JUDGMENT
R.C. Mankad, J.
1. The assessee is a registered partnership firm. The assessment year, with which we are concerned, is 1974-75. The assessee-firm consists of seven partners, one of whom is Sumatilal Popatlal. Sumatilal Popatlal was a partner in the assessee-firm as trustee of Sumatilal Popatlal Family Trust. There were three accounts with the assessee-firm with which Sumatilal Popatlal was concerned. On account was in the name of the trust, second in the name of Sumatilal Popatlal gift account and the third in the name of Sumatilal Popatlal individual. In the year of account relevant to the asst. yr. 1974-75, Rs. 2,400.36 were credited as interest to the account of the trust, Rs. 9,135 to Sumatilal Popatlal gift account and Rs. 5,843 to Sumatilal Popatlal individual account. In the course of assessment, the ITO disallowed interest credited in all three accounts including the account in the name of trust under s. 40(b) of the Income-tax Act, 1961 (‘the Act’). It would, thus, appear that, Sumatilal Popatlal was partner in the assessee-firm in his representative capacity or in other words, as trustee, of the trust. Since Sumatilal Popatlal was partner in the assessee-firm in his capacity as trustee of the trust, the assessee-firm did not dispute the disallowance of interest of Rs. 2,400 credited to the account of the trust. The assessee-firm, however, aggrieved by disallowance of interest credited to Sumatilal Popatlal gift account and Sumatilal Popatlal individual account, carried the matter in appeal before the AAC. The AAC held that, it was not Sumatilal Popatlal in his individual capacity who was partner of the assessee-firm, but the real partner in the assessee-firm was the trust through its trustee. He held that, only the interest paid to the trust was disallowable under s. 40(b). So far as interest credited to Sumatilal Popatlal gift account and the Sumatilal Popatlal individual account was concerned, according to the AAC, it had no connection with the trust and, therefore, such interest could not be disallowed or added back under s. 40(b). The AAC, therefore, deleted the disallowance of interest of Rs. 15,000. The Revenue, being aggrieved by the order of the AAC, carried the matter in appeal before the Tribunal. The Tribunal found that Sumatilal Popatlal was a partner in the assessee-firm in his capacity as trustee of the trust and not in his individual capacity. The Tribunal, however, took the view that when a person becomes a partner in whatever capacity, interest paid to him in any other capacity comes within the mischief of s. 40(b). The Tribunal, therefore, held that, interest credited to Sumatilal Popatlal gift account and Sumatilal Popatlal individual account was not allowable as deduction under s. 40(b).
2. It is in the background of the above facts that the following question has been referred to us for our opinion :
“Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that interest paid to the account of Shri Sumatilal Popatlal gift account and Shri Sumatilal Popatlal (individual account) can be disallowed under s. 40(b) of the IT Act, 1961 ?”
Section 40(b) reads as follows :
“40. Amounts not deductible. – Notwithstanding anything to the contrary in ss. 30 to 39, the following amounts shall be deducted in computing the income chargeable under the head ‘Profits and gains of business or profession’ :
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(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”.
3. The question which arises for our consideration is whether the interest credited to Sumatilal Popatlal gift account and Sumatilal Popatlal individual account could be disallowed under the aforesaid provision while computing the total income of the assessee-firm. We have already pointed out above that all the authorities below including the Tribunal have found that Sumatilal Popatlal was partner in the assessee-firm as trustee of the trust. In other words, he was partner in the assessee-firm not in his individual capacity but in representative capacity. The ITO had disallowed deduction of the interest paid to the trust on the ground that Sumatilal Popatlal was partner in the assessee-firm was a partner of the assessee-firm and he had joined the partnership representing the HUF of which he was the ‘Karta’. For the two accounting years relevant to the asst. yrs. 1970-71 and 1971-72, C. S. Virani maintained two accounts with the partnership, one, his own individual account and the other of the HUF which he represented as the ‘Karta’. The assessee-firm paid interest on advancers made other that the capital by HUF represented by C. S. Virani and also advances made by C. S. Virani from his own personal account. The question was whether, while computing the business profits of the assessee-firm, the interest paid to C. S. Virani on monies advanced by him from his individual funds was not allowable as deduction under s. 40(b). The Tribunal held that interest paid to C. S. Virani on monies advanced by him from his individual funds could not be allowed as deduction while computing the business profits of the assessee-firm. Question of law arising out of the said disallowance war referred to this Court at the instances of the assessee-firm. When the reference came up for hearing before a Division Bench of this Court, it was felt that the decision of this Court in CIT vs. Sajjanraj Divanchand (1980) 126 ITR 654 (Guj) required reconsideration and, therefore, the reference was referred to a larger Bench. The Full Bench which heard the reference held that in computing business profits of the assessee-firm, the interest paid to C. S. Virani on monies advanced by him from his individual funds could not be disallowed. It was held that interest paid to C. S. Virani was not paid to him a partner but as a stranger. We may refer with advantage of the Act he following observations made by the Full Bench :
“The Revenue is not precluded from looking into the real character of the partner and the capacity in which he represents himself in the partnership firm. If that be so, for ht purpose of s. 40(b) of the IT Act, 1961, is the Revenue to take note of the representative character of the assessee and make disallowance falling within the section in accordance therewith ? That is the question which we are really called upon to answer here.
