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TMI Blog1988 (5) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... e status of R. N. Mehra (HUF), partner, it was entitled to deduct the interest paid to R.N. Mehra in his individual capacity. The Income-tax Officer did not agree with the assessee. He held that since R. N. Mehra was a partner in his capacity as karta of the Hindu undivided family such payment of interest was not allowable according to the provisions of section 67(1)(b) of the Income-tax Act, 1961. He held that no distinction could be made in the two deposits, one made by R. N. Mehra in the capacity of karta of the Hindu undivided family and other in his capacity as individual Consequently, the assessee's claim was disallowed and the interest was added to the total income of the firm in the relevant years. On appeal, the Appellate Assistant Commissioner reversed the judgment of the Income-tax Officer holding that interest paid to the partner was only to be added under section 40(b) and as R. N. Mehra, individual, was not the partner, the interest paid to his account could not be added under section 40(b) of the Income-tax Act. The additions, in this behalf, made in his account were, therefore, deleted. The Revenue took up the matter in appeal before the Income-tax Appellate Tribu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... salary. The prohibition of the allowance of interest also to a case of partner stands on par with the same force as salary. The partners in a firm are ultimately entitled to the entire profits of the firm, according to their share in the business. Therefore, the entirety of such profits should be brought to charge and no portion be exempted by giving the same away to a partner camouflaged as his salary, bonus, commission, remuneration or interest. A partner is bound to find the necessary finance for the partnership and, hence, any interest on capital supplied by the partner is not deductible. In R. A. Goodsir Co. v. CEPT [1948] 16 ITR 367 (Mad) and N. M. Anniah Co. v. CIT [1975] 101 ITR 348 (Kar), it was held that section 10(4)(b) made no distinction between a payment made to a partner as partner and one made to him in a different capacity. Clause (b) re-enacts the prohibition formerly contained in section 10(4)(b) of the Indian Income-tax Act, 1922, with the addition of the word "bonus". Under the amended provision any interest, salary, bonus, commission or remuneration paid by a firm to any one of its partners cannot be deducted by the firm as an expenditure in its pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TR 488 (SC), it was laid down as follows (at p. 492) : "A Hindu undivided family is no doubt included in the expression 'person' as defined in the Indian Income-tax Act as well as in the Excess Profits Tax Act but it is not a juristic person for all purposes. The affairs of the Hindu undivided family are looked after and managed by its karta. When two kartas of two Hindu undivided families enter into a partnership agreement, the partnership is popularly described as one between the two Hindu undivided families but in the eye of the law it is a partnership between the two kartas and the other members of the families do not ipso facto become partners. There is, however, nothing to prevent the individual members of one Hindu undivided family from entering, into a partnership with the individual members of another Hindu undivided family and in such a case it is a partnership between the individual members and it is wholly inappropriate to describe such a partnership as one between two Hindu undivided families." In Firm Bhagat Ram Mohanlal v. CEPT [1956] 29 ITR 521, the Supreme Court ruled that (at p. 525): "It is well settled that when the karta of a joint Hindu family enters int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, salary, bonus, commission or remuneration made by the firm to any of its partners and does not make arty distinction in respect of the character or capacity in which the payment is made to the partner. If a partner makes deposits in the firm of monies belonging to his Hindu undivided family and also money belonging to him individually in fact and in law the partner brings in the money. In both cases the payment of interest by the firm to such a partner is as partner no matter who really has the beneficial interest in such payments. Section 40(b) of the Act would, therefore, apply to the payment of interest to the three partners who were partners in their capacity as kartas of Hindu undivided families and had deposited their individual money in the firm." This decision has been followed by another Division Bench of this court in CIT v. Chandu Lal Surajpal [1986] 157 ITR 346, by the Andhra Pradesh High Court in CIT v. T. Veeraiah and K. Narasimhulu [1977] 106 ITR 283, by the Madras High Court in Dwarkadas Rameshwar Goenka v. CIT [1981] 127 ITR 397, by the Delhi High Court in Sanghi Motors v. CIT [1982] 135 ITR 359, by the Madhya Pradesh High Court in Jalam Chand Mangilal (No. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al entity apart from the partners constituting it. The firm, as such, has no separate rights of its own in the partnership assets. The firm's assets are the properties or the assets of all the partners. Our attention was drawn to section 10 of the Taxation Laws (Amendment) Act, 1984, by which the following three Explanations had been inserted in section 40 of the Income-tax Act, after clause (b). The Explanations run thus : "Explanation 1. -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 by which the payment of interest by the firm to the partner exceeds the payment of interest by the partner to the firm. Explanation 2.-Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as 'partner in a representative capacity' and 'person so represented' respectively), (i) interest paid by the firm to such individual or by such individual to the firm otherwise than as partner in a representative capacity, shall not be taken into account for the purp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The Andhra Pradesh High Court held that the Explanations are clarificatory in nature and must govern assessments prior to the assessment year 1985-86. It has taken the same view in CIT v. Chitra Kalpana[1988] 169 ITR 678 (AP). The settled principle of law is that a new state of law ought to affect the future, not the past. A statute will not be presumed to have retrospective effect. It was precisely for that reason that the Andhra Pradesh High Court held the amending Act to be clarificatory in nature and by applying the rule of interpretation, it held that the amendment would apply to previous years also. It may be correct that the presumption against the retrospective operation is not applicable to declaratory statutes as stated in Craies on Statute Law, VII Edition, p. 58: "For modern purposes, a declaratory Act may be defined as an Act to remove doubts existing as to the common law, or the meaning or effect of any statute. Such Acts are usually held to be retrospective. The usual reason for passing a declaratory Act is to set aside what Parliament deems to have been a judicial error, whether in the statement of the common law or in the interpretation of statutes. Usual ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Taxation Laws (Amendment) Act, 1984, would not apply to earlier assessment years. In State of U.P. v. Malik Zarid Khalid, AIR 1988 SC 132, the question arose as to what are the requirements necessary to be found for declaring an amending Act as declaratory or clarificatory. The Supreme Court held (p. 138) : "If its intention in carrying out the amendment had been misunderstood by the High Court or found ambiguous, the Legislature was expected to rectify the situation by a piece of retrospective or declaratory legislation." In Dattatraya Govind Mahajan v. State of Maharashtra [1977] 2 SCC 548, AIR 1977 SC 915, 928, Bhagwati J. (as he then was), speaking for the Bench, observed: "It is true that the orthodox function of an Explanation is to explain the meaning and effect of the main provision to which it is an Explanation and to clear up any doubt or ambiguity in it. But, ultimately, it is the intention of the Legislature which is paramount and mere use of label cannot control or deflect such intention. It must be remembered that the Legislature has different ways of expressing itself and in the last analysis the words used by the Legislature alone are the true repository ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dispute. The assessee, Messrs. Nitro Phosphetic Fertilizer, Lucknow, is a registered firm constituted under a partnership deed dated January 28, 1971. A copy of the said deed has been filed as annexure A to the statement of case submitted by the Tribunal to this court. It has been recited in clause (6) of the said partnership deed that Sri Rameshwar Nath Mehra has entered into the partnership as karta representing his Hindu undivided family (in short "the HUF") constituted by him along with his son and wife and that the remaining two other partners have entered into the partnership in their individual capacity. The account books of the said firm reveal that during the assessment years 1971-72 and 1972-73 with which we are concerned in this reference, the capital account of the Hindu undivided family represented by Sri R. N. Mehra is there. Besides this, there also existed deposits with the firm in another account of Sri R. N. Mehra which account admittedly is in his individual capacity. During the said two years in question the assessee-firm paid interest on the individual deposit account of Sri R. N. Mehra and claimed the same as deduction while computing its taxable income. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of CIT v. London Machinery Co. [1979] 117 ITR 111 (All) is that in both the cases the payment of interest by the firm to such a partner is as a partner irrespective of the distinction between the two capacities in which the two accounts stand in the books of the firm. To consider the debated question which arises for consideration in the present case, it is profitable to refer to certain definitions and provisions of the Act. Sub-section (23) of section 2 of the Act reads as follows : "'Firm', 'partner' and 'partnership' have the meanings respectively assigned to them in the Indian Partnership Act, 1932 (9 of 1932), .. ." Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. In the definition of "partnership" under the Indian Partnership Act, 1932, two principles always come to be recognised. The first is that there must be an agreement between persons and, secondly, the doctrine of agency between the partners inter se is recognised in the latter part of the said definition. The business carried on by a firm is in law the business carried on by the partners. Profits of the firm are pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Statutes by K. P. Chakravarty, 1978 Edition, at page 47, it has been observed as follows : "Though the courts often hesitate to resort to external aids as means to determine the legislative intent, nevertheless, they refer to such aids not for construing the statute, but for widening the concept of the 'context'. Literal construction may have to be discarded if such construction purports to defeat the purpose of the statute. As Justice Learned Hand puts it very effectively : 'Statutes should be construed not as theorems of Euclid, but with imagination of purpose behind them... Although judges have certain limitations beyond which they are not to traverse, yet they are to see that the purpose of the law is not defeated because the entire legislative process is influenced by considerations of justice and reason which constitute general legislative intent in every piece of legislation." As