2002 (8) TMI 81 - HC - Income Tax

1. Whether on the facts and in the circumstances of the case the Tribunal was legally justified in holding that the interest paid to the assessee was not includible in the hands of the firm under section 40(b) of the Income tax Act 1961? - 2. Whether on the facts and in the circumstances of the case there was material before the Tribunal to hold that the two partners were carrying on some individual business and having some other undisclosed sources of income? - it appears that the Supreme Court in the case of Brij Mohan Das Laxman Das v. CIT held that even for the period anterior to April 1 1985 any interest paid to a partner who is a partner representing his Hindu undivided family on the deposit of his personal/individual funds does not fall within the mischief of clause (b) of section 40 of the Act and agreed with the view of the Rajasthan High Court that Explanation 2 in the context of clause (b) of section 40 is declaratory in nature. - the position of law is well settled and we do not think that this question requires any further elucidation. Accordingly both the questions are answered in the affirmative i.e. in favour of the assessee and against the Revenue.

Summary

Issues Involved:
1. Whether the interest paid to the assessee was not includible in the hands of the firm under section 40(b) of the Income Tax Act, 1961.
2. Whether there was material before the Tribunal to hold that the two partners were carrying on some individual business and having some other undisclosed sources of income.

Issue-Wise Detailed Analysis:

1. Inclusion of Interest under Section 40(b):

The primary issue was whether the interest paid to the partners, Shri Ram Sarup and Shri Ram Prasad, was includible in the hands of the firm under section 40(b) of the Income Tax Act, 1961. The Income-tax Officer noted that the assessee paid interest to the partners for the first time in the assessment year 1970-71. The partners had shown all assets in their wealth-tax returns for the assessment year 1969-70, and an attempt was made to describe a part of the investments in the firm as individual accounts. The Income-tax Officer, relying on section 40(b), held that the allowance of payment by way of interest, bonus, commission, or remuneration made by a firm to any of its partners is not permissible, and this is an absolute prohibition. This view was supported by precedents such as A. S. K. Rathnaswamy Nadar Firm v. CIT and Giridharilal Ghasiram v. CIT, which held that remuneration paid to a partner in any capacity is not deductible.

However, the Tribunal observed that the partners had individual accounts in the firm and that the interest paid on these accounts could not be disallowed. The Tribunal relied on the principle that a karta (manager) of a Hindu undivided family (HUF) is a separate entity from the individual. The Supreme Court's decision in Brij Mohan Das Laxman Das v. CIT clarified that interest paid to a partner representing an HUF on personal/individual funds does not fall within the mischief of section 40(b), even for periods prior to April 1, 1985. This view was further supported by the Supreme Court in Suwalal Anandilal Jain v. CIT.

2. Material Before the Tribunal on Individual Business:

The Tribunal had to determine whether there was material to hold that the partners were carrying on some individual business and had undisclosed sources of income. The Tribunal accepted the assessee's contention that the partners had individual businesses and undisclosed sources of income, separate from the firm. This was based on the partners' disclosure petitions and the nature and source of the deposits made by them, which were not explained. The Tribunal noted that there was no presumption that in a joint Hindu family, the business carried on by a coparcener belonged to the family. The Tribunal concluded that the partners' individual accounts in the firm were distinct from their HUF accounts, and the interest paid on these accounts was allowable as deductions.

Conclusion:

The High Court upheld the Tribunal's findings, answering both questions in the affirmative, i.e., in favor of the assessee and against the Revenue. The interest paid to the partners on their individual accounts was not includible in the hands of the firm under section 40(b), and there was sufficient material to hold that the partners had individual businesses and undisclosed sources of income. The reference was disposed of accordingly.