Interest disallowance for partners' debit balances remitted for fresh enquiry into alleged diversion of borrowed funds.

Interest disallowance for alleged diversion of borrowed funds to partners' current accounts could not be sustained without a proper enquiry into how the debit balances arose. The assessment had relied on those balances, but did not examine whether they reflected current-year drawings or earlier years' losses, and the appellate authority affirmed the addition without addressing that contention. The matter was remitted to the Assessing Officer for fresh examination of whether interest-bearing funds had in fact been diverted to the partners' accounts, after giving the assessee an opportunity of hearing.

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Issues: Whether the disallowance of interest expenditure on the footing that interest-bearing funds were diverted to the partners' accounts was justified, or whether the matter required fresh examination of the debit balances in those accounts.

Analysis: The assessment was made on the basis of debit balances in the partners' current accounts, but the reasoning did not adequately examine how those balances arose. The appellate authority also affirmed the addition without addressing the assessee's contention that no drawings were made during the year and that the debit balances were attributable to earlier years' losses. In these circumstances, the correctness of the interest disallowance could not be sustained without a proper enquiry into the nature and source of the partners' debit balances.

Conclusion: The issue was remitted to the Assessing Officer for fresh examination of whether interest-bearing funds had in fact been diverted to the partners' accounts, with an opportunity of hearing to the assessee.

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