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Facts
The assessee, an individual, invested in partnership firms using both own and borrowed funds. The Assessing Officer (AO) disallowed interest expenditure and professional fees claimed as deduction against income from these firms, citing that interest-free investments were made from borrowed funds. The CIT(A) upheld these additions.
Held
The Tribunal held that the disallowance of interest expenditure and professional fees was not sustainable. It reasoned that investments in partnership firms are business investments, and the assessee had sufficient interest-free funds. Therefore, the deduction under Section 36(1)(iii) should be allowed. The Tribunal also addressed the issue of alleged difference in interest income, stating it should be treated as business income.
Key Issues
Whether interest expenditure on borrowed funds used for business investments in partnership firms is allowable as a deduction, and whether income earned from such investments is business income.
Sections Cited
36(1)(iii), 37(1), 143(3), 28(v), 139
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, “D” BENCH MUMBAI
Before: SHRI AMIT SHUKLA & SHRI GIRISH AGRAWAL
PER GIRISH AGRAWAL, ACCOUNTANT MEMBER:
These two appeals filed by two different assessees are against the orders of Ld. CIT(A), Pune-11, vide order nos. ITBA/APL/S/250/2024- 25/1067089721(1), dated 29.07.2024 and ITBA/APL/S/250/2024- 25/1067132605(1) passed against the assessment order by DCIT, Central Circle-1, Thane, u/s. 143(3) of the Income-tax Act, 1961 (hereinafter referred to as the “Act”), dated 23.04.2021 for Assessment Year 2019-20.
Grounds taken by the Assessees are reproduced as under:
“1. The Hon CIT(A) erred in upholding addition of Rs. 35,63,562/- (Rs.35,56,062 + 7,500) made by the Id AO by disallowing interest expenditure and professional fees, claimed as deduction against interest income from partnership firm, for the alleged reason that interest free investments were made out of interest bearing borrowed funds, without appreciating the provisions of section 36(1)(iii) of the IT Act, 1961 and ignoring fact that the concerned investments were for the business purposes only and accordingly the interest expenditure was allowable as revenue expenditure as per section 36(1)(iii) of the IT Act, 1961 and should be so allowed in computing total income.
2. The Hon CIT(A) erred in also upholding the alternative argument of the Id AO to support the addition of Rs. 35,63,562/-, by relying upon the provisions of section 37(1) of the IT Act, 1961, disallowing interest expenditure incurred on borrowed loans as well as professional fees, without appreciating the fact that the entire expenditure was revenue in nature and incurred wholly and exclusively for the purposes of business and therefore fully allowable as revenue expenditure and hence the disallowance was not justified and bears to be deleted.
The Hon CIT(A) erred in upholding addition of Rs.3,86,667/- made by the Id AO on account of alleged difference in the interest income as reflected by the capital account of the appellant as on 31.03.2019 and as declared in the return of income filed u/s 139 of the IT Act, 1961, which addition is not justified and may kindly be deleted.
2. The Hon CIT(A) erred in upholding the addition of Rs.96,950/- being interest expenditure claimed as deduction against business income which disallowance being not justified may kindly be deleted.
3 and 4960/MUM/2024 Ramesh Velji Shah and Mansukh Velji Shah AY 2019-20 3. The Hon CIT(A) erred in upholding the disallowance of interest expenditure claimed u/s 36(1)(iii) of the IT Act, 1961 to the extent of Rs.13,91,605/-, being notional interest computed by the Id.AO on the capital investment made in a partnership firm for the reason that allegedly interest free investments were made out of interest bearing borrowed funds, without appreciating the provisions of section 36(1)(iii) of the IT Act, and ignoring that appellant had sufficient owned funds for such interest free investments and entire investments were for the business purposes only and accordingly disallowance of interest was not justified.