What is said for the Revenue is that while the Revenue may take note of the fact that Shri C. S. Virani really represents an HUF when it makes the individual assessment on the HUF of which he is a representative, that will have no bearing when the Revenue seeks to assessee the firm to its tax. At that stage, it is said, the real character of Shri C. S. Virani does not call for consideration and he need be treated only as a partner and if so treated, whatever is paid as interest to Shri C. S. Virani irrespective of the character in which such payment is made is to be disallowed on account of s. 40(b) of the Act. This approach would assume that, so far as the Revenue is concerned, the Revenue cannot take note of the capacity in which a person happens to be a partner of a firm. Such an approach is unsustainable in law, for whatever may be the obligations as between the partners, arising out of a contract, so far as the Revenue is concerned, it is the real character of the partner who is assessed that would be relevant for assessment purpose. If Shri C. S. Virani is a partner as representing an HUF, at all times the Revenue can only treat him as representing the HUF, whatever may be the rights of the other partners in the firm as against him. If so, when Shri C. S. Virani as representing the HUF has advanced funds of the HUF to the firm and interest thereon is paid to the HUF, it is interest paid to Shri C. S. Virani, the partner. If he advances amounts from his individual account when he is a partner as representative only of the HUF, the interest is not paid to him qua partner but as a stranger.
We should point out an anomaly if a different view is taken. Supposing a stranger advances a substantial sum of money to a firm on interest and the interest is being painting the HUF has advanced funds of the HUF to the firm and interest thereon is paid to the HUF, it is interest paid to Shri C. S. Virani, the parter. If he advances amounts from his individual account when he is a partner as representative only of the HUF, the interest is not paid to him qua partner but as a stranger.
We should point out an anomaly if a different view is taken. Supposing a stranger advances a substantial sum of money to a firm on interest and the the interest is being paid by the firm to that stranger, such interest payments could be deductible as revenue a trustee of a 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 ow 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 s. 40(b), they will have to consider the HUF 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 HUF by way of interest will alone fall within the section.
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Once we accept the situation that contracting partners alone are bound by the terms of the contract and it is open to the Revenue to see the partner as he really is, it goes without saying that when he represents a HUF the interest paid to HUF has to be disallowed and not any interest paid into his individual account as interest in lieu of advance made by him personally. Even if he happens to be the Karta of the HUF but he becomes a partner in his own account and amounts are advanced to the firm by him from his individual account and also by the HUF, the amount of interest paid to the HUF account cannot be disallowed, while the interest paid in his account has to be disallowed. That is not the situation here. We are not persuaded to agree with the approach made in the case reported in CIT vs. Sajjanraj Divanchand (1980) 126 ITR 654 (Guj), for the reasons we have explained herein. We think that that decision has necessarily to be overruled.”
It is clear from the decision of the Full Bench that, if a person is partner in a firm in a representative capacity and if interest is paid to him in his individual capacity, deduction of such interest cannot be disallowed under s. 40(b). In fact, while answering the question referred to it in favour of the assessee, as pointed above, the Full Bench gave example of interest paid to a trustee in his individual capacity while he was a partner in a firm in his capacity as trustee and observed to the effect that there was no reason or logic in disallowing interest paid to such trustee in his individual capacity and not in his capacity as trustee of the trust whom he represented as partner. In the instant case, therefore, the Tribunal was not right in holding that interest credited to Sumatilal Popatlal Gift account and Sumatilal Popatlal individual account was not allowable as deduction under s. 40(b). Since Sumatilal Popatlal was partner in the assessee-firm in his capacity as trustee of the trust, only the interest paid to the trust was not allowable as deduction under the said provision.
4. In the light of the above discussion, we answer the question referred to us in the negative and against the Revenue.
5. Reference shall stand disposed of, accordingly with no order as to costs.