Terla Veeraiah v. Commissioner Of Income-Tax, A.P

- The following question has been referred to this court by the Appellate Tribunal under s. 256(1) of the I.T. Act at the instance of the assessee :

"Whether, on the facts and in the circumstances of the case, the interest credited to Shri Terla Veeraiah Individual Account is to be disallowed under section 40(b) of the Income-tax Act, 1961 ?"

The facts giving rise to this reference are these : The assessee is one M/s. Terla Veeraiah and the assessment year is 1972-73. There was a HUF of which Terla Parasuramulu, the father of Terla Veeraiah, was the karta. The HUF was carrying on wholesale business in cloth. There was a partition between Terla Parasuramulu, his son, Terla Veeraiah, and his grandson, Terla Srisailam. After partition, the three divided members constituted themselves into a partnership firm by a deed dated December 12, 1962. Parasuramulu died on January 9, 1969. The partnership continued even after his death. Parasuramulu did not leave any other person except his son, Veeraiah, as his heir. He, therefore, succeeded to Parasuramulus properties including the capital standing to his credit in the firm. Veeraiah was being assessed as a HUF in respect of the share income from the partnership firm. The account standing in the name of Parasuramulu and inherited by his son Veeraiah was put in a separate account. So far as the account as partner of the firm was concerned, it was styled as "Terla Veeraiah (HUF) account". For the assessment years 1970-71 and 1971-72, a sum of Rs. 7,890 being the interest received from the partnership was credited to the account described as "Terla Veeraiah Individual Account". An amount of Rs. 8,585 received in respect of the same assessment years was credited to the account styled as "Terla Veeraiah (HUF) Account". So far as the interest received in respect of the individual account was concerned it was being assessed in the hands of Terla Veeraiah in the status of an individual as distinct from the assessment of HUF of Terla Veeraiah.

The ITO while making the assessment for the assessment years in question disallowed the sum of Rs. 7,890 under s. 40(b) of the I.T. Act. In so disallowing he relied upon his own earlier orders for the two preceding assessment years. The AAC dismissed the appeal relying upon the judgment of this court in R.C. 95/70 (CIT v. T. Veeraiah and K. Narasimhulu reported in [1977] 106 ITR 283). On appeal to the Appellate Tribunal the Tribunal held that the interest was being credited to the partner in both the accounts and consequently s. 40(b) is attracted. Aggrieved by the order, the assessee moved for reference and that is how the reference has been made to this court.

Mr. Anjaneyulu, the learned counsel appearing for the assessee, invited our attention to the findings of the Tribunal to contend that on those findings the Tribunal was in error in holding that s. 40(b) comes into operation. section 40(b) of the I.T. Act says :

"Notwithstanding anything to the contrary in section 30 to 39 , 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. "It is Mr. Anjaneyulus case that the payment of interest of Rs. 7,890 was not to Terla Veeraiah in his capacity as partner of the firm but it was paid to Terla Veeraiah as the karta of the HUF comprising of himself, his wife and daughters.

It is not in dispute that after the death of Parasuramulu the capital invested by him in the firm devolved on his son, Veeraiah. Veeraiah was a partner of the firm along with his father and his divided son, Srisailam, in his own right. It is for that reason he has been maintaining two accounts, one an individual account and another HUF account. The interest paid towards the capital invested by Parasuramulu was credited by Veeraiah to the HUF account and the interest paid to him on the capital invested by him was credited by him to his individual account. The Tribunal recorded the following findings : (1) The properties which Terla Veeraiah inherited from his father including the assets of his father in the partnership firm are ancestral in his hands and, therefore, they must be treated as properties of the HUF of Terla Veeraiah consisting of himself, his wife and daughter, if any. (2) It is difficult to hold that the properties inherited by Terla Veeraiah from his father, Terla Parasuramulu, must be assessed as an individual or that the income therefrom must be assessed in the hands of Veeraiah in the status of an individual. It is on those findings that the Tribunal considered the question whether s. 40(b) would be attracted in respect of the interest credited by Terla Veeraiah to the account of Terla Veeraiah, HUF. The relevant portion of the decision of the Tribunal (para. 7) which deals with the question may be extracted with advantage.

"On the above findings, the question that still remains to be considered is whether section 40(b) would be applied. We do not think that there can be any scope for the argument that the section would not be applied. We have already indicated that Terla Veeraiah as a partner was having his account under the style as Terla Veeraiah Hindu undivided family Account. In respect of properties inherited by Terla Veeraiah from his father, also we think as per our conclusion, the same must belong to Terla Veeraiah as Hindu undivided family. Therefore, the interest was paid to Terla Veeraiah in the capacity of karta representing his Hindu undivided family. To put it in a different manner, the interest is credited to the partner in both the accounts. In such an event section 40(b) is clearly attracted."

The Tribunal having recorded a finding that there were two accounts, one Terla Veeraiah HUF account and another Terla Veeraiah individual account, and having held that interest was paid to Terla Veeraiah in the capacity of karta representing HUF, erred in concluding that the interest was credited to the partner in both the accounts. We are unable to understand how the Tribunal, on those findings of fact, could say that s. 40(b) was clearly attracted. If interest on the capital of the HUF was separately credited in the HUF account and not in the account of Veeraiah representing as a partner of the firm, we are unable to understand the logic of the Tribunal : "In such an event section 40(b) is clearly attracted".

Mr. Rama Rao, learned counsel for the revenue, sought support from a decision of this court in Addl. CIT v. K. G. Narayanaiah Chetty & Co. [1977] 106 ITR 420 to which one of us (Obul Reddi C.J.) was a party. That was a case where interest was first credited to the account of the individual parties and later transferred to the HUF account. It was for that reason this court observed that if really the HUF was the creditor of the firm, there was no reason why there should be two accounts and the interest paid to the partners should be transferred to the account of the HUF. Hence, it was held that s. 40(b) was attracted and the interest paid was not deductible from the income of the assessee-firm. As already noticed the facts here are different. Two separate accounts were maintained from the beginning by the assessee, one HUF account and the other individual accounts. It is not a case where the assessee first credited the interest to his individual account and later transferred it to the account of the HUF for the revenue to say that the payment of interest is not deductible under s. 40(b). In Addl. CIT v. Chinna Balaiah Chetty and Co. [1977] 106 ITR 556, this court held that where money was advanced by the joint family, the interest realised by the joint family on that capital does not come within the purview of s. 40(b) of the Act.

For the reasons recorded, we answer the question in the negative and in favour of the assessee with costs. Advocates fee Rs. 250.