CASE NO.: Appeal (civil) 1378 of 2008 PETITIONER: Munjal Sales Corporation RESPONDENT: Commissioner of Income Tax,Ludhiana & Anr DATE OF JUDGMENT: 19/02/2008 BENCH: S.H. Kapadia & B. Sudershan Reddy JUDGMENT:
J U D G M E N T
(Arising out of S.L.P. (C) No. 4317 OF 2007)
WITH
CIVIL APPEAL NO.1379 OF 2008 arising out of S.L.P. (C) No. 4392 OF 2007,
CIVIL APPEAL NO.1380 OF 2008 arising out of S.L.P. (C) No. 4395 OF 2007,
CIVIL APPEAL NO.1381 OF 2008 arising out of S.L.P. (C) No. 4397 OF 2007,
CIVIL APPEAL NO.1382 OF 2008 arising out of S.L.P. (C) No. 6442 OF 2007,
KAPADIA, J.
Leave granted.
2. This batch of civil appeals filed by the assessee is
directed against judgments dated 12.10.06 and 16.10.06
passed by the Punjab and Haryana High Court whereby the
High Court has upheld the disallowance of interest claimed
under Section 36(1)(iii) of the Income-tax Act, 1961 (“1961
Act”, for short), placing reliance on its judgment in the case of
Commissioner of Income-tax v. Abhishek Industries Ltd.
(2006) 286 ITR 1 (P&H).
3. In this batch of civil appeals we are concerned with
Assessment Years 1993-94, 1994-95, 1995-96, 1996-97 and
1997-98.
FACTS :
4. In August/September 1991, appellant assessee granted
interest free advances to its sister concerns which were
disallowed by the Department on the ground that the said
advances were not given from the firm’s Own Funds but from
interest bearing loans taken by the assessee-firm from third
parties. Accordingly, the assessee’s claim for deduction under
Section 36(1)(iii) was disallowed by the Department for the AY
1992-93. However, vide order dated 3.1.03, the Tribunal
deleted the disallowance saying that the assessee had given
such advance from its Own Funds.
5. In the next AY 1993-94, the same situation took place.
Once again vide order dated 1.1.03, the Tribunal deleted
disallowance for AY 1993-94. It is important to note that the
Department accepted the orders passed by the Tribunal in
favour of the assessee for both the AYs 1992-93 and 1993-94.
At the same time, we need to emphasise, at this stage, that the
interest free advance given to the sister concern was repaid on
year to year basis. The said advance/loan got finally repaid in
AY 1997-98.
6. During the AY 1994-95 no further advances were made
by the assessee-firm in favour of its concerns. However,
during AY 1995-96, a small interest free loan of Rs.5 lacs was
advanced by the assessee-firm to its sister concern as during
the year in question the assessee had profits of Rs.1.91 crores.
7. At this stage, it may be noted that before Finance Act
1992, payment of interest to the partner was an item of
disallowance. Therefore, it had to be added back to the
assessable income of the firm. But, after 1.4.93, vide Finance
Act 1992, the said interest became an item of deduction,
provided that the amount of deduction does not exceed
18/12% interest per annum [See: Section 40(b)(iv) of the 1961
Act]. For the AY 1994-95, Department in this case, therefore,
disallowed the claim for deduction under Section 40(b)(iv)
saying that in this case there was diversion of funds by raising
of interest free loans. The AO did not accept the submission of
the assessee that advance(s) made by the assessee were out of
income of the firm. According to the AO, the said interest free
advances to sister concerns were out of monies borrowed by
the firm from third parties on payment of interest, hence the
assessee was not entitled to deduction under Section 40(b) of
the 1961 Act. This view was confirmed by the Tribunal.
8. For the AYs 1995-96 and 1996-97, Tribunal held that
during the said years, no interest free advances to sister
concerns were made and, therefore, there was no nexus
between “interest bearing loans” taken and “interest free
advances”. However, the Tribunal found that there was no
material to show that advances were made to sister concerns
out of the firm’s own income and, therefore, the assessee was
not entitled to deduction under Section 40(b)(iv) of the 1961
Act.
