Taxation svstem

on
lnterest on Securities

Ranjan Kumar Bhowmik oc*n

Member
National Board of Revenue

[1] lntroduction

As per section 22 of lTo 1gg4, "lnterest on securities" includes interest receivable on any
security of the Government or approved by the Government and also interest receivable
on
debentures or other securities issued by or on behalf of a local authority or a company. Thus
section 22 deals with interest on securities issued by
(i) the Government,
(ii) a local authoritY, or

(iii) a company.
All
Debentures or other securities issued by a company also fall within the scope of this section.
this
other securities, e. g. securities issued by a foreign Government, etc. are outside the ambit of
section, and interest thereon would be charged u/s 28 or 33 of ITO 1984' The shares of a
company cannot be called securities rather shares and stocks are capital assets. Dividends on
shares would be taxable under the residuary head of section. 33.

[2] Allowable deductions in computing lnterest on securities

Deductions permissible in determining income from interest on securities as per section

23 are:

(i) commission/charges deducted by the bank realizing the interest'

iiil lnterest payable on money borrowed for the purpose of investment in the securities.

investment in
To claim relief for interest on borrowed fund, such fund must be borrowed solely for
purpose
securities and should be so used throughout, even if the moneys borrowed for business
are invested in securities for a period under some legal compulsion, no deduction
for interest
under this section is allowed Ilndian Steamship Co. V. CIT (1953) l. T'R' 448]'
Likewise,
No deduction shall be allowed on account of Interest of tax-free Government securities.
on which tax
deduction will not also be allowed in respect of interest payable outside Bangladesh
has not been Paid or deducted.
 [3] When lnterest on Securities are taxable
Under section 22,tax is payable in respect of interest'receivable' by the assessee on securities.
But interest on securities becomes income only when it is actually received and not when it is
due or capable of being received by the assessee. The word 'receivable' in this section has
reference to the quantum of interest taxable and not to the time of taxability. lf interest is actually
received some times after it becomes due and receivable, the date of taxability is the date when
it is received and not the date when it becomes due. [Case reference: Lalbhai Dolpatbhai. Vs.
crT (1952) 22 r. T.R. 131.

[4] Types of securities

ln terms of taxability, securities may be classified as either Government securities (securities

issued or approved by the Government) or Commercial securities (securities issue by others).
Tax free

Government

Less tax
Approved
Securities
Debenture

Commercial Un-approved

Zero coupon bonds

Government securities: Securities issued or approved by the Government fall under this
category. lt may be tax free if tax is not imposed on interest or may be less tax on the reasoning
that the assessee will enjoy some exemption on interest income.

Tax free Government securities: These are the securities issued by the government for which
no tax is paid hence it is declared tax-free. [Sixth Schedule, Part A, Para 24 and 24A]. Income
from interest on tax-free government securities is not included in computation of taxable income.

Tax deductable Government securities: These are the government securities including
treasury bill/bond and lslamic securities on which tax is to be deducted at source at the time of
payment on maturity at specified rate [current TDS rate is 5%].

Commercial securities: Securities issued by or on behalf of a local authority or a company and

approved by the SEC will be considered as commercial securities. These types of securities may
be either debenture or zerc coupon bonds.
Debenture: These are the securities issued by or on behalf of a local authority or a company and
approved by the SEC. Thus, debentures are approved securities.
Zero-coupon bond: A Zero-coupon bond is such type of bond where coupon (interest) is zero.
This type of securities is initially sold at a price lower than its face value and the owner receives
the face value at maturity. Thus, the gap between the purchase price and face value is the
benefit of buying such security to the owner. Any income derived from Zero-coupon bond
received by a person other than Bank, lnsurance or any Financial lnstitution is fully tax free [Sixth
Schedule, Part A, Para 40).

Int. on Securities Handout prepared by Ranjan Kumar Bhowmik pctu,q Member, NBR ason06/L0/2020 Page2
[5] lnterest grossing uP

As tax @5% is deductible from interest on securities at the time of maturity, so net interest
needed to be grossed-uP.

[6] Nature of securities

Dealings of securities may have various purposes from the part of the investors. For example, it
may take any of the following three natures:

Held to maturity securities

Tradinq securities are those types of securrties where the main purpose is to earn profit through
trading (buying and selling) of securities.

Held to maturitv securities are those types of securities where investment is made for a
specific time period.

Available for sale securities fall in between which is not an investment for long time or where
the dealing is not so frequent.

The investors wait for a while to see how to maximize profit on the deal. As interest on securities
is a separate head of income, even if the securities are held as trading assets within the course
of business undertaken by a bank or an insurance company or a stock broker, the interest must
be charged under this head and not under section 28 as income from business or profession or
under section 33 as income from other sources [Central Exchange Bank LTD. V. C.l.T. (1955)
rr R 1671.
[7] Bond washing transactions through sale and buy back of securities
When some transactions happened between two parties to wash-out the impact of interest on
taxable income and thus avoiding the taxes on that mutually by both of the parties, such type of
transaction is referred to as bond washing transaction. lt is a smart way of tax avoidance. ln this
case, securities are sold cum interest with an agreement to re-sell or re-transfer the securities

Securities are sold to a person whose income is less than the minimum taxable limit and then he
doesn't need to pay any tax on interest on securities since his income is less than the taxable
limit. On the other hand since securities especially shares and stocks are capital asset; no tax
will be given on the disposal value of the securities by the seller. ln this way both the seller and
buyer can avoid tax.

To prevent the avoidance of tax in this manner, section 106(1) of the lTO, 1984 provides that
where a security owner transfers the securities on the eve of due date of interest and reacquires
them eventually, tne interest received by the transferee/purchaser will be deemed as income of
the transferor/seller and, accordingly, it will be included in the total income of the transferor/seller
and not the transferee/purchaser.

There is wide scope to avoid tax in this way and section 106 has given sufficient authority to the
DCT to handle those cases of tax avoidance. lt should be mentioned here that stocks/shares are
also defined as securities at section 106
 [8] List of tax free securities

lnterest income is exempted from taxes in the following occasions as per lTO, 1984:

Name of the securities Reference

Tax-free government securities Sixth Schedule, Part A, Para 24
[1]Wage earners development bond
[2] US dollar premium bond
[3] US dollar investment bond
[4] Euro premium bond Sixth Schedule, Part A, Para 244
[5] Euro investment bond
[6] Pound sterling premium bond
[7] Pound sterlinq investment bond
Zero-coupon bond Sixth Schedule, Part A, Para 40

Sources: [1] lncome Tax Ordinance, 1984

[2] Court case references

The End

Int. on Securities Handout prepared by Ranjan Kumar Bhowmik pcul Member, NBR as on06/70/2020 Page 4