1980 (8) TMI 51 - HC - Income Tax

Summary

Issues Involved:
1. Interpretation of Section 67(3) of the Income-tax Act, 1961.
2. Allowability of interest deduction on capital borrowed by a partner for investment in the firm.
3. Utilization of borrowed funds by the firm for non-business purposes, specifically for payment of taxes.
4. Applicability of judicial precedents and legislative intent.

Issue-wise Detailed Analysis:

1. Interpretation of Section 67(3) of the Income-tax Act, 1961:
The primary issue was whether the interest of Rs. 1,44,000 paid by the assessee on capital borrowed for investment in the firm M/s. Soorajmull Nagarmull was an allowable deduction under Section 67(3) of the Income-tax Act, 1961. The section states: "Any interest paid by a partner on capital borrowed by him for the purposes of investment in the firm shall, in computing his income chargeable under the head 'Profits and gains of business or profession' in respect of his share in the income of the firm, be deducted from the share."

2. Allowability of Interest Deduction:
The Tribunal's majority held that the share income of a partner is stamped with the character of business income, and Section 67(3) permits deduction of interest on capital borrowed for investment in the firm, irrespective of how the firm utilizes the borrowed funds. They emphasized that the term "investment" should be interpreted broadly to include any laying out of money for profit, even if the funds are used by the firm for purposes like paying taxes. The Tribunal concluded that the interest paid by the partner on the borrowed capital was deductible in its entirety from his business income.

3. Utilization of Borrowed Funds:
The assessee had borrowed funds and advanced them to the firm, which utilized these funds to pay tax liabilities. The AAC had initially rejected the interest deduction, arguing that the borrowed amount was not used for business purposes. However, the Tribunal's majority found that the timely payment of reduced tax liability under the voluntary disclosure scheme was a considerable advantage to the firm and hence to the partner. They concluded that the borrowed funds were indeed used for a legitimate purpose, benefiting the firm commercially and financially.

4. Applicability of Judicial Precedents and Legislative Intent:
The Tribunal referred to various judicial precedents and the legislative history of Section 67(3). They noted that the section was introduced to allow interest on borrowed capital for investment in the firm, similar to the allowance under Section 10(2)(iii) of the Indian I.T. Act, 1922. The Tribunal cited the case of CIT v. C. L. Bajoria, where it was held that interest on borrowed capital used for paying the firm's taxes was deductible. They distinguished this case from Mannalal Ratanlal v. CIT, where the interest on borrowed money for paying personal tax dues was not allowed as a deduction.

The Tribunal also considered the broader principles of partnership law and income tax law, emphasizing that a firm and its partners are distinct assessable entities. They concluded that the interest paid by the partner on borrowed capital, even if used by the firm for paying taxes, was deductible under Section 67(3).

Conclusion:
The High Court affirmed the Tribunal's majority view, holding that the interest of Rs. 1,44,000 was an allowable deduction under Section 67(3). The court emphasized that the borrowed capital need not be invested as capital in the firm but should be capital borrowed by the partner for investment in the firm. The court distinguished the present case from precedents where interest on borrowed money for personal tax payments was not allowed. The judgment concluded that the interest deduction was justified, benefiting the assessee. Each party was directed to bear its own costs.