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Issues: (i) Whether premium paid on Keyman insurance policies taken on the lives of partners is allowable as business expenditure; (ii) whether disallowance under section 14A was to be computed on the basis of net interest and whether partners' capital could be treated as borrowed funds for that purpose.
Issue (i): Whether premium paid on Keyman insurance policies taken on the lives of partners is allowable as business expenditure.
Analysis: The premium on a Keyman insurance policy is an allowable business deduction where the policy is taken to protect the business against financial loss arising from the death of a key person. The statutory scheme introduced by the Finance (No. 2) Act, 1996, together with the CBDT circular, recognised the business character of such premium. The policy may validly cover a partner where the policy is for the protection of the firm and the maturity proceeds accrue to the firm.
Conclusion: The premium paid on the Keyman insurance policies taken on the lives of the partners was held allowable as business expenditure, in favour of the assessee.
Issue (ii): Whether disallowance under section 14A was to be computed on the basis of net interest and whether partners' capital could be treated as borrowed funds for that purpose.
Analysis: For disallowance under section 14A read with Rule 8D, the expenditure must have a proximate nexus with exempt income. Interest on partners' capital is not interest on money borrowed or debt incurred within the meaning of section 2(28A). Where shares are held as stock-in-trade and the assessee has sufficient interest-free funds, a proportionate interest disallowance on borrowed-funds theory is not justified. The disallowance was therefore confined on a net-interest basis and the partners' capital could not be treated as borrowed funds.
Conclusion: The revenue's challenge to the net-interest basis failed and the assessee's challenge to the balance disallowance succeeded, in favour of the assessee.
Final Conclusion: The cross appeals were disposed of by upholding the deduction for Keyman insurance premium and restricting the section 14A disallowance in the assessee's favour, resulting in partial relief to the assessee.
Ratio Decidendi: Premium paid on a Keyman insurance policy taken for protecting the business is deductible as business expenditure, and for section 14A disallowance only expenditure having a real nexus with exempt income can be considered, while partners' capital is not borrowed money.
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