1. The Revenue has filed appeal against the order passed by the CIT(A) vide order dt. 13th August, 1991. The Revenue has taken following grounds in appeal : "1. On the facts and in the circumstances of the case, the learned CIT(A) was not justified in deleting the addition of Rs. 41,600 made by the AO on account of salary paid to the individual accounts of S/Sh. Mohan Lal Arora, and Mohinder Pal Arora who are partners in the firm in their representative capacity.
2. There cannot be any contract of service between the firm and its partners and consequently, there can be no question of a partner of a firm being an employee thereof. The salary paid to a partner represents the special share of the profits and retains the character of the income of the firm. [Shiva Sankari Chandra Sekran & Brinda Jayaraman vs. CIT (1991) 189 ITR 51 (Mad)]." 2. The case was fixed for hearing for 15th September, 1998. Neither the assessee nor his authorised representative attended the proceedings.
The case is, therefore, decided on merits in accordance with r. 24 of the IT (Appellate Tribunal) Rules, 1963.
3. The Departmental Representative relied on the order passed by the AO.4. The AO disallowed salary to the tune of Rs. 41,000 paid to S/Sh.
Mohan Lal Arora and Mohinder Pal Arora in their individual capacity.
Both these gentlemen are Karta of HUF and it is the HUF who are the partners of the appellant-firm. The AO is of the opinion that the salary payment is hit under s. 40(b) of the IT Act. Agitated against the order passed by the AO the appellant filed appeal before the CIT(A) and the learned CIT(A) has given his finding in para 7 of his order which are as follows : "7. I have carefully considered the submissions of the appellant's counsel and gone through the relevant record and in the circumstances of the case, I feel the appellant deserves to succeed.
I am in agreement with the appellant's counsel that the facts of the case are on all fours with the judgment of the Andhra Pradesh High Court the case of N. T. R. Estate vs. CIT (1986) 157 ITR 285 (AP).
Admittedly, the Hon'ble Supreme Court has since dismissed the Department's SLP filed against the judgment of Andhra Pradesh High Court in the case of N. T. R. Estate vs. CIT (supra), with the result that the controversy regarding the disallowance of salary/interest under s. 40(b) to the partners otherwise than in his representative capacity has been set at rest." 5. We have gone through the facts and the circumstances of the case.
The appellant has made written submission which is placed at pp. 27-29 of the paper book and is reproduced as under : "The assessee-firm has paid salary amounting to Rs. 41,600 to Sh.
Mohan Lal Arora and Sh. Mohinder Pal both of whom were partners in the firm in their HUF capacity. The assessee has claimed that the salaries are allowable and provisions of s. 40(b) cannot be applied because of the following facts : Salary has been paid to those two persons in consideration of their individual and personal skill and efforts and not by virtue of their partnership in the firm in HUF/representative capacity because : (i) There is no mention of amount or basis of salary in the partnership deed (copy attached in paper book as s. No. 14).
(ii) Salary has not been paid to other five partners which means that Sh. Mohan Lal Arora & Sh. Mohinder Pal were actively and personally engaged in the running of the business and otherwise other partners would not have agreed to pay the salary.
(iv) Sh. Mohan Lal and Sh. Mohinder Pal were not drawing salary from any other firm which means they were devoting whole-time attention to the business of the firm.
(v) Personwise detail of salary enclosed herewith at S. No. 5 shows that there was no other employee on administrative/managerial side which means that the firm actually needed their personal services for its business." It is clear from the above facts that salary has been paid to Sh. Mohan Lal Arora and Mohinder Pal on their personal and individual skill and efforts and not on account of their being partners in the firm in their HUF capacity.
In this connection, attention of your honour is drawn to decision of Andhra Pradesh High Court in the case of N.T.R. Estate vs. CIT (1986) 157 ITR 285 (AP) wherein the High Court has referred to Explanations I, II and III added to the s. 40(b) by the Taxation Law (Amendment) Act, 1984 (effective from 1st April, 1985) whereby the separate capacities of a person as individual and as representative of his HUF were recognised.
