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Venkatesh Emporium Vs. Commissioner of Income-tax, Tamil Nadu - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtChennai High Court
Decided On
Case NumberTax Case Nos. 13 to 15 of 1977 (Reference Nos. 8 to 10 of 1977)
Judge
Reported in[1982]137ITR593(Mad)
ActsIncome Tax Act, 1961 - Sections 40
AppellantVenkatesh Emporium
RespondentCommissioner of Income-tax, Tamil Nadu
Appellant AdvocateS.V. Subramaniam, Adv.
Respondent AdvocateJ. Jayaraman, Adv.
Excerpt:
.....made by firm to its partner - in present case payment not made to partner but to partner's joint family - section 40 (b) not applicable in present case - tribunal not justified in adding back payment of interest under section 40 (b). - - the transactions themselves are the family's transactions, and none the less so, for the fact that they have, per force, got to be put through by some one like the karta. trading families have been in existence cheek by jowl with other commercial organizations like sole proprietary concerns, partnership firms and, lately, joint stock companies and public corporations. we are satisfied that the decision of the tribunal in this case is quite contrary to the plain terms of s. 40(b) was clearly applicable. section 10(4)(b) of the 1922 act, in..........and maintained for the huf of venkatesan. the firm deducted the interest paid to venkatesan's joint family as an item of outgoing in making up its profit and loss account. the ito, however, invoked s. 40(b) of the i.t. act, 1961, and added back the interest so claimed while computing the taxable income of the firm. the amounts added back were rs. 4,997, rs. 7,625 and rs. 14,872 for the assessment years 1971-72, 1972-73 and 1973-74, respectively. the officer took the view that since the payment of interest was made to venkatesan as karta of the creditor family and since venkatesan was a partner, the interest paid must be held to be a payment made to the partner and hence not deductible in terms of s. 40(b) of the i.t. act. the aac on appeal, confirmed the decision of the ito. on.....
Judgment:

Balasubrahmanyan, J.

1. The assessee in these cases is a firm by name M/s. Venkatesh Emporium. The firm consists of three partners of whom K. Venkatesan is one with a 40% share therin. He is a partner in his individual capacity and has 40% share in the partnership profits. He happens to be the karta of an HUF. But the finding of the Tribunal is that he is a partner in Venkatesh Emporium only in his individual capacity and not as karta of the HUF. It appears that the HUF had advanced loans to the firm on interest. In respect of these loans, interest was being paid or credited by the firm of Venkatesh Emporium to the HUF. The interest was credit in a separate folio in the firm's account books and maintained for the HUF of Venkatesan. The firm deducted the interest paid to Venkatesan's joint family as an item of outgoing in making up its profit and loss account. The ITO, however, invoked s. 40(b) of the I.T. Act, 1961, and added back the interest so claimed while computing the taxable income of the firm. The amounts added back were Rs. 4,997, Rs. 7,625 and Rs. 14,872 for the assessment years 1971-72, 1972-73 and 1973-74, respectively. The officer took the view that since the payment of interest was made to Venkatesan as karta of the creditor family and since Venkatesan was a partner, the interest paid must be held to be a payment made to the partner and hence not deductible in terms of s. 40(b) of the I.T. Act. The AAC on appeal, confirmed the decision of the ITO. On further appeal by the assessee, the Appellate Tribunal also held that the ITO was correct in adding back in the firm's assessments, the interest paid to the HUF of the partner, Venkatesan. They expressed the view that s. 40(b) enacts an absolute prohibition, prohibiting the payment of interest to a partner in whatever capacity he might receive such interest.

2. In this reference, at the instance of the assessee, we are asked to consider the correctness of the Tribunal's decision on the following question of law :

'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the payment of Rs. 4,997, Rs. 7,625 and Rs. 14,872 should be added under the provisions under section 40(b) of the Income-tax Act, 1961, for the assessment years 1971-72 to 1973-74, respectively ?'

