Tax-free bond loss allowed, but proportionate expenditure linked to exempt income remained disallowable.

Where tax-free bond transactions are genuine, the actual loss on sale cannot be denied merely because the interest earned on those bonds is exempt; the cost of acquisition includes accrued interest paid up to purchase, and a lower sale price does not by itself justify disallowance of the loss. However, expenditure incurred in relation to exempt income remains disallowable, and where borrowed funds or related financing are not satisfactorily shown to be unconnected with the tax-free bond investment, a proportionate allocation of interest and administrative to the exempt-income stream is warranted. The loss claim was allowed, while the related expenditure disallowance was upheld.

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Issues: (i) Whether the loss arising on sale of tax-free bonds was allowable while the interest received on those bonds was exempt; (ii) Whether a part of the interest and administrative expenditure could be disallowed as expenditure relatable to exempt income.

Issue (i): Whether the loss arising on sale of tax-free bonds was allowable while the interest received on those bonds was exempt.

Analysis: The bonds were genuine tax-free securities and the sale price as well as the transaction itself was not shown to be non-genuine. The price paid for such securities, including accrued interest up to the date of purchase, formed part of the cost. The interest earned during holding was exempt under the Act, and the mere fact that the bonds later fetched a lower sale price did not justify disallowance of the actual loss. The use of lawful tax benefits did not, by itself, convert the transaction into an abuse of law.

Conclusion: The loss on sale of tax-free bonds was allowable and the disallowance was unjustified, in favour of the assessee.

Issue (ii): Whether a part of the interest and administrative expenditure could be disallowed as expenditure relatable to exempt income.

Analysis: Expenditure incurred in relation to income not forming part of total income is disallowable. The assessee did not satisfactorily establish that the borrowed funds were not used, directly or indirectly, in connection with the investment in tax-free bonds or in repaying the funds used for that purpose. On the material before it, the allocation of a part of the financial and administrative expenses to the exempt-income stream was held to be warranted.

Conclusion: The disallowance of the related interest and administrative expenditure was upheld, in favour of the Revenue.

Final Conclusion: The assessee succeeded on the allowability of the bond loss, while the Revenue succeeded on the disallowance of expenditure attributable to exempt income; the appeals were thus disposed of with relief granted to both sides on different issues.

Ratio Decidendi: Where the genuineness of a tax-free bond transaction is not in doubt, the actual loss on sale cannot be denied merely because the interest received is exempt; however, expenditure incurred in relation to exempt income is disallowable to the extent it is shown or inferred to relate to that income.

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