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PETITIONER: M/S BRIJ MOHAN DAS LAXMAN DAS

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX, AMRITSAR

DATE OF JUDGMENT:       10/12/1996

BENCH: B.P. JEEVAN REDDY, K.S. PARIPOORNAN

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T B.P. JEEVAN REDDY, J.      Clause  (b)  of  Section  40  of  the  Income  Tax  Act specifies one  of the amounts which shall not be deducted in computing the  income chargeable under the head "Profits and gains of  business  or  profession".  As  it  stood  at  the relevant time, It read thus:      "40 Notwithstanding anything to the      contrary in  sections 30 to 39, the      following  amounts   shall  not  be      deducted in  computing  the  income      chargeable under  the head  ‘Profit      and   gains    of    business    or      profession’,-      (b) in  the case  of any  firm, any      payment of interest, salary, bonus,      commission or  remuneration made by      the firm  to  any  partner  of  the      firm.      Explanation 1:  Where  interest  is      paid by  a firm  to any  partner of      the firm who has also paid interest      to the firm, the amount of interest      to be  disallowed under this clause      shall be  limited to  the amount by      which the  payment of  interest  by      the firm to the partner exceeds the      payment of  interest by the partner      to the firm.      Explanation 2:  Where an individual      is a  partner in  a firm on behalf,      or for  the benefit,  of any  other      person [such  partner and the other      person being  hereinafter  referred      to as  ‘partner in a representative      capacity’     and     person     so      represented’ respectively],-      (i) interest  paid by  the firm  to      such   individual    or   by   such      individual to  the  firm  otherwise

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    than as partner in a representative      capacity, shall  not be  taken into      account for  the purposes  of  this      clause;      (ii) Interest  paid by  the firm to      such individual  or by  the firm to      the   firm    as   partner   in   a      representative     capacity     and      interest paid  by the  firm to  the      person so  represented  or  by  the      person so  represented to the firm,      shall be taken into account for the      purposes of this clause.      Explanation 3:  Where an individual      is a  partner in  a firm  otherwise      than as partner in a representative      capacity, interest paid by the firm      to such  individual  shall  not  be      taken into account for the purposes      of this clause, if such interest is      received by  him on  behalf, or for      the benefit, of any other person."      The first  and the  main  question  arising  herein  is whether interest  paid to a partner on the amounts deposited by him individual deposited by him in individual capacity is hit by  clause (b) where the partner is a partner not in his individual capacity  but as  representing a  Hindu Undivided Family [H.U.F.]  The question  which  was  referred  by  the Tribunal for  the opinion  of the  High Court in this behalf read:      "Whether the  Tribunal was  correct      in allowing  the  assessee’s  claim      for interest  paid  on  the  credit      balance in  the individual  account      of Sri Rajendra Kumar ?"      The  assessee,   Brij  Mohan   Das  Laxman  Das,  is  a registered partnership  firm having  three partners.  One of them is Rajendra Kumar. He was a partner as the Karta of and representing his  H.U.F. The partnership firm maintained two accounts in  the name  of Rajender  Kumar, a capital account and a deposit account. The share of profit of Rajendra Kumar was credited  to the capital account while the interest paid to him  on the  deposits made  by him  was credited  to  his deposit account.  In other  words, the deposits were said to have been  made by Rajendra kumar in his individual capacity and accordingly  interest was  paid to him in his individual capacity. Rajendra  Kumar was  assessed  in  the  status  of individual  and  also  in  the  status  of  H.U.F.  For  the Assessment Year  1974-75, the Income Tax Officer called upon the assessee herein to show cause why the interest amount in a sum of Rs.7,923/- paid to Rajendra Kumar be not added back to the income of the partnership firm since it was a payment made to  a partner.  The appellant-assessee  contended  that since  the   amount  was  paid  to  Rajendra  Kumar  in  his individual capacity  and not  in his  capacity as a partner, the said  payment cannot  be disallowed  under clause (b) of Section 40.  This pals  was rejected  by    the  Income  Tax Officer and his view was affirmed in appeal by the Appellate Assistant Commissioner.  On  further  appeal,  however,  the Tribunal agreed  with the  assessee  and  deleted  the  said addition.      On reference, the High Court held following its earlier decision in  Commissioner of  Income Tax v. London Machinery Company [(1979)  117 I.T.R. 111] that the amount was rightly disallowed by  the Income  Tax Officer and that the Tribunal

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was not  right in  allowing the  assessee’s appeal. The High Court has, however, certified the case under Section 261.      It may  be mentioned that Explanations 1,2 and 3 to the above clause  were added  by the  Taxation Laws  [Amendment] Act, 1984  with  effect  from  April  1,  1985.  Explanation expressly that where an individual is a firm on behalf of or for the  benefit of  any other  person, any interest paid by the firm  to such  individual otherwise  then as  partner in representative capacity, shall not be taken into account for the purpose  of clause (b). It is, therefor, clear that with effect from  April 1,  1985,  the  question  of  the  nature involved herein would not arise. Where a person is a partner in a  representative capacity, i.e., as representing H.U.F., any interest paid to him in him individual capacity will not be hit  by clause  (b) The  only question  is  what  is  the position earlier  to April 1, 1985 - which is the case here. Prior to the introduction of the said Explanation, there was a conflict  of opinion amount the several High Courts in the Country, the  majority of  High Courts  taking the  view  in favour of  the assessee  and a  few High  Counts taking  the contrary view. There was no decision of the Supreme Court on this question.  The  Taxation  Laws  [Amendment]  Act  which introduced the  said Explanation  does not say that the said Explanation shall  have effect retrospectively. The question is whether  the said  Explanation is  merely declaratory and clarificatory in  nature, in  which case  it will govern the previous  assessment   years  as   well  or   whether  is  a substantial provision having effect only prospectively.      In Gajanand  Poonam Chand v. Commissioner of Income Tax [Tax [(1984)  174 I.T.R.346],  the Rajasthan  High Court has taken  the   view  that   the  said  Explanation  is  merely declaratory in  mature and  that, therefore,  even  for  the assessment years  prior to April 1, 1985 the position of law should be  understood 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 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 on 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  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  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 recognition of  the basic  nature of  relationship between a firm and  its partner.  In  Commissioner  of  Income  Tax  v

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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  a  collective      noun, a  compendious expression  to      income-tax law, a firm is a unit of      assessment, by  special provisions,      but is  not  a  full  person  which      leads to the next step that since a      contract of employment requires two      distinct persons  viz. the employer      and the employee, there cannot be a      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  as  a  reward  for  the      human capital  brought in.  Section      13 of  the Partnership  Act  brings      into   focus    this    basis    of      partnership business."      This Court  also quoted  with approval the passage from Lindley 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 he be employer." The  provisions in  Chapters III  and IV  of  the Partnership Act  amply  define  and  delineate  the  duties, obligations 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 law preclude an individual, who  is a  partner representing  a H.U.F.,  from depositing his  personal  funds  with  the  partnership  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. Accordingly, we  hold that  even for  the period anterior to April 1,  1985, any  interest paid  to a  partner, who  is a partner representing  his H.U.F.,  on  the  deposit  of  his personal/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  declaratory  in  nature. Accordingly, 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. No costs.

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