K. Jagannatha Shetty, J.
1. The following question has been referred under s. 256(2) of the Income-tax Act, 1961 (hereinafter referred to as 'the Act'), by the Tribunal, Bangalore :
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that only the net amount of interest paid by the firm to the partner should be disallowed under s. 40(b) in the firm's assessment ?'
2. The assessee is a firm of nine partners. In respect of each partner, two accounts were maintained for the asst. yrs. 1974-75 and 1975-76 in the books of the firm. The first one was a capital account and the second one was drawing account. The firm credited interest on the credit balance of the partners in the capital account and at the same time it charged interest on the debits to the drawing account. The ITO added the full amounts credited to the capital account of the partners without taking into consideration the amount of interest debited to the partners in their drawing account.
3. In the appeal against the assessment for the year 1974-75, the AAC directed the ITO that only the net payment of interest by the firm to the partners should be added back under s. 40(b) of the Act. It may be relevant to state that s. 40(b) provides that in the case of any firm any payment of interest made by the firm to any partner of the firm is not to be deducted.
But in the appeal preferred against the order of assessment for the year 1975-76, the AAC upheld the order of the ITO.
4. Aggrieved by the order of the AAC, the department went up in appeal before the Tribunal in relation to the assessment for the year 1974-75. As against the order of the AAC for the year 1975-76, the assessee went up in appeal before the Tribunal.
The Tribunal, while considering both the appeals, has observed that only the amount of interest paid to each partner during the year has to be added back under s. 40(b).
5. It seems to us that the view taken by the Tribunal is unassailable. Sec. 40(b) provides :
'40. Amounts not deductible. - 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.'
(a) xx xx xx xx (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.'
6. While dealing with the above clause (b) of the section, the Tribunal has observed :
'The claim of the department is that while there is an express provision under s. 40(1) 'prohibiting deduction from the firm's income of any payments by way of interest made by it to the partner, there is no provision in the Act which provides for adjustment of the interest paid by the partners to the firm. While purely hypothetically, no doubt, this is correct, the question is whether where in the case of a single partner, there are both payments by the firm and receipt of interest from the partner, what is the amount of 'payment of interest' made by the firm to the partner. Can the interpretation depend upon the way the firm keeps its accounts or on the correct position of the facts of each case If in this very case the firm had not kept two separate accounts and credited the net interest to one account after considering interest chargeable on drawings in the case of each partner, the net amount of interest only would have been debited to the firm's books. Therefore, to take the view urged by the department would be only to give an advantage to firms who keep the accounts in a particular way while that would be denied to firms, like the present one, which for the sake of convenience, keep separate accounts one for capital and one for drawings of each partner. In our opinion, the words 'payment of interest' referred to in s. 40(b) 'refer to the actual net amount of interest paid to each partner. The interpretation of s. 40(b) could not depend upon a particular way in which interest is accounted for in the books of a firm.'
7. It is clear from the above discussion that if the firm had not kept two separate accounts s. 40(b) would have been applied only in relation to net interest debited to the partners' accounts. We, therefore, fail to see how the position of law would change if two accounts were maintained as has been done in the present case. While agreeing with the view taken by the Tribunal we answer the question in the affirmative and against the revenue.