1. These two appeals pertaining to the successive assessment years 1976-77 and 1977-78 are preferred by the assessee, who is an individual and, inter alia, holds interest in a partnership firm, Shri Ramakrishna Dhanalaxmi Rice Mill Contractors Co. ('the firm'). The main question that falls for consideration in these two appeals is whether the interest debited to the capital account of the assessee in the above said partnership firm is an allowable deduction in each of the assessment years under consideration in the personal assessments of the assessee. The amounts claimed as deduction in the assessment year 1976-77 is Rs. 8,449 and the amount claimed during the assessment year 1977-78 is Rs. 9,747. In the original assessment completed under Section 143(3) of the Income-tax Act, 1961 ('the Act') for the assessment year 1976-77 dated 28-2-1977, the ITO appeared to have allowed the amount of Rs. 8,449 to be deducted from the gross total income of the assessee. However, as can be seen from the assessment order dated 30-6-1978 relating to the assessment year 1977-78, the assessment for 1976-77 was reopened and the amount of Rs. 8,449 which was allowed as deduction in the original assessment was withdrawn while computing the assessee's income for 1976-77. Neither the date of the reassessment nor the copy of the reassessment order is available in record. For the assessment year 1977-78 the ITO stated in his order dated 30-6-1978 that following his reopened assessment for 1976-77, he had disallowed the sum of Rs. 9,747 representing the interest paid to the firm. Aggrieved by the reassessment order for the assessment year 1976-77 and the assesssment order for 1977-78 the assessee went in appeal before the AAC. It is contended before him that the decision of the Andhra Pradesh High Court in the case of CIT v. Smt. Allareddy Sudarsanamma [1972] 83 ITR 759, on the basis of which the interest was disallowed by the ITO, does not apply to the facts of the case. The firm was running in losses year after year and the debit balance of the assessee was on account of the continuous losses being incurred by the firm and not on account of any personal withdrawal from the said firm.
The distinguishing feature between the decision of the Andhra Pradesh High Court in Allareddy's case (supra) and the case on hand, argued the assessee, was that in the stated decision substantial withdrawals are made by the respective partners on account of which there is a debit balance standing in the names of the partners and in view of this the interest was held by the High Court to be disal-lowable. However, in the instant case, facts stand on a different footing and, therefore, whatever interest paid by the assessee was an admissible deduction and should have been allowed. The AAC after considering this contention held that the position of the assessee in law did not permit the claim of the assessee. He held that there is no provision in the Income-tax Act for deduction of interest paid by a person to the firm. Section 67(3) of the Act allows deduction of interest paid by a partner on the capital borrowed for the purpose of investment in the firm. However, the AAC held that in the instant case no capital as such was borrowed and invested by the assessee in the firm and so the provisions of Section 67(3) would not come to the rescue of the assessee. He relied upon the decision of the Madhya Pradesh High Court in Chhotalal Keshavram v. CIT which is equivalent to Chhotalal Keshavram v. CIT [1978] 115 ITR 347 in support of his decision. Therefore, he dismissed the appeal and confirmed the reassessment for 1976-77 and the assessment for 1977-78 made by the ITO against the assessee. Aggrieved by the consolidated order dated 16-2-1980 passed by the AAC for both the assessment years under consideration, these two appeals are filed before this Tribunal and thus the matter stands for our consideration.
2. We heard Shri C.V.K. Prasad, the learned representative for the assessee and Shri D.R.C. Rao, the learned departmental representative.
Shri Prasad argued that the debit balance in the capital account of the assessee was due to losses sustained by the firm year after year and the share of losses pertaining to the assessee being debited to her capital account. He filed before us an account copy of the capital account of the assessee in the firm. It discloses that apart from the debit of the losses sustained evidences the drawals for wealth-tax for the assessment years 1973-74, 1974-75 and the total of the drawals thus made towards payment of wealth-tax for the assessment years 1973-74 and 1974-75 amounted to Rs. 3,396. We are of the view that these debit balances are not allowable either as items of business expenditure or as interest payable on the amount borrowed for tax payment under Section 80V of the Act. Section 80V contemplates allowance of interest on the amount borrowed for payment of income-tax dues and not for the payment of wealth-tax dues. Further under Section 40(a)(iia) of the Act any sum paid on account of wealth-tax cannot qualify itself as a legitimate deduction from the computable business income of the assessee. Therefore, in any event the amounts debited towards wealth-tax payments in the capital account of the assessee is not deductible expenditure. Now let us come to the main argument advanced by Shri Prasad, the learned representative for the assessee. He says that debits in the capital account of the assessee for these two assessment years would clearly reveal that they did not allow out of personal borrowings or withdrawals but due to sustained losses over the years debiting to the capital account of the assessee. For the debits outstanding in the capital accounts interest is calculated and account debited, it is argued that if amounts are borrowed from outsiders and the debit is made good out of the interest that is payable to the third parties on the amounts borrowed would have been" allowable under Section 67(3). Now what happened in this case was that instead of the partner borrowing from outside to make good the debit balances in the capital account, the firm itself took care of the capital needed for the business and thus supplied capital up to the extent of debit balance and, therefore, no distinction should be made between a case where the amounts were borrowed from outsiders and the amounts being supplied by the firm itself in favour of the partner. In both the situations, it is contended, Section 67(3) applies. Even otherwise, it was argued that the interest payable on the debit balance of the partner is an allowable deduction under Section 37 of the Act. Mr.
