Interest Paid on Capital Account of Partner to Be Allowed If It Was Borrowed to Settle Debt of Partnership Firm | ITAT

Case Details: Ariff & Co. vs. Assistant Commissioner of Income-tax - [2024] 158 taxmann.com 135 (Chennai-Trib.)

Judiciary and Counsel Details

• • Manomohan Das, Judicial Member & Manjunatha G., Accountant Member
  • S. Sridhar, Adv. for the Appellant.
  • P. Sajit Kumar for the Respondent.

Facts of the Case

Assessee-firm was engaged in the business of running a hotel. During the relevant assessment year, the firm reconstituted with the retirement of ‘4’ partners and the induction of a new partner. The retiring partners were paid their proportionate share in the assets of the partnership firm. The firm borrowed a loan from the bank and raised fresh capital from the incoming partner to settle the debt and capital account of retiring or outgoing partners.

The assessee claimed the interest paid on such loan as a deduction while computing the income. During the assessment proceedings, the Assessing Officer (AO) contended that the payment to outgoing partners was a family settlement. Thus, any interest paid on such family settlement cannot be considered as interest paid on a loan borrowed for the purpose of the assessee’s business. Accordingly, the AO disallowed the interest paid on such loan and made additions to the income of the assessee.

On appeal, the CIT(A) confirmed the additions made by AO. Aggrieved-assessee filed the instant appeal before the Tribunal.

ITAT Held

The Tribunal held that the firm was carrying on the business of running a hotel called the ‘Hotel President’. The firm borrowed a loan from Punjab National Bank and raised fresh capital from incoming partners to settle the debt or capital account of retiring/outgoing partners. The settlement of the capital account of outgoing partners becomes debt of the partnership firm.

The discharge of said debt out of borrowed funds assumes the character of loans/funds borrowed for the assessee’s business. The firm has claimed depreciation on the building on which the hotel was constructed and managed. Therefore, when the partnership firm owned the asset, any settlement out of assets belonging to the firm to the outgoing partners cannot be considered a settlement of family property just because the partners were family members. Therefore, it is very clear that retired partners take a portion of the value of the firm’s assets, and thus, just because the asset has been revalued before the reconstitution of the partnership firm cannot be a reason for the AO to treat the settlement of firm properties among partners as settlement of family property.

Since the loan borrowed from the Bank and capital raised from an incoming partner was for the purpose of the business of the assessee, any interest paid on said loan and capital account is nothing but the interest paid on the loan borrowed for the business of the assessee and allowable as per the provisions of the Act.

Accordingly, the additions made by the AO were directed to be deleted.