Partners capital takes character of loan after the death of the partner; ITAT Discussion:

Partners capital takes character of loan after the death of the partner; ITAT Discussion The Tribunal in a recent case discussed that after the death of the partner of the firm this amount ceases to be the credit in the capital account of the partner and consequently takes the character of loan from the deceased partner / legal heirs of the deceased partner. The assessee is a partnership firm and engaged in the business of Wholesale Trading. The assessee filed revised return of income on 19.11.2011 declaring total income of Rs. 23,53,830/-. The case was selected for scrutiny through CASS. During the scrutiny assessment, the AO raised queries about the payment of interest on capital account of the partners.

“3. After perusal of books of a/cs, queries raised and submissions made following observations are made

1. During the year under consideration the partnership was constituted of following partners having their share mentioned against each.

a) Chandra Kant 20%

b) Tarun Savla 20%

c) Chetan Savla 20%

d) Smt. Sangeeta Savla 20%

e) Smt. Chhaya Savla 20%

This partnership is evidenced by the partnership deed dated 01.04.2004. As per clause no. 6 of this deed it is stated- “that the firm shall pay interest at the rate of 12% per annum on the capital contribution of the partners. The rate of interest can be changed by the mutual consent of the partners.” No other clause is there in the aforesaid partnership deed for the calculation or allowability of interest to the partners.

On 05-04-2010 unfortunate demise of Sri Chetan Savla occurred as in@dent of robbery took place in his person and he was shot dead in the said incident. Thereafter, partnership was reconstituted w.e.f. 8 April 2010 with following partners with equal share in profit/loss:

a) Chandra Kant b) Tarun Savla c) Devaang Savla d) Smt Sangeeta Savla e) Smt Chhaya Savla

As per clause 6 of this deed interest to the partners shall be allowed as under: "that interest at the rate of 12% per annum or such maximum rate as may be prescribed under section 40(b) (iv) of the Income Tax Act, 1961 or any other applicable provision as may be enforced in the income tax assessment of the partnership firm in the relevant accounting period shall be payable to the partners on the amount outstanding to the credit of the account of the partners. Such interest shall be calculated and credited to the account of each partner at the close of the accounting year."

2. Perusal of the above clauses of the deeds and capital a/cs of the partners following queries were made vide order sheet entry dated 14-02-2014 i) Sri Chetan Savia was partner for 5 days only during the year. Therefore, interest on his capital as a partner is allowable only for 5 days i.e. Rs 8193/- and not Rs 12928/-@ 12% p.a.. Therefore please explain as to why Rs 4,735/- should not be disallowed being excess interest debited in p & a/c.

ii) After 05-04-2010, Shri Chetan Savla remains no longer partner of the firm and so he is not entitled for interest as a partner. His deposit has been converted into unsecured loan on 31-03-2011. So as unsecured loan interest is allowable from 01- 04-2011 only. Thus please explain as to why interest debited to p&l a/c and credited to a/c of Sri Chetan Savia amounting to Rs 5,81,781/- should not be disallowed.

iii) You have claimed interest on partner's capital @ 12% on amount credited in partners' capital a/c at the end of the accounting year. Remuneration, Interest and profit share is credited in partners' capital a/c on 31-03-2011. Deducting the said sums from the credit entries, balances in partners' capital a/c at the end of the year comes as under:-

a) Chandra Kant Savla Rs. 17,28,364/- Cr

b) Sangeeta Savla Rs. 34,92,002/- Cr

c) Tarun Savla Rs. 15,54,351/- Cr

d) Devaang Savla Rs. 2,87,073/- Cr

Interest @ 12% on the above credit balances comes to Rs 2,07,404/-, Rs 4,19,040/ Rs 1,86,522/- & Rs 33,971/- respectively whereas you have credited above partners capital a/c by Rs 2,66,322/-, Rs 5,48,881/-, Rs 3,06,876/- and 52,323/- respectively. In this way you have debited your P&L a/c under this head by a sum of (Rs 58918/+ 1,29,841/+1,20,354/- + 18,352/-) Rs 3,27,465/- more than that was admissible. Please explain as to why Rs 327,465/-should not be disallowed and added towards your income for the year under consideration.”

The learned AR of the assessee has submitted that once the partner of the firm expired, he ceases to be a partner and consequently the credit balance in the capital account of the partner is treated as loan and the interest on such loan is an allowable deduction. The AO has disallowed the claim of the assessee only on the ground that the assessee has passed the entry only on 31st March, 2011 at the end of the financial year transferring the amount from the capital account of Sh. Chetan Savla to the loan account in the name of the legal heirs. He has pointed out that once the partner expired, the credit balance in the capital account gets converted into the loan account and therefore, the interest payment on the said amount is an allowable claim. The CIT(A) has remanded the matter to the AO and also directed to verify the fact whether Sh. Devan Savla was the legal heir of the deceased Sh. Chetan Savla.

ITAT

The capital introduced by a partner of the partnership firm is always for business purposes and it is not an amount which is kept with the partnership firm only for earning the interest because it was also the need of the partnership firm for doing the business by utilizing the said amount. Accordingly, the claim of interest paid to the legal heirs on this amount which is in the nature of loan and the interest was already subjected to TDS under section 194A of the Act, the same cannot be disallowed merely on the ground of passing an entry on 31st March, 2011 or on the ground that it is not an loan amount. For Official Judgment Download PDF Given Below: