COMMISSIONER OF INCOME TAX Vs. VOCKANARDT PVT LIMITED

JUDGEMENT

(1.) BY this reference under section 256(1) of the Income -tax Act, 1961, made at the instance of the Revenue, the Income -tax Appellate Tribunal, Bombay Bench 'A', Bombay, has referred the following questions of law to this court for opinion :

(2.) THE assessee is a private limited company. It was incorporated in the year 1973. Its business is that of manufacture of pharmaceuticals. Its accounts are closed every year on 31st December. This reference pertains to the assessment year 1977 -78, the corresponding previous year being calendar year 1976. The assessee became a partner in the firm of Messrs. Wockardt Pharmaceuticals on and from January 1, 1975. On December 31, 1975, by an agreement between the partners, all the other partners of the said firm retired and the assessee became the sole proprietor of the business carried on by it. Under the said agreement, the assessee -company took over the partnership business as a running concern on and from January 1, 1976. In terms of the agreement, all liabilities of the said firm including liability on account of all deposits received by the erstwhile firm as well as the amounts standing to the credit of the outgoing partners in their capital accounts (both fixed capital account and current account), were taken over by the assessee. In terms of the dissolution deed, some shares of the assessee -company were allotted to the outgoing partners and on the balance amounts standing to the credit of the partners, the assessee paid interest. Some of these partners, in the meantime had also become directors of the assessee -company and others were shareholders. In the course of its assessment for the assessment year 1976 -77 (sic), the assessee -company claimed that out of the total interest paid by it, a sum of Rs. 1,73,002 was not on deposits received by it but represented interest on the liabilities of the old firm taken over with effect from January 1, 1976, on its becoming the sole proprietor of the business of the dissolved firm. The claim of the assessee was negatived by the authorities below. However, on appeal, the Income -tax Appellate Tribunal ('the Tribunal') accepted the contention of the assessee and held that payment of interest amounting to Rs. 1,73,002 on the liabilities of the business of the erstwhile firm which had been taken over by the assessee, could not be held to be 'expenditure by way of interest in respect of deposits received by it' and hence, section 40A(8) of the Act was not applicable. According to the Tribunal, this expenditure was on account of interest in respect of legal obligations to pay certain amounts to the partners concerned in terms of the agreement. From the above order of the Tribunal, the Revenue sought for reference under section 256(1) of the Act. The Tribunal has accordingly referred to us question No. 1.

(3.) BOTH the above provisions and liability were included in the liabilities taken over by the assessee -company. The liabilities in respect of these two amounts thus having ceased, the assessee -company transferred the above amounts, in all amounting to Rs. 8,56,440, initially to the profit and loss account and thereafter to its capital reserve account. The Income -tax Officer applied the provisions of section 41(1) of the Act and included the said amounts in the income of the assessee. This order was confirmed on appeal. However, on further appeal, the Income -tax Appellate Tribunal ('the Tribunal') reversed the above finding of the authorities below and held that these amounts were not chargeable to tax in the hands of the assessee -company under section 41(1) of the Act. Aggrieved by the above decision, the Revenue sought for reference of the question of law arising therefrom to this court which the Tribunal did by referring to us question No. 2.