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TMI Blog2002 (9) TMI 96X X X X Extracts X X X X X X X X Extracts X X X X ..... enience, we are relying upon the facts in Income-tax Reference No. 346 of 1987. The basic question referred to us by the Tribunal reads as follows: "Whether, on the facts and circumstances of the case, the assessee was entitled to deduct net interest paid by the assessee for the broken period to persons from whom the assessee bought Dated Government Securities while computing the assessee's business income?" This question is quoted from Income-tax Reference No. 173 of 1983 as it involves the principal controversy in this case. This judgment deals with the scope of section 18 and section 28 of the Income-tax Act, 1961. Preface : Meaning of. broken period interest. The assessee-American Express International Banking Corporation is a non-resident banking company. In Income-tax Reference No. 346 of 1987, we are concerned with the assessment year 1977-78 (accounting year ending on December 31, 1976), whereas in I. T. R. No. 173 of 1983, we are concerned with the assessment year 1974-75 and in I. T. R. No. 75 of 1986, we are concerned with the assessment years 1975-76 and 1976-77. Before coming to the facts of the case, a short preface needs to be mentioned. This preface expl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on August 11, 1976. In the above example, since the security was sold/transferred on August 11, 1976 (i.e., after due date for payment of interest), interest had accrued to the transferor/seller from the last due date, i.e., May 12, 1976 up to August 11, 1976. Before concluding this preface, it may be pointed out that one of us (Kapadia J.) is presiding in the special court set up under the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992. That, in several cases before the special court, operation of SGL account is in issue and the court is familiar with operation of such accounts. In this connection, it may be mentioned that there are three types of credits which find place in SGL account in the PDO, viz., credit for subscription to new loan; credit for purchase of SGL securities vide SGL transfer forms and, lastly, credit for lodgement of physicals, This aspect is important because it indicates the difference between investment and trading. Subscription to new loans would come under investment, whereas purchase of SGL securities by way of transfer forms would come under trading. After subscribing, the bank trades in SGL securities. This point ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was made by the assessee. Under the impugned adjustment, Rs. 7,13,627 (amount paid by the assessee to the sellers for purchase of the broken period interest) less Rs. 4,07,288 (amount received by the assessee from the buyers on account of the broken period interest) amounting to Rs. 3,06,399 was claimed as deduction as revenue expenditure under section 37. In the earlier ten (10) years, before the assessment year 1977-78, such deduction was allowed. During that period the impugned adjustment was permitted. However, in view of the judgment of the High Court in the case of CIT (Addl.) v. Vijaya Bank [1976] TLR 524 (Karn), the impugned adjustment was not permitted. Consequently, the Assessing Officer brought to charge, Rs. 4,07,288 as business income. However, the adjustment claimed by the assessee of Rs. 3,06,399 was disallowed. In other words, the Assessing Officer taxed receipt of payment of the broken period interest when the security was sold by the assessee, but he disallowed the deduction for payment made by the assessee for the broken period interest when the assessee bought the securities. This was done by the Assessing Officer as he was of the view that the judgment of the H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nditure against income accruing from the asset in question. He relied upon the judgment of the Supreme Court in Vijaya Bank Ltd. v. CIT (Addl.) [1991] 187 ITR 541. He also relied upon the judgment of the Karnataka High Court reported in CIT (Addl.) v. Vijaya Bank [1976] TLR 524, from which the bank had gone in appeal which was disposed of by the Supreme Court as reported in [19911 187 ITR 541. Mr. Desai also placed reliance on the judgment of the Supreme Court in United Commercial Bank Ltd. v. CIT [1957] 32 ITR 688. He contended that on purchase, the assessee paid a composite price. He contended that in this case, the basic issue was whether such composite price would be apportioned or bifurcated into interest accrued up to date of purchase and balance of the price. He contended that there is no provision under the Income-tax Act which supports such bifurcation. He further contended that interest income had accrued to the assessee by virtue of purchase and sale of Dated Government Securities. That, such interest income was assessable during the assessment year 1977-78 only under section 18. That, since such interest income came under section 18, it cannot fall under section 28. He ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tended that the method of accounting followed by the bank has been consistently followed by all banks as held by the Tribunal. He further contended that even under section 145(1) of the Act, it was mandatory to compute income chargeable under the head 'Profits and gains of business" in accordance with the method of accounting regularly employed by the assessee and that the proviso to that section applied only when income could not be deduced therefrom. He contended that in the present matter, the proviso did not apply. He further contended that the choice of method of accounting lies with the assessee ; that the valid method regularly followed by the assessee cannot be rejected on the ground that a better method could be visualised. He further contended, by citing illustrations, that there was no difference in the amounts chargeable to tax, whether the