Interest on bank deposits not taxable absent lender's knowledge of use in British India; deduction allowed.

Interest paid by a bank to its depositors was held not to be chargeable to tax where the depositors had no knowledge or concern that the bank would use the borrowed funds in British India to earn income. The governing principle applied was that taxability of such interest depended on an integral nexus between the lender and the use of the money in British India, including the lender's awareness that the funds would be taken there and employed for income production. On those facts, the bank had no obligation to deduct tax under Section 18(3A), and it remained entitled to the deduction claimed under Section 10(2)(iii).

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Issues: Whether interest paid by the assessee-bank to its depositors in Porbandar was interest chargeable under the Indian Income-tax Act so as to attract the proviso to Section 10(2)(iii) and deny the deduction claimed.

Analysis: The deduction under Section 10(2)(iii) was questioned on the footing that the depositors' interest was taxable because the bank used the borrowed funds in British India. The governing principle, as applied, was that liability to tax on such interest depended on a nexus between the lender and the use of the borrowed money in British India, and that the lender's knowledge that the money would be taken into British India and used to earn income had to form part of the integral transaction. On the facts, the depositors were concerned only with earning interest on their deposits and had no knowledge or concern as to how the bank would employ the funds. In the absence of such knowledge, the interest paid to the depositors was not chargeable to tax, and the bank was not bound to deduct tax under Section 18(3A).

Conclusion: The bank was entitled to the deduction under Section 10(2)(iii) in respect of the interest paid to its depositors.

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