Interest on Partners Capital

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CA.Tarun Maheshwari (Querist)
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23 February 2009 Dear Friends, I have a practical issue. If I paid interest on Partners capital in FY 2005-2006, then is it necessary to pay it in 2006-07 also. Case is wrt exempted areas, and hence the AO objecting is that we are inflating profits and hence disallowing that much amount. I want to know the legal points involved in this matter.

CA. B.SRINIVASULU

CA. B.SRINIVASULU (Expert)
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23 February 2009 If the deed has not been changed for the year 2006-07 then you should provide interest for the partners. The AO is correct eventhough the interest is allowed as a deduction from the firm it will treated as income in the hands of the partners. If your partners are in high tax bracket then it will be benefitial for the it department to collect tax from individual partner then from the firm. In your case you have to anlyse like that. Hence the AO is correct if you have not ammeded your partnership deed and filed along with your return of income.

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CA.Tarun Maheshwari

CA.Tarun Maheshwari (Querist)
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23 February 2009 But sir, it is nowhere written that payment of interest on capital is compulsory. There is no legal provision that if the interest is paid in one year, then it must be paid in every year. It seems like I have made a mistake by paying interest in first year, and now i will have to pay it every year. Is it not a hardship to the assessee? I agree that it is purely a tax saving in both, i.e Firm as well as in hands of partners, But this is within the tax provisions and nothing against the laws. Sir, pls clarify my doubts. Thanks in advance.

C A GROUP COACHING

C A GROUP COACHING (Expert)
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24 February 2009 CA TARUN MAHESHWARI's STAND IS CORRECT. THERE IS NO SUCH PROVISION REGARDING INTEREST PAYMENT.
RATHER IF THE PARTNER IS HAVING NEGATIVE BALANCE & ALSO THE FIRM IS PAYING INTEREST ON SOME OUTSIDE BORROWINGS BUT NOT CHARGING INTEREST TO PARTNERS ON NEGATIVE CAPITAL, THE ITO CAN MAKE A NOTIONAL CHARGE OF SUCH INTEREST ON NEG. CAPITAL & ADD TO THE INCOME OF THE FIRM