Judgment

Gokal Chand Mital, J.

1. The assessee is a registered firm. During the accounting year relevant to the assessment year 1981-82, it got interest amounting to Rs. 1,62,410 from the partners on the withdrawals made by them in the current account. The partners had made deposits with the firm and on those deposits during that period, they were paid interest amounting to Rs. 1,08,287. During the assessment, the Income-tax Officer added back interest of Rs 1,,08,287 as, under Section 40(b) of the Income-tax Act, 1961 (hereinafter referred to as "the Act"), deduction of interest paid to the partners could not be allowed. The assessee obtained some relief from the Commissioner of Income-tax (Appeals). On further appeal to the Income-tax Appellate Tribunal (for short "the Tribunal"), Delhi, the assessee got the entire relief in regard to the interest of Rs. 1,08,287 paid to the partners, in view of certain decisions referred in the order. In this background, the following question has been referred for the opinion of this court :

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in deleting the addition of Rs. 1,08,287 as interest paid to partners under Section 40(b) of the Income-tax Act, 1961 ?"

2. Section 40(b) as it stood during the assessment year in question was as follows :

"40. Notwithstanding anything to the contrary in Sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head Profits and gains of business or profession :-

- . . . (b) in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm."

3 The aforesaid provision came up for consideration before four High Courts in the following cases and on similar facts, it was held that only the net amount paid by the firm to its partners, after adjusting the interest paid by the partners to the firm, can be disallowed under Section 40(b) of the Act and not the whole of it.

(i) CIT v. Kailash Motors [1982] 134 ITR 312 (All).

(ii) CIT v. T. V. Ramanaiah and Sons [1986] 157 ITR 300 (AP).

(iii) CIT v. Kothari and Co. [1987] 165 ITR 594 (Kar).

(iv) CIT v. Mould Ramjiwan and Co. [1988] 171 ITR 294 (Raj).

4. However, a contrary view has been taken by the Madras High Court in CIT v. O. M. S. S. Sankaralinga Nadar and Co. [1984] 147 ITR 332.

5. By the Taxation Laws (Amendment) Act, 1984, three Explanations were inserted to Section 40(b) of the Act, and they came into force with effect from April 1, 1985 and Explanation 1 which is relevant for our purpose is as follows :

"Explanation 1.--Where interest is paid by a firm to any partner of the firm who has also paid interest to the firm, the amount of interest to be disallowed under this clause shall be limited to the amount by which the payment of interest by the firm to the partner exceeds the payment of interest by the partner to the firm."

6. This Explanation is in tune with the decision rendered by four High Courts referred to on behalf of the assessee. After insertion of the Explanation 1, the question cropped up before the Central Board of Direct Taxes as to whether the Explanation would be applicable prospectively or was merely of a clarificatory nature and would also be applicable for earlier years in cases which may be pending in courts. The Central Board of Direct Taxes took a decision favouring the assessee, which is printed in [1984] 149 ITR (St.) 127. The relevant para of the Boards decision which is concerned with the decision of this case is as follows :

"(2) A number of amendments have been made to bring out the legislative intention more clearly so that further controversy and litigation regarding the true intent and purport of these provisions is avoided. To illustrate ; (a) It has been clarified that in cases where a firm pays interest to a partner as well as receives interest from him, only the net amount paid by the firm to the partner will be disallowed under Section 40(b) of the Income-tax Act in computing the income of the firm."

7. Explanation 1 which came into effect from April 1, 1985, needed no clarification and the net amount, if any, paid to a partner, could be disallowed but if the result was that the amount paid by the partner to the firm was more than the amount paid by the firm to the partner, then the amount of interest paid by the firm to the partner could not be disallowed. When this provision was so clear with effect from April 1, 1985, there was no question of issuing any clarification by the Central Board unless it was considered that the Explanation 1 was of a clarificatory nature and would apply to the assessment years even before the Explanation 1 came into force. The High Courts of Allahabad, Andhra Pradesh, Karnataka and Rajasthan, in the aforesaid judgments, have taken the view that the decision of the Board is of a clarificatory nature and the amendment would be applicable to the assessment years prior to April 1, 1985. However, the Madras High Court in O. M. S. S. Sakaralinga Nadar and Co.s case [1984] 147 ITR 332 took a different view. On this matter, we have held in Income-tax Reference No. 43 of 1981 (Hindustan Steel Forgings v. CIT [1989] 179 ITR 280 (P&H)), decided on March 2, 1989, that the aforesaid decision of the Board is of a clarificatory nature and what was hidden was made apparent. There, we were considering the effect of Explanation 2.

8. The circulars issued by the Board are not binding on courts because if the assessee wants to challenge its correctness, it is open to him to do so. But at the same time, the Supreme Court has held in numerous cases that the circulars issued by the Board are binding on the Department, and the Department cannot be allowed to raise arguments opposed to the decision of the Board. In this case, we have to give effect to the circular referred to above, as it favours the assessee and would bind the Department.

9. In view of our earlier decision and the decision of the four High Courts in favour of the assessee on the point regarding the circular, we agree with the judgment referred to on behalf of the assessee and dissent from the decision rendered by the Madras High Court, and hold that only the net amount paid by the firm to its partners after adjusting the interest paid by the partners to the firm can be disallowed under Section 40(b) of the Act Since in this case the partners had paid more interest to the firm, the interest paid by the firm to the partners was rightly not disallowed by the Tribunal and the Tribunal was right in deleting the addition and we answer the referred question in favour of the assessee, in the affirmative, with no order as to costs.