N.N. Mathur, J. - (1.) ALL these applications under Section 256(2) of the Income-tax Act, 1961 (hereinafter referred to as "the Act of 1961"), which pertain to the assessment year 1993-94, have been filed at the instance of the Revenue seeking mandamus to the Tribunal for drawing up a statement of case and to refer the different questions formulated in each reference application. Though the questions have been differently worded in each reference application it is agreed by learned counsel for the Revenue as well as for the respondent-assessee that the following common questions are involved in this group of applications : "(i) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in its interpretation of Section 40(b) of the Income-tax Act and then holding that the claim of the assessee for interest on capital contribution by the partners and salary to the working partners is covered by the said provisions ? (ii) Whether, in the facts and circumstances of the case, the Income-tax Appellate Tribunal was justified in allowing the claim of depreciation, interest and salary to the partners, etc., despite the income being determined by applying net profit rate after rejecting the books of account despite that when the income is determined by applying net profit rate, all the deductions allowable are treated to be allowed ?"
(2.) IN order to better appreciate the controversy, the facts of one of the reference applications, i.e., D. B. INcome-tax Reference Application No. 12 of 1998 (CIT v. Jain Construction Co.) are stated in brief. The assessee, a registered partnership firm, filed its return for the assessment year 1993-94 in respect of the accounting period of 1992-93 declaring an income of Rs. 17,980. On account of certain discrepancies noticed in the books of account, the assessing authority, viz., the Income-tax Officer, Barmer, invoking the provisions of Section 145 of the Act of 1961, applied a net profit rate of 12.5 per cent, on receipts of Rs. 76,12,688. He further allowed deduction by way of depreciation, interest and salary to the partners to the extent of Rs. 8,67,691. As a result of this deduction, the assessable income was calculated as Rs. 83,895. The Commissioner of Income-tax Jodhpur, on a perusal of the assessment record, found that the order of the assessing authority is erroneous as it is prejudicial to the interests of the Revenue inasmuch as as a result of deduction by way of depreciation, interest and salary to the partners, the net profit in the asses-see's case came down to the rate of 1.10 per cent. In his opinion, the said net rate was extremely low. He, therefore, invoked the provisions of Section 263 of the Act of 1961 and issued a notice to the assessee. The Commissioner of Income-tax held that while taking the net profit rate of 12.5 per cent, the assessing authority had already allowed expenses to the extent of 87.5 per cent, in the case of the assessee against the net receipts. In his opinion, the provisions of Section 40(b) of the Act of 1961 were only enabling provisions and they did not provide for separate deductions of such expenses even when the income was being computed after adopting the net profit rate by rejecting the books of account. He also held that looking to the normal net profit rate, which is applicable in the case of contractors, the income determined by the assessing authority by applying the effective rate of 1.1 per cent, is very much low as compared to the income properly assessable in the case. In view of the finding, the Commissioner of Income-tax directed the assessing authority to recompute the income from the contract business without allowing any separate deduction in respect of interest claimed by the assessee including the interest and salary to the partners. The Commissioner of Income-tax also found that there is nothing on record to indicate any inquiries regarding the fulfilment of the conditions relating to allowance of depreciation in terms of ownership of the assets by the assessee and the extent of their use for business purposes. Thus, the Commissioner of Income-tax restored the matter back to the assessing authority for giving a fresh finding in the light of the directions given in his order allowing an opportunity of being heard to the assessee. Aggrieved by the order of the Commissioner of Income-tax dated March 27, 1996, the assessee filed an appeal before the Income-tax Appellate Tribunal, Jaipur Bench. The Tribunal, persuaded by the circular of the Central Board of Revenue, held that the depreciation should be worked out separately with reference to the claim of the assessee for salary and interest payable to the partners. Keeping in view, the amended provisions of Section 40(b) of the Act of 1961, the Tribunal examined the partnership deed and found that the claim of the assessee for interest on capital contribution by the partners and salary to working partners is squarely covered by the said provision. In view of the finding by a judgment dated August 30, 1996, the Tribunal set aside the order of the Commissioner of Income-tax made under Section 263 of the Act of 1961. The Revenue made an application before the Tribunal seeking reference of the questions formulated for the opinion of this court. The Tribunal declined to refer the questions for the opinion of this court as in its opinion, no referable question of law arose. The application was accordingly rejected by order dated June 24, 1997. It is contended by Mr. Sandeep Bhandawat, learned counsel appearing for the Revenue, that the Tribunal has erred in law in not appreciating the fact that when the income from the contract is determined by applying the net profit rate, all such deductions are treated to be allowed. Giving effect to the directions of the Tribunal would tantamount to allowing the same deduction twice and as a result thereof, the income would be reduced to a substantially low figure. It is also submitted that the circular of the Board relied upon by the Tribunal is only for the guidance of the assessing authority and is not binding on the courts. On the other hand, Mr. Anjay Kothari has supported the decision of the Tribunal. We have considered the rival contentions. Section 40(b) is the substitute of the original Section 10(4)(b) of the Indian Income-tax Act, 1922. As the provision existed, in each case it was required to be determined whether payment made by way of interest salary, commission or remuneration by a firm to a partner was real and bona fide or only intended to serve as a device to escape taxation. For this, it was also required to be seen whether the payment was to a partner as a partner or in a different character. In order to procure more certainty in the nature of payments, Section 40(b) was introduced by the Amendment Act of 1989. Section 40(b) under the Amendment Act 1989 was as follows : "40. Notwithstanding anything to the contrary in Sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',-- (b) in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm. Explanation I.