Interest expense allowable against even where the income from partnership firm is nil

Suresh Sreeram Vs ITO (ITAT Bangalore)

Issue before the Tribunal: -

Whether the Revenue authorities were justified in disallowing a sum of Rs. 23,23,496/- which was claimed as interest expenditure in relation to business of the assessee.

Facts of the case: -

• The assessee who is an individual is a partner in a firm M/s Rama Hi-Power Tech. He derives income from the firm in form of interest on capital, remuneration, commission which is includible as income under the head ‘Profits & Gains from business or profession’ u/s 28(vi) of the Income Tax Act.
• As per the partnership deed, all the partners of the firm are entitled for interest on capital @ 12% p.a. for capital invested by them. It is the plea of the assessee that the partners have agreed that they would claim interest on capital only when profits are earned by the firm.
• The assessee has made substantial investments in the firm and the net investment outstanding as on 31-03-2016 is Rs. 2,24,06,476/- (after deducting losses incurred in the previous years).
• The assessee had borrowed funds for making such a substantial capital contribution in the firm. The assessee claimed deduction of interest of Rs. 23,23,496/- on funds borrowed for the purpose of investment as capital in the business of the partnership firm.

The computation of income under the head PGBP of the assessee was Rs. 4,06,033 and the same was as follows: -

• As it is clear from the above that the assessee was deriving income in his personal capacity from other businesses for total amount of Rs. 27,30,129. The income from these businesses were set off against loss from the business of “Income and salary from the partnership firm” of Rs. 23,23,496. Though the computation of income as above does not reflect this position, the correct position is that it is a claim for set off of loss under the same head of income i.e. intra head adjustment which is permissible u/s 70 of the Income Tax Act.
• However, the learned A.O. held that no interest was received from M/s Rama Hi-power Tech, the partnership business, in which the capital was invested and therefore interest expense can not be allowed as deduction. The CIT (A) affirmed the order of the A.O. and he also held that the interest expense would be expenditure incurred for the purpose of earning income from the partnership firm in the form of share income and therefore the expenditure would not be allowable in terms of section 14A of the Act. This reasoning of the CIT (A) is incorrect as admittedly the firm incurred loss and the assessee did not receive any exempt income in the form of share of profits from the firm.
• The assessee filed an appeal before Tribunal being aggrieved by the order of CIT (A).

Observations of the Tribunal: -

• It is an undisputed fact that in the relevant A.Y., the partnership firm incurred heavy losses and was not in a position to pay any interest on capital to partners. Though the partners were entitled to interest on capital @ 12% p.a. from the firm as per deed but they mutually consented not to withdraw any funds keeping in mind the financial losses being made by the firm.
• However, since the funds were borrowed from external sources, interest was payable by the assessee to its unsecured lenders. The partner claimed the deduction which it was entitled u/s 36(1)(iii) and 37 with income earned from other sources of income under the same head i.e. vehicle hire, commission income and consultancy income. This resulted in a loss arising from one source under the head business which was set-off with another source of income under the head PGBP in terms of section 70.
• Interest, salary, bonus, commission or remuneration received or receivable from the firm by the partners shall be assessable in the hands of the partners as income from business or profession u/s 28 of the Act. The partner shall be entitled to all expenditure which is incurred to earn such income or for the said business.

Cases referred: -

• CIT Vs. Ramniklal Kothari (1969) 74 ITR 57 (SC)
• CIT Vs. Sohan Lal Nayar (1974) 95 ITR 90 (Del)- Delhi HC
• CIT Vs. S. Meyyappan (1969) 73 ITR 20 (Mad.)- Madras HC

Ruling of the Tribunal: -

Absence of earning any interest income on capital from the firm is no bar to claim the interest paid on borrowings for the purpose of contributing capital to the firm by the assessee as deductible expenditure. In such an event, there would be loss under the head “PGBP” subhead “interest, salary from the partnership firm” and the assessee is entitled to set off the said loss against other income under the same head “PGBP”. We are also of the view that the reasoning of the CIT (A) is incorrect that the interest expense would be expenditure incurred for the purpose of earning income from the partnership firm in the form of share income and therefore the expenditure would not be allowable in terms of section 14A of the Act. Therefore, we direct the AO to allow the claim of the assessee