9. The basic question which arises for determination is :
whether Section 40(b) of the 1961 Act is a stand-alone section
or whether it operates as a limitation to the deduction under
Sections 30 to 38 of the 1961 Act?
10. On the above question of law, Mr. S. Ganesh, learned
senior counsel appearing on behalf of assessee, contended
that prior to 1.4.93, Section 40(b) referred to disallowances per
se but after the Finance Act 1992 the said Section 40(b)(iv)
allows deduction, subject to the above limit of 18/12% per
annum. According to learned counsel, Section 40(b)(iv) talks
about statutory deduction and that the question of
disallowance comes in only to the extent that payment of
interest to the partner exceeds 12/18% per annum. In this
case, according to learned counsel, all the conditions of
Sections 40(b)(iv) have been satisfied and, therefore, the
assessee was entitled to the benefit of deduction thereunder.
In this connection, it was further argued that deduction under
Section 40(b)(iv) is not for expenditure; that it was a statutory
deduction and that the contribution by the partner to the firm
cannot be equated to a loan to the firm and that the former
falls only under Section 40(b)(iv) and, therefore, the said
Section 40(b) was a stand-alone section having no connection
with the provisions of Section 36(1)(iii) of the 1961 Act.
Further, according to learned counsel, in this case Section
36(1)(iii) had no application as this was a case of payment of
interest to the partner on his capital contribution which
cannot be equated to monies borrowed by the firm from third
parties, hence the present case fell only under Section 40(b)(iv)
and not under Section 36(1)(iii) of the 1961 Act.
11. Mr. Prag P. Tripathi, learned Addl. Solicitor General
appearing for the Department, submitted that object behind
enactment of Finance Act 1992 is not only to avoid double
taxation but also to put the firm as an assessee on par with
other assessees. In this connection, learned counsel
submitted that in view of the changed language of Section
40(b)(iv) of the 1961 Act, which is in the nature of a proviso, it
can no longer be said that Sections 30 to 38 are not applicable
to the firm as an assessee and that it will apply to all other
assessees. That, prior to 1.4.93, Section 40(b)(iv) disallowed
interest paid to the partners but after 1.4.93 the firm has to
establish its claim for deduction under Sections 30 to 38 and
that it was not disentitled under Section 40(b) would apply.
According to learned counsel, Section 40 is in nature of a
proviso to Sections 30 to 38 and, therefore, even if the
assessee establishes its claim for deduction under Section
36(1)(iii), it has still to prove that it is not disentitled under
Section 40(b)(iv). Therefore, according to learned counsel,
after Finance Act 1992 the assessee has to establish
deductions under Sections 30 to 38 and it has also to prove
that it is not disentitled under Section 40 of the 1961 Act, like
any other assessee.
12. We quote hereinbelow Sections 36(1)(iii), 40(b) as it
existed before 1.4.93 and 40(b)(iv) after Finance Act 1992
w.e.f. 1.4.93 which read as follow:
“OTHER DEDUCTIONS
36.(1) The deductions provided for in the following
clauses shall be allowed in respect of the matters
dealt with therein, in computing the income referred
to in Section 28-
(iii) the amount of the interest paid in respect of
capital borrowed for the purposes of the business or
profession.
Explanation : Recurring subscriptions paid
periodically by share-holders, or subscribers in
Mutual Benefit Societies which fulfill such
conditions as may be prescribed, shall be deemed to
be capital borrowed within the meaning of this
clause;
AMOUNTS NOT DEDUCTIBLE
40. Notwithstanding anything to the contrary in
Sections 30 to 38, 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.
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
purposes of this clause;
(ii) interest paid by the firm to such individual
or by such individual to the firm as partner in
a representative capacity and interest paid by
the firm to the person so represented or by the
person so represented to the firm, shall be
taken into account for the purposes of this
clause.
