Relief to Muthoot Bankers: ITAT Allows ₹5L Interest Deduction u/s 40(b) as Payment was within 12% Limit and Authorized by Partnership Deed [Read Order]

The Cochin Bench of the Income Tax Appellate Tribunal (ITAT) in its recent ruling granted relief to Muthoot Bankers by allowing a deduction of ₹5,00,000 paid as interest to partner, as the payment was within the 12 percent limit and duly authorized by the partnership deed.

The appellant Muthoot Bankers, a firm engaged in finance and money lending, filed its return for the Assessment Year (AY) 2006-07 declaring a total income of ₹4,62,590. The return was processed and a refund of ₹6,830 was issued, which included interest under section 244A Income Tax Act, 1961 (ITA).

The Assessing Officer (AO) reopened the case upon noting that the firm’s balance sheet showed no amount under the partner’s capital account but showed a credit balance of ₹19,73,999.85 in the partners’ current account.

The Assessing Officer further held that interest paid to the partner amounting to ₹5,00,000 was not allowable, as it was not linked to any income earned by the firm.

The assessee submitted that the firm follows the cash system of accounting, where expenditure is claimed only when it is actually paid. While ₹52.82 lakhs was payable to the partner at 12 percent per annum, only ₹5,00,000 was actually paid due to shortage of funds.

The assessee further submitted that the payment was made in accordance with the partnership deed and was within the permissible statutory limit.

It was also submitted that the Act does not prescribe any condition that the capital introduced by the partners must be utilized exclusively for business purposes to allow interest under section 40(b) of the Income Tax Act.

Subsequently the assessee earned business income by way of interest from M/s Muthoot Fincorp Ltd. of ₹5026.56 for delayed settlement of sale consideration, thereby establishing some business activity.

The AO rejected the explanation and disallowed the interest. Aggrieved by the same the assessee preferred an appeal before the Commissioner of Income Tax (Appeals) ( CIT(A) ). The CIT(A) upheld the AO’s findings, reiterating the absence of active business operation and unutilization of partner’s capital for business purposes.

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The bench comprising Inturi Rama Rao (Accountant Member) and Sonjoy Sarma (Judicial Member) set aside the order of the CIT(A) and held that the reasoning adopted by the lower authorities in disallowing interest paid to the partners solely on the ground of business activity was not sustainable in the eyes of law.

The tribunal observed that Section 40(b) of the Income Tax Act permits deduction of interest paid to the partners, provided that it is authorized by the partnership deed not exceeding 12% with simple interest per annum.

It further noted that in the present case, the assessee had paid interest in accordance with the terms and conditions of the partnership firm and at the permitted rate. Moreover, the assessee-firm follows cash basis accounting and payment of ₹5,00,000 was actually made during the year.

Accordingly, the appeal of the assessee was partly allowed.

The appellant was represented by R. Krishnan, while the Department was represented by Leena Lal.

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