A partner in a registered firm is entitled to claim deductions against the share of profits included in his total income, provided that the deductions represent necessary expenditure incurred to enable the assessee to earn the profits.

Headnote:
INCOME TAX - Deductions - Partner in registered firm - Whether entitled to claim deductions against share of profits - Conditions for allowing deductions - Interest on loans - Whether deductible - Facts and circumstances of case.
Fact of the Case:

The assessee, a partner in a registered firm, claimed a deduction for interest paid on loans taken to secure his interest in the managing agency commission and to pay off his father's creditors. The Income-tax Officer allowed interest on a portion of the loans, but disallowed the balance.
Finding of the Court:

The court held that a partner in a registered firm is entitled to claim deductions against the share of profits included in his total income, provided that the deductions represent necessary expenditure incurred to enable the assessee to earn the profits. However, the court found that the assessee had failed to establish that the loans on which the interest was paid were taken for the purpose of earning profits in the managing agency firm.
Issues: 1. Whether a partner in a registered firm is entitled to claim deductions against the share of profits included in his total income? 2. Whether the interest paid by the assessee on the loans was a justifiable deduction?
Ratio Decidendi: 1. The court held that a partner in a registered firm is entitled to claim deductions against the share of profits included in his total income, provided that the deductions represent necessary expenditure incurred to enable the assessee to earn the profits. This is because the share of profits included in the assessee's total income is not the sacrosanct figure arrived at on the assessment of the firm, but the true profits and gains of the assessee. 2. The court found that the assessee had failed to establish that the loans on which the interest was paid were taken for the purpose of earning profits in the managing agency firm. Therefore, the interest paid was not a justifiable deduction.
Final Decision: The court answered the first question in the affirmative to the extent indicated in the judgment and questions Nos. 2 and 3 in the negative.

JUDGMENT - Chagla, C.J.

1. The assessee is a partner in the firm of Messrs. Narottam Morarji Co. The firm is a registered firm and his share of the profits in this firm for the assessment year 1942-43, which corresponds with the year of account Samvat Year 1997, amounted to Rs. 2,28,706. This share was shown by the assessee in his return of total income. The assessee claimed that he had paid a certain amount as interest on moneys borrowed and he claimed that amount of interest as a permissible deduction against the profits shown by him in respect of his share in the firm of Messrs. Narottam Morarji Co. and the question that arises is, first, whether it is open to a partner in a registered firm to claim any deduction whatsoever against the amount of profit determined by the Income-tax authorities as the profits of the firm, and the other question that arises is whether, if it is so permissible to the assessee to claim those deductions, whether the deductions claimed in this case are permissible deductions.

2. Now, in the year of account Samvat year 1997 the assessee paid interest amounting to Rs. 31,382. The loans on which this interest was paid amounted to Rs. 6,19,478. The Income-tax Officer allowed interest at 6 per cent on Rs. 2,77,000. This interest came to Rs. 16,620. The balance of the claim with regard to interest which came to Rs. 14,762 was disallowed by the Income-tax Officer. It is in respect of this amount that this reference has been made.

3. Now, this interest was paid on loans which may be divided into two categories. One was loans aggregating to Rs. 1,54,097 and the other loans aggregating to Rs. 1,88,361. With regard to the first category, these were loans taken by the assessee from his relations and the important fact with regard to these loans was that he had pledged his interest in the managing agency commission with his relations to secure these loans. With regard to the other category, those loans were taken by the assessee for the purpose of paying off some of the creditors of his father Narottam Morarji. Now, the reason for paying off the creditors of Narottam Morarji was that before the death of Narottam Morarji in 1929 the firm of Messrs. Narottam Morarji Co. consisted of the assessee and his father Narottam. It appears that when Narottam dies in 1929 he left a large number of debts and as the creditors of Narottam Morarji threatened to attach the share of Narottam Morarji in their Scindia managing agency commission, according to the assessee, he paid off these creditors by raising loans and these loans amounted to Rs. 1,88,381.

4. Before we deal with the merits of the matter, we must consider the very important question of law that has been raised in this reference. The question is, what exactly are the rights of a partner in a registered firm with regard to deductions which he claims in respect of the share of profit earned by him ? Now, there is a vital and important distinction between a registered and an unregistered firm under the Indian Income-tax Act. When a firm is unregistered, the unregistered firm is the assessee and the firm itself is liable to pay tax. The profits of the unregistered firm are ascertained as an assessee, the various deductions claimed by it are considered under section 10 (2), and the amount of profit is determined and the tax payable on that amount is also determined, and it is the unregistered firm as such which is liable to pay the tax. With regard to the registered firm, the position is entirely different. It is true that up to a point the procedure followed by the Income-tax Department with regard to the registered and unregistered firm is identical. In order to assess the profits, assessment is carried on in the same way with regard to an unregistered firm and also a registered firm. But when the profits of the registered firm are ascertained, the assessee for the purpose of paying the tax is not the registered firm but each partner of the registered firm. The

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