1. These two appeals by the assessee, a limited company, are directed against orders of the CIT (A), Bhopal, upholding disallowance of interest of Rs. 7,500 and Rs. 9,000 in the A.Ys. 1981-82 and 1982-83, respectively.
2. The facts in brief are that the assessee-company took loan of Rs. 50,000 for business purposes from one non-resident, Shri Karnail Singh.
The company claimed that interest of Rs. 7,500 and Rs. 9,000 accrued on above loan in the period relevant to the A.Ys. 1981-82 and 1982-83, respectively. The above interest amounts were debited to profit and loss account and credited to the interest payable account. No tax was-deducted at the time of crediting the above interest amounts to the "interest payable account". The above amounts were claimed as a deduction in the returns by the assessee-company but were disallowed by the ITO as according to him the deduction of interest claimed without deduction of tax at source could not be allowed in view of provisions of Section 40(a)(i) of the Income-tax Act.
3. On appeal, it was claimed that provisions of Section 40(a)(i) were not attracted in this case as interest accrued was not payable outside India. It was further submitted that no tax was deductible at source as the interest claimed as deduction was not credited to Shri Karnail Singh's account or paid to him, but was taken only to "interest payable" account as per mercantile system of accounting followed by the assessee. The tax was duly deducted when interest was actually paid on 1-12-1982 to Shri Karnail Singh. The tax deducted was deposited on 4-12-1982. The learned CIT (A) did not find any force in the above submissions and after taking note of provisions of Sections 40(a)(i), 194A(1) and 195(1) of the Income-tax Act, upheld the disallowance. The assessee has brought the above issue before the Tribunal.
4. We have carefully considered the written submissions filed by the parties. Section 40(a)(i) reads as under: 40. Amounts not deductible.Notwithstanding anything to the contrary in Sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',- (i) any interest chargeable under this Act, which is payable outside India (not being interest on a loan issued for public subscription before the 1st day of April, 1938), on which tax has not been paid or deducted under Chapter XVII-B and in respect of which there is no person in India who may be treated as an agent u/s 163.
Thus, deduction of interest "chargeable under this Act" and "payable outside India" is barred where tax at source is not deducted or paid under Chapter XVII-B of the Act. Only exception being the case of a payee having an agent in India under Section 163 of IT Act.
To disallow the deduction, all the above narrated circumstances should be present. This sub-section is not applicable in this case as it has not been shown that interest claimed as deduction by the assessee "was payable outside India". No doubt, Karnail Singh is a non-resident but from this no inference can be drawn that interest on loan advanced by him was payable outside India. To determine whether interest was payable in or outside India, it was necessary to look to agreement between the parties. The assesaee from very start had been claiming that interest in this case was payable in India. This has not been controverted. The interest was also actually paid in India on 1-12-1982. The factual payment in India also supports the claim of the assessee that interest was payable in India. The revenue has not shown that interest was payable outside India and thus provisions of Section 40(a)(i) of the Income-tax Act were attracted in this case. The learned D.R. in his written submissions to justify the disallowance has relied on the decision of Kerala High Court in the case of CIT v. Lakshmi Lines Ltd. [1976] 102 ITR 196. He also relied upon the decision of the Calcutta High Court in the case of Jalan & Sons (P.) Ltd. v. CIT [1963] 50 ITR 111. We have gone through the above decisions. The decisions are clearly distinguishable and in none of these cases any issue regarding interest "payable outside India" was raised or considered. The question whether interest was payable outside India or not; is a question of fact to be determined with reference to the agreement between the parties and without material no presumption can be drawn that interest payable to every nonresident is payable outside India. In the above circumstances, we are unable to hold that interest in the case in hand was payable outside India. We must, therefore, hold that disallowance of the deductions under Section 40(a)(i) was unjustified.
5. The second argument raised before us was that assessee-com-pany was not required to deduct tax under Chapter XVII-B of the Income-tax Act from the deduction of interest claimed and, therefore, bar of Section 40(a)(i) was not attracted in this case. In view of above finding that interest claimed as deduction was not payable outside India, these appeals can be disposed of without deciding this question. However, as both the parties have submitted on this point, we record our finding on this issue also. The assessee-company admittedly follows mercantile system of accounting and, therefore, for computing its income all liabilities accrued are to be allowed as deduction. On this position there is no dispute between the parties.
6. The two provisions under Chapter XVII-B of the Income-tax Act dealing with deduction of tax from interest relevant for deciding the issue before us are Sections 194A(1) and 195(1) of the Income-tax Act.
These are as under: 194A(1). Any person, not being an individual or a Hindu undivided family who is responsible for paying to a resident any income by way of interest other than income chargeable under the head 'Interest on securities', shall at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force.
