Reasonable cause defeats TDS penalty where partner-to-firm interest issue was debatable and no revenue loss arose

Penalty under section 271C for failure to deduct tax at source on interest paid by a partner to the partnership firm was examined against section 194A and the reasonable-cause defence in section 273B. The text notes that the exemption in section 194A applies to interest paid by a firm to its partners, not to interest paid by a partner to the firm, but the issue was treated as debatable. Because the firm had disclosed the interest income, no tax loss arose, and the partners held a bona fide belief that deduction was not required, reasonable cause was accepted and the penalty was deleted.

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Issues: Whether penalty under section 271C was leviable for failure to deduct tax at source under section 194A on interest paid by the partners to the partnership firm, or whether the assessees had shown reasonable cause under section 273B.

Analysis: The assessees had paid interest to the partnership firm in which they were partners on overdrawn drawings, and no tax was deducted at source. The statutory exemption in section 194A was noted to apply to interest paid by a firm to its partners, not to interest paid by a partner to the firm. However, the question was whether the default attracted penalty. The Court accepted that the legal relationship between a partner and the firm, the nature of the statutory exemption, and the absence of revenue loss because the firm had disclosed the interest income and suffered no tax liability, made the issue debatable. In that context, the assessees' bona fide belief that no deduction was required was held to constitute reasonable cause within section 273B.

Conclusion: The penalty under section 271C was not exigible, and the assessees were entitled to deletion of the penalty.

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