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2023 (1) TMI 321 - AT - Income TaxDisallowance of interest on account of excess payment to the partners on the capital account - AO has calculated the interest @ 12% on the closing balance in the partner s capital account as on 31st March 2011 - HELD THAT - The partnership deed provides payment of interest @ 12% per annum or any rate applicable as per the provisions of section 40(b)(iv) of the Income Tax Act. It further provides that such interests shall be calculated and credited to the account of the each partner at the close of the accounting year which means that the interest will be credited only at the end of the accounting year / financial year and does not mean that the interest will be calculated on the credit balance in the capital account at the end of the accounting year. Even otherwise the interests on the credit balance in the capital account has to be calculated on the actual duration of the credit remains in the capital account and not on opening or closing day of financial year. In such a case if a partner keeps a credit balance on the opening day but subsequently withdraws the amount then payment of interest on the opening balance will not be proper and justified. Similarly if the partner withdraws the amount at the fag end of the financial year then the payment of interest only on the closing balance would also be not proper and justified when a credit balance remained for the whole financial year except on the last date of financial year. Therefore the approach of the AO in calculating the interest by considering only the closing balance as on the end of the financial year is not proper and justified. Accordingly so far as the interest calculated by the assessee firm on daily product basis is concerned the same is proper and justified. Since the method of calculating the interest by the assessee is a proper and consistently followed year after year therefore the same cannot be disturbed for the year under consideration. Accordingly the disallowance made by the AO on account of excess payment of interest to the partners is deleted. The ground no. 1 to 7 of the assessee s appeal are allowed. TDS u/s 194A - Disallowance of interest paid to the legal heirs of the deceased partners - AO disallowed the claim of interest payment to the legal heirs of the deceased partners considering the entries made on 31st March 2011 - HELD THAT - CIT(A) observed in the impugned order that this payment of interest to the legal heirs does not fall under section 40(b)(iv) and it can be considered under section 36(1)(iii) or section 37 of the Income Tax Act. Since the CIT(A) has no jurisdiction to remand the matter therefore the impugned order of the CIT(A) qua this issue is not inconformity with provisions of section 250 and 251 of the Income Tax Act. AO has made the disallowance by considering the entries made on 31st March 2011 without considering the fact that after the death of the partner of the firm this amount ceases to be the credit in the capital account of the partner and consequently takes the character of loan from the deceased partner / legal heirs of the deceased partner. The capital introduced by a partner of the partnership firm is always for business purposes and it is not an amount which is kept with the partnership firm only for earning the interest because it was also the need of the partnership firm for doing the business by utilizing the said amount. Accordingly the claim of interest paid to the legal heirs on this amount which is in the nature of loan and the interest was already subjected to TDS u/s 194A the same cannot be disallowed merely on the ground of passing an entry on 31st March 2011 or on the ground that it is not an loan amount. Accordingly the impugned order of the CIT(A) is modified and the matter is remanded to the record of the Assessing Officer for readjudication of this issue as per law.
Issues Involved:
1. Disallowance of interest on capital of Rs. 3,27,465. 2. Direction to verify the legal heir status of the new partner. 3. Disallowance of interest paid to the legal heirs of the deceased partner. Issue-wise Detailed Analysis: 1. Disallowance of Interest on Capital of Rs. 3,27,465: The assessee, a partnership firm, challenged the disallowance made by the Assessing Officer (AO) of Rs. 3,27,465 on account of excess payment of interest on the capital account of the partners. The AO recalculated the interest based on the closing balance as on 31st March 2011, contrary to the assessee's method of calculating interest on a daily product basis. The AO's interpretation of Clause 6 of the partnership deed was that interest should be calculated on the closing balance at the end of the accounting year. The Tribunal found that the partnership deed allowed interest @ 12% per annum on the amount outstanding to the credit of the partners' accounts, and this interest should be calculated based on the actual duration of the credit balance, not just the closing balance. The Tribunal held that the method followed by the assessee was proper and consistently applied over the years. Therefore, the disallowance made by the AO was deleted, and the grounds raised by the assessee on this issue were allowed. 2. Direction to Verify Legal Heir Status of New Partner: The CIT(A) directed the AO to verify whether the new partner, Sh. Devaang Savla, was the legal heir of the deceased partner, Sh. Chetan Savla, and to give relief accordingly. The Tribunal noted that Sh. Devaang Savla was not a legal heir of the deceased partner but was the son of another partner, Sh. Tarun Savla. The Tribunal found this direction of the CIT(A) to be without basis and contrary to the facts. Therefore, this direction was deemed unnecessary. 3. Disallowance of Interest Paid to Legal Heirs of Deceased Partner: The AO disallowed the interest payment of Rs. 5,81,781 to the legal heirs of the deceased partner, Sh. Chetan Savla, arguing that the interest could only be allowed as a deduction on borrowed capital under Section 36(1)(iii) of the Income Tax Act, and not under Section 40(b) after the partner's death. The Tribunal observed that once the partner expired, the credit balance in the capital account should be treated as a loan, and the interest on such a loan is an allowable deduction. The CIT(A) had remanded the matter to the AO for verification, which was beyond the CIT(A)'s jurisdiction. The Tribunal modified the CIT(A)'s order and remanded the issue back to the AO for readjudication, considering the amount as a loan from the deceased partner's legal heirs and allowing the interest deduction accordingly. Conclusion: The appeal of the assessee was partly allowed. The Tribunal deleted the disallowance of Rs. 3,27,465 for excess interest on the capital account and remanded the issue of interest paid to the legal heirs of the deceased partner back to the AO for reconsideration. The direction to verify the legal heir status of the new partner was found unnecessary. The order was pronounced in open court on 06.01.2023 at Allahabad, U.P.
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