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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 ..... ion 37(1) of the Act and the provisions in Section 40(b) of the Act were not taken into consideration while confirming the disallowance in the computation of taxable total income. 4. The CIT(A) failed to appreciate the written submissions filed in proper perspective even though referred to in the impugned order while not considering the same in confirming the disallowance in the computation of taxable total income. 5. The CIT(A) failed to appreciate that the provisions in Section 36(1)(iii) of the Act were totally overlooked and brushed aside in the process of sustaining the disallowance in the computation of taxable total income. 6. The CIT(A) failed to appreciate that having noticed the background facts leading to the charge of interest to the said partner account while establishing business nexus, the disallowance of interest in the computation of taxable total income was wrong, incorrect, unjustified, erroneous and not sustainable both on facts and in law. 7. The CIT(A) failed to appreciate that the findings recorded in para 9.1 to para 9.7 of the impugned order were wrong, incorrect, unjustified, erroneous and not sustainable both on facts and in law. 8. The CIT(A) e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on business of lodging housekeepers, restaurant keepers, bar keepers, caterers under the name and style of 'Hotel President'. 4. The assessee firm has filed its return of income for AY 2007-08 declaring total loss of Rs. 1,04,85,554/-. The case was taken up for scrutiny and the during the course of assessment proceedings, the AO observed that the firm has paid interest on capital to Smt.A. Hameeda Banu, partner, amounting to Rs. 1,26,16,872/-. The AO further noted that the firm had also borrowed a sum of Rs. 19 Crs. from Punjab National Bank, on which, it has paid interest amounting to Rs. 1,86,90,859/-. The AO called upon the assessee to file necessary evidences, including justification for payment of interest to partners' capital account and interest on loan borrowed from the Bank. In response, the assessee submitted that '4' partners namely Shri R.Ariff, Smt. A. Meharunnisa Begum, Shri A.Sheikh Alaudeen & Shri A.Asan Mohammed were expressed their willingness to retire from the partnership firm, because, all were migrated out of India. Shri A.Aboobucker, who was actively managed the Hotel and created royalty wanted to continue the business of running hotel, has negotiated with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i.e. if the principal raised can be proved to have been borrowed for the purpose of business of the firm, the same can be allowed u/s. 36(1)(iii). As seen from the facts of the case, the said partner has infused capital during the accounting period 2005-06 specifically for the purpose of repaying the credit balances in the accounts of ex-partners of the firm. On a perusal of the accounts, it is understood that the assets of the assessee firm have been revalued during the accounting period 2005-06 and the surplus generated has been allocated to the so-called ex-partners namely Shri R.Ariff, Smt. A. Meharunnisa Begum, Shri A.Asan Mohammed and Shri A.Sheikh Alaudeen (it is to be noted that any deed or any other document in support of the claim that these partners have ceased to be the partners of the firm has not been produced till date). In the absence of any deed to this effect and in the absence of any valid reason as to what was the requirement of revaluing the assets of the assessee firm, it could not be understood why the assets were revalued and these four persons were credited with sums. It could be presumed that this might be a understanding of the assessee firm entered into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been taken into consideration. In view of this, a letter was issued to the assessee requesting him to show cause why the interest paid to the Punjab National Bank shall not be disallowed. The assessee's Authorized Representative has submitted his reply in writing on 21.12.2009 and 23.12.2009 wherein, it was submitted by the AR that the revaluation of the properties was an arrangement between the family members, who were also partners in the course of the exit from the firm is entirely their decision. In other words, it is the prerogative of the owners of the property to fix values for the properties owned by them and it is not questionable by outsiders. The AR arguments may be correct to some extent that an owner can fix the value of the property. But in the instant case the same is being questioned for the reason it has got some implications of taxation. It is necessary to notice that there is no specific document even as on date to say that the four people referred to above have ceased to be partners. It is also not possible to examine those people as they are all relocated and are out of the country. There is no basis evidence or proper evaluation as to how the asset has bee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... remarks income and the taxes thereon are computed as under: Income as returned Rs. (-) 1,04,85,554 Add: (1) Disallowance of interest paid to partner Smt. Hameeda Banu as discussed above Rs. 1,26,16,872 (2) Disallowance of interest paid to Punjab National bank Rs. 1,86,90,859 (3) Income on account of Closing Stock as discussed above Rs. 4,55,333 Taxable income Rs. 