Section 13 (c) of Indian Partnership Act, 1932 : Mutual rights and liabilities.—Subject to contract between the partners— where a partner is entitled to interest on the capital subscribed by him such interest shall be payable only out of profits.
From above it is clear that interest on capital can be paid only out of profits, it means interest on capital is an appropriation and not an expense. It means if in any particular year there are no profits, no interest on capital will be paid. This happens only in case of appropriations.
In case a partner has given loan to the firm, interest on loan being an expense is payable even if there are no profits. This is the reason interest on loan is debited in the Profit & Loss A/c and not Profit and Loss Appropriation A/c.