Ganesh Purohit, Senior Advocate


The Assessee is Partner in the Partnership Firm. It earns Share of Profit, Remuneration & Interest on the Fixed Capital as well as Current Account from the Firm.

The Assessee had taken Loan and invested the same as Fixed Capital as well as Current Account of the firm.


  1. Whether the provision of section 14A r.w.r. 8D apply on the exempt income i.e. Share of profit from the Firm, even though he earns interest from the firm?
  2. Would it make any difference if there is a loss incurred by the firm?
  3. Would it make any difference in the hands of the Assessee if no interest is received by the assessee, though there is no interest received nor any interest has been in the books of the firm, but in the Partnership Deed there is a specific clause for payment of interest on the Capital & Current Account of the Firm.
  4. Would it further make any difference, if there is no such clause ?


To answer the above question, we have to understand the relation between the firm and partner as also the relevant provisions of the income tax act. Those are applicable for the assessment of firm and partner i.e. section 2(24) (ve), section 28 (v), 40(b) and 155(1A).

The business carried out by the firm is also a business carried out by the individual partner.

The receipt of interest, remuneration, business commission, bonus by whatever name called, is treated as business income in the hands of partner under the definition of income in section 2(24)(ve) includes as business income, any income chargeable to tax under section 28 (v) of the Act.

The explanation to section 28(v) provides for exclusion of that income which is not allowed to be deducted under section 40(b) in the hands of the firm from the computation of income of the individual partner.

Section 40(b) provides limits and conditions for deduction of interest and remuneration paid to the partner in accordance with the conditions and clause of partnership agreement permitting such payment of interest and remuneration to the partner.

In absence of a specific clause in the partnership deed, the interest and remuneration cannot be paid to the partner as the same is prohibited under section 40 (b) of the income tax act. Therefore, clause in partnership deed is essential for payment of interest and remuneration to the partner. The clause in the partnership deed can be introduced or deleted, by executing an amendment of the partnership or by passing a resolution in writing duly signed by all the partners and intimated to the income tax department as far as technologically possible or by filing a physical intimation to the income tax department.

Normally a partner does not incur any expenditure for earning share income from the firm, whatever expenditures incurred for conduct of business are debited to the profit and loss account of the firm. It is only interest on borrowing that is incurred by partner in his individual capacity for making investment in partnership business. Such payment of interest can be claimed as deduction from the interest received on capital contribution to the business of the firm.

Answer to question (a) in view of the Supreme Court judgement in the case of Max Corp investment Private Limited versus commissioner of income tax (2018), 301 CTR (SC) 489. The honourable apex court has observed as under in the above decision in para 32 as under:

32. In the first instance, it needs to be recognised that as per s. 14A(1) of the Act, deduction of that expenditure is not to be allowed which has been incurred by the assessee “in relation to income which does not form part of the total income under this Act”. Axiomatically, it is that expenditure alone which has been incurred in relation to the income which is (sic-not) includible in total income that has to be disallowed. If an expenditure incurred has no causal connection with the exempted income, then such an expenditure would obviously be treated as not related to the income that is exempted from tax, and such expenditure would be allowed as business expenditure. To put it differently, such expenditure would then be considered as incurred in respect of other income which is to be treated as part of the total income.

34. Having clarified the aforesaid position, the first and foremost issue that falls for consideration is as to whether the dominant purpose test, which is pressed into service by the assessees would apply while interpreting s. 14A of the Act or we have to go by the theory of apportionment. We are of the opinion that the dominant purpose for which the investment into shares is made by an assessee may not be relevant. No doubt, the assessee like Max corp Investment Ltd. May have made the investment in order to gain control of the investee company. However, that does not appear to be a relevant factor in determining the issue at hand. Fact remains that such dividend income is non-taxable. In this scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure. Keeping this objective behind s. 14A of the Act in mind, the said provision has to be interpreted, particularly, the words ‘in relation to the income that does not form part of total income. Considered in this hue, the principle of apportionment of expenses comes into play as that is the principle which is engrained ins. 14A of the Act. This is so held in Walfort Share & Stock Brokers (P) Ltd. (supra), relevant passage whereof is already reproduced above for the sake of continuity of discussion, we would like to quote the following few lines therefrom :

“The next phrase is, ‘in relation to income which does not form part of total income under the Act’. It means that if an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of s. 14A.

…. …. …

The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under s. 14A.”

39. In those cases, where shares are held as stock- in-trade, the main purpose is to trade in those shares and earn profits therefrom. However, we are not concerned with those profits which would naturally be treated as ‘income’ under the head ‘Profits and gains of business or profession’. What happens is that, in the process, when the shares are held as ‘stock-in-trade’, certain dividend is also earned, though incidentally, which is also an income. However, by virtue of s. 10(34) of the Act, this dividend income is not to be included in the total income and is exempt from tax. This triggers the applicability of s. 14A of the Act which is based on the theory of apportionment of expenditure between taxable and non-taxable income as held in Walfort Share & Stock Brokers (P) Ltd. case (supra). Therefore, to that extent, depending upon the facts of each case, the expenditure incurred in acquiring those shares will have to be apportioned.

41. Having regard to the language of s. 14A(2) of the Act, r/w r. 8D of the Rules, we also make it clear that before applying the theory of apportionment, the AO needs to record satisfaction that having regard to the kind of the assessee, suo motu disallowance under s. 14A was not correct. It will be in those cases where the assessee in his return has himself apportioned but the AO was not accepting the said apportionment. In that eventuality, it will have to record its satisfaction to this effect. Further, while recording such a satisfaction, nature of loan taken by the assessee for purchasing the shares/making the investment in shares is to be examined by the AO.

In view of the findings recorded by the honourable apex court, section 14A, will be triggered if while computing the income, the expenditure incurred by the partner is related to earning the exempt income under section 10 (2A) i.e. share income from the firm. However, when the partner is receiving interest on capital contribution including current account then 14A shall have limited application as the entire interest received is assessable in the hands of partner as business income. The interest paid by partners on borrowings for making investment in the firm shall be allowed in full from such interest income with proportionate disallowance referrable to exempt share profit.

b. In case of loss, no disallowance can be made. Since there is no exempt income is includable as income of partner, the set off of loss is not permissible in the hands of partner. It can be carried over for set off only in the hands of firm, and therefore there was no exempt income in the hands of partner. No disallowance can be made under section 14A.

c. in case of non-payment of interest in spite of there being a clause in the partnership deed, the firm shall lose the benefit of registered firm and shall be assessed as unregistered firm and the deduction of interest payable to the partner is not permissible under section 40(b) of the income tax act. In this case in my opinion, no deduction will be allowed on interest paid on borrowings for investment in firm as nothing is assessable in the hands of the partner.

d. if there is no clause for payment of interest in the partnership deed, it will not make any difference as far as deduction of interest paid on borrowings is concerned. However, the deduction shall be subject to application of section 14(A) and rule 8D of the income tax rules.

[Disclaimer the above is my considered opinion the views may differ, if any person acts on above opinion and suffers any loss the author and AIFTP shall not be liable please take your own considered action.]