1. There are two questions of law which have been referred to us by the Income-tax Appellate Tribunal in this reference arising under the I.T. Act, 1961.
2. The assessee in this case is a partnership firm carrying on business in cereals, pulses and tamarind at Virudhunagar. During the account year ended September 7, 1975, the assessee firm spent Rs. 3,622 in relation to customers who visited the assessee's place of business. The ITO disallowed the entire expenditure under Section 37(2B) of the Act. On appeal, the Tribunal went into the nature of the expenditure and found that it represented the cost of supply of coffee, tea and other refreshments, to the assessee's customers. According to the Tribunal, these expenses were petty in nature and could hardly be regarded as entertainment expenditure, because there wasnothing lavish or entertaining about it. On this ground, the Tribunal set aside this part of the assessment order of the ITO and allowed the entire expenditure of Rs. 3,622 to be allowed as an admissible deduction.
3. One other point which was the subject of controversy between the Department and the assessee was as to the quantum of add-back of interest paid by the assessee firm to one of its partners by name Natarajan. The relevant statutory provision which enjoins a disallowance, or add-back, of interest paid to a partner in the firm's total income is set out in Section 40(b) of the I.T. Act, 1961. The amount added back by the officer in this case was Rs. 783 only. But the assessee-firm made a point of principle out of it and took the matter in appeal before the Tribunal. The assessee's case was that Rs. 783 only represented the gross interest payable by the firm to the partner, Natarajan, on amounts standing to his credit in the capital account of the firm. The 'assessee, however, referred to another account of the partner, Natarajan, called drawings account, with the firm. In this account, apparently, the partner was effecting his drawings of money from the partnership. Apparently, again, this drawings account showed a debit balance. The assessee-firm charged the partner with interest on the debit balance in this drawings account. The case of the assessee was that for the purpose of disallowance of the interest paid by the assessee-firm to its partner, account must also be taken of the interest payable by Natarajan to the firm and only after a combined consideration and mutual set-off of interest in both the accounts, the question of disallowance of net interest, if any, payable by the firm to the partner can be the subject of disallowance.
4. This claim of the assessee was accepted in appeal by the AAC. According to that appellate authority, the firm and the partner must be regarded as being placed in a single jural relationship. The point decided was that although there were two accounts of the partner, Natarajan, the capital account and the drawings account, the two cannot be regarded as different or independent accounts, so far as the accounting with the firm was concerned. According to the AAC, therefore, what has to be disallowed under the Act as payment to the partner can only be the net interest paid by the firm to the partner.
5. Against this understanding of Section 40(b) of the Act by the AAC, the Department went in appeal to the Tribunal. The Tribunal, however, agreed with the view expressed by the AAC. They relied on certain decisions of the Allahabad High Court in support of their determination. They relied also on a Board circular on the subject.
6. Since the Tribunal's decision had gone against the Department on two points, viz., (1) on the allowance of expenditure in the sum of Rs. 3,622and (2) non-allowance of interest of Rs. 783 paid by the firm to the partner, the Department demanded a case to be stated to this court from the Tribunal. The Tribunal has since made a reference on the following questions of law for our opinion;
'1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the entertainment expenses of Rs. 3,622 are admissible as business expenses notwithstanding the prohibition contained in Section 37(2B) of the Income-tax Act, 1961
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that only the net interest should be disallowed under Section 40(b) of the Income-tax Act, 1961
7. On the first question, there is no need to discuss the matter at any length, for, on the finding of the Tribunal that the expenditure of Rs. 3,622 was only the sum-total of petty items relating to the cost of coffee, tea and other refreshments, incurred by the assessee for their customers, there was no warrant for the ITO for regarding the outgoing as hit by Section 37(2B) of the I.T. Act, 1961. Similar expenses have been regarded by this court as being merely the manifestation of elementary courtesy which the assessee while carrying on the business extended, or was expected to extend, to their constituents, vide CIT v. Karuppuswamy Nadar and Sons : 120ITR140(Mad) . We answer the first question in favour of the assessee and against the Department, following that decision.
