JAGANMOHAN REDDY, J. - This is a reference by the Income-tax Tribunal at the instance of the Commissioner of Income-tax at Hyderabad on the following question of law :- "Whether the order of the Income-tax Officer demanding tax from the assessee firm is in accordance with law regard being had to Section 12(5) of the Hyderabad Income-tax Act ?" The facts as stated in the reference are that the asessee is a resident but unregistered firm doing business at Warangal. On assessing it for the year 1358 F., the Income-tax Officer noted that the assessee had credited four non-residents with interest of Rs. 21,968-15-9 on monies borrowed from them. He, therefore, passed the following order purporting to act under Section 24(12) of the Hyderabad Income-tax Act :- "I find that the assessees paid interest during the year of account to the following non-residents as noted below in detail :- No deduction of tax was made from the interest at the time of payment.
I, therefore, direct that the asessees should pay the income-tax at the maximum rate on the above amount under Section 24(12) of the Hyderabad Income-tax Act.
This amount should be paid on or before April 15, 1951. A challan is enclosed for this sum." It also appears from the statement of the case that while asses sing the firm, the Income-tax Officer allowed the interest paid to the non-residents as a revenue deduction under Section 12(2)(iii) of the Hyderabad Income-tax Act. The assessee firm appealed to the Appellate Assistant Commissioner objecting to the demand of a tax amounting to Rs. 3,530-9-0 on the ground that it had not in fact paid any interest to the non-residents, but only credited it to their accounts. The Appellate Assistant Commissioner dismissed the appeal observing, "according to Section 12(5) of the Hyderabad Income-tax Act paid means actually paid or incurred according to the method of accounting upon the basis of which profits or gains are computed under this section." A further fact that has been stated is that the assessee was maintaining its books on mercantile system. It may at this stage be observed that the Supreme Court has in the recent case of Keshav Mills Ltd. v. Commissioner of Income-tax, Bombay, considered the effect of accounts based on mercantile system and the basis of liability to tax under Sections 10(2) (xi) and 4(1)(a) of the Income-tax Act, when dealing with the case of a non-resident company registered in Baroda State before it merged with India and having a guaranteed broker in British India. The company manufactured textile goods and after the goods were manufactured they were sold by it ex-mills through the guaranteed broker who guaranteed the sale price of goods sold by the company ex-mills to the purchasers from Ahmedabad and it received commission as consideration for the guarantee and the assestance rendered to the company.
Dealing with the liability of the company for the payment of income-tax for the amounts said to have been received in British India, Bhagwati, J., delivering the majority judgment of the Supreme Court (Bose, J., dissenting) after examining the nature and system of mercantile accounts observed at page 190 :- "It follows from the above that the mercantile system of accounting treats profits or gains as arising or accruing at the date of the transaction notwithstanding the fact that they are not received or deemed to be received and under that system, book profits are assessed as liable to tax. If an assessee, therefore, regularly abopts the mercantile system of accounting he would be liable to tax on the profits thus credited by him in his books of account subject to all deductions for bad debuts as provided in Section 10(2)(xi). Section 4(1)(a) has nothing to do with this basis of taxation." Again at pages 191-192 he observed :- "The moneys were neither received by the company nor could be deemed to have been received by it when the entires were made in the books of account at Petlad. They had merely accrued or arisen to it...." It is clear from the decision of the Supreme Court that in a mercantile system of accounts monies credited or debited to the account of any particular person cannot be deemed to have been either such credit or debit is made is deemed to have acqu ired a right too receive the monies, or had his right to receive the moneys extinguished by the debit.
The question that arises in this case is when accounts are main tained on a mercantile system does the crediting of interest amounts to the accounts of the lenders be deemed to be a payment within the meaning of sub-section (4) of the Section 24 (corresponding to Section 18(3A) of the Indian Income-tax Act) 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 learned Advocate for the department has urged on the analogy of the definition of the word "paid" in Section 12(5) that where as assessee maintains a mercantile system of accounts, any interest amount credited would be deemed to be paid for purposes of attracting provisions of Section 24(4) and 24(12) of the Hyderabad Income-tax Act. This analogy, in our view, is not warranted by a close reading of Sections 12 and 24.
Section 22 deals with the computation of income, profits and gains and lays down the manner and the conditions in which deductions are allowed. Section 12(2)(iii) permits deductions of interest paid on capital borrowed for purposes of the business, profession or vocation, subject to the terms of the proviso to that sub-section, viz., that it prohibits allowance where interest chargeable under the Act is "payable without HIs Exalted Highness the Nizams Dominions, except interest on which tax has already been paid or from which tax has been deducted under Section 24 or in respect of which there is an agent in His Exalted Highness the Nizams Dominions who may be assessed under Section 55 or in the case of a firm, for any interest paid to any partner of the firm." Ordinarily the word "paid" would connote that the amount should actually be paid, but as the Legislature desired to make such amoumts liable even where it accrued due as under a mercantile system of accounts, the word paid in sub-section (2) of Section 12 was specifically defined to give effect to that intention in sub-section (5) of the section to mean "actually paid or incurred according to the method of accounting upon the basis of which the income, profits or gains are computed under this section." This definition, therefore permits amounts credited or debited in a mercantile system to be taken into account for the purposes of Section 12(2). It may further be pointed out that reading sub-sectoin (2) of Section 12 with the definition given in sub-section (5) thereof it would appear that even if interest is credited in books maintained on a mercantile basis, no allowances or deductions are permissi ble unless the other conditions stated in the rpoviso are fulfilled. In these circumstances, it was open found that on interest was in fact deducted or that no interest was paid to the non-resident entitled to receive the amounts or that there was no agent of the non-resident persons within the jurisdiction.