early as in the year 1966, the Supreme Court has observed in the case of K. Narasimhiah v. H. C. Singri Gowda, AIR 1966 SC 330, at page 332, "to ascertain the intention, the court has to examine carefully, the object of the statute, the consequences that may follow from insisting on a strict ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the statute was not the one intended by the law-makers. That apart, I also find that the controversy involved in the present case is not res integra. The partner may have more than one personality, viz., he may be a partner in a representative-capacity as in the present case and yet he may be having another account in his individual capacity. In the case of Addl. CIT v. Vallamkonda Chinna Balaiah Chetty and Co. [1977] 106 ITR 556(AP), a firm consisted of four partners. One of them represented his Hindu undivided family. There was also an individual account of the same person. The person concerned had entered into the partnership in his individual capacity. It was held by the Andhra Pradesh High Court that the amount paid as interest in the joint family account was not a payment made as partner as it was a payment made to person who had advanced the amount. So the payment does not come within the mischief of section 40 (b) of the Act. The above line of argument was followed by the same High Court in the case of Terla Veeraiah v. CIT [1979] 120 ITR 502 (AP). The ratio of the decision is that if a payment of interest is made to a person not in his capacity as a partner of a fir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anger, such interest payments could be deductible as revenue expenditure under section 37. If by some fortuitous circumstance, such stranger becomes a trustee of trust, the previous trustee of which was a partner of that firm, can it, for that reason, be said that the interest which had to be paid to him as was done earlier, not as trustee but on his own individual account, should no longer be an item of expenditure to be deducted? We see neither reason nor logic in such an approach. If the income-tax authorities are to act on the basis of real facts and not on any assumptions, then, for the purpose of section 40(b), they will have to consider the Hindu undivided family as represented by Shri C.S. Virani as the partner and if that is so, what is paid to Shri C. S. Virani as representing the Hindu undivided family by way of interest will alone fall within the section." In the case of Balchand Hashmatrai and Co. v. CIT [1986] 161 ITR 121, it was held by the Madhya Pradesh High Court that no disallowance can be made under section 40(b) if the interest is paid by the firm to the partner in a capacity other than the capacity of a partner. A Full Bench of the Madhya Pradesh High Cour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ers were rendered by the partners without there being a legal or contractual obligation to so render and, consequently, the payments are not hit by the provisions contained in section 10(4)(b) of the 1922 Act. We are in complete agreement with the aforesaid distinction . . . . Thus, the character in which the partner received the amount from the firm is relevant and significant for the purpose of determining whether the provisions of section 40(b) of the Act are applicable." In the present case, while lending money to the firm as an individual, Sri R.N. Mehra does not act as an agent of the other partners of the firm. Such a payment of interest made to Sri Mehra for the money lent by him in his individual account cannot be said to form part of the profits of the firm nor can such a payment be said to be an attempt to siphon off the profits of the firm. The said interest has been paid to him not as a partner but as a stranger to the firm. To my mind, the real test in such a case is to find out as to in what capacity the payment of interest is being made by the firm. If the payment has been made not in the capacity of a partner, then if it is just a chance that the same person happ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eement between the partners regarding finance of the firm apart from capital. Therefore, on the facts of this case, the very basis that a partner was bound to find necessary finance for the partnership business was lacking in the present case. Therefore, it was open to Sri R. N. Mehra to provide finance to the firm in his capacity as lender. It will be very peculiar to say that in case a person who also happens to be a partner of the firm and has got money to provide finance in the capacity as lender to the firm, yet, in case he lends money, any payment of interest made to him in that capacity is liable to be disallowed so as to ultimately increase the computation of income of the firm thereby affecting all the partners of the firm. Obviously, payment of interest to the lender of money can by no stretch of imagination be taken to be siphoning off the profits of the firm. If the interpretation as held by my brother Agrawal J., is put, it will compel a firm to find out. Here printed in italics. finance for the firm only from persons who are lenders but not partners of the firm in any capacity whatsoever. Stich strange results could not be expected to follow. In this view of the matte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Dhakappa [1969] 72 ITR 192 and CIT v. D. C. Shaw [1969] 73 ITR 692 and a host of other cases decided by the Supreme Court and various other High Courts bearing on the point, we find that the test laid down is as to who is the real recipient, of salary. The principle enunciated is that if the real recipient of the salary is the joint family although it was paid ostensibly to the partner, then the salary paid falls to be disallowed under section 40(b) of the Act. If it is established that the salary received by the karta of the joint family from firm in which he is a partner in a representative capacity was