1988 (5) TMI 24 - HC - Income Tax

Summary

Issues Involved:
1. Disallowance of interest u/s 40(b) of the Income-tax Act, 1961.
2. Applicability of section 40(b) to interest paid to a partner in a different capacity.

Summary:

Issue 1: Disallowance of interest u/s 40(b) of the Income-tax Act, 1961

The Tribunal referred a common question of law for the assessment years 1974-75, 1978-79, and 1979-80 regarding the disallowance of interest paid by the assessee-firm to Poonam Chand in his individual capacity, distinct from his capacity as the karta of his Hindu undivided family (HUF). The Income-tax Officer disallowed the interest u/s 40(b), and this view was upheld by the Commissioner of Income-tax (Appeals) and the Tribunal. The High Court needed to determine if section 40(b) applied to interest paid to an individual partner distinct from his representative capacity as karta of an HUF.

Issue 2: Applicability of section 40(b) to interest paid to a partner in a different capacity

The High Court examined whether section 40(b) should be construed to disallow interest paid to an individual partner in a distinct capacity from his representative role as karta of an HUF. The Court noted that section 40(b) as it stood during the relevant assessment years did not include the Explanations inserted by the Taxation Laws (Amendment) Act, 1984, effective from April 1, 1985. The Court considered whether these Explanations were merely clarificatory of the existing law or introduced new provisions. The Court concluded that Explanation 2 was declaratory of the existing law, clarifying that interest paid to an individual in a capacity other than as a partner in a representative capacity does not attract the prohibition in section 40(b).

The Court referred to the definition of "person" in section 2(31) of the Act, which treats an individual, an HUF, and a firm as distinct entities. The Court found no requirement in section 40(b) to obliterate the distinction between these entities. The Court cited several High Court decisions supporting the view that interest paid to a partner in a different capacity is not disallowed u/s 40(b). The Court disagreed with contrary views from the Patna, Karnataka, and Allahabad High Courts, which did not recognize the dichotomy in the personality of an individual for the purposes of section 40(b).

Conclusion:

The High Court concluded that the Tribunal was not justified in holding that the interest paid to Poonam Chand in his individual capacity was disallowed u/s 40(b). The questions were answered in favor of the assessee and against the Revenue. No costs were awarded.