December 2011
(a) Section 40(b) r.w.s 36(1)(iii) and 14A of the Income-tax Act, 1961 — The section for allowing deduction of interest is section 36(1)(iii) and, therefore, payment of interest to partners is also an expenditure only and same is also hit by provisions of section 14A if it is found that the same has been incurred for earning exempt income. (b) Section 28(v) of the Income-tax Act, 1961 — Proviso to section 28(v) comes into play only if there is some disallowance in hands of firm under clause (b)<
By C. N. Vaze
Shailesh Kamdar
Jagdish T. Punjabi
Bhadresh Doshi
Chartered Accountants
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(2011) 47 SOT 121 (And) Shankar Chemical Works v. Dy. CIT A.Y. : 2004-05. Dated : 9-6-2011
(a) Section 40(b) r.w.s 36(1)(iii) and 14A of the Income-tax Act, 1961 — The section for allowing deduction of interest is section 36(1)(iii) and, therefore, payment of interest to partners is also an expenditure only and same is also hit by provisions of section 14A if it is found that the same has been incurred for earning exempt income.
(b) Section 28(v) of the Income-tax Act, 1961 — Proviso to section 28(v) comes into play only if there is some disallowance in hands of firm under clause (b) of section 40 and it is not applicable in case of disallowance made u/s.14A.
For the relevant assessment year, the Assessing Officer observed that the firm had made investment in mutual funds, shares, etc. out of capital of the partners. The Assessing Officer disallowed u/s.14A some amount of interest paid to partners on the ground that the capital was employed for the purpose of investment in mutual funds, shares, etc. and not for the business of the assessee-firm for which the partnership deed was formed. The CIT(A) upheld the disallowance of interest u/s.14A.
Before the Tribunal the assessee, inter alia, contended as under:
(a) Section 14A talks of disallowing expenditure incurred by the assessee in relation to exempt income and interest paid to partners is not an expenditure at all and it is a special deduction allowed to the firm u/s.40 (b).
(b) If at all any disallowance had to be made in the hands of the firm, direction should be given that, to that extent, interest income should not be taxed in the hands of concerned partners in terms of provisions of section 28(v). The Tribunal held in favour of the Revenue.
The Tribunal noted as under:
(1) Section 40(b) is a section that only restricts the amount of interest payable to partners — the section which allows the deduction of interest is section 36(1)(iii).
(2) The payment of interest to partners is also expenditure only and, therefore, the same is also hit by the provisions of section 14A, if it is found that the same has been incurred for earning exempt income.
(3) From the proviso to section 28(v), it is seen that if there is any disallowance of interest in the hands of the firm due to clause (b) of section 40, income in the hands of the partner has to be adjusted to the extent of the amount not so allowed to be deducted in the hands of the firm. Hence, the operation of the proviso to section 28(v) will come into play only if there is some disallowance in the hands of the firm under clause (b) of section 40.
(4) In the instant case, the disallowance is u/s.14A and not u/s.40(b) and, therefore, the proviso to section 28(v) is not applicable and the partner of the firm did not deserve any relief on this account.
