Anandilal Jain Vs. Commissioner of Income Tax, Bihar-Ii  INSC 275 (10 March 1997)
V. MANOHAR, K. VENKATASWAMI
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
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
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.
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 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.
have heard counsel on both sides.
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.
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
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
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 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.
(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.
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.
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 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
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.
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".
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