2025 (4) TMI 1059 - HC - Income Tax

Applicability of provisions of the Interest Tax Act 1974 - ITAT treating appellant is a credit institution as defined in Section 2(5A) r.w. Clause (va) of Section 2(5B) of the Interest Tax Act - Whether Appellate Tribunal is right in law in concurring with the views of the Commissioner (Appeals) and holding that mere acceptance of monies as deposits without any scheme or arrangement as contemplated in the Reserve Bank directions/notification will attract the provisions of the Interest Tax Act? HELD THAT - Amendments to the 1974 Act in 1991 have not authorized a levy of interest tax on the interest paid or the liability incurred by a scheduled bank or credit institution under Section 4 of the 1974 Act. Even if the Appellant/Assessee is covered under the ambit of the definition of credit institution in Section 2(5A) of the 1974 Act read with Section 2(5B) of the 1974 Act as it includes any other financial company as defined in Section 2(5B) of the 1974 Act would not mean that the Appellant/Assessee was liable to pay interest tax on the interest paid on deposits collected from its Directors Shareholders or its Group Companies. Only if the amounts were lent by the Appellant/Assessee and interest were charged on the amount lent by the Appellant/Assessee interest tax would be payable at the rate prescribed under Section 4(2) of the 1974 Act up to 31.03.2000 by the Appellant/Assessee. In our view no interest tax referred to in Section 4 of the 1974 Act is chargeable on the interest paid either by the scheduled bank or by a credit institution to its creditors/lenders. In our view there was no question of the Appellant/Assessee being held liable to pay interest tax under the 1974 Act on the interest paid on the deposits collected from its Shareholders Directors and Group Companies. Consequently invocation of Section 8 Section 9 and Section 10 of the 1974 Act were without jurisdiction. The interest charged under Section 12A of the 1974 Act was also without jurisdiction. Assessing Officer the Commissioner of Income Tax (Appeals) III Chennai and the ITAT have failed to consider the provisions of the 1974 Act and have wrongly held that the interest paid by the Appellant/Assessee as credit institution its Directors Shareholders and Group Companies was liable to tax under the 1974 Act. Unfortunately the Assessment Order dated 08.11.1999 has seen two rounds of litigation from the stage of assessment up to ITAT. Neither the Assessing Officer nor the Tribunal have examined the provisions before concluding that the interest tax was payable on the interest paid on the amounts received from deposits/loans by the Appellant/Assessee from its Directors Shareholders and Group Companies. We answer the second substantial question of law raised in these Appeals in favour of the Appellant/Assessee and against the Income Tax Department.

Summary

The core legal questions considered by the Court in these Tax Case Appeals pertain primarily to the applicability of the Interest Tax Act, 1974 (hereinafter "the 1974 Act") to the Appellant/Assessee. The issues are:

1. Whether the Appellant qualifies as a "credit institution" within the meaning of Section 2(5A) read with Clause (va) of Section 2(5B) of the 1974 Act, thereby attracting liability to pay interest tax;

2. Whether the mere acceptance of monies as deposits by the Appellant, without any "scheme or arrangement" as contemplated under Reserve Bank of India (RBI) directions or notifications, would bring the Appellant within the ambit of the 1974 Act for payment of interest tax;

3. The correctness of the orders passed by the Assessing Officer, Commissioner of Income Tax (Appeals), and the Income Tax Appellate Tribunal (ITAT) in holding the Appellant liable to pay interest tax on interest paid on deposits accepted from its Directors, Shareholders, and Group Companies.

Issue-wise Detailed Analysis

Issue 1: Whether the Appellant is a "credit institution" under Section 2(5A) read with Section 2(5B)(va) of the 1974 Act

The 1974 Act originally imposed interest tax on scheduled banks on interest charged and received on loans and advances made in India. Amendments in 1991 extended the tax to "credit institutions" as defined in Section 2(5A) and introduced the definition of "financial company" in Section 2(5B). The Appellant was held by the lower authorities to be a "credit institution" because it accepted deposits from Directors, Shareholders, and Group Companies and paid interest thereon.

The Court examined the legislative history and the definitions in the 1974 Act. It was noted that the term "credit institution" was introduced to include entities like financial companies, thereby widening the tax base. However, the Court emphasized that the tax was imposed on the interest charged and received by such institutions on loans and advances, not on the interest paid by them to depositors.

The Court referred to the definitions of "chargeable interest" (Section 2(5)) and "interest" (Section 2(7)) in the 1974 Act, which restrict taxable interest to that arising from loans and advances made in India. The Court also noted that the tax was meant to be levied on interest charged by credit institutions, not on interest paid by them. The Supreme Court's decisions were cited to highlight that "interest" under the Act is an exhaustive definition and excludes interest paid on investments or deposits.

Therefore, even if the Appellant fits within the definition of a "credit institution" or "financial company," this status alone does not impose liability for interest tax on interest paid on deposits accepted from related parties.

