National Garage Vs. Second Income-tax Officer - Court Judgment

Excerpt:
1. this appeal by the assessee is against the order of the commissioner (appeals) in his appeal no. cit (a)/145 of 1982-83 dated 4-6-1983 holding that the gross amount of interest paid to the partners by the firm was disallowable under section 40(b) of the income-tax act, 1961 ('the act') as held by the ito and not the net amount of interest after adjustment of interest received from individual partners as claimed by the appellant.2. the facts in this regard, the rival submissions and our conclusion thereon, are discussed hereunder. the assessee, a partnership firm, paid interest amounting in all to rs. 37,548 to its partners. it had also received interest from two of its partners, namely, shri v.r. shah and shri h.s. shah, of rs. 1,825 and rs. 5,838, respectively, on the amounts.....

Judgment:
1. This appeal by the assessee is against the order of the Commissioner (Appeals) in his Appeal No. CIT (A)/145 of 1982-83 dated 4-6-1983 holding that the gross amount of interest paid to the partners by the firm was disallowable under Section 40(b) of the Income-tax Act, 1961 ('the Act') as held by the ITO and not the net amount of interest after adjustment of interest received from individual partners as claimed by the appellant.

2. The facts in this regard, the rival submissions and our conclusion thereon, are discussed hereunder. The assessee, a partnership firm, paid interest amounting in all to Rs. 37,548 to its partners. It had also received interest from two of its partners, namely, Shri V.R. Shah and Shri H.S. Shah, of Rs. 1,825 and Rs. 5,838, respectively, on the amounts borrowed by them from the firm. The position of interest paid to and received from these two partners is as under:Name of the Interest Interest Net paid Net receivedpartner paid receivedShri V.R. Shah 4,880 1,825 3,055 --Shri H.S. Shah 1,952 5,838 -- 3,886 There was no receipt of interest from any other partners. The ITO, while disallowing the interest paid to the partners under Section 40(b), included therein the gross amount of interest paid to the partners Shri V.R. Shah and Shri H.S. Shah without adjusting the interest received from them on the sums borrowed by them. According to the assessee, the interest received from the partners should be set off against the interest paid to them and only the excess interest paid, if any, should be disallowed under Section 40(b). The ITO did not accept this view and disallowed the gross interest of Rs. 37,548 credited to the partners' accounts in the books of the firm.

3. On appeal to the Commissioner (Appeals), it was contended that in the case of Shri V.R. Shah, as against the interest of Rs. 4,880 credited to his account, the firm had received Rs. 1,825 from the partner and, therefore, only the excess interest of Rs. 3,055 credited to the partner's account should have been disallowed. In other words, the relief claimed in respect of this partner was Rs. 1,825 being interest received from him by the firm. As regards Shri H.S. Shah, since the interest received by the firm from this partner was Rs. 5,838 and the interest credited to his account by the firm was only Rs. 1,952 and there was an excess receipt of interest, nothing should have been disallowed under Section 40(b). In other words, the relief claimed in respect of this partner was Rs. 1,952. Thus, the total relief claimed was Rs. 3,777. Reliance was placed on the decision of the Allahabad High Court in CIT v. Kailash Motors [1982] 134 ITR 312. The Commissioner (Appeals) held that the Allahabad High Court, while deciding the case of Kailash Motors (supra), misread the earlier decisions of the same High Court in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 and Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149 and came to the conclusion that "only the net amount of interest paid by the firm to its partner, after adjusting the interest paid by the partner to the firm, could be disallowed under Section 40(b)" while, however, purporting to follow the rationale of the earlier mentioned decisions. He was of the opinion, that in the earlier mentioned two decisions, there was a categorical finding by the High Court that only the gross amount of interest should be disallowed without making any adjustment for interest received from the partners. Referring to the decision in Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149 (All.), the Commissioner (Appeals) reproduced the question referred to the High Court which was as under and which was answered in the affirmative, in favour of the department and against the assessee: Whether, on the facts and in the circumstances of the case, on proper interpretation of Section 40(b) of the Income-tax Act, 1961, the interest received from the partners of the firm could not be deducted from the interest paid to the partners by the firm for the purposes of Section 40(b) for the assessment year 1971-72 (p. 149) While answering this question, the High Court observed that Section 40(b) clearly excluded the deduction of interest paid to partners and if any authority was required that was to be found in the assessee's own case in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176. In Kailash Motors' case (supra), the question referred to the High Court was whether the Tribunal was justified in holding that only the net amount of interest paid to a partner after deducting the interest paid by him could be added to the firm's income under Section 40(b). While deciding this question, the Allahabad High Court in the above decision has held as follows: In CIT v. London Machinery Co. (Income-tax Reference No. 608 of 1977, decided on 26th October, 1978) [1979] 117 ITR 111, a Bench of this Court has held that payment of interest to a partner on amounts brought by him from his HUF or from his individual funds is in either case payment of interest to the partner and both these kinds of payments are within the purview of Section 40(b) and hence are inadmissible as deduction, but in view of the decision of this Court in Sri Ram Mahadeo Prasad the net amount paid by the firm to its partners alone is disallowable. In view of these decisions, we answer the question referred to us in the affirmative, in favour of the assessee and against the department, . . (p. 313) After referring to the above decisions in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 and Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149, the Commissioner (Appeals) was of the opinion that in Kailash Motors' case (supra), the Allahabad High Court had not properly appreciated the rationale of the decisions in these two cases and answered the question referred to it in favour of the assessee. According to him, the earlier two decisions of the Allahabad High Court were authority for the proposition that only the gross amount of interest paid to the partners should be disallowed without making any adjustment for interest received from them under Section 40(b). He, therefore, rejected the appeal filed by the assessee. Aggrieved with the same, the assessee is in appeal before us.

