2014 (6) TMI 1067 - AT - Income Tax

Disallowing the Interest paid to bank on notional basis being the amount Used by one of the partners - nexus between the withdrawals by Partner and usage of borrowed funds - AO noted that Partner had used borrowed funds for his personal use by withdrawing capital from firm s funds and interest on the said borrowed capital used for personal purpose by way of withdrawal by Shri Kanwal Khurana, partner was disallowed - case of the revenue was that the interest bearing funds were used by the assessee to advance interest free funds to one of the partners who in-turn had utilized the same for personal purposes - HELD THAT - The cumulative capital balance of the partner is negative figure. Consequently, the precedent relied upon by the ld. AR for the assessee is not applicable to the facts of the present case where one of the partner has overdrawn his capital which is over and above the cumulative capital balance (credit) of the other partners and where the assessee had borrowed interest bearing funds, then it cannot be held that there was no diversion of funds for non-business purposes. In view thereof, we hold that the interest relatable to such capital balances over drawn by the partner Shri Kanwal Khurana is to be considered for computing the disallowance of interest under section 36(1)(iii) of the Act. Assessing Officer is directed to recompute the interest expenditure relatable to such amounts by taking the day to day balance of all the three partners and also by ignoring the profits credited to the partners capital account at the close of the year. The Assessing Officer shall afford reasonable opportunity of hearing to the assessee and recompute the disallowance in the hands of the assessee in accordance with our directions. The ground of appeal raised by the assessee is thus, allowed for statistical purposes.

Summary

Issues:
1. Disallowance of interest paid to the bank on a notional basis.
2. Calculation of notional interest on an arbitrary basis.
3. Disallowance of interest expenditure in the hands of the assessee due to partner's negative capital balance.
4. Applicability of previous Tribunal rulings on diversion of funds for non-business purposes.
5. Recomputation of interest expenditure and directions to the Assessing Officer.
6. Challenge against the percentage rate applied for calculating notional interest.

Analysis:
1. The first issue revolves around the disallowance of interest paid to the bank on a notional basis. The Assessing Officer disallowed the interest on borrowed funds used for personal purposes by one of the partners, resulting in an addition to the income of the assessee. The Commissioner of Income Tax (Appeals) upheld this decision, leading to the appeal by the assessee.

2. The second issue concerns the calculation of notional interest on an arbitrary basis without considering the actual percentage rate paid to the bank. The appellant contested this calculation method as erroneous.

3. The third issue involves the disallowance of interest expenditure in the hands of the assessee due to one partner having a negative capital balance and using borrowed funds for personal use. The Tribunal examined the partners' capital accounts and directed the Assessing Officer to recompute the disallowance based on the day-to-day balance of all partners.

4. The fourth issue addresses the applicability of previous Tribunal rulings on diversion of funds for non-business purposes. The Tribunal differentiated the present case from past decisions based on the negative cumulative capital balance of the partner, leading to a different outcome.

5. The fifth issue focuses on the re-computation of interest expenditure and directions to the Assessing Officer for a fair assessment. The Tribunal allowed the appeal for statistical purposes, directing the Assessing Officer to adjust the disallowance based on specific guidelines.

6. The final issue challenges the percentage rate applied for calculating notional interest. The appellant raised this concern, but as no submissions were made during the hearing, the Tribunal dismissed this ground of appeal.

In conclusion, the Tribunal partly allowed the appeal, emphasizing the need for a meticulous re-computation of interest expenditure and providing clear directions to the Assessing Officer for a fair assessment.