Partnership account debt is not a loan unless parties agree or custom converts it into a money-lending liability

A liability arising from partnership accounts after dissolution does not become a loan in the ordinary course of a money-lending business merely because the assessee entered it in money-lending books and debited interest. Conversion of such an account debt into a loan requires evidence of an agreement between the parties or a legally recognised usage or custom changing the character of the obligation. A unilateral book entry by the assessee, even coupled with later interest credits and tax collection on that interest, is insufficient to establish a new loan relationship. On that basis, the amount was not deductible as a bad debt under section 10(2)(xi) of the Income-tax Act, 1922.

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Issues: Whether the sum due on taking accounts after dissolution of the partnership, which was entered by the assessee in his money-lending books and on which interest was also debited, had become a loan in the ordinary course of the assessee's money-lending business so as to be deductible as a bad debt under section 10(2)(xi) of the Income-tax Act, 1922.

Analysis: The liability originally arose out of partnership accounting and not out of any lending transaction. A debt arising on accounts may, in law, be converted into a loan, but such conversion requires material showing an agreement between the parties or some legally recognized usage or custom by which the character of the liability changes. The mere unilateral act of the assessee in transferring the amount to the money-lending account, and the fact that interest was later credited and tax was collected thereon, did not establish that the debtor had accepted a new loan relationship. The earlier decision relied upon concerned a different factual setting, namely an original loan transaction and a proved usage permitting division of joint loans without reference to the debtor. Those features were absent here.

Conclusion: The amount did not become a loan in the money-lending business and was not allowable as a bad debt under section 10(2)(xi); the question was answered in the negative, against the assessee.

Ratio Decidendi: A liability arising merely on partnership accounting does not become a loan for tax purposes, and cannot be claimed as a bad debt of a money-lending business, unless the conversion into a loan is shown by agreement of the parties or by a legally recognized usage or custom.

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