Commissioner of Income Tax vs Dasa N. Govindaiah Setty and Co.

Ramanujulu Naidu, J.—The following question is referred to this Court for its opinion by the Tribunal u/s 258(2) of the income tax Act, 1961 (''the Act''): Whether, on the facts and in the circumstances of the case, the interest of Rs. 40,207 and Rs. 32,415 credited to the accounts of D. Ravindranath family, D. Ravindranath family loan account, D. Suryaprakash & Sons family account, D. Suryaprakash & Sons family loan account for the assessment years 1972-73 and 1973-74, respectively, is not disallowable u/s 40(a) of the income tax Act, 1961?

The assessee is a firm carrying on business in cloth and silk. The partners of the firm are members of the erstwhile HUF which carried on the very same business under the name and style of ''M/s. Dasa. N. Govindaiah Setty & Sons, Hindupur''. The interest credited to the accounts of the partners was being added back in computing the total income of the assessee u/s 40(b) of the Act on the ground that the interest was paid to the partners. One of the partners was Shri D. Suryaprakash. The interest which was being credited to his account from year to year was also being included while computing the total income of the firm u/s 40(b). On 24-10-1965, the amount which was standing in his account was transferred with the consent of other partners to an account styled ''D. Suryaprakash & Sons family''. The first assessment, after the said transfer was effected, was for the assessment year 1966-67. The assessee pleaded that the interest was not paid to D. Suryaprakash as partner of the firm but paid to the family of which D. Suryaprakash was the karta. The claim was not accepted by the ITO and it appears that the assessee was prevailed upon to agree to the addition of interest while computing the income of the joint family property for that assessment year. In the subsequent assessment years 1967-68 and 1968-69, the assessee renewed its claim; but the ITO negatived the same. The appeal before the AAC proved unsuccessful. The assessee thereupon appealed to the Tribunal. The Tribunal, by its order dated 25-2-1972, remitted the appeals to the file of the AAC for fresh disposal in the light of the directions given therein. The AAC reheard the appeals and upheld the order of the ITO once again. For the assessment years 1970-71 and 1971-72 the assessee made similar transfers of interest standing in the accounts of two more partners, i.e., ''Dasa N. Govindaiah Setty and Dasa Ravindranath'', to new accounts called ''Dasa N. Govindaiah Setty and his family account'' and ''Dasa Ravindranath and his family account'' and claimed deduction of payment of interest credited to the said accounts u/s 40(b). The ITO as usual rejected the claim. On appeal, the AAC confirmed the order of the ITO. 2. When the assessee preferred appeals before the Tribunal for all the four assessment years, the Tribunal, by its order dated 20-7-1974, held that though the partners of the firm were representing their respective joint families, in the eye of law, the joint families were not partners, that the interest claimed was for the monies advanced by the families, that there was no stipulation in the deed of partnership that the partners should invest any capital and that the interest transferred to the accounts of the respective joint families could not be disallowed u/s 40(b).

For the assessment years 1972-73 and 1973-74, the assessee claimed deduction of interest of Rs. 40,207 and Rs. 32,415 credited to the accounts of D. Ravindranath family, D. Ravindranath family loan account, D. Suryaprakash & Sons family and D. Suryaprakash & Sons family loan account, from its total income. The claim having been negatived by the ITO and the AAC, the assessee preferred an appeal to the Tribunal. Following its earlier decision, the Tribunal allowed the appeal preferred by the assessee for the assessment years 1972-73 and 1973-74. However, at the instance of the revenue, the Tribunal referred the question formulated supra for the opinion of this Court.

As found by the Tribunal, there is no stipulation in the deed of partnership as to investment of capital by any of the partners. Though originally the amounts were credited in the accounts of the partners, the amounts were later credited to the accounts of the respective joint families, obviously realising the implication of section 40(b). The fact, however, remains that interest was paid not to the partners but to the respective joint families represented by them. u/s 40(b) payment of interest to any partner of the firm is not liable to be deducted. Inasmuch as interest was paid by the firm to the joint families represented by the partners, their being no obligation on them to invest any capital, section 40(b) is no bar and the firm is entitled to deduct the amounts of interest so paid, from its total income.

In Additional Commissioner of Income Tax Vs. Vallamkonda Chinna Balaiah Chetty and Co., , a firm consisting of four partners with equal shares, was the assessee. Ramchandraiah (R) was one of them representing his HUF. In the deed of partnership, there was no stipulation as to investment of capital by the partners. His family advanced some monies to the firm and the same was credited to the firm in the name of R. Up to the assessment year 1967-68, interest was paid to the account of R. Capital account of the firm was also in the name of R. But in 1967-68, the account was changed to R''s family account. The firm paid Rs. 4,068 to R towards interest on the capital invested by the family and claimed deduction from the profits. But the ITO disallowed the claim u/s 40(b) on the ground that the interest was really paid to the partner ''R'' and the change of account to R''s family was only to avoid the application of section 40(b). The AAC confirmed the order, while the Tribunal upheld the assessee''s plea. Rejecting an application for reference filed by the department u/s 256(2), it was held by a Division Bench of this Court consisting of Sambasiva Rao, the then Acting Chief Justice, and A. V. Krishna Rao, J.

...the amount shown in the capital account of the partner initially was not the capital invested by the partner, but was the money advanced by the joint family. The partners were not required to invest any capital as per the partnership deed. The money really belonged to the joint family and it is only on realising the implication of section 40(b) that the firm placed it in the joint family account. The transfer was made only to indicate the real state of affairs and cannot be treated as a trick or ruse to escape the provisions of section 40(b).

We are in complete agreement with the ratio laid down by the Division Bench. It is open to the assessee to transfer the capital invested by its partners from out of the funds of the joint families represented by them to the accounts of the respective joint families and claim deduction of interest paid thereon to the accounts of the respective joint families, in the absence of any obligation cast upon the partners of the firm to contribute any capital. We, accordingly, answer the question in favour of the assessee and against the revenue. Costs of the assessee, Rs. 250.