3. Section 40 is a simply-worded provision. It deals with amounts which are not deductible in the computation of income chargeable under the head 'Business'. Clause (b) in that section refers to any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm, as one of the amounts which shall not be deducted in computing the income of the firm chargeable under the head 'Profits and gains of business or profession'. The question thus would arise in the assessment of a firm. What are to be disallowed and added back in the assessment of the firm are payments of interest, salary, bonus, commission or remuneration made by the firm to a partner of the firm. The inquiry under this provision is by no means complicated. The ITO will have to see whether the firm makes any payment of interest to a partner of the firm. If the payment is not interest, then the payment cannot be disallowed or added back. If the payment is made by the firm to any one other than a partner, then too, the payment cannot be disallowed in the computation of the chargeable profits of the firm.

4. In the present case, it is clear on the finding of facts contained in the order of the Tribunal, that the amounts were advanced, not by the partner, Venkatesan, to the firm, but by an HUF of which Venkatesan happened to be the karta. The further finding of the Tribunal is that the interest payable by the firm on the amount of outstanding debt was payable and paid not to the partner, but to the joint family of which he was the karta. It is quite clear, therefore, that the interest payment made to the joint family cannot be pushed into the framework of s. 40(b) unless by a travesty of the factual situation.

5. The Tribunal in the course of their order observed that 'section 40(b) does not require the Income-tax Officer to enquire in what capacity of the partner that the payment has been made'. This is a correct understanding of s. 40(b) of the Act. It is, therefore, surprising that on the basis of this observation the Tribunal should proceed to hold that the payment of interest in the present case, although not made to the partner, but to his joint family, must nevertheless be disallowed and added back under the section.

6. It may be that the hand, which actually might receive the interest or any other amount or object for and on behalf of the HUF is of its karta. But that cannot make any difference in substance. The interest really belonged to the HUF because it was the HUF which had advanced the amounts to the firm.

7. Mr. J. Jayaraman, learned standing counsel for the I.T. department, submitted that the advances to the firm in this case cannot, in the eye of law, be regarded as having been effect by an HUF. His thesis was that for all legal purposes, the advances made by any joint family must be held to have been made only by the karta, and, in this case, by Venkatesan. It was but a step in his argument to point out that he was the partner of the firm and the payment is caught by s. 40(b). Learned counsel cited Ram Laxman Sugar Mills v. CIT : [1967]66ITR613(SC) , to support the position that a Hindu joint family is not a legal entity, such as might enter into dealings as such. Learned counsel submitted that although colloquially the HUF may be said to have advanced the moneys to the assessee-firm in this case and although the firm's accountants had opened a separate folio for the family in the firm's account books, yet in a purely legal sense the advances must be treated as having been made only by Venkatesan.

8. We do not agree either with the proposition of law propounded by the learned departmental counsel or with his understanding of the facts of this case in relation to the payment of interest on advances made out of joint family funds. In the decision quoted by the learned standing counsel, the Supreme Court was concerned with a question whether two joint Hindu families could enter into a partnership with each other. The Supreme Court held that such a thing was not possible under our partnership law. In that connection, the Supreme Court dealt with the legal position of an HUF. They summed up the position as follows (p. 616) :

'A Hindu undivided family is undoubtedly a 'person' within the meaning of the Indian Income-tax Act. It is, however, not a juristic person for all purposes and cannot enter into an agreement of partnership with either another undivided family or individual. It is open to the manager of a joint Hindu family as representing the family to agree to become a partner with another persons.'

9. This decision of the Supreme Court does not, in our opinion, rule out the capacity of a Hindu joint family, as such, to enter into any legal transactions whatever. All that the Supreme Court decided in this case was that for certain purposes, such as for instance, a partnership agreement, the HUF, as a unit, cannot enter into legal relationships. This does not mean that the family, as a unit, is incapable of being engaged in carrying on business, in entering into dealings with third parties, in buying or selling goods or in lending or borrowing moneys. Nor can we accept the thesis that even where the family, as such, had purported to enter into dealings as a unit, these transactions must be dealt with only as transactions and dealings effected by the karta of the family as an individual.

