http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 4  

PETITIONER: M/S. SUWALAL ANANDILAL JAIN

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX.BIHAR-II. RANCHI

DATE OF JUDGMENT:       10/03/1997

BENCH: SUJATA V. MANOHAR, K. VENKATASWAMI

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T K.Venkataswami J.      The question that has been referred to this Court under Section 257  of the Income Tax Act, 1961 (hereinafter called "the Act") reads as follows :-      "Whether   on    the   facts    and      circumstances  of   the  case,  the      assessee’s claim  to the benefit of      clause (b)  of Section  40  of  the      Income  Tax   Act.  1961  has  been      rightly disallowed?".      The assessment year in question is 1976-77. The case of the assessee  firm was  that M/s.  Shanti Kumar  Jain, Ashok Kumar Jain, Raj Kumar Jain and Niranjan were partners in the firm in their capacity as karta of respective HUF. They have advanced monies  to the  assessee firm  in their  individual capacity. The  assessee firm in their individual investments made in  their respective  individual capacity.  It  is  the further case of the assessee firm that it has maintained two separate ledger  accounts of the partners; one of individual as loan  creditor and  another of Karta of HUF as partner in the  firm.  The  source  of  the  money,  according  to  the assessee, quite separate. The assessee firm claimed that the interest paid  to them shall not be included while computing the income  chargeable under  head  "profits  and  gains  of business or  profession". Notwithstanding  such claims,  the Income Tax  Officer applied  Section 40(b)  of the  Act  and completed the  assessment by   Order  dated  29.1.1978.  The result was  that the  interest paid  to the  partners in the circumstance stated  above  was  included  under,  the  head "profits and gains of business or profession".      On appeal  to the Appellate Assistant Commissioner, the assessment  was   confirmed  by  an  Appellate  Order  dated 27.8.1980. Still  aggrieved,  the  assessee  firm  preferred further appeal  to the  Income Tax  Appellate Tribunal.  The Tribunal relaying  upon an  unreported decision of the Patna High Court in Tax Case No. 83-84 of 1971 in the case of M/s. Makhan Lal Harnarayan vs. Commissioner of Income Tax. Bihar, confirmed the  view taken  by the  Income  Tax  Officer  and upheld by  the Appellate  Assistant Commissioner. In view of

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 4  

the  divergence  of  views  among  the  High  Court  on  the application of  Section 40(b) of the Act, the issue has been referred to this Court.      We have heard counsel on both sides.      Under identical  circumstance, this  Court in  M/s Brij Mohan  Das  Laxman  Das  vs.  Commissioner  of  Income  Tax, Amritsar (JT  1997 (1)  SC 155)  had occasion to consider an identical issue.  Jeevan Reddy  J. Speaking  for  the  Bench after noticing  the subsequent  amendment to  section 40  by Taxation Laws  (Amendment) Act, 1984 under which Explanation (2) inter alia has been added, has observed as follows:-      In  Gajanand   Poonam   Chand   vs.      Commissioner of  Income  Tax  (1984      174 I.T.R.346),  the Rajasthan High      Court has  taken a  view  that  the      said    Explanation    is    merely      declaratory  in  nature  and  that,      therefore, even  for the assessment      years prior  to April  1, 1985, the      position of  law  should  be  under      stood to be the same. In support of      this proposition,  the  High  Court      relied   upon    the   fact    that      ordinarily  the   purpose   of   an      Explanation  is   to  clarify  that      which is already enacted and not to      introduce something  new. The  High      Court opined  that the  Explanation      was inserted by the Parliament with      a view to settle the controversy as      to the  meaning and  effect of  the      said clause  among the several High      Courts  and  that  the  Explanation      puts a seal of approval on the view      taken by  the majority  of the High      Courts.   The   High   Court   also      referred  to   the  definition   of      "person" in  clause (31) of section      2.  It     pointed   out  that  the      definition shows  clearly  that  an      individual, a H.U.F. and a firm are      distinct persons/entities  for  the      purpose of  the Income Tax Act. The      High  Court,  therefore,  concluded      that  since  an  individual  and  a      H.U.F. are  two  distinct  entities      for the  purpose of the Act. Clause      (b)   of    Section   40   has   no      application where  the interest  is      paid to  the  partner  on  deposits      made by  him with  the firm  in his      individual  capacity   where   such      person is  a  partner  not  in  his      individual    capacity    but    as      representing  a   H.U.F.  Sri  G.C.      Sharma,  learned  counsel  for  the      appellant-assessee, strongly relies      upon this  decision and commends it      for our acceptance. Learned counsel      points out  that  even  before  the      enactment    of    Taxation    Laws      (Amendment)  ACT,   1984  (   which      inserted Explanation  2 aforesaid),      a majority  of the  High Courts  in      the country had taken the same view

