1. This appeal by the assessee is against the order of the AAC, A-Range, Raipur, in his Appeal No. Rjn-B-64 1372 I, 1982-83, dated 30-3-1983, relating to the assessment year 1980-81 confirming the interest paid to the partners by the firm disallowed under Section 40(b) of the Income-tax Act, 1961 ('the Act'), as also the disallowance made by the ITO, in the loss claimed in bardana account to the extent of Rs. 3,000. The facts in this regard, the rival submissions and our conclusion thereon are discussed hereunder.
2. The assessee is a partnership concern dealing in grains and oilseeds. There was a claim for allowance of loss of Rs. 20,779 in the bardana account. The ITO noticed that the actual consumption during the year of account was 2,717 gunny bags billed at Rs. 14,582 at Rs. 6.72 per bag. He came to the conclusion that the claim of loss to the extent of Rs. 20,779 was excessive considering that the opening and closing stocks were estimated at round figures of Rs. 9,000 and Rs. 10,000, respectively, and there was no proper check on the account.
Accordingly, he disallowed Rs. 10,000 from the claim. The ITO also noticed that the firm had credited the individual accounts of the partners S/Shri Poonamchand, Bansilal and Mangalchand with interest amounting to Rs. 8,003, Rs. 3,990 and Rs. 4,636, respectively, amounting in all to Rs. 16,630. He disallowed the interest invoking the provisions of Section 40(b) which lays down, that, in the case of a firm, any payment of interest to any partner of the firm shall not be deducted.
3. On appeal, the AAC reduced the disallowance of loss in the bardana account to Rs. 3,000 and confirmed the interest disallowance observing as follows: The ITO disallowed payment of interest to the tune of Rs. 16,630 under Section 40(b). The appellant's counsel submitted that the partners represent their respective HUFs in the appellant firm and the investments were made in their capacities as individuals. So the counsel pleaded that the interest paid to the partners in their individual capacities should not have been disallowed by the ITO under Section 40(b). The counsel relied on the decision in the case of Terla Veeraiah v. CIT [1979] 120 ITR 502 (AP). However, I am of the opinion that the partners are only individuals. So far as the firm is concerned the investment made by them in their individual capacities in the firm would attract Section 40(b). I confirm the disallowance made by the ITO. The disallowance of Rs. 16,630 is confirmed.
4. Aggrieved with the retention of the disallowance to the extent of Rs. 3,000 in the bardana account and the confirmation of the disallowance of Rs. 16,630, being interest credited to the partners' accounts under Section 40(b), the assessee is in appeal before us. As regards the bardana account it was submitted on behalf of the appellant that the total loss claimed in this account was Rs. 20,779 which was made up of Rs. 10,242 being the loss in respect of 2,717 bags due to short recovery in their cost to the extent of Rs. 10,242 plus packing charges amounting to Rs. 2,595 and wear and tear of bags to the extent of Rs. 7,942. The cost of 2,717 bags was stated to be Rs. 14,582 which was fully supported by vouchers. The recovery effected in respect of these bags was only Rs. 4,340 and, therefore, there was a price difference to the extent of Rs. 10,242, which the assessee had to bear.
In addition, it was stated that wear and tear of old bags worked out to Rs. 7,942, in addition to packing expenses amounting to Rs. 2,592. It was, therefore, submitted that there was no basis for disallowance of any amount in this regard.
