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Facts
The assessee, a partner in two firms (M/s. Kailath Estate Investments and M/s. Kailath Financiers), received interest on capital contribution from one firm and paid interest on drawings from the other. The assessee sought to set off the interest paid against the interest received, but the Assessing Officer disallowed this claim, which was confirmed by the CIT(A).
Held
The Tribunal found that the lower authorities misapplied precedent and remanded the case to the AO. The AO is directed to verify if the drawings from the first firm were utilized for capital contribution to the second firm and, if so, allow the set-off of interest expenditure against the interest income.
Key Issues
Whether interest paid on drawings from one partnership firm can be set off against interest received on capital contribution to another partnership firm, requiring proof of nexus between expenditure and income.
Sections Cited
143(3), 10(2A), 28(v), 37(1)
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Income Tax Appellate Tribunal, “SMC” BENCH, COCHIN
Before: Shri Inturi Rama Rao
O R D E R This appeal filed by the assessee is directed against the order of the National Faceless Assessment Centre / Commissioner of Income- tax (Appeals) [“CIT(A)” for short] dated 14.03.2024 having DIN & Order No.ITBA/NFAC/S/250/2023-24/1062630032(1) for the assessment year 2016-2017.
Briefly, the facts of the case are that the assessee is an individual deriving income from business of partnership firm. The return of income for the assessment year 2016-2017 was filed on 16.10.2016 declaring income of Rs.4,23,830. Against the said return of income, the Assessing Officer (“the AO” hereinafter) completed the assessment vide order dated 27.12.2018 passed u/s.143(3) of the Income-tax Act, 1961 (“the Act” hereinafter) at a total income of Rs.35,87,300. While doing . Sri.Roy Cherian Kailath. so, the AO disallowed the claim of set off of interest expenditure of Rs.32,50,021 paid on drawings from partnership firm M/s.Kailath Estate Investments, of which the assessee is a partner, against the interest on capital received from M/s.Kailath Financiers of Rs.18,25,467.
The brief factual background of the case are that from the previous year relevant to the assessment year under consideration the assessee was a partner in two firms, viz., M/s.Kailath Estate Investments (“KEI” hereinafter) and M/s.Kailath Financiers (“KF” hereinafter). During the year relevant to the previous year, the assessee received interest on the capital contribution made to the firm KF of Rs.18,25,467 and also paid interest on drawings made from another firm KEI of Rs.32,50,021. In the return of income the assessee sought to claim set off of this interest paid and drawings from KEI against the capital contribution to KF. The AO was of the opinion that since the share of the income from partnership firm is exempt from tax by virtue of the provisions of sec.10(2A) of the Act the interest paid on drawings cannot be allowed as deduction, placing reliance on the judgment of the Hon’ble jurisdictional High Court in the case of CIT v. Popular Vehicles & Services Ltd. (2010) 325 ITR 523. Accordingly the AO made addition by disallowing the set off of Rs.18,25,467.
Being aggrieved with the order of the AO, an appeal was filed before the CIT(A) and contended that the claim for allowance of expenditure should have been allowed as drawings from KEI utilized for the purpose of capital contribution to the firm KF and placed . Sri.Roy Cherian Kailath. reliance on the judgment of the Hon’ble Supreme court in the case of Madhav Prasad Jatia v. CIT (1979) 118 ITR 200 (SC). It was further contended that the reliance placed by the AO on the judgement of the jurisdictional High Court in the case of Popular Vehicles & Services Ltd. (supra) is misplaced. However, the CIT(A) confirmed the action of the AO.
Being aggrieved with the order of the CIT(A), the assessee is in appeal before me in the present appeal. When the matter was called upon, none appeared on behalf of the assessee. Therefore, I proceed to dispose of this appeal on merits after hearing the learned Senior DR.
I have heard the learned DR and perused the material available on record. The solitary issue that arises for my consideration is whether the CIT(A) was justified in refusing to allow the claim for allowance of interest expenditure of one firm against the interest on capital contribution of another firm. It is the contention of the assessee that the drawings from the firm KEI were utilized for the purpose of capital contribution of another firm KF. Therefore, the interest expenditure incurred on drawings from the firm KEI should be allowed against the set off of interest earned on the capital contribution of another firm KF. It is true that the interest on capital contribution of the partnership firm is taxable as business profit u/s.28(v) of the Act, which reads as under:-
The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession",— ……………. (v) any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm.”
. Sri.Roy Cherian Kailath.
Therefore, any expenditure incurred to earn that income assessable under clause (v) of section 28 is clearly allowable as deduction u/s.37(1) of the Act, needless to mention, the nexus between the earning of income and the expenditure is required to be proved. However, the AO had not examined the nexus between the interest income earned from the partnership firm KF and the expenditure incurred in the firm KEI. The reliance placed by the AO on the decision of the Hon’ble jurisdictional High Court in the case of Popular Vehicles & Services Ltd. (supra) is misplaced, inasmuch as, the issue in the present case is not an allowability of expenditure against the share of profits of the firm. Even the CIT(A) had erred in applying the ratio of the decision of the Hon’ble jurisdictional High Court in the case of Popular Vehicles & Services Ltd. (supra). In view of the above, I set aside the orders of the lower authorities and remand the matter back to the file of the AO with the direction to allow the set off of the interest expenditure against the interest on drawings of the KEI against the interest income of the capital contribution, if it is found on due verification that the drawings from firm KEI are utilized for the purpose of making capital contribution of the firm KF.
In the result, the appeal filed by the assessee is partly allowed for statistical purposes. Order pronounced on this 11th day of February, 2025.