--Where interest is paid by a firm to any partner of the firm who has also paid interest to the firm, the amount of interest to be disallowed under this Clause shall be limited to the amount by which the payment of interest by the firm to the partner exceeds the payment of interest by the partner to the firm. Explanation 2.--Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as 'partner in a representative capacity', and 'person so represented' respectively),-- (i) interest paid by the firm to such individual or by such individual to the firm otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of this Clause ; (ii) interest paid by the firm to such individual or by such individual to the firm as partner in a representative capacity and interest paid by the firm to the person so represented or by the person so represented to the firm, shall be taken into account for the purposes of this Clause. Explanation 3.--Where an individual is a partner in a firm otherwise than as partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this Clause, if such interest is received by him on behalf, or for the benefit, of any other person."
(3.) IT seems that it imposed an absolute embargo against deductions in respect of any of the payments made by the firm, of the nature enumerated, to any partner of the firm. Explanation 2 clarified that the interest paid by the firm to an individual, who is a partner in a firm in a representative capacity, shall not be taken into account for the purposes of the said Clause. IT indicated that it covered all the payments of the nature described to a partner of the firm by the firm and did not cover other payments made to such partners. The provision also did not provide for any category of salary, remuneration, etc., though paid by a firm to a person who is a partner, falling outside the scope of the said provision. There was nothing to indicate splitting of capacities of a partner making distinction between a partner obliged to work and one not obliged to work under the terms of a contract or provisions of law. IT appears that the state of law on the subject was still not satisfactory, thus Section 40(b) has again been substituted by the Finance Act of 1992, which reads as follows : "40. Notwithstanding anything to the contrary in Sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',--. . . (b) in the case of any firm assessable as such,- (i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as 'remuneration'), to any partner who is not a working partner ; or (ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorised by, or is not in accordance with, the terms of the partnership deed ; or (iii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is authorised by, and is in accordance with, the terms of the partnership deed, but which relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorised by, or is not in accordance with, any earlier partnership deed, so, however, that the period of authorisation for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed ; or (iv) any payment of interest to any partner which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as such amount exceeds the amount calculated at the rate of eighteen per cent, simple interest per annum ; or (v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder : (1) in the case of a firm carrying on a profession referred to in Section 44AA or which is notified for the purpose of that Section- JUDGEMENT_527_ITR245_2000Html1.htm Provided that in relation to any payment under this Clause to the partner during the previous year relevant to the assessment year commencing on the 1st day of April, 1993, the terms of the partnership deed may, at any time during the said previous year, provide for such payment. Explanation 1--Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as 'partner in a representative capacity' and 'person so represented', respectively) . . .--" Thus, now in the case of working partners, payments of salary, bonus, commission or remuneration by whatever name it is called in terms of the partnership deed are allowable as deductions to the extent of limit provided under Section 40(b). In this group of cases, the Tribunal after examining the partnership deed in all individual cases found that the claim of the assessees for interest on capital contribution by the partners and salary to working partners was allowable deduction to the extent of limit provided under Section 40(b) of the Act. In our view, the Tribunal was justified in doing so. The finding of fact does not give rise to a question of law. Mr. Bhandawat has made a faint attempt to suggest that the amended provision of Section 40(b) is not applicable in the instant case for the reason that it relates to the financial year 1993-94. In our view, there is no substance in the contention. It is clearly provided that the amendment will take effect from April 1, 1993, and will, accordingly, apply in relation to the assessment year 1993-94 and the subsequent years thereto. It is also provided that it pertains to the payment to the partner during the previous year, relevant to the assessment year commencing on April 1,1993. Obviously, the previous year is 1992-93 and the assessment year is 1993-94. ;