5. As regards the disallowance of interest credited to the partners' accounts, the following submissions were made: The partners were representing their respective joint families in their capacity as kartas in the partnership in question. The partners had also advanced moneys to the firm in their individual capacity. The interest paid by the firm was in the individual accounts of the partners on the funds advanced by them, not in their capacity as partners on behalf of the respective joint families, but in their individual capacity. It was, therefore, contended, that the interest credited to these accounts was not covered by Section 40(b), as this section was applicable only in respect of interest paid to the partners of the firm. It was submitted that the decisions of the Madhya Pradesh High Court in Jalam Chand Mangilal (No. 1) v. CIT [1982] 138 ITR 343 and Jalam Chand Mangilal (No. 2) v. CIT [1982] 138 ITR 347 were no longer good law in view of the dismissal by the Supreme Court of the SLP (Civil) No. 7736 of 1981 filed by the department against the decision of the Gujarat High Court in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654. The main contention in this behalf was, that the partners were partners of the firm in their capacity as kartas of the respective HUFs and, therefore, interest credited on the moneys advanced by them in their individual capacity was not liable to be disallowed under Section 40(b) and support for this view was sought to be derived from the decision of the Gujarat High Court in Sujjanraj Divanchand's case (supra). Reliance was also placed on the following decisions of various other High Courts: CIT v. Pannalal Hiralal & Co. [1984] 146 ITR 549 (Bom.), CIT v. K. Krishnaiah Chetty & Sons [1981] 131 ITR 410 (AP), Venkatesh Emporium v. CIT [1982] 137 ITR 593 (Mad.), Ram Lal & Sons v. CIT [1980] 124 ITR 157 (All.), [19841 12 ITC 187 (sic), [1984] 20 TTJ (Mad.) 8 (sic), and [1983] 144 ITR (St.) 15.
Our attention was also invited to the decisions of the Tribunal in [1984] 12 ITC 187 (sic) and [1984] 20 TTJ 8 (Mad.) (sic) in support of the stand taken in his behalf. The assessee's representative also fairly conceded that the following cases were against the stand taken in this behalf but, however, the argument highlighted for our consideration was that though this case came under the jurisdiction of the Madhya Pradesh High Court, the decisions of that Court in Jalam Chand Mangilal (No. 1)'s case (supra) and Jalam Chand Mangilal (No. 2)'s case (supra) were no longer good law in view of the dismissal by the Supreme Court of the SLP (Civil) No. 7736 of 1981 filed by the department against CIT v. London Machinery Co. [1979] 117 ITR 111 (All.), CIT v. Brijmohan Das Laxman Das [1979] 117 ITR 121 (All.), Sanghi Motors v. CIT[ 1982] 135 ITR 359 (Delhi), Jalam Chand Mangilal (No. 1)'s case (supra) and Jalam Chand Mangilal (No. 2)'s case (supra).
6. We have heard the learned departmental representative. We are unable to agree that the decisions of the Madhya Pradesh High Court in Jalam Chand Mangilal (No. 1)'s case (supra) and Jalam Chand Mangilal (No.2)'s case (supra) are no longer good law in view of the dismissal by the Supreme Court of the SLP against Sajjanraj Divanchand's case (supra) inasmuch as, the facts in the Gujarat High Court's decision are distinguishable from the facts of the present case which are identical to those of Jalam Chand Mangilal (No. 2)'s case (supra). In the Gujarat High Court's decision, the facts were as follows: The assessee-firm had three partners out of whom SJ had joined the firm in his capacity as the karta of the HUF of SJ. During the relevant accounting year the firm had paid interest amounting to Rs. 7,777 to the HUF. Applying the provisions of Section 40(b), the ITO disallowed the interest paid to the HUF. The Tribunal held that the interest credited to the HUF's account was an admissible deduction.
On reference, the Gujarat High Court held that there were two separate accounts and in the account of the HUF it was shown that the HUF was the creditor of the firm and on the amounts standing to the credit of the HUF, interest of Rs. 7,777 was paid by the firm to the HUF. There was a separate account of the individual partner SJ and in that account, no interest was paid in the relevant year.
Therefore, the High Court held, that the amount of Rs. 7,777 was paid by way of interest to the HUF which was the creditor of the firm. They also held that the fact that the karta of the HUF was a partner of the firm was not relevant because under Section 40(b) it was only the interest paid to the partner which was not allowed to be deducted. Accordingly, the interest paid to any other creditor of the firm could not be disallowed under the provisions of Section 40(b). From the above facts, it is clear that the creditor of the firm was not the partner but the HUF of which the partner was the karta and, therefore, the creditor of the firm was a separate entity and interest paid to the separate entity was rightly held to be not governed by Section 40(b).
