1991 (7) TMI 1 - SC - Income Tax

On partition of HUF, members of that family continued business as partners - Whether the assessee was entitled to the deduction of interest on the debit balance of Rs. 1,75,310 taken over from the erstwhile HUF - rights of the assessee - claim of the assessee for allowable deduction of the interest paid cannot be defeated by the existence of personal liability of the members of the Hindu undivided family - assessee s appeal is allowed

Summary

Issues:
- Allowability of interest paid on debit balance taken over by the assessee-firm from the erstwhile Hindu undivided family under section 36(1)(iii) of the Income-tax Act, 1922.

Analysis:
The case involved a question regarding the deduction of interest on a debit balance of Rs. 1,75,310 taken over by an assessee-firm from the former Hindu undivided family. The firm contended that the debit balance was acquired in exchange for the goodwill of the business. The Appellate Assistant Commissioner initially held that the family business had no goodwill, but the Tribunal disagreed, considering the family's long-standing successful business history. The Tribunal opined that the firm assumed the liability in exchange for the goodwill, making the interest payment deductible.

The High Court scrutinized the absence of any transaction related to the sale of goodwill between the family and the firm. It emphasized that the partners were obligated to assume the family's liability upon partition, irrespective of any goodwill consideration. Section 36(1)(iii) allows deduction of interest on borrowed capital for business purposes, including if used to purchase goodwill. The Tribunal linked the debit balance to goodwill purchase due to the business takeover. However, the High Court found no evidence of goodwill sale, as reflected by the family's accounts. It also highlighted that the firm's obligation stemmed from the family's debt, not goodwill purchase.

The Supreme Court disagreed with the High Court's reasoning. It clarified that the focus should be on the firm's rights, not individual family members' liabilities. The existence of personal liabilities within the family did not negate the firm's claim for interest deduction. The Court overturned the High Court's decision, ruling in favor of the assessee and against the Revenue. Consequently, the appeals were allowed, the High Court's decision was set aside, and costs were awarded to the assessee.

In conclusion, the Supreme Court determined that the interest paid on the debit balance taken over by the assessee-firm was an allowable deduction under section 36(1)(iii) of the Income-tax Act, 1922, rejecting the High Court's contrary ruling and emphasizing the firm's rights over individual family members' liabilities.