R.K. Gulati, J. - (1.) In compliance with the direction of this court, the Income-tax Appellate Tribunal has referred the following question of law for the opinion of this court : " Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that only the net amount of interest paid to a partner after deducting the interest paid by him could be added to the firm's income under Section 40(b) of the Income-tax Act, 1961?"
(2.) The assessee is a registered firm which derives income from the financing of vehicles on hire purchase system. The dispute pertains to the assessment year 1973-74 for which the relevant previous year ended on March 31, 1972, As against the returned income of Rs. 91,800, the assessment was completed on Rs. 1,09,180 which included disallowance of interest amounting to Rs. 38,738. In making the said disallowance of interest under Section 40(b) of the Income-tax Act, 1961, the Income-tax Officer did not take into account and set off the amount which the firm had charged on the debit balance of the drawing accounts of three out of its eleven partners. The drawing accounts were maintained in the books of the firm separately from the capital accounts of the respective partners. From the details set out in the statement of the case submitted by the Tribunal of the amount of interest paid to the different partners by the firm and the interest charged from them, it is evident that a sum of Rs. 38,738 was paid as interest to its partners by the firm and the partners had in their turn paid a sum of Rs. 7,239 as interest to the firm. The net result was that the firm had paid a sum of Rs. 32,397 after adjusting the amount of Rs. 7,239, which the partners had paid to the firm. The assessee claimed that, under Section 40(b) of the Act, disallowance of interest should be restricted to the net amount of interest paid to the partners, namely, Rs. 32,397 and the entire gross amount of Rs. 38,738 could not be disallowed. The Income-tax Officer did not accept this claim which, on appeal, was, however, accepted by the Appellate Assistant Commissioner. On second appeal, at the instance of the Revenue, the Tribunal confirmed the order of the Appellate Assistant Commissioner. The present reference has been made to this court in the question set out above at the instance of the Revenue.
(3.) The question that arises for consideration is whether disallowance of interest, in terms of Section 40{b) of the Income-tax Act, 1961, paid by a firm to its partner should be the gross amount of such interest or should be confined to the net amount after setting off the interest, in turn, paid by the partner to the firm on his borrowings from the firm.;