COMMISSIONER OF INCOME-TAX V VS TEJ CLOTH WEAVING FACTORY
1991 P T D 245
[Punjab and Haryana High Court (India)]
Before Gokal Chand Mital and S.S. Sodhi, JJ
COMMISSIONER OF INCOME-TAX
versus
TEJ CLOTH WEAVING FACTORY
Income-tax Reference No. 71 of 1984, decided on 22/02/1989.
Income-tax---
----Deduction---Interest of borrowed capital---Hindu undivided Family through Kartas partners in assessee-firm---Partial partition of HUFs. on 31-3-1979-- Capital standing to the credit of HUFs. in firm partitioned and transferred to coparceners---Firm treating amounts as loans from coparceners---Interest paid to coparceners claimed as deduction---Partial partition effected after 31-12-1978 not valid after insertion of subsection (9) to S. 171 w.e.f. 1-4-1980---Kartas continued to be partners of firm and contributions continued to be by the Kartas as partners---Did not amount to borrowing of capital by firm from members of erstwhile HUFs---Interest paid to coparceners amounted to interest paid to Kartas of HUFs---Interest paid not allowable deduction---Indian Income-tax Act, 1961, Ss.36(1)(iii), 40(b) & 171(9) [as amended by Finance(No. 2) Act of 1980 w.e.f. 1-4-1980].
Three Hindu undivided families, through their Kartas, were partners in the assessee-firm. On 31-3-1979, there was a partial partition of all the three Hindu undivided families and the capital standing to their credit in the assessee firm was partitioned and was transferred to the coparceners: The coparceners of the Hindu undivided families allowed the amount to remain with the assessee firm. The assessee-firm treated the amount as loan from each of the members according to their share and paid interest on the loans in the accounting year 1979-80 and claimed deduction of the same in the assessment year 1980-81 undersection 36(1)(iii) of the Indian Income-tax Act, 1961. The Income-tax Officer disallowed the claim for deduction as, in view of section 171(9) of the Act, partial partition made after December 31, 1978, had to be ignored and the interest paid was to be treated as having been paid to the partners either in their individual capacity or in the capacity of Karta of the Hindu undivided family, which had to be disallowed by virtue of section 40(b) of the Act. The Commissioner (Appeals) found that the partial partition of the Hindu undivided families was invalid as it was made after December 31, 1978, and held that the income received from the assessee-firm was to be assessed in the hands of the Hindu undivided families and not in the hands of the members of the Hindu undivided families. So far as the assessment of the firm was concerned, the Commissioner held that the provisions of section 171(9) would not apply nor could any restriction be placed on the allowance of interest paid to the various members of the Hindu undivided families on partial partition as they became the creditors of the assessee-firm and the provision of section 36(1)(iii) applied to the case. The Commissioner, accordingly, grave relief to the assessee-firm. The Appellate Tribunal affirmed the order of the Commissioner. On a reference:
Held, that after the insertion of subsection (9) in section 171 by the Finance (No.2) Act, 1980, with effect from. 1-4-1980, partial partition of a Hindu undivided family was not to be recognised and the provisions of the Act applied as if there was no partial partition. If the partition was ignored, the three Kartas continued to be partners of the assessee-firm and the contributions continued to be by the Kartas as partners and there was no question of capital borrowing by the assessee from the members of the erstwhile Hindu undivided families and the question of payment of interest would not arise and section 36(1)(iii) would not be attracted to the case of the assessee-firm. Even if interest had been paid to the coparceners of the three Hindu undivided families, in effect, it would be treated as if interest had been paid to the Kartas of Hindu undivided families who were partners of the assessee-firm and payment of such interest had to be disallowed by virtue of section 40(b) of the Act. Therefore, the Tribunal was not right in upholding the finding of the Commissioner (Appeals) that in spite of partial partition effected on March 31, 1979, which was not valid as per section 171(9) of the Act, the interest paid was an admissible deduction in computing the income of the assessee-firm.
L.K. Sood for the Commissioner.
