N.T.R. Estate Vs. Commissioner of Income-tax - Court Judgment

Y.V. Anjaneyulu, J.

1. The Income-tax Appellate Tribunal has referred the following questions of law for consideration of this court under section 256(1) of the Income-tax Act, 1961 (for short 'the Act') :

'1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest payments of Rs. 66,671 in the assessment year 1973-74 and Rs. 75,810 in the assessment year 1974-75 are attracted by section 40(b) of the Income-tax Act, 1961, and are not deductible

2. Whether, on the facts and in lie circumstances of the case, the Tribunal was right in holding that the salary payments of Rs. 15,000 in the assessment year 1973-74 and Rs. 24,000 in the assessment year 1974-75 are attracted by section 40(b) of the Income-tax Act, 1961, and are not deductible ?'

2. The assessee is a partnership firm consisting of eight partners. During the accounting year relevant to assessment years 1973-74 and 1974-75, the partnership firm paid interest to four out of the eight partners. The partnership firm also paid salary to two out of the eight partners. The amounts paid by way of interest as well as salary were claimed as deduction in the computation of total income of the partnership firm. The Income-tax Officer declined to accept the assessee's claim for deduction on the ground that the interest as well as the salary were paid to the partners of the firm and consequently under section 40(b) of the Act, they are not deductible in computing the total income of the partnership firm. The assessee contended that the partners to whom interest and salary were paid were not partners in their individual capacity but were representing their respective Hindu joint families as 'kartas'. It is claimed that the share income derived by the respective partners was assessed in the hands of the respective joint families of which the partners were the 'kartas'. It is further claimed that the partners invested their individual funds in the partnership firm and also derived salary for services rendered by them individually to the partnership firm. It was also claimed that the salary paid to the partners by the assessee was assessed in the individual hands of the partners. The assessee-firm contended that the interest and salary paid to the partners in their individual capacity were not liable to be disallowed under section 40(b) of the Act in the computation of the total income of the partnership firm.

3. On the Income-tax Officer declining to accept the above claim, the assessee preferred an appeal to the Appellate Assistant Commissioner, who confirmed the assessment made by the Income-tax Officer. The assessee thereafter filed a second appeal to the Income-tax Appellate Tribunal, which also confirmed the assessment on the short ground that the disallowance is supported by a judgment of this court in CIT v. Veeraiah : [1977]106ITR283(AP) . The assessee thereupon applied for and secured the present reference under section 256(1) of the Act.

4. Sri S. Parvatha Rao, learned counsel for the assessee, submitted that the authorities below were in error in rejecting the assessee's claim for the deduction of the interest and salary paid to the partners. It is pointed out that the partners to whom interest and salary were paid were admittedly representing their respective Hindu joint families as 'kartas' and the share income derived by them from the assessee-firm was assessed in the hands of their respective joint families. Learned counsel also pointed out that, admittedly, the amounts on which interest was paid belonged to the partners in their individual capacity. No part of the joint family funds were invested in the assessee-firm. On the monies lent by them individually, the partners were entitled to receive interest and the payment of such interest has nothing to do with the share held by the partner in a representative capacity in the assessee-firm. According to the learned counsel, it is pure and simple transaction of loan advanced by the individual partner to the assessee-firm without having any nexus with the partnership interest held by the respective partners for and on behalf of their partnership respective joint families. Learned counsel also urged that the salary paid to the partners was for services rendered by them individually to the partnership firm and the salary so paid was assessed in their individual hands. Learned counsel submitted that the payment of salary had again no nexus with the partnership interest held by the partner for and on behalf of the joint family. Learned counsel further urged that the provisions of section 40(b) do not empower the rejection of the assessee's claim for deduction of interest and salary in the facts and circumstances above stated. Learned counsel relied on the decisions of this court in Addl. CIT v. Vallamkonda Chinna Balaiah Chetty & Co. : [1977]106ITR556(AP) and Terla Veeraiah v. CIT : [1979]120ITR502(AP) of the Gujarat High Court in CIT v. Sajjanraj Divanchand [1980] 126 ITR 655 and of the Madras High Court in Venkatesh Emporium v. CIT [1982] 137 ITR 593.