Prasad wants to draw a distinction between a case where the amounts are withdrawn for personal needs of the partners and a case where debit balance arose due to continuous sustained losses of the firm. In the former case he concedes that interest payable in the debit balance cannot be claimed as deductible expenditure whereas in the latter case he argued that the interest payable on debit balance is an allowable expenditure before the net income of the assessee is arrived at. He argues that the decision of the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) is distinguishable on facts. For the proposition that interest payment in this case is legitimate business expenditure allowable either under Section 67(3) or under Section 37, the learned representative relies upon the decisions in CIT v. Jabarmal Dugar [1972] 84 ITR 158 (Raj.), CIT v. Ganpat Rai Jaggi & Co. [1972] 86 ITR 363 (Delhi), CIT v. Sohan Lal Nyyar [1974] 95 ITR 90 (Delhi) and M.G. Bhatt v. CIT [1980] 123 ITR 931 (Bom). On the other hand, the learned departmental representative heavily relied upon the orders of the lower authorities as well as on the decision of the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) He submitted that the facts of the Madhya Pradesh High Court cited by him are quite similar with the facts on hand and so it should be applied. He also submitted that all the decisions cited on behalf of the assessee deal with different sets of facts and the ratio of those decisions cannot appropriately be applied to the facts on hand.
3. Thus we heard both sides in this matter fully and completely. We are of the view that the distinction sought to be drawn by the learned representative for the assessee between a case where a debit balance arose because of repeated personal drawings and a case where the debit balance arose because of the sustained yearly losses of the firm, is a distinction, without difference. There is no rationale, in our opinion, to mark a distinction between the two situations mentioned above.
Further, we are also of the opinion that the decisions relied upon by the learned representative for the assessee are not very much germane to the matter in issue. The cited decisions on behalf of the assessee deal with different sets of facts. For instance in Jabarmal Dugar's case (supra) the firm is at Calcutta and the assessee, who is one of the partners, manages the firm from Sardar Shahr. The question is whether the expenses incurred towards salaries for accountant and other employees working under him at Sardar Shahr are admissible deductions.
Admittedly the assessee manages the firm at Calcutta from Sardar Shahr and in order to help him in management the accountant and other employees were engaged. In those circumstances the salaries and emoluments granted to the accountant as well as the other employees, with whose help the assessee is managing the firm at Calcutta operating from Sardar Shahr, is held to be an allowable expenditure. In our view, these facts or the ratio of the High Court of Rajasthan based on these facts are not at all near to the facts of the present case or not at all applicable to the facts of the case. So also in Ganpat Rai Jaggi & Co.'s case (supra), there is a cinema hall taken on lease from R in partnership with his son-in-law D in the first instance. The owner of the cinema hall refused to renew the lease in favour of R unless R admits the owner as the only other partner in the partnership firm. R admitted the owner as the other partner in the firm and, consequently, there was reconstitution of the firm. Under the terms of the reconstituted firm R was solely responsible for the management of the cinema hall. Now R engaged his son-in-law D to act as manager and agreed to give him 5 per cent of gross collections as commission. Rs. 6,132, for the assessment year 1962-63 and Rs. 14,961 for the assessment year 1963-64 were thus paid as commission to D and these amounts were sought to be deducted. The amounts were held to be allowable by the Delhi High Court. Again it can be seen that this set of facts are quite different from the facts on hand and so the ratio, in in our opinion, does not correctly apply to the facts of the case.
In Sohan Lal Nyyar's case (supra) the facts are that in a partnership firm one partner is entitled to get commission for managing the affairs of the partnership firm. He came to an understanding with an employee of the firm that he would give a share in the commission due to him for managing the affairs of the firm in his place. The question is whether the commission paid to the employee is an allowable deduction, The Delhi High Court held that it is clearly allowable. So also in M.G.Bhatt's case (supra), in similar set of facts the amount paid towards the services of an employee of a firm to discharge the duties of a partner is held to be allowable business expenditure. However, it can be seen very easily that the facts of the above cases are quite different from the facts on hand. In our opinion, the decision of the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) relied upon by the revenue is directly applicable to the facts on hand. The second question referred to the High Court in that case is as follows : Whether, on the facts and in the circumstances of the case, in apportioning the total income of the firm between the several partners as required under Section 23(6) of the Act of 1922 and Section 158 of the Act of 1961, the interest adjusted on the debit balances of the accounts of the partners in the books of the firm is deductible from the share in profits of the respective partners ?" (p. 349) In that case in the original firm Chhotalal Keshavram, Rajnandgaon, there used to be only two partners, viz., Ghanshyamdas Chhotalal and Rameshchandra Chhotalal and the partnership was constituted under the deed dated 29-12-1954. They sustained losses and so there was reconstitution of the firm. One Amrutlal Somabhai was introduced as a financing partner. At the time of reconstitution the liabilities of the firm stood at Rs. 4,09,628 and this amount was debited to the accounts of Ghanshyamdas Chhotalal and Rameshchandra Chhotalal in equal shares.
