1986 (11) TMI 101 - AT - Income Tax

Summary

Issues Involved:
1. Applicability of Section 40(b) of the Income-tax Act, 1961.
2. Treatment of interest paid to partners in their individual capacities.
3. Interpretation of legal precedents and amendments related to Section 40(b).

Issue-wise Detailed Analysis:

1. Applicability of Section 40(b) of the Income-tax Act, 1961:

The core issue revolves around whether the interest paid by the firm to its partners in their individual capacities falls under the purview of Section 40(b) of the Income-tax Act, 1961. Section 40(b) disallows certain payments made by a firm to its partners, such as interest, salary, bonus, commission, or remuneration.

The Income Tax Officer (ITO) included the interest paid to Shri Mangal Sain and Shri Mool Chand in their individual capacities in the firm's income, citing that partners representing their HUFs in the firm and receiving interest in their individual capacities should be treated as interest paid to partners under Section 40(b).

2. Treatment of Interest Paid to Partners in Their Individual Capacities:

The assessee argued that the partners maintained two accounts: one on behalf of the HUF and another on their behalf. The interest was paid to the partners in their individual capacities, and thus, it should not be disallowed under Section 40(b).

The Appellate Assistant Commissioner (AAC) upheld the ITO's decision, relying on the Gujarat High Court's decision in CIT v. Sajjanraj Diwanchand and other precedents, which suggested that the contract between partners in a firm is in their individual capacities, even if they represent their HUFs. Hence, the interest paid to them individually was disallowed under Section 40(b).

3. Interpretation of Legal Precedents and Amendments Related to Section 40(b):

The assessee cited several case laws, including Chhotalal & Co. v. CIT, Terla Veeraiah v. CIT, CIT v. Budhalal Amulakhdas, and Venkatesh Emporium v. CIT, to argue that the interest paid to partners in their individual capacities should not be disallowed under Section 40(b). The AAC and the revenue, however, relied on the decisions of the Allahabad High Court in London Machinery Co., the Madras High Court in Dwarkadas Rameshwar Goenka, and the Delhi High Court in Sanghi Motors, which supported the disallowance of such interest under Section 40(b).

The Tribunal noted that the Gujarat High Court's decision in Chhotalal & Co. was not informed about the decisions in London Machinery Co., Dwarkadas Rameshwar Goenka, and Sanghi Motors. The Tribunal found the views of the Allahabad, Madras, and Delhi High Courts more in consonance with the spirit of Section 40(b).

Separate Judgments Delivered by the Judges:

Judicial Member's View:

The Judicial Member upheld the disallowance, stating that the interest paid to partners in their individual capacities should be treated as interest paid to partners under Section 40(b). The Judicial Member relied on the decisions of the Allahabad, Madras, and Delhi High Courts, which supported this interpretation.

Accountant Member's View:

The Accountant Member disagreed, citing the Full Bench decision of the Gujarat High Court in Chhotalal & Co., which held that interest paid to partners in their individual capacities should not be disallowed under Section 40(b). The Accountant Member also referred to the amendment to Section 40(b) and the Board's circular clarifying that the amendment was intended to reduce litigation and should apply retrospectively.

Third Member's Decision:

The Third Member agreed with the Accountant Member, emphasizing the clarificatory nature of the amendment to Section 40(b) and the Board's circular. The Third Member also referred to the Andhra Pradesh High Court's decision in N.T.R. Estate v. CIT, which supported the retrospective application of the amendment. The Third Member concluded that the interest paid to partners in their individual capacities should not be disallowed under Section 40(b).

Conclusion:

The Tribunal, by majority opinion, held that the interest paid to partners in their individual capacities should not be disallowed under Section 40(b) of the Income-tax Act, 1961. The appeal was allowed, and the addition of interest under Section 40(b) was deleted.