Income Tax Appellate Tribunal - Delhi
Mangal Sain Ram Niwas vs Income-Tax Officer on 6 November, 1986
Equivalent citations: [1987]20ITD23(DELHI)
ORDER
S.S. Mehra, Judicial Member
1. The assessee by its present appeal challenges the first appellate order dated 11-4-1984 of the learned AAC, Rohtak, for the assessment year 1982-83, inter alia, on the following ground:
That under the facts and circumstances of the case, lower authorities grossly erred in law and the facts in holding that payment of interest amounting to Rs. 8,916 and Rs. 5,125 paid by the firm to Shri Mangal Sain (individual) and Shri Mool Chand (individual) is hit by the provisions of Section 40(i) of the Income-tax Act, 1961.
2. Other grounds, i.e., ground Nos. 2 and 3 are dismissed as not pressed. Ground No. 4 is consequential and requires no separate discussion.
3. The assessee is a registered firm by status and accounting period was the year ending 31-3-1982. The assessee derives income from purchase and sale of metal. The learned ITO noticed that Shri Mangal Sain and Shri Mool Chand who are partners as kartas of their HUFs received interest from the firm on their deposits in their individual capacities. Shri Mangal Sain was said to have paid interest of Rs. 8,960 and Shri Mool Chand of Rs. 5,126. It was contended before the learned ITO that both partners represented their HUFs in the firm and thus interest paid to them in their individual capacities was not includible in the income of the assessee-firm. The learned ITO, however, made the addition with the following observation:
I have carefully considered the submission of the assessee, but am unable to accept the same. Where the partners represent themselves in a firm in HUF capacity, any interest paid to them in their individual capacity on eartain deposits is includible to the income of the firm. Such being the position and facts of the case, interest paid to Shri Mangal Sain and Shri Mool Chand in their individual capacity is held as includible to the income of the firm. I have gone through the record of the assessee-firm for the assessment years 1980-81 and 1981-82 and find that such interest was itself included to the income of the firm, while making computation of income enclosed with those returns of income. During this year, there is no merit in the assessee's submission that such interest is not includible to the income of the firm,
4. The addition was subsequently contested by the assessee. On behalf of the a ssessee the position taken before the learned ITO was explained and the reliance was also placed on the ratio in the cases of CIT v. Pannalal Himlal & Co. [1984] 146 ITR 549 (Bom), Terla Veeraiah v. CIT [1979] 120 ITR 502 (AP). The learned AAC appears to have noted suo motu the ratio in the case of CIT v. Sajjanraj Diwanchand [1980] 126 ITR 654 (Guj.). The addition was confirmed by the learned AAC with the following observation:
The Hon'ble Gujarat High Court while taking this view, has followed the judgment of the Hon'ble Supreme Court in the case of Charon Dass Hari Dass v. CIT [1960] 39 ITR 302. Thus, in the contract of partnership, the contract between the partners Writer se is in their individual capacity and that contract does not bind the HUF of any partner, even if for any reason, any partner is a partner representing his HUF and may be accountable to his HUF. Thus, considering the facts of the case and in view of the above stated case laws, the disallowance of interest of Rs. 8,916 and Rs. 5,125 paid to Shri Mangal Sain and Shri Mool Chand is confirmed, since, Shri Mangal Sain and Shri Mool Chand, individuals are partners in the firm contract and interest received by them on their individual accounts is considered in their capacity as partners, notwithstanding that for the purposes of profits, they may be accountable to their HUFs to whom they represent. In this connection, reliance is also placed on CIT v. London Machinery Co. [1979] 117 ITR 111 (All.). In the case law cited by the appellant of Bombay High Court in Pannalal Him Lal & Co. [1984] 146 ITR 549, the case of Allahabad High Court in London Machinery Co.'s case (supra) was neither discussed nor referred to. In this connection, reliance is also placed on the judgment of Hon'ble Madhya Pradesh High Court in Jalam Chand Mangi Lal (No. 1) v. CIT [1982] 138 ITR 343 and Jalam Chand Mangi Lal (No. 2) v. CIT [1982] 138 ITR 347. The MP High Court in their judgments referred supra, followed the case of Allahabad High Court of London Machinery Co. (supra) and dissented from the judgment of the Hon'ble Andhra Pradesh High Court in Terla Veeraiah v. CIT [1979] 120 ITR 502.
5. The assessee is now in further appeal before us. Shri P.D. Jain argued on behalf of the assessee and relied upon the following case laws:
In the cases of Chhotalal & Co. v. CIT [1984] 150 ITR 276 (Guj.), Terla Veeraiah (supra), CIT v. Budhalal Amulakhdas [1981] 129 ITR 97 (Guj.), Venkatesh Emporium v. CIT [1982] 137 ITR 593 (Mad.) and Pannalal Hiralal & Co. (supra).
