4.3       Query

Some points on deduction of Income-tax at source

on certain payments.

1.We purchase machinery on deferred payment terms for which a contract is executed between us and the supplier. In the contract there is a stipulation that we shall be required to pay interest at certain rate on the amount of deferred payment instalments.

2.On purchasing the machinery we pass the following entry in our Books of Accounts :

Machinery Account                                          Dr.

            To Bank (With the amount paid)

            To Supplier (with the amount of deferred payment)

3.The Machinery Supplier draws Usance Bills on us for the amount of deferred payment instalments including interest at the rate stipulated in the contract.

4.On accepting these Usance Bills, no entry is passed in our Books of Accounts. The said Usance Bills are also counter-guaranteed by our Bankers as per terms of contract.

5.The Suppliers on receiving the Usance Bills duly accepted by us and guaranteed by our Bankers, get them discounted from their Bankers and draw the full amount under I.D.B.I Scheme.

6.On the due date the Supplier’s Banker who have discounted these Usance Bills, present the same for payment to us.

7.On receiving the Usance Bills on due dates, we issue the cheque for the full amount and pass the following entry in our Books:-

(a)        Supplier Account Dr. (with the amount of instalment)

(b)        Interest Account Dr. ( with the amount of interest included in the Usance Bills)

                                    To Bank

            Kindly let us have your opinion on the following points :-

(i)         Whether we are required to deduct income-tax under Section 194-A while honouring of the said Usance Bills as they include the amount of interest also.

(ii)        Whether our honouring of the said Usance Bills can be treated as payment to the Suppliers’ Bankers in which case it would not be necessary to deduct any tax under Section 194-A.

                                                          Opinion                                                   October 26, 1968

The query relates to the requirements of section 194-A of the Income-tax Act regarding deduction of income-tax on payments honouring Usance Bills on due date, in respect of the purchaser of machinery on deferred payment terms financed through Bankers. The facts stated by the querist include an important point that the machinery supplier  draws Usance Bills on the purchaser for the amount of deferred payment instalments, including interest at the rate stipulated in the contract. The querist has also stated that, on accepting these Usance Bills, no entry is passed in the books of account.

One view would be preferable for entries to be passed in the querist’s books of accounts on the acceptance of the Bill, debiting the supplier’s account with the amount of deferred payment instalment included in the Bill; also debiting Interest Suspense Account for the interest element contained in the Bill; and crediting Bills payable Account with the full face value of the Bill. If this is done, it may be noted that acceptance of the Bill does not amount to payment of interest, nor is interest paid to the supplier at the time of acceptance of the Bill.

It is also possible to hold the view that the booking of  the above entries in the querist’s books of account at the time of acceptance of the Usance Bill would not be compulsory, provided a proper record of all such Bills accepted is maintained and adequate disclosure of Bills accepted and outstanding at the Balance Sheet date is made in the Statements of Accounts. In such case, only the cost of the machinery (as shown from the supplier’s invoice) would be debited to Machinery Account and credited to the account of the supplier. Therefore, regardless of the booking procedure adopted, in our opinion it would not be necessary for the querist to deduct income-tax under Section 194-A while honouring the Usance Bill.

Items (5) and (6) in the note of the querist say that the suppliers, on receiving the Usance Bill duly accepted by the purchaser, get them discounted with their bankers and what the suppliers draw is obviously the amount of the instalment; the amount of the interest would be discounted or deducted from the amount of the Bill, because that is the amount which the bankers would be entitled to receive on presentation of the Bill.

The bankers may not be keeping these Bills with themselves but they might be discounting those Bills with the I.D.B.I. Probably the rate of interest would be 9%, of which 6% would go to I.D.B.I. and 3% would be earned by the Banker; and what the supplier would get is only the amount of the instalment.

It is also mentioned that the bankers have discounted the Usance Bills and presented the same for payment as Holders in due course to the purchaser. In our opinion, therefore, the interest is payable to the banker and not to the supplier of the machinery. Such a payment of interest to the banker is, in our opinion, exempted from tax under sub- section (3) of section 194-A which says that the provisions of sub-section (1) shall not apply to payment of interest to any banking company.