TMI Blog1996 (12) TMI 32X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 26,108. The Income-tax Officer, in his order dated October 20, 1973, noticed that the return filed by the assessee was of income of Rs. 2,67,617 and assessed the firm to a net income of Rs. 1,90,741 and demanded a tax of Rs. 64,442. In regard to the claim for deduction towards interest in a total amount of Rs. 26,108, the officer observed that deduction in a sum of Rs. 23,166 be disallowed. He found that the partners' account showed debit balances. The assessee was asked to explain as to why interest on debit balances from the partners had not been charged. It was explained that originally a loan was taken in order to purchase the machinery, etc., and that there were debit balances because of depreciation allowed in earlier years on the fixed assets. It was explained that according to the terms of the agreement amongst the partners, no interest was to be charged on the debit balance. The officer rejected the contention on the ground that (i) the fixed assets get depreciated and they were rightly reduced to the extent the depreciation was allowed, (ii) the assessee should have returned loans to the creditors instead of permitting partners to draw excess money in their accou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... partly allowed the appeal of the Department. It summarised the order of the Appellate Assistant Commissioner in para 5 of its order, and referred to the contentions of the Department in para 6 and held that the appellate authority was in error. It referred to Roy A. Roulke's Practical Financial Statement Analysis (6th Ed.), and observed that the partners of a business were entitled to share only the profits of the business, that the concept of "profit" was quite different from the concept of "funds" at the disposal of the concern, that profit in a commercial sense could be arrived at only after all the outgoings were adjusted against gross receipts and that the depreciation though not payable in cash immediately, was one of such outgoings. A fixed asset depreciates over a number of years at the end of which it requires replacement. One of the methods of replacement is by debiting the profit and loss account of each year with a certain percentage of its value. The Tribunal observed that corresponding credit is given either to a separate fund or by making adjustment in the value of the asset itself, and that it would be incorrect to say that the profits of a business could be arrived ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... debit of depreciation was made. But merely because the amount of profit was to be determined by reducing the amount of depreciation, it could not be said that the monies borrowed had not been borrowed for the purpose of business or were diverted to the partners for non-business purposes. The Tribunal was wrong when it said that the monies borrowed could be regarded in law to have been diverted for non-business purposes where, as a result of debit of depreciation on a notional basis, the debits of the partners increased. Learned counsel for the assessee gave a simple example for the purpose of understanding the real issue involved in this case, which according to us, is very apt in the circumstances. Let us assume that "A" an advocate in the course of his profession borrowed Rs. 500 and invested the same in the purchase of his office equipment and on such investment the depreciation he would get is Rs. 15 in a year. On the above amount borrowed, let us assume he is paying interest of Rs. 20 per year. If his annual income is Rs. 100, then income after depreciation would be Rs. 85. If he withdrew the entire available cash amount of Rs. 100 as profit in that year, could it be said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... had been used for the purpose of the business of the assessee. The Income-tax Officer thought that if the assessee had collected the outstandings which were due to it from others, the assessee would have been able to reduce its indebtedness and thus save a part of the interest which it had to pay on its own borrowings and, therefore, the assessee would not be justified in allowing its outstandings to remain without charging any interest thereon, while it was paying interest on the amounts borrowed by it, and, therefore, to the extent to which it would have been in a position to collect interest on the outstandings due to it from others, it could not be permitted to claim as an allowance interest paid by it to outsiders. The learned judges held that the view taken by the Income-tax Officer was unsustainable, that as had been pointed out by the Madhya Pradesh High Court in Ram Kishan Oil Mills v. CIT [1965] 56 ITR 186, the only conditions required to be satisfied in order to enable the assessee to claim a deduction in respect of the interest under section 10(2)(iii) were, firstly, that the money must have been-borrowed by the assessee ; secondly, it must have been borrowed for the pu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t minus depreciation was in excess of the withdrawals made by the partners and in such a case, the withdrawals should be deemed to be in part from the capital account and would mean that the original borrowing was utilised for other purposes and not for business purposes. The finding of the Tribunal in this behalf is purely an inference in law. It ignores the law laid down by the Supreme Court in Madhav Prasad Jatia v. CIT [1979] 118 ITR 200 and in the Bombay High Court case CIT v. Bombay Samachar Ltd. [1969] 74 ITR 723, that once the three conditions laid down there are satisfied, the deduction under section 36(1)(iii) must be given. Again, the contention that the correct amount of debit balance to the account of the partners should be taken as Rs. 1,73,643 instead of Rs. 1,93,049 as calculated by the Income-tax Officer is again a figure arrived at as a matter of law. For the aforesaid reasons, we answer the reference in favour of the assessee and that the Tribunal was not legally correct in holding that a part of the borrowing had been diverted by the assessee for its non-business purposes. We also opine that the assessee was not disentitled to claim the interest on those borro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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