1991 (9) TMI 67 - HC - Income Tax

Court Rules Interest Payments to Minor Children and HUFs Not Disallowable under Income-tax Act

Commissioner Of Income-Tax Versus Mangalore Ganesh Beedi Works

The court ruled in favor of the assessee, holding that interest payments made to minor children of partners through their natural guardians who are also ... Business Expenditure, Explanations To Provisions, Firm Issues Involved:1. Whether interest payment to the minor children of the partners through their natural guardians who are partners of the firm were disallowable under section 40(b).2. Whether interest payments to Hindu undivided families (HUFs) of which the partners of the firm are the kartas were disallowable under section 40(b).Detailed Analysis:Issue 1: Interest Payment to Minor Children of PartnersThe primary question was whether interest payments made to the minor children of partners, through their natural guardians who are also partners of the firm, were disallowable under section 40(b) of the Income-tax Act, 1961. The Revenue contended that such payments should be disallowed as per section 40(b), which disallows any payment of interest, salary, bonus, commission, or remuneration made by the firm to any partner in computing the chargeable income of the firm.The court noted that section 40(b) was amended by the Taxation Laws (Amendment) Act, 1984, which introduced three Explanations effective from April 1, 1985. Explanation 3 was particularly relevant, stating that interest paid by the firm to an individual partner should not be taken into account if such interest is received by the partner on behalf of any other person. The court held that if this Explanation applied, the interest paid to the minor children through the partners would not be included in the firm's income.The court further observed that the Explanations were clarificatory in nature, intended to resolve doubts created by conflicting High Court decisions. Some High Courts had previously held that payments to partners were not deductible even if made in a non-partner capacity, while others considered the capacity in which the payment was made as relevant.The court concluded that the Explanations provided clarity and should be applied retrospectively, covering assessment years prior to 1985-86. The court emphasized that the real recipient of the payment should be considered, and if the payment was genuinely made to the minor children, it should not be disallowed under section 40(b).Issue 2: Interest Payments to HUFs of Which Partners are KartasThe second issue was whether interest payments to HUFs, where the partners of the firm are the kartas, were disallowable under section 40(b). Similar to the first issue, the Revenue argued for disallowance based on section 40(b). The court referred to the same Explanation 3, which clarified that interest paid to a partner in a representative capacity should not be disallowed if received on behalf of another person.The court examined various High Court decisions, noting that some courts had allowed such deductions, considering the HUF as a distinct legal entity from the individual partner. The court agreed with the view that the distinction between an individual and the HUF should be maintained for the purposes of section 40(b). The court held that the Explanations inserted by the Amendment Act were clarificatory and should be applied retrospectively.The court cited several judgments supporting this view, including decisions from the Andhra Pradesh, Gujarat, Madras, and Rajasthan High Courts, which had held that interest payments to HUFs through the karta were not disallowable under section 40(b). The court rejected the Revenue's contention that the Explanations were prospective and emphasized that the legislative intent was to clarify the existing law and reduce litigation.Conclusion:The court concluded that section 40(b) did not disallow payments made by the firm to a partner when the real recipient was someone else, such as minor children or HUFs. The Explanations inserted by the Amendment Act clarified the real meaning of section 40(b) from its inception. Consequently, the court answered both questions in the affirmative, ruling in favor of the assessee and against the Revenue. The reference was answered accordingly.