Ajit K. Sengupta, J. - The assessee is a registered firm. The original assessment of the assessee firm was completed on 31-10-1962. In the original assessment the assessee firm claimed interest of Rs. 34,895 on hundi loans appearing in the books of the assessee. The said interest was allowed while completing the original assessment. Thereafter materials came into the possession of the ITO that the said hundi loans were not genuine and fictitious. Accordingly the assessment was reopened under s. 147(a) of the IT Act, 1971. In response to the notice under s. 148 of the said Act the assessee filed return showing total income of Rs. 99,113 being the income determined in the original assessment as modified on appeal. Before the ITO it was stated by the assessee that Hundi loans were disclosed by the partners of the firm with its interest under s. 68 of the Finance Act, 1965. However, the ITO, rejected the contention of the assessee and held that since the payment of interest on bogus hundi loans has been claimed in the assessment of the firm the interest must be added back in computing the total income of the firm. The ITO also observed that the addition of such interest was upheld in earlier years by the AAC. The ITO, therefore, added back the sum of Rs. 34,895 to the income of the assessee. The assessee preferred an appeal before the AAC. The AAC followed the order of the Tribunal in the case of Vijay Industries. Calcutta where the Tribunal held that the interest disclosed under s. 68 of the Finance Act, 1965 by the partners was not once again includible in the firms assessment. The AAC held as follows :
'I have also gone through the contents of the disclosure petition submitted by the appellant and have found that the partners making the disclosure have surrendered for taxation under s. 68 of the Finance Act, 1965 the interest on the loans brought into this firm and other firms accounts in the garb inclusion of the interest on bogus hundi loans amounting to Rs. 34,895 in pursuance of the re-assessment proceedings under s. 147(a) of the IT Act was unjustified.'
He, therefore, deleted the said addition.
2. The department preferred an appeal before the Tribunal. The Tribunal followed its order in I.T.A. No. 3762 (Cal) of 1969 and held that the contention of the representative of the parties are the same which were raised in the said appeal and so were the facts and circumstances in that case as in the present one. Therefore, the Tribunal followed the said order and dismissed the appeal of the department.
3. At the instance of the Commissioner the following questions of law have been referred to this Court under s. 256(2) of the IT Act, 1961 :
'1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the sum of Rs. 34,895 (Rupees thirty four thousand eight hundred and ninety five) only being the interest paid by the assessee to its partners in respect of bogus Hundi Loans is an allowable deduction in computing the income of the assessee, a registered firm, on the ground that the said amount had been subjected to tax as a result of disclosures made by the partners ?'
2. Whether, on the facts and in the circumstances of the case, and in view of the provisions of s. 40(b) of the IT Act, 1961, the Tribunal was right in law allowing the interest paid by the assessee firm to its partners ?'
4. It is well settled that under the general law a firm is not a legal person or juridical entity but the technical view of the nature of the partnership under the general law does not hold good in income-tax proceedings. For the purpose of income-tax a firm is treated as an entity distinct and separate from the partners which constituted the firm. A firm is unit of assessment. Firm and the partners are assessed separately. Sec. 182 of the IT Act prescribes the procedure for assessment of registered firm.
5. Under s. 182 the income-tax payable by the registered firm itself is determined and the share of each partner in the income of the firm shall be included in his total income and assessed to tax accordingly. Under s. 158 the ITO has to make the allocation of income of a registered firm which forms the basis of assessment of the partners. In making the assessment of the firm the ITO cannot overlook the provision of s. 40(b) of the Act. It provides that notwithstanding anything to the contrary in ss. 30 to 39 any payment of interest, salary, bonus, commission or renumeration paid by the firm to any partner of the firm shall not be deducted in computing the total income chargeable under the head, 'profits and gains of business or profession'. Originally the assessee firm claimed the loans to have been obtained from the third parties. Accordingly interest claimed on the said loans was allowed by the ITO. The partners of the assessee firm made a disclosure petition under s.68 of the Finance Act, 1965 declaring the amount covered by the said loans to the assessee firm as there concealed income. By reason of the said declaration the said loans must be deemed to have been advanced to the assessee firm by its partners. If the loans were not genuine the interest on such loans would not be allowable. If the loans are genuine in the sense that such loans have come from the partners, the prohibition of s. 40(b) would apply. The language of s. 40(b) is clear and enacts, an absolute prohibition. The test to be applied as to whether the interest is paid to the partners. It is admitted that the assessee paid the interest to the creditors being the partners and such interest has been disclosed in their voluntary disclosure. It is immaterial whether the interest income received by the partners on the said loans has been shown by the partners in their individual assessment. The ITO assessing the firm cannot ignore the provision of s. 40(b). The assessment year involved is 1961-62. The ITO has to proceed on the facts and circumstances as appearing during the relevant previous year. A declaration made in 1965 cannot change the nature and character of the credits appearing in the books of the assessee firm. If the loans were bogus and fictitious the ITO has to disallow the interest on such loans and to add the amounts represented by cash credits as the income of the assessee firm. IF on the other hand the case made out by the assessee that such credits represented the concealed income of the partners is accepted. In that event the amounts represented by the cash credits would not be added to the income of the assessee firm but only the interest will be disallowed in view of the prohibition of s. 40(b). The ITO accepted that the loans come from the partners and, therefore, disallowed the interest under s. 40(b).
6. Under the provision of the Act a registered firm bears the tax direct as also its partners are separately assessed in respect of share of profits allocated to them out of the income of the registered firm. Sec.67 provides the method of computing and allocating a partners share in the assessed income of the firm. After the total income of the firm is computed, any interest, salary, commission or other remuneration paid to any partner is to be deducted from the total income of the firm and the balance is apportioned among the partners according to their respective shares The amount of interest, salary, commission or other remuneration paid to a partner is to be added to the apportioned amount or adjusted against apportioned amount depending on whether the apportioned amount represents profits or loss. In making an assessment of the share income of a partner, the ITO assessing the partner is bound by the allocation made partners name by the ITO assessing the firm. It will be for the partners to claim the benefit if any of the declaration made under s. 68 of the Finance Act, 1965 in their individual assessment but whether the interest income received by the partners is covered by the disclosure or not, in out opinion, will not affect, the assessment of the registered firm.
7. In that view of the matter we answer both the questions in this reference in the negative and in favour of the revenue.
8. There will be no order as to costs.
Dipak Kumar Sen, J. - I agree.