Full Judgment Text
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PETITIONER:
KESHAVJI RAVJI & CO. ETC. ETC.
Vs.
RESPONDENT:
COMMISSIONER OF INCOME TAX
DATE OF JUDGMENT05/02/1990
BENCH:
VENKATACHALLIAH, M.N. (J)
BENCH:
VENKATACHALLIAH, M.N. (J)
OJHA, N.D. (J)
VERMA, JAGDISH SARAN (J)
CITATION:
1990 SCR (1) 243 1990 SCC (2) 231
JT 1990 (1) 235 1990 SCALE (1)207
ACT:
Income Tax Act, 1961. s.
40(b)--Non-deductibility--Interest paid by partner on bor-
rowings from firm--Whether to be set off against interest-
paid on his capital.
Statutory Interpretation: Taxing statutes--Where meaning is
plain and unambiguous ascertainment of legislative intent
not required--Whether literal interpretation leads to result
not intended another construction in consonance with the
object to be adopted. Express statutory provisions departing
from general law will prevail over the latter--Rule of
construction--Not applicable invariably in all circum-
stances--Where, a provision is re-enacted using the same
word as used in old provision, subsequent to judicial ascer-
tainment of meaning of that word, the word used in the re-
enacted provision to be presumed to bear the same meaning.
’Explanation’ provision in statute--Significance and use of
Circulars issued by CBDT expressing its views on a statutory
provision-Not binding on Court.
HEADNOTE:
Section 40(b) of the Income Tax Act, 1961, as it stood
at the relevant time, prohibited deduction of interest,
salary, bonus, commission or remuneration paid by the firm
to the partner. Explanation 1 introduced thereto by the
Taxation Laws (Amendment) Act, 1984, which took effect from
1st April, 1985, provided 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 shall be limited to
the net amount of interest paid by the firm to the partner.
Circular No. 33D(XXV-24) of 1965 issued by the Central Board
of Direct Taxes provided that 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.
The assessee-appellant, a registered partnership firm,
in the accounting year for the assessment year 1975-76, paid
interest to the partners on the amounts standing to their
respective credits. It also received from the partners
interest on their borrowings from the firm. The Income-tax
Officer
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244
while disallowing the amount of interest paid to the part-
ners did not set-off the interest received from them on
their borrowings. The Appellate Assistant Commissioner
allowed the claim of the appellants that only the net inter-
est paid to the partners after setting-off the interest
received from them was to be disallowed. The Appellate
Tribunal affirmed the appellate order. The High Court an-
swered the reference in favour of the Revenue on the view
that the Tribunal was not justified in holding that net
interest should be disallowed under s. 40(b) of the Act.
In these appeals by special leave it was contended for
the appellants that: (a) the sole object of s. 40(b) was,
having regard to the special features and legal incidents of
a partnership, to enable the assessment of the ’real income’
of the firm and did not require or compel the exclusion of
the cross-interest paid by a partner in determining the
quantum to be disallowed; (b) the extent of the embargo
under s. 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. CIT, 24 ITR 176
All. and when the legislature re-enacted those provisions in
s. 40(b) of the 1961 Act in substantially the same terms,
legislature must be held to have used that expression with
the same implications attributed to it by the earlier judi-
cial exposition; (c) the interest paid to a partner on the
capital brought in by him and the interest received from a
partner on his borrowings from the firm were both integral
parts of a method adopted by the partners for adjusting the
division of profits and in that sense both payments partook
of the same character and it would be permissible to take
both the payments into consideration in quantifying the
interest and treat only such excess, if any, paid by the
firm as susceptible to the exclusionary rule in s. 40(b);
(d) the circular of the Central Board of Direct Taxes, which
was statutory in character, was binding on the authorities
and the High Court was in error in taking a view of the
legal position different from the one indicated in it; and
(e) the amendment of 1984 inserting Explanation 1 in s.
40(b), though later in point of time, constitutes a legisla-
tive exposition of the correct import of the provision and
so construed offers a guide to the correct understanding of
the provisions in s. 40(b) in their application to the
earlier years as well.
Allowing the appeals, the Court,
HELD: 1.1 As long as there is no ambiguity in the statu-
tory language, resort to any interpretative process to
unfold the legislative intent becomes impermissible. The
supposed intention of the legislature cannot then be ap-
pealed to whittle down the statutory
245
language. If the intendment is not in the words used it is
nowhere else. [255E-F]
Doypack Systems Pvt. Ltd. v. Union of India, [1988] 2
SCC 299, referred to.
