Partner Cannot Claim Deduction On Interest Paid For Capital Invested In Firm: Kerala High Court

The Kerala High Court on 20 May held that a partner cannot claim deduction under Section 36(1)(iii) of the Income Tax Act for interest paid on funds borrowed and contributed as capital to a partnership firm, since the borrowed capital was not used for the partner's own business.

A Division Bench of Justices Devan Ramachandran and Basant Balaji dismissed the appeal filed by Alice Arun Thomas and upheld the order of the Income Tax Appellate Tribunal (ITAT), Cochin Bench. It held:

"The provisions of Section 36(1)(iii) of the Act would disallow any claim of deduction by the appellant because, she admits that after she borrowed money from others, it has been invested in the Firm as her capital..."

Alice Arun Thomas, a partner in a partnership firm, borrowed funds from the open market and invested them as her capital contribution in the firm. The firm paid interest on the capital contributed by her, while she paid interest to the lenders from whom she had borrowed the funds.

For Assessment Year 2016-17, she claimed deduction of the interest paid on the borrowings under Section 36(1)(iii), contending that she had utilized the borrowed funds to earn interest income from the partnership firm. The Assessing Officer disallowed the claim. The Commissioner (Appeals) and the ITAT, Cochin Bench, subsequently affirmed the disallowance.

Challenging the Tribunal's order before the High Court, Alice argued that the interest paid on the borrowed funds qualified for deduction because she had invested the borrowings as capital in the partnership firm and earned interest on that capital contribution.

The High Court rejected the contention. It observed that Section 36(1)(iii) permits deduction only where the borrowed capital is used for the taxpayer's own business or profession.

The Bench noted that the taxpayer did not carry on any independent business and had only invested the borrowed funds as capital in the partnership firm. It held that the firm, and not the taxpayer in her individual capacity, conducted the business. Consequently, the statutory requirement that the borrowed capital be used for the taxpayer's own business remained unmet. The judges observed:

"...the appellant does not have even a whispering contention that she is running any business on her own, or that she has borrowed for the purpose of capital for such. Her conceded case is that she had borrowed, to invest it as her capital in a Firm; and that the latter is running the business. Obviously, therefore, the submissions of Sri.Jose Joseph, that only the Firm could have made any such claim – even if assumed to be eligible - stands on terra firma."

Emphasising the distinction between a partnership firm and its partners, the Bench held that any deduction, if otherwise available, could only be claimed by the firm carrying on the business and not by an individual partner who borrowed funds solely to make a capital contribution.

Accordingly, the High Court dismissed the appeal, finding no infirmity in the Tribunal's order and declined to answer the questions of law framed by the taxpayer.

For Appellant: G. Chitra, Advocate 

For Respondent: Jose Joseph, SC