2006 (3) TMI 533 - AT - Income Tax

Interest on borrowed capital, Share of profits to partner of firm, Losses - Set off and carry forward of, registered firms

Summary

Issues Involved:
1. Entitlement to claim interest payment on borrowed capital invested in a partnership firm.
2. Allowability of interest payment under different heads of income.
3. Applicability of Section 10(2A) and Section 14A of the Income-tax Act.
4. Treatment of share of profit and loss from a partnership firm.
5. Set-off and carry forward of losses in the hands of the partner.

Issue-wise Detailed Analysis:

1. Entitlement to Claim Interest Payment on Borrowed Capital:
The primary issue was whether the assessee could claim interest payment on borrowed capital invested in a partnership firm, where the share of profits from the firm is exempt under Section 10(2A). The assessee argued that the interest should be deductible under the head "Income from profits and gains of business/profession" despite showing it under "Other sources" in the return. The Assessing Officer disallowed the interest payment on the grounds that it was not related to earning any interest and the share income from the firm is exempt under Section 10(2A).

2. Allowability of Interest Payment under Different Heads of Income:
The assessee relied on the Supreme Court decision in Rajasthan State Warehousing Corpn. v. CIT, which allows deduction of expenditure under a head irrespective of whether there is positive income under that head. However, the Tribunal noted that expenditure incurred to earn income under one head cannot be allowed under another head. The Tribunal emphasized that the expenditure must be related to the income it aims to earn, and there is no transgression of heads for allowing an expenditure.

3. Applicability of Section 10(2A) and Section 14A:
Section 10(2A) exempts the share of profit from the partnership firm from being included in the partner's total income. The Tribunal clarified that Section 10(2A) applies only to positive income and not to losses. Section 14A, introduced retrospectively from 1-4-1962, disallows expenditure incurred in earning exempt income. The Tribunal concluded that Section 14A could be invoked to disallow the interest payment as it was incurred to earn exempt income.

4. Treatment of Share of Profit and Loss from a Partnership Firm:
The Tribunal held that "income" includes "loss" and that the share of loss from the firm cannot be set off against other income of the partner. The Tribunal cited several Supreme Court decisions, including CIT v. Hariprasad & Co. (P.) Ltd., to support this view. It was noted that the loss from a partnership firm should be treated as a normal business loss and not exempt under Section 10(2A).

5. Set-off and Carry Forward of Losses in the Hands of the Partner:
The Tribunal observed that losses from the firm could not be set off against the partner's other income or carried forward. This is because the amended Section 75 provides that only the firm can set off and carry forward losses. The Tribunal also referred to Circular No. 703, which clarifies that unabsorbed losses brought back to the firm can be set off against the firm's income.

Conclusion:
The Tribunal concluded that:
- Section 10(2A) applies only when the firm has a positive profit.
- Only the firm can set off and carry forward losses.
- Expenditure incurred by the partner cannot be allowed as a deduction if it relates to exempt income.
- If a partner receives salary, bonus, commission, or interest from the firm, which is allowed as a deduction in the firm's hands, the partner can claim the related expenditure.

Remand:
The matter was remanded to the Assessing Officer to decide the allowability of interest paid on borrowed funds invested in the firm, considering whether the partner received any salary, bonus, commission, or interest from the firm. The ground of the assessee was allowed for statistical purposes.