They were not allowed to draw their share of profits subsequent to the reconstitution till the amount debited against each of them is paid off. The reconstitution took place under a partnership deed dated 12-11-1958. During the assessment years 1959-60 to 1962-63, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal were debited with Rs. 31,447, Rs. 10,833, Rs. 19,200, Rs. 30,141 and Rs. 30,343 on account of interest payable by them to the firm for debit balance standing in their names of Rs. 2,66,121 each. The question is whether the interest debited in the capital account of the above said two partners is deductible from the share of profits of the respective partners. At page 355 of the decision the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) held that interest paid to the partner must necessarily be added to his share of profit in the computation of his total income and this is by virtue of Section 16(1)(6) of the 1922 Act. However, their Lordships found that there was no provision made in the 1961 Act for deduction of interest paid by a partner to the firm in like manner. In this connection, the Madhya Pradesh High Court considered Section 67(3) which was newly introduced in 1961 and held that this provision only relates to interest paid on the capital borrowed for the purpose of investment in the firm. They also held that specifically Section 67(3) has obviously no application to a case where a partner claims a deduction in respect of interest paid by him to the firm. The second question that was referred to them was held in favour of the department and against the assessee, In this connection it was sought to be argued that the provisions of Section 37 were not considered by the Madhya Pradesh High Court while giving their decision. This argument to our minds is not correct. Ultimately the High Court gave its decision regarding the allowability of the deduction urged and so there is a presumption that every provision regarding the deduction was duly considered and then only the decision was given. Further, in our opinion, Section 67(3) is exhaustive on the topic of granting interest to a partner in a firm. In this connection the legal maxim generalia specialibus non derogant is to be called in aid in order to understand the clear scope of Section 67(3). The Legislature in its wisdom has provided for the allowability of interest to a partner in a firm only if all the conditions under Section 67(3) are fulfilled. Section 67(3) is thus a special provision, in our opinion, made by the Legislature for the allowability of interest to a partner in a firm. Therefore, whatever general provision may be there in the Act allowing the interest is deemed to have been hedged by the special provision and to our minds it appears that in all cases of allowing interest one has to see only to the special provision and the special provision should be held to prevail over the general provision.
So, also, the special provision should be deemed to be exhaustive on the topic of granting interest. So apart from Section 67(3) we are not prepared to consider the claim of the assessee under any other provision. Perhaps keeping in view the same principle, the Madhya Pradesh High Court also in the above stated case did not consider the allowability of interest under any other section of the act. We respectfully follow the decision of the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) and hold that the lower authorities are quite correct in disallowing interst for the two assessment years to the assessee.
4. A feeble attempt is made to invalidate the reassessment passed under Section 147 of the Act for the assessment year 1976-77. However, we may observe that a specific ground was taken before the lower appellate authority to the effect that the reopening of the assessment for 1976-77 is not valid. However, no finding was given by the AAC and no ground was taken up before this Tribunal regarding the legality of the order passed under Section 148 of the Act for the assessment year 1976-77. As the question does not arise from the order of the lower authority, we are not prepared to allow the said ground to be agitated before us.
5. In the result, we do not see any firm ground to reverse the decision of the lower authorities and, hence, the two appeals before us are found to be without substance and they are dismissed.
1. I have gone through the order of my learned brother and I regret that I am unable to concur with all his conclusions.
2. The common issue for consideration is whether the amounts of Rs. 8,449 for the assessment year 1976-77 and Rs. 9,747 for the assessment year 1977-78 debited to the assessee's accounts as interest on his debit balances in the accounts of the firm of which she is a partner are deductible from her share Income from the firm in the facts and circumstances of the case. The assessee is an individual and is a partner in the firm. The assessee had filed a copy of her running account in the books of the firm, the debit balance in spite of some small credits brought in by her as cash or sale of paddy is on account of her past losses and interest debited to her in the past for such balances. The only drawings other than debits for past losses and interest are four amounts aggregating to Rs. 3,396 towards payment of her wealth-tax. There is no doubt that interest relating to the drawings to this extent will have to be disallowed as relating to personal purposes and to this extent I concur with the order of my learned brother. As for the interest on the balance, I am of the view that it should be allowed.
3. There is no dispute that interest was paid on debit balances pursuant to agreement between partners. It has been paid every year in the past and the interest income has also to be treated as firm's income and brought to tax in firm's case. Allocation of the assessee's share of profits does not show any adjustment for interest paid by the assessee to the firm. It is for consideration whether such interest is deductible from her share income either under Section 67(3) or Section 37 or on commercial principles or on the theory of real income. Since I am of the view that only interest other than interest pertaining to drawings to meet wealth-tax liability is deductible, reference to interest on debit balances of the partner will refer only to such balance of interest in the remaining paragraphs.
4. The Supreme Court in the case of CIT v. Ramniklal Kothari [1969] 74 ITR 57 had held with reference to analogous provisions of the 1922 Act that the share of profits from a partnership should itself be treated as profits and gains of business in the following words : ...Share in the profits of a partnership received by a partner is 'profits and gains of business' carried on by him and is on that account liable to be computed under Section 10 and it is a matter of no moment that the total profits of the partnership were computed in the manner provided by Section 10 of the Income-tax Act and allowances admissible to the partnership in the computation of the profits and gains were taken into account. Income of the partnership carrying on business is computed as business income..." (p. 59) The only further question is whether in view of Section 67(3) which authorises specifically deduction of interest on moneys borrowed for investment in the firm, the position under the 1961 Act is different.
