In a recent judgment, Supreme Court has ruled that compensation by way of interest received by banks for default in payment of Bill of Exchange purchased/discounted by it does not come in the purview of the Interest Tax Act, 1974. It also held that guarantee fees paid to the Deposit Insurance and Credit Guarantee Corporation also not the subject matter of Interest Tax Act, 1974.

Question before the Court:
The bank makes purchases of bills of exchange from its customers and charges commission thereon for services rendered by it. The discounted bills so purchased are then presented to the parties concerned for realization. If on presentation the bill is realized within time, no charges are levied by the bank. In case the bills are not realized in time but the other party pays the value of the bill beyond the stipulated time, a certain amount of compensation in the form of interest is charged by the bank on a fixed percentage basis for every day of default. This amount is credited by the bank in its interest income account.

Thus the precise question before the Court was whether such payment of compensation is “interest” liable to tax under the Interest Tax Act, 1974?

Case Details:
CIVIL APPEAL NOS.5212-5220 OF 2007
M/S. STATE BANK OF PATIALA (Appellant) vs Commissioner of Income Tax, (Respondent)
Date of Order : 18-11-2015
Coram: Justice A. K. Sikri and Justice Rohinton Fali Nariman

Various High Court Case Laws Referenced:
State Bank of Mysore v. Commissioner of I.T., Karnataka-I, Bangalore, (1989) 175 ITR 607 (Karnataka HC)
CIT v. State Bank of Patiala, (2008) 300 ITR 395 (P&H)
Commissioner of Income-Tax v. State Bank of Indore (1988) 172 ITR 24 (MP HC)
Commissioner of Income Tax vs. State Bank of Travancore, [1997] 228 ITR 40 (Ker)
Commissioner of Income Tax v. State Bank of Hyderabad, [2014] 367 ITR 128 (AP)
Commissioner of Income Tax v. Cholamandalam Investment and Finance Co. Ltd., [2008] 296 ITR 601 (Mad )

Important Observations of the Court:
The definition of interest contained in the Interest Tax Act, 1974 is a narrow one, and is exhaustive as it is a ‘means and includes’ definition.

There was a sharp cleavage of opinion between the various High Courts. The Madhya Pradesh High Court, Kerala High Court, Andhra Pradesh High Court, Madras High Court and Rajasthan High Court have all decided that such amounts are not chargeable On the other hand, the Karnataka High Court and the Punjab and Haryana High Court have stated that such amount would be so chargeable.

The precise question before Court was whether compensation that can be traced to Section 32 of the Negotiable Instruments Act, 1881 can be regarded as interest on loans and advances ?

Interest on which tax is payable under the Interest Tax Act is primarily on loans and advances made in India. By a deeming fiction discount on bills of exchange made in India is also included. It is clear, therefore, that discount on bills of exchange would obviously not come within the expression “loans and advances made in India”, and consequently any amount that becomes payable by way of compensation after a bill is discounted by the Bank would not be an amount which would be “on loans and advances made in India

Important Excerpts from the Judgment:
We are of the view that the Karnataka High Court’s reasoning is fallacious for the simple reason that Section 2(7) itself makes a distinction between loans and advances made in India and discount on bills of exchange drawn or made in India. It is obvious that if discounted bills of exchange were also to be treated as loans and advances made in India there would be no need to extend the definition of “interest” to include discount on bills of exchange. Indeed, this matter is no longer res integra. In CIT v. Sahara India Savings & Investment Corpn. Ltd., (2009) 17 SCC 43, this Court while dealing with the definition contained in Section 2(7) of the Interest Tax Act, held:-

“Section 2(5) defines “chargeable interest” to mean total amount of interest referred to in Section 5, computed in the manner laid down in Section 6. In other words, the “scope of chargeable interest” is defined under Section 5 whereas “computation of chargeable interest” is under Section 6. Section 2(7) is the heart of the matter as far as the present case is concerned.

In accounting sense, there is a conceptual difference between loans and advances on the one hand and investments on the other hand. Section 2(7) defines the word “interest” to mean interest on “loans and advances including commitment charges, discount on promissory notes and bills of exchange but not to include interest referred to under Section 42(1-B) of the Reserve Bank of India Act, 1934 as well as discount on treasury bills”. Section 2(7), therefore, defines what is interest in the first part and that first part confines interest only to loans and advances, including commitment charges, discount on promissory notes and bills of exchange.

