ITAT Allows Broken Period Interest, Rules MAT Inapplicable to Foreign Banks

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has delivered a significant ruling in favour of a foreign bank across multiple tax issues for AYs 1999-2000, 2000-01 and 2001-02. The Tribunal granted relief on disallowance under Section 14A, deductibility of broken period interest, taxation under Section 115A, tax neutrality of branch-head office transactions, and allowability of interest paid to the RBI for SLR shortfall, while remanding one issue relating to overseas interest income for factual verification.

On the issue of Section 14A, the Tribunal held that no proportionate disallowance of expenditure could be made against tax-free interest earned from NABARD bonds. It noted that the investments had been made in earlier years and no fresh investments were made during the relevant assessment years. Since the bank had sufficient interest-free funds in the form of capital and reserves exceeding the value of the investments, the presumption was that the investments were made out of own funds. Following the Supreme Court’s decision in South Indian Bank Ltd., the Tribunal deleted the disallowance.

The Tribunal also allowed the bank’s claim for broken period interest paid on the purchase of securities. Referring to the Supreme Court’s ruling in Bank of Rajasthan Ltd. (2024), it observed that the securities were consistently treated as stock-in-trade and formed part of the bank’s current investments. Therefore, the broken period interest constituted a revenue expenditure deductible in computing business income and could not be treated as part of the capital cost of acquiring the securities.

On the issue of Minimum Alternate Tax (MAT), the Tribunal held that the question of adding back the provision for standard assets while computing book profits under Section 115JA had become academic. Although Explanation (g), inserted retrospectively by the Finance Act, 2009, covered provisions for diminution in the value of assets, the Tribunal noted that Section 115JA itself did not apply to banking companies. Since the bank prepared its accounts under the Banking Regulation Act, 1949 and not under the Companies Act, the MAT provisions were held to be inapplicable.

The Tribunal further ruled in favour of the assessee on the applicability of Section 115A. It held that interest earned from foreign currency loans advanced to Indian corporates was taxable at the concessional rate on a gross basis. In view of Section 115A(3), no deduction of expenditure or allocation of borrowing costs could be made while computing such income, and the Assessing Officer was not justified in taxing only the net income after adjusting expenses.

With regard to transactions between the Indian branch and its foreign head office or overseas branches, the Tribunal followed the Special Bench decision in Sumitomo Mitsui Banking Corporation. It held that the Indian branch and the foreign head office constitute the same legal entity and, therefore, interest paid to or received from the head office represents a transaction with self. Such receipts are not taxable, corresponding payments are not deductible, and the provisions of Section 14A have no application to these internal transactions.

Finally, the Tribunal held that interest paid to the Reserve Bank of India for default in maintaining the Statutory Liquidity Ratio (SLR) was compensatory and not penal in nature. Examining the scheme under Section 24(4) of the Banking Regulation Act, it observed that the levy merely compensated for regulatory non-compliance and did not involve any criminal consequences. Following the Bombay High Court’s decision in CIT v. Bank of Baroda, the Tribunal held that the interest was an allowable deduction under Section 37(1).

To Read Full Order, Download PDF Given Below