1970 (12) TMI 20 - HC - Income Tax

Interest paid by partners to firm on money borrowed - partners are not entitled to claim deduction towards amount paid as interest from their share income

Summary

Issues Involved:

1. Deductibility of interest paid by partners to the firm from their share income.
2. Application of the doctrine of real income.
3. Double taxation of income.

Issue-wise Detailed Analysis:

1. Deductibility of Interest Paid by Partners to the Firm from Their Share Income:

The respondents-assessees, partners in M/s. Seetharama Mining Company, paid interest on amounts withdrawn from the firm for personal expenses. They sought to deduct these interest payments from their other income under section 37(1) of the Income-tax Act, 1961. The Income-tax Officer and the Appellate Assistant Commissioner denied this deduction. The Income-tax Appellate Tribunal partially allowed the appeals, directing the Income-tax Officer to exempt the interest amounts received by each partner from the firm. The High Court, however, held that the partners and the firm are distinct entities for tax purposes, and the interest payments made by the partners to the firm are commercial transactions resulting in real profits for the firm. Therefore, the partners are not entitled to deduct these interest payments from their share income.

2. Application of the Doctrine of Real Income:

The assessees argued that the interest payments should be considered notional and not real income. The High Court reviewed various precedents and principles, including the concept of "real profits" and the doctrine of real income. It concluded that the amounts received by the firm as interest from the partners were real and commercial profits. The doctrine of real income did not apply because the interest payments were actual profits earned by the firm, and the partners' share income included these amounts. Therefore, the High Court rejected the contention that the interest payments were not real income.

3. Double Taxation of Income:

The assessees contended that taxing the interest income both in the hands of the firm and the partners constituted double taxation. The High Court referred to the principle that the same income should not be taxed twice in the same form. However, it noted that the Income-tax Act, 1961, specifically provides for taxing the income of both the firm and its partners. The Supreme Court's ruling in Jain Brothers v. Union of India was cited, which stated that there is no constitutional prohibition against double taxation, and if the legislature expressly sanctions it, it is permissible. Consequently, the High Court held that the income could be taxed both in the hands of the firm and the partners, and the objection of double taxation was overruled.

Conclusion:

The High Court answered the question in the negative and against the assessee, holding that the Tribunal erred in allowing the deduction of one-third of the interest paid by the partners to the firm from their share income. The assessees were directed to pay the costs of the reference to the Commissioner of Income-tax, with the advocate's fee fixed at Rs. 300.