Bombay High Court Clarifies Revenue v. Capital Expenses under Income-tax Act

Introduction

The taxation of financial transactions, especially those related to securities and debentures, has consistently challenged financial institutions and revenue authorities. In the present case of HDFC Bank v. Deputy Commissioner of Income-tax[i], the Hon’ble Bombay High Court addressed two significant issues concerning the deductibility of (i) broken period interest paid on securities held as stock-in-trade and (ii) expenses incurred on the issuance of Fully Convertible Debentures (‘FCDs’). The case involved disputes under s. 37(1) of the Income-tax Act, 1961 (‘Act’) for the assessment year (‘AY’) 1993-94. The Court clarified the tax treatment of these expenditures by relying on legal precedent and established accounting practices.

Brief Facts

• HDFC Bank (‘Assessee’) engaged in providing long-term finance held securities as stock-in-trade, with the purchase price including broken period interest, which it claimed as deductible expenditure.
• The Assessee issued FCDs through a ‘rights issue’ incurring various expenses, including printing, advertisements, professional fees, and filing fees.
• At the end of the financial year, unsold securities were recorded at cost in the closing stock. However, the Assessee claimed deductions for broken period interest, recognising the income only upon sale or receipt in the subsequent year.
• The Assessing Officer (‘AO’) disallowed the deduction, treating the broken period interest as part of the capital cost of the securities, which was already accounted for in the Profit & Loss Account. The AO also disallowed expenses incurred for the issuance of FCDs, arguing that the issue was intended to increase capital rather than raise borrowed funds.
• The Commissioner of Income Tax (Appeals) [‘CIT(A)’] and the Income Tax Appellate Tribunal (‘ITAT’) agreed with the reasoning. They upheld the disallowances, holding that broken period interest was part of the asset’s purchase price and could not be deducted separately. Additionally, the ITAT upheld the disallowance of FCD-related expenses, reasoning that the purpose of the debenture issuance was to raise capital rather than borrow funds.
• Aggrieved by the decisions, the Assessee appealed before the High Court under s. 260A of the Act.

Held

• The High Court ruled in favour of the Assessee, holding that both broken period interest and expenses incurred on FCDs were deductible under s. 37(1) of the Act. The Court identified factual errors in the Tribunal's assessment regarding the accounting treatment of broken period interest.
• The Court relied on American Express International Banking Corporation v. CIT[ii], which recognised broken period interest paid on securities as deductible revenue expenditure.
• The? Court further cited Bank of Rajasthan Ltd. v. CIT[iii], where the Hon’ble Supreme Court reaffirmed that broken period interest on stock-in-trade securities is allowable as revenue expenditure.
• The? Court referred to Indian Cements Ltd. v. CIT[iv], where it was held that expenses incurred for raising funds for business purposes, even if related to equity-linked instruments, are allowable as revenue expenditure.
• The key distinction observed by the Court was that banks and financial institutions treat securities as stock-in-trade, not capital assets.
• The Court also relied on CIT v. Secure Meters Ltd.[v] and CIT v. Havells India Ltd.[vi], which held that FCD-related expenses are revenue in nature.
• The Court distinguished the Hon’ble Supreme Court’s ruling in Brooke Bond Ltd. v CIT[vii], noting that the present case involved convertible debentures, which initially represent a borrowing transaction.

Our Analysis

This judgment serves as a vital precedent for financial institutions and businesses issuing securities or debentures, providing clarity on the tax treatment of broken period interest and debenture issuance expenses. It provides clarity on tax deductibility for broken period interest and debenture-related expenses by following the principle that debenture issuance expenses are revenue in nature when they involve an initial borrowing element. The ruling mitigates the risk of misclassification and arbitrary tax disallowances by distinguishing revenue from capital expenses. It also reduces the risk of arbitrary disallowances, encouraging confidence among financial institutions to manage legitimate business expenses without fear of double and or retrospective liabilities. The ruling reinforces equitable taxation by balancing statutory interpretation with practical business realities.

End Notes

[i]?[2024] 169 taxmann.com 403 (Bombay) [13-11-2024].

[ii]?(2002) 258 ITR 601.

[iii]?(2024) 469 ITR 280.

[iv]?(1966) 60 ITR 52 (SC).

[v]?(2010) 321 ITR 611.

[vi]?(2013) 352 ITR 376.

[vii]?(1997) 10 SCC 362.

Authored by Adv Priyavansh K. , Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.