Interest paid to a partner in a firm, not as a partner, deemed personal income, not subject to deduction restrictions.

The High Court of Bombay ruled that interest paid to a partner in a firm, acting as the karta of a Hindu Undivided Family (HUF), does not fall under the purview of section 40(b) of the Income-tax Act, 1961. As the interest was paid to the partner in his individual capacity and not as a partner, it was considered personal income and not subject to the deduction restrictions under section 40(b). The Court held that the Revenue's challenge was not valid, directing them to cover the costs of the reference.

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Issues involved: Interpretation of section 40(b) of the Income-tax Act, 1961 regarding deduction of interest paid to a partner in a firm.

Summary:
The High Court of Bombay delivered a judgment regarding the deduction of interest paid by a partnership firm to its partners for the assessment year 1975-76. The firm had paid interest to three partners: Shri Ramniranjan Hiralal, Shri Narayandas Hiralal, and Shri Vasantkumar Hiralal. The Income Tax Officer (ITO) disallowed the deduction under section 40(b) of the Income-tax Act, 1961. However, the Appellate Assistant Commissioner (AAC) allowed the firm's appeal, which was further upheld by the Income-tax Tribunal. The Revenue challenged the Tribunal's decision specifically concerning the interest payment to Shri Vasantkumar Hiralal in his individual capacity.

The Revenue relied on section 40(b) of the Income-tax Act, which states that any payment of interest made by a firm to any partner shall not be deducted in computing the firm's income. However, the Court noted that Vasantkumar Hiralal was a partner in his capacity as the karta of the Hindu Undivided Family (HUF), not in his individual capacity. The Court cited established law that income received by the HUF through its manager is considered HUF income, while personal loans advanced by a coparcener are treated as personal income. Since the interest paid to Vasantkumar Hiralal was in his individual capacity, it did not fall under the purview of section 40(b) as a payment made to a partner.

Therefore, the Court held that the provisions of section 40(b) were not applicable to the interest paid to Vasantkumar Hiralal in his individual capacity. The question referred by the Revenue was answered in the affirmative, and the Revenue was directed to pay the costs of the reference.

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