It was argued on behalf of the assessee that the partners were maintaining two accounts, i.e., (1) on behalf of the HUF, and (2) on their own behalf and that the interest was paid to the partners in their individual capacity and they were representing their HUFs, the provision of Section 40(6) of the Income-tax Act, 1961 ('the Act') was inapplicable. According to the learned authorised representative, the learned ITO was not justified to make the addition and the learned AAC further erred in not deleting the unjustifiable additions.
6. On behalf of the revenue the learned departmental representative, Shri S.P. Jain, supported the orders of the authorities below and contended that the existence of two accounts could not prevent the operation of law. According to Shri Jain the case laws relied upon by the learned authorised representative were inapplicable, the facts being distinguishable. The reliance by the learned departmental representative was placed on the ratio in the case of CIT v. London Machinery Co. [1979] 117 ITR 111 (All.). Mention was also made of the cases in Dwarkadas Rameshwar Goenka v. CIT [1981] 127 ITR 397 (Mad.) and Sanghi Motors v. CIT [1982] 135 ITR 359 (Delhi).
7. In reply, the learned authorised representative made mention of some clarifications by the Board about the Explanation added from 1-4-1985 in Section 40(6) and contended that the disallowance under Section 40(6) was not justified even during the year under consideration, no doubt, the clarification came later on and that the spirit thereof should be implemented.
8. Contentions raised and submissions made on behalf of the contesting parties have been heard and considered and record carefully perused. The assessee is a registered firm by status. As mentioned earlier, Shri Mangal Sain and Shri Mool Chand partners represented their HUFs in that firm. The interest was credited in the individual accounts of these partners whereas there is said to be other accounts with the firm of the HUFs of these partners. Thus, in the present case, the interest by the firm was paid to its two partners. Section 40 deals with certain amounts not deductible while ascertaining the taxable income. Clause (b) of this section deals with the payment of interest, salary, bonus, commission or remuneration by the firm to any of the partners. Such payments are shown to be not deductible. This is the basic provision of law. In the present case the disallowance was made by the learned ITO relying upon the provision. From the learned ITO's finding on the point direct support is available from the ratio in the case of London Machinery Co. (supra) wherein their Lordships of the Hon'ble Allahabad High Court observed as under:
, that when a person in his capacity as karta of a HUF enters into a partnership with others, the karta is a partner only in his personal capacity. The firm can treat only the karta and not the other members of the HUF as its partners. The capacity in which he receives the payment, namely, for and on behalf of the family or for his own benefit and interest, is immaterial. Payment to a person who is a partner is the only criterion for the purposes of Section 40(6) of the Income-tax Act, 1961, which prohibits in absolute terms any allowance in respect of any payment by way of interest, salary, bonus, commission or remuneration made by the firm to any of its partners and does not make any 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 HUF 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 a partner no matter who really has the beneficial interest in such payments. Section 40(6) of the Act would, therefore, apply to the payment of interest to the three partners who were partners in their capacity as kartas of HUF and had deposited their individual money in the firm.
9. A perusal of the above ratio clearly indicates that the partner no doubt may represent his HUF but the law contemplates that he alone is the partner and the other parties of his HUF had not acquired the status of partner in any manner. The revenue's stand gets support from the ratio in this case. In fact, relying upon this very ratio the Hon'ble Madras High Court subsequently in the case of Dwarkadas Rameshwar Goenka (supra) held "that it was well settled that when the karta of a joint Hindu family enters into a partnership with strangers, the members of the family did not ipso facto become partners in that firm. Though it is the karta who entered into the partnership but he was a partner only in his individual capacity and hence any payment of interest to him would be hit by Section 40(6). Consequently, the payment of interest was rightly disallowed.
10. The facts in the case before us and in the case before the Hon'ble Allahabad High Court in the cases of London Machinery Co. (supra) and Dwarkadas Rameshwar Goenka (supra) before the Hon'ble Madras High Court were identical. The revenue's case thus gets further support from this judgment of the Hon'ble Madras High Court. Coming nearer home, the Hon'ble Delhi High Court in the case of Sanghi Motors (supra) of course, without mentioning either the London Machinery Co.'s case (supra) or Dwarkadas Rameshwar Goenka's case (supra), decided the issue in the similar circumstances exactly on the same line as was done by those Hon'ble High Courts. In fact, the Hon'ble Delhi High Court observed in the similar circumstances "that Section 40(6) applied and the salary, bonus and interest paid to S could not be allowed as deductions in computing the income of the firm. The disallowance under Section 40(6) was not restricted to cases where such payments as well as the share income from the firm were assessable in the hands of the partner in his individual capacity". In our considered view, the disallowance appears to have been made and confirmed in accordance with the three decisions discussed hereinabove and, therefore, does not appear to be unjustified or without any basis.