The decisions cited by the assessee in Jabarmal Duga's case (supra), Ganpat Rai Jaggi & Co.'s case (supra), Sohan Lal Nyyar's case (supra) and M.G. Bhatt's case (supra), no doubt, do not deal with claims of interest, but they do establish that Section 67(3) . is not exhaustive, at least, to the extent that it does not stand in the way of allowances of payments like salary and commission, etc., by a partner if circumstances warrant such payments. Hence, the provision under the 1961 Act is not materially different. However, the question is still whether Section 67(3) which is, a special clause relating to interest can be considered to be exhaustive, at least, in respect of all interest claims. This issue would ordinarily appear to be controversial but for certain guidelines available with reference to interpretations in respect of decisions under Section 10(2)(m) of the 1922 Act/Section 36(1)(iii) of the 1961 Act, which relate to deduction of similar allowance of interest on borrowed capital for purposes of business. The Supreme Court in State of Madras v. G.J. Coelho [1964] 53 ITR 186 was dealing which Section 5(k) stipulating allowance of interest on borrowed capital and Section 5(e) authorising deductions of general nature (corresponding to Section 10(2)(xv)/Section 37 of the 1922/1961 Act) under the Madras Plantations Agricultural Income-tax Act, 1955 and held that in respect of interest on unpaid purchase consideration which did not fall under Section 5(k) it was all the same allowable under Section 5(e). In Bombay Steam Navigation Co. (1953) (P.) Ltd. v. CIT [1965] 56 ITR 52 (SC) a similar claim was considered not admissible under Section 10(2)(iii) by a majority of Judges and was held to be admissible by all of them as deductible under Section 10(2)(xv). Hence, if the Supreme Court did not consider non-applicability of a specific provision analogous to Section 36(1)(iii) to certain types of interest as a bar to its being considered under a general deduction analogous to Section 37 in these cases, it stands to reason that Section 67(3) which is similar to Section 36(1)(iii) could not also be a bar. Further, Section 67(3) which is meant to authorise a deduction cannot, in my opinion, be treated as having an in-built prohibition against all other types of interest when Courts have held that it is no prohibition to deductions other than interest. I am, therefore, of the view that if Section 37, which would apply to the assessee, would authorise the deduction, the assessee is entitled to the same. The assessee is bound to pay the interest to retain her partnership interest. The debit balances had not come about because of her personal drawings (other than those to meet wealth-tax liabilities). In fact, they are business losses. If her share of loss had been met by her by borrowing from others, she would have been entitled to it. Should it make a difference if she pays interest to the firm itself on such losses, since the co-partners were content with interest in lieu of her bringing in cash to meet her debit balance? Hence, though the interest is clearly not admissible under Section 67(3), she is entitled to the allowance under Section 37.
5. Such interest would be admissible even on commercial principles.
Interest payment by a partner to a firm is a necessity to be matched by his receipts of profits. In fact, a partner is only entitled to the net income under the agreement and no commercial principle would justify one treatment to a receipt and another for payment. The Supreme Court observed as under in G.J. Coelho's case (supra) : ...In this connection, it is pertinent to note that what the Act purports to tax is agricultural income anti not agricultural receipts. From the agricultural receipts must be deducted all expenses which in ordinary commercial accounting must be debited against the receipts. There is nothing in the Act which prohibits such expenses from being deducted. No farmer would treat interest paid on capital borrowed for the purchase of the plantation as anything but expenses and as long as the deductions he claims, apart from any statutory prohibition, can be fairly said to lead to the determination of the true net agricultural income, these must be allowed under the Act. In principle, we do not see any distinction between interest paid on capital borrowed for the acquisition of a plantation and interest paid on capital borrowed for the purpose of existing plantations: both are for the purposes of the plantation." (p. 194) Since ordinary commercial principles require that in reckoning the share income from firm, what is chargeable to the partner would have necessarily to be deducted, deduction to the assessee cannot be disallowed unless such interest is for drawings for personal purposes. Hence, even in this view, it is allowable. In fact, the Andhra Pradesh High Court in a recent decision in the case of Addl.
CIT v. Akkamba Textiles Ltd. [1979] 117 ITR 294, had explained the decision in G.J. Coelho's case (supra) and referred to two later decisions of the Supreme Court for the proposition that interest and other expenses (in the context of acquisition of machinery) were admissible as a revenue expenditure under Section 37 on ordinary commercial principles though the dispute in that case related to the usual controversy as between capital and revenue expenditure. Hence, ordinary commercial principle ordinarily govern such claims and, hence, the assessee is entitled to the deduction.
6. Since the deduction, in my view, is admissible either under Section 37 or under ordinary commercial principles, I would consider it unnecessary to discuss the claim on the basis of 'real income'. But revenue itself seems to rely on the Andhra Pradesh High Court in the case of Smt. Allareddy (supra), a decision which incidentally dealt with the real income' theory. This decision was directly concerned with the question of deducibility of interest paid by a partner to the firm.
