Deductibility of interest allowed to partners on their capital contributions

 

 

If the rate of interest payable to partners to their capital balances is within the prescribed percentage, then such amount of interest is allowable as deduction from the computation of business income; thus, there is no requirement of having any book profit as a pre-condition for granting deduction in respect of interest paid to the partners, which is required for allowing remuneration to partners beyond the specified sum; therefore, the interest to partners is an allowable deduction under the head Profits and gains of business or profession even if there is loss under this head.

 

 

 

 

 

 

ITAT MUMBAI BENCHES ‘B’, MUMBAI

ITO

v

M. M. Textiles

ITA Nos. 2574 & 7418/Mum/2007

April 16, 2009

 

RELEVANT EXTRACTS:

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10.     The core of controversy in this appeal is against the deductibility or otherwise of an interest of Rs. 6,50,236 allowed to the partners which was claimed as deduction. The case of the Assessing Officer is that no deduction on account of interest to partners can be allowed. The learned D. R. submitted that the rental income of Rs. 16.70 lakhs was rightly held to be taxable under the head ‘Income from other sources’ and hence only deduction as allowable u/s. 57 could be granted. He submitted that the expenses incurred wholly and exclusively for the purpose of earning rental income were eligible for deduction. Since the interest paid to partners was not incurred wholly and exclusively for the purpose of earning the lease rent, the same was stated to be not eligible for deduction from the rental income.  We are fully convinced with the submissions made on behalf of the Revenue that the interest allowed to the partners is not deductible under the head Income from other sources'. Even the Id. CIT(A) has not held that the assessee was entitled to claim deduction on account of interest to partners from the income under the  head  'Income  from  other  sources'.  In  our considered opinion the controversy is not in   allowing deduction of interest to partners against the rental income but to allow deduction of such interest under the head "Profits and gains of business or profession'. Section 40(b) was substituted by the Finance Act, 1992 with effect from 1.4.1993 which deals with the amount not deductible in the case of firm assessable as such. Clauses (i) to (v) of section 40(b) restrict the deductible amount of remuneration paid to the working partners. Clause (ii) to (iv) of section 40(b) also place restriction on the deductible amount of interest paid to the partners.  Whereas remuneration to the partners is deductible subject to certain conditions to the extent of the availability of the book profits, the interest to partners, which is otherwise authorized by and in accordance with the terms of the partnership deed and relates to any period falling after the date of such partnership deed, is not deductible if it is in excess of the amount calculated at the rate of 12% simple interest with effect from 1.6.2002. In other words if the rate of interest payable to partners to their capital balances is within the prescribed percentage, then such amount of interest is allowable as deduction from the computation of business income; thus, there is no requirement of having any book profit as a pre­condition for granting deduction in respect of interest paid to the partners, which is required  for  allowing  remuneration  to  partners  beyond the  specified  sum; therefore, the interest to partners is an allowable deduction under the head "Profits and gains of business or profession' even if there is loss under this head. Adverting to the facts of the instant case we find that the learned CIT(A) has recorded a categorical finding that the business was continuing though temporarily suspended which implies that the business was carried on by the assessee and income under the head "profits and gains of business or profession" was calculatable. Moreover the Revenue is aggrieved only against the granting of deduction on account of interest to partners and it has accepted the granting of deduction of other expenses including the administrative expenses, which has been obviously granted under the head 'Business income. Thus we do not find any reason for which the interest to partners cannot be allowed as deduction under the head "Profits and gains of business or profession". By allowing this deduction it would mean that the loss under the head 'Business income' would swell by the amount of interest to the partners to the tune of Rs.6,50,236. From the ground of appeal, extracted above, we find that reference has been made to the capital of Rs.44.44 lakhs contributed by the partners vis-a-vis that diverted by way of loan to the parties not related to its business amounting to Rs.73.6 lakhs. There is no discussion on this aspect of the matter either in the assessment order or the remand report. What to talk of discussion on the question of diversion of capital for non-business purpose, there is no whisper, much less the finding of the XO on this issue. Even the Id. DR could not point out that where from these figures have come up. We are, therefore, not taking cognizance of such facts which are not borne out from the record, in reaching our conclusion.

11.     Section 71(1) deals with the set off of loss from one head against the income from another. It provides that where in respect of any assessment year the net result of computation under any head of income, other than "Capital gains", is a loss and the assessee has no income under the head "Capital gains", he shall, subject to the provisions of this Chapter, be entitled to have the amount of such loss set off against his income, if any, assessable for that assessment year under any other head. A bare perusal of this statutory provision divulges that the loss incurred by an assessee under the head "Profits and gains of business or profession" shall be set off against the income under any other head, which also includes 'Income from other sources".  Going by the mandate of this section the loss arising to the assessee. On account of interest to partners under the head “business income” will be set off against the income under the head ‘income from other sources’ computed by AO at Rs. 15.58 lakhs. We, therefore, uphold the impugned order on this score.

12.     In the result, the Revenue’s appeal is dismissed.

 

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