5. Learned standing counsel for the Revenue, Sri M. Suryanarayana Murthy, urged that the interest and salary paid to the partners were rightly disallowed under the provisions of section 40(b) of the Act. Learned standing counsel submits that it is immaterial whether the partners to whom the interest and salary were paid were partners in a representative capacity (as the partners were admittedly representing the joint families of which they are the 'kartas') or were partners in their individual capacity. According to the learned standing counsel, the terms of section 40(b) of the Act are absolute; the moment the assessee-firm paid any interest or salary to a person who is a partner in the firm, the provisions of section 40(b), according to the learned standing counsel, would come into operation. Learned standing counsel pointed out that qua the firm, the partners were acting in their individual capacity and it is of no consequence that they are representing their respective joint families and the income derived by them was accounted for in the hands of the joint families and assessed as such. Learned standing counsel relied on the decisions of the Karnataka High Court in Annaiah & Co. v. CIT : [1975]101ITR348(KAR) of the Allahabad High Court in CIT v. London Machinery Co. : [1979]117ITR111(All) and of the Delhi High Court in Sanghi Motors v. CIT : [1982]135ITR359(Delhi) in support of his proposition.

6. Having given our anxious consideration to the matter in dispute, we are inclined to follow the judgments of the court in Addl. CIT v. Vallamkonda Chinna Balaiah Chetty & Co. : [1977]106ITR556(AP) and Terla Veeraiah v. CIT : [1979]120ITR502(AP) and of the Gujarat High Court and the Madras High Court above referred. The facts obtaining in CIT v. T. Veeraiah : [1977]106ITR283(AP) were distinguishable and this distinction was duly pointed out by this court Addl. CIT v. Vallamkonda Chinna Balaiah Chetty & Co. : [1977]106ITR556(AP) . We consider that the present case is on all fours with the facts obtaining in the decisions of this court in Addl. CIT v. Vallamkonda Chinna Balaiah Chetty & Co. : [1977]106ITR556(AP) and Terla Veeraiah v. CIT : [1979]120ITR502(AP) . It is true that there is a conflict of judicial opinion on this aspect (vide judgments of the Karnataka, Allahabad and Delhi High Courts above referred to on which reliance was placed by the learned standing counsel for the Revenue). We do not think that any case is made out for reconsideration of the judgments of this court in Addl. CIT v. Vallamkonda Chinna Balaiah Chetty & Co. : [1977]106ITR556(AP) and Terla Veeraiah v. CIT : [1979]120ITR502(AP) for two reasons : firstly, the view taken by this court finds support in the judgments of the Gujarat High Court and Madras High Court above referred to; and, secondly, the principle enunciated by this court is now statutorily recognised by the Taxation Laws (Amendment) Act of 1984, which will be effective from the assessment year 1985-86. By section 10 of the above Amendment Act, three Explanations were inserted. Explanations 2 and 3 deal with the matter under consideration. The effect of these Explanations is : (a) if a person is a partner in a firm in a representative capacity and if such partner lends to the partnership monies belonging to him individually, then the interest paid to such partner on the monies lent by him is not liable to be added back under section 40(b) of the Act; and (b) similarly, if a person is a partner in his individual capacity and if such partner lends to the partnership monies belonging to the Hindu joint family, of which he is the 'karta', then the interest paid on the monies lent by the joint family is not liable to be added back under section 40(b) of the Act. The above amendment to the statute is clear acceptance of the views expressed by this court, the Gujarat High Court and the Madras High Court in the decisions above referred to. It is true that Explanations 2 and 3 inserted by the Taxation Laws (Amendment) Act of 1984 will be effective from the assessment year 1985-86. It is well to bear in mind that in the Statement of Objects and Reasons introducing the Taxation Laws (Amendment) Bill, 1984, it has been specifically mentioned that the amendments introduced in the Bill are intended mainly to streamline procedures in the interest of better work management, avoid inconvenience to taxpayers, reduce litigation, remove certain anomalies in and rationalise some of the provisions of these enactments and counteract tax avoidance and tax evasion. We consider that the present amendment to section 40(b) of the Act through Explanations 2 and 3 above referred to is to avoid inconvenience to taxpayers, reduce litigation and in that view, the spirit of Explanations 2 and 3 introduced by the Taxation Laws (Amendment) Bill, 1984, should be followed with respect to the preceding assessment years also in order to avoid unnecessary litigation. It cannot be gainsaid that the Legislature was fully aware of the conflict of judicial opinion in this matter among the various High Courts in the country and the present amendment to section 40(b) through Explanations 2 and 3 is brought about to set at rest the controversy. We see no reason to hold that the principle statutorily recognised by Explanations 2 and 3, following the decisions of some High Courts, is good only from the assessment year 1985-86 and ceased to be so for the preceding assessment years. In our opinion, Explanations 2 and 3 are merely clarificatory in character and must, therefore, govern the assessments prior to the assessment year 1985-86 also.