Rival and inconsistent arguments relating to questions as to (i) whether there could be a transaction as between firm and its partners in view of general law, (ii) whether the payment was only 'notional' with reference to real income theory, (iii) whether there was anything inequitable in assessing the interest in the hands of the firm while disallowing it in the case of a partner and (iv) whether in facts the deduction was barred. The High Court found as regards the first issue that 'the scheme of the 1961 Act as well as "the 1922 Act is that the firm and its partners are treated as separate and distinct entities for the purpose of assessment'. As regards the argument whether the payment by partner to firm is only notional and not 'real', the High Court after an elaborate discussion of case law characterised such argument as based on a 'misconception' that firm and partners are one and the same legal entity for purposes of tax. The High Court proceeded to summarise both its conclusions that there was a transaction and that there was real income to the firm consequent on payment by partners in the following words in the case of Smt. Allareddy (supra) as under : We are unable to accede to the submission of the assessees that there was no transaction, much less a business transaction, in respect of which the receipt of interest by the firm from the partners is chargeable to income-tax. It is now well settled that there can be transactions such as sale, mortgage, borrowal; etc., between a partner and the firm and the parties, if aggrieved under any such transactions, can establish their rights in a Court of law against the other contracting party... (p. 766) It proceeded further to observe that these amounts (interest receipts by the firm) were 'not only book profits but must be held to be commercial and real profits actually received by the firm in the year of account'. As for the alleged double taxation claim, the High Court observed that there is no prohibition in law against double taxation, if it results in this case. It reversed the order of the Tribunal ultimately because the admitted and found facts were that withdrawals were for personal purposes, a purpose specifically debarred under Section 37(1). In the assessee's case, it had been found that the payment barring withdrawals for wealth-tax payments was not for personal purpose. Since meeting business loss of the partnership is a business purpose of the partner, it is admissible under Section 37. The facts that the firm and partners are two separate assessable entities and that there could be transactions between them only support the claim of the assessee. The fact that the assessee could not get deduction on withdrawals for personal purposes on 'real income' theory or a plea of double taxation was rejected in the case before the High Court does not mean that this assessee, whose facts are totally different should be similarly treated. The decision of the Andhra Pradesh High Court supports the assessee's case on all points including the test of real income.
7. A still another decision of the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) relied upon by revenue has to be considered. In this case, the question related to the assessability of the interest received by a firm from its partners and the manner of treatment to be accorded to such interest in the allocation of profits of the firm between its partners. It was held by the High Court that the interest received from the partners was the real income of the firm and was rightly assessable in firm's hands. In holding so, it referred to the decision of the Andhra Pradesh High Court in Smt. Allareddy's case (supra) mentioned in the immediately preceding paragraph with approval. In the case of the firm (of which the assessee is a partner) there is no dispute that the interest was rightly assessed in its hands. As for allocation, the High Court held that Section 23(5)(a) of the 1922 Act makes no provision for deducting interest received from a partner as it had only provided for adding interest paid to him. Here also, the firm had not claimed the type of allocation wanted by the applicant before the Madhya Pradesh High Court. In fact, if such an adjustment had been made, the question of the assessee claiming interest payment in her personal assessment would not have arisen at all. The Madhya Pradesh High Court was not concerned with the partner's assessment at all. It had no doubt referred to Section 67(3) as not being applicable in case of interest payment by partner to firm because there can be no question of borrowing from the firm to finance the firm. Finding in the preceding paragraphs is also that it is allowable as a deduction only under Section 37 or on ordinary commercial principles. Hence, this decision relied upon by the authorities cannot come to the assistance of the revenue.
8. Therefore, the appeal is partly allowed to the extent of interest on the assessee's debit balance in the firm to the extent other than withdrawals for meeting wealth-tax liabilities.
1. My learned brothers of Hyderabad Bench 'B' could not, for a very good reason, agree as to the conclusion to be reached in this appeal, whether the claim of the assessee for the deduction of the interest should be allowed in computing the income. The President of the Tribunal is pleased to refer the difference of opinion to me for my opinion.
2. The assessee is a partner in four firms. One of them was Shri Ramakrishna Dhanalaxmi Rice Mill Contractors Co. There was accumulated debit balance in the firm's account which represented, except for a very small sum, which I shall refer to a little later, the losses incurred by the firm and debited to her account towards her share. On the debit balance, the amount of interest debited in the assessment year 1976-77 was Rs. 8,449 and Rs. 9,747 in the assessment year 1977-78. In those two assessment years, the assessee claimed that the above interest paid to the said firm should be deducted from the other incomes she received from the other firms. The ITO allowed the claim for the assessment year 1976-77 in the original assessment, but later reopened the assessment to disallow the said claim. For the assessment year 1977-78, the amount was disallowed.
3. The assessee then appealed to the AAC who confirmed the disallowances. He was of the opinion that there was only one provision which allows the deduction from the share income and that is Section 67(3) and under that section, only the interest paid on capital borrowed for the purpose of investment in a firm could be allowed as a deduction and since the accumulated debit balance on account of losses could not be treated as money borrowed for the purpose of investment in the firm, that section was inapplicable and barring 1hat there was no other provision in the Act permitting the assessee to claim the deduction. The AAC relied upon the judgment of the Madhya Pradesh High Court in the case of Chhotalal Keshavram (supra).
