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Issues:
- Interpretation of section 40(b) of the Income-tax Act, 1961 regarding disallowance of interest credited to partner accounts. - Treatment of interest payments to joint families represented by partners for deduction from total income. Analysis: The judgment pertains to a case where the Income-tax Appellate Tribunal referred a question to the High Court under section 256(2) of the Income-tax Act, 1961 regarding the disallowance of interest credited to partner accounts under section 40(b) of the Act for assessment years 1972-73 and 1973-74. The firm in question carried on business in cloth and silk, with partners being members of an erstwhile Hindu undivided family. The interest credited to partner accounts was added back to the total income of the firm under section 40(b) on the premise that the interest was paid to the partners directly. However, the partners contended that the interest was paid to their respective joint families, not to them personally. The Income-tax Officer and Appellate Assistant Commissioner rejected the claim, leading to an appeal to the Tribunal. The Tribunal, in line with an earlier decision, allowed the appeal, prompting the Revenue to seek the High Court's opinion. For the assessment years 1972-73 and 1973-74, the firm claimed deduction of interest credited to joint family accounts from its total income. The Tribunal found that there was no stipulation in the partnership deed regarding capital investment by partners, and the interest was eventually credited to joint family accounts instead of individual partner accounts. As per section 40(b) of the Act, payment of interest to partners is not deductible, but in this case, interest was paid to joint families represented by partners. Since there was no obligation for partners to invest capital, the firm was entitled to deduct the interest paid to joint families from its total income. In a similar case cited by the High Court, it was established that partners were not required to invest capital as per the partnership deed, and the money belonged to the joint family. The transfer of funds to joint family accounts was deemed a reflection of the actual state of affairs, not an attempt to evade section 40(b) provisions. The High Court concurred with this reasoning, emphasizing that in the absence of a capital contribution obligation on partners, the firm could transfer capital from joint family funds to respective joint family accounts for interest deduction. Consequently, the High Court ruled in favor of the assessee, allowing the deduction of interest paid to joint families and awarded costs to the assessee.
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