10. In our judgment, the proper way to look at the position of a karta or manager of a joint Hindu family is not to regard him as a representative, much less as an agent, of the family, but to regard him as its alter ego. This position is one of sheer legal necessity, because while an HUF is by no means a pure abstraction, its structure and its way of existence is such that it has to have some human activist to discharge its responsibilities and manage its affairs, even as an incorporated company must have a managing director for its meaningful existence. It is only in this way that the karta figures in all transactions concerning the joint family. The transactions themselves are the family's transactions, and none the less so, for the fact that they have, per force, got to be put through by some one like the karta. But, as the Supreme Court have pointed out, this concept of a joint Hindu family, being a unit by itself, may not fit in with the requirements of some branches of the law, such as the law of partnership. Our legal system thus lays down a double standard, as it were, in such cases. To take the matter of partnerships, as an example, the law governing partnerships does not recognize a joint family as such, as capable of becoming a partner, but it accepts the particular individual from the family as a partner, who alone has entered into the agreement of partnership. At the same time, however, the rules of Hindu law are not thereby abrogated. For, as between the member of the family who is a partner in the firm, and the other members of the family who are not, the ownership of the partnership interest will depend upon whether it was acquired with family funds or it involved a detriment to the family, on the one hand, or whether it was acquired with the separate funds of the member concerned, on the other. In income-tax law, however, the position is different. It recognizes the family as a unit in itself, and makes the karta its representative for purposes of assessment. We cannot, therefore, dogmatise the legal position and altogether rule out or deny any kind of legal existence whatever for an HUF in all circumstances. The Supreme Court itself, in the decision cited, has guardedly observed that a joint Hindu family is not a juristic person for all purposes. In the context of the definition in the I.T. Act, of the expressions 'firm', 'partner' and 'partnership' as having the same meaning as in the Partnership Act, an HUF cannot be a partner, as such, in a firm. This is because of the subject and context of the Partnership Act. But where the subject and context of any particular legal relationship does not militate against the family as such figuring in the transactions and being recognized as a body in itself, we do not see any reason why we should regard the family as a mere illusion and not as a legal reality. From time immemorial, joint families have been recognized by our system of law. Trading families have been in existence cheek by jowl with other commercial organizations like sole proprietary concerns, partnership firms and, lately, joint stock companies and public corporations. We would be shutting our eyes to the hard realities of our family system and also of the law merchant were we to hold, without qualification, that an HUF is not an entity known to law at all.

11. As we earlier observed, s. 40(b) only entitles the ITO to add back payments of interest made by a firm to its partner. If the payment is made not to partner but to the partner's joint family, the section cannot be invoked at all. We are satisfied that the decision of the Tribunal in this case is quite contrary to the plain terms of s. 40(b) of the Act.

12. In the course of his arguments, Mr. Jayaraman took us through a number of reported cases. A series of decisions rendered by the Andhra Pradesh High Court and also another series of decisions rendered by the Allahabad High Court were studied by us in this process. The decisions of the Andhra Pradesh High Court are : CIT v. T. Veeraiah and K. Narasimhulu : [1977]106ITR283(AP) , Addl. CIT v. Chinna Balaiah Chetty and Co. : [1977]106ITR556(AP) and Terla Veeraiah v. CIT : [1979]120ITR502(AP) . The decisions of the Allahabad High Court are : CIT v. London Machinery Co. : [1979]117ITR111(All) , Radhey Shyam Sri Krishna v. ITO (see. 602 Infra (Appendix), CIT v. Brijmohan Das Laxman Das : [1979]117ITR121(All) and Ram Lal and Sons v. CIT : [1980]124ITR157(All) . We have studied all these decisions with the care and attention they deserve, but we may be pardoned if we confess to a sense of bewilderment, trying to understand their general trend. We may, however, observe that by and large, the tendency of recent decisions, both in the Andhra Pradesh High Court and in the Allahabad High Court, would seem to be to rule out the application of s. 40(b) to a case where interest is paid by a firm to an HUF of which one of the firm's partners happens to be the karta. Vide Terla Veeraiah v. CIT : [1979]120ITR502(AP) and Ram Lal and Sons v. CIT : [1980]124ITR157(All) . We may observe that to the same effect is a decision of the Gujarat High Court in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654.

