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TMI Blog2024 (1) TMI 413X X X X Extracts X X X X X X X X Extracts X X X X ..... imed depreciation on building. Loan from Punjab National Bank has been borrowed to settle the capital account of retiring partners. As we have already stated in our earlier part of this order, unless the firm settle the outgoing partners capital account, which is nothing but a debt of the firm business cannot be run smoothly, because, the entire business of the assessee is running a hotel. Therefore, in our considered view, any loan borrowed for the purpose of settling outgoing partners capital account which has been treated as debt in the books of accounts of the firm assumes the character of loan borrowed for the purpose of business of the assessee, and consequently, interest paid on borrowed capital account is allowable deduction u/s. 36(1)(iii) of the Act. Sole basis for the AO to disallow interest paid on partners capital account and loan borrowed from Punjab National Bank is on the ground that payment to outgoing partners is nothing but family settlement - AO and CIT(A) were completely erred in coming to the conclusion that reconstitution of partnership firm to retire partners and settle their account cannot be considered as family settlement, because, asset was br ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business of the assessee, any interest paid on said loan and capital account is nothing but interest paid on loan borrowed for the purpose of business of the assessee and allowable u/s. 36(1)(iii) - AO and the Ld.CIT(A) without appreciating the relevant facts simply disallowed interest paid on partners capital account and interest paid on loan from Bank. Therefore, we direct the AO to delete the additions made towards disallowance of interest u/s. 36(1)(iii) of the Act. Appeal filed by the assessee is allowed. - Shri Manjunatha. G, Accountant Member And Shri Manomohan Das, Judicial Member For the Appellant : Shri S. Sridhar, Advocate For the Respondent : Shri P. Sajit Kumar, JCIT ORDER PER MANJUNATHA. G, AM: This appeal filed by the assessee is directed against the order of the Commissioner of Income Tax (Appeals)-19, Chennai, dated 22.02.2022 and pertains to assessment year 2007-08. 2. The assessee has raised the following grounds of appeal: 1. The order of the CIT (Appeals) - 19, Chennai dated 22.02.2022 in DIN order No. ITBA/APL/M/250/2021-22/1039997859(l) for the above assessment year is contrary to law, facts, and in the circumstances ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isallowance in the computation of taxable total income. 12. The CIT(A) erred in terming the transaction as a family settlement as opposed to business settlement and ought to have appreciated that the purpose of reconstitution of the firm to bring about the dispute among the partners and to continue the business without any break which established the business motive of the transaction(s), thereby vitiating the related findings. 13. The CIT(A) failed to appreciate that there was no proper opportunity given before passing the impugned order and any order passed in violation of the principles of natural justice is nullity in law. 14. The Appellant craves leave to file additional grounds/arguments at the time of hearing. 3. The brief facts of the case are that the assessee is a partnership firm engaged in the business of running hotel under the name and style of Hotel President . The assessee s firm had its origin to 1975 with the incorporation of partnership firm M/s.Ariff Co., on 18.12.1974 with 5 partners consisting of Shri R.Ariff, Smt.A.Meherunneesa, Smt.A. Hameeda Banu, Shri A.Sheik Allauddin Shri A. Asan Mohammad. The partnership firm was reconstitute ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re, the assessee submitted that interest paid on capital account of partner and loan borrowed from Punjab National Bank, is nothing but interest paid on capital borrowed for the purpose of business, and allowable as deduction u/s. 36(1)(iii) of the Act. 5. The AO, however, was not convinced with the explanation of the assessee and according to the AO, the assets of the partnership firm, has been revalued to artificially increase the credit balance of outgoing partners. Further, although, the assessee claims to have reconstituted Partnership Deed to induct Smt. A. Hameeda Banu as new partner and retirement of 4 partners, no such evidence, including any deed of reconstitution, has been filed. Further the settlement among the parties is nothing but a family settlement to share the family asset but not settlement of capital account of retiring partners. Therefore, the AO opined that interest paid on capital account of incoming partner and loan borrowed from Punjab National Bank, cannot be considered as loan borrowed for the purpose of business of the assessee, and thus, rejected arguments of the assessee and disallowed interest paid to partner Smt. A. Hameeda Banu and interest p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9.12.2009 have also been taken into consideration. In view of this, in the light of provisions of Section 36, it was opined that the interest paid by the firm to Smt Hameeda Banu on the capital raised by her, is not allowable. In view of this, a notice was issued to show cause as to why the interest paid by the firm to Smt. Hamida Banu on her capital shall not be disallowed as the said money has not been utilized wholly and exclusively for the purpose of business. 2.2 It was further observed that the assessee firm has raised a loan of Rs. 1p crores during the relevant accounting period from Punjab National Bank on which the firm has incurred an expenditure in the nature of interest amounting to Rs. 1,86,90,859/-. This money has also been utilized for the purpose of clearing the credit balance of the four persons referred to above who are claimed to be erstwhile partners. 2.3 For the reasons discussed at length in the prior paragraphs, it was opined that these credit balances were artificially created and were never a burden of the assessee firm as such. Hence, it was opined that interest paid to Punjab National bank by the assessee firm is not an allowable expenditure for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. 37 of the Income Tax Act, 1961. I am also of the opinion that the expenditure incurred in this regard is more of capital in nature for the reason that said expenditure is non-recurring and of enduring benefit in the nature of almost eliminating the partners who are coming in the way of smooth functioning of the assessee firm. In view of all these reasons, the expenditure incurred by the assessee firm towards interest of Rs. 1,26,16,872/- paid to partner on her capital is disallowed as an expenditure claimed u/s. 36 or the Income Tax Act, 1961. 