C.P. Sen, J.
1. This Full Bench has been constituted for resolving the conflict in two sets of opinion by different High Courts regarding the application of Section 40(b) of the Income-tax Act in respect of payment of interest to the partner of a firm as a non-allowable or allowable deduction. In fact, there are two conflicting decisions of this court in Jalamchand Mangilal v. CIT : [1982]138ITR343(MP) and 347 and in Balchand Hashmatrai & Co. v. CIT : [1986]161ITR121(MP) which have been noticed by this court in Sobhagmal Phoolchand v. CIT (infra p. 541) and the matter has been referred to a larger Bench. One view is that irrespective of the capacity in which a person joins a partnership firm and is paid interest by the firm, Section 40(b) is a bar to payment of interest to the partner of the firm as an allowable deduction, while the other view is that when the interest is paid to a partner in a somewhat different capacity, the amount has to be deducted as an allowable deduction.
2. Briefly, the facts of the present case are that reference has been made under Section 256(1) of the Income-tax Act, at the instance of the Commissioner of Income-tax by the Income-tax Appellate Tribunal, Nagpur Bench, to answer the following question : 'Whether the Tribunal was correct in allowing the assessee's claim for interest paid on the credit balance in the individual account of Shri Prakashchand ?' The question arose in the assessment of the firm, M/s. Narbharam Popatbhai & Sons, Raipur, for the assessment year 1977-78. Shri Prakashchand was a partner in the firm in his capacity as a karta of the joint Hindu family consisting of himself, his wife and minor son. The firm had two accounts, one in the name of the joint Hindu family and the other in the individual account of Shri Prakashchand who had deposited certain amounts with the firm. The firm paid interest on the deposit of Shri Prakashchand to the tune of Rs. 18,385 during the year under assessment and the firm claimed this amount as permissible expenditure deductible under Section 37 of the Income-tax Act. The Income-tax Officer held that the amount so paid as interest by the firm was to its partner and, therefore, in terms of Section 40(b) of the Act, this amount cannot be deducted in computing the assessee's income chargeable under the head 'Profits and gains of business or profession' This order was upheld by the Commissioner of Income-tax (Appeals) but in second appeal, the Income-tax Appellate Tribunal relying on certain decisions allowed the claim for interest and, therefore, this reference has been made at the instance of the Revenue. Finding a conflict of decisionsbetween different High Courts on this question, the matter has been referred to the Full Bench.
3. Sections 30 to 39 of the Income-tax Act provide for various allowances and deductions to be made in computing the income chargeable under the head 'Profits and gains of business or profession' Though generally these deductions are to be made for the purpose of determining the net income of any assessee, Section 40 envisages situations where some of the deductions are not to be made and some are to be made in a modified manner in the case of certain classes of assessees. Clause (b) deals with firms which reads as under:
'Notwithstanding anything to the contrary in Sections 30 to 39, 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'.
