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2009 (4) TMI 544 - AT - Income TaxRevision order u/s 263 - claimed deduction for expenses inter alia, interest paid to partners - income by way of leave and licence rent under the head Profits and gains of business or profession - HELD THAT - We find that CIT(A) has recorded a categorical finding that the business was continuing though temporarily suspended which implies that the business was carried on by the assessee and income under the head profits and gains of business or profession was calculatable. Moreover, the revenue is aggrieved only against the granting of deduction on account of interest to partners and it has accepted the granting of deduction of other expenses including the administrative expenses, which has been obviously granted under the head Business income . Thus we do not find any reason for which the interest to partners cannot be allowed as deduction under the head Profits and gains of business or profession . By allowing this deduction it would mean that the loss under the head Business income would swell by the amount of interest to the partners. A bare perusal of Section 71(1) divulges that the loss incurred by an assessee under the head Profits and gains of business or profession shall be set off against the income under any other head, which also includes Income from other sources . We, therefore, uphold the impugned order on this score. In the result, the revenue s appeal is dismissed. Deduction being the interest paid to the partners on the capital contributed by them - interest paid to the partners on capital - utilized for the purpose of advancing loan to the parties from whom no interest was charged - Whether AO was justified in invoking the provisions of section 40A(2) - HELD THAT - In our considered opinion there is a basic fallacy in the opinion of CIT(A) for the reason that after the Finance Act, 1992 interest paid to the partners has been made as deductible subject to the limitations contained under section 40(b)(iv). With the insertion of non-obstante clause at the beginning of section 40, it has become clear that even if the expense is allowable under any of the sections 30 to 38, it will not be allowed as deduction if the conditions contained in section 40 are not fulfilled. The Hon ble Supreme Court in Munjal Sales Corpn. v. CIT 2008 (2) TMI 19 - SUPREME COURT has held so by further laying down that the assessee in the first instance is required to establish that it was entitled to claim deduction under section 36(1)(iii) and that it was not disentitled to claim such deduction on account of applicability of section 40(b)(iv). Therefore, the deductibility of interest to partners is primarily to be considered u/s 36(1)(iii) and if such interest is allowable then it has to be seen whether there is any disentitlement u/s 40(b). CIT(A) has misdirected himself in holding that section 40( b ) was a stand-alone provision and if the interest to partners is deductible as per the parameters laid down in clause ( iv ) of section 40( b ), then the same has to be allowed as deduction without considering the provisions of section 36(1)( iii ). We, therefore, do not approve the view taken by CIT(A) on this issue. If the interest has been paid at 12 per cent to the partners and the money is available in the market under similar circumstances at 8 per cent, then the differential rate of 4 per cent can be held as excessive u/s 40A(2). The co-relation of the funds contributed by the partners with the rate of interest on which the money is actually lent by the assessee, for making disallowance u/s 40A(2), is misconceived. We, therefore, hold that AO was not justified in invoking the provisions of section 40A(2). Scope of the power of the Tribunal u/s 254 - Whether disallowance made by AO under one section is not sustainable then is it permissible to sustain such disallowance under any other section - In our considered view there should not be any difficulty in answering this question as the power of the Tribunal extends to disallowing a particular deduction under one section if it is not disallowable under another section The Hon ble High Court in the case of Steel Containers Ltd. v. CIT 1974 (11) TMI 10 - CALCUTTA HIGH COURT has considered the scope of the power of the Tribunal u/s 254 in particular the power to pass such order on appeal as it thinks fit . The Hon ble High Court held that if for the reasons recorded by the departmental authority in respect of a contention raised by the assessee, grant of relief to him on another ground was justified, it would be open to the departmental authority and the Tribunal would be under a duty to grant that relief. Similarly if the disallowance of certain expenditure to an assessee was warranted by certain provisions of law where the allowance and disallowance were the subject-matter of the appeal, the Tribunal is competent u/s 254 to deal with that question and decide the same in accordance with law. Therefore, it was open to the Tribunal yet to sustain the disallowance partially u/s 37 . Thus it is clear that the Tribunal is empowered to consider the same disallowance made by AO under one section, if it is not sustainable under the section made by AO. Therefore, it is noted that though AO discussed the issue of availability of capital and other interest free funds vis-a-vis the amount given by loan without interest, yet he chose to make addition u/s 40A(2). CIT(A) erroneously took a view which is no more a valid law in the light of the judgment of the Hon ble Supreme Court in Munjal Sales Corpn. (supra) in which it has been held that the deductibility of interest to partners has to be proved u/s 36(1)(iii) and thereafter the question of applicability of section 40(b) arises. Under these circumstances we are of the considered opinion that it will be just and fair if the impugned order on this issue is set aside and the matter is restored to the file of AO. We order, accordingly, and direct him to verify the nature and purpose of loan given by the assessee. If it is found that such loans were not used for the purpose of business, obviously the assessee will not be entitled to deduction on interest paid to the partners on their capital accounts and vice versa. Disallowance of interest - Ld Counsel for the assessee contended that if the order of CIT(A) is reversed and interest paid to partners is held to be not deductible, in that case a direction may be given that the income of the partners be adjusted, accordingly, in accordance with the proviso to section 28( v ) - HELD THAT - We find that the proviso to section 28( v ) applies in a case where interest, salary etc., is received by partner of a firm and subsequently, due to operation of section 40( b ) deduction is not allowed. In such a case the income of the partners should be adjusted to the extent of the amount not so allowed to be deducted. Primarily we have not ordered for the confirmation of disallowance of interest as the matter has been sent back to AO. Moreover, the proviso to section 28( v ) is relevant in the assessment of the individual partners and it has no bearing in the assessment of the firm. We, therefore, hold that this ground is misconceived. If in the fresh proceedings, AO makes the disallowance of interest, the partners are entitled to take remedial action as per the provisions of law. In the result, the appeal of the revenue is allowed for statistical purposes and the C.O. of the assessee is dismissed.
