Dwarkadas Rameshwar Goenka vs Commissioner of Income Tax, Madras

V. Ramaswami, J.—The assessee is a registered firm carrying on business of trading in cotton piece goods. The firm consisted of seven

partners. In completing the assessment, the ITO disallowed interest payments to the tune of Rs. 10,164 to Shiv Bhagwan Goenka and Rs. 2,586

to Omprakash Goenka under s. 40(b) of the I.T. Act. The assessee claimed that these payments were made to these persons in their capacity as

individuals whereas they were partners in the firm representing their HUF. The ITO held that any payment of interest to the partners has to be

disallowed under s. 40(b). This view was confirmed on appeal by the AAC and by the Tribunal on further appeal. At the instance of the assessee,

the following question has been referred :

Whether, on the facts and in the circumstances of the case, the disallowance of interest of a sum of Rs. 12,750 u/s 40(b) of the Income Tax Act,

1961, paid by the assessee to M/s. Shiv Bhagwan Goenka and Omprakash Goenka despite the fact that they represent their respective Hindu

undivided families in the partnership is valid in law ?

The learned counsel for the assessee strenuously contended that there was no dispute that the capital invested by the said two partners were the

joint family assets and that they were partners in the firm as kartas of their respective HUFs. The share income of the individual is also returned as

the HUF income and, in the circumstances, the interest paid should be deemed to be payments to the HUF as such and not to any partner as an

individual. It is now well settled that when the karta of a joint Hindu family enters into a partnership with strangers, the members of the family do

not ipso facto become partners in that firm. They have no right to take part in its management or to sue for its dissolution. The creditors of the firm

would no doubt be entitled to proceed against the joint family assets including the shares of the non-partner coparceners for realisation of their

debts. But that is because under the Hindu law, the karta has the right when properly carrying on business to pledge the credit of the joint family to

the extent of its assets, and not because the junior members become partners in the business [vide Firm of Bhagat Ram Mohanlal Vs. The

Commissioner of Excess Profits Tax, Madhya Pradesh, Nagpur and Another, . The Supreme Court in a later decision in Commissioner of Income

Tax, Madras Vs. Bagyalakshmi and Co., Udamalpet, also observed :

A contract of partnership has no concern with the obligation of the partner to others in respect of their shares of profit in the partnership. It only

regulates the rights and liabilities of the partners. A partner may be the karta of a joint Hindu family; he may be a trustee; he may enter into a sub-

partnership with others; he may, under an agreement, express or implied, be the representative of a group of persons; he may be a benamidar for

another. In all such cases he occupies a dual position. Qua the partnership, he functions in his personal capacity; qua the third parties, in his

representative capacity.

Thus, there could be no doubt that though the karta of an HUF enters into a partnership with others, the karta in his personal capacity alone is

the partner. Any payment made to the partner by way of interest is, therefore, clearly governed by s. 40(b).

A similar view was also taken by the Allahabad High Court in CIT v. London Machinery Co., (1979) 117 ITR III. But the learned counsel for

the assessee relied on TERLA VEERAIAH Vs. COMMISSIONER OF Income Tax, A.P., in support of his argument that the interest paid

should be treated as payment to the HUF. We are of the view that that decision does not support the contention of the learned counsel. In that

case, one Terla Parasuramulu, his son, Veeraiah, and grandson, Srisailam, who constituted an HUF, got themselves divided by a partition. After

such partition, the three divided members constituted themselves into a partnership firm. Parasuramulu died on January 9, 1969. The partnership

continued even after his death. For the accounting years relevant to the assessment year 1970-71 and 1971-72, there were two accounts in the

partnership firm. One account was relating to Veeraiah as a partner of the firm. This account was styled as Terla Veeraiah (HUF) account. This

Veeraiah, being the sole legal heir of the deceased, Parasuramulu, became entitled to whatever amount that the deceased was entitled to from the

firm. The amount payable to Parasuramulu was credited to an account styled as ""Terla Veeraiah''s Individual account"". The account credited to

Terla Veeraiah''s HUF"" account represented the interest paid to Veeraiah as partner. The amount credited to Terla Veeraiah''s individual account

represented the interest payable to Parasuramulu and inherited by Veeraiah. The ITO disallowed both these amounts under s. 40(b). The

disallowance of the amount paid to Terla Veeraiah as partner and credited to Terla Veeraiah''s HUF account was not disputed and the dispute

related only to the amount credited to the account, Terla Veeraiah''s individual account, representing the interest payable to Parasuramulu. It was

contended on behalf of the department that since subsequent to the death of Parasuramulu, Veeraiah was continued as partner and the interest was

paid to Veeraiah, it was also governed by s. 40(b). That was rejected by the Andhra Pradesh High Court holding that the amount received by

Veeraiah was not in his capacity as karta representing the HUF in which capacity alone he was a partner, but it was received by him as a legal

representative of the deceased, Parasuramulu. The decision, therefore, is based on the fact that the interest in dispute was payable to the share of

the decease partner, Parasuramulu, which was received by the legal representatives and that, strictly, it was not a payment to a partner as the

interest accrued related to a period subsequent to the death of the deceased. In other words, the view of the Andhra Pradesh High Court was that

the amount received by Veeraiah which was disputed did not belong to the HUF as the karta of which he was a partner. In the circumstances,

therefore, it was purely rested on the facts in that case and no principle of low could be detected so as to make it applicable to the present case.

The other decision relied on by the learned counsel for the assessee is the one in Additional Commissioner of Income Tax Vs. Vallamkonda

Chinna Balaiah Chetty and Co., . That was a case, where the karta of an HUF was a partner in a partnership firm. In the partnership deed, there

was no stipulation as to investment of a capital by any of the partners. The joint family had advanced certain monies to the partnership in which the

karta was a partner. In respect of those advances certain interest amounts were paid. The department sought to disallow these payments in the

assessment of the firm. The court held that since that amount did not represent the interest paid on the capital contribution by the karta or any

amount advanced to the partnership by the partners, but it was advanced by the HUF as such, s. 40(b) is not applicable. In other words, though

the karta was a partner, the HUF which advanced the money was treated as a separate person and creditor and the interest was paid. That

decision also, therefore, is not applicable to the facts of the instant case. The decision in Commissioner of Income Tax Vs. Sanka Sankaraiah, ,

referred to by the learned counsel for the assessee related to the assessment of an HUF under s. 64. The Andhra Pradesh High Court held that

unless the assessee is an individual, s. 64 could not be applied. That decision has no application to the facts in this case.

The payment of interest to the said two partners were, therefore, rightly disallowed under s. 40(b). The question is accordingly answered in the

affirmative and against the assessee. The revenue will be entitled to its costs. Counsel''s fee Rs. 500.