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CS Professional · Advanced Direct Tax Laws and Practice · Computation of Total Income, Tax Liability and Filing of Returns of various Entities excluding Companies

Mehta & Sons, a partnership firm, owes interest of ₹1,20,000 to a scheduled bank on a term loan for tax year 2026-27. Before the year ended, the bank and the firm agreed that the unpaid interest would be converted into a new loan. How is this interest treated under section 37?

The interest is not deemed actually paid, so it is not deductible yet. Section 37(4) says converting interest due to a specified financial entity, such as a scheduled bank, into a loan or other deferred instrument is not payment. The deduction is allowed only when it is actually paid.

  1. ADeductible in 2026-27 because it accrued under mercantile accounting
  2. BDeductible in 2026-27 because the conversion is a settlement
  3. CNot deemed actually paid, so not deductible until it is actually paidCorrect
  4. DDeductible only in the year the new loan is repaid, and also again in 2026-27

Explanation

Section 37(2)(e) covers interest owed to specified financial entities, which include scheduled banks. Under section 37(4), conversion of unpaid interest into a loan, debenture or other instrument deferring payment is not deemed actual payment. So the deduction waits for actual payment, and the firm's accounting method does not matter.

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