1. Both these appeals involve common point for consideration on common facts. These are, therefore, being disposed of by this consolidated order.
2. The assessee appellants are the partners of M/s. Mali Ram Puranmal & Co. which exports precious and semi-precious stones and whose income from exports is totally exempt from tax as per provisions of Section 80HHC of the IT Act, 1961 (the Act). For the year under consideration Shri Moti Chand Rawat had returned his income at Rs. 17,580 and Shri Ravi Kumar Rawat at Rs. 14,866. At the assessment proceedings the Assessing Officer noted that Shri Moti Chand Rawat assessee had received interest of Rs. 32,616 and Shri Ravi Kumar Rawat Rs. 21,276 from the partnership firm of M/s. Maliram Puranmal & Co. on their capital invested in the said firm but they had not shown their interest incomes for tax purposes. Though the assessees urged before the ITO that their interest incomes from the partnership firm of M/s. Maliram Puranmal & Co. had the character of business income being part of their share income and as such was exempt from tax yet the ITO did not accept such contention. He was of the view that the benefit of exemption from tax under Section 80HHC, which had once been extended to the partnership firm could not be available to the partners in the computation of their incomes. In appeals, the learned DC (A) endorsed the view of the Assessing Officer and held that since the firm of M/s.
Maliram Puranmal & Co. had already got a deduction under Section 80HHC, any other person deriving interest income from the firm could not again be allowed deduction under Section 80HHC of the Act. He accordingly dismissed assessees appeals giving thus thereby rise to the present appeals by them.
3. Shri N.M. Ranka, Advocate appearing for the assessee appellants vehemently urged that as per provisions contained in Section 67(1)(a)(b) read with Sections 158 and 247 and the newly amended provisions of Section 28(5) the interest received by the assessee from the partnership firm had the character of business income and was part of the their share of profit received from the firm. It was submitted that in computing the business income of the partnership firm the interest paid or payable to the assessees was considered and then exemption under Section 80HHC was allowed. It was submitted that the share income inclusive of the interest received by the assessees on their capital investments had the same character as was determined in the case of the firm. The learned counsel, therefore, submitted that the interest incomes of the assessees were not liable to be subjected to tax and they had not rightly offered the same for taxation. These arguments were supported with the cases of Karanpura Development Co.
Ltd. v. CIT [1962] 44 ITR 362 (SC), CIT v. Ramniklal Kothari [1969] 74 ITR 57 (SC), CIT v. R.M. Chidambaram Pillai [1977) 106 ITR 292 (SC), Chhotalal Keshavram v. CIT [1978] 115 ITR 347 (MP) and CIT v. Maharani Lalita Rajya Laxmi Saheba [1980] 121 ITR 1012 (Pat.) 4. Regarding the reasons given by the Income-tax authorities for not accepting assessees contention, Shri Ranka submitted that the CBDT vide their letter No. F. 178/152/91-ITA-1, dated 31-7-1992 had clarified that the deduction allowed to a firm under various sections was available to the partner of the firm in the computation of his income.
In support of such contention a copy of the order passed by the ITO on 20-8-1992 under Section 154 in the case of Smt. Meera Katta for A.Y.1990-91 was relied upon.
5. The learned Departmental Representative supported the orders under appeal and further submitted that once deduction under Section 80HHC had been obtained by the partnership firm of M/s. Maliram Puranmal & Co. the assessees could not have been allowed the same deduction in respect of their interest income from that firm.
6. After having considered the rival submissions and on a study of the case law and other relevant material as relied upon by the learned counsel for the parties, I am of the opinion that the interest incomes of the assessees cannot be subjected to tax.
7. In so far as the view of the Income-tax Authorities that once deduction under Section 80HHC has been given to the partnership firm, the same benefit was not available to the partners in respect of their share incomes is concerned, that cannot be endorsed in view of the CBDT Circular referred to above. In the said letter the CBDT has clarified the position that the deduction allowed to the firm under various sections would be available to the partners of the firm in the computation of their total incomes which would be inclusive of the share incomes from their firm. Following such instruction of the CBDT, the Assessing Officer in the case of Smt. Meera Katta had rectified his assessment order and had deleted the addition made in respect of the exempted share profits of the partners from their firm. The present appeals may thus conveniently be disposed of in favour of the assessees on the strength of the letter of the CBDT referred to above.
8. However, I find ample force in the arguments of Shri Ranka. It is the settled position of law that a firm is not a legal person even though it has some attributes of personality. In income-tax law a firm is a unit of assessment by special provision but, as has been held by the Supreme Court in the case of R.M. Chidambaram Pillai (supra), it is not a full person. That being the legal position, there cannot be a contract of service, in contract law, between a firm and one or more of its partners. In fact payment of salary to a partner would represent a special share of profits. Thus the salary paid to a partner would retain the same character of the income of the firm.
9. In the case of R.M. Chidambaram Pillai (supra) the partnership firm was deriving income from growing and selling tea and its income was considered as partly agricultural and partly non-agricultural. The Supreme Court held that salary paid to a partner by the firm was exempt from tax under Rule 24 of the Indian Income-tax Rules, 1922 to the extent of 60 per cent thereof representing agricultural Income and was liable to tax only to the extent of 40 per cent. This authority clearly lays down the proposition that the salary paid to a partner retains the same character of the income of the firm.
10. In the case of Ramniklal Kothari [supra], the Supreme Court held that business carried on by a firm is business carried on by the partner and profits of the firm are profits earned by all the partners in carrying on the business. Their Lordships clearly held that the share of the partners is business income in their hands for the purpose of Section 10(1) of the IT Act, 1922 and being business income expenditure necessary for the purpose of earning that income and appropriate allowances were deductible therefrom in determining the taxable income of the partner. This case, therefore, reiterates the same legal proposition as was laid down by the Supreme Court in the case of R.M. Chidambaram Pillai (supra).
