Section 40 – Income computation of—Interest charged to a partner on debit balance—Whether the income of the firm
Circular No. 33-D(XXV-24) of 1965.
In Board Circular No. 55 of 1941, it was stated that interest charged to a partner on his overdrawn account should not be included in the total income of the firm.
It was further stated that where it appears that the capital borrowed for the purpose of business was partly diverted towards over-drawn account, the correct procedure would be to disallow the proportionate share of the interest payable on this capital in computing the income of the firm.
It has been brought to the Notice of the Board that under the law as it stands it would not be correct to exclude interest received by a firm from its partners while computing the total income of the firm. Whereas the interest paid to partners has to be disallowed in the assessment of the firm under the provisions of section 40(b) of the Income-tax Act, 1961, there is no provision to exclude any portion of the interest of other income received by the firm from its total income. The matter has been examined by the Board and it has been decided that the interest received by a firm from its partners should be assessed as the income of the firm. However, where a firm pays interest to as well as received interest from the same partner, only the net interest can be stated to have been received or paid by the firm, as the case may be and only the net interest should be taken into consideration. This view also finds support in the decision of the Allahabad High Court in the case of Shri Ram Mahadeo Prasad,  24 I.T.R. 176. In view of the above, the instructions contained in Board’s Circular No. 55 of 1941 may be treated as modified accordingly.
[Circular No. 33-D(XXV-24) of 1965.]