8. The second question as to the non-disallowance of the interest payment made by the firm to the partner, Natarajan, in the computation of the firm's total income has to be considered in the language of Section 40(b) of the Act. This provision is a replica of Section 10(4)(b) of the Indian I.T. Act, 1922. These provisions relate to the computation of the total income of an assessee who is a partnership firm. Section 40(b) of the Act refers to ' 'any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm', as an amount which shall not be deducted in computing the income of a firm under the head ' profits and gains of business or profession'.' The Officer had disallowed the sum of Rs. 783 in this case because it was interest paid by the assessee-firm to the partner, Natarajan. It cannot be denied that the amount is interest paid by the firm to the partner. What is claimed by the assessee, however, is that in an independent account called the drawings account, the firm has to receive interest from the same partner concerned, because that account has been overdrawn by him. According to the assessee, the expression 'any paymentof interest' occurring in Section 40(b) only refers to the net interest arrived at by taking all the accounts inter se between the firm and its partner.
9. We do not accept this contention as warranted by the words of the section. We have earlier quoted verbatim from the crucial words of the section. The collocation of the words shows that what is disallowed in the matter of payment of interest cannot be the net interest, but can only be interest paid with reference to a given account relating to payment of interest by the firm to the partner. This is because the subject of disallowance in the matter of payment of interest appears in Section 40(b) cheek by jowl with salary, bonus, commission or remuneration made by the firm to the partner. There cannot be any net salary or net bonus or net remuneration as matters of disallowance. They can only be salary, as such, or bonus, as such, or commission, as such, or remuneration as such which are the subject of disallowance. In like manner, when the section speaks of payment of interest by the firm to a partner as the subject of disallowance, it can only be payment of 'gross' interest in the particular account in which interest is payable. Salary, bonus, commission or remuneration do not have what may be characterised as a two-way traffic. Salary is payable only by the firm to the partner. Bonus, commission or remuneration are similarly payable by the firm to the partner and this is the reason why they are all disallowed. There can be no scope, therefore, of any set-off on account of any dues under these heads owed by the partner to the firm. In this collocation of ideas and expressions, therefore, we cannot construe the payment of interest occurring in the section as payment of net interest.
10. Learned counsel referred to a string of decisions from the Allahabad High Court, beginning from Sri Ram Mahadeo Prasad v. CIT : 24ITR176(All) , down to CIT v. Kailash Motors : 134ITR312(All) . In between, there are two other decisions of the same court CIT v; London Machinery Co. : 117ITR111(All) and 'Sri Ram Mahadeo Prasad v. CIT : 120ITR149(All) . In all these decisions, we do not find any effort expended on the interpretation of Section 40(b), or its precursor, Section 10(4)(b) of the 1922 Act. In the earliest of the cases, the Allahabad High Court endorsed the Tribunal's decision to disallow only the net interest. The court did so, not on a construction of the words of the section, but on equitable grounds of 'fairness'. The following observation in that case, makes clear the basis of the court's judgment (p. 184 of 24 ITR) :
'The Appellate Assistant Commissioner and the Tribunal thus treated the assessee most fairly and our answer to the second question is in the affirmative.' (Underlining* ours).
12. There is a saying that income-tax and equity are strangers. TheAllahabad decisions have only' laid down what, according to that HighCourt, is equitable. They have not laid down the construction of therelevant statutory provision.
13. Learned counsel pressed on us the departmental circular which was relied on by the Tribunal. When a matter comes before this court for an advisory opinion on the state of the law or of a fiscal principle, or on the construction of any provision in the taxing enactment, the last place where we should look for aid or guidance would be a circular from the CBDT on the subject. We are not bound by the Board circulars. Besides, these circulars have the knack of being inconsistent. For, they are, for the most part, circulars for the occasion. We are not, therefore, inclined even to take a look into the circular referred to us. If the circular has expressed a view which the Department has not followed in this case, the remedy is not to ask this court to render an opinion in accordance with the circular. The relief has to be sought elsewhere. It would be quite different from what or how a court of advisory jurisdiction would render on the merits,
14. Be that as it may, for the reasons which we have earlier stated, ouranswer to the second question is in favour of the Department and againstthe assessee.
15. In view of the mixed results of the reference, there will be no order asto costs.