4. Against the] order of the AAC, appeals were preferred to the Tribunal. The learned Judicial Member of the Tribunal was of the opinion that the claim made by the assessee was inadmissible, that the Madhya Pradesh High Court decision in Chhotalal Keshavram's case (supra) squarely applied to the facts of this case and according to that judgment, the AAC was right in disallowing the claim. The contention of the assessee that the accumulated debit balance which arose on account of yearly business losses, should be equated to capital borrowed for the purpose of business so that the claim could be allowed under Section 67(3), was not appealing to the learned Judicial Member. He was of the opinion that the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra) had decided a similar point though it was arising under Section 23(6) of the 1922 Act and that there was discussion about the allowabilily of the claim in that case even under Section 67(3) of the 1961 Act, which the High Court had rejected. He was of the opinion that when Section 67(3) made a provision for the allowance of interest paid on capital borrowed for investment in a firm, that section alone should be applied, that being a special provision and the general Section 37 should not be invoked. This was his answer to the contention raised before the Tribunal that even if the claim was inadmissible under Section 67(3), it should be considered for allowance under Section 37 since the allowance of this claim under Section 37 was not considered by the Madhya Pradesh High Court.
5. But the learned Accountant Member was of a different opinion. He held that the allowances permissible under Section 67(3) could not be interpreted as standing in the way of the assessee from claiming any other admissible deduction from the share income, like salary and commission, etc., by a partner if circumstances so warrant. Drawing analogy from the interpretation placed by the various High Courts on the provisions of Section 10(2)(iii) of the 1922 Act and Section 10(2)(xv), with Section 36(1)(iii) of the 1961 Act and Section 37, he held that it stood to reason that Section 67(3), which was similar to Section 36(1)(iii), could not act as a bar for the allowance of the claim. He was firmly of the opinion that Section 67(3) could not read as containing an in-built prohibition against the allowance of any other types of interest. He also held that the claim was admissible even under Section 37. He distinguished the case decided by the Madhya Pradesh High Court and pointed out that the Madhya Pradesh High Court did not deal with the allow-ability of the claim under Section 37, the claim of the assessee could be put under Section 37. He also allowed the claim of the assessee under the 'real income' theory as propounded by the Andhra Pradesh High Court in the case of Smt. Allareddy (supra).
Thus, the learned brothers differed and the following difference of opinion has been referred to me by the President for my opinion : Whether in the facts and circumstances of the case, the interest payable by the assessee to the firm of which she is a partner on her debit balance in the firm's books, to the extent such interest relates to assets not drawn for personal purposes, is allowable as a deduction in computing her income from share of profits of such firm 6. I have heard at length Shri Prasad, the learned counsel for the assessee and Shri S.R. Deshpande, the learned departmental representative. The following basic issues arise in this case : (a) whether the debit balance on account of accumulated business losses could be regarded as a debt owed by the assessee to the firm so that the interest paid on that debt could be treated as a business expense, (b) whether Section 67(3) puts a bar on the allowance of any claim from the share income from the firm of a partner other than the interest paid on the capital borrowed for the purpose of investment in the firm and (c) whether Section 37 could be invoked.
7. Before I deal with these basic issues, I must refer to a certain portion of the debit balance which did not represent the business loss.
Certain amounts paid by way of wealth-tax were also debited to this account and interest relatable to the payment of wealth-tax was held by both my learned brothers as disallowable and on that point there was no difference of opinion. Hence I would confine my discussion only to the allowance of interest on the balance of debit balance.
8. What is the nature of the debit balance of a partner in a firm if the debit balance of a partner is either on account of his withdrawing for personal reasons or on account of loss incurred in business and debited to the account. Insofar as the debit balance on account of personal drawings is concerned, the interest paid cannot be treated as a business expense for the very simple reason that those drawings represent personal expenses and neither Section 67(3) nor Section 37 authorises the allowance of such interest. The debit on account of wealth-tax in this case is an instance on the point. The other debit balance arising out of business loss, if it is in the nature of a business liability, then the interest paid thereon should be entitled to deduction. The responsibility of a partner in a business to recoup the losses incurred is so well recognised under the Partnership Law that it does not requite any authoritative enunciation. Section 48 of the Partnership Act lays down the mode of settlement of accounts between partners after dissolution. It says that 'losses', including deficiencies of capital, shall be paid first out of profits, next out of capital, and, lastly, if necessary, by the partners individually in the proportions in which they were entitled to share profits. Then that section goes on to say : The assets of the firm, including any sums contributed by the partners to make up deficiencies of capital, shall be applied in the manner and order indicated in that section. This section shows that the liability for the losses in the business of a partnership is a business liability which a partner has to discharge.
Thus the general principle that partners must contribute rateably to their shares towards the losses and debts of the firm is not open to question. Their obligation to contribute is not necessarily founded upon agreement. The Courts have gone to the extent of saying that even when there is no agreement to the contrary, if one of the partners acting within the limits of his authority, contracts a debt on behalf of the firm, he is entitled to the contribution from his co-partners.
If one partner enters into a contract on behalf of the firm in such a manner as to render himself alone liable to be sued, he is entitled to be indemnified by the firm, provided he did not exceed his authority in entering into the contract. When the liability is thus clear, the obligation of the partner to contribute to the losses of the partnership firm is fastened on her, she has to pay either the money back or incur the further liability of paying interest on the money which she had not contributed by reason of which the firm was deprived of the use of the money. When the firm was thus deprived of the use of the money, it is naturally entitled to levy of interest. That interest comes upon the partner as a business expense, as a liability and that liability has to be discharged. If there is no prohibition for the allowance of such a liability under the Act in computing the income of the partner, then that interest automatically becomes allowable.
Reference may usefully be made to the Supreme Court decision in the case of Dr. Shamlal Narula v. CIT [1964] 53 ITR 151.
