" and "Interest"
The court analyzed Sections 2(5), 2(7), 4, 5, and 6 of the Interest Tax Act, 1974. Section 2(5) defines "chargeable interest" as the total amount of interest referred to in Section 5, computed as per Section 6. Section 2(7) defines "interest" to mean interest on loans and advances, including commitment charges and discounts on promissory notes and bills of exchange, but excludes interest on bonds and debentures. The court noted that the legislative intent was to levy interest tax only on interest accruing on loans and advances, not on investments like bonds and debentures.

3. Classification of the Respondent as a "Credit Institution"
The court addressed whether the respondent was a "credit institution" under Section 2(5A) of the Interest Tax Act, 1974. The term "credit institution" includes banking companies, public financial institutions, State Financial Corporations, and other financial companies. The court found that residuary non-banking companies did not fall under the definition of "credit institution" as per Sections 2(5A) and 2(5B) of the Act. The court also referred to the Residuary Non-Banking Companies (Reserve Bank) Directions, 1987, which classify such companies based on their specific activities and regulatory requirements.

4. Applicability of the Interest Tax Act, 1974 to Residuary Non-Banking Companies
The court examined the applicability of the Interest Tax Act, 1974 to residuary non-banking companies. It was noted that the Reserve Bank of India (RBI) regulates these companies under Chapter IIIB of the Reserve Bank of India Act, 1934. The RBI Directions require these companies to invest in approved securities and maintain sufficient capital to protect depositors' interests. The court concluded that interest on such investments could not be taxed under the Interest Tax Act, 1974, as these investments are classified as investments, not loans or advances.

Conclusion
The court dismissed the Civil Appeals, holding that the interest earned on bonds and debentures by the respondent was not chargeable to tax under the Interest Tax Act, 1974. The respondent was not classified as a "credit institution" under the Act, and residuary non-banking companies were not subject to interest tax on their investments in bonds and debentures. The court emphasized the importance of legislative intent and regulatory frameworks in determining the scope of taxable interest under the Act.