2017 (5) TMI 900 - AT - Income Tax

Advancing interest bearing funds to partnership firm on no interest - Reasonable nexus of business expediency - Held that - The factual position has not been disputed inasmuch as it is not disputed that the funds were invested in the capital of partnership firm and, therefore, the primary intention of assessee was to earn profits from the firm. The contention of assessee that since the profits from firm were exempt u/s 80-IC, therefore, it cannot be said that the investment was not made for the purposes of earning taxable income from firm is not correct because the main issue to be considered in the present scenario is as to how the receipts from firm would be taxable in the hands of assessee. Admittedly, the share of the profits derived from firm is exempt u/s 10(2A) in the hands of assessee and, therefore, to this extent proportionate disallowance can be made. However, interest and remuneration from firm would be taxable as business income in the hands of assessee and, therefore, interest paid on borrowed funds in this regard cannot be disallowed. The taxability of income in the hands of firm is not relevant while considering the nature of receipt in the hands of assessee. Therefore, the assessee s claim that it had not invested the money to earn any exempt income is not correct. The nature of profits in the hands of firm cannot be the decisive factor for considering the nature of profits in the hands of assessee. In view of above discussion, the Assessing Officer is directed to re-compute the disallowance. - Appeal of the assessee allowed for statistical purposes.

Issues:
1. Disallowance of interest on advances made to a partnership firm.
2. Rejection of claim based on lack of business expediency.
3. Applicability of judgments cited by the assessee.
4. Interpretation of taxability of income from the partnership firm.

Issue 1: Disallowance of interest on advances made to a partnership firm:
The appeal concerns an order by the Commissioner of Income Tax (Appeals) regarding the disallowance of interest claimed on borrowed funds by the assessee. The Assessing Officer noted that the assessee had advanced a significant sum to a partnership firm without charging any interest. The AO concluded that the funds diverted to the partnership concern without interest were not required for the assessee's business, leading to the disallowance of a proportionate amount of interest. The CIT(A) upheld this disallowance, prompting the assessee to appeal to the Tribunal.

Issue 2: Rejection of claim based on lack of business expediency:
The key point of contention was the business expediency of advancing interest-bearing funds to the partnership firm without charging interest. The CIT(A) rejected the claim due to the lack of a reasonable nexus between the advances and business exigency. However, it was acknowledged that the funds were invested in the capital of the firm to earn profits. The Tribunal noted that while the profits from the firm were exempt under section 80-I of the Act, interest and remuneration from the firm would be taxable as business income for the assessee. Therefore, the disallowance of interest paid on borrowed funds was deemed incorrect, and the Assessing Officer was directed to re-compute the disallowance.

Issue 3: Applicability of judgments cited by the assessee:
The assessee cited various judgments, including the case of S. A. Builders vs. CIT, to support their claim that no interest should be disallowed for advances to a sister concern made out of commercial expediency. However, the Tribunal focused on the specific circumstances of the case and the taxability of income from the partnership firm, ultimately directing a re-computation of the disallowance.

Issue 4: Interpretation of taxability of income from the partnership firm:
The Tribunal analyzed the taxability of income from the partnership firm in the hands of the assessee, emphasizing that the nature of profits in the firm does not dictate the tax treatment of income for the assessee. While profits from the firm were exempt under section 80-I of the Act, interest and remuneration from the firm would be taxable as business income for the assessee. This distinction was crucial in determining the correctness of the disallowance of interest on borrowed funds.

In conclusion, the Tribunal allowed the appeal for statistical purposes, directing a re-computation of the disallowance of interest. The judgment clarified the interplay between business expediency, taxability of income, and the appropriateness of disallowing interest on advances made to a partnership firm in the given context.

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