Ancestral property and partner's capital: inherited funds kept their character, but interest on capital remained non-deductible.

Property inherited by a son from his father retains its ancestral character qua his own male issue, even though it is taken by succession as tenant-in-common, and later reversal entries in the partnership books do not alter that legal character. On the tax issue, interest paid by a firm on capital standing to the credit of partners admitted under the partnership arrangement remained interest on partner's capital contribution, so the accounting form could not convert it into a deductible item. The claimed deduction was therefore disallowed on the substantive nature of the payment.

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Issues: (i) Whether the capital inherited by the sons of the deceased partner constituted their individual property or ancestral property in their hands qua their sons, and whether the subsequent reversal entries in the partnership books altered its legal character; (ii) Whether interest paid by the firm on such capital accounts was a permissible deduction.

Issue (i): Whether the capital inherited by the sons of the deceased partner constituted their individual property or ancestral property in their hands qua their sons, and whether the subsequent reversal entries in the partnership books altered its legal character.

Analysis: The inherited capital, though taken under the mode of succession recognised by section 19(b) of the Hindu Succession Act, 1956 as taken per capita and as tenants-in-common, retained its ancestral character in the hands of each son qua his own male issue. The change in book entries merely reflected the true legal position and did not convert the property into self-acquired property.

Conclusion: The capital was ancestral property in the hands of the sons qua their sons, and the reversal entries were justified.

Issue (ii): Whether interest paid by the firm on such capital accounts was a permissible deduction.

Analysis: The partnership arrangement required the sons to bring in capital for becoming partners, and the amount credited to their accounts represented capital contributed by partners of the firm. Even if the money belonged in law to their respective HUFs, the payment remained interest on the capital contribution of a partner. The form of the accounting entries could not change the substance of the payment.

Conclusion: The interest was not a permissible deduction.

Final Conclusion: The tax deduction claimed for interest on the capital accounts was disallowed, and the revenue position was upheld on the substantive issue.

Ratio Decidendi: Property inherited by a son from his father retains its ancestral character qua his own male issue, but interest paid by a firm on capital contributed by a person admitted as partner remains non-deductible as interest on partner's capital, even if the funds are traced to an HUF.

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