2,12,77,510 Tax on total income Rs. 63,38,253 Surcharge Rs. 6,38,325 Rs. 70,21,578 Educational Cess Rs. 1,40,430 Rs. 71,62,008 Less: TDS Rs. 4,86,650 Rs. 66,75,358 Add: Interest u/s. 234 B Rs. 22,02,849 Balance Taxable Rs. 88,78,207 6. Being aggrieved by the assessment order, the assessee preferred an appeal before the Ld.CIT(A). Before the Ld.CIT(A), the assessee has reiterated its arguments made before the AO and submitted that the partnership firm has been reconstituted in the year 2006 and out of '5' partners, '4' partners have been retired from the firm and one new partner has been inducted into the partnership firm. Incoming partner, Smt.A. Ham ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her' than the father mother and brothers of the main partner Shri Aboobucker. From 01.02.2006 onwards as per the new partnership deed, Shri Aboobucker and his wife were only the partners of the firm. Shri Aboobucker is the managing partner and his wife is the working partner. 9.3 It may be appreciated that the erstwhile partners were paid a substantial amount to relinquish their partnership. The amount was paid as per the revaluation of the firm's asset. 9.4 While going through the partnership deed, it can be seen that the partnership deed is silent about the payment of consideration to the erstwhile partners as well as the mode of repayment etc. The valuation of asset was made at the choice of the partners. In other words, it may be termed as the family settlement. Now the issue is whether the interest paid by the firm for the amount inducted by the new partner as well as the amount borrowed from the bank for payment to the earlier partners (family members) can be claimed as an expenditure as per the provisions of Sec.36(1)(iii) of the Act. 9.5 The appellant firm has borrowed a sum of Rs. 19 crores from Punjab National Bank and thereby incurred expenditure to the ext ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee without appreciating the fact that the revaluation of asset was carried out in accordance with the values fixed by the approved valuer. The firm is liable to pay the amount to the credit of those partners who retired from the firm. Therefore, he submitted that any loan borrowed by the firm for the purpose of settlement of outgoing partners' capital account, is for the purpose of business of the assessee, because, unless, the firm discharged debt of outgoing partners', it cannot continue the business. Therefore, he submitted that the AO and the Ld.CIT(A) were erred in rejecting the arguments of the assessee and disallowed interest u/s. 36(1)(iii) of the Act. In this regard, he relied upon the decision of the Hon'ble Supreme Court in the case of Narayanappa v. Bhaskara Krishnappa (supra) 9. The Ld.DR, Shri P. Sajit Kumar, JCIT, supporting the order of the Ld.CIT(A), submitted that the assessee could not file any evidences to prove that the asset is belongs to the partnership firm. On the other hand, the AO brought out clear facts to the effect that it is a personal asset of partners. Further, settlement among the family members cannot be considered as settlement of partnersh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing partners has been treated as debt of the partnership firm. To settle outgoing partners' capital account, the firm has borrowed loan from Punjab National Bank and paid interest. The firm had also taken capital contribution from incoming partner, Smt.A. Hameeda Banu and paid interest as per the clauses of the Partnership Deed which is in accordance with provisions of Sec.40(b) of the Act. 11. In this factual back ground, the issue that needs to be resolved is whether interest paid by the assessee / partnership firm to the capital account of partners and loan borrowed from Punjab National Bank, is allowable as deduction u/s. 36(1)(iii) of the Act or not? Admittedly, incoming partner, Smt.A. Hameeda Banu, has infused fresh capital to settle the capital account of retiring partners. Unless, the retiring partners' capital accounts are settled, the business of the assessee cannot be smoothly continued. Therefore, in our considered view, interest paid on capital account of partners partakes the nature of funds borrowed for the 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 f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of family property, just because, the partners were family members. Therefore, it is very clear that retired partners taking a portion of value of firm's assets and thus, just because, the asset has been revalued before reconstitution of partnership firm, cannot be a reason for the AO to treat the settlement of firm properties among partners as settlement of family property. 13. At this stage, it is necessary to consider the observation of the Hon'ble Supreme Court in the case of Narayanappa v. Bhaskara Krishnappa, where it has been clearly held that - "What is meant by the share of a partner is his proportion of the partnership assets after they have been all realized and converted into money, and all the partnership debts and liabilities have been paid and discharged. This it is, and this only, which on the death of a partner passes to his representatives, or to a legatee of his share, and which on his bankruptcy passes to his trustee". The Hon'ble Supreme Court further held that - "After the dissolution 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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