4. The Hon CIT(A) erred in denying the deduction of Rs.10,000/- for professional fees expenditure claimed as deduction against interest income earned from partnership firm, M/s Shri Neminath Buildpro by recomputing assessed business income at Rs.45,85,672/- instead of Rs.45,75,672/- after giving effect of all the additions made by the Id.AO.”
Both the appeals have common issues and therefore are taken up together for adjudication by passing this consolidated order. In appeal, vide there are two grounds, vide ground no.2 and 4, which are not pressed, as stated in the course of hearing. Accordingly, the two grounds are dismissed as not pressed.
3.1. In the same appeal, in ground no.1, addition of Rs.3,86,667/- on account of alleged difference in the interest income as reflected by the capital account and as declared in the return of income is contested. The treatment of the same, will be consequential to the outcome of the common ground in both the appeals, i.e., ground no.3 of this appeal and ground no.1 and 2 of the appeal in ITA No.4959/Mum/2024.
3.2. We take up the appeal in as the lead case and the observations and findings for this shall apply mutatis mutandis to the appeal in .
Brief facts of the case are that assessee is an individual having income from house property, business, capital gains and interest income. Assessee filed his return of income on 09.03.2020 reporting a total income at Rs. 56,50,660/-. Ld. Assessing Officer completed the 4 and 4960/MUM/2024 Ramesh Velji Shah and Mansukh Velji Shah AY 2019-20 assessment u/s 143(3) on 23.04.2021, disallowing Rs.35,63,562/- claimed as deduction u/s. 36(1)(iii) on account of interest expenditure on borrowed funds as well as professional fees. Also, ld Assessing Officer alternatively held that deduction u/s. 37(1) would also not be available in respect of such interest expenditure. The breakup of disallowance is under:
- Interest Expenditure 35,56,062/- - Professional Fees 7,500/- -------------- Total 35,63,562/- ==========
Assessee is a partner in several partnership firms and has invested capital in such firms, primarily out of own funds and partly out of borrowed funds. In the year under consideration, income as remuneration and interest on capital was reportedfrom such partnership firms and the deduction claimed u/s. 36(1)(iii) on account of interest expenditure was claimed. Details of the same are as under: -
Sr. No. Particulars Amount (Rs) i. M/s. Square Feet Infrastructure LLP 42,38,733/- Interest on partners' capital ii. M/s. Arha Buildpro LLP Interest on 13,48,296/- partners capital iii. M/s Shree Sumatinath Enterprises LLP 25,00,000/- Remuneration as partner Total 80,87,029/- iv. Less: Deduction - Interest on borrowed funds 35,56,062/- - Professional fees 7,500/- v. Net income from partnership firms 45,23,467/- declared as business income 5.1. For demonstrating investments made by the assessee in various firms/LLPs, summary of Balance-Sheet for the year ending 31.03.2019, is extracted as under:-
Ramesh V. Shah Balance-Sheet as at 31.03.2019
CAPITAL AND Amount ASSETS Amount LIABILITIES (Rs.) (Rs.) Capital 11,60,97,108.00 Fixed Assets 84,89,828.00 Balance Unsecured 9,19,97,000.00 Investments 15,23,646,00 loans Secured Loan 54,61,745.00 Current Assets Current 19,05,089.00 Capital 20,42,02,427.00 Liabilities balance with partnership firms Other assets 4,68,233.00 Deposits 16,100.00
Loans & 1.331.00 Advances Cash & Bank 7,59,377.00 Balances Total 21,54,60,942.00 Total 21,54,60,942.00 5.2. Assessee had claimed deduction of Rs. 35,63,562/- being interest expenditure on borrowed funds as well as professional fees against interest income and remuneration from partnership firms. Authorities below denied the entire deduction for the reason that even though assessee during the year has invested a sum of Rs. 2,55,44,169/- in several partnership firms, interest income is not realized from all the partnership firms. The fact that assessee had invested borrowed funds in various partnership firms is undisputed by the ld. Assessing Officer.
