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Petitioner: KESHAVJI RAVJI & Co. VS Respondent: COMMISSIONER OF INCOME-TAX and others
Court Name: Supreme Court of India Judge(s): M. N. Venkatachaliah, N. D. Ojha, J. S. Verma Title: KESHAVJI RAVJI & Co. vs COMMISSIONER OF INCOME-TAX and others Case No.: Civil Appeals Nos. 1177 to 1184 of 1990 Date of Judgment:1990-02-05 Reported As: 1992 PTD 96 Result: Appeals allowed
JUDGMENT
JUDGMENT ' VENKATACHALLAH, J.---These special leave petitions arise out of and are directed against the orders of the High Court of Judicature at Madras disposing of references made under section 256(1) of the Income-Tax Act, 1961 ("Act" for short), in Tax Cases Nos. 694 of 1982, 565 of 1980, 1404 of 1980, 637 and 638 of 1981, 521 of 1981, 429 of 1983 and 572 of 1983. The High Court, following its earlier pronouncement in C.I.T. v. O.M. S.S. Aankaralinga Nadar and Co. (1984) 147 ITR 332, answered the question of law, similar in all the cases, in favour of the Revenue. The question was whether, in making a disallowance of the interest paid by a partnership firm to a partner under section 40(b) of the Act, the interest, in turn, paid by the partner on his borrowings from the firm should be taken account of and deducted and only the balance disallowed under section 40(b). ' On this question there is a sharp divergence of judicial opinion in the High Courts. In Sri Ram Mahadeo Prasad v. C.I.T. (1953) 24 ITR 176 (All.); C.I.T. v. Kailash Motors (1982) 134 ITR 312 (A11); C.I.T. v. T.V. Rainanaiah and Sons (1986) 157 ITR 300 (AP); C.I.T. v. Kothari and Co. (1987) 165 ITR 594 (Kar.); C.I.T. v. Balaji Commercial Syndicate (1987) 165 ITR 596 (Kar); C.I.T. v. Motilal Ramjiwan and Co. (1988) 171 ITR 294 (Raj); C.I.T. v. Precision Steel and Engg. Works (1989) 179 ITR 283 (P&H), the High Courts have taken the view that, where a firm pays interest to its partner and the partner also pays interest to the firm, only the net amount of interest paid by the firm to the partner is liable to disallowance under section 40(b) of the Act. However, in C.I.T. v. 0.M.S.S. Sankaralinga Nadar and Co. (1984) 147 ITR 332 (Mad.), the High Court of Madras has taken a contrary view. 'We have heard Sri Ramachandran, learned senior counsel for the appellants and Sri Manchanda, learned senior counsel and Sri B.B. Ahuja for the Revenue. Special leave is granted. The appeals are
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taken up for final hearing, heard and are disposed of by this common judgment. ' We may refer to the facts in S.L.P. (Civil) No,14291 of 1985 which is representative of and typifies the context in which the question arises. The appellant, Messrs Keshavji Ravji and Co., is a registered firm consisting of six partners and carries on a business in the manufacture and export of stainless steel articles. In the accounting year ended November 13, 1974, corresponding to the assessment year 1975-76, the firm paid interest to its partners on the amounts standing to their respective credits in the firm. The firm also received from the partners interest on their borrowings from the firm. For the relevant assessm ent year, the appellant filed a return disclosing a total income of Rs,2,55,225. The Income-tax Officer, while disallowing the amount of interest paid to the partners, did not set off the interest received from the partners on their own borrowings. With this disallowance, the income of the firm was assessed at Rs,2,79,730. In the assessee's appeal, the Appellate Assistant Commissioner of Income-tax, by his order dated October 18, 1977, allowed the claim of the appellant that only the net interest paid to the partners, after setting off the interest received from them, was to be disallowed. The Revenue took up the matter in further appeal before the Income-tax Appellate Tribunal which, by its order, dated January 6, 1979, dismissed the appeal and affirmed the order of the Appellate Assistant Commissioner. The Tribunal, as did the Appellate Assistant Commissioner, placed reliance on the decision of the Allahabad High Court in Sri Ram Mahadeo Prasad (1953) 24 ITR 176 (All.). ' At the instance of the Revenue, the Tribunal stated a case and referred the following question of law for the opinion of the High Court: "Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in holding that the net interest should be disallowed under section 40(b) of the Income-tax Act, 1961?" ' This reference under section 256(1) of the Income-tax Act was registered in the High Court as Tax Case No,694 of 1982 and the High Court, by its order, dated March 5, 1985, answered the question in the negative and against the appellant relying, as stated earlier, on its earlier pronouncement in Sankaralinga Nadar's case (1984) 147 ITR 332 (Mad.). Broadly similar are the circumstances under which the other appeals arise. ' Before we advert to and evaluate the merits of the contentions, it is appropriate to refer to the statutory provision as it then stood. Section 40 of the Act provided: "40. Notwithstanding anything to the contrary in sections 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..." ' By the Taxation Laws (Amendment) Act, 