assessee's view is adopted or the view of the Department is adopted. He further contended that the stand of the Department would lead to double taxation. He contended that when the assessee bought securities, the assessee paid the broken period interest to the sellers. That payment amounted to Rs. 7,13,627. That, similarly, when the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re part of the trading assets of the company doing business, the interest income had to be assessed under section 8 of the Indian Income-tax Act, 1922 (corresponding to section 18 of the Income-tax Act, 1961). Findings: (A) Comparison between the assessee's method of accounting and the Department's method of accounting. The key issue which arises for determination in this case is the correct treatment of the broken period interest under the Income-tax Act. According to the Department's contention, the broken period interest (net) paid by the assessee at the time of purchase was a part of the capital cost of the investment and, therefore, the purchase price of the securities cannot be bifurcated into interest accrued up to the date of purchase and balance of the price. Consequently, according to the Department, payment for the broken period interest (net) cannot be claimed as revenue expenditure. On the other hand, the banks have been valuing the securities/interest held by it at the end of each year and offer for taxation, the appreciation in their value by way of profits/interest earned due to efflux of time. They also claimed deduction for the broken period interest payment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... towards capital cost of the investment and consequently, profit on sale of a security should be taxed in the accounting year corresponding to the assessment year when the security is sold/redeemed. However, while disallowing deduction for the broken period interest payment, the Department has taxed broken period interest receipt in the hands of the assessee-bank when the security was sold. This anomaly is not answered till today by the Department. Even before the Tribunal, learned senior counsel who appeared for the Department could not explain as to on what basis broken period interest payment was disallowed while broken period interest receipt was taxed. According to the Department, the difference referred to above represented interest on securities. That, such difference came under section 18 of the Income-tax Act. This was the point which was argued orally before the court. This argument is contrary to what is on record. On record, and as held by the Tribunal, the Department has assessed the assessee, not under section 18 as in the case of Vijaya Bank Ltd. v. CIT (Addl.) [1991] 187 ITR 541 (SC), but the assessee's income is brought to tax under section 28 of the Act. Therefore, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er authorities. On August 11, 1976, 43/4 per cent. Government of India Loan, 1980, f.v. Rs. 5 lakhs was purchased for Rs. 4,92,000. That security was sold on November 6, 1978. The half-yearly interest was payable on May 12 and November 12, each year. The bank became the holder of the security on August 11, 1976, and it received interest on November 12, 1976, of Rs. 11,875 from the Reserve Bank of India. The bank's year-ending was December 31, 1976. At the time of purchase, the assessee-bank also paid for the broken period interest of Rs. 5,871.63 to the transferor/seller. This amount was debited to interest receivable account. On August 31, 1976, the interest receivable account was debited and the interest income account was credited by Rs. 1,319.44 (being the interest from August 11, 1976, up to August 31, 1976). Similarly, on September 30, 1976, Rs. 1,979.17 was credited to interest income account. The same method is followed for crediting interest income account as on October 31, 1976, November 12, 1976, and December 31, 1976. Therefore, for 142 days, the interest which was credited to interest income account came to Rs. 9,236.12, which was offered for tax. Similarly, on the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n so far as interest on securities traded is concerned. Under the above method, the assessee has also accounted for Rs. 5,871.53, which the assessee paid for the broken period interest and they have also accounted for Rs. 11,479.17, which is taxed, being the amount which the assessee received for the broken period interest on November 6, 1978, when the above security was sold by the assessee. The Department has taxed broken period interest received of Rs. 11,479.17 as business income. But, they have denied deduction for Rs. 5,871.53 for payment made for the broken period interest at the time of purchase of the security. This point is very important. It distinguishes the facts of this case from that of Vijaya Bank Ltd.'s case [1991] 187 ITR 541 (SC). In the present case, as held by the Tribunal, the Department has proceeded to compute the entire income under section 28. In this case, the Department has sought to tax the broken period interest received under the head "Business" and not under the head "Interest on securities", whereas in the case of Vijaya Bank Ltd. [1991] 187 ITR 541 (SC), the facts show that the Department sought to assess the interest income under section 18, i.e., ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is offered to tax is as follows: Rs. Revaluation of security for the year ending 31-12-1976 829.03 Revaluation of security for the year ending 31-12-1977 2,131.80 Revaluation of security for the year ending 31-12-1978 1,806.11 Loss on sale of security (page 115) (516.94) Interest for the broken period received at the time of sale (page 118) 11,479.17 Interest for the broken period paid at the time of purchase (page 117) (5,871.53) ---------- 9,857.64 ---------- Therefore, under either method, the same amount is offered for tax. The Department has not been able to show in