Net interest payment to a partner alone is disallowed under section 40(b) where reciprocal interest is set off.

Where a firm both pays interest to a partner and receives interest from the same partner, disallowance under section 40(b) applies only to the net interest payment after setting off the reciprocal receipt. The effective liability must be computed on a net basis rather than by ignoring interest received from the partner. On that footing, only the net interest amount is disallowed and the Revenue's challenge fails.

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Issues: Whether, for the purpose of disallowance under section 40(b), only the net interest payable to a partner after setting off interest received from the same partner is to be disallowed.

Analysis: The allowance or disallowance was examined on the footing that the firm had both paid interest to and received interest from certain partners. Reliance was placed on the view that, where reciprocal interest transactions exist between the firm and a partner, the effective liability should be worked out on a net basis rather than by ignoring the interest received by the firm from the same partner.

Conclusion: Only the net interest payment is to be disallowed under section 40(b), and the Revenue's challenge fails.

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