4. Shri Dewani, the learned Counsel for the assessee, submitted that the Kailash Motors' case (supra) was an authority for the proposition that only the net amount of interest paid to the partners after adjustment of interest received from them by the firm, should be disallowed under Section 40(b), inasmuch as, the question highlighting this aspect, which was referred to it, was answered in the affirmative by the High Court, in favour of the assessee and against the department. He, therefore, urged that this being the latest decision on the subject, the same should be followed by this Bench in the absence of any other decisions to the contrary in this regard.

5. On behalf of the revenue, the learned departmental representative invited our attention to Chhotalal Keshawam v. CIT [1978] 115 ITR 347 of the Madhya Pradesh High Court and submitted that only the gross amount of interest should be disallowed under Section 40(b). He also submitted that Section 10 of the Taxation Laws (Amendment) Act, 1984 has inserted an Explanation in Section 40 with effect from the assessment year 1985-86, to provide for the disallowance of only the net amount of interest paid to the partner after adjustment of interest received from him and, therefore, the position in this regard prior to the amendment, was by implication, to the contrary, namely, the gross amount of interest should be disallowed.

6. We have carefully considered the rival submissions, we are of the opinion that there is overwhelming authority in support of the view that only the net amount of interest should be disallowed under Section 40(b) and not the gross amount of interest. Kailash Motors' case (supra) is directly on the subject and the same holds that only the net amount of interest paid by the firm to its partners is disallowable. In coming to this conclusion, the Allahabad High Court has relied on the earlier decisions of the same High Court in Sri Ram Mahadeo Prasad v.CIT [1953] 24 ITR 176 and Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149. That the rationale of the decision in Kailash Motors' case (supra) is the same as the one in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 would be evident, if we refer to the body of the judgment of the latter decision instead of confining our attention to head note. One of the question-referred to the High Court in Sri Ram Mahadeo Prasad v.CIT [1953] 24 ITR 176 was as under: Whether the excess interest received from the partners of the firm on the amounts overdrawn by them after adjustment against the payments of interest made to them by the firm is taxable income in the hands of the firm (p. 179) While holding that there was no reason why the interest paid by the partner should not be treated as profit made by the partnership, the High Court held, with respect to the interest disallowance under Section 40(b), as under; In the case before us, the Appellate Assistant Commissioner and the Tribunal treated the case of a partner, who had lent money to the partnership and had also borrowed money from it, as a case of double entry and treated the balance alone as the amount either borrowed by him from or lent by him to the partnership, as the case might be, and after having made this adjustment they disallowed all interest paid by the partnership to such a partner by reason of the provisions of Section 10(2)(iii) and 10(4)(b) quoted above, while in the case of a partner, who had borrowed more than he had lent, the excess amount paid as interest was treated as profits. (p. 184) From the above observations, it is quite evident, that even in Sri Ram Mahadeo Prasad v.. CIT [1953] 24 ITR 176, the issue was exactly identical as one decided in Kailash Motors' case (supra) and the one before us. The finding of the High Court in Sri Ram Mahadeo Prasad v.CIT [1953] 24 ITR 176 is quite categorical that the net amount of interest paid to the partners should be disallowed and if the net amount happens to be a payment by the partners to the firm, the same should be assessed as the profit of the firm. In view of this, we are of the opinion that this issue has already been decided by the Allahabad High Court in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 and the same has been the basis of the latest decision of the same High Court in Kailash Motors' case (supra). The decision in Chhotalal Keshavram's case (supra), referred to by the learned departmental representative, is not directly with reference to the issue before us.

There the question was, whether the interest paid by partners to the firm represented the income of the firm. While holding that the same represented the income of the firm, the High Court held that while apportioning the total income of the firm between the partners under Section 23(6) of Indian Income-tax Act, 1922 or Section 158 of the 1961 Act, the interest adjusted on the debit balances of the partners in the books of the firm was not deductible from the share of profits of the respective partners. In the present case, the question at issue is totally different, namely, whether the interest disallowance to be affected under Section 40(b) in the assessment of the firm is to be confined to the net amount after adjustment of interest received from the partners or the same should be extended to the gross amount of interest. We, therefore, do not agree that this decision of the Madhya Pradesh High Court has a direct bearing on the issue. Accordingly, following the case of Kailash Motors (supra), we direct that the interest from the individual partners should be adjusted against the interest paid to them by the firm and only the net amount of interest paid to them should be disallowed under Section 40(b).

7. In the result, we direct allowance of relief to the extent of Rs. 3,777. The appeal filed by the assessee is allowed.