4. This provision corresponds to Section 10(4)(b) of the Indian Income-tax Act, 1922, the difference being that bonus has now been added in this Clause (b). This provision was enacted to prevent siphoning off the profits in some form or the other so as to reduce the tax liability and in the case of a firm, this siphoning off is envisaged by payment, to a partner, of a portion of the profit in one form or another as envisaged in the section, viz., by way of interest, salary, bonus, commission or remuneration. Evidently, that is the reason why though normally any interest paid other than the interest paid on the capital would be an allowable item of expenditure under Section 37 of the Act, special provision was made in Section 40(b) to see that such payment of interest is taken out of the scope of 'allowable expenditure'. Same is the approach towards salary, bonus, commission or remuneration. The Privy Council in Pichappa Chettiar v. Chockalingam Pillai AIR 1934 912 held that where a managing member of a joint family enters into a partnership with a stranger, the other members of the family do not ipso facto become partners in the business so as to clothe them with all the rights and obligations of a partner as defined by the Indian Contract Act. In such a case, the family as a unit does not become a partner, but only such of its members as in fact enter into a contractual relation with the stranger : the partnership will be governed by the Act. Approving this decision, the Supreme Court in Charandas Haridas v. CIT : [1960]39ITR202(SC) held that there are three different branches of law to notice. There is the law of partnership, which takes no account of a Hindu undivided family. There is also the Hindu law, which permits a partition of the family and also a partial partition binding upon the familyThere is then the income-tax law, under which a particular income may be treated as the income of the Hindu undivided family or as the income of the separated members enjoying separate shares by partition. The income-tax law before the partition takes note, factually, of the position of the karta, and assesses not him qua partner but as representing the Hindu undivided family. In doing so, the income-tax law looks not to the provisions of the Partnership Act but to the provisions of the Hindu law. In another decision, the Supreme Court in CIT v. Bagyalakshmi & Co. : [1965]55ITR660(SC) held that a partnership is a creature of contract. Under the Hindu law, a joint family is one of status and right to partition is one of its incidents. The income-tax law gives the Income-tax Officer a power to assess the income of a person in the manner provided by the Act. Except where there is a specific provision of the Income-tax Act which derogates from any other statutory law or personal law, the provision will have to be considered in the light of the relevant branches of law. A contract of partnership has no concern with the obligation of the partners to others in respect of their shares of profit in the partnership. It only regulates the rights and liabilities of the partners. A partner may be the karta of a joint Hindu family; he may be a trustee; he may enter into a sub-partnership with others; he may, under an agreement, express or implied, be the representative of a group of persons ; he may be a benamidar for another. In all such cases, he occupies a dual position. Qua the partnership, he functions in his personal capacity ; qua the third parties, in his representative capacity. The third parties, whom one of the partners represents, cannot enforce their rights against the other partners nor can the other partners do so against the said third parties. Their right is only to a share in the profits of their partner-representative in accordance with law or in accordance with the terms of the agreement, as the case may be. Therefore, the position is well-settled that there is no impediment in a Hindu undivided family becoming a partner of a firm through its representative. In such a case, the members of the family cannot exercise rights which their representative can as against the other partners. They can make their representative accountable to them. They can seek to enforce his obligations and the representative will be bound to observe all obligations which law casts on him as such representative. Where one of the partners is really a representative of others, third parties are not barred from dealing with him in his representative capacity, for, they are not parties to the contract of partnership. The Revenue is in no way precluded from dealing with a partner as a representative if he is one such, as for instance, where he is the 'karta' of a Hindu undivided family. The income derived by him as a partner would really be the income of the Hindu undivided family and really derived by the Hindu undivided family. If it is a Hindu undivided familyon behalf of which he receives the income, the partner being its representative, it is the income of the family which is ultimately to be assessed.
5. The matter has been made clear by adding Explanations 1 to 3 to Section 40(b) by the Taxation Laws (Amendment) Act, 1984, which came into force from April 1, 1985. Explanations 2 and 3, which are relevant for our purpose, are quoted hereunder:
'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 purpose of this clause.
Explanation 3.--Where an individual is a partner in a firm otherwise than as a 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.'
6. The Statement of Objects and Reasons of the amendment are intended mainly to streamline procedures in the interest of better work management, avoid inconvenience to taxpayers, reduce litigation, remove certain anomalies and rationalise some of the provisions of these enactments and counteract tax avoidance and tax evasion. The effect of these Explanations is that (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 a partner on the monies lent by him is not liable to be added back under Section 40(b) of the Act; and (b) 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(b) of the Act. Therefore, these Explanations confirm the correctness of the other set of view taken in certain decisions that interest paid to a partner in a different capacity has to be deducted computing the income chargeable and Section 40(b) will not come into operation.