this case as to why the method adopted by the assessee-bank ought to be rejected. On the other hand, the Department has not been able to explain as to why broken period interest received should be taxed whereas broken period interest payment should be disallo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r section 28 of the Income-tax Act. In this connection, the Department followed the judgment of the Karnataka High Court in Vijaya Bank's case [1976] TLR 524. Therefore, the point which we are required to consider in this case is: Whether the judgment of the Karnataka High Court in Vijaya Bank's case [1976] TLR 524 was applicable to the facts of the present case. Before going further we may mention at the very outset that the security in this case was of the face value of Rs. 5 lakhs. It was bought for a lesser amount of Rs. 4,92,000. The difference was of Rs. 8,000. The assessee has revalued the security: The assessee offered the notional profit for taxation, as explained hereinabove, on accrual basis in the appropriate assessment year during which the assessee held the security. This difference could have been treated by the Department as interest on securities under section 18. However, in the instant case, the Department has assessed the said difference under section 28 under the head "Business" and not under the head "Interest on securities". Having treated the difference under the head "Business", the Assessing Officer disallowed the broken period interest payment, which ga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee-bank should be discarded. Therefore, the judgment in Vijaya Bank Ltd.'s case [1991] 187 ITR 541 (SC) has no application to the facts of the present case. If the Department had brought to tax, the amounts received by the assessee-bank under section 18, then Vijaya Bank Ltd.'s case [1991] 187 ITR 541 (SC) was applicable. But, in the present case, the Department brought to tax such amounts under section 28 right from the inception. Therefore, the Tribunal was right in coming to the conclusion that the judgment in Vijaya Bank Ltd.'s case [1991] 187 ITR 541 (SC) did not apply to the facts of the present case. However, before us, it was argued on behalf of the Revenue, that in view of the judgment in Vijaya Bank Ltd.'s case [1991] 187 ITR 541 (SC), even if the securities were treated as part of the trading assets, the income therefrom had to be assessed under section 18 of the Act and not under section 28 of the Act as income from securities can only come within section 18 and not under section 28. We do not find any merit in this argument. Firstly, as stated above, Vijaya Bank Ltd.'s case [1991] 187 ITR 541 (SC) has no application to the facts of this case. Secondly, in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, 1922 (similar to section 28 of the present Act). It is for this reason that in the subsequent judgment of the Supreme Court in the case of Cocanada Radhaswami Bank Ltd. [1965] 57 ITR 306, the Supreme Court has observed, after reading United Commercial Bank Ltd.'s case [1957] 32 ITR 688 (SC), that where securities were part of trading assets, income by way of interest on such securities could come under section 10 of the Indian Income-tax Act, 1922. In the light of what we have discussed hereinabove, we find that the assessee's method of accounting does not result in loss of tax/revenue for the Department. That, there was no need to interfere with the method of accounting adopted by the assessee-bank. That, the judgment in the case of Vijaya Bank Ltd. [1991] 187 ITR 541 (SC), had no application to the facts of the case. That, having assessed the income under section 28, the Department ought to have taxed interest for the broken period interest received and the Department ought to have allowed deduction for the broken period interest paid. Conclusion We now propose to answer the questions referred to us under section 256(1) of the Income-tax Act, 1961. Questions in Incom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ances and which is not taken to the Therefore, the assessee is not liable to be profit and loss account for the relevant taxed for amounts credited to Interest accounting year? Suspense Account on account of interest on sticky loans and advances and which is not taken to profit and loss account. (5) Whether, on the facts and in the cir- In view of the judgment of this court in cumstances of the case, the Tribunal was the case of Mercantile Bank Ltd. v. CIT right in law in holding that the restriction [2001] 252 ITR 225 , the question is ans- of deduction of expenses at 5 percent,laid wered in favour of the assessee and down in section 44C of the Act, was not against the Department, i.e., section 44C applicable in respect of expenditure came into force from June 1, 1976, and, incurred up to June 1, 1976? therefore, restriction of deduction of expenses at 5 percent was not applicable to expenditu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -tax Rules, 1962, cannot be invoked in the case of the applicant for determining the value of rent-free accommodation? (2) Whether, on the facts and in the cir- In the affirmative, i.e., in favour of the cumstances of the case, the assessee was assessee and against the Department. entitled to deduct the sum of Rs. 6,07,302 being the net interest paid by the assessee for the broken period to the persons from whom it brought the securities while computing its business income? Accordingly, all the above references are accordingly disposed of. No order as to costs. ANNEXURE I Statement showing interest received and interest offered for tax Rs. Interest received on 12-11-1976 11,875.00 Interest received on 12-5-1977 11,875.00 Interest received on 12-11-1977 11,875.00 Interest received on 12-5-1978 11,875.00 Interest received (on sale) on 6-11-1978 11,479.17 ---------- Total interest received ..... (A) ..... 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