1.2 Section 40 of the Income Tax Act, 1961 opens with
the nonobstante clause and directs that outgoings such as
interest, salary, bonus, commission or remuneration specifi-
cally enumerated in cl. (b) shall not be deducted in comput-
ing the income chargeable under the head "profits and gains
of business or profession". The words used therein on their
own terms, are plain and unambiguous. They manifest the
intention of the legislature and must, therefore, be applied
as they stand. [255D-E, F-G, 256B]
1.3 Artificial and unduly latitudinarian rules of con-
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struction, with their general tendency to ’give the tax-
payer the breaks’, are out of place where the legislation
has a fiscal mission. Taxation is regarded as a potent
fiscal tool of State policy to achieve equitable distribu-
tion of the burdens of the community to sustain social
services. [256C-D]
Thomas M. Cooley: Law of Taxation, Vol. 2, referred to.
1.4 The test of ’real income’ as one on which the opera-
tion of s. 40(b) could be sought to be limited is not a
reliable one. It 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 and thus lead to positions and results,
whose dimensions and implications are not fully explored. It
must not, therefore, be called in aid to defeat the funda-
mental principles of the law of income tax. [257 A, 256A,
256G, 257D1
State Bank of Travancore v. CIT, [1986] 158 ITR 102 at
155, referred to.
2.1 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. [257G]
H.H. Ruckmaboye v. Lulloobhoy Mottichund, Moore’s Indian
Appeals, Vol. 5, p. 234 at 250, referred to.
2.2 However, the rules of interpretation are not rules of
law. they
246
are mere aid 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. [258E-F]
Maunsell v. Olins, [1975] 1 All ER 16 and Utkal Contrac-
tors & Joinery v. State of Orissa, [1987] 3 SCR 317 at 330,
referred to.
2.3 The decision in Sri Ram Mahadeo Prasad v. CIT, (24
ITR 176 All.) proceeded on a construction of the relevant
provision i.e.s. 10(4)(b) of the 1922 Act and on what the
High Court considered as affording to the assessee a fair
treatment. It did not rest on any special or technical
connotation of the word ’interest’ nor any special legal
sense which that word could be said to have acquired by the
earlier judicial ascertainment of its amplitude. The appeal
to this principle of construction in the instant case is,
therefore, out of place. [258D-E]
3.1 To the extent the statute expressly or by necessary
implication departs from the general law, the latter can not
be invoked to displace the effect of the statute. But if
there is no such statutory departure the general principle
operating in that branch of law would determine the nature
of legal relationship. [261F-H]
Sir Francis Bennion, on Statutory Interpretation, p.
350, 354, referred to.
In the case of partners, therefore, to the extent not
prohibited by s. 40(b) of the Act, the incidents of the
general law of partners would be attracted to ascertain the
legal nature and character of a transaction. This is quite
apart from distinguishing the ’substance’ of the transaction
from its ’form’. But the legal effect of a transaction,
cannot be displaced by probing into the substance of the
transaction. The Court, however, is not precluded from
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treating what the transaction is in point of fact as one in
point of law also. [262C-D, 263A-B]
Sargaison v. Roberts, [1969] 45 Tax Cases 612; CIT v.
Gillanders Arbuthnot & Co., 87 ITR 407; Narayanappa v.
Krishtappa, [1966] 3 SCR 400; CIT v. Chidambaram, [1977] 106
ITR 292; Lindley on Partnership, (14th Edn.) p. 30; Regional
Director Employees State Insurance Corporation, Trichur v.
Ramanuja Match Industries, [1985] 2 SCR 119 and Ellis v.
Joseph Ellis & Co., [1905] 1 KB 324. referred to.
3.2 If interest paid by the firm to a partner and the inter-
est, in
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turn, received from the partner are mere expressions of the
application of the funds or profits of the partnership and
which, having regard to the community of interest of the
partners, are mere variations of the method of adjustment of
the profits, they could be treated as part of the same
transaction if, otherwise, in general law they admit of
being so treated. The provisions of s. 40(b) do not exclude
or prohibit such an approach. [263B-D]
If instead of the transactions being reflected in two
separate or distinct accounts in the books of the partner-
ship they were in one account, the quantum of interest paid
by the firm to the partner would, to the extent of interest
on drawings of the partner, stand attenuated. The mere fact
that the transactions were split into or spread over to two
or more accounts would not by itself make any difference if,
otherwise. the substance of the transaction was the same.
