Issue 1: Whether Interest accrued but not due on the balance sheet date is taxable
The assessee is a company incorporated in and is a tax resident of Cyprus. It carries on business of banking and was, at the relevant time, registered in India with the Securities & Exchange Board of India (SEBI) as an approved sub-account of Credit Suisse First Boston, a Foreign Institutional Investor (FII). SEBI had permitted the assessee to invest in India exclusively in debt-securities, including Government securities. The assessee follows the mercantile system of accounting. The assessee filed its return of income for the assessment year 2001-2002 on 31st October, 2001, declaring a total income of Rs.5,94,28,493 comprising of interest income from securities and claimed exemption in respect of income on sale of securities.
The AO held that Rs.1,21,57,517/- is required to be taxed as interest accrued though not due on securities held by the assessee as on 31st March, 2007, being the last date of the financial year. The Commissioner of Income Tax (Appeals) [CIT(A)] deleted both the additions. The ITAT upheld the order.
Tax Authority’s arguments:
- Income accrues, as and when the assessee acquires a right to receive such income or the right becomes vested in it.
- In the case of Government securities etc. although interest becomes due for payment only at six monthly intervals, such interest certainly accrues from day to day.
- When the assessee purchases certain securities it pays not only cost of securities, but also the interest which has accrued, on day to day basis, from the last date of payment of interest to the date of purchase.
- Thus the interest not only accrues from day to day, but the quantum of interest accruing is also known, for the assessee bank to determine the amount of interest accrued till the date of transfer, which is to be added to the cost of securities to be paid by the purchaser.
- Thus, since the right to receive such interest is vested with the assessee, it is clear that such interest has accrued to the assessee. Reference is made in this regard to Supreme Court decisions in the case of E.D. Sasoon & Co. 26 ITR 27 and Shri Govardan Ltd. 69 ITR 675
- When an instrument or an agreement stipulates interest to be payable at a specified date, interest does not accrue to the holder thereof on any date prior thereto.
- Interest would accrue or arise only on the date specified in the instrument.
- Whatever be the connotation of the term accruing in general parlance, for the purpose of the Income Tax Act, interest does not accrue during such periods to the creditor/assessee. For want of a better term, it may be said that during such periods interest keeps mounting or if we may use the expression interest keeps ticking.
- The creditor however, does not during these periods have an enforceable right to demand interest.
- On the date stipulated in the agreement for payment of interest, the creditor has an enforceable right to be paid interest calculated at the rate and for the period stipulated therein.
- Interest accrued on the securities only on the due dates. The contention that interest accrues for broken periods between two consecutive dates stipulated in the agreement/instrument for payment of interest is without any basis in law.
Issue No: 2: Whether the sale of securities is covered by Article 14 of the tax treaty between India and Cyprus i.e. capital gains OR Article 11 i.e. Interest
The assessee claimed that Rs.40,53,62,518/-, being gains in transactions of Government debt-securities and contended that the income from sale of these securities constituted capital gains which falls within Article 14(4) and is, therefore, exempt from tax in India.
However, the AO held the same to be interest within the meaning of that term in Article 11(4) of the “Agreement Between the Republic of India And The Republic Of Cyprus DTAA and liable, therefore, to tax in India.
- The principal or governing words in Article 11(4) are “interest means income from debt-claims of every kind”.
- These words predicate the existence of a debtor-creditor relationship. Clause 4 relates to interest “from” debt-claims. In other words, the income must arise out of, on account of a debt-claim.
- It is important to note the difference between the debt-claim itself and any accretion thereto, such as interest. Once this distinction is noted, it is easy to appreciate that the price realised upon the sale of the debt-claim itself is not interest.
- The sale price recovered in excess of the value of the security, bond or debenture cannot be said to be a premium “attaching to such securities, bonds or debentures”. To fall within the term “interest”, the premium or prize referred to in Article 11(4) must be attached to and arise from and in terms of the security, bond or debenture to wit it must be an inherent part of, and a right created by and contained in the instrument itself realisable on the terms of the instrument and not de-hors the same.
- The assessee is, therefore, entitled to the benefit of the exemption under Article 14 of the DTAA.