. - This is a reference under Section 66(2), Income Tax Act. The assessee is a firm carrying on business at Karachi. This firm was constituted under as agreement which, inter alia, recites as follows :
'3. The capitalist partners of the first part shall contribute to the partnership Rs. 1,00,000 (one lac) out of which the partner ship shall pay interest on Rs. 94,900 at the rate of 6 per cent. per annum. The balance of Rs. 5,100 shall not carry any interest. It is optional with the capitalist partners to advance further capital if they so choose in which event the further advances shall carry interest to be borne by the partnership at the same rate as above said.'
During the period of assessment in question the firm paid two sums of Rs. 2,166 and Rs. 5,555 to the capitalist partners as interest on a sum of Rs. 76,000 which remained with it in excess of the sum of Rs. 5,100 which was not to carry interest. Before the Income-tax Collector it was contended that in assessing the taxable income of the firm, the Income-tax Collector was bound to make an allowance for both these items of interest in view of the provision of Section 10, clause (2), sub-clause (iii). He, however, disallowed credit for these items, on the ground that that amount invested by the capitalist partner was not capital borrowed but capital contributed. On appeal the Assistant Commissioner of Income-tax upheld the decision of the Income-tax Collector but gave a small relief to the assessee in so far that he allowed a deduction of Rs. 204-13-0 on the following ground :
'That a sum of Rs. 5,554-0-0 had actually been assessed at Quota for the assessment of the year 1928-29 and 1929-30, as being the amount earned by the capitalist partner in order to obviate double taxation.'
The assessee being dissatisfied with the finding of the Assistant Commissioner asked for a reference to this court, and in submitting the case to this Court, the Commissioner has also taken the same view. He has said :
'The above clause [cl. (iii) referred to above] distinctly says that the capitalist partners shall contribute to the partnership Rs. 1,00,000 which clearly means that they have to invest a sum Rs. 1,00,000 in the firm as capital. The clause does not say that the capitalist partners shall lend to the partnership Rs. 1,00,000. Hence I am of opinion that in this case the sum of Rs. 1,00,000 is not capital borrowed for the purposes of the business but is capital contributed to the partnership; or in other words, invested in the business by one of the partners. Hence the amount of interest is not allowable.'
After discussing the cases of Board of Revenue v. Subramania Chettiar and Bholashar Narsingdas v. Commissioner of Income-tax, the Commissioner has observed :
'These two cases clearly wealth with money lent by a partner beyond the initial capital and not with the initial capital subscribed to the partnership. Hence the Commissioner is respectfully of opinion that interest has been paid in this case not on account of capital borrowed but on account of initial capital subscribed to the partnership by the capitalist partner. It is from this very fact of their having subscribed capital to the partnership that they are designated as capitalist partners.'
Now, there is nothing in sub-clause (iii), Section 10, to suggest that interest paid on the initial capital invested in a firm cannot be the subject-matter of an allowance. In express words clause (iii) provides that only in case where payment of interest is not in any way dependent on the earning of profits and is paid on capital borrowed, it shall be allowed. Where therefore, a capitalist partner advances money to the firm on condition that interest would be paid to him, whether the business of the firm results in profits or not and is in no way made dependent on the profit if any earned, the firm is entitled to claim an allowance for the interest paid on such capital. It is immaterial whether such capital was advanced as initial capital or subsequently. It is also not possible to draw any distinction between capital borrowed and capital contributed. It is only a different way of expressing one and the same thing. Capital contributed by a capitalist partner is capital borrowed from any construction which may be put under cl. (3) of the agreement referred to above the firm was entitled to a deduction in respect of both these items. All that this clause contemplates is that the capitalist partners agree to advance money to the firm to the extent of Rs. 1 lac, in other words, to lend money to the firm to that extent, if and when required, but that with regard to the first sum of Rs. 5,100 they agree not to charge interest and the balance is to carry interest. If money in excess of Rs. 1 lac is required, it is optional with them to advance if they so wish. But the amount advanced by them is nothing more and nothing less than money advanced by them is nothing more and nothing less than money borrowed by the firm.
I would accordingly answer this reference by holding that the firm is entitled to credit for both these items and that their taxable income should be assessed after giving them credit for these two items. The assessee will have costs of this reference. Costs to be taxed in the ordinary way, and in addition to that they will be entitled to the refund of Rs. 100 which they have deposited.