JUDGMENT

1. - This reference under section 256(1) of the Income-tax Act, 1961, at the instance of the Revenue, is to answer the following question of law, namely :

"Whether, on the facts and in the circumstances of the case, and on a correct interpretation of the provisions of section 40(b) of the Income-tax Act, 1961, only the net and not the gross amount of interest paid to each of the partners in the instant case shall be deducted in computing the assessee-firm's income chargeable under the head "Profits and gains of business" for the accounting period relevant to the assessment year 1978-79 ?"

2. The relevant assessment year is 1978-79 for which the accounting period ended on November 11, 1977. The assessee is a partnership firm comprising of six partners. The books of the assessee contained the capital account of each of the partners as well as the account showing withdrawals made by the parties. In respect of the credit entries in favour of each partner, the assessee-firm paid interest and had also charged interest in respect of the debit entries of each of these partners. The total amount of interest paid by the assessee-firm to its six partners amounted to Rs. 25,226 while the interest received from the assessee-firm from these six partners amounted to Rs. 16,769. The assessee claimed that only the difference between these two amounts, i.e., Rs. 8,457 was required to be added in accordance with section 40(b) of the Act and not the gross amount of interest. The Income-tax Officer rejected the contention. However, the Commissioner of Income-tax (Appeals) accepted the assessee's contention and thereafter the Tribunal also upheld the assessee's contention. Hence, this reference at the instance of the Revenue.

3. Admittedly, in the present case, interest paid by the assessee-firm was to the same partner from whom the interest was received and it is only the difference in the amount of interest so paid and received in respect of the same partner that the assessee claims this benefit. This position is clear from the account books and is not in controversy.

4. A direct decision on the point is CIT v. Kailash Motors [1982] 134 ITR 312 (All). It was expressly held therein that only the net amount paid by the firm to its partner, after adjusting the interest paid by the partner to the firm could be disallowed under section 40(b) of the Act. There appears to be some controversy when interest paid by the firm was to one partner, while the interest received from the firm was from another partner of the firm. However, in a case like the present, where interest was paid by the firm to a partner from whom it had received interest, this view of the Allahabad High Court does not appear to have been dissented from in any other decision. No decision taking a contrary view has been cited before us.

5. Learned counsel for the Revenue referred to Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149 (All) , suggesting that this decision of the Allahabad High Court takes the contrary view. It is sufficient to state that in this case reliance was placed on an earlier decision between the same parties reported in [1953] 24 ITR 176, as was done in CIT v. Kailash Motors [1982] 134 ITR 312 (All) for the conclusion reached therein. The decision in Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149 (All) does not deal with the matter at length but the conclusion appears to be consistent with the view taken in CIT v. Kailash Motors [1982] 134 ITR 312 (All) , that the disallowance under section 40(b) of the Act is only of the net amount paid by the firm to its partner after adjusting the interest paid by the partner to the firm. This conclusion is also supported by the fact that in Sri Ram Mahadeo Prasad v. CIT [1953] 24 ITR 176 (All) , the action of the Tribunal in upholding the disallowance only of the net amount, after adjusting the amount of interest paid by the same partner to the firm from the amount of interest received by him, was upheld. The decision is Sri Ram Mahadeo Prasad v. CIT [1979] 120 ITR 149 (All) following Sri Ram Mahadeo Prasad v. CIT[1953] 24 ITR 176 (All) has, therefore, to be construed in this manner only and so construed, it is in line with the decision in CIT v. Kailash Motors [1982] 134 ITR 312 (All) and not in conflict with it.

6. We may also observe that Explanation 1, added in clause (b) of section 40 of the Act, by the Taxation Laws (Amendment) Act, 1984, with effect from April 1, 1985, also supports the construction we have made of clause (b) of section 40. Explanation 1, was apparently inserted merely to declare this meaning of clause (b) and to remove ambiguity, if any, in its construction. The fact that the main enacting part of clause (b) remains untouched by the amendment which has only inserted the Explanation, lends support to the view taken by us. This is an additional reason for the conclusion reached by us. We do not find any reason to differ from the view of the Allahabad High Court cited earlier, which appears to be a construction of clause (b) of section 40.

7. Consequently, the reference is answered against the Revenue and in favour of the assessee by holding that the view taken by the Tribunal is justified.No costs.

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