9. The question now is whether the Act contained a prohibition for the allowance of such interest. The learned Judicial Member depended upon Section 67(3) for such a prohibition. Let me see what is Section 67(3).
It says : 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.
This sub-section appears in Section 67, which is the section which lays down the method of computing a partner's share in the income of the firm. Once again, I repeat, the section is meant to tell the ITO how a partner's share in the income of a firm has to be computed. The heading of the section does not say that it was the method of arriving at the income of the partner for the purpose of making the assessment. Again I repeat, it only says it is the method of computing the partner's share in the income of the firm. Once a partner's share in the income of the firm is computed in the manner laid down in Section 67, the purpose of Section 67 comes to an end. It works out itself. Thereafter, what takes over for the purpose of arriving at income assessable to income-tax, is not Section 67, but other sections starting from Section 28 of the Act, if it is income only from business and other sections if he has income from other sources and the other sections of the Act which permit further allowances, deduction, exemption, etc. It is, therefore, my firm opinion that the purpose of Section 67 when it enacted the method of computing a partner's share in the income of a firm, cannot be construed as laying down that the allowances to be made against the share income were only those mentioned in Section 67 and none else. It is the analysis of this Section 67 which was done by the Madhya Pradesh High Court in Chhotalal Keshavram's case (supra). The first step in computing a partner's share in the income of the firm is to deduct from the total income of the firm, any interest, salary, commission or other remuneration paid to a partner and if the firm is a registered firm, any income-tax payable in respect of the total income of the firm. The second step is the balance to be ascertained and apportioned among the partners in the profit-sharing ratio [Section 67(1)(a)]. The next step is, where the apportioned amount is a profit, the salary, interest, commission or other remuneration paid to the partner by the firm should be added to that amount. The resultant amount shall be regarded as the partner's share in the income of the firm [Section 67(1)(6)]. The next step is, where the apportioned amount is a Joss, the reverse position for profits should be made. Section 67 called it the 'partner's share in the income of the firm'. Then Sub-section (2) of Section 67 further lays down that for the purposes of assessment, the partner's share shall be further apportioned under the various heads of income in the same manner in which the income of the firm has been determined under each head of income. Then, Sub-section (3) comes in and says as a concession, that the interest paid by a partner on capital borrowed by him for the purposes of investment in the firm shall be deducted from the share. Then, Sub-section (4) says that if the share of a partner is a loss, that loss can be set off, or carried forward and set off, in accordance with the provisions of this Chapter. Therefore, the object of enacting Section 67 is just confined to computing what is legally designated as 'partner's share in the income of the firm'. In arriving at the partner's share in the income of the firm, provision was made for the deduction of interest paid on capital borrowed by him for the purpose of investment in the firm. This is provided for invoking the assessment of the firm, only for the sake of administrative convenience. There is also a history behind enacting Sub-section (3) of Section 67. In the 1922 Act, there was no provision for the allowance of interest paid by a partner on capital borrowed for the purpose of investment in a firm. Then the question arose whether for the purpose of the assessment of a partner, the share of profit should be taken as computed in the hands of the firm and whether any further deduction is permissible for interest paid on capital borrowed. It was judicially recognised that the partner is entitled to deduction in computing his share in the firm's profits, the interest paid by him on the capital borrowed for the purpose of investment in the firm. It is to give effect to this judicially recognised principle, that Sub-section (3) has been enacted in the Act. Since this is the object of enacting Section 67, this purpose should not be confused with introducing into it a prohibition from allowing any other deduction from the share income thus arrived at. It is also to be remembered at this stage that the share income of a partner of a firm is to be assessed as income from business. If it is to be taken as income from business, all other deductions that are admissible in arriving at the income under the head 'Business' are admissible provided there is no prohibition in terms.
This is also a settled law.
10. In the case before the Madhya Pradesh High Court, on which reliance has been placed by the learned Judicial Member, the facts were these : The assessee-firm which consisted of two partners, was reconstituted by a partnership deed by admitting a third partner as financing partner.
