1978 (11) TMI 8 - HC - Income Tax

Summary

Issues involved: Interpretation of section 40(b) of the Income-tax Act regarding disallowance of interest paid by a partnership firm to its partners.

Summary:
The High Court of Allahabad considered a case where a partnership firm paid interest to its partners on the balances in the capital account and charged interest from the partners on the debit balances of their current account. The Income Tax Officer (ITO) disallowed the entire amount of interest paid by the firm to its partners in respect of the capital account under section 40(b) of the Income-tax Act for the assessment years 1970-71, 1972-73, and 1973-74. The assessee appealed, and the Appellate Assistant Commissioner (AAC) held that only the net amount paid by the firm to the partner, after adjusting the interest paid by the partner to the firm, could be disallowed under section 40(b, granting relief to the partners accordingly.

The revenue appealed to the Tribunal, which upheld the AAC's view and relied on a previous decision of the court in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176. The Tribunal referred the question of law to the High Court, seeking clarification on whether only the net amount of interest paid to a partner after deducting the interest paid by him could be added to the firm's income under section 40(b) of the Income-tax Act.

In a related case, CIT v. London Machinery Co., the court held that payment of interest to a partner on amounts brought from his Hindu Undivided Family (HUF) or individual funds is within the purview of section 40(b) and hence inadmissible as a deduction. However, following the decision in Sri Ram Mahadeo Prasad, the net amount paid by the firm to its partners alone is disallowable under section 40(b).

Based on these precedents, the High Court answered the question in favor of the assessee, stating that only the net amount of interest paid to a partner after deducting the interest paid by him could be added to the firm's income under section 40(b) of the Income-tax Act. The assessee was awarded costs amounting to Rs. 200.