TaxTMI 
TaxTMI 
2012 (8) TMI 17
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.... is a company incorporated in and is a tax resident of Cyprus. It carries on business of banking and was, at the relevant time, registered in India with the Securities & Exchange Board of India (SEBI) as an approved sub-account of Credit Suisse First Boston, a Foreign Institutional Investor (FII). 3. SEBI had permitted the respondent to invest in India exclusively in debt-securities, including Government securities. The present case concerns the respondent's transactions in Government debt-securities, whereunder interest was payable every six months. 4(A). The respondent follows the mercantile system of accounting. The respondent filed its return of income for the assessment year 2001-2002 on 31st October, 2001, declaring a total income of Rs.5,94,28,493/-. The case was selected for scrutiny and notices under sections 142(1) and 143(2) were issued. The respondent offered for taxation, interest income from securities for the said sum of Rs. 5,94,28,493/- and claimed exemption in respect of income on sale of securities. (B). The Assistant Director of Income-tax (International Taxation) [hereinafter referred to as "the Assessing Officer"] determined the total income at Rs.....
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.... not which broken period was considered - the period from the last due date to the end of the financial year i.e. 31st March, 2001, or the period from the date of purchase to the date of sale of the security or otherwise. We have come to the conclusion that interest can be said to accrue or arise only to the holder of the instrument and only on the date stipulated in the security for the payment of interest. If we are correct in this conclusion, then the holder of a security would not be liable for notional interest for the proportionate period as on the last date of the financial year in respect of the securities held on that date or for notional interest to the extent of the proportionate amount from the day he purchased it to the date of the sale of the same by him or for any other broken period. (B)(i) Secondly it is not clear whether the appeal pertains to the Department's contention that interest is deemed to accrue on a proportionate basis upto to the end of the financial year on the securities held by the respondent on that date or whether it pertains to the Department's contention that the gain from the sale of the securities constitutes interest within the meaning of t....
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....e is not actually received or is foregone. Recently, the Supreme Court has admitted the SLP filed by the department against the decision of the Karnataka High Court in the case of Canara Bank dated 27.7.1992. The issue there was, whether interest accrued but not due, would be includible in the taxable income for the assessment year. (SLP No.15076 of 92). These decisions made it clear that in the mercantile system of accounting, the profit or loss at the end of the accounting year is based not on the difference between what was actually received or paid but on the difference between the right to receive and the liability to pay. 6.2 The assessee is a foreign institutional investor and has invested in government securities. The purchase consideration consisted of the face value of the security, interest accrued upto that date and discount portion. Similarly, the sale consideration also consisted the face value and the interest accrued upto the date of sale. The difference of interest between the purchase consideration and sale consideration is the interest earned in respect of such dealings." 7. In E.D. Sassoon & Co. Ltd. v. Commr. of Inc.-Tax [1954] 26 ITR 27, the Supreme Cour....
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....id to have accrued for any part of the broken period. In other words, interest can be said to have accrued only on the date on which it was due as per the terms and conditions of the security. 11. When an instrument or an agreement stipulates interest to be payable at a specified date, interest does not accrue to the holder thereof on any date prior thereto. Interest would accrue or arise only on the date specified in the instrument. That a creditor has a vested right to receive interest on a stated date in future does not constitute an accrual of the interest to him on any prior date. Where an instrument provides for the payment of interest only on a particular date, an action filed prior to such date would be dismissed as premature and not disclosing a cause of action. Subject to a contract to the contrary, a debtor is not bound to pay interest on a date earlier to the one stipulated in the agreement/instrument. In the present case, it is admitted that interest was not payable on any date other than that mentioned in the security. The assignee or purchaser of such a security does not stand on a different footing. He has, by virtue of the assignment or purchase, the right veste....
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....so factors which would go into determining the price at which such securities are bought and sold. There is nothing in the Act or in the DTAA, to which we will shortly refer, that warrants the position in law being determined on the basis of such factors viz. the degree of probability of the particular issuer of the security, bond or debenture or such instruments, honouring the same. 14. When an agreement provides for payment of interest on a particular date, what, it is asked on behalf of the appellant, happens between the date of the agreement and the date on which payment of interest is due ? When an agreement provides for interest to be payable at stated intervals what, it is asked again, happens between the last due date for payment of interest and the next ? Interest, it is suggested, keeps accruing each day during these periods. We are unable to agree. Whatever be the connotation of the term accruing in general parlance, for the purpose of the Income Tax Act, interest does not accrue during such periods to the creditor/assessee. For want of a better term, it may be said that during such periods interest keeps mounting or if we may use the expression interest keeps tick....