At the time when the business was taken over, there was an excess of liabilities over the assets amounting to Rs. 4,09,628 and this amount was debited to the accounts of the two partners in equal shares. During the assessments years 1959-60 to 1962-63, the personal accounts of the two partners in the account books of the firm were debited with the interest payable by them to the firm for the debit balances standing in their names. The interest debited to the accounts of the two partners was credited to the profit and loss account by including it in the interest account. In the assessment of the firm, it contended that the amounts of interest paid by the two partners to the firm, did not represent the real income of the firm, it being only an adjustment entry. The ITO negatived this contention. While apportioning the income of the partners, the ITO did not take into account the interest charged and debited to the partners. The assessee then appealed to the AAC. The AAC held that the proper place for claiming deduction for interest paid to the firm, was in the individual assessment of the partners and certainly not in the assessment of the firm. On further appeal, the Tribunal confirmed the view taken by the AAC. On a reference, the Madhya Pradesh High Court held that the interest debited to the two partners having been transferred to the interest account and ultimately adjusted to the profit and loss account, it was not a mere adjustment entry but represented commercial and real profits actually received by the firm and, therefore, it was the income of the firm. Then it held that in apportioning the total income of the firm between the several partners as required under Section 23(6) of the 1922 Act, the interest adjusted on the debit balances of the accounts of the partners is net deductible from the share of profits of the respective partners. In arriving at the conclusion that the interest paid to the partners was not to be allowed as a deduction from the share of profits of the partners, the Madhya Pradesh High Court pointed out that under Section 23(6) of the 1922 Act and Section 16(1)(b) of the same Act, no provision similar to the one under Section 67(3) under the 1961 Act was made. It was for this reason that the non-deduction of the interest from the share of profits was upheld. The High Court pointed out : Interest paid to the partner must necessarily be added to his share of profits, in the computation of his total income. This is by virtue of Section I6(1)(b) of the Act. There is no provision made in the Act for deduction of any interest paid by a partner to the firm, in like manner. We may point out that Section 67(3) of the 1961 Act has introduced a new provision, which runs thus : '(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..."(p. 355) After quoting Sub-section (3) of Section 67, the learned Chief Justice Shri A.P. Sen, as his Lordship then was, pointed out : ...No provision, similar to this sub-section, finds a place in the 1922 Act....(p. 355) Therefore, this decision cannot be an authority for the proposition that no deduction is permissible from the share income of a partner from a firm other than the interest paid on the capital borrowed for investment in the firm. The question whether under Section 37, a deduction is permissible or not could not have been raised on the facts of that case before the High Court. On the contrary, it would appear that the finding of the AAC that the proper place for claiming deduction on account of interest paid to the firm was in the individual assessments of the partners and not in the assessment of the firm, was not negatived by the High Court nor by the Tribunal. The Tribunal approved of this finding of the AAC and when the order of the Tribunal has been approved of by the High Court, it meant that the proper place for claiming the deduction of interest paid by the partners was in their individual assessments and not in the assessment of the firm. The position under the Act is different because now a provision has been made in Section 67(3). Therefore, the Madhya Pradesh High Court decision in Chhotalal Keshavram's case (supra) is not only not on the point now in issue before the Tribunal but the point did not arise before the High Court for decision and, therefore, that decision could not be taken as an authority for laying down the rule that the interest paid by the partners cannot be allowed as a deduction against the share income from other firms. This computation has necessarily to be made under the provisions of the Act treating the share income as income from 'business'. Now that it is a settled proposition of law and in fact on this point there is no dispute before me that the share income is income from 'business' and if the liability to pay interest on the debit balance arose on account of accumulated losses of the business, that should be allowed in computing the income of the assessee for the purpose of the assessment. In this context, reference may be made to a recent decision of the Calcutta High Court in the case of CIT v. Smt.
Shanti Devi Jalan [1983] 139 ITR 152. In this case, the question was identical to the one that arose before me, namely, whether interest paid to firm by a partner on debit balance on account of losses, could be allowed as a deduction in computing the income for the purpose of the assessment. In the wake of this question, the other related question, namely, whether Section 67(3) has put an embargo on the allowance of any other item and whether it is exhaustive as interpreted by the learned Judicial Member in this case, had also come up for consideration. The Calcutta High Court pointed out that Section 67(3) is not exhaustive. It merely provided for a case where a particular interest paid by a partner of a firm is allowable as a deductible expense. It is not comprehensive in the sense that it cannot be said that no other kind of interest can be deductible. If such interest complies with the requirements of the other provisions of the Act which allow a deduction, there is no reason why such deduction should not be allowed merely because of the provisions of Section 67(3). Where the debit: balance is made up of the personal drawings of the partner and also the loss of the firm, interest paid to the firm on that portion of the debit balance in the capital account of the partner which is attributable to the partner's share in the loss of the firm is allowable as a deduction in assessing the partner. The Calcutta High Court referred to the decision of the Andhra Pradesh High Court in the case of Smt. Allreddy (supra), which was followed by the AAC and on which reliance has been placed also before me by the learned departmental representative. Since this decision has been distinguished by the Calcutta High Court, I do not have to say that this decision is inapplicable and totally different on facts. Thus my view is fortified by the Calcutta High Court. Apart from providing a complete answer to the view held by the learned Judicial Member, that Section 67(3) is not exhaustive, as held by the Calcutta High Court in the case of Smt.
Shanti Devi Jalan (supra). Should that view be correct, the Rajasthan High Court would not have allowed from the share income of a partner the expenses incurred towards salaries to accountant and other employees as in the case of Jabarmal Dugar (supra) nor the salary to look after the cinema hall as in Ganpat Rai Jaggi & Co.'s case (supra) by the Delhi High Court, nor the commission for managing the affairs of the partnership firm as in the case of Sohan Lal Nyyar (supra) by the Delhi High Court and more recently, the services of the employee of a firm to discharge the duties of a partner as in the case of M.G. Bhaatt (supra) by the Bombay High Court. Since I have held that Section 67(3) does not put a prohibition on the allowance of the interest, the question whether a special provision made should prevail over the general provision and the discussion relating thereto adopted by the learned Judicial Member, need not be gone into.
11. For these reasons, I am of the opinion that the view taken by the learned Judicial Member does not accord with the principles. I, therefore, agree with the learned Accountant Member and hold that the interest paid by the partner on the debit balance arising on account of accumulated losses, is allowable as a deduction in computing the total income of the assessee assessable under the head 'business'.
12. In view of my above conclusion, I do not consider it necessary to refer to the various other decisions referred to before me.
13. Now the matter will go back before the regular Bench for passing the necessary order in accordance with the majority view.