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Interest accrued but not due is not taxable in income tax

• The respondent-bank incorporated in and tax resident of Cyprus was, at the relevant time, registered in India with SEBI as an approved sub-account of Credit Suisse First Boston, a Foreign Institutional Investor (FII). SEBI had permitted the respondent to invest in India exclusively in debt-securities, including Government securities.

• The respondent followed the mercantile system of accounting.

• AO taxed Rs.1,21,57,517/- as interest accrued though not due on securities held by the respondent as on 31st March, 2007, being the last date of the financial year. The respondent contended that the same had not accrued to it as under the Government securities, the interest was not due on 31st March, 2007.

• The AO held Rs.40,53,62,518/-, being gains in transactions of Government debt-securities to be interest within the meaning of that term in Article 11(4) of the Indo-Cyprus DTAA and liable, therefore, to tax in India. The respondent 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.

• CIT(A) allowed assessee's appeal and deleted the additions. ITAT upheld CIT(A)'s order. Hence, the present appeal filed to the High Court.

• 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. That a creditor has a vested right to receive interest on a stated date in future does not constitute an accrual of the interest to him on any prior date.

• 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 assignee or purchaser of such a security does not stand on a different footing. He has, by virtue of the assignment or purchase, the right vested in him to receive the interest but only on the terms of the security and subject to all the incidents thereof as were applicable to the original owner.

• It cannot be contended that the difference between sales price of securities and their face value is necessarily the broken period interest. The securities or agreements do not regulate the price at which the holder is to sell the same to a third party. The holder is at liberty to sell the same at any price. The interest component for the broken period i.e. the period prior to the due date for interest is only one of the factors that may determine the sale price of the security. There are a myriad other factors, both personal as well as market driven, that can be and, in fact, are bound to be taken into consideration in such transactions.

• The appellant's (Revenue's) contention is also based on the erroneous presumption that what is paid for is the face value of the security and the interest to be paid for the broken period from the last date of payment of interest till the date of purchase. What, in fact, is purchased is the possibility of recovering interest on the date stipulated in the security. It is not unknown for issuers of securities, debentures and bonds, to default in payment of interest as well as the principal. The purchaser therefore hopes that on the due date he will receive the interest and the principal. The purchaser therefore, purchases merely the possibility of recovery of such interest and not the interest per se. It would be pointless to even suggest that in the case of Government securities, the possibility of a default cannot arise. The interpretation of law does not depend upon the solvency of the debtor or the degree of probability of the debts being discharged. There is nothing in the Act or in the DTAA that warrants the position in law being determined on the basis of such factors viz. the degree of probability of the particular issuer of the security, bond or debenture or such instruments, honouring the same. - [2012] 23 taxmann.com 424 (Bombay)
Tags-interest income tax rule,income tax rule on interest income,tds on interest,interest accrued income tax rule,income tax rule on interest accrued

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