Real character test: interest paid to insurer through a partner was not interest to a partner under section 40(b).

Interest paid directly to the Life Insurance Corporation was not disallowable under section 40(b) of the Income-tax Act, 1961 because the transaction had to be tested by its real character. The assessee recorded the corporation as creditor, the loan funds came from the corporation, and the interest was paid to it directly. The partner merely acted as a conduit in arranging the loan on the security of his policies, so he was not in substance the lender and no interest was paid to a partner. Section 40(b) was therefore not attracted and the proposed disallowance failed.

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Issues: Whether interest paid by the assessee to the Life Insurance Corporation on funds arranged through a partner could be disallowed under section 40(b) of the Income-tax Act, 1961 as interest paid to a partner.

Analysis: The transaction had to be judged by its real character. The funds were obtained from the Life Insurance Corporation, the assessee treated the corporation as its creditor in its books, and the interest was paid directly to it. The partner's role was only that of a medium through whom the loan was arranged on the security of his policies. On these facts, the partner had not in substance advanced the money to the assessee, nor was any interest paid to him.

Conclusion: Section 40(b) of the Income-tax Act, 1961 was not attracted, and the disallowance of interest was unsustainable.

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