Borrowed capital treatment for partner advances allowed interest deduction where the funds were used in the business.

Interest on a bona fide loan advanced by a partner to a firm, over and above the agreed capital contribution, was deductible where the money was used for capital expenditure in the business. The court construed the statutory phrase to include sums borrowed for business capital use and held that the lender's identity did not matter, since a partner may act in a dual capacity and lend to the firm as a distinct loan. The existence of an obligation to pay interest irrespective of profits supported the borrowing character of the advance, and describing the funds as surplus capital did not change their true legal nature.

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Issues: Whether money advanced by a partner to the firm, beyond the agreed initial capital, and used for capital expenditure, constitutes capital borrowed for the purposes of the business so that the interest paid thereon is deductible under Section 10(2)(iii) of the Income-tax Act, 1922.

Analysis: The relevant statutory expression was construed to cover sums borrowed for capital expenditure, and no limitation was found in the provision restricting borrowing to outsiders only. A partner may stand in a dual capacity and may lend money to the firm as a genuine loan distinct from his agreed capital contribution. The character of the transaction depends on the use of the money and the nature of the borrowing, not on the identity of the lender. Where the borrowed sum is used like capital in the business, it becomes borrowed capital. The fact that the advances were described as surplus capital did not alter their true legal character, and the existence of an agreed obligation to pay interest, irrespective of profits, satisfied the statutory condition.

Conclusion: The interest paid by the partnership on the partner's advances was deductible in computing the profits or gains of the business under Section 10(2)(iii) of the Income-tax Act, 1922.

Ratio Decidendi: A bona fide loan advanced by a partner to a firm, over and above the agreed capital contribution, is borrowed capital for the purposes of the business when it is used as capital in the business, and interest paid on such borrowing is deductible if the statutory conditions are otherwise satisfied.

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