The Income Tax Appellate Tribunal, Delhi, has clarified a critical distinction in tax treatment of income from Non-Convertible Debentures (NCDs), holding that interest accrued during the broken period and received from the buyer, rather than the issuer, retains its character as interest income and cannot be reclassified as capital gain. This decision reinforces the principle that the source of payment does not alter the nature of the receipt under the Income-tax Act, 1961.
Background & Facts
The Dispute
The assessee, Macquarie SBI Infrastructure Investments Pte Ltd., a Singapore-based Foreign Venture Capital Investor registered with SEBI and holding a valid Tax Residency Certificate (TRC) of Singapore, invested in Non-Convertible Debentures (NCDs) issued by GMR Airports Limited (GAL). The dispute centered on the tax treatment of Rs. 6,35,79,070 received from JP Morgan Securities Asia Pte Ltd (JPMSA) upon the sale of NCDs on 05.07.2019. This amount represented interest accrued for the final five days of the interest period (26.06.2019 to 30.06.2019), which GAL had not yet paid. The assessee had declared the interest up to 30.06.2019 as income under 'Income from Other Sources' but claimed the Rs. 6,35,79,070 received from JPMSA as short-term capital gain (STCG), exempt under Article 13(5) of the India-Singapore Double Taxation Avoidance Agreement (DTAA).
Key Facts
- The assessee purchased NCDs issued by GAL on private placement basis
- Interest on NCDs was payable quarterly by GAL to the holder
- On 05.07.2019, the assessee sold the NCDs to JPMSA on a cum-interest basis
- Interest accrued up to 30.06.2019 (Rs. 107,85,00,291) was paid by GAL and declared as interest income
- The broken period interest for 5 days (26.06.2019 to 30.06.2019) amounting to Rs. 6,35,79,070 was paid by JPMSA to the assessee at the time of sale
- The assessee filed its return for A.Y. 2020-21 on 29.10.2020, declaring interest income of Rs. 1,573,113,432 and STCG of Rs. 114,443,808
- The Assessing Officer (AO) treated the Rs. 6,35,79,070 as interest income under 'Income from Other Sources' and made an addition accordingly
- The Dispute Resolution Panel (DRP) upheld the AO’s addition
- The assessee appealed to the ITAT, Delhi, challenging the classification and taxability of the amount
Procedural History
- 29.10.2020: Assessee filed return for A.Y. 2020-21
- 26.07.2023: Final assessment order passed by AO under Section 143(3) read with Section 144C(13)
- 13.05.2026: Hearing before ITAT, Delhi
- 15.06.2026: Judgment pronounced
The Parties' Positions
Assessee’s Position: The Rs. 6,35,79,070 was received from JPMSA, the buyer, not GAL, the issuer. Since it was not paid by the issuer as interest, it constituted a premium on the sale of a capital asset (NCDs) and should be treated as STCG. The assessee further contended that the entire amount of Rs. 107,85,00,291 shown as interest was inadvertently declared and should also be treated as STCG exempt under Article 13(5) of the DTAA.
Revenue’s Position: The nature of the receipt is determined by the underlying instrument, not the payer. NCDs are debt instruments; any amount received in lieu of interest, regardless of whether paid by issuer or buyer, remains interest income. The payment by JPMSA was merely a settlement of the accrued interest liability owed to the assessee, which had already been recognized in the return.
Relief Sought
The assessee sought:
- Quashing of the addition of Rs. 6,35,79,070
- Reclassification of the amount as STCG exempt under Article 13(5) of the India-Singapore DTAA
- Reconsideration of the Rs. 107,85,00,291 shown as interest, seeking its reclassification as STCG
- Cancellation of interest under Sections 234A and 234B, and penalty under Section 270A as consequential
The Legal Issue
The central question was whether the broken period interest of Rs. 6,35,79,070 received by the assessee from the buyer of NCDs, rather than the issuer, constitutes interest income taxable under 'Income from Other Sources' or short-term capital gain exempt under Article 13(5) of the India-Singapore DTAA.
