Section 42 deeming rule: interest on fixed deposits became taxable where funds were moved under an integrated lending scheme.

Interest on fixed deposits made from branch profits was held taxable because the deposits formed part of an integrated scheme to bring funds into the taxable territories for lending there. Section 42 of the Indian Income-tax Act, 1922 deems income to arise in the taxable territories where money is lent at interest outside those territories and, under the transaction, is brought in cash or in kind. The Tribunal's findings of effective control over the bank, branch operations designed to support the mills, and deposits made with knowledge that loans would be advanced in British India brought the arrangement within the deeming provision, making the interest taxable against the assessee-companies.

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Issues: Whether the interest earned on fixed deposits made out of branch profits was taxable on the footing that the money had been brought into the taxable territories under a basic arrangement or scheme between the assessee-companies and the bank.

Analysis: Section 42 of the Indian Income-tax Act, 1922 deems income to arise in the taxable territories where money is lent at interest outside the taxable territory and, under the transaction, is brought into the taxable territories in cash or in kind. The Tribunal's findings showed that the assessee-companies had effective control in the creation and management of the bank, that the Pudukottai branch functioned in a manner intended to support the financial operations of the mills, and that the deposits were transmitted with the assessee-companies' knowledge so that loans could be advanced in British India. On those findings, the transaction was not a mere ordinary banking arrangement but part of an integrated scheme attracting the deeming provision.

Conclusion: The interest was taxable under section 42 of the Indian Income-tax Act, 1922, and the answer was against the assessee-companies and in favour of the Revenue.

Ratio Decidendi: Where money is placed outside the taxable territory under an arrangement known to the parties, and the transaction is part of a basic scheme for bringing the funds into the taxable territory to earn income there, section 42 applies and the resulting interest is deemed taxable within the taxable territories.

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