[263D-E]
Official Liquidator v. Lakshmikutty, [1981] 2 SCR 349,
referred to.
Even the idea of a set-off itself, which presupposes a
duality of entities may be out of place in the very nature
of the relationship between a firm and its partners where
the former is a mere compendious reference to the latter.
But even to the extent the income tax law which identifies
the firm as a distinct entity and unit of assessment goes,
the idea of set-off may be invoked in view of the mutuality
implicit in the putative duality inherent in deeming the
firm as a distinct entity under the Act for certain pur-
poses. The fiction may have to be pushed to its logical
conclusions. [263H-264B]
3.3 Where a strict literal construction leads to a
result not intended to subserve the object of the legisla-
tion another construction, permissible in the context should
be adopted. Therefore, though equity and taxation are often
strangers, attempts should be made that these do not remain
always so. More so, a taxing statute being not different
from other statutes it is not to be construed differently.
The duty of the Court is to give effect to the intention of
the legislature. [264C, E-F, G-H, 265A]
CITv. J.H. Gotla, 156 ITR 323 and A.G.V. Carlton Bank,
[1899] 2 QB 158, referred to.
3.4 Accordingly, where two or more transactions on which
interest is paid to or received from the partner by the firm
are shown to have the element of mutuality and are referable
to the funds of the
248
partnership as such, s. 40(b) should not be so construed as
to exclude in quantifying the interest on the basis of such
mutuality. If that be so, the interest, if any paid to a
partner by the firm in excess of what is received from the
partner could alone be excluded from deduction under s.
40(b). [265B-C]
C.I.T. v. T.V. Ramanaiah & Sons, 157 ITR 300 A.P., approved.
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C.I.T. v. O.M.S.S. Sankaralinga Nadar & Co., 147, ITR
332 Mad., overruled.
4. The Central Board of Direct Taxes cannot pre-empt a
judicial interpretation of the scope and ambit of a provi-
sion of the Income Tax Act by issuing circulars on the
subject. A circular cannot even impose on the tax payer a
burden higher than what the Act itself on a true interpreta-
tion envisages. Nor can it detract from the Act. The task of
interpretation of the laws is the exclusive domain of the
courts. The circulars do not bind them. [265E-F, 266D, 265F,
G-H]
State Bank of Travancore v. CIT, [1986] 158 ITR 102., re-
ferred to.
Since the circular of 1965 broadly accords with the view
taken on the true scope and interpretation of s. 40(b) as
regards qualification of interest it is unnecessary to
examine whether or not such circulars are recognised legiti-
mate aids to statutory construction. [266E-F]
5. An ’Explanation’ is generally intended to explain the
meaning of certain phrases and expressions contained in a
statutory provision. There is no general theory as to the
effect and intendment of the Explanation except that the
purpose and intendment of the Explanation are determined by
its own words. An Explanation depending on its language,
might supply or take away something from the contents of a
provision. An Explanation may also be introduced by way of
abundant caution in order to clear the meaning of a statuto-
ry provision and to place what the legislature considers to
be the true meaning beyond controversy or doubt. [266G-267B]
In the instant case, the notes on clauses appended to
the Taxation Laws (Amendment) Bill, 1984 say that clause 10
which seeks to amend s. 40will take effect from 1st April,
1985 and will, accordingly, apply in relation to the assess-
ment year 1985-86 and subsequent years. In view of the
express prospective operation and effectuation of the Expla-
nation
249
it is not necessary to examine its possible purpose any
further. [267C-E]
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal Nos. 1177 to
1184 (NT) of 1990.
From the Judgments and Order dated 5.3.85, 21.1.85,
25.2.85, 11.2.85, 14.10.85, 11.2.85 and 20.10.86 of the
Madras High Court in T.C. Nos. 694/82,565/80, 1404/80,
637/81,638/81,521/81,429/83 and 572/83.
T.A. Ramachandran and Mrs. Janki Ramachandran for the
Appellant.
S.C. Manchanda, B.B. Ahuja and Ms. A. Subhashini for the
Respondent.
The Judgment of the Court was delivered by
VENKATACHALIAH, 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 Case 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 of that
Court in Commissioner of Income-tax v. O.M.S.S. Sankaralinga
Nadar & Co., 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 for the inter-
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est paid by a partnership firm to a partner under Section
4O(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 judi-
cial opinion in the High Courts. In Sri Ram Mahadeo Prasad
v. C.I.T., 24 ITR 176 (All) 1; C.I.T. v. Kailash Motors, 134
ITR 312; C.I.T. v. T.V. Roman sigh & Sons, 157 ITR 300;
C.I.T. v. Kothari & Co., 165 ITR 594 (Kar.); C.I.T. v.
