M. Jagannadha Rao, J.

( 1 ) THIS is a reference under Section 256 of the Income Tax Act,1961 by the Income Tax Appellate Tribunal (Delhi Bench) in respect of the assessment-year 1973-74 for which the relevant previous year ended on 31. 10. 1972. The question referred is as follows:

"whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in holding that a part of the borrowing had been directed by the assessee to its non-business purposes and that the assessee is not entitled to claim interest on those borrowings under Section 36 (1) (iii) of the Income Tax Act,1961?"

( 2 ) THE petitioner is a partnership concern running a cinema called Regal Theatre in Delhi as also a restaurant. The dispute relates to disallowance of deduction towards interest in a sum of Rs. 23,166 out of a total claim for interest-deduction in a sum of Rs. 26,108.

( 3 ) THE Income-tax Officer in his order dated 20. 10. 73 noticed that the return filed by the assessee was of income of Rs. 2,67,617 and assessed the firm to a net income of Rs. 1,90,741 and demanded a tax of Rs. 64,442.

( 4 ) IN regard to claim for deduction towards interest in a total amount of Rs. 26,108, the Officer observed that deduction in a sum of Rs. 23,166 be disallowed. He found that the partner s account showed debit balances. The assessee was asked to explain as to why interest on debit balances from the partners had not been charged. It was explained that originally a loan was taken in order to purchase the machinery etc. and that there were debit balances because of depreciation allowed in earlier years on the fixed assets. It was explained that according to the terms of the agreement amongst the partners, no interest was to be charged on the debit balance. The Officer rejected the contention on the ground that (i) the fixed assets get depreciated and they were rightly reduced to the extent the depreciation was allowed (ii) the assessee should have returned loans to the creditors instead of permitting partners to draw excess money in their account. Under those circumstances, noting that the assessee had been paying interest at 12% on borrowed money, he calculated 12% interest on the average debit balances in the capital account and he arrived at Rs. 23,166 as interest which could not be deducted from the net income.

( 5 ) IN the appeal, the Appellete Assistant Commissioner of Income-tax in his order dated 2. 8. 74, after a very elaborate discussion of the facts and law, partly allowed the appeal. He held that the partners had overdrawn in the assessment years 65-66,66-67 and 67-68 and thereafter w. e. f. assessment year 68-69, the withdrawls were less than their capital with the firm. Only withdrawals over and above their capital would amount to diversion of capital for non-business purpposes to the extent they are covered by the borrowing made by the firm. After referring to the borrowings during 1965-66 to 73-74, he held that loans amounting Rs. 2,43,140 were made by the appellant, that the investment in fixed assets amounted to Rs. 2,15,985 only. This showed their total loans were not invested in fixed assets. At the close of the accounting period relevant to the assessment year 65-66, the partners had overdrawn to the extent of Rs. 39,367 and this represented the diversion of loans for non-business purposes. The position for 66-67,67-68, were similarly computed. On those facts, he held that the fresh loans of Rs. 3650 were diverted for non-business purposes. In the assessment years for 68-69,69-70, there was no fresh loans taken and no question of diversion of loans arose. In 1970-71,71-72,72-73 and 73-74, fresh loans taken amounted to Rs. 57,428, Rs,18,500, Rs. 3610 and Rs. 50,790 respectively. The capital of the partners in the assessment years 70-71,71-72,72-73 and 73- 74 was in excess of the withdrawals since the partners did not draw over and above their capital in those assessment years, and therefore, he held that there was no divers

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