As regards, more particularly, government securities, and bonds and debentures, the text specifies that premiums or prizes attaching thereto constitute interest. Generally speaking, what constitutes interest yielded by a loan security, and may properly be taxed as such in the State of source, is all that the institution issuing the loan pays over and above the amount paid by the subscriber, that is to say, the interest accruing plus any premium paid at redemption or at issue. It follows that when a bond or debenture has been issued at a premium, the excess of the amount paid by the subscriber over that repaid to him may constitute negative interest which should be deducted from the interest that is taxable. On the other hand, any profit or loss which a holder of such a security realises by the sale thereof to another person does not enter into the concept of interest. Such profit or loss may, depending on the case, constitute either a business profit or a loss, a capital gain or a loss, or income falling under Article 21.
HIGH COURT OF BOMBAY
Director of Income-tax (International Taxation)
Credit Suisse First Boston (Cyprus) Ltd.
IT APPEAL NO. 1026 OF 2011
JULY 9, 2012
S.J. Vazifdar, J – This is an appeal under section 260-A of the Income Tax Act, 1961 against the order of the Income Tax Appellate Tribunal (ITAT) dismissing the appellant’s appeal and allowing, in part, the respondent’s cross objections.
The appeal is admitted and, with the consent of the parties, heard finally on the following substantial questions of law :
(I). Whether interest can be said to have accrued to the respondent/assessee on 31st March, 2001 (i.e. the last date of the financial year) in respect of securities held by it on that day although the interest was not due or payable on that date ?
(II). Whether the CIT(A) and the ITAT were right in holding that the sale of securities was covered by Article 14 of the tax treaty between India and Cyprus?
2. The respondent 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.47,69,48,530/-.
Rs.1,21,57,517/- was taxed as interest accrued though not due on securities held by the respondent as on 31st March, 2007, being the last date of the financial year. The respondent contended that the same had not accrued to it as under the Government securities, the interest was not due on 31st March, 2007.
The Assessing Officer held Rs.40,53,62,518/-, being gains in transactions of Government debt-securities to be interest within the meaning of that term in Article 11(4) of the “Agreement Between the Republic of India And The Republic Of Cyprus For The Avoidance Of Double Taxation And The Prevention Of Fiscal Evasion With Respect To Taxes On Income And On Capital” (hereinafter referred to as the “DTAA”) and liable, therefore, to tax in India. The respondent contends that the income from sale of these securities constituted capital gains which falls within Article 14(4) and is, therefore, exempt from tax in India.
Rs. 5,94,28,493/- was offered by the respondent for tax as interest from the securities.
(C). The Commissioner of Income Tax (Appeals) [CIT(A)] deleted both the additions. The ITAT upheld the order. The appellant challenged the same before the Tribunal on grounds similar to those raised before us.
5. Before proceeding further, we must note two aspects which are not clear although they are of no consequence to either the basis of this judgment or the result of this appeal.
(A)(i) Firstly, the precise period for which the interest has been calculated by the Assessing Officer is not clear from the record. It appears that the Assessing Officer deemed the interest as having accrued for the proportionate period, both upto the end of the financial year on 31st March, 2001, when the due date for payment of interest had not arisen under the security as well as the period thereafter and upto the date of the sale thereof on which date also the due date for payment of interest as per the securities had not arisen.
(ii) It is, however, sufficient to note that interest was not calculated on the date on which it fell due as per the terms of the security. In other words, interest was not calculated for the entire period between two consecutive dates on which it fell due. It was admittedly calculated for a broken period between two consecutive due dates for payment of interest. Considering the view that we have taken, it matters 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 that term in Article 11(4) of the DTAA. Mr. Kaka submitted that the appeal pertains only to the latter and not to the former.
(ii) The question, as framed in the memo of appeal, appears to support Mr. Kaka’s contention. However, the grounds in the appeal challenge the decision of the appellate authorities disallowing the addition of interest deemed to have accrued for the broken period upto 31st January, 2007. We however, presumed that the appeal pertains to both the issues which were argued before us extensively. Thus though only the second question was raised in the appeal, we allowed the appellant to frame the first question as well.
