JUDGMENT
V.V. Kamat J.
1. These two references cover the assessment years 1981-82 and 1982-83 expecting answer to the following common question in regard to them :
“Whether, on the facts and in the circumstances of the case, ‘the interest paid to the partner who represented the Hindu undivided family in the capacity of a karta’ on the amount advanced by him to the firm is hit by Section 40(b) of the Income-tax Act ?”
2. Section 40(b) of the Income-tax Act, 1961, is analogous in content to the provisions of Section 10(4)(b) of the Indian Income-tax Act, 1922. The statutory provision relates to situations relating to the amounts that was not to be deducted in computing the income chargeable under the head “Profits and gains of business or profession”. In regard to this situation, in the case of any firm in accordance with the provisions of Section 40(b) of the Act, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm cannot be claimed to be deducted in computing the income chargeable under the aforesaid head. Therefore, the question is as to whether the partnership firm in question is concerned with the payment of interest to any partner of the
firm or to any other person in the context, may be the same individual in more than one capacity. The amount in question is Rs. 86,400 consisting of interest at the rate of 12 per cent per annum with regard to the deposit of Rs. 7,20,000 made by Sri Ramachandran, one of the partners of the firm. The rival contentions are relating to the position as to whether the deposit concerns Sri Ramachandran as an individual in his capacity as the karta of the Hindu undivided family or in his capacity as the partner of the firm.
3. The concerned deed of partnership is dated October 1, 1979, and it is between two partners, viz., V. Ramachandran and V. Thiruvenkatam. They are brothers. The preamble specifies that Sri Ramachandran acquired proprietary interest on December 31, 1978, of the business at Quilon carried on in the name and style of S. Veeriah Reddiar and this business was carried on by the two proprietors Sri Veeriah Reddiar and Sri V. Thiruvenkatam. It is necessary to state that V. Ramachandran and V. Thiruvenkatam are brothers. It is also necessary to state that the very preamble of the deed makes it clear that Sri V. Ramachandran obtained the above proprietary rights in the business at Quilon from none else, but for and on behalf of the Hindu undivided family of Veeriah Reddiar. In other words, the factual position is beyond the pale of dispute. The partner, V. Ramachandran, under the sale deed dated December 31, 1978, purchased the property from the two proprietors–Sri Veeriah Reddiar and Sri Thiruvenkatam. The property was business at Quilon being carried on in the name and style of S. Veeriah Reddiar. This was purchased by Sri Ramachandran on behalf of the Hindu undivided family; in other words, in his capacity as the karta of the Hindu undivided family. In the present proceedings, the fact that deposit of Rs. 7,20,000 was kept by Sri Ramachandran with the partnership firm in his individual capacity as the karta of the Hindu undivided family with 12 per cent, interest per annum is not in dispute.
4. The Income-tax Officer referred to the general provision of law relating to the position of the partners of the firm. The officer held that it is not a question for consideration as to whether any of these partners represents anybody else. He observed that there are only two partners and the amount of interest of Rs. 86,400 was paid to one of them-V. Ramachandran–and, therefore, has to be disallowed in view of the provisions of Section 40(b) of the Act.
5. The first appellate authority considered the question in paragraph 5 of its order. The said authority observed that applicability of section
40(b) to payment made to partners proceeded on the basis that the eyes of the seeker need travel no further than to ascertain the status of the recipient of interest and if that person were to be a partner in whatever capacity, the prohibition enjoined by Section 40(b) will apply. The said authority observed that this was the settled position for a long time. The authority further observed that the Andhra Pradesh High Court in Addl. CIT v. Vallamkonda Chinna Balaiah Chetty [1977] 106 ITR 556, as well as the Gujarat High Court in Chhotalal and Co. v. CIT [1984] 150 ITR 276 [FB], took the view that the status or character of the recipient of interest paid by the partnership firm should be noticed and where the interest was paid to an individual for the advances made by him in his capacity representing the Hindu undivided family, payment of interest can be allowed as a deduction. Payment of interest on amounts lent to the partnership firm can be traced either to the individual or even to a representative body with reference to the nature of the funds advanced. The situation is different with reference to the work or labour put in by one of the partners because such a partner works in the firm and receives salary as an individual or as a representative of the family cannot be known from the way he functions and, therefore, payment of salary must stand on a different footing.
6. In this process of reasoning, the first appellate authority recorded a finding in the following manner :
“Examined from this standpoint, it will be clear in this case that advances of Rs. 7,20,000 made by Shri V. Ramachandran to the appellant were in his individual capacity and his membership of the firm was in the capacity as the karta of the Hindu undivided family, which was the partner. Hence, there is a lack of identity in the two status of the recipient.”
7. The said authority also has drawn strength, not (?) particularly according to law, from the Taxation Laws (Amendment) Act, 1984, with effect from April 1, 1985, adding an Explanation to Section 40(b) supporting the situation in the context by reason thereof.
8. The decision was an occasion for the Revenue to come before the Income-tax Appellate Tribunal. The Tribunal has sought advantage additionally from the decision of the Madhya Pradesh High Court in CIT v. Narbharam Popatbhai and Sons [1987] 166 ITR 534 [FB], as well as from the Allahabad High Court in CIT v. Nitro Phosphetic Fertiliser [1988] 174 ITR 269 [FB], to find out the object of the provision under Section 40(b) of the Act. Relying on the observations of the Allahabad High Court to the effect that the provision is to prevent partners siphoning off substantial
profits in the guise of salary, interest, bonus, commission, etc., it is observed that actually the prohibition of allowance of interest to a partner stands on par with a similar disallowance of salary paid to a partner. The partners are ultimately entitled to the entire profits of the firm, according to their shares in the business. It is observed that a partner is bound to find the necessary finance for the partnership and, hence, any interest on the capital supplied by the partner is not deductible. The Tribunal sought support from the decision of the Andhra Pradesh High Court also in N. T. R. Estate v. CIT [1986] 157 ITR 285, holding that salary and interest paid by the firm to some of the partners as individuals who were also in their capacity as the karta of the Hindu undivided family during the accounting years in question and it is held that their claim could not be disallowed under Section 40(b) of the Act. The Tribunal has also relied upon the similar decision of the Punjab and Haryana High Court in Hindustan Steel Forgings v. CIT [1989] 179 ITR 280.
9. Additionally, learned counsel for the assessee has invited our attention to the decision of the Calcutta High Court in CIT v. Mohanlal Bhagwati Prosad [1993] 204 ITR 234. After going through the judgment we find that the Calcutta High Court has taken a resume of all the reported decisions that could be legitimately thought of in support of the proposition that if a partner is also in a representative capacity and as such lends to the partnership firm monies belonging to him individually, then the interest paid to such partner on the monies lent by him is not liable to be added back under Section 40(b) of the Act. Similar would be the situation and the question in the case of a partner in his individual capacity lending monies belonging to the Hindu joint families of which he is the karta, to follow the same result.
10. For all these reasons, we endorse the decisions of the first appellate authority as well as of the Tribunal. We answer the question in the negative–against the Revenue and in favour of the assessee.
11. A copy of this judgment under the seal of this court and the signature of the Registrar shall be forwarded to the Income-tax Appellate Tribunal, Cochin Bench, for passing consequential orders.