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Issues: Determination of whether the payment of interest to the estate account was subject to section 40(b) of the Income-tax Act, 1961 for the assessment year 1974-75.
Analysis: The judgment delivered by the High Court of Madras involved a case where the deceased partner had earmarked amounts in his capital account for his grandsons through a will. Following the partner's death, the amounts were transferred to the estate account, and interest was credited to the estate. The trustee appointed under the will received the interest, and the minor sons of the trustee were admitted to the benefits of the partnership firm. The Income Tax Officer (ITO) disallowed the deduction of interest under section 40(b) of the Income-tax Act, considering it as interest payable to the minor partners. The assessee contended that the interest was paid to the estate account, not the minors directly. The Appellate Authority Commission (AAC) and the Tribunal both ruled in favor of the assessee, stating that the interest was paid to the trustee, not the minor partners, and thus, section 40(b) did not apply. The key issue revolved around the interpretation of section 40(b) of the Income-tax Act, which disallows deductions for certain payments made by a firm to its partners. The court analyzed whether the interest payment was made to a partner of the firm, as stipulated in the section. It was established that the trustee received the interest in his capacity as a trustee under the will, not as a partner of the firm. The court emphasized that for section 40(b) to apply, the payment must be made to a partner of the firm, which was not the case here. The court further referenced a Supreme Court decision and a recent Madras High Court decision to support its interpretation. The Supreme Court case highlighted that until the minor partners attained majority, no right accrued to them for the interest payment. Similarly, the recent Madras High Court decision clarified that even if a partner represents their family in the partnership, payments made to the family would not trigger section 40(b) as long as the partner is treated as an individual partner. Applying these precedents, the court concluded that since the interest was paid to the estate account in the hands of the trustee, section 40(b) was not applicable, and the assessee was entitled to the deduction of interest. In conclusion, the court answered the reference question in the negative, in favor of the assessee, allowing the deduction of interest. The judgment clarified that the payment was not made to the minor partners but to the trustee administering the estate, thereby excluding the application of section 40(b) of the Income-tax Act. The assessee was awarded costs from the Revenue, and the counsel's fee was set at Rs. 500.
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