It was against this decision, that the SLP filed by the department was dismissed by the Supreme Court vide [1983] 144ITR (St.) 15. In the present case the facts are totally different. The interest was not paid by the firm in the HUF's account. The interest was credited in the individual partners' accounts and the individuals were representing their respective HUFs in the partnership. The distinction between these two cases is, that, in the Gujarat High Court's decision, interest was paid to the HUF's account and not in the individual partners account's.
That was the reason for the High Court holding that the creditor of the firm was not the partner but HUF of which the partner was the karta and, therefore, interest paid to the HUF's account was interest paid to separate entity and not to be disallowed under Section 40(b). In this case, the interest was paid not in the HUF's account but in the individual partners' accounts who were partners in the firm representing their respective HUFs. This fundamental difference between these two cases should not be overlooked in trying to find out whether the decisions of the Madhya Pradesh High Court in Jalam Chand Mangilal (No. 1)'s case (supra) and Jalam Chand Mangilal (No. 2)'s case (supra) are no longer good law. In Jalam Chand Mangilal (No. 1)'s case (supra) the facts were as under: Interest on capital and loans had been paid to the partners of the firm and the same was disallowed under Section 40(b). It was held by the Madhya Pradesh High Court in the above decision, that it did not matter whether the partners had joined the firm in their individual capacity or as kartas of their respective HUFs. The High Court referred to the decision of the Supreme Court in CIT v. Bagyalakshmi & Co. [1965] 55 ITR 660 that whatever be the relationship of the partner qua his undivided family in respect of the partnership he acts as an individual qua the partnership firm. The High Court also referred to the decision of the Allahabad High Court in London Machinery Co.'s case (supra) which held that a person who was a partner in a firm entered into a contract in his personal capacity only and even though he represented his HUF, the interest paid to him would not be deductible in computing the business income in view of the embargo contained in Section 40(b). A reference was also made to the Madras High Court's decision in Dwarkadas Rameshwar Goenka v. CIT [1981] 127 ITR 397 to the same effect. On reliance being placed on behalf of the assessee in Sajjanraj Divanchand's case (supra) the Madras High Court distinguished the facts of that case from those of the case with which it was dealing. They mentioned that in the decided case one of the partners had entered into partnership in his individual capacity but the loan was advanced from the HUF's account and interest was also credited into a separate account. They found that these facts were totally different from the facts of the case before them and did not see any reason to follow the decision in Sajjanraj Divanchand's case (supra).
7. In Jalam Chand Mangilal (No. 2)'s case (supra), the High Court decided that irrespective of the capacity in which a person became a partner of a firm, Section 40(b) was a bar to the payment of interest to him. They held that the main fact to be considered for applying Section 40(b) was not as to in what capacity the loan was advanced or interest was paid to a person who had joined as partner of the firm.
They further held that where a person joined as a partner of a firm in his individual capacity and interest was paid to him as karta of a HUF, the payment of interest was not deductible under Section 40(b). While coming to this conclusion they referred to the decision of the Allahabad High Court in London Machinery Co.'s case (supra) with approval. In that case, the karta partners deposited funds in their individual capacity and the firm paid interest to them as individuals as exactly happened in this case. The matter being finally taken to the Allahabad High Court, it was held that the interest paid by the firm to the partners on amounts brought in their individual capacity was a case of interest paid to the partners and as such inadmissible under Section 40(b). The Madhya Pradesh High Court also referred to the Gujarat High Court's decision in Sajjanraj Divanchand's case (supra) and summarised the salient features of the decision as under: The Gujarat High Court in Sajjanraj's case seems to distinguish a case where a person enters into a partnership in his capacity as the karta of an HUF and is paid interest in his individual capacity and a case where a person enters into a partnership agreement in his individual capacity and the interest is paid to him representing his HUF. In the former case, the Gujarat High Court agrees with the Allahabad High Court that the interest is not allowable as a deduction but in the latter case it is so allowable. We are unable to accept this dichotomy.
