MUTHOOT BANKERS,MANANTHAVADY vs. INCOME TAX OFFICER, WARD-1(4), MANANTHAVADY

Brief facts of the case are that the assessee is a partnership firm engaged in the business of financing. The return of income for AY 2006-07 was filed on 30.10.2006 declaring income of Rs. 12,460/-. Against the said return of income assessment was completed by the Assessing Officer (AO) vide order dated 17.10.2008 u/s. 143(3) of the Income Tax Act, 1961 (the Act) at a total income of Rs. 9,16,990/-. While doing so the AO made a disallowance of Rs. 9,00,000/- u/s. 40(b) of the Act, being interest on capital contribution by the partners by holding that the same is not allowable u/s.

Being aggrieved, an appeal was filed before the CIT(A) who vide the impugned order confirmed the action of the AO.

Being aggrieved, assessee is in appeal before the tribunal. The learned A.R. submits that interest on capital contribution of the partner is eligible for deduction in terms of provisions of section 40(b) of the Act, as the same was authorised by the partnership deed and the provisions of section 37(1) of the Act have no role to play in allowability of interest on capital contribution made by the partners.

On the other hand, the learned Sr. DR, placing reliance on the orders of the lower authorities and submits that no interference is called for in this matter.

I have heard the rival contentions of both the parties and perused the material available on record. The solitary issue in the appeal relates to eligibility of interest on capital contribution made by the partners of the firm for deduction. The allowability of interest on capital contribution by the partner is governed by the provisions of section 40(b) of the Act. The said provision reads as under: - “40. …………………………. (a) …………………………… (b) in the case of any firm assessable as such,— (i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as "remuneration") to any partner who is not a working partner; or (ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorised by, or is not in accordance with, the terms of the partnership deed; or (iii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is authorised by, and is in accordance with, the terms of the partnership deed, but which relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorised by, Muthoot Bankers or is not in accordance with, any earlier partnership deed, so, however, that the period of authorisation for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed; or (iv) any payment of interest to any partner which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as such amount exceeds the amount calculated at the rate of twelve per cent simple interest per annum; or (v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder :— Rs. 1,50,000 or at the rate of 90 on the first Rs. 3,00,000 of the (a) per cent of the book-profit, book-profit or in case of a loss whichever is more; on the balance of the (b) at the rate of 60 per cent : book-profit Provided that in relation to any payment under this clause to the partner during the previous year relevant to the assessment year commencing on the 1st day of April, 1993, the terms of the partnership deed may, at any time during the said previous year, provide for such payment. Explanation 1.—Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as "partner in a representative capacity" and "person so represented", respectively),— (i) interest paid by the firm to such individual otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of this clause; (ii) interest paid by the firm to such individual as partner in a representative capacity and interest paid by the firm to the person so represented shall be taken into account for the purposes of this clause. Explanation 2.—Where an individual is a partner in a firm otherwise than as partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf, or for the benefit, of any other person. Explanation 3.—For the purposes of this clause, "book-profit" means the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.

A mere perusal of the above provisions it is crystal clear that the payment of interest, when authorised by the partnership deed and the rate of interest does not exceed 18%, the same should be allowed as deduction. The provisions of section 40(b) does not lay down that it would be utilised for the purpose of business. In any event from a reading of the assessment order it is crystal clear that the AO computed the income, which means that the assessee firm had commenced business activities. The fact that the capital introduced by the partners had not utilised in business has no relevance in deciding the allowability or otherwise of the interest expenditure on capital contribution. The reasoning adopted by the lower authorities is illegal and unreasonable and, therefore, set aside. The AO is directed to allow interest on capital contribution u/s. 40(b) of the Act.

This assessee’s appeal stands partly allowed.