Interest on borrowings for partnership business remains deductible absent proof of non-business diversion of funds.

Interest on borrowings advanced to a partnership firm in which the assessee, his wife and minor children were involved was treated as allowable business expenditure where the advance was referable to business investment and used for the purposes of the assessee's business. The firm's separate tax status, the deeming of income under section 16(3), and the absence of registration or commencement of production did not change that character. A debit balance in the profit and loss account was also not enough, by itself, to justify disallowance of interest unless there was evidence of actual diversion of borrowed funds for non-business use. On the materials noted, the stated conclusion favoured allowance of the interest claim.

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Issues: (i) Whether interest on borrowings advanced to a partnership firm consisting of the assessee, his wife and minor children was allowable as business expenditure in computing the assessee's income. (ii) Whether the debit balance in the assessee's profit and loss account represented a diversion of borrowed funds for non-business purposes so as to justify disallowance of interest.

Issue (i): Whether interest on borrowings advanced to a partnership firm consisting of the assessee, his wife and minor children was allowable as business expenditure in computing the assessee's income.

Analysis: A firm is a distinct entity for income-tax purposes, but the computation of business income under section 10 permits the aggregate assessment of profits and losses from the assessee's businesses. The controlling principle is that borrowed funds used for the purposes of a business carried on by the assessee, including money advanced to a firm in which he is a partner, may attract deduction of interest if the advance is referable to business investment. The fact that the firm's income may be deemed to be the assessee's income under section 16(3) and the fact that the firm was not registered or had not commenced production did not alter the character of the advance as one made for the purposes of the firm's business.

Conclusion: The interest on the borrowings advanced to the firm was allowable, and the disallowance was unsustainable.

Issue (ii): Whether the debit balance in the assessee's profit and loss account represented a diversion of borrowed funds for non-business purposes so as to justify disallowance of interest.

Analysis: The materials did not establish that the debit balance reflected actual withdrawal of monies by the assessee for non-business use. The account entries were capable of being explained as adjustments, and the accumulated depreciation and profits available in the business accounts were sufficient to cover the balance in question. In the absence of evidence showing that the amount, or any part of it, was in fact diverted from business, the premise for proportionate disallowance of interest failed.

Conclusion: The debit balance was not proved to be a non-business diversion, and the interest disallowance on that basis was not justified.

Final Conclusion: The references were answered in favour of the assessee, with costs awarded against the Revenue.

Ratio Decidendi: Interest on borrowings is deductible when the borrowed funds are used for business purposes of the assessee's business computations, and a mere book debit or advance to a partnership firm does not by itself prove non-business diversion absent evidence of actual withdrawal or non-business use.

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