A) ABSTRACT / HEADNOTE

This case pertains to the treatment of “broken period interest” under the Income Tax Act, 1961. The key issue is whether such interest should be treated as capital expenditure or revenue expenditure when government securities are considered as either stock-in-trade or investments. The Supreme Court clarified that the classification of securities plays a pivotal role in determining tax implications. It was held that when securities are treated as stock-in-trade, broken period interest constitutes revenue expenditure eligible for deduction. However, if held as investment, such interest is capitalized as part of the acquisition cost and adjusted in subsequent transactions. The Court also analyzed earlier precedents and regulatory guidelines to support the conclusion.

Keywords:

Broken Period Interest, Stock-in-Trade, Revenue Expenditure, Capital Expenditure, Held-to-Maturity (HTM) Securities.

B) CASE DETAILS

i) Judgement Cause Title:
Bank of Rajasthan Ltd. v. Commissioner of Income Tax

ii) Case Number:
Civil Appeal Nos. 3291-3294 of 2009

iii) Judgement Date:
16 October 2024

iv) Court:
Supreme Court of India

v) Quorum:
Justice Abhay S. Oka and Justice Pankaj Mithal

vi) Author:
Justice Abhay S. Oka

vii) Citation:
[2024] 10 S.C.R. 860 : 2024 INSC 781

viii) Legal Provisions Involved:

• Income Tax Act, 1961: Sections 14, 28, 36, 56, and 57
• Banking Regulation Act, 1949
• Guidelines from the Reserve Bank of India (RBI)
• CBDT Circulars No. 665 of 1993, 4 of 2007, and Circular No. 18 of 2015

ix) Judgments Overruled by the Case (if any):
The decision indirectly distinguished and limited the applicability of Vijaya Bank Ltd. v. Additional Commissioner of Income Tax, Bangalore (1991 Supp 2 SCC 147).

x) Case is Related to which Law Subjects:
Income Tax Law, Banking Law, Corporate Taxation.

C) INTRODUCTION AND BACKGROUND OF JUDGMENT

The case arose from disputes regarding the deductibility of broken period interest paid by banks when purchasing government securities. The appellant, Bank of Rajasthan, had treated these securities as stock-in-trade, claiming deductions for broken period interest under the head “profits and gains of business.” However, the Income Tax Department contended that such deductions were invalid as they considered the securities as investments. The matter underwent several rounds of litigation, culminating in this Supreme Court decision, which harmonized the treatment of broken period interest with the principles of income recognition under business income.

D) FACTS OF THE CASE

The Bank of Rajasthan, a scheduled bank, regularly purchased and sold government securities to comply with the Statutory Liquidity Ratio (SLR) requirements prescribed by the Banking Regulation Act, 1949. During these transactions, the bank paid broken period interest to the sellers for the accrued interest up to the purchase date. This interest was claimed as a deduction. Initially, the Income Tax Appellate Tribunal allowed this deduction on the ground that the securities were held as stock-in-trade. However, the High Court reversed this ruling by applying the decision in Vijaya Bank Ltd..

E) LEGAL ISSUES RAISED

i. Whether broken period interest paid by the bank constitutes capital expenditure or revenue expenditure under the Income Tax Act.
ii. Whether the securities held by the bank should be classified as stock-in-trade or investments for tax purposes.
iii. The applicability of earlier precedents, particularly Vijaya Bank Ltd. v. Additional Commissioner of Income Tax, Bangalore (1991 Supp 2 SCC 147).

F) PETITIONER/APPELLANT’S ARGUMENTS

i. Classification of Securities as Stock-in-Trade:
The petitioner argued that the securities purchased were integral to the bank’s normal trading activities. Since the bank treated the securities as stock-in-trade in its accounts, the related broken period interest should qualify as revenue expenditure under Section 28 of the Income Tax Act.

ii. Relevance of Banking Norms:
The appellant highlighted the RBI guidelines that require banks to classify securities under categories such as HTM, Available for Sale (AFS), and Held for Trading (HFT). For AFS and HFT categories, broken period interest is treated as an operational expense.

iii. Applicability of Precedents:
The appellant distinguished this case from Vijaya Bank Ltd., arguing that the latter dealt with securities classified as investments under a different legal regime.

G) RESPONDENT’S ARGUMENTS

i. Securities Held to Maturity (HTM):
The respondent emphasized that HTM securities are usually held as investments. Hence, the broken period interest should be capitalized as part of the acquisition cost and not deducted as revenue expenditure.

ii. Reliance on Precedent:
The respondent relied heavily on the Supreme Court’s decision in Vijaya Bank Ltd., where broken period interest was treated as a capital expense.

iii. Revenue Neutrality:
The respondent argued that even if the deduction was allowed, the same amount would eventually be adjusted against the acquisition cost, rendering the exercise revenue-neutral.

H) JUDGEMENT

a. Ratio Decidendi:

Broken period interest paid on securities classified as stock-in-trade constitutes revenue expenditure. This conclusion aligns with the established accounting practices and reflects the real income earned by banks.

b. Obiter Dicta:

The Court observed that the applicability of Vijaya Bank Ltd. was limited to a pre-1988 legal framework when Sections 18-21 of the Income Tax Act specifically governed securities’ interest income. Post-1988, the classification of securities under Section 28 takes precedence.

c. Guidelines:

1. Securities categorized as AFS or HFT must always be treated as stock-in-trade for tax purposes.
2. For HTM securities, whether they are stock-in-trade or investments must be determined on a case-to-case basis.
3. Deduction of broken period interest is only permissible for securities classified as stock-in-trade.
4. When disallowed as a deduction, the broken period interest must be added to the acquisition cost of the security.

I) CONCLUSION & COMMENTS

The Supreme Court’s ruling offers much-needed clarity on the tax treatment of broken period interest. By distinguishing between stock-in-trade and investment securities, the judgment upholds the principle of taxing real income while aligning with international banking norms. However, the case also highlights the need for harmonized regulations to minimize litigation over similar issues in the future.

J) REFERENCES

1. Vijaya Bank Ltd. v. Additional Commissioner of Income Tax, Bangalore (1991 Supp 2 SCC 147).
2. American Express International Banking Corporation v. Commissioner of Income Tax (2002 SCC OnLine Bom 944).
3. Commissioner of Income Tax, Andhra Pradesh v. Cocanada Radhaswami Bank Ltd. (1965 SCC OnLine SC 186).
4. United Commercial Bank Ltd. v. Commissioner of Income Tax (1957 SCC OnLine SC 74).
5. Commissioner of Income Tax, Jalandhar v. Nawanshahar Central Cooperative Bank Ltd. (2007) 15 SCC 611.