Balaji Commercial Syndicate, 165 ITR 596 (Kar.); C.I.T. v.
Motiisi Ramjiwan and Co., 171 ITR 294 (Raj.); C.I.T. v.
Precision Steel and Engg. Works, 179 ITR 283 (Pun & Har.),
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. O.M.S.S.
250
Sankaralinga Nadar & Co., 147 ITR 332 (Mad.), the High Court
of Madras has taken a contrary view.
2. We have heard Shri 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 taken up for final hearing, heard
and are disposed of by this common judgment.
3. We may refer to the facts in SLP(C) No. 14291/1985
which is representative of and typifies the context in which
the question arises. The appellant, M/s. Keshavji Ravji &
Co. is a registered firm consisting of 6 partners and car-
ries on a business in the manufacture and export of stain-
less steel articles. In the accounting year ended 13.11.
1974, corresponding to the assessment year 1975-76, the firm
paid interest to the 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 assessment 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 partners did not set-off the interests received from
the partners on their own borrowings. With this disallow-
ance, 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 18.10.1977 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 6.1.1979 dismissed the appeal and
affirmed the appellate order of the 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 v. C.I.T., 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 net
interest should be disallowed under section 40(b) of the
Income-tax Act, 1961 ?"
This reference under Section 256(1) of the Act was regis-
tered in
251
the High Court as Tax Case No. 694/82 and the High Court by
its order dated 5.3. 1985 answered the question in the
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negative and against the appellant relying, as stated earli-
er, on its earlier pronouncement in Sankaralinga Nadar’s
case. Broadly, similar are the circumstances under which the
other appeals arise.
4. 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",
(a) ]
(1) ]
to ] Omitted as unnecessary
(v) ]
(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."
(c) ]
] Omitted as unnecessary
(d) ]
By the Taxation Laws (Amendment) Act, 1984, several amend-
ments were introduced in the body of Section 40. One of them
was the introduction of Explanation 1 in clause (b) of
Section 40. That Explanation reads:
"Explanation 1: 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:
252
"This clause seeks to insert three new Explanations to
section 40(b) of the Act. Explanation 1 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 part-
ner, 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."
"The proposed amendments will take effect from 1st April,
1985, and will, accordingly, apply in relation to the as-
sessment year 1985-86 and subsequent years."
The Explanation I, which was introduced in 1984, proprio-
vigore, 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 the circular No. 33-D
(XXV-24) of 1965 of the Central Board of Direct Taxes, the
operative part of which provides:
"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 ITR 176. In view of the above, the in-
structions contained in Board’s Circular No. 55 of 1941 may
be treated as modified accordingly ...... "
5. Section 40 imposes a restriction on the deductibility
of certain outgoings and expenses which are, otherwise,
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enabled under Sections 30-39 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 manda-
tory 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 and emphasised by the
learned counsel for the Revenue. The reasoning of the Madras
High Court in that case and of the Andhra Pradesh High Court
in Commissioner of Income-tax v. T.V. Ramanaiah & Sons, 157
253
ITR 300 (A.P.) illustrate the rival points of view. The
Madras High Court held:
" ..... 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 refer-
ence 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
s. 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 mat-
ters 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"......"
(P. 336)
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 Rarnanaiah’s case said:
" ..... 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 pay-
ment 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
254
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 inter-
est to the partnership firm and ascertain the amount of
interest effectively paid by the partnership firm to the
partner ......"
[157 ITR 300 at p. 304]
5A. The arguments of the learned counsel on both sides
covered a wide range of contentions. The submissions of Sri
Ramachandran in support of the appeals admit of being formu-
lated thus:
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(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 the assessment of the
’real-income’ of the firm. The outgoings disallowed by
Section 40(b) are not really outgoings at all, but consti-
tute 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 Maha-
deo Prasad v. Commissioner of Income-tax, 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, 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
255
Section 40(b) it would be permissible to take both the
payments into consideration and treat only such excess, ii
any, paid by the firm as susceptible to the exclusionary
rule in Section 40(b).