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 4  

    though   a few  High Courts  in the      country had  taken  the  same  view      though a  few High  Courts have  no      doubt taken a contrary view. Looked      at from any angle, sri sharma says,      the  issue   must  be  answered  in      favour of the assessee.      Clause (b)  of Section  40 is based      upon and is a resconginition of the      basic   nature    of   relationship      between  a firm and its partner. In      Commissioner  of   Income  Tax  vs.      Chidambaram  Pillai  (  (1977)  106      I.T.R. 292), this Court observed:-      "Here the  first thing that we must      grasp is that a firm is not a legal      person  even  though  it  has  some      attributes     of      personality.      Partnership is  a certain  relation      between  persons,  the  product  of      agreement to share the profits of a      business.  ’Firm’   is   collective      noun, a  compenditous expression to      designate an  entity, not a person.      In Income-tax law, a firm is a unit      of    assessment,     by    special      provisiors,  but   is  not  a  full      person which  leads t the next step      that since a contract of employment      requires two  distinct persons viz,      the  employer   and  the  employee,      there cannot  be a  contract of the      service. in  strict law,  between a      firm and  one of  its partners.  So      that any agreement for remuneration      of a partner for taking part in the      conduct of  the  business  must  be      regarded as  portion of the profits      being made over as a reward for the      human capital  brought in.  Section      13 of  the  patnership  Act  brings      into   focus    this    basis    of      partnership business."      This   Court   also   quoted   with      approval the  passage from  Lingley      on the  law of  Partnership to  the      effect: In  point of law, a partner      may be  the debtor  or the creditor      of his  co-partners, but  he cannot      be either debtor or creditor of the      firm  of  which  he  is  himself  a      member, nor  can be  employed y his      firm, for  a man  cannot be his own      employer".   The    provisions   in      Chapters  III   and   IV   of   the      Partnership Act  amply  define  and      delineate  the  duties,  obligation      and rights  of the  partners vis-a-      vis  the  firm.  The  question  yet      remains where  an individual  is  a      partner in  one capacity, e.g. as a      representative of  another  person,      can he  have no other capacity vis-      a-vis  the   firm.  To   be   more,      precise.does the  above position of

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 4  

    law preclude an idividual. Who is a      partner represeting  a H.U.F.  from      depositing his  personal funds with      the   patnership    and   receiving      interest  thereon?   Explanation  2      says in  clear terms  that there is      no   such    bar.   This   is   the      legislative  recognition   of   the      theory of  different capacities  an      individual  may   hold-  no   doubt      confined to  clause (b)  of Section      40. Once  this is  so,  we  see  no      reason to  hold that this theory of      different capacities  is not  valid      or   available   for   the   period      anterior   to    April   1,   1985.      According, we  hold that  even  for      the period  anteriror to  April  1,      1985,  any   interest  paid   to  a      partner,   who    is   a    partner      representing  his   H.U.F.  on  the      deposit    of     his    personally      individual  funds,  does  not  fall      within the  mischief of  clause (b)      of Section  40. In this view of the      matter we agree with the view taken      by  the  Rajasthan  High  Court  in      Gajanand   Poonam   chand      that      Explanation 2  in  the  context  of      clause  (b)   of  Section   40   is      declarateory in  nature. According,      we allow this appeal, set aside the      judgment  of  the  High  Court  and      answer the  question referred under      Section  256  in  the  affirmative,      i.e. in  favour of the assessee and      against the Revenue".      In view of the above pronouncement of this Court. we do not  think   that  this   question  requires   and   further elucidation. According the question is answered in favour of the assessee and against the Revenue. There will be no order as to costs.