Judgment

M.N.VENKATACHALIAH,J.

(1) THESE special leave petitions arise out of and are directed against the orders of the High court of Judicature at Madras disposing of references made under S. 256(1) of the Income Tax Act, 1961 (the Act for short) in Tax Case Nos. 694 of 1982, 565 of 1980, 1404 of 1980, 637 and 638 of 1981, 521 of 1981, 429 of 1983 and 572 of 1983. The High court following its earlier pronouncement of that court in COMMISSIONER OF INCOME TAX v. O.M.S.S. Sankaralinga Nadar & Co. answered the question of law, similar in all the cases, in favour of the revenue. The question was whether in making a disallowance for the interest paid by a partnership firm to a partner under S. 40(b) of the Act the interest, in turn, paid by the partner on his borrowings from the firm should be taken account of and deducted and only the balance disallowed under S. 40(b).

(2) ON this question, there is a sharp divergence of judicial opinion in the High courts. In Sri Ram Mahadeo Prasad v. Commissioner of Income Tax, COMMISSIONER OF INCOME TAX v. Kailash Motors", COMMISSIONER OF INCOME TAX v. T.V. Ramanaiah & Sons", COMMISSIONER OF INCOME TAX v. Kothari & Co., COMMISSIONER OF INCOME TAX v. Balaji Commercial Syndicate, COMMISSIONER OF INCOME TAX v. MolUal Ramjiwan and Co., COMMISSIONER OF INCOME TAX v. Precision Steel and Engg. Works, the High courts have taken the view that where a firm pays interest to its partner and the partner also pays interest to the firm, only the net amount of interest paid by the firm to the partner is liable to disallowance under S. 40(b) of the Act. However, in COMMISSIONER OF INCOME TAX v. O.M.S.S. Sankaralinga Nadar & Co. the High court of Madras has taken a contrary view.

(3) WE have heard Sri Ramachandran, learned senior counsel for the appellants and Sri Manchanda, learned senior counsel and Sri B.B. Ahuja for the revenue. Special leave is granted. The appeals are taken up for final hearing, heard and are disposed of by this common judgment.

(4) WE may refer to the facts in Special Leave Petition (Civil) No. 14291 of 1985 which is representative of and typifies the context in which the question arises. The appellant, M/s Keshavji Ravji & Co. is a registered firm consisting of 6 partners and carries on a business in the manufacture and export of stainless steel articles. In the accounting year ended 13/11/1974, corresponding to the assessment year 1975-76, the firm paid interest to the partners on the amounts standing to their respective credits in the firm. The firm also received from the partners interest on their borrowings from the firm. For the relevant assessment year, the appellant filed a return disclosing a total income of Rs. 2,55,225.00. The Income Tax Officer while disallowing the amount of interest paid to partners did not set-off the interests received from the partners on their own borrowings. With this disallowance, the income of the firm was assessed at Rs. 2,79,730.00. In the assesseeS appeal, the Appellate Assistant Commissioner of Income Tax by his order dated 18/10/1977 allowed the claim of the appel- lant that only the net interest paid to the partners, after setting off the interest received from them, was to be disallowed. The revenue took up the matter in further appeal before the Income Tax Appellate Tribunal which by its order dated 6/01/1979 dismissed the appeal and affirmed the appellate order of the Assistant Commissioner. The tribunal, as did the Appellate Assistant Commissioner, placed reliance on the decision of the Allahabad High court in Sri Ram Mahadeo Prasad v. COMMISSIONER OF INCOME TAX

(5) AT the instance of the revenue the tribunal stated a case and referred the following question of law for the opinion of the High court:

"WHETHER, on the facts and in the circumstances of the case, the Appellate tribunal was correct in holding that net interest should be disallowed under S. 40(b) of the Income Tax Act, 1961?"

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