(d) The circular No. 33-D(XXV-24) of 1965 of the Central
Board of Direct ’Faxes, 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 legis-
lative exposition of the correct import of the provision and
so construed offers a guide to the correct understanding of
the provisions in Section 40(b) in its application to the
earlier years as well.
6. Re: Contention (a)
The premises of the argument is good in parts; but the
inference does not logically follow. Section 40(b), it is
true, seeks to prevent the evasion of tax by diversion of
the profits of a firm; but the legislative expedience adopt-
ed 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 profession": As long as there is no ambiguity in
the statutory language, resort to any interpretative process
to unfold the legislative intent becomes impermissible. The
supposed intention of the legislature can not then be ap-
pealed 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,
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ambivalent and do not manifest the intention of the Legisla-
ture. In Doypack Systems Pvt. Ltd. v. Union of India, [1988]
2 SCC 299 it was observed:
"The words in the statute must, prima facie, be given their
ordinary meanings. Where the grammatical construction is
clear and manifest and without doubt, that construction
ought to prevail unless there are some strong and obvious
reasons to the contrary ...... "
(p. 33 1)
256
"It has to be reiterated that the object of interpretation
of a statute is to discover the intention of the Parliament
as expressed in the Act. The dominant purpose in construing
a statute is to ascertain 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 unam-
biguous, be applied as they stand ...... "
(Emphasis Supplied)
(p. 332)
Artificial and unduly latitudinarian rules of construc-
tion which, with their general tendency to "give the tax-
payer 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 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 social services
and purposes on the other- These words of Thomas M. Cooley
in ’Law of Taxation’ Vol.2 are worth mentioning;
"Artificial rules of construction have probably found more
favour with the 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 mani-
fest purpose in enacting the laws. Penal laws have sometimes
had all their meaning construed away and in remedial laws,
remedies have been found which the legislature never intend-
ed 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 Ramachan-
dran. Limiting of the ambit of Section 40(b) on the supposed
’real income’ test would, perhaps, lead to positions and
results, whose dimensions and implications are not, to say
the least, fully explored. The test suggested by Sri Rama-
chandran, 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 deal-
257
ings 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 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
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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 con-
sistency 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 generalisation
which incur the criticism of being too-broad and have cer-
tain limitations of their own.
Contention (a) does not advance appellants’ case.
7. Re: Contention (b)
The submissions of Sri Ramchandran 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 recog-
nised 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 principle was stated by the
Judicial Committee in H.H. Ruckmaboye v. Lulloobhoy Mottic-
hund, Moore’s Indian Appeals, Vol. 5, p. 234 at 250 thus:
258
" .... 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, al-
though 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. Commissioner of Income-tax, 24 ITR 176 did not
proceed or rest on any special or technical connotation of
the word "interest" nor 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 particu-
lar 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
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Reid’s in Maunsell v. olins, [1975] 1 All ER 16:
"Then rules of construction are relied on. They
are not rules in the ordinary sense 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 circum-
stances and decide as a matter of judgment what weight to
attach to any particular ’rule’."
259
This passage was referred to with approval by this Court in
Utkal Contractors and Joinery v. State of Orissa, [1987] 3
SCR 317 at 330.
Contention (b) is, therefore, not of any assistance to
the appellants.
8. 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 in 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 partner-
ship property vests in all the partners and in that sense
every partner has an interest in assets of the partnership.
However, during the subsistence of the partnership no part-
ner can deal with any portion of the property as his own. In
Narayanappa v. Krishtappa, [1966] 3 SCR 400, this Court
referred to the nature of the interest of a partner in the
firm and observed:
" ..... The whole concept of partnership is to
embark upon a joint venture 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 the
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 ...... "
In CIT v. Chidambaram, [1977] 106 ITR 292 at 295 & 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 at-
tributes of personality. Partnership is a certain relation
between
260
persons, the product of agreement to share the profits of a
business. ’Firm’ is a collective noun, a compendious expres-
sion 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, there cannot be a con-
tract of service, in strict law, between a firm and one 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 the human capital brought in. Section 13 of the
Partnership Act brings into focus this basis of partnership
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business."
" ..... It is implicit that the share income of the part-
ner 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, salary is
a different label for profits, in the context of a partner’s
remuneration"
(Underlining Supplied)
In Lindley on Partnership (14th Edn.), we find this
statement of the law:
" ..... In point of law, a partner may be the debtor or
the creditor of his co-partners, but he cannot be either
debtor or creditor of the firm of which he is himself a
member, nor can he be employed by his firm, for a man cannot
be his own employer." (p. 30)
The position as stated above was approved by this Court in
Chidabaram’s case.
