Section 263 r.w.s. 40(b) – Allowability of interest to partners – Interest amount calculated as per daily product method by the assessee – Whether CIT is justified in holding the view that the interest should be calculated on the average amount of opening and closing balances – Held, no.

Section 263 r.w.s. 40(b) – Allowability of interest to partners – Interest amount calculated as per daily product method by the assessee – Whether CIT is justified in holding the view that the interest should be calculated on the average amount of opening and closing balances – Held, no.

The CIT noticed that the assessee had paid interest of Rs. 2.05 crores to a partner on his current account, which was computed under daily product method. According to him, it should have been calculated on the average amount of opening and closing balances, based on which, the interest payable to partner worked out to Rs. 1.59 crore. Accordingly, he set aside the order of the AO by holding that the assessment was erroneous and prejudicial to the interest of the revenue. The assessee appealed before the tribunal challenging the order of the CIT.

Held:

Referring to the Supreme court decision in the case of Malabar Industrial Co. Ltd. vs. CIT (243 ITR 83), the tribunal observed that the revision of order u/s. 263 is permissible only after showing that the order passed by the AO is erroneous and prejudicial to the interest of the revenue. It further noted that the assessee has followed the product method for the purpose of calculating interest payable to the partner, since the partner was having frequent transaction of both receipts and payments. According to it, the said product method is scientific and also followed by the banks and financial institutions. The method takes into account all transactions of payments and receipts carried out throughout the year. On the other hand, the method suggested by the CIT was unscientific which does not taken into account the transactions that have taken place during the year. Accordingly, it held that the CIT has failed to establish that the assessment order was erroneous. Therefore, it set aside the order of the CIT.