1987 (6) TMI 110 - AT - Income Tax

Summary

Issues:
1. Interpretation of section 40(b) of the Income Tax Act, 1961 regarding the taxation of interest credited to the account of a deceased partner in a reconstituted firm.
2. Determination of whether the heirs of the deceased partner constituted a body of individuals or an Association of Persons (AOP) for tax purposes.

Detailed Analysis:

1. The judgment revolves around the interpretation of section 40(b) of the Income Tax Act, 1961 concerning the taxation of interest credited to the account of a deceased partner in a reconstituted firm for the assessment year 1980-81. The issue arose as to whether four-fifths of the interest credited to the account, excluding the share of a non-participating heir, should be added to the firm's income. The Assessing Officer (AO) applied section 40(b) and added four-fifths of the interest to the firm's income, leading to an appeal by the assessee.

2. The contention of the assessee was that section 40(b) should apply only when payments are made directly to partners, not to an Association of Persons (AOP). The AO argued that the heirs did not constitute an AOP as per the Hindu Succession Act, and therefore, the interest income should be taxed. The Commissioner of Income Tax (Appeals) (CIT(A)) deleted the addition, stating that until distribution, the amount belonged to the estate, not the heirs individually, and therefore, section 40(b) did not apply.

3. The Tribunal analyzed the legal position based on the Hindu Succession Act and relevant case law. It was established that on the demise of the deceased partner, the heirs immediately became entitled to the property left by him, with each heir having a definite share. The heirs did not form an AOP due to lack of voluntary association or agreement. Referring to a relevant High Court judgment, the Tribunal concluded that the heirs did not constitute a body of individuals. Therefore, each heir's one-fifth share in the interest credited should be treated as interest received by a partner under section 40(b).

4. Consequently, the Tribunal allowed the appeal of the revenue, setting aside the CIT(A)'s decision and restoring the addition made by the AO. The judgment clarified the distinction between AOP and body of individuals, emphasizing the lack of voluntary association among the heirs and their equal entitlement to the deceased partner's assets.