2021 (8) TMI 202 - AT - Income Tax

Disallowance towards interest u/s.36(1)(iii) in the hands of partner - interest paid on borrowed funds - as per revenue since assessee was not receiving any interest income from the capital contribution made in the partnership firm, the only income that would be received by the assessee would be share of profit from the partnership firm which would be exempt from tax and hence, interest paid on borrowed funds is not eligible for deduction u/s.36(i)(iii) - HELD THAT - We are unable to persuade ourselves to accept to this proposition there is absolutely no nexus of borrowed funds being used for investment in capital contribution of partnership firm which is brought on record by the lower authorities. We hold that there cannot be any assumption / presumption that only borrowed funds were used for making investment in capital contribution of partnership firm, unless there is mixed funds (i.e borrowed funds and own funds inextricably mixed in the same bank account). In any case, there is no dispute that assessee is a partner in Ambhe Properties (firm) - it is a duty of the assessee in the capacity of a partner to pump in sufficient capital contribution for the smooth running of the business of the partnership firm. This investment is to be considered as an investment made as a measure of commercial expediency. Obviously, the amount contributed by the partner would be certainly a business investment and would be for business purposes. Even if the funds required for the said contribution were received out of borrowed funds, still the business purpose of making the investment and business purpose of utilisation of borrowed funds thereon is proved beyond doubt and cannot be doubted at all. For the purpose of allowability of interest on borrowed funds u/s.36(1)(iii) of the Act, what is required is only whether the borrowed funds have been used by the assessee for the purpose of business. It is totally irrelevant and immaterial whether any return on investment has been received in the form of taxable income or exempt income by the assessee out of utilisation of such borrowed funds. As already held hereinabove that amount invested in partnership firm by the assessee partner is certainly for business purpose and hence, there cannot be any disallowance of interest u/s.36(1)(iii) of the Act. In view of the aforesaid observations, the grounds raised by the assessee are allowed.

Summary

Issues involved:
Disallowance of interest under section 36(1)(iii) of the Income Tax Act, 1961.

Detailed Analysis:

1. Background:
The appeal in ITA No.6435/Mum/2018 for A.Y.2014-15 arises from the order by the ld. Commissioner of Income Tax (Appeals)-24, Mumbai against the order of assessment passed by the ld. Asst. Commissioner of Income Tax 27(1), Mumbai.

2. The Issue:
The main issue in this appeal is whether the disallowance of ?19,10,536/- towards interest under section 36(1)(iii) of the Act was justified.

3. Facts and Findings:
The assessee, an individual engaged in trading, had debited interest paid on bank loans and unsecured loans in the return of income for A.Y.2014-15. The ld. AO observed the capital account balance with a partnership firm where the assessee is a partner and questioned the interest paid on loans in relation to the capital contribution in the partnership firm.

4. Disallowance Basis:
The ld. AO presumed that borrowed funds were used for the investment in the partnership firm without establishing a clear nexus. Consequently, the interest paid on unsecured loans was disallowed under section 36(1)(iii) of the Act.

5. Argument and Decision:
The ld. DR contended that since the assessee did not receive interest income from the partnership firm, the interest on borrowed funds should not be deductible under section 36(1)(iii). However, the Tribunal rejected this argument based on the following reasons:
a) No clear nexus of borrowed funds with the investment in the partnership firm was established.
b) The capital contribution in the partnership firm was for business purposes, even if funded by borrowed funds.
c) The utilization of borrowed funds for business purposes is crucial for the allowability of interest deduction under section 36(1)(iii).

6. Legal Precedents:
The Tribunal relied on various legal precedents such as decisions of Andhra Pradesh High Court, Calcutta High Court, and Supreme Court to support its conclusion that interest on borrowed funds used for business purposes is allowable, irrespective of the return on investment.

7. Tribunal's Decision:
The Tribunal held that the investment in the partnership firm was for business purposes, and hence, disallowance of interest under section 36(1)(iii) was not warranted. Consequently, the appeal of the assessee was allowed.

8. Conclusion:
The Tribunal pronounced the order on 22/06/2021, ruling in favor of the assessee and setting aside the disallowance of interest.