Issues Involved:
1. Deduction of interest to partners (Assessment Year 2001-02 and 2005-06). 2. Classification of rental income (Assessment Year 2001-02). 3. Set-off of business loss against income from other sources (Assessment Year 2001-02). 4. Applicability of Section 40A(2) for disallowance of interest (Assessment Year 2005-06). 5. Adjustment of partners' income if interest disallowed (Cross Objection for Assessment Year 2005-06). Detailed Analysis: 1. Deduction of Interest to Partners (Assessment Year 2001-02 and 2005-06): Assessment Year 2001-02: The primary issue was whether the interest paid to partners amounting to Rs. 6,50,236 was deductible. The CIT(A) allowed the deduction, considering the business was still continuing, albeit partially. The Tribunal upheld this decision, stating that the interest was deductible under the head "Profits and Gains of Business or Profession" and could be set off against "Income from Other Sources" under Section 71. The Tribunal rejected the Department's additional ground challenging the continuation of business, citing Rule 11 of the Income-tax (Appellate Tribunal) Rules, 1963, which allows raising additional grounds only if all necessary facts are on record. Assessment Year 2005-06: The Department contested the deduction of Rs. 2,76,392 paid as interest to partners, arguing that the capital was diverted to non-interest-bearing loans. The CIT(A) allowed the deduction, stating that Section 40(b) overrides Sections 30 to 38, and thus the interest was not disallowable under Section 36(1)(iii) or Section 37. The Tribunal, however, found this reasoning flawed, citing the Supreme Court's decision in Munjal Sales Corpn. v. CIT, which mandates proving the deductibility under Section 36(1)(iii) before considering Section 40(b). The Tribunal remanded the matter to the Assessing Officer to verify the nature and purpose of the loans. 2. Classification of Rental Income (Assessment Year 2001-02): The Assessing Officer classified the rental income of Rs. 16,70,000 under "Income from Other Sources" instead of "Profits and Gains of Business or Profession" or "Income from House Property," as the assessee was not the owner of the property and had no business income from textiles. The CIT(A) and the Tribunal upheld this classification, noting that the rental income did not involve any organized business activity. 3. Set-off of Business Loss Against Income from Other Sources (Assessment Year 2001-02): The Tribunal upheld the CIT(A)'s decision to allow the set-off of business loss, including the interest paid to partners, against the rental income classified under "Income from Other Sources," as per Section 71(1). The Tribunal emphasized that the interest to partners was deductible under "Profits and Gains of Business or Profession," thereby increasing the business loss, which could be set off against other income. 4. Applicability of Section 40A(2) for Disallowance of Interest (Assessment Year 2005-06): The Assessing Officer disallowed the interest under Section 40A(2), considering it excessive since the partners' capital was allegedly diverted to non-interest-bearing loans. The Tribunal disagreed, stating that Section 40A(2) applies only if the expenditure is excessive compared to the market rate. The Tribunal remanded the case to the Assessing Officer to verify if the loans were used for business purposes, which would justify the interest deduction under Section 36(1)(iii). 5. Adjustment of Partners' Income if Interest Disallowed (Cross Objection for Assessment Year 2005-06): The assessee's cross-objection sought adjustment of partners' income if the interest was disallowed. The Tribunal dismissed this, clarifying that the proviso to Section 28(v) applies to individual partners' assessments and not the firm's. The Tribunal noted that if the interest is disallowed upon remand, the partners could seek remedial action as per the law. Conclusion: The Tribunal upheld the CIT(A)'s decisions on several key points but remanded the issue of interest deduction for further verification. The classification of rental income and the set-off of business loss were affirmed, while the applicability of Section 40A(2) was rejected in favor of a detailed factual examination. The cross-objection regarding partners' income adjustment was dismissed as misconceived.
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