In Regional Director Employees State Insurance Corpora-
tion, Trichur v. Ramanuja Match Industries, [1985] 2 SCR
119, this Court dealing with the question whether there
could be a relationship of master and servant between a firm
on the one hand and its partners on the other, indicated
that under the law of partnership there can be no such
relationship as it would lead to the anomalous position of
the same person being both the master and the servant. The
following observations of Justice Mathew in Ellis v. Joseph
Ellis & Co., [1905] 1 KB 324 were referred to with approval:
261
"The argument on behalf of the applicant in this appeal
appears to involve a legal impossibility, namely, that the
same person can occupy the position of being both master and
servant, employer and employed."
(p. 126)
And observed:
"..... A partnership firm is not a legal entity. This Court
in Champaran Cane Concern v. State of Bihar and Anr., point-
ed out that in a partnership each partner acts as an agent
of the other. The position of a partner qua the firm is thus
not that of a master and a servant or employee which concept
involves an element of subordination but that of equality.
The partnership business belongs to the partners and each
one of them is an owner thereof ...... "
(p. 123)
"It is thus clear that in the United States, Great Britain
and Australia, a partner is not treated as an employee of
his firm merely because he receives a wage or remuneration
for work done for the firm. This view is in complete accord
with the jurisprudential approach. In the absence of any
statutory mandate, we do not think there is any scope for
accepting the view of the Rajasthan High Court."
(p. 127)
9. Sri Ramachandran’s contention is that both the capi-
tal brought-in by the partners to the firm and the amounts
that may be drawn by them from the partnership firm partake
of the same nature and character as the funds of the part-
nership. This may be so. But in effectuating the conse-
quences of the recognition of this position, it is necessary
to ensure that express provisions of the statute departing
from the general law are not whittled down. To the extent
that the statute expressly or by necessary implication
departs from the general law, the latter cannot be invoked
to displace the effect of the statute.
But, if there is no such statutory departure the general
principles operating in that branch of the law determine the
nature of the legal relationship. Sir Francis Bennion in his
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Statutory Interpretation observes:
"Unless the contrary intention appears, an enactment by
262
implication imports any principle or rule of law (whether
statutory or non-statutory) which prevails in the territory
to which the enactment extends and is relevant to its opera-
tion in that territory." (p. 350)
"Unless the contrary intention appears, an enactment by
implication imports the principle of any legal maxim which
prevails in the territory to which the enactment extends and
is relevant to the operation of the enactment in that terri-
tory." (p. 354)
What follows is that, to the extent not prohibited by the
statute, the incidents of the general law of partners are
attracted to ascertain the legal nature and character of a
transaction. This is quite apart from distinguishing the
’substance’ of the transaction from its ’from’. In Sargaison
v. Roberts, [1969] 45 Tax Cases 612 at 617 & 618, Megarry,
J., observed:
"I appreciate that what I have to do is to construe
the words used, and not to insert words which are not there,
or to resort to a so-called "equitable construction" of a
taxing statute. But even when I have given full weight to
this consideration, I think that I am entitled to distin-
guish between the substance of a transaction and the machin-
ery used to carry it through ..... "
"..... "Substance" and "form" are words which must no doubt
be applied with caution in the field of statutory construc-
tion. Nevertheless, where the technicalities of English
conveyancing and land law are brought into juxtaposition
with a United Kingdom taxing statute, I am encouraged to
look at the realities at the expense of the technicalities.
In Commissioner of Income-tax v. Gillanders Arbuthnot & Co.,
87 ITR 407 at 418, this Court said:
"..... The taxing authority is entitled and is indeed bound
to determine the true legal relation resulting from a trans-
action. If the parties have chosen to conceal by a device
the legal relation, it is open to the taxing authority to
unravel
263
the device and to determine the true character of the rela-
tionship. But the, legal effect of a transaction cannot be
displaced by probing into the substance of the transaction"
(Emphasis Supplied)
The Court is not precluded from treating what the trans-
action is in point of fact as one in point of law also.