1984, several amendments were introduced in the body of section 40. One of them was the introduction of Explanation I in clause (b) of section 40. That Explanation reads: "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." ' Referring to the new Explanation inserted in clause (b) of section 40 by the amendment, the "Notes on Clauses" say (at page (1948) 149 I T R (St.) 44): "This clause seeks to insert three new Explanations to section 40(b) of the Act. Explanation I seeks to provide that where interest is paid by a firm to a partner who has also paid interest to the firm, the amount of interest to be disallowed under section 40(b) of the Act shall be limited to the net amount of interest paid by the firm to the partner, that is, 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."
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"The proposed amendments will take effect from 1st April, 1985, and will, accordingly, apply in relation to the assessm ent year 1985-86 and subsequent years." ' Explanation I, which was introduced in 1984, propos vigor, does not apply to the assessment relating, as here, to an earlier year. Whether the Explanation brings about a change in, or admits of being understood as an exposition of the law is, however, a different matter. It is, perhaps, also appropriate here to refer to Circular No,33-D (XXV-24) of 1965 of the Central Board of Direct Taxes, the operative part of which porridges: "However, where a firm pays interest to as well as receives interest from the same partner, only the net interest can be stated to have been received or paid by the firm, as the case may be, and only the net interest should be taken into consideration. This view also finds support in the decision of the Allahabad High Court in the case of Sri Ram Mahadeo Prasad (1953) 24 I T R 176. In view of the above, the instructions contained in Board's Circular No,55 of 1941 may be treated as modified accordingly...." ' Section 40 imposes a restriction on the deductibility of certain outgoings and expenses which are, otherwise, enabled under sections 30 to 39 of the Act and constitutes an exception to these sections. Clause (b) of section 40 is analogous, with some enlargement, to section 10(4)(b) of the predecessor Act of 1922. The prohibition in section 40 against the deductibility of certain outgoings is in mandatory terms. It is this aspect that has loomed large in the reasoning supporting the view accepted by the Madras High Court in Sankaralinga Nadar's case (1984) 147 ITR 332 and emphasized by learned counsel for the Revenue. The reasoning of the Madras High Court in that case and of the Andhra Pradesh High Court in C.I.T. v. T.V. Ramanaiah and Sons (1986) 157 I T R 300, illustrate the rival points of view. The Madras High Court held (at page 336 of 147 I T R). "The collocation of the words shows that what is disallowed in the matter of payment of interest cannot be the net interest, but can only be interest paid with reference to a given account relating to payment of interest by the firm to the partner. This is because the subject of disallowance in the matter of payment of interest appears in section 40(b) cheek by jowl with salary, bonus, commission or remuneration made by the firm to the partner. There cannot be any net salary or net bonus or net remuneration as matters of disallowance. They can only be salary, as such, or bonus, as such, or commission, as such, or remuneration as such which are the subject of disallowance. In like manner, when the section speaks of payment of interest by the firm to a partner as the subject of disallowance, it can only be payment of `gross' interest in the particular account in which interest is payable. Salary, bonus, commission or remuneration do not have what may be characterised as a two-way traffic In the earliest of the cases, the Allahabad High Court endorsed the Tribunal's decision to disallow only the net interest. The Court did so, not on a construction of the words of the section but on equitable grounds of `fairness'..." ' The Andhra Pradesh High Court, however, taking the contrary view relied on what it considered the Revenue's own understanding of the legal position as made manifest in the Board's circular that the "real purpose of section 40(b) of the Act was to add back only the net amount of interest and not the gross amount". On the interpretation of section 40(b), the High Court in Ramanaiah's case said (at page 304 of 157 ITR): "....As a matter of interpretation of section 40(b) of the Act, we find that there is nothing in the provision which expressly states that the amount to be added back is either gross or net. The provision requires that 'any payment of interest' by a partnership firm to a partner shall not be deducted in computing the income of the partnership firm. For the purpose of finding out the amount paid by way of interest, it is necessary for the Income-tax Officer to find out the amount of interest paid by the partnership firm to the partner and also see if the same partner paid any interest to the partnership firm and ascertain the amount of interest effectively paid by the partnership firm to the partner..."
