Interest on Securities under the head ‘Income from Other Sources’ [Section 56(2)(id)]

1. Meaning of Interest on Securities

Income, by way of interest on securities, is chargeable under the head “income from other sources”, if such income is not chargeable to income-tax under the head, “Profits and Gains of Business or Profession”.

According to Section 2(28B) “Interest on securities” means:

  1. Interest on any security of the Central Government or a State Government;
  2. Interest on debentures or other securities for money issued by, or on behalf of a local authority or a company or a corporation established by Central, State or Provincial Act.

Thus securities may be divided into following categories:

  1. Securities issued by Central/State Governments;
  2. Debentures/bonds issued by a local authority;
  3. Debenture/bonds issued by companies;
  4. Debenture/bonds issued by a corporation established by a Central, State or Provincial Act i.e. autonomous and statutory corporations.

2. Chargiability of Interest on Securities :

  • Income by way of interest on securities is taxable on “receipt” basis, if the assessee maintains books of account on “cash basis”.
  • It is taxable on “due” basis when books of account are maintained on mercantile system.
  • Interest is taxable on “receipt” basis, if such interest had not been charged to tax on due basis for any earlier previous year.
Interest on Securities
Interest on Securities

3. Accrual of Interest on Securities :

Interest on securities does not accrue everyday or according to the period of holding of investment. For instance, if one holds 7% securities from January 1, 2019 to February 28, 2019, it cannot be said that interest of two months has accrued to the security holder. Generally, interest becomes due on due dates specified on securities. For instance…, if specified due dates of interest of particular securities are March 1 and September 1 every year, interest of six months falls due on each such date and holder of securities on these dates will be entitled to interest of six months on each such date.

For instance :

If X purchases 7% Rs. 20,000 Securities (specified due dates: March 1 and September 1) on February 25, 2019 and sells the same on March 2, 2019, he will become entitled for interest of 6 months (i.e., Rs. 20,000 × ½ × 7 ÷ 100 = Rs. 700), irrespective of the fact that he holds Securities just for 6 days. As, in this case, interest of 6 months has become due to X on March 1, 2019, he will be liable to pay tax on the entire interest of Rs. 700 in the previous year 2018-19 if he maintains books of account on “mercantile system”. If, however, X maintains books of account on “cash” system, then Rs. 700 is taxable in the previous year in which it is received.

. Grossing up of Interest on Securities :

Gross interest [i.e., Net Interest + TDS (Tax Deducted at Source] is Taxable.

Net interest is grossed up in the hands of recipient if tax is deducted at source by the payer.

Net interest (if tax is deducted at source) in the hands of the recipient should be grossed up by multiplying it by the following fraction :

Net Interest x 100 ÷ [100 – Rate of TDS (tax deduction at source)]

Grossing up is required in the case of the following securities:—

  1. 8% Saving (Taxable) Bonds if the amount of interest payable exceeds Rs.10,000 (these Bonds have now been withdrawn. New 7.75% Government of India Savings (Taxable) Bonds, 2018 have been issued);
  2. securities issued by a statutory corporation or a local authority or by any company.

5. Deductions for Expenses from Interest on Securities [Section 57(i) and (iii)]:

As discussed in the case of dividends, the following deductions will also be allowed from the gross interest on securities:

  1. Collection charges [Section 57(i)]:
  2. Interest on loan [Section 57(iii)]:
  3. Any other expenditure [Section 57(iii)]:Any other expenditure, not being a expenditure of a capital nature, expended wholly and exclusively for the purpose of making or earning such income can be claimed as a deduction.

6. Avoidance of Tax in respect of Interest on Securities (Section 94)

Interest on securities does not accrue from day to day but on certain fixed dates. If, on the eve of due date of payment of interest, a person transfers securities to another person and reacquires the same or similar securities after interest has been received by the transferee, the transferor would be able to evade tax in respect of such interest. To prevent this malpractice, section 94 provides certain checks under sub-sections (1) and (2).

(A) Bond Washing Transactions [Section 94(1)]-

A bond washing transaction is narrated as a transaction which consists of selling securities (to a friend or relative) some time before the due date and acquiring back the same (or similar) securities after the due date of interest is over. This practice is generally adopted by high-income class assessees to evade the tax while transferring securities to low-income class assessees on the eve of due date of payment of interest. If this practice is not checked, interest is includible in the total income of the transferee, as interest is chargeable in the hands of the person who is legal owner of securities on the due date of payment of interest.

To prevent the avoidance of tax in this manner, section 94(1) provides that where a security owner transfers the securities on the eve of due date of interest and reacquires them, the interest received by the transferee will be deemed as income of the transferor and, accordingly, it will be included in the total income of the transferor and not of the transferee.

(B) Sales Cum-Interest on Securities [Section 94(2)] –

Another method of avoiding tax is sale of securities cum-interest. Section 94(2) provides that if an assessee, having beneficial interest in securities during the previous year, sells them in such a way that either no income is received or income received is less than the sum he would have received if interest had accrued from day to day, then income from such securities for such year would be deemed as income of such person.


Deeming provisions of section 94(1)/(2), discussed above, are not applicable if the security owner proves to the satisfaction of the Assessing Officer that —

  1. There has been no avoidance of income-tax; or
  2. The avoidance of income-tax was exceptional and not systematic and there was not any avoidance of incometax under section 94(1)/(2) in his case, during three years preceding the previous year.

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