R.V. Easwar, J.M. - (1.) THE appeal for the asst. yr. 1989-90 is by the Department and that for the asst. yr. 1991-92 is by the assessee. Since they were heard together and since a common issue is also involved, they are disposed of by a single order.
(2.) The assessee is a company whose main object is the carrying on of business in investments and financial management activities such as hire-purchase finance equipment leasing, portfolio management, inter-corporate deposits, bill discounting and Government securities and units of the Unit Trust of India. In the accounting year relevant for the asst. yr. 1989-90, the assessee incurred a loss of Rs. 8,44,156 in the purchase and sale of tax-free bonds. It also received interest of Rs. 6,96,480 on tax-free public sector bonds, which was claimed to be exempt under Section 10 of the IT Act. While completing the assessment, the AO noted that the assessee has claimed exemption in respect of the interest received whereas it has kept the loss on the sale of tax-free bonds merged into the sale and purchase transactions of shares and securities. This treatment given by the assessee was not proper, according to the AO. He noted that while buying and selling the tax-free bonds, the important factor to be noticed was the interest accrued on them and the price of the bonds depended on the interest accrued thereon. He, therefore, held that the purchase and sale transactions in the bonds and the assessee's right to receive the interest thereon are not mutually exclusive, but were merged into each other. He, therefore, held that the interest in respect of which exemption was claimed under Section 10 can only be the net interest. Accordingly, he held that there was only a negative earning from the tax-free bonds (Rs. 6,96,460 - Rs. 8,44,156) and hence, the assessee will not be eligible for any exemption under Section 10. In this view of the matter, the loss on sale of tax-free bonds was added back in the assessment. On appeal, the assessee contended that the business loss of Rs. 8,44,156 cannot be ignored. It was pointed out, relying on the judgment of the Supreme Court in Vijaya Bank Ltd. v. Addl. CIT (1991) 187 ITR 541 (SC), that the entire consideration paid for the purchase of bonds, including the interest accrued thereon upto the date of purchase, shall be considered as capital outlay and no part thereon can be set off against the interest received. The argument was accepted by the CIT(A) who held that the interest received cannot be attributed to the cost of the bonds and adjusted against the interest paid and held that the interest received was exempt under Section 10. In this view, he held that the AO was not justified in disallowing the loss of Rs. 8,44,156.
(3.) THE Revenue is in appeal. THE learned standing counsel for the Revenue submitted that the assessee was systematically attempting to reduce its taxable income by adopting the device of buying and selling tax-free bonds and claiming the loss on sale of bonds as business loss and at the same time enjoying tax-free interest. He submitted that this was opposed to the ruling of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO (1985) 154 ITR 148 (SC). He further submitted, relying on the judgment of the Bombay High Court in American Express International Ltd. v. CIT (2002) 258 ITR 601 (Bom), that the matching principle must be adopted, which requires that the interest received on the tax-free bonds should be adjusted against the interest paid and if that is done, there will be no scope for claiming any loss. On this basis, it was contended that the decision of the CIT(A) was erroneous.;