Interest on Capital--Funds invested in House Property

Hi Gurdev,

You are right—the AO is erring in law by insisting on disallowance of interest on capital to the extent the capital is invested in the building rental income from which is assessable under the head Income from House Property. Section 40(b) allows the claim of deduction of interest on capital and other forms of remuneration to partners out of income chargeable under the head Business and Profession only. If after reducing income from HP from the firm's book profits, there were no business income left, there'd be no allowance u/s 40(b). But the AO can not interpret the concept of calculation of book profits to mean that the portion of partners' capital invested in non-business assets has to be excluded to determine the figure on which 12% rate will be applied. The law has already taken care what the AO is uneasy about—any stream of income, unless it emanates from the B/P source, will not be eligible to be given the benefit of Section 40(b) allowance. By not contesting, and agreeing to its rental income being assessed as HP income, the firm has already denied itself the benefit of setting off partner's remuneration including interest on capital against the rental income. The interest on capital, although calculated with reference to the capital outstanding to the partners' credit, is also subject to the availability of business profits. The firm gets to claim amount allowable u/s 40(b) because it is offering sufficient income chargeable under the head B/P. Taking twelve per cent of the figure of capital is only a mode of distribution of business profits amongst partners. The interest on capital too could well have been allowable on the basis of slabs of book profits as is the case with remuneration to partners. The fact that it isn't and is calculated with reference to the quantum of capital does not take away from the fact that it's a charge against business profits and not any other income. The AO it appears feels it's a diversion of funds from business to other uses, like granting interest free loans to a sister concern. But the point is interest from loan--had it been received--would' ve been chargeable to tax under B/P head and hence part of book profits. But rental income is already outside the purview of book profits u/s 40(b).I think you ought to be able to persuade the AO to drop the idea of disallowance of the interest on capital.Regarding payment of interest on capital, please note that interest is not remuneration u/s 40(b). Therefore, it can be paid even in the case of a book loss. Remuneration— -salary, bonus, commission, etc--can be paid only to working partners; interest on capital on the other hand can be paid even to a sleeping partner. Thanks,CA Sanjeev Bedi--- In

ICAI_CIRC_MEERUT_ CA@yahoogroups. com, "garrysingh2001" wrote:>> A Partnership firm owns a building constructed out of capital > invested by the partners to the tune of 20 lakhs in the year > 1981.The interest on capital has duly been allowed out of the income > of the firm which includes rental income of the building apart from > business income on account of lease of assets such as generators, > lifts etc and maintenance income. However the IT department chose to > assess the rental income as Income from House property to which the > assessee has accepted. Since one set of books of accounts are > maintained, the firm makes the computation of income as under-> > Business Head> Net profit As per P&L account> less: Rental income to be considered separately> Add: Municipal Taxes debited to P&L to be considered > separately XXXXXX> > House Property> Rental Income> Less: Municipal Taxes> Less:Deduction u/s 24> XXXXXX> The said method has been followed for years at length and accepted > by the department even in cases u/s 143(3). Now during the current > year, the AO wants to disallow Interest on capital on 20 Lakhs out > of the business Income. His Claim is: Since out of the total capital > 20 Lakhs is invested in Building, income from which is being > assessed under House Property, Interest to that extent on 20 Lakhs > cannot be allowed as a business expenditure.> My Claim is : Since this is a case of a partnership firm, and there > is no doubt to the total capital invested by the partners, section > 40 does not bar the assessee to give interest to it's partners upto > a maximum of 12% and as such the AO is erred in disallowing the > interest on capital claimed out of business income> Friends, please guide me on the said issue and assist with rulings > in favour of the assessee.Also please let me know, if interest on > capital can be given in case of Book loss. Thanks.regards CA Gurdev > Bly>