1993 (10) TMI 314 - AT - Income Tax

Summary

Issues Involved:

1. Disallowance of interest on borrowed funds due to alleged diversion for non-business purposes.
2. Whether interest disallowance is justified for 22 days only.
3. Taxability of cash compensatory support.

Issue-Wise Detailed Analysis:

1. Disallowance of Interest on Borrowed Funds Due to Alleged Diversion for Non-Business Purposes:

The primary issue in these appeals is the disallowance of interest on the grounds that borrowed funds were diverted to partners for non-business purposes. The Assessing Officer disallowed interest for the assessment years 1985-86, 1986-87, and 1987-88, based on the nexus between the borrowed funds and the withdrawals made by partners. Specifically, a sum of Rs. 3,10,000 was transferred from the Allahabad Bank export loan account to the current account, and Rs. 1,39,263 each was withdrawn by two partners, Smt. Satyawati Garg and Ch. Atul Kumar Garg. The disallowance was made only for Smt. Satyawati Garg due to her debit balance, while no disallowance was made for Ch. Atul Kumar Garg due to his credit balance. The Commissioner of Income-tax (Appeals) partially upheld the disallowance, directing further examination of the nexus and limiting disallowance to the period of withdrawal to repayment.

The Third Member, Ch. G. Krishnamurthy, concluded that the withdrawals by partners with credit balances do not constitute non-business purposes. He emphasized that partners are entitled to withdraw from their credit balances, and such withdrawals should not be construed as diversion of borrowed funds for non-business purposes. The firm had sufficient credit balances from other partners, and the withdrawal by Smt. Satyawati Garg was allowed with mutual consent, implying it was from the partners' capital rather than borrowed funds.

2. Whether Interest Disallowance is Justified for 22 Days Only:

The assessee contended that the interest disallowance should be limited to 22 days, the period between the withdrawal and repayment of the borrowed amount. The Commissioner of Income-tax (Appeals) had directed the Assessing Officer to restrict disallowance to this period. However, the Accountant Member found the claim of the assessee that the loan was utilized for 22 days only to be misplaced and without merit. The Judicial Member, on the other hand, accepted the alternate contention, stating that the disallowance of interest should be limited to 22 days based on the bank statements provided.

The Third Member did not find it necessary to address this issue separately, as he concluded that no disallowance was warranted in the first place due to the sufficient credit balances of the partners.

3. Taxability of Cash Compensatory Support:

Another common ground raised in the appeals was the taxability of cash compensatory support. In light of retrospective amendments, the cash compensatory support was deemed liable to tax. Therefore, this ground of appeal raised by the assessee was dismissed for all three years.

Conclusion:

The appeals were partly allowed, with the Third Member concluding that the disallowance of interest on borrowed funds was not warranted due to the sufficient credit balances of the partners. The taxability of cash compensatory support was upheld, and the appeals were dismissed on this ground. The matter was referred back to the regular Bench for disposal in accordance with the majority opinion.