Banking tax issues: section 14A relief, NPA interest recognition, MAT inapplicable, and perpetual bond interest deductible.

ITAT Mumbai held that section 14A disallowance could not be sustained on securities held by a bank as stock in trade, so the addition was deleted. It further held that interest on NPAs is taxable only in line with RBI recognition norms under section 43D, and that broken period interest on purchase of securities is allowable as revenue expenditure. The Tribunal also held that section 115JB does not apply to a corresponding new bank, and that interest on perpetual bonds remains deductible because the instruments are borrowings, not equity. Foreign branch income in treaty countries was, however, held taxable in India, with treaty credit available.

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Issues: (i) Whether disallowance under section 14A could be sustained in respect of securities held by a bank as stock in trade; (ii) whether income of foreign branches in treaty countries was includible in total income in India; (iii) whether interest on non-performing assets was taxable on accrual basis or only in accordance with RBI guidelines under section 43D; (iv) whether section 115JB applied to a banking company constituted under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970; (v) whether broken period interest paid on purchase of securities was allowable as revenue expenditure; (vi) whether interest accrued but not due could be excluded from taxable income; and (vii) whether interest on perpetual bonds was allowable as deductible interest or had to be treated as equity-related outgo.

Issue (i): Whether disallowance under section 14A could be sustained in respect of securities held by a bank as stock in trade.

Analysis: The claim under section 14A was examined in the context of a bank holding securities as stock in trade and earning exempt income incidentally. The Tribunal followed its own earlier decisions in the assessee's case and the settled approach that, for bank-held securities treated as stock in trade, the expenditure nexus required for section 14A disallowance was not made out in the same manner as in an investment portfolio case. The issue was treated as covered by precedent and the principle of consistency.

Conclusion: The disallowance under section 14A was deleted and the issue was decided in favour of the assessee.

Issue (ii): Whether income of foreign branches in treaty countries was includible in total income in India.

Analysis: The exclusion claim based on double taxation avoidance agreements and Article 7 was considered along with the Central Government notification under section 90(3). The Tribunal followed its earlier binding coordinate bench view in the assessee's own case that the foreign branch income of the assessee remained taxable in India, with credit to be granted for taxes paid abroad in accordance with the treaty mechanism.

Conclusion: The foreign branch income was held taxable in India and the issue was decided against the assessee.

Issue (iii): Whether interest on non-performing assets was taxable on accrual basis or only in accordance with RBI guidelines under section 43D.

Analysis: The Tribunal considered section 43D and the prescribed rules in the light of RBI prudential norms and prior decisions holding that income by way of interest on bad and doubtful debts of banks is governed by the RBI framework for recognition. It accepted that the relevant income could not be taxed on a mercantile accrual basis contrary to the statutory scheme as applied to banks.

Conclusion: The interest on NPAs was held taxable only as per RBI guidelines and the issue was decided in favour of the assessee.

Issue (iv): Whether section 115JB applied to a banking company constituted under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.

Analysis: The Tribunal relied on the Special Bench view that the insertion of clause (b) to section 115JB(2) did not bring such banks within the MAT regime. On that basis, it held that banks constituted as corresponding new banks were outside the scope of section 115JB and book profit taxation under MAT.

Conclusion: Section 115JB was held inapplicable to the assessee bank and the issue was decided in favour of the assessee.

Issue (v): Whether broken period interest paid on purchase of securities was allowable as revenue expenditure.

Analysis: The Tribunal applied the settled position, including the Supreme Court's recent authority, that where Government securities are held as stock in trade, the broken period interest paid on acquisition does not assume the character of capital outlay. It is treated as part of the revenue trading operations of the bank.

Conclusion: The broken period interest was allowed as revenue expenditure and the issue was decided in favour of the assessee.

Issue (vi): Whether interest accrued but not due could be excluded from taxable income.

Analysis: The Tribunal followed the jurisdictional High Court authority applied by the CIT(A) and accepted that the disputed amount representing interest accrued but not due was not taxable in the manner proposed by the Revenue on the facts of the case.

Conclusion: The deletion of the addition on account of interest accrued but not due was upheld and the issue was decided against the Revenue.

Issue (vii): Whether interest on perpetual bonds was allowable as deductible interest or had to be treated as equity-related outgo.

Analysis: The Tribunal examined the character of the instruments, their treatment in the books, the fixed interest obligation, redemption features, and the distinction between borrowings and equity. Following coordinate bench authority, it held that the perpetual bonds were in the nature of borrowings and not equity capital for the purpose of deduction of interest.

Conclusion: The interest on perpetual bonds was held allowable and the issue was decided in favour of the assessee.

Final Conclusion: The assessee succeeded on the principal disallowance and deduction issues, while the Revenue succeeded only on the foreign branch income issue, resulting in an overall partial allowance of the assessee's appeal and dismissal of the Revenue's appeal.

Ratio Decidendi: In the case of a bank, securities held as stock in trade, NPA interest governed by RBI-recognition norms, and borrowings evidenced by perpetual debt instruments are to be treated according to their commercial and statutory character, while MAT under section 115JB does not apply to corresponding new banks.

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