Partner-level interest payments in a reconstituted firm are not disallowed under section 40(b), clarificatory explanations do not change that position.

Interest paid by a partnership firm to partners in their individual capacity was treated as outside the disallowance rule under section 40(b) of the Income-tax Act. The text explains that, after reconstitution of the firm, the recipients were partners personally rather than as karta-representatives of the earlier Hindu undivided family, so the interest was not required to be added back to the firm's income. It also states that the Explanations inserted from 1 April 1985 were regarded as clarificatory and did not alter the settled legal position retrospectively.

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Issues: Whether interest paid by a firm to partners, who were partners in their individual capacity after the earlier karta-partner died and the firm was reconstituted, was liable to disallowance under section 40(b) of the Income-tax Act, 1961.

Analysis: The reference arose from the assessment of a partnership firm for assessment year 1976-77. The deceased partner had earlier represented a Hindu undivided family, but the relevant payment of interest was made to the three sons after reconstitution of the firm, when they were partners in their individual capacities. The controlling authority held that interest paid to a partner in his personal capacity was not required to be added back under section 40(b). The Explanations inserted with effect from 1 April 1985 were treated by the binding Full Bench decision as clarificatory and not as altering the settled position.

Conclusion: The interest was not liable to disallowance under section 40(b); the question was answered in the negative, in favour of the assessee.

Final Conclusion: The reference was disposed of by holding that the impugned interest payment could not be added back to the firm's income under section 40(b).

Ratio Decidendi: Interest paid by a firm to a partner in his individual capacity is not disallowable under section 40(b), and later clarificatory explanations do not change that position retrospectively.

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