P.D. Mulye, J.
1. The Income-tax Appellate Tribunal, Indore Bench, Indore, at the instance of the assessee has made this reference under Section 256(1) of the Income-tax Act, 1961, for the opinion of the court on the following question of law :
'Whether, on the facts and in the circumstances of the case, interest of Rs. 4,234 paid to the Hindu undivided family, Hashmatrai Balchand, creditor of the firm, was allowable under Section 36(1)(iii) of the Income-tax Act, 1961?'
2. Facts giving rise to this reference as per the statement of the case received may be stated in brief thus: The assessee is a registered firm. The previous year relevant to the assessment year 1976-77 ended on March 31, 1976. The return under Section 139(1) of the Act was filed on July 26, 1976, declaring an income of Rs. 73,410.
3. The Income-tax Officer in the assessment order pointed out that Shri Hashmatrai (individual), who is a partner in the firm, made a transfer of Rs. 51,000 on April 1, 1970, to his own Hindu undivided family by withdrawing from his individual account maintained by the firm and the said amount has been credited in the Hindu undivided family's account in the firm. He also pointed out that the amount of interest on the credit balance standing in the Hindu undivided family's account was assessable in the hands of the individual partner in view of the provisions of Section 64(2)(b) of the Act. He further held that the interest payment in question was to a partner and, as such, the same would be added back in the total income of the assessee. Consequently he added a sum of Rs. 4,234in the income of the assessee and thus the assessment was completed on a total income of Rs. 73,493.
4. Being aggrieved with the order of the Income-tax Officer, the assessee went up in appeal before the Appellate Assistant Commissioner who dismissed the appeal.
5. The assessee thereafter went in second appeal before the Tribunal before whom it was contended on behalf of the assessee that the partner, Hashmatrai, transferred a sum of Rs. 51,000 from his account in the firm to the credit of his Hindu undivided family of which he was the head in his individual capacity; that in the assessment order of the firm for the assessment year 1974-75, interest has been added in the hands of the individual partner and that, therefore, the interest paid to the Hindu undivided family should not have been disallowed and he placed reliance on the decision in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654 .
6. The contention of the departmental representative was that in terms of Section 40(b) of the said Act, any interest paid to any partner cannot be allowed. So, in the present case, the Income-tax Officer rightly disallowed the interest and reliance was placed on the decision in CIT v. London Machinery Co. : [1979]117ITR111(All) .
7. The Tribunal, after hearing the parties, held as under :
'The contents of page 8 of the assessee's paper book, i.e., disallowance of interest during the assessment year 1974-75 do not lead anybody anywhere. In the circumstances of the assessee's case, in terms of Section 64(2)(b) of the Act, the interest income in dispute accrues to the partner as individual and not to the Hindu undivided family. Thus, it is safe to infer that the payment of interest said to have been made to the Hindu undivided family, in fact, was made to the partner. Such payment of interest to the partner in terms of Section 40(b) cannot be allowed. The ratio in the case of Sajjanraj Divanchand [1980] 126 ITR 654 in the peculiar circumstances, does not appear to help the assessee. The above addition of the interest and the confirmation, therefore, do not appear to be incorrect and, therefore, impugned order requires no interference.'
8. Hence, this reference.
9. The learned counsel for the assessee placed reliance on the decision in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654 wherein it has been held that (headnote at pp, 654 and 655):
'A Hindu undivided family cannot be a partner in a firm. Only an individual person in his own right can be a partner in a firm. Since an Hindu undivided family cannot be a partner in a firm, whoever represents the Hindu undivided family in a firm is the partner for all practicalpurposes both of partnership law and income-tax law. It is, therefore, not possible to proceed on the footing that a Hindu undivided family is a partner in a firm for the purpose of Section 40(b) of the Income-tax Act, 1961.'
10. In this decision, it has further been held that (headnote at p. 655):
'There were two separate accounts and in the account of the Hindu undivided family, it was shown that the Hindu undivided family was the creditor of the firm and on the amount standing to the credit of the Hindu undivided family, interest of Rs. 7,777 was paid by the firm to the Hindu undivided family. There was a separate account of the individual partner, SJ, and in that account no interest was paid in the relevant year. Therefore, the amount of Rs. 7,777 was paid by way of interest to the Hindu undivided family which was the creditor of the firm. The fact that the 'karta' of the Hindu undivided family was a partner of the assessee-firm was not relevant because, under Section 40(b), it is only the interest paid to the partner which is not allowed to be deducted. Interest paid to any other creditor of the firm cannot be disallowed under the provisions of Section 40(b).'