Even the view of the Madhya Pradesh High Court decision in Sajjanraj Divanchand's case (supra) favoured disallowance of interest paid to a partner in his individual capacity when he has entered the partnership in his capacity as the karta of the HUF. They no doubt held that the distinction made by the Gujarat High Court with regard to interest paid when a person entered the partnership in his individual capacity and the interest was paid to him representing his HUF, was not acceptable to them. From this, it is very clear, that the Gujarat High Court itself in Sajjanraj Divanchand's case (supra) held that interest paid to a partner in his individual capacity when he has entered the partnership in his capacity as karta of the HUF is not admissible under Section 40(b).
8. In the present case, the partners are representing their respective HUFs in the firm. However, interest has been paid in their individual accounts on the funds individually advanced by them to the partnership and no interest has been paid in the accounts of the HUFs. In Sajjanraj Divanchand's case (supra) it has been clearly laid down that interest credited to the HUF's account, when the karta is representing the same in the partnership alone, is not to be disallowed under Section 40(b).
The following passage from this decision makes this point very clear: Under these circumstances, in every case the test to be applied is as to who is the partner of the firm and irrespective of the character in which he is the partner of the firm, whether any interest is paid to him as partner. If the creditor of the firm is not the partner but the HUF of which the partner is the karta, then a separate entity is the creditor of the firm and interest paid to that separate entity will not be governed by Section 40(b) and cannot be disallowed.
In the instant case, there were two separate accounts. One in the individual name of Sajjandas Jwaladas and the other in the name of HUF of Shri Sajjandas Jwaladas. The amount of Rs. 7,777 was paid as interest to the HUF of Sajjandas Jwaladas. That being the case, it was paid to the creditor who was not a partner of the firm. Under these circumstances, the conclusion of the Tribunal was correct. We, therefore, answer the question referred to us in the affirmative that is, in favour of the assessee and against the revenue. The Commissioner will pay the costs of the reference to the assessee.
9. In the present case, the creditors of the firm are definitely the partners. This distinction has been very clearly brought out by the Madhya Pradesh High Court in Jalam Chand Mangilal's case (supra). We are, therefore, of the opinion that, even as per the decision of the Gujarat High Court in Sajjanraj Divanchand's case (supra), the interest paid to the individual partners cannot be allowed as a deduction in Jalam Chand Mangilal (No. 2)'s case (supra).
10. We are, therefore, of the opinion, that the decision of the Madhya Pradesh High Court in Jalam Chand Mangilal's case (supra) has not been overruled by implication as suggested on behalf of the assessee by virtue of the dismissal of the SLP No. 7736 of 1981 by the Supreme Court.
11. The very same view has been upheld in London Machinery Co.'s case (supra) and Brijmohan Das Laxman Das's case (supra) as also by the Delhi High Court in Sanghi Motors' case (supra). In Sanghi Motors' case (supra) the assessee was a partner in his capacity as karta of the HUF and advanced moneys also in his individual capacity. Interest paid on his individual account was held to be inadmissible under Section 40(b).
12. The decision of the High Court in [1976] CTR Bom. 5 482, is not apposite in the context of this case, as that decision turned on the fact, whether the provisions of Section 154 of the Act were applicable to disallow interest paid in the individual account of the partner. It is, therefore, needless for us to discuss the other decisions, inasmuch as we are of the opinion, that, even as per the decision of the Gujarat High Court in Sajjanraj Divanchand's case (supra) interest paid on the advances made by the partners in their individual capacity when they are partners of the firm in their representative capacity is to be disallowed under Section 40(b). This proposition has been clearly established by the Madhya Pradesh High Court in Jalam Chand Mangilal (No. 1)'s case (supra) and Jalam Chand Mangilal (No. 2)'s case (supra).
We are, therefore, of the opinion that the decision of the Madhya Pradesh High Court still holds good and, since this case falls within the jurisdiction of that High Court, we are bound to follow that decision with respect. Even otherwise, as mentioned by us, even Sajjanraj Divanchand's case (supra) of the Gujarat High Court lends support to the view that the interest paid in the individual accounts of the partners is not admissible under Section 40(b). We, therefore, confirm the disallowance of interest effected by the ITO under Section 40(b).