13. It must, therefore, he held that except in a case where the ITO is in a position to show that the interest payment by a firm is to a partner as such, s. 40(b) cannot be invoked for disallowing the payment in the computation of the firm's chargeable income, and this would be the position even though the interest is paid to a family in which the partner is a karta and even though the tax treatment of the share income of that partner would be considered not in his individual assessment, but in the assessment of his joint family. Our answer to the question is, therefore, in the negative and in favour of the assessee.

14. Apart from the decisions of the High Courts of Andhra Pradesh and Gujarat, one reported decision of a Bench of this court was also brought to our notice, Dwarkadas Rameshwar Goenka v. CIT : [1981]127ITR397(Mad) . That was a case where a firm consisting of seven partners made interest payments to two of them in the sums of Rs. 10,164 and Rs. 2,586 in a given account year. In the firm's assessment for the relevant assessment year, the ITO disallowed these interest payments under s. 40(b) of the I.T. Act. The assessee-firm claimed that the payments were made to the partners in their capacities as individuals. The Tribunal quite easily upheld the disallowance. On a reference to this court, however, a curious contention was advanced on behalf of the assessee-firm. The argument was that the interest was paid on the capital invested by the two partners, and the respective contributions were out of joint family assets. It was further urged that since the partners themselves were representatives of their respective joint families in the firm, s. 40(b) should not be applied for disallowance of the interest payment. On the clear finding of the Tribunal based on the assessee's own claim that the payments of interest were made by the assessee-firm to the partners concerned in their capacity as individuals, s. 40(b) was clearly applicable. But the argument advanced in this saw ( : [1981]127ITR397(Mad) - Dwarkadas Rameshwar Goenka v. CIT) was that the HUF, as such, was the partner, since family funds had been utilized for capital contribution to the partnership, and this was the ground urged to rule out the application of s. 40(b) of the Act. With arguments so addressed and on the quite different facts found by the Tribunal, this court had no difficulty whatever in holding that s. 40(b) was properly applied in that case. Our only reflection about this case is that the arguments addressed by the assessee-firm before the learned judges could not carry them anywhere in their effort to keep out of s. 40(b) of the Act. For, it is unthinkable that a Hindu family, as such, could claim to be a partner in a firm. This, as we have earlier observed by reference to Ram Laxman Sugar Mills v. CIT : [1967]66ITR613(SC) , is an impossibility under our legal system. The proper way of understanding Dwarkadas Rameshwar Goenka v. CIT is to regard it as a decision rejecting the legal argument that a joint family, as such, can be a partner. More particularly, it is a decision turning on its own facts, namely, that interest payments were made to the assessee's partners in their individual capacity, even though these partners represented their respective joint families.