6 and 4960/MUM/2024 Ramesh Velji Shah and Mansukh Velji Shah AY 2019-20 These investments in partnership firms are business investments of the assessee. Assessee has sufficient interest free funds available to fund any investment not generating income and for this reason, no disallowance u/s 36(1)(iii) of the IT Act, 1961 is warranted. Section 28(v) provides that any interest, salary, bonus and commission or remuneration, by whatever name called, due or received by a partner of a firm shall be chargeable to income tax under the head ‘profits and gains of business or profession’.
5.3. Ld. Assessing Officer further held as an alternative argument that deduction of interest expenditure/prof. fees would also not be available to the assessee u/s.37(1) of the Act. Assessee elucidated deduction u/s 37(1) of the Act requires the following conditions to be fulfilled:-
(i) Expenditure is not of the nature as described in sections 30 to 36 of the Act; (ii) Expenditure is of revenue in nature not of capital in nature; (iii) Expenditure is not personal expense of the assessee; (iv) Expenditure has been laid down or expended wholly and exclusively for the purposes of business or profession of the assessee; (v) Expenditure has not been incurred for any purpose which is an offence or which is prohibited by law.
5.4. As there is no cause for disallowance, assessee submitted that deduction for business expenses have to be allowed in the hands of the assessee unless the facts establish that assessee has violated the conditions prescribed in the above section.
7 and 4960/MUM/2024 Ramesh Velji Shah and Mansukh Velji Shah AY 2019-20 5.5. Ld. Counsel for the assessee placed reliance on decision of the Coordinate Bench of ITAT, Mumbai in ITA No. 5014/Mum/2024, order dated 21.11.2024. wherein similar addition made by the ld. Assessing Officer upheld by the ld. CIT(A) in the case of another partner of the assessee, Shri Sachin Chandru Mirani was deleted, contents of which are reproduced below. “6. We heard the parties and perused the material on record. The assessee is a partner in various partnership firms in which the assessee has made an investment to the tune of Rs.38,21,95,742.11 as of 31.03.2019. Out of this capital with various partnership firms, the assessee is earning interest income only from one firm M/s.Shri Neminath Buildpro and the assessee is also earning remuneration as partner from M/s.Shri Sumatinath Enterprises LLP. The assessee has claimed interest expenditure of Rs.69,53,573 against these two incomes which have been offered to tax under the head profits and gains from business or profession. The contention of the revenue is that the investment in the partnership from where assessee is earning interest income is very low compared to the borrowed funds. The revenue is also contending that the assessee has utilized the interest bearing funds to make investment in partnership firms from where no income is derived, and that the borrowed funds are also used for giving interest free loans and advances. The assessee's argument is that the investment in the capital of the partnership firms are business investments and therefore irrespective of whether any income is earned or not the deduction under section 36(1)(iii) cannot be denied. The assessee has submitted the statement of major contributors for sources and application of funds for the year under consideration before the AO as tabulated below:
Particulars of Amount – Rs. Particulars of Amount – Rs. Source of Funds Application of funds Loans taken from 8,76,33,070 Loans (Liability) 4,15,36,027 friends and Relatives Capital 11,14,21,015 Investment in 14,84,37,308 withdrawn from Firms various firms Receipts of 1,55,12,000 Loans and 2,60,12,650 advances given advances Total 21,45,66,08 Total 21,45,66,085
From the perusal of above table we notice that the assessee has sourced funds from both interest bearing loans and non-interest bearing funds and that the same is majorly invested in the capital of the partnership firms. There is no dispute that the investment made by the assessee in partnership firms is for the purpose of business. The AO in assessment order has observed that the investment in partnership firms is not earning any income to the assessee except one firm, and therefore the claim of interest paid under section 36(1)(iii) is not allowable. In this regard it is relevant to consider the following observations of
