1965 (8) TMI 7 - HC - Income Tax

Deduction under s. 10(2)(iii) or 12(2)- It cannot be said that the interest debited in the partners accounts of the firm could be regarded as expenditure solely for the purpose of earning any dividend on the shares allotted to them by the company - deduction not allowed

Summary

Issues Involved:
1. Disallowance of interest payments by the firm.
2. Deduction of interest payments in the individual assessments of partners.

Detailed Analysis:

1. Disallowance of Interest Payments by the Firm
The primary issue in this case revolves around the disallowance of interest payments claimed by the assessee-firm for the assessment years 1958-59 and 1959-60. The firm, Messrs. Roopchand Chabildass & Sons, transferred its flour mills business to a limited company in 1954. The consideration for this transfer was satisfied by the allotment of shares in the company, which were credited to the partners' accounts. The firm claimed interest payments amounting to Rs. 86,152 and Rs. 86,325 for the respective assessment years. However, the Income-tax Officer disallowed Rs. 76,675 and Rs. 74,496, respectively, on the grounds that the borrowings were diverted for non-business purposes, such as payment of income-tax on behalf of the partners and advances to another firm, Sangali firm, which was not in the course of the business of the assessee-firm.

The Tribunal confirmed the findings of the Appellate Assistant Commissioner, noting that the borrowed money was not used for any business activity post the transfer of the flour mill business. Instead, substantial amounts were diverted to the partners' accounts to pay income-tax and meet liabilities of the Sangali firm. The Tribunal observed that the firm's business activities had ceased, and the borrowed money was not utilized for business purposes, thus justifying the disallowance of interest payments.

2. Deduction of Interest Payments in Individual Assessments of Partners
The partners, in their individual assessments, claimed deductions of interest payments amounting to Rs. 38,338 each, under sections 10(2)(iii) or 12(2) of the Indian Income-tax Act. This claim was contingent on the disallowance of the firm's interest payments. The Tribunal, however, rejected this claim, stating that the partners utilized the firm's borrowed capital for personal purposes, such as purchasing shares in the South India Flour Mills Ltd., and not for any business activity. The Tribunal emphasized that the partners were not charged interest for the amounts advanced to them by the firm, and these transactions did not constitute "capital borrowed for the purpose of the business."

The court reiterated that for a deduction under section 12(2), the expenditure must be incurred solely for the purpose of earning income, must not be capital or personal expenditure, and must be incurred in the relevant accounting year. The partners' advances for purchasing shares were personal expenses and did not meet these criteria. Therefore, the interest debited in the partners' accounts could not be regarded as expenditure solely for earning dividends on the shares.

Conclusion:
The court concluded that the assessee-firm was not entitled to claim a deduction of interest for the period in question, as the borrowed capital was not utilized for business purposes. Similarly, the partners were not entitled to claim deductions in their individual capacities, as the advances were for personal purposes and not for earning income for the firm. All references were answered in favor of the department, with costs awarded against the assessees.