Re. : Question I :
6. With regard to the said sum of Rs.1,21,57,517/- assessed to tax for the broken period upto 31st March, 2001, Mr. Suresh Kumar, the learned counsel appearing on behalf of the appellant reiterated the reasoning of the Assessing Officer in paragraph 4.3 and 6.2 of the assessment order, the relevant part whereof reads as under :-
“4.3 Income accrues, as and when the assessee acquires a right to receive such income or the right becomes vested in it. In the case of Government securities etc. although interest becomes due for payment only at six monthly intervals, such interest certainly accrues from day to day. When the assessee purchases certain securities it pays not only cost of securities, but also the interest which has accrued, on day to day basis, from the last date of payment of interest to the date of purchase. Similarly, when the assessee sells the securities it receives not only sale value, but also the broken period interest which has accrued on the securities till the date of sale. Thus the interest not only accrues from day to day, but the quantum of interest accruing is also known, for the assessee bank to determine the amount of interest accrued till the date of transfer, which is to be added to the cost of securities to be paid by the purchaser. Thus, since the right to receive such interest is vested with the assessee, it is clear that such interest has accrued to the assessee. Reference is made in this regard to Supreme Court decisions in the case of E.D. Sasoon & Co. 26 ITR 27 and Shri Govardan Ltd. 69 ITR 675. It has further been held by the Supreme Court in the case of Morvi Inds. 82 ITR 835 that once the income has accrued, it is chargeable to tax, even if subsequently the same 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  26 ITR 27, the Supreme Court held at page 51 that income can be said to accrue or arise when there is a right to receive the same. At page 52, the Supreme Court held :
“……….. A debt must have come into existence and he must have acquired a right to receive the payment. Unless and until his contribution or parenthood is effective in bringing into existence a debt or a right to receive the payment or in other words a debitum in prasenti, solvendum in futuro it cannot be said that any income has accrued to him. The mere expression “earned” in the sense of rendering the services etc. by itself is of no avail.”
The Supreme Court further held at page 55
“…………. What has however got to be determined is whether the income, profits or gains accrued to the assessee and in order that the same may accrue to him it is necessary that he must have acquired a right to receive the same or that a right to the income, profits or gains has become vested in him though its valuation may be postponed or though its materialisation may depend on the contingency that the making up of the accounts would show income, profits or gains.”
8. The question, therefore, is whether interest accrues to the holder of a security on a date other than the one stipulated in the instrument to be the date on which interest is payable. The answer to the question would be the same in respect of any transaction where interest is payable only on a particular date.
9. It is not disputed that the securities in this case expressly provided for payment of interest in respect thereof only on the dates specified therein at six monthly intervals. It is also admitted that such dates did not fall on the last date of the respondent’s financial year viz. 31st March.
10. The appellant’s submission is entirely unfounded and is based on the erroneous premise that the amount received upon the sale of a security in excess of the face value thereof includes the interest for the proportionate period upto the date of the sale. The erroneous presumption is that interest accrues de die in diem even when the agreement between the parties stipulates interest to be payable only on a specified date. If the appellant’s argument is well founded, it makes no difference as to the broken period for which interest is deemed to have accrued. If, on the other hand and as we have held, it is not well founded, the interest cannot be said 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 vested in him to receive the interest but only on the terms of the security and subject to all the incidents thereof as were applicable to the original owner.
12. The appellant’s submission ignores the fact that such securities or agreements do not regulate the price at which the holder is to sell the same to a third party. The holder is at liberty to sell the same at any price. The interest component for the broken period i.e. the period prior to the due date for interest is only one of the factors that may determine the sale price of the security. There are a myriad other factors, both personal as well as market driven, that can be and, in fact, are bound to be taken into consideration in such transactions.
For instance, a person may well sell the securities at a reduced price in the event of a liquidity crisis or a slow down in the market and/or if he is in dire need of funds for any reason whatsoever. Market forces also play a significant part. For instance, if the rate of interest is expected to rise, the securities may well be sold at a discount and conversely if the interest rates are expected to fall, the securities may well earn a premium. This, in turn, would also depend upon the period of validity of the security and various other factors such as the financial position and commercial reputation of the debtor.
