Interest on retiring partners' capital was not deductible, as successor capital was treated as own capital rather than borrowed funds.

A surviving partner who took over the business of a dissolved firm was not entitled to deduct interest paid to retiring partners on the capital paid over to them under Section 10(2)(iii) read with Section 26(2) of the Income-tax Act, 1922. The Madras HC held that, on a plain reading of the provisions, the capital standing to the credit of the retiring partners became the capital of the successor and did not assume the character of borrowed capital in the hands of the surviving partner. As the payment was not referable to borrowed funds, the interest did not qualify as a deductible business expense.

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Issues: Whether a surviving partner who succeeds to the business of a dissolved firm can deduct interest paid to retiring partners on the capital paid over to them under Section 10(2)(iii) read with Section 26(2) of the Income-tax Act, 1922.

Analysis: The question turned on the character of the capital standing to the credit of the retiring partners after dissolution. The Court held that, on the plain reading of the provisions, the capital of the predecessors became the capital of the successor and was not to be treated as borrowed capital in the hands of the surviving partner. The interest paid to ex-partners was therefore not a deductible business expense under the cited provisions.

Conclusion: The surviving partner was not entitled to deduct the interest paid to the retiring partners.

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