1983 (10) TMI 293 - AT - Income Tax

Summary

Issues Involved:
1. Disallowance of interest payment under Section 36(1)(iii) of the Income-tax Act, 1961.
2. Nexus between borrowings and withdrawals by partners.
3. Applicability of case laws cited by both parties.
4. Treatment of partners' capital withdrawals and their impact on interest deduction.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Payment under Section 36(1)(iii):
The assessee's appeal pertains to the disallowance of Rs. 60,475 out of the interest payment claimed as a deduction under Section 36(1)(iii) of the Income-tax Act, 1961. The Income Tax Officer (ITO) found that the borrowed sums of Rs. 3 lakhs and Rs. 77,000 were not utilized for business purposes but were withdrawn by the partners. Relying on the provisions of Section 36(1)(iii), which permits deduction of interest on capital borrowed for business purposes, the ITO disallowed the interest attributable to these borrowings.

2. Nexus Between Borrowings and Withdrawals by Partners:
The Commissioner (Appeals) upheld the ITO's disallowance, noting a direct nexus between the borrowings from Mansukhlal Investment and the withdrawals by the partners on the same date. The Commissioner emphasized that Section 36(1)(iii) does not allow deduction for interest on amounts borrowed but not used for business purposes. The Commissioner also distinguished the facts of the present case from the case of Kishinchand Chellaram v. CIT [1978] 114 ITR 654, which was cited by the assessee.

3. Applicability of Case Laws Cited by Both Parties:
The assessee argued that the withdrawals by the partners did not reduce the firm's finances and relied on the Bombay High Court's decisions in Kishinchand Chellaram v. CIT and CIT v. Bombay Samachar Ltd. The assessee contended that the partners' withdrawals were akin to depositors withdrawing their funds, and such withdrawals should not affect the interest deduction. The Commissioner (Appeals) relied on the decisions in Milapchand R. Shah v. CIT [1965] 58 ITR 525 (Mad.), Roopchand Chabildass & Sons v. CIT [1967] 63 ITR 166 (Mad.), and CIT v. United Breweries [1973] 89 ITR 17 (Mys.), supporting the disallowance.

4. Treatment of Partners' Capital Withdrawals and Their Impact on Interest Deduction:
The Tribunal considered whether partners could withdraw capital from borrowed funds and if the interest on such borrowings could be disallowed. The Tribunal noted that the partners had withdrawn their capital, resulting in nominal credit/debit balances in their accounts. The Tribunal emphasized that there is no bar against partners withdrawing their capital, and such withdrawals do not necessarily mean the borrowings were not for business purposes. The Tribunal referred to Kishinchand Chellaram's case, which allowed interest deduction to the extent of credit balances in partners' accounts. The Tribunal concluded that the disallowance of interest was not justified, as the partners' withdrawals were matched by borrowings from a third party, and the overall financial position of the firm remained constant.

Conclusion:
The Tribunal allowed the appeal, holding that the disallowance of interest was not warranted except for nominal overdrawings by two partners. The Tribunal found that the partners' withdrawals were within their credit balances and did not affect the firm's overall financial position. Therefore, the interest on borrowings was deductible under Section 36(1)(iii) of the Income-tax Act, 1961.