Shenbagam Auto Works and Another vs Commissioner of Income Tax

N.V. Balasubramanian, J.—At the instance of the assessee, the following five questions of law have been referred to us for the assessment

year 1981-82 for our opinion :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest paid to the partners representing

the smaller Hindu undivided families, should be disallowed u/s 40(b) of the Income Tax Act, 1961 ?

Whether the Tribunal was right in holding that the decisions of the Madras High Court in Venkatesh Emporium Vs. Commissioner of Income

Tax, Tamil Nadu, and T.M.N.M. SOMASUNDARA NADAR SONS Vs. COMMISSIONER OF Income Tax, TAMIL NADU-IV., , relied

on by the assessee were not applicable to the assessee''s case ?

Whether the Appellate Tribunal had any material to come to the conclusion that the Hindu undivided family (minors) were not creditors of the

assessee ?

Whether the Appellate Tribunal was right in its inference that the details furnished in the statement of accounts of the assessee-firm did not reveal

that the Hindu undivided family (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 ?

Whether the Tribunal had not erred in holding that there was nothing on record to show that the payments disallowed u/s 40(b) had been paid to

the respective Hindu undivided family (minors) as different entity altogether ?

There were two firms by name Shenbagam Auto Works, Madurai, and Shenbagam Tractors, Madurai. One R. Ratnasabai was a partner in

Shenbagam Auto Works and one Sri P. V. Parthasarathy was a partner in both the firms representing their bigger Hindu undivided families. For

the assessment year 1981-82, the firm paid interest to the partners on several accounts, viz., Hindu undivided family (major), individual and Hindu

undivided family (smaller Hindu undivided family). The firm, while returning the income for the said assessment year, added back the interest paid

to the partners in respect of the Hindu undivided family (major) and individual accounts. The Income Tax Officer, while computing the income of

the assessee-firm, invoked the provision of Section 40(b) of the Income Tax Act, and disallowed the interest paid to the smaller Hindu undivided

family. A sum of Rs. 5,663 paid to Sri Ratnasabai and Rs. 1,419 paid to Sri P. V. Parthasarathy in the case of Shenbagam Auto Works, Madurai,

were disallowed by the Income Tax Officer, and in the same manner, he disallowed the interest paid to the smaller Hindu undivided family in the

other firm.

The assessee carried the matter in appeal before the Commissioner of Income Tax (Appeals). The Commissioner of Income Tax (Appeals)

found that the smaller Hindu undivided families were different entities and the disallowance made by the Income Tax Officer u/s 40(b) of the Act

was not justified, and, directed the Income Tax Officer to allow interest paid to the smaller Hindu undivided families which was no doubt

represented by the same karta of the bigger Hindu undivided family in the firm, but, in a different capacity. The Revenue preferred an appeal

challenging the order of the Commissioner of Income Tax (Appeals). 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 Hindu undivided family or smaller Hindu undivided family and that the provisions of

Section 40(b) of the Act were correctly invoked by the Income Tax Officer, 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 law set out earlier.

Mr. P. P. S. Janarthana Raja, learned counsel for the assessee, submitted that the order of the Appellate Tribunal is erroneous as the Tribunal

proceeded on the wrong assumption that the karta of the smaller Hindu undivided family was a partner in the firms and the smaller Hindu undivided

family was only a creditor as the monies have been deposited by the smaller Hindu undivided family. Learned counsel for the Revenue, on the

other hand, submitted that the members of the smaller Hindu undivided families were also members of the bigger Hindu undivided families and the

interest paid to the karta was paid to him, in his representative capacity and, therefore, the provisions of Section 40(b) of the Act are applicable to

the facts of the case.

We have carefully considered the rival submissions. In our opinion, the questions have to be considered in the light of the provisions of Section

40(b) of the Act and the Explanation introduced in the said section. Section 40(b) of the Act provides that in the case of any firm, any payment of

salary, interest, bonus, commission or remuneration made by the firm to any partner of the firm shall be disallowed in computing the income

chargeable under the head ""Profits and gains of business or profession."" An Explanation was introduced to Section 40(b) of the Act by the

Taxation Laws (Amendment) Act, 1984. The Supreme Court in the case of Brij Mohan Das Laxman Das Vs. Commissioner of Income Tax,

Allahabad, , held that Explanation 2 to Section 40(b) of the Act, with which we are concerned, is declaratory in nature and would apply even for

periods prior to April 1, 1985, on which date Explanation 2 to Section 40(b) was inserted. The said Explanation has full retrospective effect and

under the said Explanation 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) of the Act. In other words, Section 40(b) of the Act would apply only where the interest was paid by the firm to the

individual as a partner when he is in a representative capacity.

We have seen the facts of the case and they clearly show that it was the bigger Hindu undivided family which was a partner and the karta of the

said family was representing the bigger Hindu undivided family in both the firms. Therefore, it can be said that he was a partner in a representative

capacity representing the bigger Hindu undivided family in the two firms. On the other hand, the smaller Hindu undivided family was not a partner in

the firm and the karta of the smaller Hindu undivided family, though he happened to be the karta of the bigger Hindu undivided family, was not

representing the smaller Hindu undivided family in the firm as a partner. In other words, his representative capacity was different and the amounts

deposited by the smaller Hindu undivided family were deposited in the character of the creditor. u/s 40(b) of the Act if interest amount was

received by him otherwise than in the capacity of the partner the provisions of Section 40(b) of the Act cannot be invoked. It may be true that

some of the members are common in both the families, but under the Income Tax law both the joint families are different taxable entities and

because some of the members are common in both the families that would not make both families one unit and it cannot also presume that the karta

was representing the smaller Hindu undivided family as a partner. His capacity is different. In our view, the provision of Section 40(b) of the

Income Tax Act does not apply to the facts of the case.

We are of the opinion that in view of the clear language employed in Explanation 2 to Section 40(b) of the Act and in view of the finding that

only the bigger Hindu undivided family was a partner in the two firms, there is no scope for application of the provisions of Section 40(b) of the

Act, in so far as the interest paid by the firm to the karta of the smaller Hindu undivided family, is concerned. In our view, the view of the Appellate

Tribunal that the provisions of Section 40(b) of the Act are attracted is erroneous.

There are five questions that have been referred to us raising different facets of the same question regarding the applicability of Section 40(b) of

the Act and we consolidate all the questions of law referred to us as a single question and question No. 1, as framed would take in all aspects. We

reframe the questions referred to us as under :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest paid to the partners representing the

smaller Hindu undivided families should be disallowed u/s 40(b) of the Income Tax Act, 1961 ?

Our answer to the question is in the negative, in favour of the assessee and against the Revenue. The assessee is entitled to costs of Rs. 750.