R.S. Aulakh for the Assessee.
JUDGMENT
GOKAL CHAND MITAL, J.--Tree joint Hindu families through their kartas were partners of Tej Cloth Weaving Factory, the assessee. On March 31, 1979, there was a partial partition of all the three joint Hindu families and the capital standing to their credit in the assessee-firm was partitioned and was transferred to the coparceners. The coparceners allowed the amount to remain with the assessee-firm. The amount was treated as loan from each of the members, according to their share, by the assessee-firm and it paid total interest amounting to Rs. 23,442 in the accounting year 1979-80, and in the assessment year 1980-81 claimed deduction of the aforesaid amount, under section 36(1)(iii) of the Income-tax Act, 1961 (for short "the Act").
The Income-tax Officer did not allow the deductions, as, in view of section 171(9) of the Act, partial partition made after December 31, 1978, had to be ignored and the interest paid was considered as having been paid to the partners either in their individual capacity or in the capacity of karta of the Hindu undivided family, which had to be disallowed by virtue of section 40(b) of the Act. However, on appeal, the Commissioner of Income-tax (Appeals) held the partial partition of the Hindu undivided families to be invalid as it was made after December 31, 1978, but concluded that the assessment of the income received from the assessee-firm would be assessed in tire hands of the Hindu undivided family and not in the hands of the members of the Hindu undivided families. So far as the assessment of the assessee-firm is concerned, it was held that the provision of section 171(9) of the Act would not apply, nor would it place any restriction on the allowance of interest paid to the various members of the Hindu undivided families on partial partition as they became the creditors of the assessee-firm and the provisions of section 36(1)(iii) of the Act would apply. Accordingly, relief was allowed to the assessee-firm.
The aforesaid appellate order was upheld by the Income-tax Appellate Tribunal, Amritsar, and at the instance. of the Revenue, the following question has been referred for the opinion of this Court:
"Whether, on the facts and in the circumstances of the case, the Income tax Appellate Tribunal is right in law in upholding the finding of the Commissioner of Income--tax (Appeals) to the effect that interest payable to various members of the Hindu undivided families after partial partition, with effect from March 31, 1979, which is not valid as per section 171(9) of the Income-tax Act is are admissible deduction in computing the income of the assessee-firm?" .
The assessee-firm has claimed deduction of the interest paid by virtue of section 36(1)(iii) of the Act which reads as under:
"36(1) .....(iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession."
For the applicability of the aforesaid provision, the assessee has to show that the interest paid is in respect of the capital borrowed for the purposes of business. In this case, no amount was borrowed. The three Hindu undivided families which had become partners of the assessee-firm had made business investments. On the alleged partial partition, the amount standing in the names of the Hindu undivided families through the respective kartas was divided and separately shown in the names of the coparceners, and this is being considered by the assessee concern as capital borrowed for the purposes of business and interest paid thereon is being claimed under the aforesaid provision. It has to be seen on the facts of the case, whether the amount which remained with the assessee-firm on behalf of the Hindu undivided family has to be considered as capital borrowing on partial partition or not.
Subsection (9) was inserted in section 171 of the Act by the Finance Act (No. 2) of 1980, with effect from April 1, 1980. The assessment year in question is 1980-81, and it is beyond the pale of controversy that subsection (9) of section 171 of the Act was in force during that year. Subsections (1) to (8) of section 171 of the Act provide for the mode of assessment and the procedure for doing so on the total or partial partition of a Hindu undivided family. By the insertion of subsection (9) in section 171 of the Act, any partial partition after December 31, 1978, is not to be recognised and by virtue of clause (a) thereto, no claim, when partial partition had taken place, shall be inquired into and no finding shall be recorded and if any finding is recorded, the same shall be null and void. Clause (b) to subsection (9) of section 171 of the Act provides that such family shall continue to be liable to be assessed under the Act as if no such partial partition had taken place. Clause (c) to subsection (9) of section 171 of the Act provides that each member or group of members of such family, immediately before such partial partition and the family shall be jointly and severally liable for tax, penalty, interest and fine, or any other sum payable under the Act. Clause (d) provides that the several liability of any member or group of members shall be computed according to the portion of the joint family property allotted to him or it at such partial partition. By no means, is the last sentence after clause (d), which is in the following terms, insignificant:
"and the provisions of this Act shall apply accordingly."