for services rendered by him individually and that there was no real and sufficient connection between the investment of the joint family assets in the firm and the salary or remuneration paid to him, the salary or remuneration received by the karta could not be treated as income of the family. Applying the above test to the facts of the case, I find that in the present case we are not concerned with the payment of interest in the capital account of Sri R. N. Mehra as representing the Hindu undivided family but in respect of the sum lent by Sri R. N. Mehra as an individual to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ates thus: "An Explanation does not enlarge the scope of the original section that it is supposed to explain. It is axiomatic that an Explanation only explains and does not expand or add to the scope of the original section ... The purpose of an Explanation is, however, not to limit the scope of the main provision . . . The construction of the Explanation must depend upon its terms, and no theory of its purpose can be entertained unless it is to be inferred from the language used. An 'Explanation' must be interpreted according to its own tenor." The principles laid down by the aforesaid authors are fully supported by various decisions of the Supreme Court. To quote only a few, in Burmah Shell Oil Storage Distributing Co. of India Ltd. v. CTO [1960] 11 STC 764, 776 ; [1961] 1 SCR 902 ; AIR 1961 SC 315, 321, a Constitution Bench decision, Hidayatullah J., speaking for the court, observed thus: "Now, the Explanation must be interpreted according to its own tenor, and it is meant to explain clause (1)(a) of the article and not vice versa. It is an error to explain the Explanation with the aid of the article, because this reverses their roles." In Bihta Co-operative Developmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to provide additional support to the dominant object of the Act in order to make it meaningful and purposeful; (d) to help or assist the court in interpreting the true purport and intendment of the enactment, in order to suppress the mischief and advance the object of the Act where some gap is left which is relevant for the purpose of the Explanation though it cannot in any way interfere with or change the enactment or any part thereof. Now, in order to arrive at the true intendment of a statute, the court should pose to itself the questions : (1) what was the situation prior to the provision under construction, (2) what mischief or defect was noticed before introducing the provision, (3) whether it was remedial, and (4) the reason for the remedy. ( Babaji Kondaji Garad v. Nasik Merchants Co-op. Bank Ltd. [1984] 2 SCC 50, AIR 1984, SC 192 at page 197). Applying the above tests, we find that in so far as our case is concerned, admittedly, the provision regarding disallowance of payment of salary or interest to a partner under the Indian Income-tax Act, 1922, and thereafter under the Income-tax Act, 1961, was designed to meet the mischief noticed before introducing the provisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inciple has since received statutory recognition by the Taxation Laws (Amendment) Act, 1984, which added three Explanations to section 40(b) of the Act. Explanation 2, newly added, provides that, where an individual is partner in a firm in a representative capacity, the interest paid by the firm to such individual otherwise than as partner in a representative capacity shall not be taken into account for the purposes of clause (b) of section 40 of the Act. The reason for recognising the above principle statutorily is stated in the Statement of Objects and Reasons, as mainly to streamline the procedures in the interest of better work-management, avoid inconvenience to taxpayers, reduce litigation, remove certain anomalies in, and rationalise some of, the provisions and counteract tax avoidance and tax evasion. It is, therefore, clear that an amount paid to a partner by a firm otherwise than in the capacity of a partner is not caught by the provisions contained in section 40(b) of the Act." I fully agree with the aforesaid view taken in the case of Chitra Kalpana [1988] 169 ITR 678 (AP). The next aspect of the question that falls for consideration is, although nothing has been ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mendment, clause (b) of section 15 of the Central Act reads as under: '(b) Where a tax has been levied under that law in respect of the sale or purchase inside the State of any declared goods and such goods are sold in the course of inter-State trade or commerce, and tax has been paid under this Act in respect of the sale of such goods in the course of inter-State trade or commerce, the tax levied under such law shall be reimbursed to the person making such sale in the course of inter-State trade or commerce in such manner and subject to such conditions as may be provided in any law in force in that State'. The amended provision makes it plain beyond any pale of controversy that the tax levied under the State Act in respect of declared goods has to be reimbursed to the person making sale of those goods in the course of inter-State trade or commerce in such manner and subject to such conditions as may be provided in the law in force in that State. According to the notes explaining the different clauses appended to the Statement of Objects and Reasons of the Bill, which emerged as the amending Act, the amendment made in clause (b) makes it clear that local sales tax would be reim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or possession by pre-emption of the land so sold. On the rival contentions raised between the parties, the High Court held that the daughter being not the daughter of the vendor-widow because she was the daughter of the step-wife of late Sri Santa Singh, therefore she had no right of pre-emption under section 15(2) of the Punjab Pre-emption