1970 (1) TMI 19 - HC - Income Tax

Interest on borrowed capital - deduction claimed in respect of the interest paid under section 10(2)(iii)

Summary

Issues:
1. Disallowance of interest on accounts transferred from Karachi in reassessment proceedings under section 34(1)(b) for the assessment years 1951-52 and 1952-53.
2. Allowability of interest charged to accounts transferred from Karachi as a deduction from the assessee's business income for the assessment years 1953-54 to 1958-59.

Analysis:
The judgment pertains to a reference under section 66(1) of the Indian Income-tax Act, 1922, involving transactions between two firms formed after the dissolution of a partnership firm. The key issue in the first part of the judgment concerns the disallowance of interest on accounts transferred from Karachi in reassessment proceedings for the years 1951-52 and 1952-53. The Income-tax Tribunal disallowed the interest deduction, asserting that the entries did not pertain to the business activity of the assessee-firm and were not for commercial consideration. However, the High Court disagreed, emphasizing that the entries were genuine and akin to "havala entries," creating a legitimate business asset. The court highlighted that the credits to the creditors were supported by a corresponding debit to the Karachi firm, constituting capital borrowed for the business and thus deductible under section 10(2)(iii).

Moving on to the second issue, the judgment addresses the allowability of interest charged to accounts transferred from Karachi as a deduction for the assessment years 1953-54 to 1958-59. The Tribunal had rejected the claim for deduction, stating that there was no business necessity for the transfer entries and that no asset was created. However, the High Court disagreed, emphasizing that the transactions were legitimate business activities. The court highlighted that the original creation of credits in favor of the creditors was supported by the corresponding debit to the Karachi firm, constituting capital borrowed for business purposes. Therefore, the interest charged to these accounts was deemed deductible under section 10(2)(iii) as it was part of the business operations.

In conclusion, the High Court answered the questions referred by the Tribunal in favor of the assessee-firm, allowing the deduction of interest on accounts transferred from Karachi as a legitimate business expense. The judgment clarifies the commercial nature of the transactions and the eligibility of the interest charges for deduction under the Income-tax Act.