SC allows deduction of broken period interest paid by banks for securities held as stock-in-trade

In the case of Bank of Rajasthan Ltd. ^[1] (Taxpayer), the issue arose before the Supreme Court (SC) whether the Taxpayer-bank can claim deduction (as a business expense) of broken period interest paid at the time of purchase of government securities which are held as stock-in-trade.

In the facts of the case, the Taxpayer, being a Scheduled Bank, was required to purchase government securities to maintain statutory liquidity ratio and categorized them as (a) Held to Maturity (HTM); (b) Available for Sale (AFS); and (c) Held for Trading (HFT). At the time of acquisition of security between two coupon dates, the Taxpayer was required to pay interest accrued for the period from the last coupon date till the date of purchase (known as “broken period interest”) along with purchase price. 

The Taxpayer claimed deduction of such broken period interest while computing income under the head “Profits and gains from business or profession”. The Tax Authority disallowed the broken period interest by relying on earlier SC decision in case of Vijaya Bank Ltd. vs. ACIT [(1991) (187 ITR 541)] which held that broken period interest forms part of cost of acquisition and is not allowed as deduction. 

The SC ruled in favor of the Taxpayer and allowed revenue deduction of broken period interest since the securities were held as stock-in-trade. The SC relied on its earlier ruling in the case of CIT vs. Citi Bank NA [Civil Appeal No. 1549 of 2006] which upheld Bombay High Court (HC) ruling in the case of American Express International Banking Corporation v. CIT [(258 ITR 601) (Bom.)]. The Bombay HC had held that broken period interest is allowable as deduction and it distinguished Vijaya Bank’s ruling (supra) on the basis that its ratio is not applicable when interest income is assessed under Business income head.   The Bombay HC had also relied on the SC ruling in case of CIT v. Cocanada Radhaswami Bank [57 ITR 306] wherein the SC held that interest on securities although assessable under the head ”Interest on securities” did not lose its character as a business income for the purpose of set off of losses.

In relation to characterization of securities, the SC held that securities held by banks as a part of the banking business are treated as stock-in-trade and not as an investment^[2] . Further, it held that securities held by bank as AFS and HFT are always stock-in-trade and interest accruing thereon is assessable as Business income. Thus, the deduction of broken period interest is allowable.  But characterization of HTM securities as investment or stock in trade is fact specific. HTM securities are liable to treated as investment if the securities are purchased at their cost price or face value and actually held till maturity. If HTM securities are treated as investment, broken period interest is not deductible. However, if HTM securities are treated as trading asset, broken period interest is allowable as revenue deduction.

[1] [(2024) (167 taxmann.com 430) (SC)]
[2] Reliance placed on ratio in case of Cocanada Radhaswami Bank Ltd. (supra), Bihar State Co-operative Bank Ltd. v. CIT [[1960] 39 ITR 114 (SC)] , Punjab Co-operative Bank v. Commissioner of Income Tax [(1940) SCC Online PC 46]