1998 (1) TMI 31 - HC - Income Tax

Summary

Issues:
1. Interpretation of section 40(b) of the Income-tax Act, 1961 regarding the disallowance of interest paid to individual partners representing Hindu undivided families.
2. Clarificatory nature of Explanations 2 and 3 to section 40(b) introduced by the Taxation Laws (Amendment) Act, 1984.

Analysis:

The High Court of Madras considered the interpretation of section 40(b) of the Income-tax Act, 1961, in a case where the assessee, a firm with nine partners, paid interest to two partners representing their Hindu undivided families. The firm did not deduct this interest, arguing that the real partners were the Hindu undivided families and not the individuals. The Income-tax Officer accepted this treatment in the assessment for the years 1981-82 and 1982-83. However, the Commissioner of Income-tax invoked his revision powers under section 263 of the Act, contending that section 40(b) should have been applied to disallow the interest paid to individual partners. The Commissioner held that the amendments to section 40(b) by the Taxation Laws (Amendment) Act, 1984, were not applicable to the assessment years in question and directed the Income-tax Officer to disallow the interest. The assessee appealed to the Tribunal, arguing that the amendments were clarificatory, while the Revenue disagreed.

The Appellate Tribunal, relying on a decision of the Andhra Pradesh High Court, held that the Explanation to section 40(b) applied retrospectively and canceled the Commissioner's order. Upon the Revenue's application, the High Court directed the Tribunal to refer questions of law. The High Court noted the Supreme Court's decision in Brij Mohan Das Laxman Das v. CIT, which held that Explanation 2 to section 40(b) is declaratory and applies even before April 1, 1985. This view was reiterated in Suwalal Anandilal Jain v. CIT. Although a subsequent case doubted these decisions, the High Court found no issue with the Tribunal's decision that interest paid to partners in their individual capacity was deductible in computing the firm's profits. Therefore, the High Court upheld the Tribunal's decision, answering both questions of law in favor of the assessee and against the Department.