C BHASKARAN NAIR Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) AS directed by this Court, the CIT, Trivandrum, referred the following questions of law said to arise from the order of the Tribunal, Cochin Bench, in ITA No. 126 (Coch.) 1981 relating to the asst. yr. 1979-80 :

(2.) THE assessee is a partner of two firms, namely, South Indian Timber Industries, Kudamaloor and Kumaranalloor Tile Works, Kottayam. The previous year ended on March 31, 1978, relevant to the assessment year 1979-80. The assessee claimed interest paid by him to the firms on the overdrawn amounts from the firm as an allowable deduction. According to the assessee, the partnership deeds of the two firms stipulated payment of interest at 9per cent per annum on the debit balances. The interest paid was treated as income of the firms. The amount of interest paid to South Indian Timber Industries was Rs. 26,408 and to Kumaranalloor Tile Works was Rs. 103. Therefore, the assessee claimed these amounts of interest as expenditure allowable in the computation of his share incomes from the two firms. The ITO disallowed the claim as he found that the interest amount is not incurred for earning his share income. The ITO relied on the decision in Chhotalal Keshavram vs. CIT (1978) CTR (MP) 118 : (1978) 115 ITR 347 (MP). The assessee filed an appeal and the AAC upheld the action of the ITO. In the course of the discussion, the appellant's representative has agreed before the AAC that the interest paid to the firms is not for earning profit and that it is as per the agreement in the partnership clause that the interest is paid by the assessee in respect of overdrawals. The AAC, therefore, held that such interest is not deductible in computing the income of the assessee from business share income from the firms. The AAC also relied on the above decision, namely, Chhotalal Keshavram's case (supra). The assessee took up the matter in second appeal before the Tribunal. The Tribunal also dismissed the appeal. The Tribunal found that, under the relevant clauses of the partnership deeds of the two firms, the assessee was liable to pay interest at 9per cent per annum on the debit balances. Such interest has been treated as the income of the firms. The Tribunal also noted that the debit balance arose on account of the heavy losses incurred by the firm and such losses have been debited to the accounts of the partners. It was contended before the Tribunal on behalf of the assessee that the share income of the partner in a firm is income to be assessed under the head "Business". Therefore, the interest payment has to be allowed under s. 37 of the IT Act. The contention of the Revenue was that the only deduction that is permissible against the share income of the partner is under s. 67(3) of the Act. The Tribunal distinguished the decisions in CIT vs. Ramniklal Kothari (1969) 74 ITR 57 (SC) and CIT vs. Sohan Lal Nyyar (1974) 95 ITR 90 (Del) and held that the case of the assessee was directly covered by the decision of the High Court of Andhra Pradesh in CIT vs. Smt. Allareddy Sudarsanamma (1972) 83 ITR 759. The Tribunal further held that the decision of the Madras High Court in M. S. P. Raja vs. CIT (1976) 105 ITR 295 relied on by the Department laid down that as far as the payment of interest by a partner is concerned, it is governed only by the provisions of s. 36 (1)(iii) of the Act. In that view of the matter, the Tribunal held that s. 37 of the Act would not apply. The Tribunal further observed that the interest payment in question could not be considered to be interest paid on capital borrowed as it was only interest on the debit balance of the partner and such debit balance has arisen on account of the osses sustained by the firm. The Tribunal dismissed the appeal on the aforesaid reasoning. It is thereafter that the Tribunal has referred the above questions of law at the instance of the assessee.

(3.) QUESTIONS Nos. 1, 3, 4 and 5 relate to the claim for deduction of interest paid by the assessee to the two firms in accordance with the partnership agreement in respect of the overdrawals by the assessee. Counsel for the assessee referred to ss. 67(3) and 36(1)(iii) of the IT Act and also relied on the decisions in CIT vs. Ramniklal Kothari (supra) CIT vs. Sohan Lal Nyyar (supra) and Smt. Rahim Khatoon vs. CIT (1987) 167 ITR 697 (AP). Counsel for the Revenue referred to the decisions in CIT vs. Smt. Allareddy Sudarsanamma (supra) , M. S. P. Raja vs. CIT (supra), Chhotalal Keshavram vs. CIT (supra) and also a passage in Kanga and Palkhivala on Income-tax, 7th Edn., Vol. 1, at p. 353.