Recently, it has been held by worthy Supreme Court of India in case of Brij Mohan Das Laxman Das vs. CIT (1997) 233 ITR 825 (SC) and Suwalal Anandi Lal Jain vs. CIT (1997) 224 ITR 753 (SC) that where person is a partner in a firm as Karta representating his HUF, interest paid by the firm on deposits made by him with the firm in his individual capacity is deductible while computing the income of the firm chargeable under the head 'Profit & gains of business or profession" even for periods prior to April, 1985 from which date Expln. 2 to s. 40(b) was inserted in the IT Act, 1961.
In the above referred case, the worthy Supreme Court has referred to decision of Rajasthan High Court in the case of Gajanand Poonam Chand & Bros. vs. CIT (1988) 174 ITR 346 (Raj). In that case the worthy Rajasthan High Court has referred to the definition of 'person' in cl.
(31) of s. 2, it pointed out that the definition shows clearly that an individual, HUF and a firm are distinct persons/entities for the purposes of the IT Act.
The relevant portion of judgment of worthy Supreme Court is reproduced hereunder : The question yet remains where an individual is a partner in one capacity e.g. as a representative of another person, can he have no other capacity vis-a-vis the firm To be more precise, does the above position of law preclude an individual who is a partner representing an HUF from depositing his personal funds with the partnership and receiving interest thereon. Expln. 2 says in clear terms that there is no such bar. This is legislative recognition of the theory of different capacities an individual may hold no doubt confined to cl. (b) of s. 40.' In view of the above views of the worthy Supreme Court, it is hereby prayed that the salary and bonus to Sh. Mohan Lal Arora and Sh.
Mohinder Pal in their individual capacity and for their personal efforts and skills be not disallowed under s. 40(b) which clearly recognises dual capacity of an individual." 6. The Hon'ble Supreme Court has decided this issue in two judgments.
The first judgment is in case of Brij Mohan Das Laxman Das vs. CIT (1997) 223 ITR 825 (SC) and the second judgment is related to the case of Suwalal Anandi Lal Jain vs. CIT (1997) 224 ITR 753 (SC).
"Here the first thing that we must grasp is that a firm is not a legal person even though it has so attributes of personality.
Partnership is a certain relation between persons, the product of agreement to share the profits of a business. Firm is a collective noun, compendious expression to designate an entity, on a person. In Income-tax law, a firm is a unit of assessment, by special provisions, but is not a full person which leads to the next step that since a contract of employment requires two distinct persons, viz. the employer and the employee, there cannot be a contract of service, in strict law, between a firm and one of its partners. So that any agreement for remuneration of a partner for taking part in the conduct of the business must be regarded as a part of the profits being made over as a reward for the human capital brought in. Sec. 13 of the Partnership Act brings into focus this basis of partnership business.
This Court also quoted with approval the passage from Lindley on the Law of Partnership to the effect. : "In point of law, a partner may be the debtor or the creditor of his co-partners, but he cannot be either debtor or creditor of the firm of which he is himself a member, nor can he be employed by the firm of which he is himself a member, nor can he be employed by his firm, for, a man cannot be his own employer". The provisions in Chapters III and IV of the Partnership Act amply define and delineate the duties, obligations and rights of the partners vis-a-vis the firm. The question yet remains where an individual is a partner in one capacity, e.g., as a representative of another person, can he have no other capacity vis-a-vis the firm. To be more precise, does the above position of law preclude an individual, who is a partner representing an HUF, from depositing his personal funds with the partnership and receiving interest thereon Expln. 2 says in clear terms that there is no such bar. This is the legislative recognition of the theory of different capacities an individual may hold - no doubt confined to cl. (b) of s. 40. Once this is so, we see no reason to hold that this theory of different capacities is not valid or available for the period anterior to April, 1985. Accordingly, we hold that even for the period anterior to 1st April, 1985, any interest paid to a partner, who is a partner representing his HUF, on the deposit of his personal/individual funds, does not fall within the mischief of cl. (b) of s. 40. In this view of the matter, we agree with the view taken by the Rajasthan High Court in Gajanand Poonam Chand & Bros.
vs. CIT (1988) 174 ITR 346 (Raj) that Expln. 2, in the context of cl. (b) of s. 40, is declaratory in nature. Accordingly, we allow this appeal, set aside the judgment of the High Court and answer the question referred under s. 256 in the affirmative i.e., in favour of the assessee and against the Revenue." 7. Keeping in view the above discussions, the appeal filed by the Revenue is dismissed and order passed by the learned CIT(A) on this issue is confirmed.