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Tax Publishers Rajesh Madanmohan Chaudhary v. ITO [ITA No. 1119/Pun/2019, dt. 4-12-2020] : 2020 TaxPub(DT) 5137 (Pune-Trib.) Partner paying interest on overdrawn capital but not receiving interest on capital balance where there is a credit despite there being a clause for interest on the partnership deed -- Notional taxability thereof *Facts:* Assessee a partner in a handful of firms claimed a loss of Rs. 20.74 lakhs in this return. The loss has primarily risen from the interest paid to certain firms on the debit balances of the capital account of the assessee in those firms. It was also observed that there was one firm Sai Prestige Developments where the assessee had a credit balance of capital for Rs. 2 crores whose partnership deed also stipulated interest on capital at 12% p.a. This interest income was not offered on querying assessee's counter was -- "06. Interest on capital is deductible as provided in section 40(b)(iv). Though the partners get interest on capital if firm pays so and although it is called interest actually is appropriation of profit only and it will partake the character of business income. In case of partner who pays interest on excess withdrawals, for him it would be nothing but an expenditure to be claimed or loss to be allowed. Further section 40 starts with the heading "Amounts not deductible" meaning thereby certain amounts are not deducted fully or beyond a certain figure. Anything below that certain figure does not fall into disallowable category. As regards interest, it is provided that it would be deductible only if it is provided in the partnership firm. The section does not provide for mandatorily chargeable interest when the firm and its partners have consciously decided not to charge the same. Further the said deduction is to be allowed from the book profit of the firm. This presupposes that there should be book profits. If book profits are not there then such interest will not be allowed to the firm. The partners of the partnership firm can decide amongst themselves whether interest can be charged in a particular year or not. It cannot be thrust upon the firm. He placed his reliance in the case of Tulsa Ram Kanhaiyalal v. ITO (2008) 25 SOT 402 (Jodhpur) : 2008 TaxPub(DT) 2199 (Jod-Trib) wherein it was held that it is prerogative of firm whether to charge interest or not. He also enclosed an addendum signed by all partners about charging of interest in the firm M/s. Sai Prestige Developments for assessment year 2016-17." The assessing officer's allegation was assessee diverted his drawings into a single firm and thus did not get interest but paid interest and is claiming this accordingly he notionally added 12% interest on the credit balance and thus effectively negated the loss claimed by the assessee. On appeal Commissioner (Appeals) upheld the views of the assessing officer. On further appeal assessee's claim was there was no provision to notionally tax the interest on the capital account if the same was not paid by the firm on mutually agreed basis in the firm where he had a credit balance of capital. Held in favour of the assessee to tax interest on capital under section 28(v) in the hands of the partner it has to be received and there cannot be a notional addition and effectively the expenditure claimed by the assessee being disallowed was held to be incorrect.

Tax Publishers

Rajesh Madanmohan Chaudhary v. ITO [ITA No. 1119/Pun/2019, dt. 4-12-2020] : 2020 TaxPub(DT) 5137 (Pune-Trib.)

Partner paying interest on overdrawn capital but not receiving interest on capital balance where there is a credit despite there being a clause for interest on the partnership deed -- Notional taxability thereof

Facts:

Assessee a partner in a handful of firms claimed a loss of Rs. 20.74 lakhs in this return. The loss has primarily risen from the interest paid to certain firms on the debit balances of the capital account of the assessee in those firms. It was also observed that there was one firm Sai Prestige Developments where the assessee had a credit balance of capital for Rs. 2 crores whose partnership deed also stipulated interest on capital at 12% p.a. This interest income was not offered on querying assessee's counter was --

"06. Interest on capital is deductible as provided in section 40(b)(iv). Though the partners get interest on capital if firm pays so and although it is called interest actually is appropriation of profit only and it will partake the character of business income. In case of partner who pays interest on excess withdrawals, for him it would be nothing but an expenditure to be claimed or loss to be allowed. Further section 40 starts with the heading "Amounts not deductible" meaning thereby certain amounts are not deducted fully or beyond a certain figure. Anything below that certain figure does not fall into disallowable category. As regards interest, it is provided that it would be deductible only if it is provided in the partnership firm. The section does not provide for mandatorily chargeable interest when the firm and its partners have consciously decided not to charge the same. Further the said deduction is to be allowed from the book profit of the firm. This presupposes that there should be book profits. If book profits are not there then such interest will not be allowed to the firm. The partners of the partnership firm can decide amongst themselves whether interest can be charged in a particular year or not. It cannot be thrust upon the firm. He placed his reliance in the case of Tulsa Ram Kanhaiyalal v. ITO (2008) 25 SOT 402 (Jodhpur) : 2008 TaxPub(DT) 2199 (Jod-Trib) wherein it was held that it is prerogative of firm whether to charge interest or not. He also enclosed an addendum signed by all partners about charging of interest in the firm M/s. Sai Prestige Developments for assessment year 2016-17."

The assessing officer's allegation was assessee diverted his drawings into a single firm and thus did not get interest but paid interest and is claiming this accordingly he notionally added 12% interest on the credit balance and thus effectively negated the loss claimed by the assessee. On appeal Commissioner (Appeals) upheld the views of the assessing officer. On further appeal assessee's claim was there was no provision to notionally tax the interest on the capital account if the same was not paid by the firm on mutually agreed basis in the firm where he had a credit balance of capital.

Held in favour of the assessee to tax interest on capital under section 28(v) in the hands of the partner it has to be received and there cannot be a notional addition and effectively the expenditure claimed by the assessee being disallowed was held to be incorrect.