15. One other reported case remains to be noticed and that is A. S. K. Rathnaswamy Nadar Firm v. CIT : [1965]58ITR312(Mad) , a decision on which the Tribunal had relied in its order. That case, however, was not one where the claim by the assessee-firm was to deduct interest paid on borrowings. That was a case where the partner of a firm who represented an HUF in the firm, got remuneration for service rendered by him to the firm. The question arose under s. 10(4)(b) of the Indian I.T. Act, 1922, and this court was required to consider whether the ITO was justified in disallowing the salary paid to the partner and adding it back to the income of the firm chargeable under the head 'Business'. It was contended before the learned judges that though the partner who received the salary represented his joint family in the partnership as manager thereof, he did work in the firm only in his individual capacity and it was for that work he was remunerated by the firm, since the firm recognized nobody else as the partner. It was urged that the payment should not have been disallowed under s. 10(4)(b) of the Act. Section 10(4)(b) of the 1922 Act, in relation to the question which arose in that case prohibited the grant of 'any allowance in respect of any payment by way of salary made by a firm to any partner of the firm'. On the facts of the case, as well as on the very argument addressed by the assessee in that case, namely, that it was the partner who performed services to the firm and it was he who was remunerated by the firm for services rendered, there could be no other conclusion than that the payment was hit by s. 10(4)(b) of the Act. This was precisely the decision of the learned judges in that case. The Tribunal, while disposing of the present case, was not justified in drawing a parallel from that case and in applying it to the different circumstances of the present case. As might be remembered, the interest in the present case was payable and paid by the firm not for anything done or any money advanced by the partner, Venkatesan, himself, but it was paid by the firm to the HUF which had advanced its own funds to the firm at interest. The decision of this court in A. S. K. Rathnaswamy Nadar Firm v. CIT : [1965]58ITR312(Mad) has, therefore, no bearing on the present case. We may observe that this decision and other salary cases of this kind might well stand on a different footing not only on facts, but on law as well.

16. Another question has been referred to us in this group of references relating to two of the assessment years in which the assessee-firm of Venkatesh Emporium figures, namely, 1971-72 and 1972-73. It appears that in making the original assessment, the ITO at first allowed the claim for payment of interest of Rs. 4,997 and RS. 7,625, respectively; as allowable deductions in the computation of the firm's income. Subsequently, however, the ITO sought to revise those assessments on the footing that the allowance granted by him for the payment of interest was a mistake and had to be rectified appropriately by invoking s. 40(b) of the Act. One of the questions debated before the Appellate Tribunal in regard to these two assessment years 1971-72 and 1972-73, was whether the ITO was justified in invoking his powers of rectification under s. 154 of the Act, for the purpose of going back on his original allowance of interest payments and for proceeding to add back by way of amendment of the assessment order. The assessee had argued before the Tribunal that what the ITO did was to review his own earlier order of assessment and not really take up for rectification some mistake which might be regarded as one apparent from the record. The Tribunal rejected this contention and held that the ITO had jurisdiction to proceed under s. 154 of the Act, since the allowance of the interest payments in the original assessment can well be regarded as a mistake apparent from the record. This decision of the Tribunal has given rise to the following question of law :

'Whether, on the facts in the circumstances of the case, the Appellate Tribunal was right in holding that there was a mistake apparent from the record which can be rectified under section 154 of the Income-tax Act, 1961, and that the add back of a sum of Rs. 4,997 and a sum of Rs. 7.625 under section 40(b) of the Income-tax Act, 1961, for the assessment years 1971-72 and 1972-73, respectively, were correct ?'

17. We have already expressed our view that the ITO was not right in invoking s. 40(b) of the Act for adding back in the firm's assessment the interest paid to the HUF. The relevant question of law to which we have returned this answer covers three assessment years, namely, 1971-72, 1972-73 and 1973-74. Of these, assessments for 1971-72 and 1972-73 alone, are assessments in which the ITO happened to exercise his powers under s. 154 of the I.T. Act for making the disallowance of interest. Since, however, we have held that there was no scope whatever to make any disallowance under s. 40(b) of the Act, it is quite unnecessary for us to go into the further question, whether the ITO was right in bringing to bear his powers of rectification for the purpose of effecting the disallowance. This question of jurisdiction, therefore, has to remain unanswered. But, on our answer to the earlier question of law, which is one of substance, this reference is answered in favour of the assessee. Since the assessee has substantially succeeded in the reference, it will have its cost the Department. Counsel's fee Rs. 500 (one set).


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