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TMI Blog1990 (2) TMI 1X X X X Extracts X X X X X X X X Extracts X X X X ..... stion was whether, in making a disallowance of the interest paid by partnership firm to a partner under section 40(b) of the Act, the interest, in turn, paid by the partner on his borrowings from the firm should be taken account of and deducted and only the balance disallowed under section 40(b). On this question, there is a sharp divergence of judicial opinion in the High Courts. In Sri Ram Mahadeo Prasad V. CIT [1953] 24 ITR 176 (All) ; CIT v. Kailash Motors [1982] 134 ITR 312 (All) ; CIT V. T. V. Ramanaiah and Sons [1986] 157 ITR 300 (AP) ; CIT v. Kothari and Co. [1987] 165 ITR 594 (Kar) ; CIT v. Balaji Commercial Syndicate [1987] 165 ITR 596 (Kar) ; CIT v. Motilal Ramjiwan and Co. [1988] 171 ITR 294 (Raj) ; CIT v. Precision Steel and Engg. Works [1989] 179 ITR 283 (P H), the High Courts have taken the view that, where a firm pays interest to its partner and the partner also pays interest to the firm, only the net amount of interest paid by the firm to the partner is liable to disallowance under section 40(b) of the Act. However, in CIT v. 0. M. S. S. Sankaralinga Nadar and Co. [1984] 147 ITR 332. (Mad), the High Court of Madras has taken a contrary view. We have heard Sri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered the question in the negative and against the appellant relying, as stated earlier, on its earlier pronouncement in Sankaralinga Nadar's case [1984] 147 ITR 332 (Mad). Broadly similar are the circumstances under which the other appeals arise. Before we advert to and evaluate the merits of the contentions, it is appropriate to refer to the statutory provision as it then stood. Section 40 of the Act provided : "40. Notwithstanding anything to the contrary in sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession' . . . (b) in the case of any firm, 'any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm..." By the Taxation Laws (Amendment) Act, 1984, several amendments were introduced in the body of section 40. One of them was the introduction of Explanation I in clause (b) of section 40. That Explanation reads: "Explanation I :-Where interest is paid by a firm to any partner of the firm who has also paid interest to the firm, the amount of interest to be disallowed under this clause shall be limited to the amount ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case [1984] 147 ITR 332 and emphasised by learned counsel for the Revenue. The reasoning of the Madras High Court in that case and of the Andhra Pradesh High Court in CIT v. T. V. Ramanaiah and Sons [1986] 157 ITR 300, illustrate the rival points of view. The Madras High Court held (at page 336 of 147 ITR) : "The collocation of the words shows that what is disallowed in the matter of payment of interest cannot be the net interest, but can only be interest paid with reference to a given account relating to payment of interest by the firm to the partner. This is because the subject of disallowance in the matter of payment of interest appears in section 40(b) cheek by jowl with salary, bonus, commission or remuneration made by the firm to the partner. There cannot be any net salary or net bonus or net remuneration as matters of disallowance. They can only be salary, as such, or bonus, as such, or commission, as such, or remuneration as such which are the subject of disallowance. In like manner, when the section speaks of payment of interest by the firm to a partner as the subject of disallowance, it can only be payment of 'gross' interest in the particular account in which interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... extent of the embargo under section 10(4)(b) of the 1922 Act on the disallowance of 'interest' paid to a partner was judicially interpreted and ascertained in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 (All) and when the Legislature re-enacted those provisions in section 40(b) of the 19.61 Act in substantially the same terms, the Legislature must be held to have used that expression with the same implications attributed to it by the earlier judicial exposition. (c) Interest payable by the partners to the firm pursuant to an agreement between the partners is of the same nature as that payable by the firm to the partners on the capital brought in by them. Interest paid to and received from a partner are both integral parts of a method adopted by the partners for adjusting the division of profits and, in that sense, both payments partake of the same character. In identifying and quantifying the 'interest' for purposes of section 40(b), it would be permissible to take both the payments into consideration and treat only such excess, if any, paid by the firm as susceptible to the exclusionary rule in section 40(b). (d) Circular No. 33D(XXV 24) of 1965 of the Central Board of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tself, which must, if they are plain and unambiguous, be applied as they stand . . . " (Emphasis supplied) Artificial and unduly latitudinarian rules of construction, which with their general tendency to "give the taxpayer the breaks", are out of place where the legislation has a fiscal mission. Indeed, taxation has ceased to be regarded as an "impertinent intrusion into the sacred rights of private property" and it is now increasingly regarded as a potent fiscal tool of State policy to strike the required balance-required in the context of the felt needs of the times-between the citizens' claim to enjoyment of his property on the one hand and the need for an equitable distribution of the burdens of the community to sustain special services and purposes on the other. These words of Thomas M. Cooley in 'Law of Taxation', Volume 2, are worth mentioning: "Artificial rules of construction have probably found more favour with courts than they have ever deserved. Their application in legal controversies has often times been pushed to an extreme which has defeated the plain and manifest purpose in enacting the laws. Penal laws have sometimes had all their meaning construed away and in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent content. This is, no doubt, a well recognised guide to construction. When words acquire a particular meaning or sense because of their authoritative construction by superior courts, they are presumed to have been used in the same sense when used in a subsequent legislation in the same or similar context. This principle was stated by the Judicial Committee in H. H. Ruckmaboye v. Lulloobhoy Mottichund [1852] 5 M.I.A. 234 at 250, thus : ". . . it is, therefore, of considerable importance to ascertain what has been deemed to be the legal import and meaning of