10. How do. these principles operate on the present
controversy? It appears to us that if in substance interest
paid by the firm to a partner and the interest, in turn,
received from the partner are mere expressions of the appli-
cations of the funds or profits of the partnership and
which, having regard to the community of interest of the
partners, are a mere variations of the method of adjustment
of the profits, there should be no impediment in treating
them as part of the same transaction if, otherwise, in
general law they admit of being so treated. The provisions
of Section 40(b) do not exclude or prohibit such an ap-
proach. If instead of the transactions being reflected in
two separate or distinct accounts in the books of the part-
nership they were in one account, the quantum of interest
paid by the firm to the partner would. to the extent of the
drawings of the partner, stand attenuated. The mere fact
that the transactions are split into or spread over to two
or more accounts should not by itself make any difference
if, otherwise, the substance of the transaction is the same.
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One of the relevant tests would be whether the funds on
which interest is paid or received partake of the same
character.
A broad analogy, though in itself may not be conclusive,
is furnished by the idea of "mutual-dealings" and the prin-
ciple of set-off statutorily recognised in bankruptcy pro-
ceedings under Section 46 of the Provincial Insolvency Act
and attracted also to proceedings for winding-up of compa-
nies by virtue of Section 529 of the Companies Act, 1956,
where the ’mutual-credit’ clause steps in to avoid the
injustice, which would otherwise, arise, of compelling a
creditor to pay the official-assignee the full amount of the
debt due from him to the insolvent, while the creditor
would, perhaps, only receive a small dividend on the debt
due from the insolvent to him under a pari-passu payment.
This principle was recognised by this Court in Official
Liquidator v. Lakshmikutty, [1981] 2 SCR 349. The set-off in
this case is, no doubt, the result of a statutory provision.
In the case of partners, the special legal incidents of
their relationship would substitute for the statutory provi-
sion and govern the situation. Indeed, even the idea of
264
a set-off itself, which presupposes a duality of entities,
may be out of place in the very nature of the relationship
between a firm and its partners where the former is a mere
compendious reference to the latter. But even to the extent
the income tax law which identifies the firm as a distinct
entity and unit of assessment goes, the idea of set-off may
be invoked in view of the mutuality implicit in the putative
duality inherent in deeming the firm as a distinct entity
under the Act for certain purposes. The fiction may have to
be pushed to its logical conclusions.
11. The decision of the Madras High Court in Sankaralin-
ga Nadar’s case speaks of income-tax and equity being
strangers. To say that a Court could not resort to the so-
called "equitable construction" of a taxing statute is not
to say that where a strict literal construction leads to a
result not intended to subserve the object of the legisla-
tion, another construction, permissible in the context,
should not be adopted. In Commissioner of Income-tax v. J.H.
Gotla, 156 ITR 323, this Court said:
" ..... we should find out the intention from the language
used by the Legislature and if strict literal construction
leads to an absurd result, i.e., a result not intended to be
subserved by the object of the legislation found in the
manner indicated before, then if another construction is
possible apart from strict literal construction, then that
construction should be preferred to the strict literal
construction. Though equity and taxation are often strang-
ers, attempts should be made that these do not remain always
so and if a construction results in equity rather than in
injustice, then such construction should be preferred to the
literal construction. Furthermore, in the instant case, we
are dealing with an artificial liability created for coun-
teracting the effect only of attempts by the assessee to
reduce tax liability by transfer ...... "
(p. 339-40)
In this respect taxing statutes are not different from other
statutes. In A. G v. Carlton Bank, [1899] 2 QB 158, Lord
Russel of Killowen, CJ said:
"I see no reason why any special canons of construction
should be applied to any Act of Parliament, and I know of no
authority for saying that a taxing Act is to be construed
265
differently from any other Act. The duty of the court is, in
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my opinion, in all cases the same, whether the Act to be
construed relates to taxation or any other subject, viz. to
give effect to the intention of the legislature ...... "
12. We, accordingly, accept the submission of Sri Rama-
chandran on this point. In our opinion, where two or more
transactions on which interest is paid to or received from
the partner by the firm are shown to have the element of
mutuality and are referable to the funds of the partnership
as such, there is no reason why Section 40(b) should be so
construed as to exclude in quantifying the interest on the
basis of such mutuality. In such circumstances the interest,
if any, paid to a partner by the firm in excess of what is
received from the partner could alone be excluded from
deduction under Section 40(b).
Contention ’c’ is held and answered accordingly.
13. Re: Contention (d)
Sri Ramachandran contended that circular of 1965 of the
Central Board of Direct Taxes was binding on the authorities
under the Act and should have been relied upon by the High
Court in support of the Court’s construction of Section
40(b) to accord with the understanding of the provision made
manifest in the circular.