2.4 As has been discussed at length in the prior paragraph, the liability of the assessee firm in the nature of credit of so called ex-partners is not well grounded rather is not correct. In view of this and on account of detailed reasoning given in the prior paragraphs, the interest paid by the firm out of the loans raised from the Punjab National bank cannot be said to have been incurred wholly and exclusively for the purpose business. In view of this reason, the expenditure in the nature of interest amounting Rs. 1,86,90,859/- paid to Punjab National Bank by the assessee firm is not allowed under 37 0f the IT Act. 1961. 3. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... retired from the firm and one new partner has been inducted into the partnership firm. Incoming partner, Smt.A. Hameeda Banu, infused fresh capital into the partnership firm to settle outstanding credit balance in retiring partner s accounts. The firm had also borrowed loan from Punjab National Bank to settle credit balance in partner s capital account. Since, the retiring partners credit balance in capital account becomes debt of the firm and loan has been borrowed from bank for the purpose of discharging the debt of the firm, interest paid on said loan is in the nature of interest paid on loan borrowed for the purpose of business of the assessee, and thus, same needs to be allowed as deduction. 7. The Ld.CIT(A) after considering relevant submissions of the assessee and also taken note of relevant facts opined that interest paid on partners capital account and also interest paid on loan borrowed from Punjab National Bank, cannot be considered as loan borrowed for the purpose of business of the assessee, because, out of the borrowed funds, the assessee has discharged the liability of outgoing partners and same has been arised due to revaluation of the assets. The Ld.CIT(A) f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9.5 The appellant firm has borrowed a sum of Rs. 19 crores from Punjab National Bank and thereby incurred expenditure to the extent of Rs. 1,86,90,859/- by way of interest and the same has been claimed as expenditure. 9.6 It can be seen from the records that the amount inducted by the new partner as well as the amount borrowed were utilized only for the purpose of payment to the earlier partners. The amount was paid to the earlier partners just by way of a family settlement rather than the business settlement. The borrowed capital was never utilized for the purpose of running the current business. In other words, the borrowed capital was utilized for payment of artificial liability. 9.7 In this background, I am of the view that the borrowed capital was utilized by the firm only to settle the family dispute among the father, mother and brother rather than the business settlement. Even otherwise it can be termed the capital inducted/borrowed is more in the nature of capital by way of eliminating the erstwhile partners. 9.8 In view of this, the action of the AO in disallowing the interest paid under the two count is hereby sustained and the grounds raised by the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acts to the effect that it is a personal asset of partners. Further, settlement among the family members cannot be considered as settlement of partnership firm assets. Since, the assessee could not file any evidences to prove that their assets belong to partnership firm and it is the part of the business of the assessee, any settlement to partners towards settlement of family property, cannot be considered as settlement of firm debt. He further submitted that the assessee has borrowed funds from Bank and partners. However, utilized the borrowed funds for the purpose of settlement of family debt. Therefore, the AO has rightly invoked provisions of Sec.36(1)(iii) of the Act, and disallowed interest paid on borrowed capital. The Ld.CIT(A) After appreciating relevant facts has rightly confirmed the additions made by the AO and their orders should be upheld. 10. We have heard both the parties, perused the materials available on record and gone through orders of the authorities below. The facts borne out from the record clearly indicate that Shri R.Ariff along with his wife and three children entered into a partnership firm namely M/s.Ariff Co. by way of partnership deed dated 18. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of business of the assessee and consequently, interest paid on said capital account needs to be allowed as deduction u/s. 36(1)(iii) of the Act. In so far as interest paid on loan borrowed from Punjab National Bank, the AO has not disputed that the assessee s firm has borrowed Rs. 19 Crs. loan from Punjab National Bank. The said loan has been borrowed for the purpose of business of the assessee s firm, because, the firm was carrying on the business of running hotel called the Hotel President which was owned by the partnership firm which is evident from the financial statement of the assessee for earlier years where the property is in the name of partnership firm and the assessee has claimed depreciation on building. Further, the loan from Punjab National Bank has been borrowed to settle the capital account of retiring partners. As we have already stated in our earlier part of this order, unless the firm settle the outgoing partners capital account, which is nothing but a debt of the firm business cannot be run smoothly, because, the entire business of the assessee is running a hotel. Therefore, in our considered view, any loan borrowed for the purpose of settling outgoin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... olution of the partnership or with his retirement from partnership of the value of his share in the net partnership assets as on the date of dissolution or retirement after a deduction of liabilities and prior charges , shall be paid to the retiring partner. 14. From the above observations of the Hon ble Supreme Court, it is clear that the share of partner in partnership assets means his proportion share in the assets of the firm is net of liabilities. Therefore, when the outgoing partners are taking out their share in the assets of the firm, the Fair Market Value of the assets needs to be ascertained. In the present case, the assessee has revalued the assets to ascertain the Fair Market Value of the assets of the firm before settlement of retiring partner s shares in the proportionate assets of the firm. Therefore, we are of the considered view that the AO and the Ld.CIT(A) erred in holding that settlement to partners is a family settlement and the same cannot be considered as settlement of firm assets. 15. In this view of the matter and considering the facts and circumstances of the case, we are of the considered view that there is no dispute with regard to the fa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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