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' The arguments of learned counsel on both sides covered a wide range of contentions. The submissions of Sri Ramachandran in support of the appeals admit of being formulated thus: "(a) The scheme of section 40 of the Act does not evince any intention to penalise a firm for the outgoings which are rendered non-deductible; but the sole object of section 40(b) is, having regard to the special features and legal incidents of a partnership, to enable to assessment of the 'real income' of the firm. The outgoings disallowed by section 40(b) are not really outgoings at all, but constitute what are, otherwise, ingredients or components of the real income of the firm. Therefore, the ascertainment of the real income or the real commercial profits does not require or compel the exclusion of the cross-interest paid by a partner in determining the quantum to be disallowed under section 40(b). (b) The extent of the embargo under section 10(4)(b) of the 1922 Act on the disallowance of 'interest' paid to a partner was judicially interpreted and ascertained in Sri Ram Mahadeo Prasad v. C.I.T. (1953) 24 ITR 176 (All) and when the Legislature re-enacted those provisions in section 40(b) of the 1961 Act in substantially the same terms, the Legislature must be held to have used that expression with the same implications attributed to it by the earlier judicial exposition. (c) Interest payable by the partners to the firm pursuant to an agreement between the partners is of the same nature as that payable by the firm to the partners on the capital brought in by them. Interest paid to and received from a partner are both integral parts of a method adopted by the partners for adjusting the division of profits and, in that sense, both payments partake of the same character. ' In identifying and quantifying the 'interest' for purposes of section 40(b), it would be permissible to take both the payments into consideration and treat only such excess, if any, paid by the firm as is susceptible to the exclusionary rule in section 40(b). (d) Circular No,33D (XXV 24) of 1965 of the Central Board of Direct Taxes, which is statutory in character, is binding on the authorities. The High Court was in error in taking a view of the legal position different from the one indicated in it. (e) The amendment of 1984, inserting Explanation I in section 40(b), though later in point of time, constitutes a legislative exposition of the correct import of the provision and, so construed, it offers a guide to the correct understanding of the provisions in section 40(b) in its application to the earlier years as well. Re: Contention (a): ' The premise of the argument is good in parts; but the inference does not logically follow. Section 40(b), it is true, seeks to prevent evasion of tax by diversion of the profits of a firm; but the legislative expedience adopted to achieve that objective requires to be given effect on its own language. Section 40 opens with the non obstante clause and directs that certain outgoings specifically enumerated in it "shall not be deducted" in computing the income chargeable under the head "Profits and gains of business or profesion" As long as there is no ambiguity in the statutory language, resort to any interpretative proces to unfold the legislative intent becomes impermissible. The supposed intention of the Legislature cannot then be appealed to to whittle down the statutory language which is otherwise unambiguous. If the intendment is not in the words used, it is nowhere else. The need for interpretation arises when the words used in the statute are, on their own terms, ambivalent and do not manifest the intention of the Legislature. In Doypack Systems (P.) Ltd. v. Union of India (1988) 2 SCC 299, 331, 332; (1989) 65 Comp Case 1, 29, 30, it was observed: "The words in the statute must, prima facie, be given their ordinary meanings. Where the grammatical construction is clear, manifest and without doubt, that construction ought to prevail unless there are some strong and obvious reasons to the contrary..." "It has to be reiterated that the object of interpretation of a statute is to discover the intention of Parliament as expressed in the Act. The dominant purpose in construing a statute is to ascertain
