Regarding Interest
This query is : Resolved
Saurabh Mittal
(Querist)
10 September 2009
A has taken Rs.100000 on loan @ 18%p.a.He invested Rs.50000 on which he gets interest @ 14% & Rs.50000 is contributed by A in p'ship firm as capital on which he gets interest@ 12%.
Pls tell tax effect supported by relevant provisions.
Pls tell tax effect supported by relevant provisions.
Late CA Sampat Jain
(Expert)
10 September 2009
AN EXPENDITURE FOR THE PURPOSE OF EARNING INCOME IS ONLY ALLOWABLE.....AO MAY DISALLOW THE EXCESS INTEREST PAID ON THE GROUND THAT IT WAS NOT FOR THE PURPOSE
Saurabh Mittal
(Querist)
11 September 2009
But whole interest expenditure is for purpose of investment so it should be allowed.
20 July 2025
Here's the tax treatment based on your scenario:
Loan Interest (Rs. 100,000 @ 18%) — This is an expenditure. To claim deduction under Income Tax Act, the interest must be incurred wholly and exclusively for earning taxable income.
Investment of Rs. 50,000 @ 14% Interest — This generates income (interest received). The interest income is taxable under "Income from Other Sources."
Rs. 50,000 contributed as capital in partnership firm, earning interest @ 12% — This interest income from partnership is taxable in the hands of A.
Tax Effect:
Interest Expense Deduction: Allowed only to the extent interest is paid for earning taxable income. Since Rs. 50,000 is invested in capital (earning interest), it can be argued that interest paid on loan related to this capital amount is for earning income, so interest expense on that portion should be allowed.
If AO finds part of interest is not for earning income, AO can disallow that part.
Interest Income Received: Taxable under "Income from Other Sources" for both 14% and 12% interest.
Relevant Provisions:
Section 36(1)(iii) — Deduction of interest on borrowed capital for business or profession.
Section 56(2)(vi) — Interest income from partnership firm is taxable.
Explanation: Interest expense has to be incurred wholly and exclusively for earning taxable income to be deductible.
So, overall, interest expense on Rs. 50,000 loan linked to investment earning interest @14% and Rs. 50,000 contributed in partnership earning 12% interest should be allowable as deduction proportionately.
Loan Interest (Rs. 100,000 @ 18%) — This is an expenditure. To claim deduction under Income Tax Act, the interest must be incurred wholly and exclusively for earning taxable income.
Investment of Rs. 50,000 @ 14% Interest — This generates income (interest received). The interest income is taxable under "Income from Other Sources."
Rs. 50,000 contributed as capital in partnership firm, earning interest @ 12% — This interest income from partnership is taxable in the hands of A.
Tax Effect:
Interest Expense Deduction: Allowed only to the extent interest is paid for earning taxable income. Since Rs. 50,000 is invested in capital (earning interest), it can be argued that interest paid on loan related to this capital amount is for earning income, so interest expense on that portion should be allowed.
If AO finds part of interest is not for earning income, AO can disallow that part.
Interest Income Received: Taxable under "Income from Other Sources" for both 14% and 12% interest.
Relevant Provisions:
Section 36(1)(iii) — Deduction of interest on borrowed capital for business or profession.
Section 56(2)(vi) — Interest income from partnership firm is taxable.
Explanation: Interest expense has to be incurred wholly and exclusively for earning taxable income to be deductible.
So, overall, interest expense on Rs. 50,000 loan linked to investment earning interest @14% and Rs. 50,000 contributed in partnership earning 12% interest should be allowable as deduction proportionately.
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