Pausing here, it is clear that the interest tax is meant to be levied only on interest accruing on loans and advances but the legislature, in its wisdom, has extended the meaning of the word “interest” to two other items, namely, commitment charges and discount on promissory notes and bills of exchange. In normal accounting sense, “loans and advances”, as a concept, is different from commitment charges and discounts and keeping in mind the difference between the three, the legislature, in its wisdom, has specifically included in the definition under Section 2(7) commitment charges as well as discounts. The fact remains that interest on loans and advances will not cover under Section 2(7) interest on bonds and debentures bought by an assessee as and by way of “investment”. Even the exclusionary part of Section 2(7) excludes only discount on treasury bills as well as interest under Section 42(1-B) of the Reserve Bank of India Act, 1934.” [at paras 5 – 7]

The Karnataka High Court’s view is directly contrary to the view of this Court, and, therefore, cannot be countenanced. “Loans and advances” has been held to be different from “discounts” and the legislature has kept in mind the difference between the two. It is clear therefore that the right to charge for overdue interest by the assessee banks did not arise on account of any delay in repayment of any loan or advance made by the said banks. That right arose on account of default in the payment of amounts due under a discounted bill of exchange. It is well settled that a subject can be brought to tax only by a clear statutory provision in that behalf. Interest is chargeable to tax under the Interest Tax Act only if it arises directly from a loan or advance. This is clear from the use of the word “on” in Section 2(7) of the Act. Interest payable “on” a discounted bill of exchange cannot therefore be equated with interest payable “on” a loan or advance. This being the case, it is clear that the reasoning contained in the High Courts which differ from the Karnataka view is obviously correct but for the reasons given by us.

It will be interesting to notice at this stage that the expression “interest” is also defined under the Income Tax Act. Section 2(28A) defines interest as follows:-

“2. Definitions.--- In this Act, unless the context otherwise requires. [(28A) “interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized.]”

It will be noticed that this definition is much wider than that contained in Section 2(7) of the Interest Tax Act, 1974. The expression “payable in any manner in respect of any moneys borrowed” is an expression of considerable width. It will be noticed that the aforesaid language of the definition section contained in the Income Tax Act is broader than that contained in the Interest Tax Act in three respects. Firstly, interest can be payable in any manner whatsoever. Secondly, the expression “in respect of” includes interest arising even indirectly out of a money transaction, unlike the word “on” contained in Section 2(7) which, we have already seen, connotes a direct arising of payment of interest out of a loan or advance. And thirdly, “any moneys borrowed” must be contrasted with “loan or advances”. The former expression would certainly bring within its ken moneys borrowed by means other than by way of loans or advances. We therefore conclude that the Interest Tax Act, unlike the Income Tax Act, has focused only on a very narrow taxable event which does not include within its ken interest payable on default in payment of amounts due under a discounted bill of exchange.

In fact, when we come to the second point agitated in some of the appeals by revenue namely as to whether guarantee fees paid to the Deposit Insurance and Credit Guarantee Corporation could be included in the definition of interest in Section 2(7) of the Interest Tax Act, 1974, it will be clear that such definition does not include any service fee or other charges in respect of monies borrowed or debt incurred, again unlike the definition of ‘interest’ under the Income Tax Act. We find that the Rajasthan High Court in the impugned judgment in Civil Appeal No.4988 of 2015 is correct when it observed:-

“On conjoint reading of the definition of interest, which has been quoted herein above and under the Interest Tax Act in para 4 (supra), it is noticed that the Interest Tax Act, does not include the term “any service fee or other charges in respect of money charge or debt incurred.” under its ambit and putting to test the principle of harmonious interpretation, it is evident that the parliament in its wisdom has chosen not to add the aforesaid terminology under the Interest Tax Act, and what has not been mentioned neither be added nor is 22 required to be read in between the lines. We have already observed about principles of interpretation in para 8.5 and 8.6 (supra) and mere crediting the said amount as interest will certainly not entitle the revenue to treat the same as interest. Hon'ble Apex Court in the case of Sutlej Cotton Mills and Godhra Electricity (supra) have clearly expressed that mere crediting the amount under a head is not determinative of the real nature and real intent and purpose of the transaction is required to be seen. Therefore, we hold that the amount recovered by the assessee from the constituents (borrower) cannot be taxed as interest in the hands of the assessee. On perusal of definition, it is distinctively clear that such charges recovered by the bank cannot be equated to the term interest under the Act. Though the receipt of Guarantee Fees received from constituents (borrowers) is not linked to what is paid to DICGC as insurance cover on behalf of depositors, the issue is not relevant for the reason stated by us herein above.”

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