Supreme Court: Banks Entitled To Tax Deductions For Broken Period Interest On HTM Securities Held As Trading Assets
Supreme Court: Banks Entitled to Tax Deductions for Broken Period Interest on HTM Securities Held as Trading Assets
The Supreme Court has ruled that banks can claim tax deductions for broken period interest on Held to Maturity (HTM) government securities if they are classified as trading assets.
The bench, comprising Justices Abhay Oka and Pankaj Mithal, clarified that if HTM securities are held as investments, the benefit of broken period interest would not be available. Conversely, if they are held as trading assets, the deduction would be applicable. “Whether HTM securities are held as investments or stock-in-trade depends on the facts of each case,” the Court stated. If a bank retains HTM securities until maturity and values them at cost, these securities may be considered investments, making the broken period interest non-deductible. However, if they are held as trading assets, the deduction can be claimed.
The Court's decision came while addressing various appeals from banks and the Revenue Department regarding the treatment of interest paid on securities for the period between the last coupon date and the date of purchase (the broken period).
In the case, Bank of Rajasthan Ltd. was involved in purchasing and selling government securities. These securities are typically held by banks as part of their statutory liquidity ratio (SLR) obligations under the Banking Regulation Act, 1949, and fall into three categories: Held to Maturity (HTM), Available for Sale (AFS), and Held for Trading (HFT).
Interest on these securities is periodically paid by the government on coupon dates. When a bank purchases a security between coupon dates, it must pay an amount equivalent to the interest accrued from the last coupon date until the acquisition date, known as the broken period. When the next coupon payment is due, the purchasing bank receives interest for the entire duration, including the broken period.
The Court addressed whether broken period interest could be deducted as a business expenditure by banks following the repeal of sections 18 to 21 of the Income Tax Act in 1989, which previously governed the taxation and deductions related to interest on securities.
Before 1989, interest on securities was taxed under Section 18, with deductions permitted under Sections 19 and 20 for expenses incurred in realizing such interest. After the repeal, the taxation of interest on securities shifted to Section 28 (income from business) or Section 56 (income from other sources), depending on how the securities were treated by the assessee.
The Bank of Rajasthan maintained a practice of treating government securities as stock-in- trade, claiming deductions for broken period interest and offsetting this against the interest income from the securities when calculating taxable income. Initially, this practice was accepted by the assessing officer, but the Commissioner of Income Tax (CIT) later intervened under Section 263 of the Income Tax Act, disallowing the deduction for broken period interest, citing the Supreme Court's earlier decision in Vijaya Bank Ltd. v. Additional Commissioner of Income Tax (1991), which deemed broken period interest as capital expenditure not eligible for deduction.
The Income Tax Appellate Tribunal (ITAT) ruled in favor of the banks, asserting that the Vijaya Bank decision was made in a different legal context under the repealed sections of the Income Tax Act. It emphasized that since the banks treated the securities as stock-in-trade, broken period interest should be deductible as a business expense. However, the High Court overturned this decision, prompting the bank to appeal to the Supreme Court.
The bank contended that government securities, even when classified as HTM, were held as stock-in-trade as part of normal banking operations. It highlighted its consistent practice of claiming broken period interest as a business expense, which the department had accepted in prior assessments.
The Revenue Department argued that broken period interest should be classified as capital expenditure, especially for securities categorized as HTM, as these were typically held for long-term investment rather than trading purposes.
The Supreme Court noted that following the 1989 amendments, interest on securities could be taxed under Section 28 (profits and gains from business) if held as stock-in-trade, or under Section 56 (income from other sources) if held as investments. The nature of the securities whether held as stock-in-trade or investments was critical in determining the tax treatment of broken period interest.
The Court referenced Circular No. 599 of 1991 issued by the CBDT, which required banks to treat securities as stock-in-trade. However, this circular was withdrawn following the Vijaya Bank ruling. In subsequent years, the RBI issued circulars in 1998 and 2001, stating that broken period interest paid by banks should be treated as an expense in the profit and loss account rather than 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 (treated as capital assets) and a trading portfolio (treated as stock-in-trade).
The Supreme Court reiterated that whether HTM securities are held as investments or stock- in-trade relies on the facts of each case. If a bank holds HTM securities until maturity and values them at cost, they may be considered investments, disallowing broken period interest deductions. However, if they are held as trading assets, the deductions can be claimed.
The Court cited its prior decision in Commissioner of Income Tax v. Associated Industrial Development Company (P) Ltd., establishing that the classification of shares or securities as investments or trading assets is a matter known to the assessee. Therefore, the treatment of HTM securities as either investments or stock-in-trade depends on the specific circumstances.
The ITAT concluded that the Bank of Rajasthan had consistently treated its securities as stock-in-trade and noted that the interest income from these securities had been taxed under Section 28 of the Income Tax Act since 1989-90. Furthermore, the bank had been treating its securities as stock-in-trade since 1982-83.
Ultimately, the Supreme Court ruled that since the bank treated the securities as stock-in- trade, broken period interest could not be classified as capital expenditure. Instead, it should be recognized as revenue expenditure, which is deductible under the Income Tax Act.
