2007 (6) TMI 275 - AT - Income Tax

Summary

Issues Involved:

1. Whether the Assessing Officer (AO) was justified in recomputing the capital balances of partners by reducing depreciation.
2. Whether the AO was justified in disallowing the interest claimed by the assessee u/s 40(b) of the IT Act.
3. Whether the AO was justified in making an addition towards the interest receivable from the partners.

Summary:

Issue 1: Recomputing Capital Balances by Reducing Depreciation

The assessee firm, engaged in running a nursing home, declared taxable income for the assessment years 2003-04 and 2004-05. The AO noticed that the assessee did not charge depreciation to the P&L account but claimed it in the computation of total income, which artificially increased the partners' capital accounts. The AO recomputed the capital balances by reducing the depreciation, resulting in debit balances and implying withdrawals from the capitals. The AO disallowed the interest payment to partners and added back the interest receivable from the partners as per the adjusted capital accounts. The CIT(A) upheld the AO's decision, stating that the capital balances reflected in the books were not in accordance with standard accountancy principles and needed correction.

Issue 2: Disallowing Interest Claimed u/s 40(b)

The assessee contended that the interest paid to partners should be based on the books of account maintained by the assessee, which consistently did not charge depreciation to the P&L account. However, the CIT(A) and the AO held that the assessee's method of not charging depreciation resulted in artificially inflated profits and capital balances, contrary to the mandatory provisions of the IT Act and accounting standards. The AO's action of disallowing the interest claimed u/s 40(b) was justified as it corrected the error and ensured the true and correct state of affairs of the partnership firm.

Issue 3: Addition Towards Interest Receivable from Partners

The AO added the interest receivable from the partners based on the recomputed capital balances. The CIT(A) supported this action, stating that the AO's verification of the correctness of the capital balances was necessary and justified. The Tribunal upheld the AO's decision, emphasizing that the assessee's method did not disclose true and proper income, and the AO was duty-bound to correct the mistakes in conformity with the standard method of accounting.

Conclusion:

The appeals filed by the assessee were dismissed, and the AO's actions of recomputing the capital balances, disallowing the interest claimed u/s 40(b), and adding the interest receivable from the partners were upheld as justified and in accordance with the law.