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Issues: Interpretation of section 40(b) of the Income-tax Act, 1961 regarding the disallowance of interest paid by a firm to its partners.
In this judgment, the High Court of GAUHATI addressed the question of whether the total amount of interest paid by an assessee-firm to its partners was rightly disallowed under section 40(b) of the Income-tax Act, 1961. The firm, consisting of four partners, had paid Rs. 36,771 as interest to its partners and received Rs. 78,239 as interest from them. The Income-tax Officer disallowed the entire amount paid to the partners, but the Tribunal held that only the net amount paid to any partner should be considered for the purposes of section 40(b). The Tribunal relied on the decision of the Allahabad High Court in a similar case. The Department argued for a strict literal interpretation of section 40(b, but the High Court noted that different High Courts, including decisions in other cases, have consistently interpreted it to mean that only the net amount of interest payable to a partner should be disallowed. An Explanation added to section 40(b) further clarified this interpretation, limiting the disallowance to the difference between interest paid by the firm to a partner and interest paid by the partner to the firm. The High Court agreed with this interpretation, stating that it is logical and reasonable to disallow only the net interest paid by the firm to a partner. The Court ruled in favor of the assessee, clarifying that interest paid by the firm should be deducted after considering the interest paid by each partner individually. Each partner's account should be examined separately for the deduction to be applied accurately.
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