KONDAIAH, J. -
(1.) THE following two questions have been referred for the opinion of this Court by the Tribunal, Hyderabad Bench, under S. 66(1) of the Indian IT Act, 1922 (hereinafter referred to as "the Act") :
"1. Whether, on the facts and in the circumstances of the case, the assessee is entitled to claim the sum of Rs. 38,394 as allowable under S. 10 of the IT Act ?
(2.) WHETHER, on the facts and in the circumstances of the case, the assessee is entitled to claim Rs. 6,589 from April 1, 1959, to July 14, 1959, pertaining to the accrued profit allocatable to the deceased partner till his death is allowable as a deduction ?"
2. For a proper appreciation of the scope of the reference, it is relevant and necessary to refer to the material facts that gave rise to the aforesaid two questions : M/s N. Annaji Rao and Brother, Ongole (hereinafter referred to as "the assessee") is a firm consisting of two partners, viz., N. Annaji Rao and N. Kuppu Rao, who are brothers. The firm which came into existence w.e.f. April 1, 1950, was carrying on the business of distribution of oil products of Burmah-Shell and also derived income from other sources. Another firm constituted under an instrument of partnership dated December 21, 1941, for a period of five years w.e.f. October 9, 1941 (hereinafter referred to as "the Nellore firm") consisted of two partners, viz., P. T. Gopalachari and Annaji Rao with equal shares in the profits or losses. One of the clauses of the deed required Sri Annaji Rao to contribute the capital of Rs. 10,000. A fresh agreement was entered into between the partners, P. T. Gopalachari, Annaji Rao, P. T. Ramanujam and P. T. Venkasam on March 31, 1947, w.e.f. October 8, 1946, when the period of five years under the prior deed of partnership expired. The entire capital of Rs. 20,000 required for the partnership was contributed by Shri Annaji Rao and the other partners undertook to pay their individual shares of Rs. 5,000 each to him. If the capital of Rs. 20,000 was found to be short for the effective and efficient conduct of the business, the other partners might lend as and when necessary the requisite amounts on which they would be entitled to 5 per cent interest. Though the tenure of the firm was originally fixed at five years, it was eventually renewed at an interval of five years and the last renewal was made on March 31, 1957, with the same terms and conditions of the original deed of partnership dated March 31, 1947. Sri Annaji Rao, when he joined the Nellore firm, was a partner in his capacity as Karta of the HUF consisting of himself and Kuppu Rao. After partition of the family on April 1, 1950, when the assessee-firm came into existence, he represented the assessee firm.
The Nellore firm was dissolved on July 14, 1969, when Sri Annaji Rao died. However, the Ongole firm continued. A credit balance of Rs. 1,33,394 representing the capital advances and undrawn share of profits together with accrued interest was found in the account of the deceased partner, Sri Annaji Rao, in the books of the Nellore firm. The legal representatives of the deceased, Annaji Rao and Sri Kuppu Rao, agreed on September 2, 1959, to receive a sum of Rs. 95,000 from the other partners of the Nellore firm in settlement of the credit balance of Rs. 1,33,394 referred to above on the ground that there were difficulties in realising the outstandings of the Nellore firm.
For the asst. yr. 1960-61, relevant to the accounting year ending with March 31, 1960, the sum of Rs. 38,394 (i.e., difference between Rs. 1,33,394 and Rs. 95,000), was claimed by the assessee-firm as a bad debt deductible from its profits and gains earned in that year. The ITO, on a scrutiny of the terms of the agreement dated September 2, 1959, and the relevant entries in the accounts of the assessee and the Nellore firm, rejected the assessee's claim holding that there was no bad debt at all satisfying the requisite conditions laid down in the Act and it was only a capital loss. The appeal to the AAC proved unfruitful. On further appeal to the Tribunal, the contention advanced on behalf of the assessee was two-fold : (1) that the loss of Rs. 38,394 was admissible as a bad debt, as the assessee represented by Sri Annaji Rao was carrying on the business of being a partner in the Nellore firm to which advance by way of capital was made, and (2) that the assessee who was assessed on accrual basis was a partner of the Nellore firm which was registered under the Act and the deemed profits have not reached the assessee and, hence, it is entitled to set-off the amount of Rs. 38,394 in the year of adjustment. The Tribunal, on a consideration of the entire facts and circumstances, found that the assessee was merely a partner in the Nellore firm but it was not carrying on the business of being a partner in a firm and that it was carrying on money-lending business. It was further held that the profits earned by the Nellore firm have been ascertained and credited to the account of the assessee represented by Sri Annaji Rao, one of its partners and, hence, it was not right to state that the profits earned by the assessee in the Nellore firm did not reach it ; that the assessee, subsequent to its allocation, had deposited the income receipts in the capacity of a depositor as the assessee had complete control and domain over the amounts standing in the account of Sri Annaji Rao in the books of account of the Nellore firm and that the loss, was not a business loss or a loss of revenue nature, but it was a capital loss. The Tribunal agreeing with the view expressed by the AAC and the ITO dismissed the appeal. Hence, this reference at the instance of the assessee.