7. We are fortified in our view by a Full Bench decision of the Gujarat High Court in Chhotelal & Co. v. CIT : [1984]150ITR276(Guj) wherein it has been held as under (headnote):
'V, the karta of an Hindu undivided family, was a partner in the assessee-firm representing the family. He advanced monies to the firm from his own individual funds, and the assessee-firm paid interest thereon to V. The question was whether in computing the business profits of the assessee-firm, the interest paid to V on monies advanced by him from his individual funds should not be deducted in view of Section 40(b) of the Income-tax Act, 1961. The Tribunal held that the interest paid should be disallowed. On a reference: Held, that in computing the business profits of the assessee-firm, the interest paid to V on monies advanced by him from his individual funds could not be disallowed. The interest paid to V was not paid to him as a partner but as a stranger.'
8. The facts of the aforesaid case are identical to the facts of the present case. Similar view has been taken by the Bombay High Court in CIT v. Hansa Dyeing & Printing Works and CIT v. Pannalal Hiralal & Co. : [1984]146ITR549(Bom) by the Madras High Court in Venkatesh Emporium v. CIT [1982] 137 ITR 593 and CIT v. Colombo Stores : [1984]149ITR108(Mad) and Terla v. CIT : [1979]120ITR502(AP) . The Gujarat, Andhra Pradesh and Madras High Courts have differed and distinguished their earlier contrary view taken, in the aforesaid cases. A Division Bench of the Andhra Pradesh High Court in N. T. R. Estate v. CIT : [1986]157ITR285(AP) held as under (headnote):
'The Taxation Laws (Amendment) Act of 1984, has inserted three Explanations with effect from 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 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; and (b) 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(b) of the Act. The Explanations are clarificatory in character and must govern assessments prior to the assessment year 1985-86.'
9. Taking note of these amendments, a Division Bench of this court in Balchand Hashmatrai & Co. v. CIT : [1986]161ITR121(MP) held that (headnote) :
'The provisions of Explanations 2 and 3 of Section 40(b) of the Income-tax Act, 1961, and circular make it clear that disallowance of interest paid' by a firm can be made under Section 40(b) only if the interest is paid by the firm to the partner in his capacity as partner. No disallowance can be made under Section 40(b) if the interest is paid by the firm to the partnerin a capacity other than the capacity of a partner. Where a member of a Hindu undivided family is a partner in his individual capacity, interest paid to him as a representative of the Hindu undivided family cannot be disallowed. Though Explanations 2 and 3 were inserted with effect from April 1, 1985, they point out the effect of interest paid in such cases.'
10. The Allahabad High Court in CIT v. London Machinery Co. [1919] 117 ITR 111 held as under (headnote):
'When a person in his capacity as karta of a Hindu undivided family 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 Hindu undivided family 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(b) 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 Hindu undivided family 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(b) of the Act would, therefore, apply to the payment of interest to the three partners who were partners in their capacity as kartas of Hindu undivided family and had deposited their individual money in the firm.'
11. This has been followed by the same High Court in CIT v. Chandu Lal Surajpal : [1986]157ITR346(All) by the Andhra Pradesh High Court in CIT v. T. Veeraiah and K. Narasimhulu : [1977]106ITR283(AP) by the Madras High Court in Dwarkadas Rameshwar Goenka v. CIT : [1981]127ITR397(Mad) by the Delhi High Court in Sanghi Motors v. CIT : [1982]135ITR359(Delhi) by this court in Jalam Chand Mangilal v. CIT : [1982]138ITR343(MP) and by the Karnataka High Court in CIT v. Khoday Eswarsa & Sons : [1985]152ITR423(KAR) . We are of the opinion that the view taken in these series of cases does not lay down the correct law as has been made clear by the Explanations which have been added to Section 40(b) by the Taxation Laws Amendment) Act, 1984.
12. We, therefore, opine that the Gujarat Full Bench decision in Chhotelal & Co. v. CIT : [1984]150ITR276(Guj) lays down the correct law, as has been made clear by the Andhra Pradesh High Court in N. T. R. Estate v. CIT : [1986]157ITR285(AP) and by this court in Balchand Hashmatrai & Co. v. CIT : [1986]161ITR121(MP) that 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(b) of the Act.