Act, 1913, as amended by the Punjab Pre-emption (Amendment) Act 1960. The contention raised on behalf of the appellants before the Supreme Court was that there is no indication in the Amendment Act of 1964 that it was to have retrospective operation and therefore the amendment made by it should be deemed to be only prospective. After considering the scheme of the Act, the Supreme Court relied upon the predominant idea that the property must not go outside the line of the last male holder and the right has been given to his male lineal descendants. The principle that has been kept in view is that the person on whom the right of pre-emption is conferred must be a male lineal descendant of the last male holder of the property sold. Therefore it could never be intended that if a female has had a previous husband who has either died or with whom the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at page 395, to explain a former statute, the subsequent statute has relation back to the time when the earlier Act was passed. In such a case, as the Act is 'declaratory', the presumption against construing it retrospectively so as to respect vested rights, is not applicable." Regarding retrospectivity of statutes it is not only that tile declaratory or clarificatory statutes can be given retrospective effect, but in a recent decision in the case of Bharat Singh v. Management of New Delhi Tuberculosis Centre (AIR 1986 SC 482), the Supreme Court has gone further even to hold that in appropriate cases, retrospective effect can be given even to prospective statute in case there are no words in the section to compel the courts to hold that it cannot operate retrospectively. This was so done by the court on the basis that once the intention of the Legislature is discerned in the context of the background in which a particular section is enacted, the courts have necessarily to give a purposeful or functional interpretation. A construction that promotes the purpose of the legislation should be preferred to a literal construction. In our case, we find that the intention of the Legislat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expected to rectify the situation by a piece of retrospective or declaratory legislation. The 1977 Ordinance was, but the later Ordinances and the 1985 Act, are not, of this nature. They neither are, nor purport to be, declaratory or retrospective from 5-7-1976." In our case, we find, that there has been no earlier amendment in section 40( b) of the Act. The fifth reason that prevailed with the Supreme Court in putting the said construction is also absent in our case. Obviously, that situation does not operate in the present case. The background of the quotation in the other case referred to by my brother K.C. Agrawal J., in the case of Central Bank of India v. Their Workmen [1959] 29 Comp Cas 367; AIR 1960 SC 12 at p. 27, is that in that decision the. Supreme Court was considering the distinction between declaratory Act and a remedial Act. It was held that a declaratory Act is usually held to be retrospective whereas a remedial Act, on the contrary, is not necessarily retrospective. The remedial Act may be either enlarging or restraining and it takes effect prospectively, unless it has retrospective effect by express terms or necessary intendment. With profound respect, I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Ministry of Finance, Department of Economic Affairs, is intimately conversant not only with the policy of legislation for the purpose of implementation of the provisions of the Central Act but is also familiar with the nature and quality of the commodities as also their use from time to time. If, therefore, such an authority issued a notification including certain commodities under the head of 'Oil seeds', as defined under the Central Act, it cannot be said that the Tribunal and the High Court were not right in preferring such an opinion of the Government as good evidence for its conclusion, to the opinions relied upon by the Andhra Pradesh High Court on which great reliance has been placed by the appellant." To the same effect is also a decision of this court in the case of CST v. Om Engineering Works [1986] UPTC 55 [1987] 65 STC 465. After the elucidation of the nature and effect of such instructions/ circular issued by the Central Broad of Direct Taxes, let us now revert back to the concerned instructions. According to a report, the Central Board of Direct Taxes has also issued instructions in regard to the provisions of the Taxation Laws (Amendment) Act, 1984, which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Board of Direct Taxes, to my mind, the position is affirmed that the Explanation in question added by the Taxation Laws (Amendment) Act, 1984, is only clarificatory. At any rate, the said instructions are certainly binding on the Commissioner of Income-tax, the applicant in the present reference, and the authorities subordinate to him. Hence, in view of the aforesaid tests, the decisions of the Supreme Court regarding payment of salary where the principles are at par with payment of interest, the ratio underlying the decision of a Full Bench of this court in CIT v. Ram Laxman Sugar Mills [1973] 90 ITR 13 and also the view of the two Full Benches of the Gujarat and Madhya Pradesh High Courts, [1984] 150 ITR 276 and [1987] 166 ITR 534, the law laid down on the mooted question in the three decisions cited above including CIT v. Chitra Kalpana [1988] 169 ITR 678 that the Explanation is only clarificatory in nature, the instructions of the Central Board of Direct Taxes and the discussion stated by me above, the overall result is that, in our case, I am firmly of the view that the assessee is entitled to the deduction claimed for by it in the years in question and that the case of CIT ..... X X X X Extracts X X X X X X X X Extracts X X X X
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