The question which has now been referred to us, viz., whether the Income-tax authorties could assess the assessee for non-deduction of income-tax payable by a non-resident upon interest credited to him, is, however, quite different to the case where deduction of interest has been allowed under Section 12. The answer to this question will depend upon the provisions of Section 24(4). Section 24(4) which corresponds to Section 18 (3A) of the Indian Income-tax Act in so far as it relevant is as follows :- "Any person responsible for paying to a person not resident in H.E.H.the Niazams Dominions any interest not being interest on securities or any other sum chargeable under the provisions of this Act shall, at the time of payment, unless he is himself liable to pay income-tax thereon as an agent, deduct income-tax at the maximum rate." The opening words of the sub-section, viz., "any person responsible for paying to a person non-resident" would indicate the liability of the person to pay a certaina sum to a non-resident, whether as interest or otherwise which will also include the liability to a pay amounts accrued due according to the mercantile system of accounts. But the latter words of the sub-section restict that meaning when it is said that such amounts as are payable "shall at the time of payment unless he is himself liable to pay income-tax thereon as an agent, deduct income-tax at the maximum rate." The natural interpretation f the words "shall on payment" would tend to show that the payments must be actual and not notional before any deduction cab be claimed.
"There must", in the language of Lord Macmillan in the case of Paton v.Inland Revenue Commissioners, "be a payment such as discharge the debt; the payment must be a fact not a fiction." In that case Section 36(1) of the English Income Tax Act provided that "where interest payable in the United Kingdom on an advance from a bank carrying on a bona fide banking business in the United Kingdom is paid to the bank without deduction of tax out of profits or gains brought into charge to tax, the person by whom the interest is paid shall be entitled, on proof of the facts to the satisfaction of the Special Commissioners, to repayment of tax on the amount of the interest." In 1918 F borrowed from a bank pound 2,50,000 on the security of certain property. At the material date F had paid nothing on the account in reduction of principle of interest, the bank debiting the account each half-year with the interest thereon and carrying forward the accumulated amount.
The House of Lords unanimously held that the action of the bank in so debiting the account with interest did not constitute as between it and F payment of interest by F within the meaning of Section 36(1) of the Income Tax Act, 1918, so as to entitle the trustee of Fs estate to recover the amount of amount of income-tax thereon.
"The simple fact is that the amount of interest accruing during the half-year is ascertained at the end of the half-year and is added to the account as a debt in precisely the same position as the other debit items whether for money lent, the price of securities bought, commission or other source of debt. It takes its position as part of the whole debt due to the bank, and, as part of the whole debt, is in the next half year chargeable with interest. It is no more paid than are other items of the total debt." "All that has happened is that, because the interest has not in fact been paid, the creditor has added the amount of the unpaid interest to the debtors principal indebtedness. In my opinion interest which is so dealt with cannot be interest paid to the bank." This case was approved in the case of Inland Revenue Commissioners v.Oswald. There the question was whether the interest capitalised was deemed to have been paid for purposes of rule 21 of the General Rules applicable to Schedules A,B,C and E of the Income Tax Act, 1918, which is in the following words : "Upon payment of any interest of money, annuity or other annual payment charged with tax under Schedule D, or of any royalty or other sum paid in respect of the user of a patent, not payable, or not wholly payable out of profits or gains brought into charge, the person by or through whom any such payment is made shall deduct thereout a sum representing the amount of the tax thereon at the rate of tax in force at the time of the payment." Lord Thanderton observed at page 369, dealing with and distinguishing the observations of Romer, L.J., in Inland Revenue Commissioners v.Lawrence, Graham & Co. :- "It is clear that the interest due may be paid in moneys worth in such a way as to discharge the debtors liability for the interest. But I find myself quite unable to agree that the debtors liability for the interest was discharged as a result of the arrangement between the mortgagor and the society in that case." Lord Macmillan also while considering his opinion in Patons case cited above observed at page 374 : "I adhere to this opinion and I am equally satisfied that the word payment in rule 21 has the same effect." The crucial test, as tersely observed by Lord Simonds at page 381 is in the following words : "The question in the simplest terms is whether, when the mortgagee capitalizes interest, the mortgagor pays it, and the answer, in terms as simple, is that the mortgagee capitalizes it just because the mortgagor does not pay it. It is not a form of payment; it is not a substitute for payment : the interest remains unpaid, but it is impressed with a new quality, viz., that it carries interests as if it were capital." In the case of Raja Raghunandan Prasad Singh v. Income-tax Commissioner, which dealt with the actual payment of principal and interest on the original mortgage, Lord Macmillan at pages 103 and 104 observed :- "Their Lordships are of the opinion that there was in the circumstances no realization of the principal and interest of the original mortgage of 1894, and that when the assessees received the new mortgage for Rs. 7,33,135 which included the principal and interest of the original mortgage they did not thereby receive payment or the equivalent of payment of the principal and interest of the original mortgage........
To give security for a debt is not to pay a debt. If the assessees had received payment in kind of the amount outstanding on the original mortgage, in the shape, say, of realizable shares or bonds, the case would have been different, but they merely received further and better security for their debt. It is, in their Lordships view, quite immaterial that the assessees discharged the original mortgage and all liability under it, for that was merely an incident in the transaction whereby the new security was substituted for the old." It appears to us that both on the language of the relevant section, and on authority, the Appellate Tribunal was right in interpreting the word "payment" in Section 24(4) as actual payment and not a notional payment. The answer to the reference is, therefore, in the negative.
The assessee will have his costs. Advocates fee Rs. 100.