K.C.Agrawal, J. - (1.) The following question has been referred by the Income-tax Appellate Tribunal under Sub-section (1) of Section 256 of the Income-tax Act: "Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was legally correct in holding that payment of interest made to the partner, Shri Hari Nath, on his interest earning deposit account was not covered by Section 40(b) of the Income-tax Act, 1961, and in its deleting the additions of Rs. 7,083, Rs. 7,537, Rs. 3,882 and Rs. 5,914, respectively, made by the Income-tax Officer on this account? "
(2.) The assessee is a registered firm consisting of several partners. Hari Nath, one of the partners, in his individual capacity received interest on the amounts invested by him in the firm in his individual capacity. The Income-tax Officer added back these amounts to the total income of the assessee-firm. The assessee-firm appealed to the Appellate Assistant Commissioner. It was contended in the appeal that an individual and the Hindu undivided family are two different entities and are assessed separately. Consequently, the interest paid to Hari Nath on the loans advanced to the assessee-firm could not be added to the income of the firm. The Appellate Assistant Commissioner relied on the decision of the Delhi High Court in Pannalal Girdharilal v. CIT [1971] 81 ITR 624 and held that interest paid to the partner in whatever capacity could not be treated as legitimate deduction and thus confirmed the addition of the amounts made by the Income-tax Officer. The assessee-firm filed an appeal before the Income-tax Appellate Tribunal which was allowed and the additions made by the Income-tax Officer of the amounts paid to Hari Nath by way of interest were directed to be deducted. The Income-tax Appellate Tribunal held that interest paid to a person in respect of his individul accounts when he is also a partner of the firm representing his Hindu undivided family was not covered by Section 40(b) of the Income-tax Act. The Revenue thereafter moved the application for reference under Sub-section (1) of Section 256 which was allowed. Hence, the reference.
(3.) There is a divergence of judicial opinion on the controversy whether interest paid to a partner in whatever capacity the payment is made is not allowable under Section 40(b).;