(3.) THE contentions raised before the Tribunal have been reiterated before us by Mr. Dasaratharama Reddi, the learned counsel appearing for the assessee. THE sum and substance of his pleas was that the profits earned by the assessee in the Nellore firm which have been allowed to be accumulated without withdrawal by the deceased partner, Annaji Rao, must be construed to be constructive loans to the Nellore firm under cl. 8 of the deed of partnership on payment of 5 per cent interest subject to tax in the hands of the assessee. Hence, it was argued that the amount of Rs. 38,394 and Rs. 6,589 should be allowed as bad debts or in the alternative as business losses. In any event, it was urged that the amount of Rs. 6,589 being the accrued income from April 1, 1959, to July 15, 1959, has to be allowed as notional but not real income. This claim of the assessee is resisted by Mr. P. Ramarao, the learned standing counsel for the Revenue, contending, inter alia, that the assessee was not carrying on money-lending business and hence, the amounts cannot be claimed to be bad debts and, in any event, they are not proved to be bad debts within the meaning of the Act nor were they referable to any year of account. It was further contended that the loss was claimed after the dissolution of the Nellore firm and it was a capital loss.
Before adverting to the respective contentions of the parties, it is profitable to notice the material provisions of the Act relating to income chargeable to tax. Sec. 3 of the Act charges the total income of the previous year of every individual, HUF, company and local authority, and of every firm and other AOP or the partners of the firm or the members of the association individually, to tax at any rate or rates specified in the respective Finance Acts. "Total income" as defined under S. 2(15) of the Act is the total amount of income, profits and gains specified in sub-s. (1) to S. 4 and computed in the manner laid down in the Act. The definition of "income" in S. 2(6C) is only an inclusive one but not exhaustive. But, however, S. 4 states what the total income of a previous year of any person is. It is an inclusive definition which is of wider import. It takes in all income, profits and gains received, accrued or arisen or deemed to have been received, accrued or arisen to him in the year of account from whatever source derived. Chapter III deals with taxable income. Sec. 6 specified the heads chargeable to income-tax, namely, salaries, interest on securities, income from property, profits and gains from business, profession or vocation, income from other sources and capital gains. Sec. 10 provides for the computation of business income. The income derived by an assessee in respect of any business, profession or vocation carried on by him is chargeable to tax under S. 10(1). The business profits or gains chargeable under sub-s. (1) of s. 10 r/w S. 3 has to be computed after making the deductions specified in sub-s. (2) to S. 10. The tax being levied on the income earned by a person in any previous year, it is the total income computed as per the provisions of the Act, but not the gross receipts of a person that is chargeable to income-tax under S. 3. The unit of assessment under the Act being the previous year, all the receipts of income of a person, from whatever source they are derived, have to be totalled up and the permissible losses, expenditure and other allowances provided in the Act have to be deducted from the gross income so arrived at, in order to compute the "total income" chargeable to tax. For the purpose of computing the income, profits and gains earned by a person in business, all the business expenditure and allowances specified in sub-s. (2) to S. 10 must be deducted from the total income earned under the head "business". Hence, any capital expenditure or loss or expenditure unconnected with the business is not a permissible deduction. Clause (xi) of sub-s. (2) to S. 10 provides for the deduction from the income of the assessee of any debts due to him if it is established that they have become bad and irrecoverable in the year of account and accordingly written off in the accounts maintained by him in due course of business. Where any expenditure or loss incurred by the assessee during the year of account is proved to have a proximate relationship, nexus or connection with the business carried on by him, it is also permissible to be deducted from the profits and gains earned by him in business so as to arrive at the total income chargeable to tax. Therefore, any capital receipt by an assessee during the year of account is not liable to be taxed. Similarly, any loss or expenditure of a capital nature is not permissible to be deducted from the business profits and gains of a person.;