13. The appellant’s contention is also based on the erroneous presumption that what is paid for is the face value of the security and the interest to be paid for the broken period from the last date of payment of interest till the date of purchase. What, in fact, is purchased is the possibility of recovering interest on the date stipulated in the security. It is not unknown for issuers of securities, debentures and bonds, to default in payment of interest as well as the principal. The purchaser therefore hopes that on the due date he will receive the interest and the principal. The purchaser therefore, purchases merely the possibility of recovery of such interest and not the interest per se. It would be pointless to even suggest that in the case of Government securities, the possibility of a default cannot arise. The interpretation of law does not depend upon the solvency of the debtor or the degree of probability of the debts being discharged. Indeed the solvency, reputation and the degree of probability of recovering the interest are also 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 ticking. The creditor however, does not during these periods have an enforceable right to demand interest. The search for a term to describe what happens during these periods is really unnecessary. The position quiet simply is this. On the date stipulated in the agreement for payment of interest, the creditor has an enforceable right to be paid interest calculated at the rate and for the period stipulated therein.
15. In Wigmore (H.M. Inspector of Taxes) v. Thomas Summerson & Sons Limited, IX Tax Cases, 527 = 41TLR 568, the High Court of Justice (King’s Bench Division) considered a case where the defendant-company purchased 5% War stock whereon interest was payable on the 1st day of June and the 1st day of December in each year. On 10th April, 1923, the company sold the stock with interest rights at a profit. It is significant to note that it was in that case admitted, that a part of the profit was on account of capital accretion. The balance profit had been brought into charge to income tax against the company as untaxed interest. The figure was arrived at by calculating interest payable on the stock from 1st December, 1923 i.e. the date of the last payment of dividend upto the 10th April, 1923 i.e. the date of sale of the stock. The Revenue contended that if a security is sold between two dates of payment of interest, the interest must be deemed to have been received by the vendor upto the date of sale inasmuch as the purchase money of the security includes an amount of interest accrued that can be definitely ascertained and the purchaser must be assessed in respect of the income between that date and the date when he receives the interest or sells the security, whichever first happens. In other words, the Revenue contended that there must be an apportionment between the seller and the purchaser for broken periods. Rejecting the contention, it was held as under :-
“It must be appreciated that the point turns upon this : that it is because the thing is sold and the interest accrued to date, as Mr. Hills said, is turned into money, that the amount of interest up to the day when that money is received is taken to have been encashed as interest to the seller so as to attract tax upon it. Now stock of this kind is not sold like real estate, with an apportionment of the incomings. Real estate is sold for a price for the property, and the rents receivable are separately 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 £400,000 of War Loan is being sold, the interest on that is £20,000 a year, and a half year’s interest is £10,000, and three months from the last interest payment £5,000 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 £5,000 in March for £5,000 to be paid in June. He does not do it. Therefore, there would have to be, in any case, a valuation of the amount of accrued interest that has been sold. The truth of the matter is that the seller does not receive “interest,” and “interest” is the subject matter of the taxation. He receives the price of the expectancy of interest, and that is not the subject of taxation, and the whole thing, I think, really depends upon the fallacy. In truth you cannot put the case without relying on the theory that the interest accrues de die in diem. If that could be said it would be, at any rate, correct in point of figures and economics ; but that cannot be said ; it is not said ; Mr. Hills sees he cannot say that, but when he gives up that he gives up the whole really, because you cannot get, as I have pointed out, out of the price paid a sum which answers the description of the word in the statute, which is “interest”.”
We are in respectful agreement with the judgment for the reasons already stated.
16. The judgment was followed by a Division Bench of the Karnataka High Court in The Additional Commissioner of Income Tax, Mysore, Bangalore v. The Vijaya Bank Limited, Mangalore 1976 (1) Indian Law Reports, 490. The stand of the parties in that case were reversed – the Revenue’s stand there correspondents to the assessee’s stand before us and the assessee’s stand there correspondents to the stand of the Revenue before us. In that case, the respondent entered into an agreement with Jayalakshmi Bank Limited whereby it took over the liabilities of Jayalakshmi Bank Limited towards its depositors and creditors in consideration, inter-alia, of that bank transferring certain assets to the respondent. One of the assets specified in the schedule to the agreement was an amount of Rs. 1,37,523/- shown as “interest accrued on investments and deposits”. According to the respondent, out of this amount, a sum of Rs. 58,568/- related to interest accrued on Government securities held by Jayalakshmi Bank Limited for the broken period upto the date of transfer of such securities to the respondent i.e. 29th May, 1967. The respondent claimed a deduction of this amount from its income. The respondent also claimed a deduction of Rs. 11,630/- representing interest in respect of certain securities acquired by it during the previous year.