11. On behalf of the assessee before us the mention was made of two accounts being maintained in the firm, i.e., one in the name of the HUF ard another in the name of the partner individually. In this connection the reliance was placed on the ratio in the case of Budhalal Amulakhdas (supra), The issue before the Hon'ble Gujarat High Court in the case was altogether different. The disallowance of interest under Section 40(b) was not the point for determination. In fact, the issue pertained to the registration and their Lordships observed there that a person could become partner in dual capacities, i.e., representing self or his HUF. Thus, the partner having two capacities or two accounts does not mean that provision of Section 40(6) becomes inoperative or inapplicable. Having two accounts does not mean that the provision was not to be applied. In the case before us the interest was paid to the partner and that too in his individual account and it is not clear as to how the provision of law is inapplicable. On behalf of the assessee reliance was also placed on the ratio in the case of Chhotalal & Co. (supra) It is noticed that the Hon'ble Gujarat High Court while deciding the issue perhaps was not informed about the decisions in the cases of London Machinery Co. (supra), Dwarkadas Rameshwar Goenka (supra) and Sanghi Motors (supra) as those cases would appear to have not been referred to in the judgment. With due deference to the Hon'ble Gujarat High Court, we are inclined to infer that the views taken by the other three Hon'ble High Courts we have already discussed are in consonance with the spirit of Section 40(6). The assessee thus does not get any support from the finding in the case of Chhotalal & Co. (supra). Similarly, the ratio in the case of Terla Veeraiah (supra) also is of no help to the assessee as the decision in the case of London Machinery Co. (supra) appears to have not been brought to the notice of the Hon'ble Andhra Pradesh High Court while deciding the issue. The next reliance was by the learned authorised representative on the ratio in the case of Venkatesh Emporium (supra). No doubt, in the said case the Hon'ble Madras High Court commented upon the ratio in the case of London Machinery Co. (supra) appears to have not taken the notice of the ratio in the case of Dwarkadas Rameshwar Goenka (supra) decided by itself on 16-4-1980 whereas the present judgment was announced on 20-7-1981. In view of this factual position we are inclined to follow the earlier judgment of the Hon'ble Madras High Court--with due deference to their Lordships--as the said ratio is more in conformity with the provision of law and the view taken by the Hon'ble Allahabad and Delhi High Courts. Thus, the case of Venkatesh Emporium (supra) also, in our view, does not enhance the assessee's case. Similarly, the reliance by the assessee on the ratio in the case of Panna Lal Hiralal & Co. (supra) would not be of any help as the other judgments relied upon by the revenue appear to have not been brought to the notice of the Hon'ble High Court while deciding the issue.
12. In the given circumstances, with due deference to the other Hon'ble High Courts, we are inclined to follow the ratios laid down by the Hon'ble Allahabad, Madras and Delhi High Courts. The findings of the lower authorities are in conformity with the language of the section and the ratios in these cases. For these reasons, we see no scope for interference. The impugned order on this point is, therefore, confirmed.
13. In the result, the appeal is dismissed.
K.C. Srivastava, Accountant Member
1. I have gone through the order recorded by the learned Judicial Member. However, I am not inclined to agree with his conclusion. I am, therefore, recording a separate order.
2. The assessee is a registered firm. There were three partners in the firm, namely, Shri Mangal Sain, Shri Mool Chand and Shri Suresh Chand. Shri Mangal Sain and Shri Mool Chand were partners in their representative capacity representing their HUFs in the firm. The ITO found that interest had been paid to Shri Mool Chand and to Shri Suresh Chand in their accounts and he added the same to the firm's income under the provisions of Section 40(6). He also found that Shri Mool Chand and Shri Mangal Sain had accounts in their individual capacity and interest had been paid to them in those accounts. He added Rs. 14,041 which represented interest to these persons in their individual capacity and added it under Section 40(b). The allocation of the shares of the partners as made by the ITO would clarify the position:
Sl. Name of partner Salary Interest Profit Interest Total
No. in individual
capacity
1. Shri Mangal Sain
one-third 4,800 -- 11949 -- 16,749
2. Shri Mool Chand
one-third 4,800 1,781 11,949 -- 18,530
3. Shri Suresh Chand
One-third 3,000 3,701 11,949 -- 18,650
4. Shri Mangal Sen -- -- -- 8,916 8,916
5. Shri Mool Chand -- -- -- 5,125 5,125
12,600 5,482 35,847 14,041 67,970
3. When the matter came before the AAC it was contended before him that the accounts of Shri Mangal Sain and Shri Mool Chand represented their individuals accounts whereas these persons were representing their HUFs in the firm. The AAC noted that the account of Shri Mool Chand in his individual capacity stood as under:
Copy of account of Shri Mool Chand (individual) Rs. Rs.
