1984 (4) TMI 40 - HC - Income Tax

Summary

Issues Involved:
1. Disallowance of interest paid to a partner u/s 40(b) of the I.T. Act, 1961.
2. The capacity in which a partner represents in the firm (individual vs. HUF).
3. The relevance of the partner's representative character for tax assessment.

Summary:

Disallowance of Interest Paid to a Partner u/s 40(b):
The primary issue revolves around the disallowance of interest paid to Shri C. S. Virani, both in his individual capacity and as a representative of the HUF, by the firm for the assessment years 1970-71 and 1971-72. The ITO disallowed these payments under s. 40(b) of the I.T. Act, 1961. The Tribunal confirmed this disallowance, leading to the reference to the High Court.

The Capacity in Which a Partner Represents in the Firm:
The court examined whether the interest paid to Shri C. S. Virani in his individual capacity should be disallowed when he was a partner representing the HUF. The court noted that while s. 40(b) disallows interest payments to a partner, it is crucial to distinguish between the partner's individual capacity and his representative capacity. The court emphasized that the Revenue must consider the real character of the partner, i.e., whether he is acting in his individual capacity or as a representative of the HUF.

The Relevance of the Partner's Representative Character for Tax Assessment:
The court highlighted that the Revenue is not precluded from recognizing the representative character of a partner. If a partner represents a HUF, any interest paid to his individual account should not be disallowed under s. 40(b) as it is not paid to him qua partner but as a stranger. The court pointed out that treating interest paid to the individual account of a partner representing a HUF as disallowable would lead to an illogical and unsustainable approach.

Conclusion:
The court concluded that the interest paid to Shri C. S. Virani in his individual capacity should not be disallowed under s. 40(b) of the I.T. Act, 1961, as he was a partner representing the HUF. The earlier decision in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654 was overruled. The question referred to the court was answered in the negative, in favor of the assessee and against the Revenue.