K. Jagannatha Shetty, J.
1. These are references under section 256(1) of the income-tax Act, 1961. The common question referred by the Tribunal is :
'Whether, on the facts and in the circumstances of the case, the amount of interest paid by the firm on the accounts which were transferred from the capital accounts of the seven/five partners to the family accounts was disallowable under section 40(b) of the Income-tax Act, 1961 ?'
2. The partners in the assesses-firm were 'kartas' representing their respective Hindu undivided families. The assesses-firm paid a sum of Rs. 16,124 as interest to the account of the Hindu undivided families Before the Income-tax Officer, the assesses-firm claimed that the interest so paid to the Hindu undivided families should be allowed as deduction and section 40(b) of the Income-tax Act, 1961, is no bar for such a claim. The Income-tax Officer did not agree with the contention. He observed that for purposes-of section 40(b) of the Income-tax Act, 1961, whether the partner received the interest in his individual capacity or in the capacity of the 'karta' of the Hindu undivided family, is not a relevant factor. So stating, he disallowed the entire interest.
3. In the appeal before the Appellate Assistant Commissioner, the assesses-firm succeeded. The Appellate Assistant Commissioner deleted the additions stating that since the interest had not been paid to the individual accounts of the partners, but to the accounts of their Hindu undivided families, the interest should not have been disallowed.
4. The Department, being aggrieved by the order of the Appellate Assistant Commissioner, preferred an appeal to the Tribunal. The Tribunal noted the following facts :
'As a matter of fact, all the partners had contributed the capital. Seven partners who represented their Hindu undivided families had also contributed the capital and interest was being paid to them on that capital. But on October 14, 1970, the amounts standing to the capital account of these seven partners was transferred to the family account and thereafter the capital account of the partners was only used to credit the profits and then the same was carried over to the family account. It is not the case of the assessee that by mistake the amount which had been lent by the Hindu undivided family to the firm had been credited to the capital account of the partners and thereafter the mistake was rectified.'
5. On the said facts, the Tribunal inferred :
'The only inference on facts, therefore, can be that all the partners including the seven kartas of the Hindu undivided families had agreed to contribute the capital and the amounts transferred on October 14, 1970, to the family were, in fact, the capital of the firm contributed by these seven partners and not the amount lent by the family to the firm.'
6. The Tribunal further observed :
'Transferring the amount from capital account of the partners to the family was a mere device to escape the provision of section 40(b). Therefore, interest had rightly been disallowed by the Income-tax Officer.'
7. The scope of section 40(b) of the Income-tax Act, 1961, has been considered by this court in CIT v. Khoday Eswarsa & Sons : 152ITR423(KAR) (I.T.R.C. No. 253 of 1979, decided on September 13, 1984). There this court observed (page 424) :
'The scope of this section is no longer in dispute. It imposes a bar to allowances in respect of any payments by way of interest, salary, bonus, commission or remuneration made by the firm to any of its partners. The prohibition contained in this clause is absolute and makes no distinction between the payments by way of interest, commission, etc., made to a partner as a partner and such payments made to him in a different character, i.e., in his personal capacity when he is a karta of a joint family or in his capacity as a proprietor of an independent concern. This was also the view taken by a Division Bench of this court in N. M. Anniah & Co. v. Commissioner of Income-tax : 101ITR348(KAR) , wherein it was observed that section 40(b) is attracted even in regard to payment of salary made by a firm to any partner irrespective of the character in which the person has become a partner of a firm. Therefore, the capacity with which an individual becomes a partner of a firm has nothing to do with the allowances prohibited under section 40(b). A partner may have a dual capacity as an individual by himself or as a representative of another assessable entity, but when once he becomes a partner, the bar imposed under section 40(b) is immediately attracted.'
8. Mr. Prasad, however, contended that that decision is not against the case of the assessee since the interest in this case was credited to the Hindu undivided family account by the assesses-firm and that interest must be construed as interest payable on the advance made by the respective families.
9. Mr. Prasad also relied upon the Board's Circular (Notification No. 997), dated August 11, 1976.
10. Before considering the said Circular, we may state at the outset there is no basis for presuming that the interest credited to the family account was towards the loan advanced by the Hindu undivided families. The seven partners in question were representing their respective Hindu undivided families. All the partners agreed that the amounts standing in their capital account should be transferred to the family account and also the profits which they were entitled to. So such amount was transferred from one account to another. The Tribunal has observed that transferring the amount from capital account of the partners to their family account was a mere device to escape the provision of section 40(b) of the Income-tax Act, 1961, and it was not the amount lent by the family to the firm. This finding has not been challenged before us. Therefore, the operation of section 40(b) cannot be excluded.
11. The Board's Circular (Instruction No. 997), dated August 11, 1976, referred to by Mr. Prasad, equally does not help the case of the assesses-firm. The relevant portion of the Circular reads :
'Section 40(b) of the Income-tax Act, 1961, provides, inter alia, for disallowance in the case of a firm, of any payment of interest to any partner of the firm.
2. The Board have examined the question as to what treatment should be accorded to interest paid by the firm to a partner in the following circumstances :
(a) Where interest is paid to a Hindu undivided family, and not to a partner in whatever capacity;
(b) Where interest is paid to a partner whether as representing a Hindu undivided family or in his individual capacity.
3. In the former case, since the payment of interest is to the Hindu undivided family, it cannot be disallowed. In such a case section 40(b) will not apply.'
12. Para. 2(a) of the above circular would be applicable only where the payment of interest is to the Hindu undivided family and not to a partner in whatever capacity. Evidently, it must be a payment of interest towards the amount lent to the firm by the Hindu undivided family apart from its capital contribution.
13. In the instant case, there is a finding of fact recorded by the Tribunal that the amount utilised by the assesses-firm was the capital of the firm. The circular, therefore, is clearly inapplicable.
14. In the result, we answer the question in the affirmative and against the assesses-firm.