To cash (gift to By balance
assessee's son) 3,000.00 brought forward 30,900.40
1-4-1981
To balance
Carryforward 31-3-1982 37,825.90 By salaries
31-3-1982 4,800.00
By interest
31-3-1982 5,125.50
40,825.90 40,825.90
There was another account of Shri Mool Chand representing his HUF
which stood as under:
Copy of account of Shri Mool Chand (HUF)
Rs. Rs.
To drawings 8,889.05 By balance 14,845.61
31-3-1983 brought forward
1-4-1981
To balance carry forward 21,413.45 By interest
31-3-1982 1,781.47
By profit
31-3-1982 13,675.42
30,302.50 30,302.50
Similarly there was an individual account of Shri Mangal Sain, which
stood as under:
Copy of account of Shri Mangal Sain (individual)
Rs. Rs.
To balance carry forward 63,251.47 By balance
31-3-1982 brought forward 49,535.17
1-4-1981
By interest 8,916.30
4,800.00
63,251.47 63,251.47
There was another account of Shri Mangal Sain representing his HUF
which stood as under:
Copy of account of Shri Mangal Sain (HUF)
Rs. Rs.
To balance carry forward 12,188.01 By share of net
1-4-1981 profit 31-3-1982 13,675.42
To interest 31-3-1982 1,462.56
To drawings By balance
12,560.00 carry forward 12,535.15
31-3-1982
26,210.57 26,210.57
The AAC did not accept the plea of the assessee that the interest paid to Shri Mangal Sain and Shri Mool Chand in their individual accounts should not be added under Section 40(6). While doing so he referred to case laws which had held that the HUF could not be a partner in the firm and only some individual should become a partner in the firm though he may represent the HUF in the firm. The AAC referred to the decision of the Gujarat High Court in the case of Sajjanraj Divanchand (supra) and held that the interest paid in individual account had to be added as the interest paid to the partner. The AAC also relied on the decision in the case of London Machinery Co. (supra). He also referred to the fact that the Madhya Pradesh High Court in Jalam Chand Mangilal (No. 1) v. CIT [1982] 138 ITR 343 had dissented from the decision of the Andhra Pradesh High Court in Terla Veeraiah's case (supra).
4. Before us the learned counsel for the assessee has submitted that the decision of the Gujarat High Court relied upon by the AAC has been overruled by the Full Bench of that Court in the case of Chhotalal & Co. (supra). In that case there was a person representing his HUF as a partner in a firm. He has advanced money from his own individual funds and the assessee-firm gave interest thereon to that firm. The question arose whether in computing business profits of the assessee-firm, the interest paid to that person on his individual funds should be added under Section 40(6). It was held by the High Court that the interest was not paid to the partner as such but to another person who was not a partner. Their Lordships held that there was no impediment in the HUF becoming a partner in a firm in representative capacity. However, the contract is only between the persons who were party to the contract. Their Lordships had held that if the partner representing HUF advances amounts from his individual account to the firm, the interest will not be paid to him in his capacity as a partner but as a stranger. Their Lordships, therefore, dissented from the earlier decision and held accordingly.
5. It was also pointed out that this was a case where the person who contracted was having one account as a partner and another account in his individual capacity where his individual funds were invested. Reliance was also placed on the decision of the Andhra Pradesh High Court in Terla Veeraiah's case (supra) where also their Lordships were concerned with two accounts in the firm, one belonging to the HUF and the other belonging to the individual. Some interest had been credited in the HUF account and it was held that interest could not be added as it was in the account of the partner. A reference was also made to the decision of the Madras High Court in the case of Venkatesh Emporium (supra) which was a reverse case. In that case a partner in individual capacity was also a karta of a HUF which had advanced certain moneys to the firm. The interest paid by the firm to the family was credited in a separate account maintained for the family. The question was whether the interest paid in HUF's account could be added. The High Court held that the interest was not paid to the partner and, therefore, it could not be added.
6. The departmental representative besides relying on the decision of the Allahabad High Court in the case of London Machinery Co. (supra) further submitted that the decision of the Madras High Court in the case of Venkatesh Emporium (supra) was a reverse case and it does not help the case of the assessee, He also relied on the decision of the Delhi High Court in the case of Sanghi Motors (supra). In this case, S was a partner in a firm in his capacity as karta of his HUF. Salary and bonus paid to the partners were being assessed in individual capacity and the share income was being assessed in the hands of the HUF. There were certain deposits in individual account and some interest was being credited in that account. It was held that for the purpose of Section 40(6) there was no logical reason for distinguishing between one payment made by the firm to the partner and another whatever may be the capacity in which he received. Their Lordships clarified that the addition in the hands of the firm does not determine the assessability of that amount in the hands of the persons who receives it.
