Mody, A.C.J:— This is a reference under section 66(1) of the Indian Income-tax Act, 1922.

2. Messrs. Mills Store Company, a partnership firm constituted of six partners, was carrying on business at Karachi with branches, amongst other places, at Bombay. As at the end of March, 1948, that partnership was dissolved and its accounts were made up. As from 1st April, 1948, three of the six partners took over the Karachi business and continued it in the same name. This new Karachi firm will be referred to as “the Karachi firm”. As from 1st April, 1948, the three remaining partners took over the Bombay business and continued it in the same old name in partnership with two new partners. This firm will be referred to as “the assessee-firm”. After these two new firms were formed there were numerous transactions between them. The Income-tax Tribunal has found that in the accounting year 1948-49 ending on 31st March, 1949, the assessment year being 1949-50, an amount of Rs. 3,94,823 was debited to the account of the Karachi firm and a corresponding credit was given to certain parties who were creditors of the Karachi firm for an equivalent amount and that the amount in fact represented loans taken by the Karachi firm from a number of creditors who had later on migrated to India as a result of the partition of India. In its books of account the assessee-firm credited that amount to these creditors, hereinafter referred to as “the said creditors”, and debited the same in the account of the Karachi firm maintained by it in its books of accounts. It has also been found that in the Karachi firm's account for the same accounting year 1948-49, the Karachi firm remitted to the assessee-firm diverse sums aggregating to Rs. 5,98,300. In the assessment year 1949-50, relating to the accounting year 1948-49, the assessee-firm credited in the account of the said creditors maintained by it in its books of accounts interest on the amounts due to them by the assessee-firm and simultaneously charged and debited to the Karachi firm interest payable by it to the assessee-firm. The assessee-firm was assessed in the assessment year 1949-50, on the basis of interest debited to the Karachi firm being included in its taxable income and interest payable by it to the said creditors being deducted from its income under the provisions of section 10(2)(iii).

3. In the assessment year 1950-51 relating to the accounting year 1949-50, although in the books of accounts of the assessee-firm no interest was charged in the account of the Karachi firm, interest payable by the Karachi firm was estimated and included in its income and interest payable by the assessee-firm to its said creditors and credited in the account of the said creditors was allowed as a deduction.

4. In the accounting year 1950-51, the assessment year being 1951-52, the assessee-firm wrote off as a bad debt its outstanding claim against the Karachi firm and simultaneously debited a like amount to the capital account of its partners maintained by it in its books of account. The assessee-firm claimed the bad debt so written off as a revenue loss. In its books of accounts the assessee-firm had, in this year also, credited to the said creditors interest on the amounts due to them by the assessee-firm and claimed it as a deduction from its taxable income. The Income-tax Officer disallowed the claim for the bad debt so written off as a revenue loss and completed the assessment by allowing the interest credited to the said creditors as a deduction.

5. In respect of the assessment year 1952-53, the accounting year being 1951-52, the assessee-firm claimed and was allowed interest credited to the said creditors as a deduction from its taxable income.

6. The assessments for the two assessment years 1951-52 and 1952-53 were reopened under section 34 on the ground that certain income had escaped assessment on the ground that in the assessment year 1951-52 depreciation had been wrongly allowed in respect of a building at Saharanpur and in the assessment year 1952-53, depreciation had been wrongly allowed in respect of the said building and also in respect of a motor car.

7. In the reassessment proceedings for both these years the Income-tax Officer not only disallowed the said depreciation which was done with the consent of the assessee-firm, but overruling the assessee-firm's objection, also disallowed the deduction for interest credited by the assessee-firm to the said creditors for the amounts due by it to them.

8. In respect of each of the six assessment years 1953-54 to 1958-59, the assessee-firm claimed interest paid by it to the said creditors as a deduction, but that claim was disallowed in respect of each of these six years.

9. In respect of all these eight assessment years the assessee-firm, having appealed to the Appellate Assistant Commissioner and lost before him, appealed to the Income-tax Tribunal. The Tribunal held that, so far as the assessment years 1951-52 and 1952-53 were concerned, only such income which had escaped assessment for which the department was competent to take recourse to the provisions of section 34(1)(iii) could be brought to tax in the reassessment proceedings, but, that as the allowance of the interest paid to the said creditors during each of these two years was not the ground for reopening the assessment for each of the two years, it was not competent to disallow the same in such reassessment proceedings and allowed the appeal to that extent. So far as the said six assessment years were concerned, the Tribunal rejected the claim of the assessee-firm for deduction of interest paid to the said creditors and dismissed its appeal in so far as it related to the same. The Tribunal has, thereafter, referred the undermentioned questions of law to this court under section 66(1). The questions are:

“1. Whether, on the facts and in the circumstances of the case, interest on accounts transferred from Karachi could be disallowed in the course of assessment proceedings under section 34(1)(b) for the assessment years 1951-52 and 1952-53 after they had been allowed in the original assessments for those years?