Explanation 3 : Where an individual is a
partner in a firm otherwise than as partner in
a representative capacity, interest paid by the
firm to such individual shall not be taken into
account for the purposes of this clause, if such
interest is received by him on behalf, or for the
benefit, of any other person;”
Section 40(b)(iv) after Finance Act 1992 w.e.f.1.4.93:
“AMOUNTS NOT DEDUCTIBLE
40. Notwithstanding anything to the contrary in
Sections 30 to 38, 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 assessable as such, –
(iv) any payment of interest to any partner which is
authorized by, and is in accordance with, the terms
of the partnership deed and relates to any period
falling after the date of such partnership deed
insofar as such amount exceeds the amount
calculated at the rate of eighteen per cent simple
interest per annum;”
ISSUE
13. Whether the claim for special deduction made by the
assessee exclusively came only under Section 40(b)(iv) and
that it never came under Section 36(1)(iii) of the 1961 Act as
argued on behalf of the assessee?
Legal Position Explained
14. Before enactment of FA 1992, broadly speaking, payment
of interest by the firm to any partner of the firm constituted
Business Disallowance per se. After FA 1992, Section 40(b)(iv)
of the 1961 Act places limitations on the deductions under
Sections 30 to 38. Prior to FA 1992, payment of interest to the
partner was an item of Business Disallowance. However, after
FA 1992 the said Section 40(b) puts limitations on the
deductions under Sections 30 to 38 from which it follows that
Section 40 is not a stand-alone section. Section 40, before
and after FA 1992, has remained the same in the sense that it
begins with a non-obstante clause. It starts with the words
“Notwithstanding anything to the contrary in Sections 30 to
38” which shows that even if an expenditure or allowance
comes within the purview of Sections 30 to 38 of the 1961, the
assessee could lose the benefit of deduction if the case falls
under Section 40. In other words, every assessee including a
firm has to establish, in the first instance, its right to claim
deduction under one of the sections between Sections 30 to 38
and in the case of the firm if it claims special deduction it has
also to prove that it is not disentitled to claim deduction by
reason of applicability of Section 40(b)(iv). Therefore, in the
present case, the assessee was required to establish in the
first instance that it was entitled to claim deduction under
Section 36(1)(iii) and that it was not disentitled to claim such
deduction on account of applicability of Section 40(b)(iv). It is
important to note that Section 36(1) refers to Other
Deductions whereas Section 40 comes under the heading
Amounts not Deductible. Therefore, Sections 30 to 38 are
Other Deductions whereas Section 40 is a limitation on that
deduction. It is important to note that Section 28 to 43C
essentially deal with Business Income. Sections 30 to 38 deal
with Deductions. Sections 40A and 43B deal with Business
Disallowances. Keeping in mind the said scheme the position
is that Sections 30 to 38 are deductions which are limited by
Section 40. Therefore, even if an assessee is entitled to
deduction under Section 36(1)(iii), the assessee(firm) will not
be entitled to claim deduction for interest payment exceeding
18/12% per se. This is because Section 40(b)(iv) puts a
limitation on the amount of deduction under Section 36(1)(iii).
15. It is vehemently urged on behalf of the assessee that
partner’s capital is not a loan or borrowing in the hand of a
firm. According to the assessee, Section 40(b)(iv) applies to
partner’s capital whereas Section 36(1)(iii) applies to
loan/borrowing. Conceptually, the position may be correct
but we are concerned with the scheme of Chapter IV-D. After
the enactment of FA 1992, Section 40(b)(iv) was brought to the
statute book not only to avoid double taxation but also to
bring on par different assesses in the matter of assessment.