7. During the course of the argument a reference was also made to the fact that the provisions of Section 40(6) have been amended by adding an Explanation 2 by the Taxation Laws (Amendment) Act, 1984. The Explanation reads as under:
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.
The departmental representative said that this provision is applicable only from 1-4-1985, but the assessee submitted that this Explanation was added as a clarificatory measure and the Board has stated that this was only to remove a doubt about the legal position which was now being accepted by clarifying the intention. In this connection, reference was made to the Board's information regarding the salient features of the Taxation Laws (Amendment) Act, 1984--[1984] 149 ITR (St.) 127. In this connection it had been stated that a number of amendments have been made to bring out the legislative intention more clearly so that further controversy and litigation between the intent and purports of these persons is avoided. It has been clarified that where a person is a partner in his representative capacity interest paid to him in his individual capacity will not be disallowed under the abovementioned provisions and vice versa.
8. There is no doubt that the matter has been full of contentions and different views have been taken from time to time by different Courts. I will first take the decision of the Allahabad High Court in the case of London Machinery Co. (supra), which has been relied upon by the departmental representative and a reference to that case has also been made in the order of the learned Judicial Member. In this case the first thing to be noted is that there were three partners acting as kartas of their HUFs but the partnership deed provided that no interest shall be paid on the contribution of the capital employed by the HUF unless the partners agree otherwise. Three partners have deposited their individual funds with the firm. Interest was paid in these accounts. Their Lordships held that payment to a person who is a partner has to be disallowed under Section 40(6) and the character or capacity in which the payment is made to the partner was not material. If a partner makes a deposit in the form of monies belonging to his HUF and also monies belonging to individually, it is a partner who gives the money. The Court, therefore, held that Section 40(6) would apply to the payment of interest to the three partners though the amounts were deposited in their individual capacity. It is no doubt true that their Lordships had laid down the above law but one thing can be noted that in that case interest was being paid to only one account and not in two accounts. If the partner is having only one account and in that monies are brought by the individual and the HUF, interest in that account has to be considered as interest paid to the partner. In the case before us, however, there was account in the name of the kartas representing the HUF's account in which the profit is also being credited at the end of the year. The profit belongs to the HUF as the karta represents it in the firm. The other account is admittedly the account of the funds brought by certain persons. Thus, this case is distinguishable.
9. The Madras High Court in the case of Venkatesh Emporium (supra) refers to a reverse position but throws light on the problem and a reasonable inference from that would be that interest paid in an account which does not belong to the partner cannot be added.
10. The Bombay High Court had also an occasion to consider this question in the case of Pannalal Hiralal & Co. (supra) where the partner was representing his HUF. The interest was paid on the personal loan given by the representative of the HUF and that had been added as income of the firm under Section 40(6). Their Lordships held that such interest could not be added as it had not been paid to the partner.
11. Having considered the legal position, I find that the latest decision given by the Full Bench of the Gujarat High Court in Chhotalal & Co.'s case (supra). According to me this represents the correct legal position. Where there are two distinct accounts, one belonging to the partner where the share of profit is credited and the other where deposits are made on deposits which do not belong to the partner, only one account can be considered as belonging to the partner and that account in the present case will be the account standing in the name of the HUF. If such an account had not been there and there had been only an account in the name of the partners, then the interest paid in those accounts could be hit under Section 40(b). I am of the view that both the accounts could not be treated as belonging to the partner. Thus, following the decision of the Full Bench of the Gujarat High Court and considering the facts of the case, I hold that interest paid in the accounts of Shri Mangal Sam and Shri Mool Chand in their individual accounts could not be added under Section 40(b) as the interest paid to the partners. It may be clarified that Shri Mangal Sain's account representing the HUF has also been credited with interest of Rs. 1,462 but the ITO has not referred to that amount in his order though the AAC has referred.
12. There is one more strong reason why the claim of the assessee should be accepted. The provisions of Section 40(6) have been amended by adding Explanation 2 which has already been reproduced above. This is a clarificatory amendment as stated in the Board's circular and it is said in the clarification given by the Board (supra) that this amendment was made to bring out the legislative intention more clearly so that further controversy and litigation regarding the intents and purports of these provisions is avoided. At the end of this clarification it is stated that such amendments seek to eliminate continued and unnecessary litigation regarding the true import of these provisions. According to me, under the Explanation where partners represent their HUFs, interest paid on their individual funds in any other account cannot be brought under Section 40(b). Where the Government itself has stated that the purpose was to avoid future litigation which is considered as unnecessary. The provisions should be interpreted in that manner, more so when the Full Bench of a High Court has also given the same opinion. We may clarify that in the present case the High Court having jurisdiction is the Punjab and Haryana High Court and no case of that High Court has been cited before us.