195(1). Any person responsible for paying to a non-resident, not being a company, or to a company which is neither an Indian company nor a company which has made the prescribed arrangement for the declaration and payment of dividends within India, any interest, not being 'Interest on securities' or any other sum, not being dividends, chargeable under the provisions of this Act, shall at the time of payment unless he is himself liable to pay any income-tax thereon as an agent, deduct income-tax thereon at the rates in force.
From the above extracted provisions it is clear that Section 194A(1) is applicable where interest is payable to "resident payee" other than individual or HUF. Section 195(1) is applicable in case of "non-resident". The above provisions do not take into account whether interest is payable in India or outside India. Only resident or non-resident status of payee is relevant. There may be cases notwithstanding provisions of the Foreign Exchange Regulation Act where interest to a resident may be payable outside India. The provision of Section 194A(1) of the Income-tax Act would be attracted. Likewise interest to a non-resident may be payable in India requiring deduction of tax at source under Section 195(1) of the Income-tax Act. It will all depend upon the terms of the agreement under which interest is payable. No general proposition, that in every case of non-resident interest must be taken to be payable outside India, can be accepted nor any authority was shown to us in support of the above proposition. The argument of the assesses that tax at source was not deductible under Section 195(1) of the Income-tax Act as the interest was not actually paid when entry in interest payable account was made is required to be accepted. In terms of Section 195(1) tax is to be deducted "at the time of payment" of interest. The credit of interest payable account will not tantamount to "payment" of interest to Shri Karnail Singh. Only the "interest payable account" has been credited. The credit of amounts cannot be equated with disbursement of amount. The words "at the time of payment" in Section 195(1) certainly envisage actual payment of amount. When provisions of Section 194A(1) are read conjectively with Section 195(1) of the Income-tax Act, it is abundantly clear that former covers both time of credit as well as time of payment whereas the latter only refers "the time of payment". Thus, the Legislature clearly maintained a distinction that tax under Section 195(1) is to be deducted only at the time of making "payment" to the payee. In view of clear language used by the Legislature, we are of opinion that Section 195(1) is attracted only at the time of payment of interest and not when interest is simply credited to the "interest payable account" as is the case before us. For the above view we also derive support from the Bench decision of Hyderabad High Court in the case of C1T v.Nagaria Oil Mills [1954] 25 ITR 258 wherein their Lordships observed as under: The assessee-firm maintaining its accounts on the mercantile system credited certain non-residents with interest on monies borrowed from them and this interest was allowed as a revenue deduction under Section 12(2)(iii) of the Hyderabad Income-tax Act. The Income-tax Officer however, held that as no tax was deducted from the interest, the assessee should pay on that amount income-tax at the maximum rate under Section 24(12) of the Hyderabad Income-tax Act. Held that "payment" in Section 24(4) of the Hyderabad Income-tax Act [corresponding to Section 18(3A) of the Indian Income-tax Act, 1922] should be interpreted as meaning actual payment and therefore crediting of interest amounts to the accounts of the lenders could not be deemed to be payment within the meaning of that sub-section so as to attract the provisions of Section 24(12) of the Hyderabad Income-tax Act [corresponding to Section 18(7) of the Indian Income-tax Act] The order of the Income-tax Officer demanding tax from the assessee was, therefore, not in accordance with law.
7. Their Lordships of the Supreme Court in CIT v. Toshoku Ltd. [1980] 125 ITR 525 considered the question whether making of entries in the account of non-residents would tantamount to actual or constructive receipts by non-residents in taxable territories. Their Lordships at page 530 held as under: It cannot be said that the making of the book entries in the books of the statutory agent amounted to receipt by the assessees who were non-residents as the amounts so credited in their favour were not at their disposal or control. It is not possible to hold that the non-resident assessees in this case either received or can be deemed to have received the sums in question when their accounts with the statutory agent were credited, since a credit balance, without more, only represents a debt and a mere book entry in the debtor's own books does not constitute payment which will secure, discharge from the debt. They cannot, therefore, be charged to tax on the basis of receipt of income actual or constructive in the taxable territories during the relevant accounting period.
8. Thus, their Lordships of the Supreme Court have clearly held that mere book entry favouring non-residents will not constitute actual or constructive payment to non-residents. The case in hand is definitely on much sounder footings as even the credit entry was not made in the account of a non-resident but only in the "interest payable account".
Thus, in any view of the matter, the disallowance of deduction by invoking provisions of Section 40(a)(i) of the Income-tax Act was not justified. The interest claimed was wrongly disallowed. Consequently, we direct that deduction of interest as claimed by the assessee be allowed in both the assessment years.