Interest to a non-resident: disallowance fails unless payable outside India, and tax deduction arises only on actual payment.

Interest on a loan from a non-resident was not disallowable under section 40(a)(i) merely because the payee was non-resident; the Revenue had to show that the interest was payable outside India and that tax was not deducted, and on the facts the interest was payable and paid in India. Section 195(1) was not triggered by a mere credit to an 'interest payable' account, because tax deduction for a non-resident arises at the time of actual payment, not by book entry. The mercantile system did not change that statutory requirement, so the interest deduction was allowed.

---

---

Issues: (i) Whether interest on a loan from a non-resident was disallowable under section 40(a)(i) on the footing that it was payable outside India and tax had not been deducted at source. (ii) Whether crediting interest to an 'interest payable' account, without making actual payment, attracted deduction of tax under section 195(1).

Issue (i): Whether interest on a loan from a non-resident was disallowable under section 40(a)(i) on the footing that it was payable outside India and tax had not been deducted at source.

Analysis: Disallowance under section 40(a)(i) applies only where the interest is chargeable under the Act, is payable outside India, and tax has not been paid or deducted under Chapter XVII-B. Mere non-resident status of the payee does not by itself show that the interest was payable outside India. The place of payment depends on the terms of the agreement and the surrounding facts. On the facts, the interest was claimed to be payable in India and was in fact paid in India, while the Revenue produced no material to show that it was payable outside India.

Conclusion: The disallowance under section 40(a)(i) was not justified and the issue was decided in favour of the assessee.

Issue (ii): Whether crediting interest to an 'interest payable' account, without making actual payment, attracted deduction of tax under section 195(1).

Analysis: Section 194A(1) covers credit or payment in the case of a resident payee, while section 195(1) applies to payments to a non-resident and speaks only of deduction at the time of payment. A mere book entry in an 'interest payable' account does not amount to payment. The distinction between credit and actual disbursement is material, and actual payment is required before section 195(1) can operate. The mercantile system of accounting does not alter that statutory requirement.

Conclusion: No tax was deductible at the stage of mere credit to the 'interest payable' account, so the issue was decided in favour of the assessee.

Final Conclusion: The interest disallowance was unsustainable, and the assessee was entitled to deduction of the interest in both assessment years.

Ratio Decidendi: For disallowance of interest under section 40(a)(i), the Revenue must establish that the interest was payable outside India; and for section 195(1), tax deduction is triggered only by actual payment, not by a mere book entry in an interest payable account.

---