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 under section 28 of the Act. The partner shall be entitled to all expenditure which is incurred to earn such income or for purposes of the said business. Other deductions as admissible in law can also be claimed by the partner against such income. Under the old provisions, section 67(3) entitled a partner to claim deduction in respect of any interest paid by a partner on capital borrowed by him for the purposes of investment in the firm from the share income. The Supreme Court in CIT v. Ramniklal Kothari [1969] 74 ITR 57 held the share of the partner as business income in his hands and being business income expenditure necessary for the purpose of earning that income and appropriate allowances are deductible there from in determining the taxable income of the partner. The Court held that the amount paid as salary and bonus to staff, expenditure for maintenance and depreciation of motor cars and travelling expenses expended by him in earning the income from firm are deductible from the income. The Delhi High Court in CIT v. Sohan Lal Nyyar [1974] 95 ITR 90 held that section 67(3) is not exhaustive and any deduction otherwise allowable under section 37(1) will have to be allowed even if it does not fall within the ambit of section 67(3) of the Act. Salary paid to a manager by a partner for looking after his interest in the firm stands allowed by the Madras High Court in CIT v. S. Meyyappan [1969] 73 ITR 20. Therefore 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) 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 be not allowable in terms of sec.14A of the Act. This reasoning of the CIT(A) is incorrect because admittedly the firm incurred loss and the assessee did not receive any exempt income in the form of share of profits from the firm. (emphasis supplied)
8. Section 36(1)(iii) provides that the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession shall be allowed as a deduction. Accordingly the conditions for allowing deduction under this section is that the money, that is capital, must have been borrowed by the assessee, for the purpose of business, and the assessee must have paid interest on the borrowed amount. For the purpose of allowability of interest under section 36(1)(iii), the commercial expediency has to be looked into as has been held in various judicial pronouncements. In assessee's case, there is no contention in this regard is raised by the revenue and the reason for disallowance is that the assessee is not earning any interest income from the investment made in the partnership firms. This in our considered view is not correct reason for making the disallowance under section 36(1)(iii) in assessee's case. Further from the 9 and 4960/MUM/2024 Ramesh Velji Shah and Mansukh Velji Shah AY 2019-20 perusal of the above funds flow statement, it is noticed that the loans and advances given during the year is coming out of the pool of funds which includes capital withdrawn from partnership firms, and without a one-to-one match being established by the revenue, it cannot be said that the borrowed funds are used for giving interest free loans and advances. It was also submitted during the course of hearing that some of the loans extended are earning interest and not the entire loans and advances are interest free. In view of these discussions and considering the facts peculiar to assessee's case, we are of the view that the disallowance made under section 36(1)(iii) is not sustainable. Accordingly, the AO is directed to deleted the disallowance made in this regard.”
From the perusal of the above order and there being no change in fact and circumstances and applicable law in the present case as narrated above, respectfully following the findings arrived at by the Coordinate Bench, the same applies mutatis mutandis to the present case before us. Accordingly, disallowance made by the ld. Assessing Officer of Rs.35,63,562/- is deleted.
7. In respect to ground no.1 in , for which ld. CIT(A) having agreed that there is no undisclosed interest income of Rs.3,86,667/- but held that it should be taxed as income from other sources instead of business income, while directing for such a treatment, he did not grant consequential relief by reducing the business income, leading to double taxation of the same amount. In view of our observations and findings in the above paragraphs, while dealing with the common issue, interest income earned by the assessee is business income u/s.28(v) from which deduction has been allowed u/s.36(1)(iii). Thus, in view of these observations and findings, the treatment given by ld. CIT(A) does not hold good and therefore will have the character of business income only. Accordingly, addition made by the ld. Assessing Officer in this respect is deleted. In the result, ground no.1 is allowed.
10 and 4960/MUM/2024 Ramesh Velji Shah and Mansukh Velji Shah AY 2019-20 7.1. For ground no.3, our observations and findings in ITA No.4959/Mum/2024 apply mutatis mutandis, there being no change in fact pattern. Accordingly, this ground is allowed.
In the result, both the appeals are allowed.
Order is pronounced in the open court on 05 June, 2025