Banks Can Claim Tax Deductions For Broken Period Interest On HTM Securities If Held As Trading Assets: Supreme Court

“Therefore, on facts, if it is found that HTM Security is held as an investment, the benefit of broken period interest will not be available. The position will be otherwise if it is held as a trading asset”, the Court held.

A bench of Justice Abhay Oka and Justice Pankaj Mithal observed that whether HTM securities are held as investments or stock-in-trade depends on the facts of each case. If a bank holds HTM securities until maturity and values them at cost, they may be considered investments, in which case the broken period interest would not be deductible. If held as trading assets, the deduction would be available

“Whether the Bank has held HMT security as investment or stockintrade will depend on the facts of each case. HTM Securities can be said to be held as an investment (i) if the securities are actually held till maturity and are not transferred before and (ii) if they are purchased at their cost price or face value.”

The Court said this while deciding various appeals filed by banks and the Revenue Department concerning how to treat interest paid on securities for the period between the last coupon date and the date of purchase (i.e., the broken period).

The appellant in the lead case, Bank of Rajasthan Ltd., had been engaged in the purchase and sale of government securities. These securities are typically held by banks as part of their statutory liquidity ratio (SLR) obligations, mandated by the Banking Regulation Act, 1949, and categorized into three types: Held to Maturity (HTM), Available for Sale (AFS), and Held for Trading (HFT).

Interest on these securities is paid periodically by the government on coupon dates, but when a bank purchases a security between two coupon dates, apart from the price, it has to pay an amount equivalent to the interest accrued from the last coupon date till the date of acquisition i.e., the broken period. When the interest becomes due on the next coupon date, the purchaser bank receives interest for the entire period, including the broken period.

The issue before the Court was whether this broken period interest could be deducted as a business expenditure by the banks, in the period after sections 18 to 21 of the Income Tax Act were repealed in 1989. These sections had previously governed the taxability of interest on securities and related deductions.

Before 1989, interest on securities was taxed under Section 18 of the Income Tax Act, with deductions allowed under Sections 19 and 20 for the expenses incurred in realizing such interest. These provisions were repealed, and after 1989, the taxability of interest on securities shifted to Section 28 (income from business) or Section 56 (income from other sources), depending on the treatment of the securities by the assessee.

In this case, the appellant-bank followed a practice of treating government securities as stock-in-trade, claiming deductions for broken period interest and netting this against the interest income from securities when computing taxable income.

This practice was initially accepted by the assessing officer, but the Commissioner of Income Tax (CIT) intervened under Section 263 of the Income Tax Act, disallowing the deduction for broken period interest.

The CIT relied on the Supreme Court's decision in Vijaya Bank Ltd. v. Additional Commissioner of Income Tax (1991), which held that broken period interest was a capital expenditure and could not be deducted from income.

The Income Tax Appellate Tribunal (ITAT) ruled in favor of the banks, holding that the Vijaya Bank decision was rendered in a different legal context under the repealed sections of the Income Tax Act. It emphasized that since the banks held the securities as stock-in-trade, broken period interest was deductible as a business expense. However, the High Court reversed the Tribunal's decision. Thus, the bank approached the Supreme Court in the present appeal.

The bank argued that government securities, even when classified as HTM, were held as stock-in-trade as part of their normal banking business. The bank highlighted that it had consistently followed a practice of claiming broken period interest as a business expense, which had been accepted by the department in earlier assessments.

The Revenue argued that broken period interest should be treated as a capital expenditure, especially for securities categorized as HTM, since these were held for long-term investment rather than trading.

The Court noted that after 1989, interest on securities could be taxed under Section 28 (profits and gains from business) if the securities were held as stock-in-trade, or under Section 56 (income from other sources) if they were held as investments.

The Court emphasized that the nature of the securities (whether held as stock-in-trade or investments) was crucial in determining the tax treatment of broken period interest.

Circular No. 599 of 1991 issued by the CBDT required banks to treat securities as stock-in-trade. However, this circular was withdrawn following the Supreme Court's ruling in Vijaya Bank Ltd. v. Additional Commissioner of Income Tax (1991).

Later, RBI issued a circular in 1998 and another in 2001, directing that broken period interest paid by banks should be treated as an expenditure in the profit and loss account and not capitalized as part of the acquisition cost. In 2007, the CBDT issued Circular No. 4, allowing banks to maintain two separate portfolios: an investment portfolio (to be treated as capital assets) and a trading portfolio (to be treated as stock-in-trade).

The Court observed that whether HTM securities are held as investments or stock-in-trade depends on the facts of each case. If a bank holds HTM securities until maturity and values them at cost, they may be considered investments, in which case the broken period interest would not be deductible. If held as trading assets, the deduction would be available.

The Court referred to its earlier decision in Commissioner of Income Tax v. Associated Industrial Development Company (P) Ltd., which established that whether shares or securities are held as investments or trading assets is a matter within the knowledge of the assessee. Therefore, the treatment of HTM securities as either investments or stock-in-trade depends on the specific circumstances of each case.

The ITAT had concluded that the Bank of Rajasthan had been consistently treating its securities as stock-in-trade and noted that the interest income on these securities had been taxed under Section 28 of the Income Tax Act since 1989-90, and the bank had treated its securities as stock-in-trade since 1982-83.

The Supreme Court held that since the bank treated the securities as stock-in-trade, the broken period interest could not be classified as capital expenditure. Instead, it must be treated as a revenue expenditure, which is deductible under the Income Tax Act.

Case no. – Civil Appeal Nos. 32913294 of 2009

Case Title – Bank of Rajasthan Ltd. v. Commissioner of Income Tax

Citation : 2024 LiveLaw (SC) 817