Partner advances beyond agreed capital used for capital expenditure qualify as borrowed capital, allowing deductible interest if payment is real.

Advances by a partner made beyond his agreed capital contribution and applied to capital expenditure are treated as capital borrowed for the purposes of the business; the decisive criterion is the use of the funds rather than the lender's identity. Consequently, interest paid on such advances (including by account adjustment) is deductible in computing partnership profits provided the payment is real and not contingent on profit. Revenue characterisation of such sums as 'surplus capital' was held to be a legal mischaracterisation rather than a factual finding; characterisation depends on the legal nature of the advance and its application to the business.

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Issues: Whether advances made by a partner to the firm in excess of his agreed capital contribution and used for capital expenditure are "capital borrowed for the purposes of the business" within the meaning of Section 10(2)(iii) of the Income-tax Act, and whether interest paid thereon is deductible in computing the profits of the partnership.

Analysis: The Court analysed the meaning of "capital borrowed for the purposes of the business" by distinguishing (i) a partner's agreed capital contribution, which is at risk and not a debt, from (ii) advances made by a partner over and above the agreed capital. The decisive criterion is the use to which the sums are put: if sums borrowed (whether from outsiders or from a partner) are applied for capital expenditure in the business, they qualify as borrowed capital. The identity of the lender does not determine the character of the advance. Where interest is paid (including by account adjustment) and the payment is not made contingent on the earning of profits, the interest is deductible under Section 10(2)(iii). Findings by the Revenue that additional sums were "surplus capital" were held to rest on incorrect legal principles rather than disputed facts; characterization is a question of law and of the use of the funds.

Conclusion: Advances by a partner, made beyond his agreed capital contribution and used for capital expenditure, are "capital borrowed for the purposes of the business" within Section 10(2)(iii). Interest paid thereon in the year of assessment (so long as payment is real and not profit-contingent) is deductible in computing the partnership's profits.

Ratio Decidendi: Where a partner lends money to the partnership in excess of his agreed capital contribution and the money is used for capital expenditure, such advances are borrowed capital and interest paid thereon is deductible under Section 10(2)(iii) of the Income-tax Act.

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