This contention and the proposition on which it rests,
namely, that all circulars issued by the Board have a bind-
ing legal quality incurs, quite obviously, the criticism of
being too broadly stated. The Board cannot pre-empt a judi-
cial interpretation of the scope and ambit of a provision of
the ’Act’ by issuing circulars on the subject. This is too
obvious a proposition to require any argument for it. A
circular cannot even impose on the tax prayer a burden
higher than what the Act itself on a true interpretation
envisages. The task of interpretation of the laws is the
exclusive domain of the courts. However,--this is what Sri
Ramachandran really has in mind--circulars beneficial to the
assessees and which tone down the rigour of the law issued
in exercise of the statutory power under Section 119 of the
Act or under corresponding provisions of the predecessor Act
are binding on the authorities in the administration of the
Act. The Tribunal, muchless the High Court, is an authority
under the Act. The circulars do not bind them. But the
benefits of such circulars to the assessees have been held
to be permissible even though the circulars might have
departed from the strict tenor of the statutory provision
and mitigated the
266
rigour of the law. But that is not the same thing as saying
that such circulars would either have a binding effect in
the interpretation of the provision itself or that the
Tribunal and the High Court are supposed to interpret the
law in the light of the circular. There is, however, support
of certain judicial observations for the view that such
circulars constitute external aids to construction.
In State Bank of Travancore v. C.I.T., [1986] 158 ITR
102, however, this Court referring to certain circulars of
the Board said:
" ..... The earlier circulars being executive in character
cannot alter the provisions of the Act. These were in the
nature of concessions and could always be prospectively
withdrawn. However, on what lines the rights of the parties
should be adjusted in consonance with justice in view of
these circulars is not a subject-matter to be adjudicated by
us and, as rightly contended by counsel for the Revenue, the
circulars cannot detract from the Act."
(Emphasis Supplied) (p. 139)
The expression ’executive in character’ is, presumably,
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used to distinguish them from judicial pronouncements. The
circulars referred to in that case were also of the Central
Board of Direct Taxes and were, presumably also, statutory
in character.
However, this contention need not detain us, as it is
unnecessary to examine whether or not such circulars are
recognised, legitimate aids to statutory construction. In
the present case, the circular of 1965 broadly accords with
the view taken by us on the true scope and interpretation of
Section 40(b) in so far as the quantification of the inter-
est for purposes of Section 40(b).
Contention (d) is disposed of accordingly.
14. Re: Contention (e)
Sri Ramachandran urged that the introduction, in the
year 1984, of Explanation I to Section 40(b) was not to
effect or bring about any change in the law, but was intend-
ed to be a mere legislative exposition of what the law has
always been. An ’Explanation’, generally speaking, is in-
tended to explain the meaning of certain phrases and expres-
sions contained in a statutory provision. There is no gener-
al theory as
267
to the effect and intendment of an Explanation except that
the purposes and intendment of the ’Explanation’ are deter-
mined by
own words. An Explanation, depending on its language, might
supply or take away something from the contents of a provi-
sion. It is also true that an Explanation may--this is what
Sri Ramachandran suggests in this case--be introduced by way
of abundant--caution in order to clear any mental cobwebs
surrounding the meaning of a statutory provision spun by
interpretative errors and to place what the legislature
considers to be the true meaning beyond controversy or
doubt. Hypothetically, that such can be the possible purpose
of an ’Explanation’ cannot be doubted. But the question is
whether in the present case, Explanation I inserted into
Section 40(b) in the year 1984 has had that effect.
15. The notes on clauses appended to the Taxation Laws
(Amendment) Bill, 1984, say that Clause 10 which seeks to
amend Section 40 will take effect from 1st April, 1985 and
will, accordingly, apply in relation to the assessment year
1985-86 and subsequent years. The express prospective opera-
tion and effectuation of the ’Explanation’ might, perhaps,
be a factor necessarily detracting from any evincement of
the intent on the part of the legislature that the Explana-
tion was intended more as a legislative-exposition or clari-
fication of the existing law than as a change in the law as
it then obtained. In view of what we have said on point (c)
it appears unnecessary to examine this contention any fur-
ther.
Contention (e) is disposed of accordingly.
16. In the result, for the foregoing reasons these
appeals are allowed; the orders of the High Court under
appeal set-aside and the question of law referred for opin-
ion is answered in the affirmative in terms of para 12
(supra). In the circumstances, there will be no orders as to
the costs in these appeals.
P.S. S Appeals allowed.
268