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Interest foregone on pre-closure of deposits

In view of the increase in interest rates, I foreclosed some earlier deposits for reinvestment in high-yield deposits, though in the process I lost some interest on the old deposits on foreclosure. My banker has deduc

ted tax on gross amount, so that TDS certificate is for a larger amount of interest, while I receive a smaller amount. My question is whether I am bound to report the gross income and whether I would get the full deduction of TDS certificate, if report of net income is permissible.

This is a query received from a number of taxpayers, because of the practice of foreclosing past deposits to earn higher interest. Interest loss on foreclosure by way of reduction of interest already paid is compensated by the higher interest, where maturity date is distant.

A taxpayer is expected to pay tax only on his real income. The amount he has received as interest is only the net interest.

Taxable event consequent on reduction in interest occurs only in the year the deposit is foreclosed, so that the interest loss can be claimed against interest received on the same deposit or even other deposits. Bank need not have deducted tax on the gross amount, but then, where interest payable after the interest forfeited on foreclosure is a minus figure, it is not possible for the bank to refund the tax deducted from interest found to be in excess on foreclosure.

But that is no reason, why the tax deduction should be on an amount larger than the tax on interest paid during the year, since the bank is obliged to pay tax only for interest paid.

The question raised is, whether there is any provision in the income-tax law for deduction of interest forfeited. No such provision is necessary, because the liability itself is only on net interest.

Where there was both interest received and paid in partner’s accounts in a firm, the Supreme Court has held that the net amount alone should be taken into consideration under Section 40(b) of the Income-tax Act.

Sometimes a question is raised, whether disallowance can be made on the basis of the decision of the Supreme Court in CIT v Dr. V.P. Gopinathan (2001) 248 ITR 449 (SC), where the assessee’s claim for deduction of interest paya ble on overdraft against deposit was disallowed as not deductible in computation of interest on deposit.

The reasoning was that the borrowing was not for purposes of investment in the deposit, since the deposit was anterior to the loan.

The assessee could have got such interest allowed against business income, if the loan was taken for business or against income from Other Sources, if it is for making any other deposit. If the assessee borrows money for the purposes of marriage of his daughter, such interest would not be allowable, though he could have avoided the loss by foreclosing the deposit instead of borrowing on the deposit. In the reader’s case, he has suffered interest loss in order to earn more interest.

Though the reader is even otherwise liable only on net interest, even in the view that gross interest is assessable, the loss on foreclosure is deductible under Sec. 57(iii) of the Act from the gross interest as an expenditure, which is wholly and exclusively for the purpose of earning such income.

Where an assessee claimed loss on foreclosure of deposits made with a view to investing in shares, it was held, that such foreclosure loss is deductible from dividend income in the case of CIT v Sri Ananth G. Pai (1984) 150 ITR 249 (Kar) , while pointing out that Sec. 57(iii), which is on a par with Sec. 37 for business income, would permit deduction of such amount and that the loss on foreclosure is not different from borrowing on interest.

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