COMMISSIONER OF INCOME TAX Vs. ALLAREDDY SUDARSANAMMA SMT

JUDGEMENT

(1.) THIS is a reference by the Income-tax Appellate Tribunal, Hyderabad Bench, under Section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as "the Act"). In order to appreciate the scope of the reference, it is necessary to refer to the material facts : For the assessment year 1962-63 corresponding to the accounting year ended on March 31, 1962, the respondents-assessees were partners in a firm styled M/s. Seetharama Mining Company, Gudur, having one-third share each in the profit or loss of the firm. The assessees bad capital accounts in the books maintained by the firm. The partners individually withdrew substantial amounts from the firm for the purpose of meeting their personal expenses. The terms of the deed of partnership did not provide for payment of any interest on the capital investments of the partners, but they had to pay interest to the firm in respect of their drawings. In the accounting year in question, A. Sudarsanamma, A. Jayalakshmamma and M. Sulochanamma, the assessees-partners, have paid Rs. 12,356, Rs. 12,598 and Rs. 11,30.6, respectively, towards interest on their withdrawals from the firm. The claim made by the assessees that these amounts of interest paid by them be deducted from their other income was negatived by the Income-tax Officer and the Appellate Assistant Commissioner on appeal. In the appeals to the Appellate Tribunal, the submission of the assessees was three-fold--firstly, that the payment of interest was allowable under Section 37(1) of the Act on the ground that it was laid out wholly and exclusively for the purpose of carrying on their business as partners of the firm or to earn the share income; secondly, that the payments made by the assessees were treated as part of the income of the firm and assessed to tax in its hands and, therefore, it would be inequitable to tax the partner's share of the interest in their hands once again; and, thirdly, that the payment of interest by a partner to a firm was really a payment to oneself and it was entirely notional and, therefore, the share income should be reduced to the proportion of the partner's share in the firm in order to give effect to the principle that an assessee can only be taxed in respect of his or her real income. The first two facts of the submission of the assessees did not find favour with the Income-tax Appellate Tribunal. However, the Tribunal holding that the share income received by the assessee from the firm could not be treated as her real income to the extent it consisted only in a return of a portion of the interest income of the firm which she herself contributed, directed the Income-tax Officer to exempt the amount of interest received by each of the partners from the firm after its ascertainment and partly allowed the appeals to the extent indicated above. At the request of the Commissioner of Income-tax who was aggrieved by the decision of the Tribunal, the following question has been referred for our opinion under Section 256(1) of the Act by the Tribunal which submitted a consolidated statement of case for all the three cases as the question that arises out of the orders of the Tribunal is one and the same:

(2.) IT was contended by Sri P. Rama Rao, the learned counsel for the revenue, that the doctrine of real income has been misconstrued and misapplied by the Appellate Tribunal to the facts of the present case and that the assessecs in the instant case are not entitled to claim any portion of the amount paid by them to the firm towards borrowals made by them for the purpose of their personal expenses as they are not permissible under any of the provisions of the Act. This claim of the department was resisted by Sri Dasaratharama Reddy, the learned counsel appearing for the assessees, contending, inter alia, that there is complete identity between the partners and the firm and there can be no transaction, much less a business transaction between the partners and the firm relating to the withdrawal of the amounts from the firm for the purpose of meeting their personal expenses, and, in substance, it is only an adjustment by the same entity and, hence, the decision of the Tribunal is perfectly valid and justified.

(3.) WE shall now refer to what is meant by the doctrine of real profits, Profits may be real or notional. Book profits in a case where the assessee maintains his accounts on a mercantile system are only notional profits but not actual or real profits. To arrive at the net profits, the assessee would be entitled to deduct from the gross profits, all the business expenditure and deductions permissible under the Act. The book, profits arrived at as per the provisions of the taxing enactment are not the real or actual pro-profits. The real profits have to be arrived at on the application of commercial principles and only by making the permissible deductions as per the provisions of the Act. There is a catena of decided cases on the aspect. Suffice it to refer to a few leading cases. The earliest case to be noticed is Gresham Life Assurance Society v. Styles, 1892 0 AC 309, 315; 3 T.C. 185, 188 (H.L.) wherein Lord Chancellor Halsbury observed :