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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI CHANDRA POOJARI & SMT. BEENA PILLAI
Per Chandra Poojari, Accountant Member This appeal by the assessee is directed against the order dated 30.10.2019 of the CIT(Appeals)-2, Bengaluru for the assessment year 2014-15 on the following grounds:-
“1. On the facts and in the circumstances of the case, the learned Commissioner of Income-Tax (Appeals) erred in passing the order in the manner he did. 2. The learned Commissioner of Income-Tax (Appeals) grossly erred in not appreciating the fact that the appellant had borrowed a loan for business purposes which had been advanced to the Partnership Firms where he is a Partner and is earning
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interest on the sums advanced. The same has been shown by the Appellant in his Return of Income. 3. The learned Commissioner of Income-Tax (Appeals) grossly erred in not appreciating that Interest on Borrowed Capital is a legitimate expense and the Appellant is allowed set off of the interest expenses so incurred. The Appellant had submitted Bank Loan Statement; Interest Certificate as well as all related records, but the learned Commissioner of Income-Tax (Appeals) has passed the Order on 30.10.2019. Hence the appeal to Tribunal. 4. It needs to be clearly noted that the Appellant has taken a loan for business purposes and advanced it to his Partnership Firms on which he is earning Interest income which is offered in his Return of Income. 5. The learned Commissioner of Income-Tax (Appeals) erred by adding the Interest on Borrowed Capital without appreciating the legitimacy of the deduction as claimed. 6. Without prejudice, the disallowance is excessive, arbitrary and unreasonable and ought to be deleted. 7. The learned Commissioner of Income-Tax (Appeals) erred in disallowing the Interest on Borrowed Capital u/s 24(b) of the Act. 8. For these and other grounds that may be urged at the time of hearing of the appeal the Appellant prays that the appeal may be allowed.” 2. The crux of the above grounds are that the interest paid by the assessee on borrowed capital which was advanced to two firms where the assessee is a partner is to be allowed as a deduction u/s. 24(b) of the Act while computing the income under the head ‘income from house property’.
The facts are that the AO has made an addition of interest on borrowed capital. The assessee had borrowed from Karnataka Bank and had advanced the monies received to two Partnership Firms where he is a
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partner as they were in urgent need of capital. The assessee received interest Income from the partnership firm on the loans advanced and also paid interest to Karnataka Bank as per the loan terms and conditions. It is as per law to set off interest paid against interest received form the Partnership Firm on the loans advanced. An error of setting of the interest paid on the Bank Loan u/s 24n does not take away from the fact that the assessee is allowed the 'set off' of interest paid on interest received from Firm and same should have been allowed by the AO. By oversight interest is claimed under the head property income instead of being claimed as business income.
On appeal, the CIT(Appeals) observed that the amount borrowed from bank was never used in acquisition of house property on which rental income has been offered under the head income from house property. As such, interest paid by the assessee on the borrowings invested in the two firms as a partner cannot be allowed as a deduction out of rental income offered by the assessee. Against this, the assessee is in appeal before us.
At the time of hearing, the ld. AR fairly conceded that the borrowings were not used for acquisition of any house property from which the rental income was offered for taxation, as such the assessee has no case on this count. However, he made an alternative claim that the amount borrowed from bank at Rs.2 crores has been invested in the two firms viz., Sri Venkateshwara Textiles (SVT) at Magadi Road at Rs.1.50 crores and DVG Road at Rs.50 crores totalling to Rs.2 crores. He submitted that the assessee received interest from these two firms as follows:-
SVT Magadi Road Rs.14,70,345 SVT DVG Road Rs.16,64,416
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Accordingly, he submitted that the above interest income received from the firm was duly offered for taxation in the assessment year under consideration i.e. AY 2014-15 and the interest paid on borrowings is to be allowed on the reason that the said loan amount has been invested as a capital in these firms and at least the set off benefit has to be given out of the interest income received from the firms.
The ld. DR submitted that this is a new claim which cannot be entertained by the Tribunal.
We have heard both the parties and perused the material on record. Admittedly, the assessee has claimed before the CIT(Appeals) regarding set off of interest paid on interest received from firms which is evident from para 2 of the CIT(Appeals)’s order. However, there was no adjudication on this issue by the CIT(Appeals). Hence the ld. DR is not justified in making such an argument, as such it is rejected.
Regarding the allowability of interest paid by the assessee on borrowed funds used for investment in the firms, we find that u/s. 14A of the Act, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act for the purpose of computing total income under the Chapter, meaning thereby, if any expenditure is incurred on the borrowed funds which did not earn any income, such expenditure is not allowed as deduction in computing the total income of the assessee. In the present case, the assessee borrowed funds to make investment in the two firms under his capital account. From the partnership firms the assessee has received interest and the same was offered for taxation. The interest received by the assessee from the partnership firms is on account of capital investment made by the assessee. Until and unless there is a nexus established between the borrowed funds and income of the assessee,
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deduction of interest paid on borrowed funds would not be allowed against the income received from the firms. In the instant case, since there is a nexus between the capital investment made by the assessee and also payment of interest on borrowed funds by the assessee, hence in our opinion, there is merit in the argument of the ld. AR that interest paid by the assessee on borrowed funds used for investment in firms as capital has to be set off against the interest income received by the assessee from these two firms. For this purpose, we place reliance on the decision of co- ordinate Bench in the case of Shri Suresh Sreeram v. ITO in ITA No.1605/Bang/2019 dated 28.01.2021 wherein it was held as under:-
“8. We have carefully considered the rival submissions. It is an undisputed fact that in AY 2016-17 the partnership firm incurred heavy losses from its business and was not in a position to pay any interest on capital for the investment. Due to the poor financial condition of the partnership firm, the partners of the firm mutually decided to delay the withdrawal of interest on capital from the partnership and withdraw the same only when the partnership firm starts making profits. Though the partners were entitled to interest on capital @12% p.a. from the partnership firm as per the agreed partnership deed, the partners on mutual consent postponed this withdrawal of funds keeping in mind the financial losses being made by the partnership firm. The necessary Income Tax Returns & Balance sheet of Partnership firm was also filed before the AO. 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 of PGBP in terms of section 70. 9. 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
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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 vs. Ramniklal Kothari (1969) 74 ITR 57 (SC) 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 vs. Sohan Lal Nayar (1974) 95 ITR 90 (Del) 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 vs. S. Meyyappan (1969) 73 ITR 20 (Mad). 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. 10. For the reasons given above, we direct the AO to allow the claim of the assessee and allow the appeal.”
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Accordingly, we allow this ground of the assessee and directed the AO to give the benefit of telescoping of receipt and payment of interest and recompute the income of the assessee accordingly.
In the result, the assessee’s appeal is partly allowed.
Pronounced in the open court on this 27th day of December, 2021.
Sd/- Sd/- ( BEENA PILLAI ) ( CHANDRA POOJARI ) JUDICIAL MEMBER ACCOUNTANT MEMBER
Bangalore, Dated, the 27th December, 2021.
/Desai S Murthy /
Copy to:
Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.
By order
Assistant Registrar ITAT, Bangalore.