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TMI Blog1978 (3) TMI 67X X X X Extracts X X X X X X X X Extracts X X X X ..... partners in the books of the firm constituted taxable income of the assessee ? (2) Whether, on the facts and in the circumstances of the case, in apportioning the total income of the firm between the several partners as required under section 23(6) of the Act of 1922 and section 158 of the Act of 1961, the interest adjusted on the debit balances of the accounts of the partners in the books of the firm is deductible from the share in profits of the respective, partners ? " The firm, styled " M/s. Chhotalal Keshavram, Rajnandgaon ", constituted of two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, carrying on business of manufacture arid sale of bidis, was reconstituted by a partnership deed dated December 29, 1954, whereby a third partner, Amrutlal Somabhai, was introduced as a financing partner. At the time when the business was taken over, the total liabilities of the firm amounted to Rs. 6,44,655. After adjusting certain assets of the firm, there was an excess of liabilities over the assets amounting to Rs. 4,09,628 and this amount was debited to the accounts of the two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, in equal shares. As provide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... account of the two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, as well as the amount of interest credited to the account of Amrutlal Somabhai, were included in the interest account maintained in the books of the firm, and the resultant amount went into the profit and loss account of the firm. Thus, it appears that the debit entries on account of interest payable by the two partners, Ghanshyamdas and Rameshchandra, passed through the books of the firm. It was argued by the assessee before the ITO that the amount in question did not represent the real income of the firm but represented only adjustment of entries whereby the interest account of the firm was credited and the accounts of the two partners were debited. It was urged that the liability to pay interest arose by virtue of the partnership agreement and not by virtue of carrying on the firm's business. The contention did not prevail before the ITO and he held that the amount of interest in different years should be treated as the firm's income. While apportioning the income of the partners, the ITO did not take into account the interest charged to the partners. On appeal, the AAC also rejected the conten ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d is Gresham Life Assurance Society v. Styles [1892] AC 309, 315 (HL), wherein Lord Chancellor Halsbury observed : " The word ' profits' I think is to be understood in its natural and proper sense--in a sense which no commercial man would misunderstand. But when once an individual or a company has in that proper sense ascertained what are the profits of his business or his trade, the destination of those profits, or the charge which has been made on those profits by previous agreement or otherwise, is perfectly immaterial The tax is payable upon the profits realized, and the meaning to my mind is rendered plain by the words 'payable out of profits'. " The aforesaid dictum has been approved by Lord Macmillan in Pondicherry Railway Co. Ltd. v. CIT, AIR 1931 PC 165. Here, we may notice the following observations of Greene M.R. in British Sugar Manufacturers Ltd. v. Harris [1939] 7 ITR 101, 106, 108 ; [1938] 2 KB 220 (CA): " Once you realise that as a matter of construction the word 'profits' may be used in one sense for one purpose and in another sense for another purpose, I think you have the real solution of the difficulties that have arisen in this case." In the same case, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pportion the income among the various partners. S. 23(5)(a)(i) and (ii) of the 1922 Act, so far as relevant, reads : " (5) Notwithstanding anything contained in the foregoing sub-sections, when the assessee is a firm and the total income of the firm has been assessed under sub-section (1), sub-section (3) or sub-section (4), as the case may be,-- (a) in the case of a registered firm, (i) the income-tax payable by the firm itself shall be determined; and (ii) the total income of each partner of the firm, including therein his share of its income, profits and gains of the previous year, shall be assessed and the sum payable by him on the basis of such assessment shall be determined ......" The relevant part of s. 182 of the Act of 1961 reads as follows: " 182. Assessment of register firms.--(1) Notwithstanding anything contained in sections 143 and 144 and subject to the provisions of sub-section (3), in the case of a registered firm, after assessing the total income of the firm,-- (i) the income-tax payable by the firm itself shall be determined; and (ii) the share of each partner in the income of the firm shall be included in his total income and assessed to tax ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held to be a step in the proceedings for assessment of the firm." Shri Thakar, learned counsel for the assessee, strenuously contends that in computing the total income of the two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, the ITO fell into an error in holding that they were riot entitled to deduction, in computing their share in the firm's profits, in respect of interest paid by them on their outstanding liabilities. We are afraid, the contention cannot be accepted. It will be noticed that deduction was not claimed in respect of interest paid by them on the capital borrowed for the purpose of investment in the firm. Assessment of a firm is governed by the provisions of s. 23(5). If the firm is registered, each partner's share in the firm's profits would be added to his other income and charged as a part of his total income. The computation of the partner's share in the firm's profits is dealt with by s. 16(1)(b) of the Act of 1922, which reads : " 16. Exemptions and exclusions in determining the total income.-- (1) In computing the total income of an assessee--... (b) when the assessee is a partner of a firm then, whether the firm has made a profit or a lo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the capital borrowed for the purpose of investment in the firm. S. 67(3) has obviously no application to a case where a partner claims a deduction in respect of interest paid by him to the firm. In Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 (All), the Allahabad High Court disallowed interest paid by the firm to a partner by reason of the provisions of s. 10(2)(iii) and s. 10(4)(b), while in the case of a partner who had borrowed more than he had lent, the excess amount paid as interest was treated as profits of the firm. For all these reasons, both the questions referred by the Income-tax Appellate Tribunal are answered in favour of the CIT and against the assessee. It must accordingly be held that the Income-tax Appellate Tribunal was justified in holding that the amounts of Rs. 31,447, Rs. 10,833, Rs. 19,200, Rs. 30,141 and Rs. 30,343, by which the partners were debited towards interest on their outstanding liability of Rs. 2,66,121, constituted the taxable income of the assessee for the assessment years 1959-60 to 1962-63. It must further be held that, in apportioning the total income of the firm between the several partners as required under s. 23(6) of the Indian In ..... 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