1058. Whether payer would be liable to deduct tax at source from interest in a case where he follows mercantile system of accounting and he, instead of crediting interest income to the account of payee, credits the same to “Interest payable account”, etc.

1. Section 194A requires every person, other than an individual or a Hindu undivided family, to deduct income-tax at source at the prescribed rates from interest (other  than “interest on securities”) at the time of credit of such interest to the ac­count of the payee or at the time of payment thereof where the amount credited or paid, or likely to be credited or paid, to the assessee during any financial year exceeds Rs. 1,000. The deduc­tion is required to be made under section 194A in the case of residents only. (For non-residents the provisions are different and are contained in section 195.)

2. Some representations have been received by the Board enquiring as to whether a person would be liable to deduct tax at source from interest where his accounts are being maintained in accord­ance with the mercantile system of accounting and who, instead of crediting the interest income to the account of the payee, cred­its the same to the “Interest Payable Account” or the “Liability for Expense Account” or “Suspense Account” or any other nominal account.

3. The material expression in section 194A(1) is “at the time of credit of such income in the account of the payee…”. When interest is debited to “Interest Account”, or any other nominal account, the debit is for a specific amount calculated with reference to the deductor’s liability to a particular creditor in accordance with the terms and conditions of the loan. What is, therefore, important is that the interest payable to a creditor has constructively been credited to the account of the payee; the apparent nomenclature of the particular account in which the credit is made is not conclusive in the matter. The nominal accounts like “Interest Payable Ac­count”, “Liability for Expense Account”, “Suspense Account”, etc., are heads or captions meant to cover stray transactions of unidentifiable receipts and payments. Except in stray cases failure to credit the interest to the account of the payee cannot also be called a method of accounting regularly employed within the meaning of section 145(1) and would not, therefore, be ac­cepted as an explanation for the consequential failure to deduct the tax at source. The burden of proving that there was a valid justification for crediting interest to any account other than the account of the payee would rest obviously on the person responsible for making the deduction. The time for deduction would be when the interest is credited.

4. It may be added that the time for making the payment of the tax deducted at source is governed by section 200 read with rule 30 of the Income-tax Rules and would reckon from the date of credit of interest made constructively to the account of the payee which would ordinarily be within one week from the last day of the month in which deduction is made. Where, however, the interest is credited by an assessee, carrying on business or profession, as on the date up to which the accounts thereof are made, the amount of tax deducted would be payable to the Central Government within two months of the expiration of the month in which the accounts of the assessee are made, falls. For example, if the accounts are made up to, say November 7, 1980, the tax deducted on the interest credited on that date would be payable to the Central Government by January 31, 1981 irrespective of when the closing entries are actually made.

5. The above clarification may please be brought to the notice of all your members so that they can comply with the requirement for deducting tax at source.

Circular: No. 288 [F. No. 275/46/79-IT(B)], dated 22-12-1980.

JUDICIAL ANALYSIS

COMMENTED UPON – The above circular was adversely commented upon in Koshalya Investments (P.) Ltd. v. ITO [1990] 83 CTR (Trib.) (Ahd.) 143, with the following observations :

“6.3 The reliance placed by the authorities below and the learned Departmental Representative on Board’s Circular No. 288, dated 22nd December, 1980 is not valid as the clarifications issued by the Board are not in consonance with the clear interpretation based on the plain language of section 194A. If the interpretation as clarified by the Board in the aforesaid circular would have been possible on the basis of interpretation of section 194A as it existed prior to insertion of Explanation  in section 194A, there would have been no need to insert the aforesaid Explanation in section 194A by the Finance Act, 1987. The provisions of section 194A clearly prescribe that the liability for deduction of tax at source will arise only when the amount of interest is credited to the account of the payee or when the same is paid to them, whichever is earlier. The Board in the aforesaid circular has mentioned that even if the amount is credited to nominal accounts like interest payable account, liability for expenses account, suspense account, etc., it should be treated as constructively been credited to the account of the payee when the specific amount calculated with reference to the deductor’s liability to a particular creditor in accordance with the terms and conditions of the loan has been provided for; such an interpretation, in the absence of such specific words in the language of section 194A would amount to extending the scope of section 194A as it stood prior to insertion of Explanation to the said section w.e.f. 1st June, 1987. The very fact that the framers of the law considered it necessary to insert an Explanation in section 194A clearly supports the assessee’s contention that but for the aforesaid Explanation  the plain language of section 194A as it stood prior to the insertion of the aforesaid Explanation did not cover a case like that of the assessee and the assessee, according to the original section 194A was not liable to deduct tax at source at the time of crediting the interest in the interest payable account.” (pp. 159-160).