It is significant to note that in that case, the stand of the Revenue was diametrically opposed to the stand of the Revenue before us. In other 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’. In these circumstances, the payment made for the acquisition of such ‘interest’ can only be a part and parcel of the consideration paid for the acquition of the securities themselves. The amount so paid cannot, therefore, be termed as expenditure incurred in the course of the assessee’s business and, therefore, not deductible. Furthermore, having regard to the scheme of the Act the total income of an assessee has to be computed only after the computation of the incomes separately under the various heads specified in Section 14 and in the manner provided therein. Therefore, if an item of income falls specifically under one head, it has to be charged under that head and no other. Therefore, the ‘interest on securities’ in the present case when received on the due date is liable to be charged subject to permissible deductions as are provided under the specific provisions governing such computation.
On behalf of the assessee the very same contentions which found favour with the Appellate Tribunal were reiterated.”
The Division Bench cited with approval, the judgment in Wigmore v. Thomas Summerson & Sons (supra), set out the ratio of the judgment of the Supreme Court in E.D. Sassoon’s case and held as under :
“21. In our opinion, the above enunciations would be equally applicable to the facts of the present case. Viewed in the light of the said enunciations, it would be clear that the amount paid and separately specified as representing interest, that might be attributable to the broken period, prior to the purchase of securities, is only an amount paid for the acquisition of an income bearing asset forming part and parcel of the total consideration paid for the purchase, of the securities, and therefore, cannot at all be termed as ‘interest’ as such or as an amount spent for acquiring it is as an independent asset. It is also clear that such interest for the broken period had not accrued or crystalised into a debt, and thus had not become due and payable, to be characterised as income chargeable to tax in the hands of the transferor, and hence could not be said as deductible in the hands of the assessee transferee. The contention of the Revenue in this behalf has clearly to be sustained.”
Even at the cost of repetition, it is significant to note that the question of law was decided to this effect despite the fact that the agreement stated that Rs. 1,37,523/- 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 income attracted Section 18.” (emphasis supplied).
18. In Commissioner of Income Tax v. M/s. Canara Bank, 1992 (1) Kar. L.J., 245 (DB) = (1992) 195 ITR 66, another Division Bench of the Karnataka High Court followed the above judgments. The High Court construed the last sentence quoted above from the judgment of the Supreme Court emphasised by us as under :-
“The last sentence conveys the idea that actually the income fructifies to the assessee only when the securities yield the interest and only in such a situation Section 18 is attracted and that the securities do not yield any income during the broken period of any year.”
We are in respectful agreement with this interpretation of the judgment of the Supreme Court. It logically follows from the fact that the Supreme Court upheld the judgment of the High Court in Vijaya Bank Limited (supra).
19. The right to receive interest on the Government securities vested in the respondent only on the due date mentioned in the securities. Consequently, interest accrued on the securities only on the due dates and cannot be said to have accrued to the respondent on any date other than the date stipulated therein. The contention that interest accrues for broken periods between two consecutive dates stipulated in the agreement/instrument for payment of interest is without any basis in law.
If the respondent held the security upto 31st March, 2001 and sold the same thereafter, but before the date on which interest was payable as stipulated in the security, interest cannot be said to have accrued to the respondent.
It is not disputed that in respect of the securities held by the respondent on 31st March, 2001, the due date for payment of interest thereon had not arrived on 31st March, 2001 and that the respondent sold some of such securities prior to the next due date for payment of interest. It is only the holder of the security on such date to whom interest can be said to have accrued. In any event interest did not accrue to the respondent on 31st March, 2001, as admittedly interest was not payable on that date as per the terms of the said securities.
20. The appellate authorities, therefore, rightly deleted the addition of Rs.1,21,57,517/- by the Assessing Officer as interest income.
Re : Question II
21. This brings us to the position under the DTAA.
22. Mr. Suresh Kumar submitted that the receipt 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.
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 debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article.”