13. In view of this, I hold that interest of Rs. 8,915 and Rs. 5,125 paid by the firm to Shri Mangal Sain and Shri Mool Chand on their individual funds is not hit by the provisions of Section 40(6) and the addition is, therefore, deleted.
14. The appeal is allowed.
ORDER UNDER SECTION 255(4) OF THE INCOME-TAX ACT, 1961 K.C. Srivastava, Accountant Member
1. Having differed in the above matter, we proceed to frame the point of difference and refer the same to the President, Tribunal, for referring the matter to one or more Members under Section 255(4) of the Act.
POINT OF DIFFERENCE Whether, on the facts and in the circumstances of the case, interest paid in the individual accounts of Shri Mangal Sain and Shri Mool Chand could be added under Section 40(b) of the Income-tax Act, 1961 ?
THIRD MEMBER ORDER G. Krishnamurthy, Senior Vice President
1. This appeal was heard by Delhi Bench 'B' consisting of Shri K.C. Srivastava and Shri S.S. Mehra. They could not agree on the conclusion to be reached on the following point. Hence, that point was referred to me as Third Member by the President of the Tribunal for my opinion. The point of difference of opinion is:
Whether, on the facts and in the circumstances of the case, interest paid in the individual accounts of Shri Mangal Sain and Shri Mool Chand could be added under Section 40(b) of the Income-tax Act, 1961 ?
2. I have heard the learned departmental representative as well as the learned counsel for the assessee and I am of the view that the opinion of the learned Accountant Member is proper and justified and I am inclined to agree with him.
3. The facts are: The assessee is a registered firm. There were three partners in the firm, namely, Shri Mangal Sain, Shri Mool Chand and Shri Suresh Chand. Shri Mangal Sain and Shri Mool Chand joined the firm as partners as representatives of their respective HUFs, i.e., Shri Mangal Sain was the karta of a joint family as well as Shri Mool Chand. and both of them in their capacity as karta of the joint family joined the firm as partners. In the books of the firm there are personal accounts for Shri Mangal Sain and Shri Mool Chand on which interest was paid by the firm. The interest paid to these personal accounts which amounted to Rs. 14,041 was added back by the ITO under Section 40(6) in the assessment of the said firm. The assessee objected to the disallowance of this interest and filed appeal before the AAC. Even though the AAC mentioned that there are individual accounts maintained in the books of the firm both for Shri Mangal Sain and Shri Mool Chand in addition to the accounts maintained in the names of the joint families of Shri Mangal Sain and Shri Mool Chand, he took the view that interest paid to Shri Mangal Sain and Shri Mool Chand in their individual capacity should also be disallowed under Section 40(6). In particular, he relied upon a decision of the Gujarat High Court in the case of Sajjanraj Divan-chand (supra) to fortify his view. There are several other decisions which he relied upon of which the decision of the Allahabad High Court in the case of London Machinary Co. (supra) is important. The assessee relied upon the decision of the Andhra Pradesh High Court in Terla Veeraiah's case (supra) but he declined to follow this decision on the ground that the Andhra Predesh High Court decision was not followed by the Madhya Pradesh High Court in the case of Jalam Chand Mangilal (No. 1) (supra). On these facts the learned Judicial Member took the view that interest was rightly disallowed whereas the learned Accountant Member was of a different opinion. Further the learned Judicial Member not only relied upon the decision of the Allahabad High Court in the case of London Machinery Co. (supra) but on another decision of the Delhi High Court in the case of Sanghi Motors (supra) and that of the Madras High Court decision in the case of Dwarkadas Rameshwar Goenka (supra). The learned Judicial Member was of the opinion that even if there are two accounts for each partner, one in his individual capacity and the other in his representative capacity, and even if he became a partner in his representative capacity, yet the interest paid on both the accounts should be considered as interest paid to a partner and the provisions of Section 40(6) would apply inasmuch as that section does not make any distinction between a partner in his individual capacity and a partner in his representative capacity. In his opinion the interest paid to individual account nonetheless is interest paid to a partner. Referring to the Gujarat High Court decision in Chhotalal & Co.'s case (supra) on which reliance was placed on behalf of the assessee, the learned Judicial Member mentioned that the Gujarat High Court did not notice the decision of the Allahabad High Court in London Machinery Co.'s case (supra) and also the decision of the Madras High Court in Dwarkadas Rameshwar Goenka's case (supra) and that of the Delhi High Court in Sanghi Motors' case (supra). He, therefore, preferred to follow the other three High Courts decisions rather than the Gujarat High Court decision. Even though there was a reference during the course of the argument before the Bench to a circular issued by the Board and even though the learned Judicial Member referred to it, there was no discussion in his order about the applicability of the circular.
