Interest Deductibility for Banks: entire interest on ordinary-course deposits treated as business expenditure under section 10(2)(iii), not apportioned.

The article explains the Madras High Court's treatment of bank deposit interest under the Income-tax Act, 1922, holding that interest paid on deposits received in the ordinary course of banking merges with the bank's general funds and constitutes interest on capital borrowed for business, therefore deductible under section 10(2)(iii). The Court rejected apportionment on the basis that investments in tax-free securities were independent transactions and that, absent the later statutory Explanation, the proviso to section 8 did not apply. Applied to the facts, no portion of deposit interest was treated as interest on money borrowed exclusively to invest in tax-free securities, so the entire interest was allowable.

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Issues: Whether the entire interest paid by a banking company on deposits is deductible as trading expenditure under section 10(2)(iii) of the Income-tax Act, 1922, or whether a portion must be treated as interest payable on money borrowed for the purpose of investment in tax-free securities within the proviso to section 8 of the Income-tax Act, 1922.

Analysis: The Court examined the statutory language of the proviso to section 8 as it stood for the assessment year 1951-52 and the scope of section 10(2)(iii) as a provision for deduction of interest on capital borrowed for business. It analysed the nature of bank deposits as monies borrowed in the course of banking business and held that deposits received in the ordinary course merge with the bank's general funds and constitute capital borrowed for the purposes of the banking business. The Court distinguished situations where monies are borrowed specifically and exclusively for investment in securities from cases where borrowing and investment are independent transactions carried out in the ordinary course of business. The Court also considered earlier authorities (including Hughes v. Bank of New Zealand and domestic precedents) and concluded that absent a statutory provision (such as the Explanation later inserted in 1956) there was no basis for apportioning trading interest on the ground that part of the receipts from trading produced tax-free income. Applying these principles to the facts, the Court found no evidence that any portion of the deposits on which interest was paid in the year of account were borrowed for the express purpose of investing in the Mysore securities; the investments and borrowings were independent transactions in the normal course of banking business. Consequently, the proviso to section 8 did not apply and the interest paid fell within section 10(2)(iii).

Conclusion: The entire interest paid by the bank in the year of account, including the sum of Rs. 2,80,194, is a permissible deduction under section 10(2)(iii) of the Income-tax Act, 1922. The decision is in favour of the assessee.

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