Issue 2: Whether mere acceptance of deposits without any scheme or arrangement attracts interest tax under the 1974 Act

The Assessing Officer and subsequent authorities contended that the Appellant accepted deposits from related parties and paid "periodical interest," thereby attracting the provisions of the 1974 Act. The Appellant argued that mere acceptance of monies as deposits, without any formal scheme or arrangement as envisaged under RBI notifications, does not amount to acceptance of deposits under the Act.

The Court analyzed the legislative intent behind the 1974 Act, which was to tax interest earned by scheduled banks and credit institutions on loans and advances, not interest paid on deposits. The Court referred to the Finance Minister's speech at the time of enactment, which clarified that the tax was an anti-inflationary measure targeting interest income of banks and credit institutions, not their interest expenses.

The Court found that the lower authorities failed to consider the distinction between interest earned on loans and advances and interest paid on deposits. The Court held that interest paid on deposits accepted from Directors, Shareholders, and Group Companies, especially without any formal scheme or arrangement, cannot be taxed under the 1974 Act.

Issue 3: Legality and correctness of the Assessment Orders and appellate orders holding the Appellant liable to pay interest tax

The Assessment Orders dated 26.12.2006, upheld by the Commissioner of Income Tax (Appeals) and the ITAT, imposed interest tax on the Appellant for the Assessment Years 1994-95 through 1997-98, on the basis that the Appellant accepted deposits and paid interest thereon.

The Court found that these orders suffer from a "serious non-application of mind." The authorities below failed to properly interpret the provisions of the 1974 Act and the legislative intent behind it. They did not examine whether the amounts accepted were loans or deposits in the statutory sense, or whether interest tax was chargeable only on interest earned (charged) and not on interest paid.

The Court emphasized that the 1974 Act's charging provisions (Section 4) and definitions (Sections 2(5), 2(5A), 2(5B), and 2(7)) clearly restrict the tax to interest earned by scheduled banks and credit institutions on loans and advances, not interest paid on deposits. The Court held that the invocation of Sections 8, 9, 10, and 12A of the 1974 Act in this context was without jurisdiction.

The Court noted that the lower authorities did not consider the exemption of interest on government securities, debentures, and other securities, nor the exclusion of interest paid on deposits from the tax base. The Court also pointed out that the interest tax was allowed as a deduction in computing taxable income under the Income Tax Act, indicating the tax's nature as a levy on interest income, not expenses.

Application of Law to Facts and Treatment of Competing Arguments

The Appellant's contention that it did not receive deposits under any scheme or arrangement and that the interest tax applies only to interest earned on loans and advances was supported by the statutory definitions and legislative history. The Respondent contended that the oral arrangements and periodic interest payments evidenced a fixed pattern akin to deposit acceptance attracting tax liability.

The Court rejected the Respondent's argument, holding that the mere acceptance of monies from related parties and payment of interest does not automatically transform the Appellant into a "credit institution" liable under the 1974 Act. The Court underscored that the 1974 Act's tax base is limited to interest income and does not extend to interest expenses or payments on deposits, especially when not under any formal deposit scheme.

The Court relied on precedents including decisions of the Supreme Court and this Court that interpreted the definitions of "interest," "chargeable interest," and "credit institution" narrowly and in line with the legislative intent to tax interest earned, not interest paid.

Significant Holdings

"Tax on the interest paid by the Appellant/Assessee to its Shareholders, Directors and Group Companies, are not chargeable to Tax under the 1974 Act."

"The object of the 1974 Act was to impose a special tax on the total amount of interest received by scheduled banks on loans and advances made in India."

"Interest tax under the 1974 Act was never intended to be imposed on the interest paid by the scheduled banks on deposits received from depositors."

"Even if the Appellant/Assessee is covered under the ambit of the definition of 'credit institution' in Section 2(5A) of the 1974 Act read with Section 2(5B) of the 1974 Act as it includes any other 'financial company' as defined in Section 2(5B) of the 1974 Act, would not mean that the Appellant/Assessee was liable to pay interest tax on the interest paid on deposits collected from its Directors, Shareholders or its Group Companies."

"No interest tax referred to in Section 4 of the 1974 Act is chargeable on the interest paid either by the scheduled bank or by a credit institution to its creditors/lenders."

"Invocation of Section 8, Section 9 and Section 10 of the 1974 Act were without jurisdiction. The interest charged under Section 12A of the 1974 Act was also without jurisdiction."

"The Assessing Officer, the Commissioner of Income Tax (Appeals) III, Chennai and the ITAT have failed to consider the provisions of the 1974 Act and have wrongly held that the interest paid by the Appellant/Assessee as 'credit institution', its Directors, Shareholders and Group Companies was liable to tax under the 1974 Act."

The Court ultimately allowed the Tax Case Appeals, setting aside the impugned orders and holding that the Appellant was not liable to pay interest tax on the interest paid on deposits accepted from its Directors, Shareholders, and Group Companies under the Interest Tax Act, 1974.