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....eparately apportioned, an apportionment subject to Income Tax as between the parties. This stock is not sold like that, it is sold en bloc for a sum for principal and accrued and accruing interest ; and it is not true to say in fact that in the purchase price there is necessarily to be found a sum as purchase money of the accrued interest exactly equivalent to the amount of interest which has accrued. In the first place it might be uncertain (it is not in fact uncertain with regard to War Loan) whether it would be paid at all, but it is quite certain that it is not going to be paid yet, and it may be that the purchase is being made say three months after the last interest was paid and three months before the next was payable ; and if the amount is considerable, if GBP400,000 of War Loan is being sold, the interest on that is GBP20,000 a year, and a half year's interest is GBP10,000, and three months from the last interest payment GBP5,000 has accrued, but it is not going to be paid for another three months. To my mind, it is absurd to say that a person is paying GBP5,000 in March for GBP5,000 to be paid in June. He does not do it. Therefore, there would have to be, in any case, a v....
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....er words, the stand of the Revenue in that case was in conformity with the view that we have taken. It is useful, therefore, to refer to paragraph 6 of the judgment which sets out the stand of the Revenue in that case. It reads as under : "6. On behalf of the Revenue, it is contended as follows : The proportionate interest on the securities purchased by the assessee proportionate to the broken period till the date of their purchase, had in fact neither accrued nor become due and payable on the date of purchase. Such interest can accrue on the securities in question only on the dates specified therein and not on any earlier day during the currency of interest period. Hence no asset of any kind apart from the securities could be said to have come into existence on the date of their purchase by the assessee, much less of an enduring or lasting nature as observed by the Tribunal. Further more, such 'interest' would not answer the description 'interest on securities' under the Income-tax Act, 1961 ('Act' for short), and it matters not whether such 'interest' had been separately shown as having been purchased. What was purchased in the transaction is only the 'expectancy of interest'.....
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....,37,523/- was "interest accrued on investments and deposits" and the respondent stated that out of this amount Rs. 58,568/- related to interest accrued on Government securities held by the Jayalakshmi Bank Limited for the broken period upto the date of transfer of such securities to the respondent i.e. 29th May, 1967. The correctness of these statements was not doubted. They are in fact irrelevant to this question of law. 17. The judgment was confirmed in appeal by the Supreme Court in Vijaya Bank Limited v. Additional Commissioner of Income Tax 1991 Supp. (2) SCC 147 = 1987 ITR 541. The Supreme Court held :- "In the instant case, the assessee purchased securities. It is contended that the price paid for the securities was determined with reference to their actual value as well as the interest which had accrued on them till the date of purchase. But the fact is, whatever was the consideration which prompted the assessee to purchase the securities, the price paid for them was in the nature of a capital outlay and no part of it can be set off as expenditure against income accruing on those securities. Subsequently, when these securities yielded income by way of interest, such i....
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....eipt of consideration towards the sale of the securities would not fall within Article 14(4) as Government securities are specifically referred to in Article 11(4). This was the reasoning adopted by the Assessing Officer in paragraph 6.3.5 of the assessment order. Mr. Kaka on the other hand submitted that the same constitutes capital gains and is, therefore, exempt from taxation in view of Article 14 of the DTAA. Articles 11(1), 11(2) and 11(4) read as under :- "ARTICLE 11 : Interest - 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of the gross amount of the interest. 3.... 4. The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or d....
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....includes within the ambit of the term "interest", income from Government securities and interest from bonds and debentures as well as "premiums and prizes attached to such securities, bonds or debentures". The sale price recovered in excess of the value of the security, bond or debenture cannot be said to be a premium "attaching to such securities, bonds or debentures". The amount paid by the purchaser of a bond in excess of its value would not be a premium attaching to the bonds/securities/debentures. To fall within the term "interest", the premium or prize referred to in Article 11(4) must be attached to and arise from and in terms of the security, bond or debenture to wit it must be an inherent part of, and a right created by and contained in the instrument itself realisable on the terms of the instrument and not de-hors the same. The sale price in excess of the value of the bond cannot be said to be attached to the instrument or transaction. It arises independently and de hors the terms of the instrument. A claim cannot be made in respect thereof by the holder of the instrument/promisee against the issuer of the security, bond or debenture as it is not a right inherent in or at....
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....rious domestic laws; (b) the formula employed offers greater security from the legal point of view and ensures that conventions would be unaffected by future changes in any country's domestic laws; (c) in the Model Convention references to domestic laws should as far as possible be avoided." 32. The consideration received by the respondent in respect of the sale of the said securities is therefore a capital gain. 33. Article 14 of the DTAA reads as under :- "ARTICLE 14 : Capital gains - 1. Gains derived by a resident of a Contracting State from the alienation of immovable property, referred to in Article 6, and situated in the other Contracting State may be taxed in that other State. 2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone ....