S.M.P. Periaswami Nadar and Others vs The Commissioner of Income Tax

Horace Owen Compton Beasley, C.J.—On this petition we are asked to direct the Commissioner of Income Tax to refer the following

question:

Whether interest payments made to partners of the petitioners'' firm, under the circumstances mentioned in the petition, and in the order of the

Assistant Commissioner of Income Tax are admissible items of expenditure u/s 10(2)(iii) of the Indian Income Tax Act.

The assessees are a partnership firm carrying on business in the purchase and sale of cotton seeds and it appears now to be a very flourishing

business. In the year of assessment, 1928-1929, it was assessed to Income Tax in the amount of Rs. 25,095. In arriving at this assessment, the

Income Tax Officer disallowed a sum of Rs. 7,633-4-0, which the assessees claimed to be entitled to a deduction of from the gross profits of the

partnership. They based their claim, as is apparent from the question we are asked to direct the Commissioner of Income Tax to refer, on Section

10(2)(iii) of the Income Tax Act. That section allows a deduction ""in respect of capital borrowed for the purpose of the business where the

payment of interest thereon is not in any way dependent upon the earning of profits, the amount of interest paid"". It was contended by the

assessees that this sum of money was interest on capital borrowed from or at least a loan to the partnership by the individual partners and as such

not assessable to Income Tax. In this connection much reliance was placed by Mr. K.V. Sesha Aiyangar on the Full Bench decision in

Commissioner of Income Tax v. Subramaniam Chettiar ILR (1928) M 787 : 55 M.L.J. 416. There a Full Bench of which I was a member held

that where a partner genuinely lends money, beyond the initial capital, to the partnership at an agreed reasonable rate of interest and the money is

used for capital expenditure, the interest paid by the partnership to him in the year of assessment must be deducted in computing the profits or

gains of the partnership as provided by Section 10(2)(iii) of the Indian Income Tax Act. That is all that that case decides; and when the facts of the

case are looked into, it will be seen that before the partnership started, there was an agreement in which the amount of capital contributed by each

of the partners was set out and the rate, of interest agreed to be paid upon the capital so contributed was also agreed upon. In this case there is no

such agreement. Furthermore, in the agreement in that case, there was a provision that after the partnership started working, the partners might

contribute further capital to the partnership, and that if they did so, they should receive interest at a certain rate on the capital so contributed. That

case in no way, in our view, supports the contention of Mr. Sesha Aiyangar. There is no agreement whatever in the present case to contribute any

capital or lend any monies nor is there an agreement to pay any interest. It is contended by the asses-sees that when the partnership started the

business, the business was a very small one and that there was no initial capital. But it is quite obvious as the Assistant Commissioner of Income

Tax says in his order that a business with so large a turnover as this one could not possibly be conducted without some capital and that what

happened in this case was that a certain amount of the profits earned by the partnership were allowed to remain in the partnership as capital by

means of which to carry on the partnership. This is a very different case to the Full Bench case where there was a specific agreement to contribute

further capital beyond the initial capital already contributed. There is a further difficulty in the way of Mr. Sesha Aiyangar, namely, that whereas in

the Full Bench case there was an agreement to pay a fixed rate of interest, here, as I have already stated, there was no agreement to pay any

interest at all. But as a fact it does appear that for a period of 17 years 12 per cent, interest was paid on the amounts allowed to remain in the

partnership by the partners and it is therefore quite obvious that in those years the partnership earned sufficient profits to enable the partnership to

pay that high rate of interest. It must also be equally clear that had there been no such profits, no such rate of interest could have been paid.

Therefore, the payment of interest was dependent; on the earning of profits. There is not as in the Full Bench case a definite and an enforceable

agreement to pay interest. What was strenuously argued before us in that case so far as my recollection serves me was that, quite irrespective of

any profits being earned the rate of interest agreed upon was payable. Mr. Sesha Aiyangar is, therefore, unable to bring himself within the provision

of Section 10(2)(iii) of the Indian Income Tax Act.

Another matter which I think I ought to mention is that Thiruvenkatachariar, J., who was a member of that Full Bench in his answer to the

question referred stated that this question is purely a question of fact, and with that statement I am inclined to agree.

Under these circumstances, we decline to direct the Commissioner of Income Tax to refer this case. The assessees will pay Rs. 150 costs to the

Commissioner.

Anantakrishna Aiyar, J.

I agree.

Curgenven, J.

I agree.