Madras High Court rules in favour of Karur Vysya Bank on dividend deduction, bad debts and securities interest

The Madras High Court, in a consolidated decision dated 20/02/2026 in CIT Vs Karur Vysya Bank Ltd. (TCA Nos. 290, 291, 292, 293, 294, 295 and 663 of 2010), resolved multiple income-tax issues relating to a scheduled bank for Assessment Years (AYs) 1994-95, 1996-97, 1997-98 and 1998-99.

All substantial questions of law were ultimately decided in favour of the assessee and against the Revenue, leading to dismissal of seven departmental appeals.

Key issues addressed included:

• Manner of computing deduction under Section 80M on dividend income.
• Disallowance of expenditure allegedly relatable to dividend and tax-free income, particularly where the bank had sufficient own funds.
• Scope and interaction of Section 36(1)(vii) and Section 36(1)(viia) on bad debts and provisions for bad and doubtful debts.
• Tax treatment of interest paid on purchase of securities held as stock-in-trade, including broken-period interest.
• Characterisation of bank securities as stock-in-trade versus capital investments.

The Court relied heavily on binding Supreme Court precedents, as well as its own earlier rulings in the assessee’s case, and also referred to CBDT Circular No.18/2015 dated 02.11.2015.

1. Background of the appeals

The batch comprised seven appeals filed by the Revenue against Karur Vysya Bank Ltd., a scheduled bank. These appeals covered multiple AYs and raised overlapping questions of law under the Income Tax Act 1961.

Counsel appearances:

• For Revenue/appellant: Mr. V. Mahalingam, Senior Standing Counsel.
• For assessee/respondent: Mr. R. Vijayaraghavan for Mr. Subbaraya Aiyar.

Since many issues were common across years, the High Court grouped the substantial questions of law and decided them issue-wise, indicating the concerned AYs and appeal numbers for each question.

2. Deduction under Section 80M and expenditure relatable to dividend income

2.1 Substantial question on Section 80M

For TCA Nos. 290 of 2010 (AY 1996-97), 291 of 2010 (AY 1997-98) and 292 of 2010 (AY 1998-99), the admitted question was:

Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in holding that the deduction u/s 80M should be worked out applying Rule 80D read with Section 14A without appreciating that it was not applicable for the dividend income for the Assessment Year under consideration, instead of upholding the Assessing Officer’s action in working out the expenditure to be deducted on the basis of the Supreme Court’s decision in 200 ITR 478?

2.2 Assessment proceedings and AO’s approach

In one of the relevant years, the Assessing Officer (AO):

• Determined total taxable income at Rs.63.22 Crores (approx.).
• Noted that dividend income received from corporate entities amounted to Rs.37,06,331/-.
• Allowed deduction under Section 80M on a net basis, after deducting what he considered proportionate expenditure allocable to dividend income.

Relying on Commissioner of Income-Tax vs United General Trust Ltd. (200 ITR 488) the AO:

• Computed proportionate expenditure at Rs.31,35,470/- using a formula,
• Reduced that from the gross dividend to arrive at net dividend, and
• Applied 60% to the net dividend figure for deduction under Section 80M.

The final deduction allowed under Section 80M was Rs.3,42,516/-.

2.3 CIT(A)’s decision – limited disallowance at 2% of dividend

On first appeal, the assessee contended that no expenditure should be reduced from dividend income for Section 80M purposes.

The Commissioner of Income Tax (Appeals) [CIT(A)]:

• Affirmed that as per Distributors (Baroda) P. Ltd. vs Union of India and others, 155 ITR 120, deduction under Section 80M must be computed on net dividend, i.e., dividend forming part of gross total income after permissible deductions.
• Clarified that the Supreme Court in Commissioner of Income-tax vs Union General Trust Ltd. 200 ITR 488 had dealt only with managerial expenses, as that was the issue before it.
• Held that the AO was right in principle to consider disallowance of expenses relatable to dividend eligible for Section 80M.

However, on facts, the CIT(A):

• Noted that the assessee had substantial interest-free funds, and therefore no part of interest-bearing borrowings could be treated as used for investments in shares generating the dividend in question.
• Accepted that only minimal managerial effort was involved since the number of dividend warrants and related vouchers was small.
• Ultimately accepted the assessee’s own offer that 2% of the dividend income could reasonably be taken as attributable expenditure.

The CIT(A) directed the AO to recompute deduction under Section 80M after restricting expenditure to 2% of dividend income.

2.4 Tribunal’s approach – application of Rule 8D (Daga Capital)

Both sides appealed to the Income Tax Appellate Tribunal:

• The Tribunal followed the Special Bench decision in Income Tax Officer v Daga Capital Management Pvt. Ltd. (2009) 312 ITR (AT) 1 (Mumbai) (SB).
• It proceeded on the basis that Rule 8D laid down a retrospective formula for computing expenditure relatable to exempt income.
• It, therefore, remanded the matter to the AO with directions to apply the Special Bench decision and determine the disallowance accordingly.

2.5 Parallel assessee appeals and South Indian Bank Ltd.