( 1 ) IN this reference at the instance of the revenue, the following question has been referred for the opinion of this Court in respect of assessment year 1982-83:- "whether, on the facts and circumstances of the case, the provisions of section 40a (2) were applicable?"

( 2 ) THE facts giving rise to this Reference, briefly stated, are as under:-2. 1 the assessee is a private limited company engaged in the business of re-rolling steel into C. T. D. . bars as also the conversion work of P. W. D. on job basis. Its directors R. R. Malhotra, A. R. Malhotra and Ravinder Malhotra, were carrying on business in partnership in the name and style of M/s. Malhotra Steel Corporation. On 16-10-1978, the assessee-company became a partner in that firm. Thereafter the firm was dissolved with effect from 30-6-1980 and the business was taken over by the assessee-company. A dissolution deed was drawn on 1-8-1980. Clause 6 of the deed of dissolution stated that the company was not in a position to make full payment of the balance standing to the credit of the above mentioned three persons in their capital account and hence they agreed to retain amounts of Rs. 2 lacs each in each of their respective sarafi account for ten years (aggregate amount of retained capital Rs. 6 lacs ). In consideration thereof, the company agreed to pay to each of them for a period of 10 years 5% of the net profit of the company (aggregate 15% net profit) or 15% per annum on the amounts credited to the sarafi account of each of them, whichever is higher. 2. 2 the accounting year in question ended on 30-6-1981 relevant to assessment year 1982-83. The assessment was framed on 14-3-1983 determining the total income of the assessee at Rs. 43,01,922. 00. The assessee companys claim for deduction of Rs. 7. 93 lacs paid to the former partners as return on their retained capital of Rs. 6 lacs was allowed on the basis of Clause 6 in the dissolution deed for payment of 5% of the gross profits payable to each of the three former partners. 2. 3 on 31-1-1985, the Commissioner of Income Tax (CIT) issued a show cause notice under section 263 of the Act. The assessee-company submitted its reply dated 22-2-1985. After considering the same, the CIT passed order dated 12-3-1985 holding that the order dated 14-3-1983 passed by the I. T. O. was erroneous and prejudicial to the interest of the revenue, inasmuch as the payment of Rs. 2,57,729. 00 each to the three Directors of the company had been wrongly allowed by the I. T. O. while computing the total income. The CIT directed the I. T. O. to revise the assessed income by adding the amount in question as the same was not allowable as a deduction. Alternatively, the CIT was of the view that the provisions of section 40 A (2) as also section 40 A (8) were applicable to the aforesaid payment, as the payment was excessive and unreasonable. 2. 4 the assessee-company carried the matter in appeal before the Tribunal against the aforesaid order of the CIT under section 263. The Tribunal dismissed the appeal holding that the CIT had rightly invoked his powers and assumed jurisdiction under section 263. The Tribunal was of the view that provisions of section 40 A (2) would be squarely applicable in view of the close connection between the payer and the payee, as the outgoing partners were also the present Directors of the assessee-company, a closely held private limited company. While observing that it was for the assessee-company to decide whether to retain the amount of Rs. 6 lacs being the capital of the three partners (who are now Directors of the company) with the assessee-company as a deposit, the Tribunal held that the payment of Rs. 7. 93 lacs made by the assessee-company to the three former partners of the firm (who are now the Directors of the assessee-company) as profit/interest for retaining the refundable deposit of Rs. 6 lacs for the year under consideration and also a recurring liability to share 15% profits/pay 15% inter