2. Whether, on the facts and in the circumstances of the case, interest charged to accounts transferred from Karachi was allowable as a deduction from the assessee's business income for the assessment years 1953-54 to 1958-59?”

10. In respect of the disallowances of the assessee-firm's claim for deduction of interest paid by it to the said creditors, the Tribunal has held:

“It is not the case of the assessee that it is doing any financing business. At that relevant piece of time, there was no business necessity for which the assessee agreed to the making of these transfer entries. Truly speaking, no asset has been brought into existence at all. The assessee took upon itself the liability of the Karachi firm in order to accommodate its creditors. It was thus not for any commercial consideration that it agreed to do so. These transfer entries do not pertain to any business activity of the assessee and as such the assessee is not entitled to claim any deduction of interest on the aforesaid credits…”

11. Mr. Joshi, the learned counsel for the respondent, also advanced an argument on the same basis and contended that in giving credit to the Karachi creditors “no money came into the till of the assessee-firm” and that, therefore, this credit was not given for the purposes of the business of the assessee-firm. What the Tribunal has found on this point and this contention of Mr. Joshi, in our opinion, fail to appreciate the correct position. These entries effected in the accounting year 1948-49 have been referred to by the Tribunal as “transfer entries” and are what are commonly known as “havala entries”. When creating these credits in favour of the said creditors, the assessee-firm obtained an asset of an exactly equivalent amount in favour of the assessee-firm of a claim or a debt due to it by the Karachi firm. A trading or business firm would in its normal course of business effect such havala entries. Inasmuch as such a havala entry would not in the least affect the financial position of the person effecting such entry, a trading or business firm would effect the same from diverse motives such as to keep up and foster good business relations. The genuineness of the debit to the Karachi firm and credits to the said creditors is not in dispute. The bona fides of this havala entry are not challenged, and, in any event, it cannot be challenged because of two reasons. The first reason is that in the same accounting year the Karachi firm remitted to the assessee-firm an aggregate sum of Rs. 5,98,300 which by far exceeds the amount of the said havala entry. The second reason is that when the assessee-firm about a couple of years later wrote off its outstanding claim against the Karachi firm as a bad debt, it simultaneously made a corresponding debit in the capital account of its partners maintained in its books of accounts. The subsequent making of this havala entry did not in any way alter what we have said about the original position of the creation of the credits in favour of the said creditors. But in any event this second reason needs analysis. At that later point of time the partners were at liberty to withdraw the sum of Rs. 3,94,823 from their capital account and then to advance it to the said creditors, who, in their turn, could have advanced the said amount to the assessee-firm. Such is exactly the effect of the debit to the partners' capital account and continuing the original credit in favour of the said creditors, subject to such payments one way or the other as may have been made in the interval after writing off the said debt due by the Karachi firm as a bad debt. The effect of making these entries was that the consideration to support the credits in favour of the said creditors which was originally the corresponding debit to the Karachi firm was, on its being written off as a bad debt, substituted by a corresponding debit to the capital account of the partners and the original transaction of creating the credits in favour of the said creditors continued, but only the consideration supporting it changed. So far as the original transaction was concerned, it was a business transaction because it was by itself for the purposes of the assessee-firm's business and in any event because the obligation to pay interest to the said creditors was created to earn interest from the corresponding debit to the Karachi firm. The interest so earned would be included in the assessee-firm's taxable income and the interest which the assessee-firm would, in its turn, pay to the said creditors would become entitled to deduction under section 10(2)(iii). The answer to the contention that the original creation of credits in favour of the said creditors did not bring even a single rupee into the till of the assessee-firm is that money did come into the books of accounts, which is equivalent to a till, of the assessee-firm by reason of the corresponding debit to the Karachi firm. In our opinion, considerable confusion has arisen by reason of looking only to the credits originally created in favour of the said creditors as an isolated transaction uncorrelated with the corresponding debit of an exactly equal amount made to the Karachi firm. In our opinion, therefore, the original credits created in favour of the Karachi firm, in the accounting year 1948-49, amounts to capital borrowed for the purposes of the business of the assessee-firm and is entitled to be deducted under the provisions of section 10(2)(iii). We, therefore, answer question No. 2 in the affirmative. In view of this answer to question No. 2, it is unnecessary to consider and answer question No. 1, because even if question No. 1 were to be answered in the affirmative, which we make it clear we do not do, the result of answering question No. 2 would make the answer to question No. 1 of no practical effect.

12. The respondent to pay the applicant's costs of this reference.