23. Our attention has not been invited to any judgment construing Article 11(4). We must, therefore, construe it on its plain language.
24. Clauses (1) and (2) of Article 11 merely provide which of the States is entitled to tax interest arising in a Contracting State and the rate at which such interest may be taxed. It is necessary first, however, to determine what constitutes interest under the DTAA.
25. Clause (4) of Article 11 defines interest.
The principal or governing words in Article 11(4) are “interest means income from debt-claims of every kind”. These words predicate the existence of a debtor-creditor relationship. Clause 4 relates to interest “from” debt-claims. In other words, the income must arise out of, on account of a debt-claim. It is important to note the difference between the debt-claim itself and any accretion thereto, such as interest. Once this distinction is noted, it is easy to appreciate that the price realised upon the sale of the debt-claim itself is not interest. Interest arises from and on the terms of the debt-claim/security and would be on revenue account. The sale proceeds upon a transfer or assignment of the security arise not from but on account of and represents the debt claim/security itself.
26. The words in clause 4 “whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits” appear after the opening words “The term interest as used in this Article means income from debt-claims of every kind” and, therefore, clearly relate to income from debt-claims. Thus, if and only if the transaction is a debt-claim, it matters not whether it is secured by a mortgage and whether or not it carries a right to participate in the debtor’s profits.
27. The subsequent words in Article 11(4) “in particular, income from Government securities and income from bonds or debentures” constitute merely an inclusive provision which by way of illustration refer to Government securities and income from bonds or debentures which, in turn, include the further and other accretions thereto as stated therein viz. premiums and prizes attaching to securities, bonds or debentures.
28. Article 11(4) 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 attached to the instrument.
If the issuer of the debt instrument demands a premium while issuing it, it may well be a different matter but with that we are not concerned in this case.
29. To reiterate, therefore, the governing provision of Article 11(4) is that interest means income from a debt-claim of every kind and a debt-claim arises on account of a transaction that creates a debtor-creditor relationship.
30. Thus, under the Income Tax Act, 1961, as well as under the DTAA, the position remains the same at least so far as such securities are concerned viz. securities which provide for payment of interest on a particular date or at stated intervals.
31. Mr. Kaka relied upon The Model Tax Convention on Income Tax & on Capital (22nd July, 2010) which supports our view. Article 11(3) thereof is identical to Article 11(4) of the DTAA. It is not necessary, therefore, to set it out. Paragraph 11-22 of the Commentary reads as under :-
“11-22 20. As regards, more particularly, government securities, and bonds and debentures, the text specifies that premiums or prizes attaching thereto constitute interest. Generally speaking, what constitutes interest yielded by a loan security, and may properly be taxed as such in the State of source, is all that the institution issuing the loan pays over and above the amount paid by the subscriber, that is to say, the interest accruing plus any premium paid at redemption or at issue. It follows that when a bond or debenture has been issued at a premium, the excess of the amount paid by the subscriber over that repaid to him may constitute negative interest which should be deducted from the interest that is taxable. On the other hand, any profit or loss which a holder of such a security realises by the sale thereof to another person does not enter into the concept of interest. Such profit or loss may, depending on the case, constitute either a business profit or a loss, a capital gain or a loss, or income falling under Article 21. (emphasis supplied)
21. Moreover, the definition of interest in the first sentence of paragraph 3 is, in principle, exhaustive. It has seemed preferable not to include a subsidiary reference to domestic laws in the text; this is justified by the following considerations :-
(a) the definition covers practically all the kinds of income which are regarded as interest in the various 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 or together with the whole enterprise) or of such fixed base, may be taxed in that other State.
3. Gains from the alienation of ships or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.
4. Gains from the alienation of any property other than that mentioned in paragraphs 1, 2 and 3 shall be taxable only in the Contracting State of which the alienator is a resident.”
34. As stated earlier, the appellant’s case is that the respondent’s case does not fall within Article 14(4) only because it falls within Article 11(4). Having rejected the submission that the gain from the sale of the said securities falls under Article 11(4), it follows that the same falls under Article 14(4).
The respondent is, therefore, entitled to the benefit of the exemption under Article 14 of the DTAA.
35. In the circumstances, the questions are answered in favour of the respondent/assessee. The appeal is therefore dismissed. There shall be no order as to costs.