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Issues Involved:
1. Applicability of Section 40(b) of the Income-tax Act, 1961, to interest payments made by a firm to the HUF of a partner. 2. Jurisdiction of the ITO to rectify the original assessment u/s 154 of the Income-tax Act, 1961. Summary: Issue 1: Applicability of Section 40(b) of the Income-tax Act, 1961 The primary issue was whether the interest payments made by M/s. Venkatesh Emporium to the HUF of one of its partners, Venkatesan, should be disallowed u/s 40(b) of the Income-tax Act, 1961. The Tribunal had held that the interest paid to the HUF should be added back to the firm's income, as s. 40(b) enacts an absolute prohibition on the payment of interest to a partner in any capacity. However, the High Court disagreed with the Tribunal's interpretation. The Court noted that the interest payments were made to the HUF and not to Venkatesan in his individual capacity. The Court emphasized that s. 40(b) only applies to payments made to a partner and not to payments made to the partner's HUF. The Court stated, "The interest really belonged to the HUF because it was the HUF which had advanced the amounts to the firm." Therefore, the interest payments to the HUF could not be disallowed under s. 40(b). The Court also reviewed various decisions from other High Courts, including Andhra Pradesh, Allahabad, and Gujarat, which supported the view that s. 40(b) does not apply to interest payments made to the HUF of a partner. The Court concluded that the Tribunal's decision was contrary to the plain terms of s. 40(b) and held in favor of the assessee. Issue 2: Jurisdiction of the ITO to Rectify the Original Assessment u/s 154 of the Income-tax Act, 1961 For the assessment years 1971-72 and 1972-73, the ITO initially allowed the interest payments as deductions but later sought to rectify this by invoking s. 154 of the Act, treating the allowance as a mistake apparent from the record. The Tribunal upheld the ITO's jurisdiction to rectify the assessment. However, the High Court found that since there was no scope to disallow the interest payments under s. 40(b), the question of whether the ITO was right in invoking s. 154 became moot. The Court stated, "It is quite unnecessary for us to go into the further question, whether the ITO was right in bringing to bear his powers of rectification for the purpose of effecting the disallowance." Thus, this jurisdictional question remained unanswered. Conclusion: The High Court answered the primary question of law in the negative and in favor of the assessee, holding that the interest payments to the HUF could not be disallowed under s. 40(b) of the Income-tax Act, 1961. Consequently, the assessee was entitled to costs from the Department, with counsel's fee set at Rs. 500.
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