4. The learned Accountant Member, on the other hand, distinguished the decisions relied upon by the learned Judicial Member and relying upon the language of Section 40(6) particularly after it was amended by the Taxation Laws (Amendment) Act, 1984, and the information issued by the Board (supra) and placing strong reliance upon a Full Bench decision of the Gujarat High Court reported in Chhotalal & Co.'s case (supra) which the learned Judicial Member declined to follow, held that interest paid to individual account was not hit by Section 40(6) because the individual was not a partner in the firm. He applied the circular issued by the Board to the facts of this case by pointing out that the amendment made to Section 40(6) referred to earlier was stated to be of a clarificatory nature by the Board in its circular and since it was of a clarificatory nature intended to bring out the legislative intention more clearly in order to avoid controversy and litigation, the circular must be held to be applicable to the assessee and, therefore, the interest paid on the individual accounts could not be treated as interest paid to a partner. He drew support for his view from the decision of the Full Bench of the Gujarat High Court. He noticed that there was no decision given by the Punjab and Haryana High Court which is the jurisdictional High Court. He thus held that the interest was not to be disallowed by applying the provisions of Section 40(6).
5. Before me the arguments proceeded on these lines alone. In addition, reliance was placed very strongly on a judgment of the Andhra Pradesh High Court in N.T.R. Estate v. CIT [1986] 157 ITR 285 in which the Andhra Pradesh High Court held that the amendment made to Section 40(6) was retrospective in nature and being of clarificatory nature applicable to earlier assessment years, salary and interest paid to partners in their individual capacity would not be disallowable under Section 40(6) if members of those HUFs become partners in their representative capacity. By relying on this decision it was urged that the controversy, must be deemed to have been set at rest as to the effect of the amendment particularly its retrospective nature. For the department reliance was placed on a decision of the Allahabad High Court in the case of CIT v. Chandu Lal Surajpal [1986] 157 ITR 346 where the Allahabad High Court reiterated its earlier view expressed in the case of London Machinery Co. (supra). Reliance was also placed on the decision of the Karnataka High Court in CIT v. Khoday Eswarsa & Sons [1985] 152 ITR 423 as well as the decision of the Delhi High Court in Sanghi Motors' case (supra).
6. As I have expressed earlier I did not find any difficulty in agreeing with the view expressed by the learned Accountant Member that the clarificatory nature of the amendment brought to Section 40(6) as expressed by the Board circular found favour with the latest decision of the Andhra Pradesh High Court in the case of N.T.R. Estate (supra). I think it is necessary to briefly refer to the decision of the Andhra Pradesh High Court. The Andhra Pradesh High Court held that the Taxation Laws (Amendment) Act, 1984 has inserted three Explanations with effect from the assessment year 1985-86. The effect of these Explanations is (a) if a person is a partner in a firm in a representative capacity and if such partner lends to the partnership moneys belonging to him individually, then the interest paid to such partner on moneys lent by him is not liable to be added under Section 40(6), and (b), if a person is a partner in his individual capacity and if such partner lends to the partnership moneys belonging to the HUF of which he is the karta then the interest paid on the moneys lent by the joint family is not liable to be added back under Section 40(6). The Andhra Pradesh High Court held in this case that the same principles are applicable in the case of salaries paid to the partners. The observations made by the Andhra Pradesh High Court through Justice Y.V. Anjaneyulu, who spoke for the Court are as under:
. . . We consider that the present case is on all fours with the facts obtaining in the decisions of this Court in Addl. CIT v. Vallamkonda Chinna Balaiah Chetty & Co. [1977] 106 ITR 556 (AP) and Terla Veeraiah y. CIT [1979] 120 ITR 502 (AP). It is true that there is a conflict of judicial opinion on this aspect (vide judgment of the Karnataka, Allahabad and Delhi High Courts above referred to on which reliance was placed by the learned standing counsel for the revenue). We do not think that any case is made out for reconsideration of the judgments of this Court in Addl. CIT\. Vallamkonda Chinna Balaih Chetty & Co. [1977] 106 ITR 556 and Terla Veeraiah v. CIT [1979] 120 ITR 502 for two reasons: firstly, the view taken by this Court finds support in the judgments of the Gujarat High Court and Madras High Court above referred to; and, secondly, the principle enunciated by this Court is now statutorily recognised by the Taxation Laws (Amendment) Act of 1984, which will be effective from the assessment year 1985-86. By Section 10 of the above Amendment Act, three Explanations were inserted. Explanations 2 and 3 deal with the matter under consideration. The effect of these Explanations is: (a) if a person is a partner in a firm in a representative capacity and if such partner lends to the partnership 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(6) of the Act; and (6) similarly, if a person is a partner in his individual capacity and if such partner lends to the partnership monies belonging to the Hindu joint family, of which he is the 'karta', then the interest paid on the monies lent by the joint family is not liable to be added back under Section 40(6) of the Act. The above amendment to the statute is clear acceptance of the views expressed by this Court, the Gujarat High Court and the Madras High Court in the decisions above