The aforesaid part of subsection (9) of section 171 of the Act, to our mind, is of great significance when read with the remaining provisions of subsection (9). This confirms that partial partition is to be ignored and the provisions of the Act shall apply as if there was no partial partition. If the partition is to be ignored, the three kartas continued to be partners of the assessee-firm and the contributions continued to be by the kartas as partners, and if this is so, there is no question of capital borrowing by the assessee from the members of the erstwhile Hindu undivided families. If it is not a case of capital borrowing, the question of payment of interest will not arise, and even if interest is paid, it would not be on capital borrowing and section 36(1)(iii) of the Act would not come to the aid of the assessee-firm to claim deduction of interest even if paid by it to the members of the respective Hindu undivided families. This would be one of the reasons for disallowing the interest.
Another way of looking at the case would be that since partial partition is to be ignored, the contributions made by the three Hindu undivided families through their kartas would continue to be contributions by the kartas as partners of the assessee-firm. If, on that amount, the assessee-firm pays interest to the kartas who are their partners, the same has to be disallowed by virtue of section 40(b) of the Act, as the payment of interest to a partner is to be disallowed. It would be a contradiction in terms to recognise the division of the contributions made by the three Hindu undivided families amongst its coparceners, when partial partition is to be ignored, which in terms of clause (a) of subsection(9) of section 171 of the Act has to be considered as null and, void. The necessary incident of ignoring the partial partition would be that the investment made by the three Hindu undivided families in the assessee-firm continues to be that of the Hindu undivided families and the kartas of the Hindu undivided families continue to be partners of the assessee-firm. It is nobody's case that the kartas ceased to be the partners of the firm. Therefore, even if in the books of account payment of interest is shown to have been made to the coparceners of the three Hindu undivided families, in effect, it will be taken as if interest has been paid to the kartas of the Hindu undivided families who are partners of the assessee-firm and payment of such interest has to be disallowed by virtue of section 40(b) of the Act.
On behalf of the assessee, an ingenuous argument was raised by Shri Aulakh to the effect that the legal fiction of ignoring partial partition of Hindu undivided family is only limited and for a definite purpose to assessee the family as a Hindu undivided family as if no such partial partition had taken place, and this fiction could not be carried any further while considering the case of the firm, the assessee before us. We are not impressed with the argument. There is no carrying forward of the legal fiction to an extent which-is not permissible by the statute. Subsection (9) of section 171 of the Act itself provides for ignoring the partial partition and for applying the provisions of the Act, as if no partial partition had taken place. The amount standing with the assessee-firm on behalf of the Hindu undivided family would continue to belong to the Hindu undivided family and if this is so, interest paid thereon would be interest paid to the karta as the karta became a partner of the assessee-firm, and payment of interest to such a partner is to be disallowed under section 40(b) of the Act. The other point again becomes necessary to be repeated here to reject the argument, namely, that if partial partition is to be ignored, the amount belonged to the Hindu undivided family and the question of treating that amount as loan for doing business would not arise, with the result that section 36(1)(iii) of the Act would not be applicable.
For the reasons recorded above, we are of the opinion that the interest paid in this case is not allowable under section 36(1)(iii) of the Act and is disallowable under section 40(b) of the Act. Thus, the Tribunal was not right to upholding the finding of the Commissioner of Income-tax (Appeals) that in spite of partial partition effected on March 31, 1979, which is not valid as per section 171(9) of the Act, the interest was an admissible deduction in computing the income of the assessee-firm. The question is answered in favour of the Revenue, in the negative, with no order as to costs.
Z.S./761/T Order accordingly.