Each partner is allowed to charge interest on the amounts loaned by him to the firm. This interest paid by the firm is deductible expenditure while computing taxable profits. Income Tax Act stipulates maximum rate of interest that can be paid for such loans. However, this interest is deductible only in cases where the amount borrowed by the firm is used for the use of the business. This point was once again reinforced in the recent judgment by Supreme Court of India in the case of Munjal Sales Corpn. Vs  Commissioner of Income-tax, Ludhiana 

In the instant case, the issue came up whether section 40 is a standalone section or it is corollary to sections 30 to 38 and its object is to put limitation on amount of deduction with assessee is entitled to under sections 30 to 38.

 

The court held in affirmative and ruled that after enactment of Finance Act, 1992, every assessee including a firm has to establish, in first instance, its right to claim deduction under one of sections between sections 30 to 38 and in case of firm, if it claims special deduction, it has also to prove that it is not disentitled to claim deduction by reason of applicability of section 40 (b).

 

In case of a firm to claim deduction in respect of interest paid on capital borrowed from third parties (apparently partners), firm is required to establish, in first instance, that it is entitled to claim deduction under section 36(1)(iii), and secondly that it is not disentitled to claim such deduction on account of applicability of section 40(b)(iv.

 In the instant case, Assessee’s claim for deduction under section 36(1)(iii) was disallowed on ground that it that it had given interest-free and advances to its sister concerns from interest-bearing loans taken from third parties.