1. This appeal by the assesses is against the order of the AAC relating to the assessment year 1980-81. The ground is against the disallowance of interest to the extent of Rs. 2,126 while making the assessment on the assessee-firm. The ITO found that this amount of interest had been paid by the assessee-firm to LIC and this loan had been raised by the partners from the LIC against their insurance policies. The ITO was of the view that as a loan was raised by the partners of the firm, the payment of interest to LIC on behalf of the partners could not be allowed. He, therefore, added Rs. 2,126 while computing the assessee's income.
3. Before us, it has been submitted by the learned counsel for the assessee that the lower authorities have not considered the facts of the case properly. It was submitted that this loan has been in existence for seveal years and originally the loan of Rs. 50,000 had been raised from the LIC against the security of insurance policies of certain persons some of whom were the partners of this firm. The total value of the policies which was given as security was as under :--------------------------------------------------------------------------------------------------------------------------------------------------------------------Shri Mitter Pal Aggarwal 22265102 5,000Shri Manohar Pal Aggarwal 22217516 20,000Shri Jagdish Kumar Aggarwal 65651059 15,000 22224784 20,000Shri Brij Mohan Aggarwal 22224785 20,000---------------------------------------------------------------------------------- Thus, on the security of the policies for Rs. 80,000, a loan of Rs. 50,000 had been raised and out of this now a loan of Rs. 30,000 or so remains to be payable back to the LIC. It was pointed out that many of these persons were no more partners in this firm and only Shri Mitter Pal Aggarwal was a partner of this firm. He pointed out that Shri Jagdish Kumar Aggarwal and Shri Manohar Pal Aggarwal ceased to be partners in 1977. Shri B.M. Aggarwal was representing the family trust and was not a partner himself in his individual capacity. It was contended that the interest was paid by .the firm to the LTC and not to the partners and the loan which had been taken was credited in the account of the LIC and no part of it was credited to the capital account of any of the partners. It was, therefore, contended that the firm has never paid any interest to any of the partners and the interest which has been paid to the LIC was an allowable deduction as the loan has been utilised for the purpose of the firm.
4. The learned counsel has also referred to the order of the Commissioner (Appeals) in the assessment year 1980-81, where on similar facts the Commissioner (Appeals) disallowed interest to the extent of one-sixteenth out of the total claim on the policies of the partner Shri Mitter Pal Aggarwal. It is, however, contended that even this amount should not have been disallowed as this was not an interest paid to a partner.
5. On behalf of the department, it was submitted by the departmental representative that only the partners could have raised this loan against their policies and to the extent that those persons were still partners, the interest should be treated as interest payment to the partners and be disallowed under Section 40(fc). He submitted that besides Mitter Pal Aggarwal, B M. Aggarwal was also a partner and it was a different matter that he was representing his family trust. As far as the firm was concerned, he was a partner. He relied on an order of the Appellate Tribunal in IT Appeal No. 16 (Asr.) of 1979 in the case of Nathumal Durgadass Weaving Mills, where the Tribunal upheld the disallowance of interest paid to LIC by treating it as interest paid to partners. Besides this order, there is another order in IT Appeal No.607 (Asr.) of 1978-79 in the case of Agra Tannery.
6. We have carefully considered the facts of the case and the rival arguments. In computing the income of an assessee, interest paid on capital borrowed for the purpose of business is an allowable deduction.
In the case of a firm any payment of interest, salary, bonus, commission, or remuneration paid by the firm to another partner of the firm is not deductible in computing the income chargeable in the hands of the firm. This provision makes an exception to the general rule regarding the deduction to be allowed in computation of income. It is true that Section 40(6) of the Income-tax Act, 1961 ("the Act"), is absolute in its terms and makes no distinction between the payment by way of interest, etc., made to a partner as a partner and such payment made to him in any other capacity. The requirement, however, is that the payment should be to any partners of the firm. Unless the interest is paid to the partner, the provisions of Section 40(6) cannot be invoked.
7. Now in the present case the firm has raised the loan from the LIC on the security of the policies which belonged to a few persons, two of whom were still partners in one capacity or other. But the question for consideration is, where the assets of the partners are given as security for raising a loan for the purpose of the firm's business and the interest is paid directly to the creditor, ..can it to be held that this was a payment of interest to the partners. Answer to this question would depend on the manner in which this transaction is affected. The partners can certainly raise loan on their policies and if after raising those loans put it in their capital account and interest is paid either to them or to the LIC, it can be held that the interest is being paid to the partners. However, where the partner merely lends his signature for raising the loan on the security of his policy and the loan is taken by the firm for the purpose of its business and the interest is paid to the LIC, it cannot be held that the firm is paying any interest to the partner.
8. In the present case, the position becomes clearer. The order of the lower authorities is admittedly wrong insofar as the policies for Rs. 50,000, which had been given as security, belonged to the persons who are not partners of this firm. One of the partners Sfari Mitter Pal Aggarwal who has 25 per cent share in the firm's income has given a security of his policy of Rs. 5,000. The lower authorities have disallowed the whole interest without consideration of these facts. The interest can be said to be paid to a partner when in any way it benefits him. Here neither the money comes to the partner nor in his account. It cannot, therefore, be held that the firm had paid any interest to the partner merely because the policies, which have been offered as security, belonged to the partners. In the present case, we also find that the interest paid to partners is not reflected in their share income and the disallowance has gone to increase the share income of each partner equally though they might have contributed different amounts by way of security. The disallowance of interest paid to partner is from the point of view of considering all the benefits which come to a partner from the firm for the purpose of computation of firm's income. We cannot forget that along with Section 40(6), Section 67 provides for the method of computing the partner's share in the income of the firm and if the ITO had proceeded to give effect to this section, he would have found the incongruity of his accounting. On consideration of all these aspects, we are of the view that the disallowance of interest could not be justified under the provisions of Section 40(6).
9. The department has relied on the decision of the Tribunal in IT Appeal No. 16 (Asr.) of 1979 which has already been referred to above.
We find that the various aspects of the matter had not been brought out before the Tribunal at that time and, therefore, the matter had not been considered from all these aspects.
10. There is another aspect of the matter that the partner, who has to pay any interest on the money invested by him in the firm, can claim it under Section 36 of the Act. In the present case, however, as the partner has not borrowed any money himself, he cannot claim this deduction in its assessment. The disallowance of such claim in the hands of the firm and non-allowance of such amount in the hands of the partners would result in injustice as far as the claim of interest is concerned. In the result, the appeal is allowed.