them, because, if it shall appear that they have long been used, in a sense which may not improperly be called technical, and have been judicially construed to have a certain meaning, and have been adopted by the Legislature in that sense, long prior to the Statute, 21 James I., c. 16, the rule of construction of statutes will require that the words in the statute should be construed according to the sense in which they had been so previously used, although that sense may vary from the strict literal meaning of them." This principle has been reiterated by this court in several pronouncements. But the limitations of its app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The partnership property vests in all the partners and in that sense every partner has an interest in the assets of the partnership. However, during the subsistence of the partnership, no partner can deal with any portion of the property as his own. In Addanki Narayanappa v. Bhaskara Krishnappa, AIR 1966 SC 1300 [1966] 3 SCR 400, this court referred to the nature of the interest of a partner in the firm and observed (at page 1304 of 1966 AIR): ". . . The whole concept of partnership is to embark upon a joint venture and for that purpose to bring in as capital money or even property including immovable property. Once that is done whatever is brought in would cease to be the exclusive property of the person who brought it in. It would be the trading asset of the partnership in which all the partners would have interest in proportion to their share in the joint venture of the business of partnership. The person who brought it in would, therefore, not be able to claim or exercise any exclusive right over any property which he has brought in, much less over any other partnership property. He would not be able to exercise his right even to the extent of his share in the business of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , were referred to with approval (at page 126 of [1985] 2 SCR) : "The argument on behalf of the applicant in this appeal appears to involve a legal impossibility, namely, that the same person can occupy the position of being both master and servant, employer and employed." And this court observed (at page 123 of [1985] 2 SCR) : ". . . A partnership firm is not a legal entity. This court in Champaran Cane Concern v. State of Bihar, [1963] 49 ITR (SC) 152, pointed out that in a partnership each partner acts as an agent of the other. The position of a partner qua the firm is thus not that of a master and a servant or employer and employee which concept involves an element of subordination, but that of equality. The partnership business belongs to the partners and each one of them is an owner thereof . . ." "It is thus clear that in the United States, Great Britain and Australia, a partner is not treated as an employee of his firm merely because he receives a wage or remuneration for work done for the firm. This view is in complete accord with the jurisprudential approach. In the absence of any statutory mandate, we do not think there is any scope for accepting the view of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, I am encouraged to look at the realities at the expense of the technicalities . . ." In CIT v. Gillanders Arbuthnot and Co. [1973] 87 ITR 407 at page 418, this court said : ".. .. The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authority to unravel the device and to determine the true character of the relationship. But, the legal effect of a transaction cannot be displaced by probing into the 'substance of the transaction'. .." (emphasis supplied) The court is not precluded from treating what the transaction is in point of fact as one in point of law also. How do these principles operate on the present controversy ? It appears to us that, if, in substance, the interest paid by the firm to a partner and the interest, in turn, received from the partner are mere expressions of the applications of the funds or profits of the partnership and which, having regard to the community of interest of the partners, are mere variations of the method of adjustment of the profits, there should be no impediment in treatin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n. The decision of the Madras High Court in Sankaralinga Nadar's case [1984] 147 ITR 332, speaks of income-tax and equity being strangers. To say that a court could not resort to the so-called "equitable construction" of a taxing statute is not to say that, where a strict literal construction leads to a result not intended to subserve the object of the legislation, another construction, permissible in the context, should not be adopted. In CIT v. J. H. Gotla [1985] 156 ITR 323, this court said " ... we should find out the intention from the language used by the Legislature and if strict literal construction leads to an absurd result, i.e., result not intended to be subserved by the object of the legislation found in the manner indicated before, then if another construction is possible apart from the strict literal construction, then that construction should be preferred to the strict literal construction. Though equity and taxation are often strangers, attempts should be made that these do not remain always so and if a construction results in equity-rather than in injustice, then such construction should be preferred to the literal construction. Furthermore, in the instant case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... really has in mind circulars beneficial to the assessees and which tone down the rigour of the law issued in exercise of the statutory power under section 119 of the Act or under corresponding provisions of the predecessor Act are binding on the authorities in the administration of the Act. The Tribunal, much less the High Court, is an authority under the Act. The circulars do not bind them. But the benefits of such circulars to assessees have been held to be permissible even though the circulars might have departed from the strict tenor of the statutory provision and mitigated the rigour of the law. But that is not the same thing as saying that such circulars would either have a binding effect in the interpretation of the provision itself or that the Tribunal and the High Court are supposed to interpret the law in the light of the circular. There is, however, the support of certain judicial observations for the view that such circulars constitute external aids to construction. In State Bank of Travancore v. CIT [1986] 158 ITR 102, however, this court, referring to certain circulars of the Board, said (at page 139): " ...The earlier circulars being executive in character cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X
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