7. In this view of the matter, we consider that the interest paid by the assessee-firm to its partners on monies lent by them in their individual capacity is not liable to be disallowed under section 40(b) of the Act, inasmuch as the partners were acting in a representative capacity so far as the partnership interest is concerned.

8. In our opinion, the same principles as are mentioned above in connection with the payment of interest by a partnership firm to its partners are also applicable in regard to the payment of salary to a partner. In order to determine whether the salary paid to a partner should be allowed as a deduction in computing the income of the partnership firm, it is necessary to examine who is the real recipient of the salary paid to the partner. We may refer to the decision of the Madras High Court in Somasundara Nadar Sons v. CIT : [1982]137ITR815(Mad) . That was a case relating to allowance of interest under section 40(b). The principle enunciated by the Madras High Court is that the allowance or otherwise of interest shall have to be determined with reference to the real recipient of the interest and not merely with reference to the person formally receiving the interest. We are in entire agreement with this view. The principle of 'real recipient' is as much applicable to salary as it is to interest. In some cases, salary may be paid to a partner under the agreed terms and conditions between the partners for services rendered by the partner individually in connection with the business carried on by the partnership; in some cases, the payment of salary may have connection with the investment of capital by the Hindu joint family whom the partner is representing in the partnership. In a case, where a person is a partner in his individual capacity and salary is paid to him for services rendered by him individually in connection with the business carried on by the partnership, there can be little dispute that such salary paid to the partner falls to be disallowed under section 40(b) of the Act. If it is, however, found that the person concerned is not a partner in the partnership firm in his individual capacity but is a partner in a representative capacity (representing for instance the joint family of which he is either the karta or a member) and the payment of salary has no real and sufficient connection with the share held by the joint family through the partner concerned, then the salary paid to the partner for his individual services cannot be disallowed in the computation of he income of the partnership firm. If, however, the real recipient of the salary is the joint family, although it was paid ostensibly to the partner, then the salary paid falls to be disallowed under section 40(b) of the Act. If it is established that the salary or remuneration received by the karta of a joint family from a firm in which he is a partner in a representative capacity was for services rendered by him individually and that there was no real and sufficient connection between the investment of the joint family assets in the firm and the salary or remuneration paid to him, the salary or remuneration received by the karta could not be treated as income of the family. It has to be treated as his individual income and assessed as such. Please see the decisions of the Supreme Court in V. D. Dhanwatey v. CIT : [1968]68ITR365(SC) CIT v. Gurunath V. Dhakappa : [1969]72ITR192(SC) and CIT v. D. C. Shaw : [1969]73ITR692(SC) and a hot of other cases decided by the Supreme Court and various High Courts bearing on this point. In the present case, it is admitted that salary was paid to two of the partners of the assessee-firm for services rendered by them individually, although they were partners in a representative capacity as kartas of their respective joint families. It is further admitted that the salary paid to the two partners was assessed in their individual hands, obviously accepting that there was no real and sufficient connection between the partnership interest held by the joint family through the karta and the salary or remuneration paid to the partner. In such circumstances, the same principles as are applicable in the matter of disallowance of interest which we have set out above are applicable in the matter of disallowance of salary or remuneration paid to a partner. On the admitted facts in this case, we are clearly of the view that the salary paid to the two partners for services rendered by them individually cannot be disallowed under section 40(b) of the Act.

9. For the aforesaid reasons, we answer both the questions in the negative, that is to say, in favour of the assessee and against the Revenue. In the circumstances of the case, the parties shall bear their own costs. Advocate's fee Rs. 500.