Bank interest deduction on fixed deposits allowed in full where securities were part of circulating capital, not specific borrowed investment.

A banking company's interest on fixed deposits was treated as deductible business expenditure under section 10(2)(iii) because the deposits were received in the ordinary course of banking and formed part of the bank's borrowed capital used in its business. The securities, including the Mysore securities, were held as circulating capital and stock-in-trade, so the deposits could not be characterised as money borrowed specifically for investment in tax-free securities under the proviso to section 8. The later 1956 Explanation was regarded as creating a legal fiction not applicable to the assessment year concerned. Accordingly, no apportionment of interest was permitted merely because some securities yielded exempt income, and the entire interest remained allowable.

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Issues: Whether the entire interest paid by a banking company on fixed deposits could be deducted as business expenditure under section 10(2)(iii) and whether any part of it could be disallowed under the proviso to section 8 on the footing that the deposits were money borrowed for the purpose of investment in tax-free securities.

Analysis: The deposits received by the bank in the ordinary course of banking were treated as borrowed capital used in its business. The securities, including the Mysore securities, were held and dealt with as part of the bank's circulating capital and stock-in-trade, and there was no borrowing undertaken specifically for investment in those securities. On the language of the proviso to section 8 as it stood in the relevant year, the Court held that the deposits and the later purchase of securities could not be treated as a borrowing for the purpose of investment in securities. The later Explanation added in 1956 was regarded as creating a legal fiction that did not govern the assessment year in question. Since the interest was deductible as business interest under section 10(2)(iii), no apportionment was permissible merely because some securities produced tax-free income.

Conclusion: The entire interest paid by the bank, including the sum apportioned by the Department, was an allowable deduction under section 10(2)(iii), and the assessee succeeded.

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