11. A Full Bench of the Gujarat High Court in its decision in Chhotalal & Co. v. CIT : [1984]150ITR276(Guj) has overruled the decision in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654 . However, on going through the said decision, we find that it has also been held 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 a partner in his capacity as a partner of the assessee-firm. It has also been held that no disallowance of interest can be made under Section 40(b) if the interest is paid by the firm to a partner in a capacity other than the capacity of a partner. In the above case, the partner of the firm was representing a Hindu undivided family in the firm, but the interest was paid by the firm to the partner in the capacity of individual in respect of disputed funds belonging to him as individual and, therefore, it has been held that Section 40(b) was not applicable to payment of such interest to the partner and accordingly laid down that disallowance of interest paid by the firm to the partner was not justified. Therefore, it is apparent that interest paid to the partner of the firm by the firm in respect of deposits made by a bigger Hindu undivided family cannot be disallowed under Section 40(b) because the partner of the firm to whom interest was paid had a different capacity while receiving the interest. He received the interest from the firm as representative of the bigger Hindu undivided family whereas he was a partner in the assessee-firm in the capacity of an individual. Therefore, interest was paid not to the partner of the firm and disallowance under Section 40(b) cannot be madein the case of the firm. Therefore, it is not quite clear on what point this Full Bench has overruled the earlier decision.
12. We may note at this stage that against the decision in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654 special leave petition was sought by the Department before the Supreme Court of India, but the same was refused as would be clear from the note at page 15 in [1983] 144 ITR . It appears that this fact was not brought to the notice of the Full Bench.
13. The learned counsel also relied on the decision in CIT v. Pannalal Hiralal & Co. : [1984]146ITR549(Bom) .
14. The learned counsel for the Revenue submitted that the question referred by the Tribunal in fact does not arise because according to the learned counsel for the Revenue, the assessee who was a partner in the firm had transferred some amount to the Hindu undivided family account in the same firm and thus interest that accrued on this amount was being paid to the partner as such and, therefore, such interest paid could be disallowed under Section 40(b) of the Income-tax Act. He further submitted that according to Section 64(2) of the Income-tax Act, which was inserted by the Taxation Laws (Amendment) Act, 1970, with effect from April 1, 1971, it has been provided that:
'Where, in the case of an individual being a member of a Hindu undivided family, any property having been the separate property of the individual has, at anytime after the 31st day of December, 1969, been converted by the individual into property belonging to the family through the act of impressing such separate property with the character of property belonging to the family or throwing it into the common stock of the family or been transferred by the individual, directly or indirectly, to the family otherwise than for adequate consideration (the property so converted or transferred being hereinafter referred to as the converted property), then, notwithstanding anything contained in any other provision of this Act or in any other law for the time being in force, for the purpose of computation of total income of the individual under this Act for any assessment year commencing on or after the 1st day of April, 1971,--
(a) the individual shall be deemed to have transferred the converted property, through the family, to the members of the family for being held by them jointly;
(b) the income derived from the converted property or any part thereof shall be deemed to arise to the individual and not to the family ;...
Provided that the income referred to in Clause (b) or Clause (c) shall, on being included in the total income of the individual, be excluded, from the total income of the family, or, as the case may be, the spouse or minor child of the individual.'
15. The learned counsel for the Revenue also placed reliance on the decision in CIT v. London Machinery Co. : [1979]117ITR111(All) and Jalam Chand Mangilal (No. 2) v. CIT : [1982]138ITR347(MP) wherein it has been held that (headnote):
'Irrespective of the capacity in which a person becomes a partner of a firm, Section 40(b) is a bar to the payment of interest to him. The main fact to be considered for applying Section 40(b) is not as to in what capacity the loan was advanced or interest was paid to a partner but whether the interest was paid to a person who had joined as a partner of a firm.
Where a person joined as a partner of a firm in his individual capacity and interest was paid to him as karta of a Hindu undivided family, the payment of interest was not deductible in the hands of the firm in view of the provisions of Section 40(b).'
16. He, therefore, submitted that admittedly one of the partners of the firm having transferred the amount in the partnership firm to the account of the Hindu undivided family, though not as a creditor of the firm, the interest paid obviously should be deemed to have been paid to the partner of the firm, whatever may be the capacity in which the same is paid.
17. However, after hearing the learned counsel and after going through the case law, we are of the opinion that the provision has been interpreted by making a subsequent amendment to Section 40(b), Explanation 2, which was inserted by the Taxation Laws (Amendment) Act, 1984, with effect from April 1, 1985, that:
'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 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.'
18. Though this Explanation is not applicable to the present case as it was brought into effect from April 1, 1985, still the Explanation so added points out the effect of interest paid in such cases. That apart, it was not disputed that there is a circular issued by I he Department, which is binding on the Department, Thus, we are of opinion that the authority cited by the learned counsel for the Revenue being distinguishable does not support the contention of the Revenue on the facts and circumstances of the case.
19. In the result, this reference is answered in the favour of the assessee and against the Department with no order as to costs.