2010 (11) TMI 371 - AT - Income Tax

Addition - Interest on overdrawing - The overdrawing made by the partners have been charged with interest so much so it remains compensated - What has been paid to the partners is only the net interest after reducing the interest attributable to the overdrawing - In fact the AO has also recognized the system of accounting followed by the assessee to be cash - Held that - As per the decision of the Hon ble Kerala High Court reported in CIT vs. Muthoot Finance Corporation (22000 -TMI - 14562 - KERALA High Court) the Hon ble Tribunal has accepted the system of accounting followed by the appellant group concerns as cash system and held that the income can be recognized only when it is actually received. Interest payment to the partners - Since interest has been offered by the partner in his individual return and since there is no condition that interest has to be credited by the firm in the partners account the disallowance of interest paid of Rs. 3.27 crores was not warranted - Hence the opinion that since enhancement notice has not been issued in terms of s. 251(2) thereby not giving a reasonable opportunity of show cause to the assessee the enhancement is bad in law - As per the order of this Bench in ITA No. 595/Coch/2006 for the asst. yr. 2002-03 in respect of Muthoot Bankers vs. Asstt. CIT dt. 27th Sept. 2007 wherein at para 15 the Hon ble Bench held that the term expenditure in s. 40A(3) should not be given wild interpretation so as to adversely affect the assessee and therefore interest payment to the partners are not covered under s. 40A(3) - Therefore delete the disallowance made of Rs. 3.27 crores. Cash has been introduced on different dates - It is clear that the assessee had introduced a sum of Rs. 12.18 crores in his account with the assessee firm - The various sources of drawing made by him(partner - Shri George Jacob) from the firms viz. Muthoot Bankers and Muthoot Builders have been filed with the AO thereby the assessee s stand has been established - The genuiness of the credit remained satisfied - The AO has not attempted to verify such explanation of the assessee - Since the firms Muthoot Bankers and Muthoot Builders were already assessed at Trivandrum these facts could have been easily verified by the AO - Therefore we are of the opinion that addition made on this score cannot be sustained and accordingly it is deleted. Keyman insurance policy premium - As per the case of Bombay High Court in the case of CIT vs. B.N. Exports (2010 -TMI - 76319 - BOMBAY HIGH COURT) wherein their Lordships have held that under a keyman insurance policy the firm has not taken insurance for the personal benefit of the partner but for the benefit of the firm in order to protect itself against setback that may be caused on account of the death of the partner and therefore insurance premium is deductible - Held that keyman insurance policy premium on the life of the partners is an allowable deduction.

Summary

Issues Involved:
1. Addition of interest charged on excess drawings of partners.
2. Disallowance of interest paid to a partner.
3. Addition under section 68 of the Income Tax Act.
4. Disallowance of keyman insurance policy premium.

Issue-wise Detailed Analysis:

1. Addition of Interest Charged on Excess Drawings of Partners:
The assessee contested the addition of Rs. 19,90,753 as interest on excess drawings by partners, arguing that the firm follows a cash system of accounting where interest is recognized on actual payment or receipt. The AO and CIT(A) justified the addition, stating that the partnership deed should provide for interest on excess drawings and that the firm should be compensated for interest-bearing funds diverted by partners. However, the Tribunal found that interest was charged on overdrawings and that the cash system of accounting was accepted by the AO. The Tribunal deleted the addition, supporting the assessee's method of recognizing interest only upon actual receipt.

2. Disallowance of Interest Paid to a Partner:
The AO disallowed Rs. 3.27 crores paid as interest to a partner, doubting its genuineness since it was not credited to the partner's drawings account and was allegedly not disclosed in the partner's return. The CIT(A) confirmed the disallowance, suggesting the transaction was fictitious and invoking sections 40A(3) and 40(a)(ia). The Tribunal, however, found that the interest was shown in the partner's return and that the provisions of sections 40A(3) and 40(a)(ia) were not applicable. The Tribunal deleted the disallowance, emphasizing that the interest was indeed disclosed and paid directly.

3. Addition under Section 68 of the Income Tax Act:
The AO added Rs. 12.18 crores introduced in a partner's current account as unexplained income under section 68. The assessee explained that the funds were drawn from other firms where the partner was also a partner, providing detailed sources. The CIT(A) upheld the addition due to lack of confirmations. The Tribunal found that the assessee had satisfactorily explained the sources and that the AO did not verify the details. The Tribunal deleted the addition, recognizing the genuineness of the transactions.

4. Disallowance of Keyman Insurance Policy Premium:
The AO disallowed Rs. 61,29,162 paid as keyman insurance premium for a partner, arguing that keyman insurance should be for employees, not owners. The CIT(A) supported this view, stating that the claim was not allowable under sections 36(ib) or 40A(b)(iv). The Tribunal, however, held that keyman insurance includes partners and is for the firm's benefit. Citing the Bombay High Court's decision in CIT vs. B.N. Exports, the Tribunal allowed the deduction, recognizing the premium as a legitimate business expense.

Conclusion:
The Tribunal allowed the appeal filed by the assessee, deleting the additions and disallowances made by the AO and CIT(A). The stay petition was dismissed as infructuous.