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Interest on Capital

Amit Jain (Proprietor ) (533 Points)

17 October 2019

"Partner will also be entitled to a simple interest on Capital @ 12% p.a. on their closing Capital Balances standing at the end of the year but subject to provisions of Income Tax Act". This line is written in Partnership Deed.

I have a question that Interest will be charged on opening capital balance or closing capital balance

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5 Replies

rama krishnan (12234 Points)
Replied 17 October 2019

Interest on capital to be charged starting from opening balance and to be charged according to the Closing balance whenever any new fund introduced or taken out of the capital

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Amit Jain (Proprietor ) (533 Points)
Replied 17 October 2019

But in the partnership deed above line is mentioned

RAMAKRISHNAN R (INCOME TAX OFFICER) (1736 Points)
Replied 17 October 2019

But that's not the procedure to compute interest on capital

Amit Jain (Proprietor ) (533 Points)
Replied 17 October 2019

Now how to calculate as it is a audit case

Suresh Thiyagarajan (Student) (3986 Points)
Replied 17 October 2019

1. "Interest on capital" is nothing but an interest provided to partners for the purpose of the introduction of capital into the firm. It is almost the same as the loan obtained from the bank.
2. The amount borrowed from bank interest will be payable on the outstanding balance at the end of each month. Similarly, partners should also be paid interest on their capital for the number of days for which the capital was outstanding.
3. Though income tax has not specified any method of computation with respect to interest on capital unlike salary to partners, it has only specified a maximum of the rate of interest (12%)that is allowed as per income tax act u/s 40(b).
4. However, interest on capital is to be computed from opening balance and whenever new funds are introduced that should be included for the above calculation.
Example :
A being a partner has outstanding capital of Rs. 100000 as on 01.04.2019.
He further introduced Rs. 1,00,000 on 01.10.2019. IOC @ 12% as per partnership deed.
Now, his interest on capital for the year ending 31.03.2020 would be as follows,
1,00,000*12%*6/12 = 6,000 (from 01.04.2019 - 30.09.2019)
2,00,000*12%*6/12 = 12,000 (from 01.10.2019 -31.03.2020)
Total interest on capital to be credited to his current account for the year ending 31.03.2020 would be Rs. 18,000.
5. Actual, interest on capital allowed as per sec 40(b) would be Rs. 18,000.
6. Partnership deed cannot authorize its own way of computing interest on capital.
Please correct me if the above solution has an alternative view.