COMMENTED UPON – In Alkapuri Investment (P.) Ltd. v. D.S. Khoba [1997] 226 ITR 506 (Guj.) it was held that Circular No. 288, dated December 22, 1980, was not in consonance with the true import of section 194A and cannot be given effect to.

See also Sivakami Finance (P.) Ltd. ITO [1983] 6 ITD 351 (Mad. – Trib.)

CLARIFICATION 2

I am directed by the Committee of the Federation to address you as under : Under section 194A of the Income-tax Act, an assessee is required to deduct income-tax at source from the interest income of a resident at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or otherwise.

Many assessees, while finalising their accounts, do not neces­sarily credit the amount of interest payable to each creditor; instead they credit the interest payable on the amount of loans raised by them in a separate interest payable account. Since such assessees do not credit the amount of interest to the account of the respective payee, they do not deduct tax at  the time of finalising the accounts. Tax is, however, deducted at the time when the interest is either actually credited to the account of the respective payee or is paid to them. It has been brought to the notice of the Federation that the Department is insisting upon deduction of tax at source even at the time of crediting the amount of interest to the interest payable account as aforesaid and has even launched prosecution for alleged failure to deduct tax at source and pay to Government.

The section, as it is worked, requires deduction of tax at source only at the time when the interest is credited to the account of the payee or payment thereof. There is, therefore, no obligation on the part of assessee to deduct tax at the time of making a provision in the accounts in respect of interest payable by him. The crediting of interest to the account of the payee is not the same thing as crediting the interest to the ‘interest payable account’. It is, therefore, suggested that suitable instructions be issued to the authorities below not to insist deduction of tax at source at the time of crediting the interest to the interest payable account. All pending penal or prosecution proceedings may also be directed to be withdrawn immediately.

Letter  : No. 276/72/77-IT (B), dated 25-1-1979.

[Source : Arundathi Investments Ltd. v. ITO  [1984] 10 ITD 754 (Mad.) (TM), 759, 760].

CLARIFICATION 3

3. The matter has been examined and the Board are advised that section 194A indicates not only the circumstances in which the person responsible to deduct tax at source has to do so but also specified the time at which the deduction has to be made. Thus, where payment has to be made in cash or by issue a cheque or draft, the deduction is to be made at the time of payment. But, if the payment is not made physically, but by way of book adjustment, as in the mercantile system of accounting then the income-tax at source is to be deducted at the time of credit of such income to the account of the payee. The question under consideration here rests on the exact meaning of the expression ‘credit of the income to the account of the payee’. These words have to be taken to mean that the persons should have credited the amount in the personal account of the payee or in some other manner to indicate his immediate intention to effect the transfer of the amount of interest to the payee. The mere fact of posting the entry in the Interest Payable Account or the ‘Liability for Expenses Account’ does not amount to crediting the entry in the account of the payee, even though it would be indicative of an acknowledgement of the liability to the creditors with respect to that amount of interest. As such the obligation to deduct the tax could not arise at that time but would arise when subsequently, the payment of interest is made to the payee or it is credited to his account.

Instruction : No. 1215 [F. No. 385/61/78-IT (B)], dated 8-11-1978.

[Source : Paterson Engg. Co. (P.) Ltd. v. ITO [1989] 30 ITD 454 (Bom.), 456]

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