1992 (11) TMI 69 - HC - Income Tax

Court rules in favor of assessee on tax law interpretation, rejecting tax avoidance claims.

The court ruled in favor of the assessee, holding that section 40(b) of the Income-tax Act did not apply to interest payments made to entities other than ... Business Expenditure, Disallowance, Firm, Loans, Transfer Issues Involved:1. Applicability of section 40(b) of the Income-tax Act.2. Applicability of sections 64(1)(vii) and 64(2) of the Income-tax Act.3. Consideration of transactions as tax avoidance devices under the principle laid down by the Supreme Court in McDowell's case.Detailed Analysis:1. Applicability of Section 40(b) of the Income-tax Act:The primary issue was whether the provisions of section 40(b) were applicable to the interest payments made by the firm to the wives, minor children, and Hindu undivided families (HUFs) of the partners. The court noted that the partners had withdrawn funds from their capital accounts, which were not earning interest, and lent these funds to their respective wives, minor children, and HUFs at a nominal rate of 1% per annum. These funds were then deposited back into the firm, earning a higher interest rate of 15% per annum. The Income-tax Officer disallowed these interest payments under section 40(b) and added them to the income of the partners.The Commissioner (Appeals) and the Appellate Tribunal held that section 40(b) did not apply to these transactions as the payments were made to entities other than the partners themselves. The court affirmed this view, referencing its earlier decision in CIT v. Mangalore Ganesh Beedi Works [1992] 193 ITR 77 (Kar), which clarified that section 40(b) does not affect payments made by the firm to a partner when the real recipient is someone else. Therefore, the first question in I.T.R.Cs. Nos. 45 to 65 of 1989 and the second question in I.T.R.C. No. 23 of 1990 were answered in the affirmative and against the Revenue.2. Applicability of Sections 64(1)(vii) and 64(2) of the Income-tax Act:The court examined whether the loan transactions between the partners and their respective wives, minor children, and HUFs constituted 'transfers' under sections 64(1)(vii) and 64(2). The Revenue argued that these loans should be considered transfers, thereby attributing the income to the partners themselves. However, the court emphasized that the term 'transfer' in section 64 should be understood in its normal sense and not in the expansive sense used in sections 60 to 62.The court distinguished between a 'transfer' and a 'loan,' noting that a loan does not create any legal interest in the transferee over the subject matter. The court referenced several decisions, including Tulsidas Kilachand v. CIT [1961] 42 ITR 1 and R. K. Murthi v. CIT [1961] 42 ITR 379, to support its view that a loan is not a transfer. Consequently, the court held that section 64 did not apply to these transactions, answering the questions in favor of the assessee and against the Revenue.3. Consideration of Transactions as Tax Avoidance Devices:The Revenue contended that the transactions should be viewed as tax avoidance devices under the principle laid down by the Supreme Court in McDowell's case [1985] 154 ITR 148. The court noted that the genuineness of the transactions had not been doubted by the Income-tax Officer, and there was no material to show that the higher interest earned by the HUF escaped income tax.The court acknowledged that the transactions might appear as a device to evade tax but emphasized that the actual tax loss to the Revenue was not demonstrated. The court also pointed out that the same transactions had been accepted as genuine in previous assessment years. Therefore, the court did not accept the Revenue's contention that these transactions were tax avoidance devices, answering the third question in I.T.R.C. No. 23 of 1990 in favor of the assessee.Conclusion:All the questions referred were answered in the affirmative and against the Revenue, affirming the decisions of the Commissioner (Appeals) and the Appellate Tribunal. The court concluded that section 40(b) did not apply to the interest payments, sections 64(1)(vii) and 64(2) did not apply to the loan transactions, and the transactions were not tax avoidance devices under the principle laid down by the Supreme Court in McDowell's case.