Arguments Presented
For the Appellant/Petitioner
The assessee relied on the nature of NCDs as capital assets under Section 2(14) of the Act and argued that the receipt of Rs. 6,35,79,070 arose from the transfer of the asset, not from the debt obligation. It cited Khushaal C. Thackersey v. ACIT to assert that redemption or sale of debentures may give rise to capital gains if the consideration exceeds the cost of acquisition. It further contended that since the issuer (GAL) had already discharged its interest liability up to 30.06.2019, the amount received from JPMSA was a separate consideration for the transfer of the asset, not interest. The assessee also argued that the DTAA’s Article 13(5) should prevail over domestic law to exempt capital gains on transfer of shares or securities.
For the Respondent/State
The Revenue relied on Taparia Tools Ltd. v. JCIT and Khushaal C. Thackersey v. ACIT to argue that the character of income from debentures is determined by the instrument’s terms, not the payer. It emphasized that NCDs are debt instruments, and any premium or interest component, even if paid by the buyer, is part of the interest income arising from the debt. The Revenue contended that the assessee had already declared the interest up to 30.06.2019 as income, and the amount received from JPMSA was merely the realization of that accrued liability. It further argued that Article 13(5) applies only to capital gains on shares, not to interest income disguised as capital gain.
The Court's Analysis
The Tribunal examined the nature of NCDs as debt instruments under Section 2(30) of the Companies Act, 2013, and reaffirmed that debentures represent a creditor-debtor relationship, not ownership. The Tribunal noted that the assessee had consistently treated the NCDs as yielding interest income, not capital appreciation, in its books and returns.
"Simply because the interest in question has been received not directly from the issuer (i.e. GAL) but from the buyer of debentures (i.e. JPMSA), this would not change the nature of receipts in assessee's hands."
The Tribunal distinguished Khushaal C. Thackersey on the ground that in that case, the debentures were redeemed by the issuer, whereas here, the debentures were sold to a third party. However, the Tribunal held that the distinction was immaterial because the receipt of Rs. 6,35,79,070 was not a premium on the sale of the asset but the realization of accrued interest. The Tribunal cited Taparia Tools Ltd. to reinforce that the method of payment (issuer vs. buyer) does not alter the character of the receipt when the underlying obligation is interest.
The Tribunal also rejected the assessee’s argument that Article 13(5) of the DTAA applied, noting that Article 13(5) exempts capital gains on the transfer of shares, not interest income. The amount in question was not a gain arising from the appreciation of the NCD’s market value but was purely interest accrued on the debt instrument. The Tribunal further held that the assessee’s inadvertent declaration of Rs. 107,85,00,291 as interest did not alter the legal character of the receipt, and the claim for reclassification was not maintainable.
The Verdict
The assessee’s appeal was dismissed. The Tribunal upheld the addition of Rs. 6,35,79,070 as interest income under the head 'Income from Other Sources'. The Tribunal confirmed that the amount received from JPMSA was not capital gain but interest, and therefore taxable at 40% (plus surcharge and cess) under domestic law. The levy of interest under Sections 234A and 234B and penalty under Section 270A were held to be consequential and were not separately adjudicated. The order of the AO dated 26.07.2023 was affirmed.
What This Means For Similar Cases
Interest Character Is Determined by Instrument, Not Payor
- Practitioners must assess the nature of income based on the underlying financial instrument, not the identity of the payer
- Any amount received as compensation for accrued interest on debt instruments remains interest income, even if paid by a transferee
- This applies to bonds, debentures, and other fixed-income securities traded cum-interest
DTAA Exemptions Do Not Override Domestic Characterization
- Article 13(5) of DTAA applies only to capital gains on shares, not to interest income disguised as capital gain
- Taxpayers cannot reclassify interest as capital gain to avail DTAA benefits
- The burden is on the taxpayer to prove the receipt is genuinely a capital gain, not interest
Accidental Declaration Does Not Alter Tax Treatment
- A taxpayer’s inadvertent classification of income in the return does not bind the tax authority to accept it as correct
- The tax authority may reclassify income based on its true nature under the Act
- Taxpayers must ensure accurate classification at the time of filing to avoid adverse adjustments
