(Judgment of the Court was delivered by the Honourable the Chief Justice).
The assessee are a firm registered under the provisions of Section 26-A of the Indian Income-tax Act, 1922. There are two partners and the partnership deed is dated 27th February 1936. It appears, however, that the partnership was constituted on the 20th of March 1934. The senior partner advanced to the firm in his own name and the name of his wife a total sum of Rs. 31,141-0-4 and the junior partner a sum of Rs. 5,973-2-5. The partnership deed provides that 'the net profits of the business after deducting all working expenses and interest paid or payable on capital whether belonging to the partners or depositors or others from whom moneys might have been borrowed shall be divided between the parties hereto in the proportion of :3, either share going to the party of the first part and three shares going to the party of the second part.' For the year of assessment, 1936-37, the assessee claimed to be entitled to deduct a total sum of Rs. 8,914 which had been paid as interest to the partners, to the wife of the senior partner and to strangers who had deposited moneys with the firm. The Income-tax authorities allowed the deductions so far as they represented interest payments to strangers, but refused to allow the deduction of Rs. 2,774 paid to the partners and Rs. 1,680 paid to the wife of the senior partner. The Income-tax authorities have held that the payment of Rs. 1,680 to the senior partners wife was really a payment to the husband and this finding is not open to question in these proceedings, but it is said that the partners are still entitled to deduct the two sums of Rs. 2,774 and Rs. 1,680 as being payments of interest on moneys lent by them to the firm. Section 10(2)(iii) of the Act allows to be deducted from the profits interest in respect of capital borrowed for the purposes of the business, where the payment of interest thereon is not in any way dependent on the earning of profits. The assessee contended before the Commissioner that inasmuch as the moneys which they paid represented interest on loans borrowed for the purposes of the business they should be allowed the deductions. This was refused, and the Commissioner of Income-tax has stated the grounds in his statement of the Case.
It is not disputed that the moneys which the assessee paid into the firm were used for the purposes of the business. The Commissioner however refused to allow the deduction on two grounds :-
(1) The assessee had not proved that the partners had given the firm a legal loan, namely 'a loan made under an instrument on which they could sue and under which interest at a fixed rate was payable annually'.
(2) The partners are themselves the owners of the firm and the moneys which they have invested in the business are their own and 'it is difficult to imagine how it can be said that the partners borrowed money for themselves from themselves.' As these reasons reflected misconception of the law this Court under the provisions of Section 66(3) directed the Commissioner to refer the following question :-
'Where a deed of partnership contains this provisions The net profits of the business after deducting all working expenses and interest paid or payable on capital whether belonging to the partners or depositors or others from whom moneys might have been borrowed shall be divided between the parties hereto in the proportion of :3, eight shares going to the party of the first paid and three shares going to the party of the second part, are the amounts paid as interest to the partners to be treated as profits of the firm and liable to assessment to income-tax or are they to be allowed as deductions under Section 10(2)(iii) of the Income-tax Act ?'
In Commissioner of Income-tax, Madras v. Subrahmanyan Chettiar (51 Mad. 787), a Full Bench of five Judges of this Court held that where a partner genuinely lends money to the partnership in addition to the money paid in by him as initial capital and the money is used for capital expenditure, the interest paid by the partnership to him in the year of assessment must be deducted from the profits of the partnership under the provisions of Section 10(2)(iii) of the Act. In this case the partners had subscribed capital and the Court was called upon to consider the position with regard to subsequent loans, but there is nothing in law to prevent a partnership starting business without capital and there is nothing to prevent a partner of partners in such a case lending to the partnership money which would bear interest deductible under Section 10(2)(iii). Whether a sum paid into the firm by a partner represents capital subscribed by him to the partnership or money lent as a separate loan to the partnership depends upon the facts of the case. As pointed out by Wallace, J., in Commissioner of Income-tax, Madras v. Subrahmanyan Chettiar 51 Mad. 787, it might fall to be decided as a point of fact whether the alleged borrowing of capital was not a genuine loan but a mere device to evade the Act. If it is a device made to avoid the Act, then obviously the partnership would not be entitled to the benefit of Section 10(2)(iii).
In the present case, it has not been held that there was any such device. As I have indicated, the Commissioner has refused to recognise the moneys paid into the firm as representing loans and has treated them as contributions towards capital. He was impressed by the absence of any instrument on which a suit might in his opinion be based. The Commissioner overlooked the fact that in law a partner cannot sue a firm for moneys advanced to the firm. His rights in respect of such moneys can only be enforced in a suit for the taking of the partnership accounts. Moreover it is not necessary that there should be an instrument to evidence a loan. His statement that it is difficult to imagine how it could be said that the partners borrowed money for themselves from themselves show that he had overlooked the decision in Commissioner of Income-tax, Madras v. Subrahmanyan Chettiar, 51 Mad. 787. In that case the Commissioners findings were based on a misconception of law and the Court pointed out that ther could not be accepted as findings of fact binding upon the Court, That is the position here. It might very well have been that if the inquiry into the value of those of these loans had proceeded on different lines, the Income-tax authorities might have come to the conclusion that the partnership deed of the 27th of February 1936 was really a device for evading the Act. We do not say that this would necessarily have been the finding. It is sufficient to say that the inquiry in this case did not proceed on these lines and that it has not been held that this is a case of the nature referred to in the judgment of WALLACE, J. The finding that these loans represented capital contributions in the true sence rests entirely on the misconceptions of law to which we have referred. These is nothing here to justify the Court holding that these sums paid by the partners were not loans made to the partnership. In these circumstances, the answer to the question referred is that the interest payments to the partners should be treated as deduction under SEction 10 (2) (iii). We wish to make it quite clear that our judgment is based on the particular facts of this case and is not intended to go beyond this case.
The Income-tax Commissioner has observed that the question is one of academic interest. It is so far as the Income-tax authorities are concerned because they will recover the full amount either from the partnership or from the partners. But the question is not of academic interest so far as the partnership is concerned. The question therefore required to be answered.
The assessees have succded and are entitled to their costs, Rs. 250. The refund of the deposit of Rs. 100 is ordered.