Back
1998 Supreme(Mad) 560
High Court of Judicature at Madras
THE HONOURABLE MR. JUSTICE N.V. BALASUBRAMANIAN & THE HONOURABLE MR. JUSTICE R. JAYASIMHA BABU
Shenbagam Auto Works and Shenbagam Tractors - Appellant
Versus
Commissioner of Income Tax - Respondents
Tax Case Nos. 855 & 856 of 1987
Decided On : 02 April 1998
Interest paid to an individual otherwise than as a partner in a representative capacity is not hit by Section 40(b) of the Income Tax Act, 1961.
Headnote:
INCOME TAX - Section 40(b) - Interest paid to partners - Disallowance - Applicability - Explanation 2 to Section 40(b) - Retrospective effect - Interest paid to individual otherwise than as partner in representative capacity - Not within mischief of Section 40(b) - Karta of bigger HUF representing bigger HUF as partner - Karta of smaller HUF not representing smaller HUF as partner - Interest paid to Karta of smaller HUF - Not hit by Section 40(b).
Fact of the Case:
The assessee, a firm, paid interest to its partners, including the Karta of a smaller HUF. The ITO disallowed the interest paid to the smaller HUF under Section 40(b) of the Income Tax Act, 1961. The CIT(A) allowed the interest, holding that the smaller HUF was a different entity and the disallowance was not justified. The Tribunal held that the provisions of Section 40(b) were correctly invoked by the ITO and the disallowance was justified.
Finding of the Court:
The court held that the interest paid to the Karta of the smaller HUF was not hit by Section 40(b) of the Act, as the Karta was not representing the smaller HUF as a partner in the firm. The court relied on Explanation 2 to Section 40(b), which provides that any interest paid by the firm to an individual otherwise than as a partner in a representative capacity, does not fall within the mischief of Section 40(b).
Issues: Whether the interest paid to partners representing the small HUFs should be disallowed under Section 40(b) of the IT Act, 1961.
Ratio Decidendi: The court held that the provisions of Section 40(b) of the Act do not apply to the facts of the case, as the interest paid by the firm to the Karta of the smaller HUF was not paid to him in his capacity as a partner. The court relied on Explanation 2 to Section 40(b), which provides that any interest paid by the firm to an individual otherwise than as a partner in a representative capacity, does not fall within the mischief of Section 40(b).
Final Decision: The court answered the question in the negative, in favor of the assessee and against the Revenue.
N.V. BALASUBRAMANIAN, J.
At the instance of the assessee, the following five questions of law have been referred to us for the asst. yr. 1981-82 for our opinion,
"1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest paid to partners representing the small HUFs should be disallowed under s. 40(b) of the IT Act, 1961 ?
2. Whether the Tribunal was right in holding that the decisions of the Madras High Court in Venkatesh Emporium vs. CIT and T.M.N.M. Somasundaram Nadar & Sons vs. CIT relied on by the assessee were not applicable to the assessee's case ?
3. Whether the Tribunal had any material to come to the conclusion that the HUF (minors) were not creditors of the assessee ?
4. Whether the Tribunal was right in its inference that the details furnished in the statement of accounts of the assessee-firm did not reveal that the HUF (minors) were the creditors inasmuch as the interest to such entries were not shown along with the category of interest paid to others notwithstanding the fact that in the accounts placed before it the payments of the interest accounts had been shown only as such ?
5. Whether the Tribunal had not erred in holding that there was nothing on record to show that the payments disallowed under s. 40(b) had been paid to the respective HUF (minors) as different entity altogether ?"
2. There were two firms by name M/s. Shenbagam Auto Works, Madurai and M/s. Shenbagam Tractors, Madurai. One R. Ratnasabai was a partner in M/s Shenbagam Auto Works and one Sri. P. V. Parthesarathy was partner in both the firms representing their bigger HUFs. For the asst. yr. 1981-82, the firm paid interest to the partners on several accounts viz., HUF (major), individual and HUF, (smaller HUF). The firm, while returning the income for the said assessment year, added back the interest paid to the partners in respect of HUF (major) (sic) ITO while computing the income of the assessee-firm, invoked the provision of s. 40(b) of the IT Act, and disallowed the interest paid to small HUF, A sum of Rs. 5, 663 paid to Sri. Ratnasabai and Rs. 1, 419 paid to Sri. P. V. Parthasarathy in the case of M/s Shenbagam Auto Works, Madurai, were disallowed by the ITO, and in the same manner, he disallowed the interest paid to smaller HUF in the other firm.
3. The assessee carried the matter in appeal before the CIT(A). The CIT(A) found that the smaller HUFs were different entities and the disallowance made by the ITO under s. 40(b) of the Act was not justified, and, directed the ITO to allow interest paid to smaller HUFs which was no doubt represented by the same Karta of the bigger HUF in the given, but, in a different capacity. The Revenue preferred an appeal challenging the order of the CIT(A). The Tribunal found from the deeds of partnership that the partners contributed capital which bears interest as mutually agreed upon and if the partners advance moneys to the firms by way of loans and advances, interest was payable on the current account of the partners, and it was immaterial that the interest was received for the beneficial enjoyment of the partners in their individual capacity or on behalf of the bigger HUF or small HUF and that the provisions of s. 40(b) of the Act were correctly invoked by the ITO and the disallowance made by him was justified. On an application preferred by the assessee, the Tribunal has stated the case and referred the questions of the law set out earlier.
4. Mr. P. P. S. Janardhana Raja, learned counsel for the assessee, submitted that the order of the Tribunal is erroneous as the Tribunal proceeded on the wrong assumption that the Karta of the smaller HUF was a partner in the firms and the smaller HUF was only creditor as the monies have been deposited by the smaller HUF. Learned counsel for the Revenue, on the other hand, submitted that the members of the smaller HUFs were also members of the bigger HUFs and the interest paid to the Karta was paid to him
