Court rules interest to partners in firm taxable under section 40(b)

The court ruled in favor of the Department, holding that section 40(b) of the Income-tax Act, 1961 applied to the interest paid to partners in a firm, even if received in their representative capacity. The court emphasized that the key criterion was payment to a partner, irrespective of the capacity in which it was made. The Tribunal's decision allowing the deduction was overturned, and the Commissioner of Income-tax was awarded costs of Rs. 200.

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Issues:
1. Deduction of interest paid to partners in a firm.
2. Interpretation of section 40(b) of the Income-tax Act, 1961.
3. Application of section 40(b) to partners receiving interest in their representative capacity.

Analysis:
During the assessment year 1970-71, a registered firm with partners acting as kartas of their Hindu undivided families paid interest to two partners. The firm claimed deduction for these amounts, but it was disallowed by the Income-tax Officer and the Appellate Assistant Commissioner. The Tribunal, on further appeal, allowed the deduction, considering the interest was paid to the partners in their individual capacity. The Commissioner of Income-tax sought a ruling on whether section 40(b) applied to the interest paid to these partners. The court referenced a previous case where it was established that when a karta of a Hindu undivided family enters a partnership, the karta is a partner only in a personal capacity. The court emphasized that the payment to a person who is a partner is the key criterion under section 40(b), regardless of the capacity in which the payment is made. Therefore, the court held that section 40(b) applied to the interest paid to the partners, even if they had deposited individual money in the firm. The court ruled in favor of the Department, stating that the Tribunal was incorrect in holding that section 40(b) did not apply to the interest paid to the partners in their representative capacity. The Commissioner of Income-tax was awarded costs assessed at Rs. 200.

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