11. In an earlier case of Karanpura Development Co. Ltd. (supra) the Supreme Court had laid down that before income, profits, or gains can be brought to computation, they have to be assigned to one or more heads. These heads are in a sense exclusive of one another and income which falls within one head cannot be assigned to, or taxed under, another head. The proposition laid down in this case clearly suggests that the character of the income would not change when such income comes to the hands of the partner. The income would bear the same character as it was having in the hands of the firm.
12. The Madhya Pradesh High Court in the case of Chhotalal Keshavram (supra) held as under :- Section 16(1)(b) of the Indian Income-tax Act, 1922, lays down the mode of computing the partner's share in the profit or loss of the firm. The formula is to take any salary, interest, commission or other remuneration payable to the partner by the firm and to add to or substract from it respectively the partner's share in the balance of the profit or loss of the firm, after deduction of any interest, salary, commission or other remuneration payable to another partner.
Hence, while interest paid to the partner of a firm must be added to his share of profit in the computation of his total income by virtue of Section 16(1)(b) of the 1922 Act, there is no provision in the Act for deduction of any interest paid by the partner to the firm in like manner. Even Section 67(3) of the Income-tax Act, 1961, which gives statutory recognition to the principle judicially recognised that a partner is entitled to a deduction, in computing his share in the firm's profits, in respect of interest paid by him on the capital borrowed for for the purpose of investment in the firm, relates only to interest paid on the capital borrowed for the purpose of investment in the firm and has no application to a case where a partner claims a deduction in respect of interest paid by him to the firm.
In the above mentioned case the assessee firm had debited the interest to the accounts of the two partners and the interest so debited had been transferred to the interest account and the resultant sum had gone into the Profit and Loss Account. The Tribunal had held that they were not mere adjustment entries or only book profits but were commercial and real profits actually received by the firm in the relevant accounting years and they represented the real income of the firm. Such view of the Tribunal was upheld by the Madhya Pradesh High Court which further clarified that in apportioning the total income of the firm between the several partners as required under Section 23(6) of the Indian Income Act Tax 1922 and Section 158 of IT Act, 1961, the interest adjusted on the debit balances of the accounts of the partners in the books of the firm was not deductible from the share of profits of the respective partners.
13. The Patna High Court had the occasion to consider a similar point in the case of Maharani Lalita Rqjya Laxmi Saheba [supra). In that case the Tribunal had found that the amount of interest had accrued to the assessee partner of the firm but had not been received by the partner.
It was held by the Patna High Court that the determination of income of the assessee partner under Section 16(1)(b) would depend upon the allotment of the assessee's share in the balance of the loss of the firm after setting off the interest payable to her. It was further held that the total interest in that case had been taken as the assessable income without application of principle of Section 16(1)(b) of the Act.
In the absence of order of an allotment from the ITO who assessed the firm, the Tribunal was perfectly justified in excluding the amount of interest from the assessable income of the partner.
14. On the basis of the discussion made above it may safely be concluded that the ratio in the decisions of the cases cited favours the proposition that the interest paid or payable to the partners by their partnership firm on their capital investments would be liable to be considered in the computation of the income of the business income of the firm and thereafter the share of profit or loss would be allotted to the partners. Section 67 lays down the method of computing partner's share in the income of the firm and the relevant part thereof runs as under :- 67. (1) In computing the total income of an assessee who is a partner of a firm, whether the net result of the computation of total income of the firm is a profit or a loss, his share (whether a net profit or a net loss) shall be computed as follows:- (a) any interest, salary, commission or other remuneration paid to any partner in respect of the previous year, (and, where the firm is a registered firm or an unregistered firm assessed as a registered firm under Clause (b) of Section 183) the income-tax, if any, payable by it in respect of the total income of the firm and the balance ascertained and apportioned among the partners; (b) where the amount apportioned to the partner under Clause (a) is a profit, any salary, interest, commission or other remuneration paid to the partner by the firm in respect of the previous year shall be added to that amount and the result shall be treated as the partner's share in the income of the firm; (c) where the amount apportioned to the partner under Clause (a) is a loss, any salary, interest, commission or other remuneration paid to the partner by the firm in respect of the previous-year shall be adjusted against that amount and the result shall be treated as the partner's share in the income of the firm.
(3) Any interest paid by a partner on capital borrowed by him for the purposes of investment in the firm shall, in computing his income chargeable under the head "Profits and gains of business or profession" in respect of his share in the income of the firm, be deducted from the share.
The bare reading of the above provisions would support the statement made above. In fact, the amended provisions of Section 28(5) as inserted by the Finance Act, 1922 with effect from 1-4-1993 clearly exhibit the legislative intent in this respect. The said amended provision runs as under :- 28. The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession",- (v) any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm: Provided that where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under Clause (b) of Section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted.
The insertion of the above provision supports the view that interest, salary, bonus, commission or remuneration due to, or received by a partner of a firm from such firm would be considered in computing the profit and gains of the business of the firm as per provisions of Section 28. The interest paid to a partner on his capital investment would thus be taken into account in computing the business income of the firm, The share of profit coming to the hands of the partners would thus have the same character of income as it was having in the hands of the firm. That being so, I find ample force in the argument of Shri Ranka that the interest incomes of the assessees from their firm was not liable to be taxed in their hands as such incomes had the character of business income for its being the allotted share of profit by the firm to its assessee-partners. In my opinion, therefore, the interest income of the assessees is not to be considered in the, computation of their taxable income. I order accordingly.