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the intention of the Legislature as expressed in the statute, considering it as a whole and in its context. That intention, and, therefore, the meaning of the statute, is primarily to be sought in the words used in the statute itself, which must, if they are plain and unambiguous, be applied as they stand...." (Emphasis supplied). ' Artificial and unduly latitudinarian rules of construction, which with their general tendency to "give the taxpayer the breaks", are out of place where the legislation has a fiscal mission. Indeed, taxation has ceased to be regarded as an "impertinent intrusion into the sacred rights of private property" and it is now increasingly regarded as a potent fiscal tool of State policy to strike the required balance---required in the context of the felt needs of the times---between the citizens' claim to enjoyment of his property on the one hand and the need for an equitable distribution of the burdens of the community to sustain special services and purposes on the other. These words of Thomas M. Cooley in 'Law of Taxation', Volume 2, are worth mentioning: "Artificial rules of construction have probably found more favour with Courts than they have ever deserved. Their application in legal controversies has often times been pushed to an extreme which has defeated the plain and manifest purpose in enacting the laws. Penal laws have some times had all their meanings construed away and in remedial laws, remedies have been found which the legislature never intended to give. Something akin to this has befallen the revenue laws..." (Emphasis supplied). ' There are, indeed, strong and compelling considerations against the adoption of the test suggested by Sri Ramachandran. Limiting of the ambit of section 40(b) on the supposed "real income" test would, perhaps, lead to positions and results, the dimensions and implications of which are not, to say the least, fully explored. The test suggested by Sri Ramchandran might, on its own extended logic, validate a set-off of the interest paid to one partner against interest received from another and, likewise, "interest" received from one partner on some other dealings between him and the firm against interest paid to another partner on his or her capital contribution. The test of "real income" as one on which the operation of section 40(b) could be sought to be limited is not a reliable one. Indeed, the following observations of this Court on the concept of "real income" in State Bank of Travancore v. C.I.T. (1986) 158 ITR 102 at page 155, though made in a different context, are apposite: "...The concept of real income is certainly applicable in judging whether there has been income or not but, in every case, it must be applied with care and within well-recognised limits. ' We were invited to abandon legal fundamentalism. With a problem like the present one, it is better to adhere to the basic fundamentals of the law with clarity and consistency than to be carried away by common cliches. The concept of real income certainly is a well-accepted one and must be applied in appropriate cases but with circumspection and must not be called in aid to defeat the fundamental principles of the law of income-tax as developed." ' This contention of Sri Ramachandran rests on generalisations which incur the criticism of being too broad and have certain limitations of their own. ' Contention (a) does not advance the appellants' case. Re: Contention (b): ' The submissions of Sri Ramchanadran on the point are that where the meaning of a word used in a statute had been judicially ascertained by a Court and where the Legislature, while re-enacting the law on the subject, uses the same word, it must be taken to have been aware of the meaning so judicially ascertained earlier and not to have used the word with a different content. This is, no doubt, a well-recognised guide to construction. When words acquire a particular meaning or sense because of their authoritative construction by superior Courts, they are presumed to have been used in the same sense when used in a subsequent legislation in the same or similar context. This
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principle was stated by the Judicial Committee in H.H. Ruckmaboye v. Lulloobhoy Mottichund (1852) 5 M.IA. 234 at 250, thus: "....It is, therefore, of considerable importance to ascertain what has been deemed to be the legal import and meaning of them, because, if it shall appear that they have long been used, in a sense which may not improperly be called technical, and have been judicially construed to have a certain meaning, and have been adopted by the Legislature in that sense, long prior to the Statute 21 James I., c. 16, the rule of construction of statutes will require that the words in the statute should be construed according to the sense in which they had been so previously used, although that sense may vary from the strict literal meaning of them." ' This principle has been reiterated by this Court in several pronouncements. But the limitations of its application in the present cases arise out of the circumstance that the decision of the Allahabad High Court in Sri Ram Mahadeo Prasad