Therefore, the assessee-firm, in the present case, was required
to prove that it was entitled to claim deduction for payment of
interest on capital borrowed under Section 36(1)(iii) and that it
was not disentitled under Section 40(b)(iv). There is one more
way of answering the above contention. Section 36(1)(iii) and
Section 40(b)(iv) both deal with payment of interest by the firm
for which deduction could be claimed, therefore, keeping in
mind the scheme of Chapter IV-D every assessee who claims
deduction under Sections 30 to 38 is also requires to establish
that it is not disentitled under Section 40. It is in this respect
that we have stated that the object of Section 40 is to put
limitation on the amount of deduction which the assessee is
entitled to under Sections 30 to 38. In our view, Section 40 is
a corollary to Sections 30 to 38 and, therefore, Section 40 is
not a stand-alone section.
Application of the 1961 Act to the facts of this case
16. As stated above, in this batch of civil appeals we are
concerned with the Assessment Years 1993-94, 1994-95,
1995-96, 1996-97 and 1997-98. At this stage, it may be
mentioned that as far back as in August/September 1991
assessee herein had given interest free advances to its sister
concerns. These advances stood reduced over a period, till AY
1997-98. Each year the balances stood reduced. Further,
vide Order dt.3.1.03 the Tribunal held, for AY 1992-93, that
the assessee had given interest free loans from its Own Funds
and not from interest bearing loans taken by the firm from
third parties and consequently the assessee was entitled to
claim deduction under 36(1)(iii). In other words, the Tribunal
held that loans were given for business purposes. Similarly,
for AY 1993-94, the Tribunal had taken the view that the said
loans given to the firm’s sister concerns were for business
purposes. Accordingly, the Tribunal had deleted the
disallowances during the AYs 1992-93 and 1993-94. It is
equally true that for the AY 1994-95 the Tribunal took a
contrary view in view of change in law brought about by
Finance Act 1992. Prior to 1.4.93 payment of interest to the
partner had to be added back to the assessable income of the
firm whereas after Finance Act 1992 such payment became an
item of deduction for computing the assessable income of the
firm and it became part of the business income of the partner.
In view of this change of law, the Tribunal disallowed payment
of the interest in the present case for AYs 1994-95, 1995-96,
1996-97 and 1997-98. However, the point which has been left
out from consideration is that the loans which were given in
August/September 1991 to the sister concerns got wiped out
only in AY 1997-98. As stated above, for AY 1992-93 and AY
1993-94, the Tribunal held that the loans given to the sister
concerns were out of the firm’s Funds and that they were
advanced for business purposes. Once it is found that the
loans granted in August/September 1991 continued upto AY
1997-98 and that the said loans were advanced for business
purposes and that interest paid thereon did not exceed
18/12% per annum, the assessee was entitled to deductions
under Section 36(1)(iii) read with Section 40(b)(iv) of the 1961
Act.
17. One aspect needs to be mentioned during the AY 1995-
96, apart from the loan given in August/September 1991, the
assessee advanced interest free loan to its sister concern
amounting to Rs.5 lacs. According to the Tribunal, there was
nothing on record to show that the loans were given to the
sister concern by the assessee-firm out of its Own Funds and,
therefore, it was not entitled to claim deduction under Section
36(1)(iii). This finding is erroneous. The Opening Balance as
on 1.4.94 was Rs.1.91 crores whereas the loan given to the
sister concern was a small amount of Rs.5 lacs. In our view,
the profits earned by the assessee during the relevant year
were sufficient to cover the impugned loan of Rs.5 lacs.
18. Before concluding, we may mention that the importance
of the judgment is the clarification which we were required to
give in the context of deductions under Sections 30 to 38 to be
read with the limitation prescribed under Section 40. Since
there was some confusion with regard to the status of Section
40, particularly, after enactment of Finance Act 1992, we have
explained the law in the context of deductions under Chapter
IV-D of the 1961 Act. We have accepted the submissions
advanced by the learned Addl. Solicitor General in that regard.
However, the assessee succeeds in this batch of civil appeals
on the peculiar facts of this case.
19. Accordingly, the impugned judgments of the High Court
are set aside and the civil appeals preferred by the assessee
stand allowed with no order as to costs.