referred to. It is true that Explanations 2 and 3 inserted by the Taxation Laws (Amendment) Act of 1984 will be effective from the assessment year 1985-86. It is well to bear in mind that in the statement of objects and reasons introducing the Taxation Laws (Amendment) Bill, 1984, it has been specifically mentioned that the amendments introduced in the Bill are intended mainly to streamline procedures in the interest of better work management, avoid inconvenience to taxpayers, reduce litigation, remove certain anomalies in and rationalise some of the provisions of these enactments and counteract tax avoidance and tax evasion. We consider that the present amendment to Section 40(6) of the Act through Explanations 2 and 3 above referred to is to avoid inconvenience to taxpayers, reduce litigation and in that view, the spirit of Explanations 2 and 3 introduced by the Taxation Laws (Amendment) Bill, 1984, should be followed with respect to the preceding assessment years also in order to avoid unnecessary litigation. It cannot be gainsaid that the Legislature was fully aware of the conflict of judicial opinion in this matter among the various High Courts in the country and the present amendment to Section 40(b) through Explanations 2 and 3 is brought about to set at rest the controversy. We see no reason to hold that the principle statutorily recognised by Explanations 2 and 3, following the decisions of some High Courts, is good only from the assessment year 1985-86 and ceased to be so for the preceding assessment years. In our opinion, Explanations 2 and 3 are merely clarificatory in character and must, therefore, govern the assessments prior to the assessment year 1985-86 also.
In my opinion the matter is fully governed by the decision of the Andhra Pradesh High Court and the observations extracted above answer fully all the points raised by the revenue against the assessee. I thought I can do no better than to reproduce the above observations. Since it has been held that the amendment brought to Section 40(6) is clarificatory in nature and it applies to earlier assessment years also, it must be held that the decision rendered by the Allahabad High Court in London Machinery Co.'s case (supra) cannot be said to be correct proposition of law before amendment of Section 40(6). For the same reason the decision in Chandu Lal Suraj Pal's case (supra) which is a reiteration of the same view as expressed in London Machinery Co. 's case (supra) cannot also be said to be the correct enunciation of Jaw after Section 40(6) was amended as above. What is more significant about the decision of the Andhra Pradesh High Court is that it not only interpreted the amendment to Section 40(6) it also considered the circular issued by the Board on the point and held that that was clarificatory in nature and its object could only be to reduce litigation, alleviate difficulties and hardships and, therefore, it could only be retrospective in its applicability. This is also the view expressed by the learned Accountant Member in his dissenting view, which the learned Judicial Member has not considered. Another important reason is that all the decisions now referred to me both for and against the assessee were considered by the Andhra Predesh High Court in that decision and the above conclusion was arrived at. That being the latest decision directly on the point, I follow with respect that decision and applying it to the facts of this case, I hold that the Legislature itself has brought in the dichotomy between the interest paid to a person in his individual capacity and to a person in his representative capacity and if one is the partner in one capacity, the interest paid by the firm in another capacity is no more available for disallowance under Section 40(6). As pointed out by the learned Accountant Member this case comes from the Punjab and Haryana State and there is no decision of that High Court. Therefore, respectfully following the decision of the Andhra Pradesh High Court, I am of the view that the learned Accountant Member has correctly decided the matter and I would agree with him.
7. Referring to the Allahabad High Court decision in Chandu Lal Surajpal's case (supra), I may point out that this decision relies for its support only on the earlier decision given in the case of London Machinery Co. (supra). By referring to its earlier decision the Allahabad High Court held that when a person in his capacity as karta of HUF enters into a partnership with others, the karta is a partner only in his personal capacity. The firm can treat only the karta and not the other members of the joint family as its partner. The capacity in which he receives the payment, namely, for and on behalf of the family or for his own benefit and interest, is immaterial. Payment to a person, who is a partner is the only criterion for the purpose of Section 40(6). But this decision proceeds on the basis that when a person in his capacity as karta of HUF enters into partnership with others, karta alone is a partner in his personal capacity. But this basis is no more available after the amendment of Section 40(6) which recognises statutorily that a person can become a partner in a firm in his representative capacity as well as in his individual capacity. His entering into a partnership in either of the two capacities having thus been recognized by law, it is no more open to say that the interest paid to one is the same as interest paid to the other. It is also significant to note that in the Allahabad High Court decision in Chandu Lal SurajpaVs case (supra), the amendment to Section 40(6) was not at all discussed as it was not brought to its notice. Thus, the decisions given by the Allahabad High Court based upon Section 40(6) as it existed before the amendment, cannot now be pressed into service.
8. The matter will now go before the regular Bench for decision according to majority opinion.