v. C.I.T. (1953) 24 ITR 176, did not proceed or rest on any special or technical connotation of the word "interest" nor on any special legal sense which that word could be said to have acquired by the earlier judicial ascertainment of its amplitude. The decision proceeded on a construction of the relevant provision, i,e,, section 10(4)(b) of the 1922 Act, and on what the High Court considered as affording to the assessee a fair treatment. Nothing particular stemmed from the interpretation of the expression "interest". The appeal to this principle of construction is, in our opinion, somewhat out of place in this case. The rules of interpretation are not rules of law; they are mere aids to construction and constitute some broad pointers. The interpretative criteria apposite in a given situation may, by themselves, be mutually irreconcilable. It is the task of the Court to decide which one, in the light of all relevant circumstances, ought to prevail. The rules of interpretation are useful servants but quite often tend to become difficult masters. It is appropriate to recall the words of Lord Reid in Maunsell v. Olins (1975) 1 All ER 16, 18 (HL): "Then rules of construction are relied on. They are not rules in the ordinary sens,,, of having some binding force. They are our servants not our masters. They are aids to construction, presumptions or pointers. Not infrequently one 'rule' points in one direction, another in a different direction. In each case we must look at all relevant circumstances and decide as a matter of judgment what weight to attach to any particular 'rule': ' This passage was referred to with approval by this Court in Utkal Contractors and Joinery P. Ltd. v. State of Orissa (1987) 3 SCR 317 at 330. ' Contention (b) is, therefore, not of any assistance to the appellants. Re: Contention (c): ' There are certain aspects of the legal relationship amongst partners which do impart a special complexion to the question under consideration. The point raised in these appeals is confined to a situation where a partner receives interest on the capital subscribed by him and the same partner pays interest on the drawings made by him. ' A firm under the general law is not a distinct legal entity and has no legal existence of its own. The partnership property vests in all the partners and in that sense every partner has an interest in the assets of the partnership. However, during the subsistence of the partnership, no partner can deal with any portion of the property as his own. In Addanki Narayanappa v. Bhaskara Krishnappa, AIR 1966 SC 1300; (1966) 3 SCR 400, this Court referred to the nature of the interest of a partner in the firm and observed (at page 1304 of 1966 AIR): and for that purpose to bring in as capital money or even property including immovable property. Once that is done whatever is brought in would cease to be the exclusive property of the person who brought it in. It would be the trading asset of the partnership in which all the partners would have interest in proportion to their share in the joint venture of the business of partnership. The person who brought it in would, therefore, not be able to claim or exercise any exclusive right over any property which he has brought in, much less over any other partnership property. He would not be able to exercise his right even to the extent of his share in the business of the partnership..."
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' In C.I.T. v. R.M. Chidambaram Pillai (1977) 106 ITR 292 at 295 and 296, this Court observed: "Here the first thing that we must grasp is that a firm is not a legal person even though it has some attributes of personality. Partnership is a certain relation between persons, the product of agreement to share the profits of a business. 'Firm' is a collective noun, a compendious expression to designate an entity, not a person. In income tax law, a firm is a unit of assessment, by special provisions, but is not a full person which leads to the next step that since a contract of employment requires two distinct persons, viz., the employer and the employee, the cannot be a contract of service, in strict law, between a firm and ouc of its partners. So that any agreement for remuneration of a partner for taking part in the conduct of the business must be regarded as portion of the profits being made over as a reward for hP or the human capital brought in. Section 13 of the Partnership Act brings into focus this basis of partnership business." "....It is implicit that the share income of the partner takes in his salary. The telling test is that where a firm suffers loss, the salaried partner's share in it goes to depress his share of income. Surely. Therefore,…
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