Own-fund investments prevent expenditure disallowance, while bank securities remain stock-in-trade and related interest is revenue expenditure.
Deduction for dividend income is computed on net dividend, but no expenditure is disallowable where sufficient own funds financed the dividend-yielding investments rather than interest-bearing borrowings. For scheduled banks, the bad-debt deduction rules distinguish urban advances written off under section 36(1)(vii) from rural advances covered by section 36(1)(viia), with the proviso preventing double deduction only for the latter. Bank-held securities are stock-in-trade, making purchase interest and broken-period interest revenue expenditure. Similarly, sufficient own funds preclude proportionate disallowance of expenditure against exempt bond income.
Issues: (i) Whether deduction under section 80M of the Income-tax Act, 1961 was to be computed on the gross dividend or the net dividend, and whether any expenditure could be disallowed where the assessee had sufficient own funds. (ii) Whether the proviso to section 36(1)(vii) of the Income-tax Act, 1961 restricted deduction for bad debts claimed by a scheduled bank. (iii) Whether securities held by the bank were stock-in-trade and whether interest on purchase of securities, including broken period interest, was allowable as revenue expenditure. (iv) Whether proportionate expenditure relatable to tax-free bond income was liable to disallowance.
Issue (i): Whether deduction under section 80M of the Income-tax Act, 1961 was to be computed on the gross dividend or the net dividend, and whether any expenditure could be disallowed where the assessee had sufficient own funds.
Analysis: Deduction under section 80M is to be worked out on the basis of net dividend and not gross dividend. However, on the facts recorded, the assessee had sufficient surplus own funds and the investment yielding dividend was not made out of interest-bearing borrowings. In such circumstances, there was no justification for estimating and disallowing expenditure against the dividend income.
Conclusion: The issue was answered in favour of the assessee.
Issue (ii): Whether the proviso to section 36(1)(vii) of the Income-tax Act, 1961 restricted deduction for bad debts claimed by a scheduled bank.
Analysis: The statutory scheme treats clause (viia) and clause (vii) of section 36(1) as distinct. The proviso to section 36(1)(vii) operates to prevent double deduction in relation to rural advances covered by clause (viia), but does not curtail deduction for bad debts arising from urban advances written off in the accounts.
Conclusion: The issue was answered in favour of the assessee.
Issue (iii): Whether securities held by the bank were stock-in-trade and whether interest on purchase of securities, including broken period interest, was allowable as revenue expenditure.
Analysis: Securities held by a bank form part of its banking business and are treated as stock-in-trade. On that footing, expenditure incurred in relation to such securities, including interest on purchase and broken period interest, is revenue in nature and not capital expenditure.
Conclusion: The issue was answered in favour of the assessee.
Issue (iv): Whether proportionate expenditure relatable to tax-free bond income was liable to disallowance.
Analysis: In view of the settled position applied in the assessee's case and the factual finding that own funds were sufficient to cover the investments, no proportionate disallowance of expenditure attributable to exempt income was warranted.
Conclusion: The issue was answered in favour of the assessee.
Final Conclusion: The departmental appeals failed on all substantial questions of law and the assessee's positions were accepted on merits, resulting in dismissal of the appeals.
Ratio Decidendi: Where a bank has sufficient own funds, no proportionate expenditure can be disallowed against dividend or exempt investment income; bad debt deductions under section 36(1) must be read according to the distinct operation of clauses (vii) and (viia); and bank-held securities are stock-in-trade so related interest and broken period interest are revenue expenditures.