SC Clarifies Tax Treatment of ‘Broken Period Interest’

In a recent judgment of Bank of Rajasthan Ltd. v. Commissioner of Income Tax, 2024 SCC OnLine SC 2877, dated October 16, 2024, the Hon’ble Supreme Court of India has allowed banks to claim tax deductions for broken period interest on Held to Maturity (HTM) government securities, provided they are classified as stock-in-trade. The decision clarifies the tax treatment for banks regarding interest paid for the period between the last coupon date and the date of purchase of securities, resolving a long-standing issue between banks and tax authorities.

The appellant, Bank of Rajasthan, was engaged in purchasing and selling government securities, particularly those held to meet statutory liquidity ratio (SLR) obligations under the Banking Regulation Act, 1949. The dispute arose over whether broken period interest, i.e., the interest accrued between the last coupon date and the date of purchase of government securities, could be deducted as a business expense when computing taxable income. 

The Commissioner of Income Tax (CIT) disallowed the deduction for broken period interest, relying on the Supreme Court’s ruling in Vijaya Bank Ltd. v. Additional Commissioner of Income Tax, Bangalore, 1991 Supp (2) SCC 147, dated September 19, 1990, where broken period interest was classified as capital expenditure and hence not deductible as a business expense. 

The appellant argued that it had consistently treated government securities as stock-in-trade and that broken period interest should be considered a business expense. The practice of treating such securities as stock-in-trade had been accepted by the tax authorities in prior assessments. Whereas the Revenue Department argued that broken period interest should be treated as capital expenditure, particularly for HTM securities, which are usually held for long-term investment purposes.

The Apex Court stated that the classification of HTM securities as stock-in-trade or investment fact-specific queries. It noted that:

1. HTM securities are treated as investments if held until maturity and valued at cost. In such cases, broken period interest is not deductible.
2. If the securities are treated as stock-in-trade, broken period interest qualifies as a deductible business expense.

The court referred to its earlier decision in Commissioner of Income Tax v. Associated Industrial Development Company (P) Ltd., (1972) 4 SCC 447, dated September 7, 1971, which clarified that whether assets are held as investments or stock-in-trade is a matter which is within the assessee’s knowledge.

The court emphasized that since the Bank of Rajasthan consistently treated its securities as stock-in-trade, the broken period interest should be treated as revenue expenditure, making it deductible under Section 28 of the Income Tax Act. The court, in this case, ruled in favor of the Bank of Rajasthan, holding that broken period interest on government securities held as stock-in-trade is deductible as a business expense under the Income Tax Act, 1961.

This ruling strengthens the principle that the classification of securities for tax purposes depends on their actual use, providing public institutions the flexibility to deduct broken period interest if the securities are treated as trading assets.