Keshavji Ravji & Co. Etc. Etc. v. Commissioner of Income Tax
VENKATACHALIAH, J. These Special Leave Petitions arise D
out of and are directed against the orders of the High Court of Judica
ture 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, 521of1981, 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. Sankara- E
linga 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 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 ). F
On this question, there is a sharp divergence of judicial opinion
in the High Courts. In Sri Ram Mahadeo Prasad v. C./. T., 24 ITR 176
(All) 1; C./. T. v. Kailash Motors, 134 ITR 312; C./. T. v. T. V.
Ramanaiah & Sons, 157 ITR 300; C.I. T. v. Kothari & Co., 165 ITR
594 {Kar.); C. /. T. v. Ba/aji Commercial Syndicate, 165 ITR 596 G
(Kar.); C./. T. v. Motilal 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 disallo
wance under Section 40(b) of the Act. However, in C./. T. v. O.M.S.S. H
Sankaralinga Nadar & Co., 147 lTR 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 consist
ing of 6 partners and carries on a business in the manufacture and
export of stainless steel articles. In the accounting year ended
13. 11.1974, corrsponding 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 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 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 Commis
sioner, placed reliance on the decision of the Allahabad High Court in
Sri Ram Mahadeo Prasadv. C.I. T., 24 lTR 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?"
H This reference under Section 256( 1) of the Act was registered in
'
KESHAVJI & CO. v. C.I.T. [VENKATACHALIAH, J.) 2Sl
the High Court as Tax Case No. 694/82 and the High Court by its order A
dated 5.3.1985 answered the question in the negative and against the
appellant relying, as stated earlier, 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 conten- B
tions, 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 C
and gains of business or profession",
(a) I
( l) I
to I Omitted as unnecessary
(v) I
(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." •
W E
Omitted as unnecessary
(d)
1 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 Ex- F
planation 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 G
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 qn Clauses" say: . -
252 SUPREME COURT REPORTS [ 1990] 1 S.C.R.
"This clause seeks to insert three new Explanations to sec
tion 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 dis
allowed 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."
"The proposed amendments will take effect from 1st April,
1985, and will, accordingly, apply in relation to the assess
ment 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 !TR 176. In view of the above,
the instructions 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, 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 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 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
l
·(
\
KESHAVJI & CO. v. C.l.T. [VENKATACHALIAH, J.l 253
!TR 300 (A.P.) illustrate the rival points of view. The Madras High A
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 refe
rence to a given account relating to payment of interest by
the firm to the partner. This is because the subject of dis
allowance 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 can
not 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 man
ner, 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 sharacterised 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 'fair-
ness". . .... "
(P. 336)
The Andhra Pradesh High Court, however, taking the contrary
view relied on, what it considered, the revenue's own understanding F
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:
" ..... As a matter of interpretation of section 40(b) of the G
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 H
\
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 par-
tner . ..... "
[157 ITR 300 at p. 304]
SA. 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 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 the 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 com
ponents of the real income of the firm. Therefore, the ascertain
ment 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 Sec
tion 40(b ).
(b) The extent of the embargo under Section 10(4)(b) of the
l92L Act on the disallowance of "interest" paid to a partner was
judicially interpreted and ascertained in Sri Ram Mahadeo
• Prasad v. Commissioner of Income-tax, 24 ITR 176 (All.) and
when the legislature re-enacted those provisions in Section 40(b)
F 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 th2t
payable by the firm to the partners on the capital, brought-in by
th~m. 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.
Iii identifying and quantifying the 'interest' for purposes of
KESHAVJJ & CO. v. C.I.T. IVENKATACHALIAH, J.} 255
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 susceptible to the exclusionary rule in Section 40(b).
(d) The circular No. 33-D(X:XV-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 B
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 con
strued offers a guide to the correct understanding of the provi
sions in Section 40(b) in its application to the earlier years as C
well.
6. Re: Contention (a)
The premises of the argument is good in parts; but the inference D
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 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 E
head "profits and gains of business or profession": A-" long as there is
no ambiguity in the statutory languagt, resort to any interpretative
process to unfold the legislative intent becomes impermissible. The
supposed intention of the legislature can not then be appealed to whit-
tle down the statutory language which is otherwise unambiguous. If
the intendment is not in the words used it is nowhere/ else. The need F
for interpretation arises when the words used in the statute are, on
their own terms, ambivalent and do not manifest the intenti(Ji1 of the
Legislature. In Daypack Systems Pvt. Ltd. v. ilniorl of iridid, [ 1988] 2
sec 299 it was observed:
"The words in the statute must, prima facie, be given their C
ordinary meanings. Where the grammatical consiniction is
clear and manifest and without doubt, that construction
ought to prevail unless there are sorhe strong and obvicitis
reasons to the contrary ...... "
(p. 33i)
"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 unambiguous,
be applied as they stand . ..... "
(Emphasis Supplied)
(p. 332)
Artificial and unduly latitudinarian rules of construction 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 citi·
zens' claim to enjoyment of his property on the one hand and the need
for an equitable distribution of the burdens of the community to sus·
tain 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
manifest 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 legisla·
ture never intended to give. Something akin to this has
befallen the revenue laws ..... "
(Emphasis Supplied)
There are, indeed, strong and compelling considerations against
G 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, whose dimensions and implica·
tiorrs are not, to say the least, fully explored. The test suggested by Sri
Ramachandran, might on its own extended logic, validate a set-off of
the interest paid to one partner against interest received from another
Ji and likewise, 'interest' received from one partner on some other deal·
l
" )
' l .
l
\ '
KESHAVJI & CO. v. C.l.T. [VENKATACHALIAH, J.] 257
ings between him and the firm against interest paid to another partner A
on his or her capital contribution. The test of 'real income' as one on
whi.ch tlie 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.l. T.
[ 1986] 158 !TR 102 at 155, though made in a different context, are
apposite: B
" ..... 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-recog
nised 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 circumspec- D
tion 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 certain limitations of
their own. E
Contention (a) does not advannce appellants' case.
7. Re: Contention (b)
~ /
The submissions of Sri Ramchandran on the pomt are that where F
the meaning of a word used in a statute nad been juc11cially ascertained
b_y 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 G
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.
Lul/oobhoy Mottichund, Moore's Indian Appeals, Vol. 5, p. 234 at 250
thus: ll
" ..... it is, therefore, of considerable importance to ascer
tain 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 Legisla
ture 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 pronounce
ments. 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 lncome-tax, 24 !TR
J 76 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
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 circums
tances, 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's in Maunse/l 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 infrequen
tly one 'rule' points in one direction, another in a different
direction. In each case we must look at all relevant cir
cumstances and decide as a matter of judgment what
weight to attach to any particular 'rule'."
\
I
!
....,
I
l
KESHAVJI & CO. v. C.l.T. [VENKATACHALIAH, J.] 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. A
Contention (b) is, therefore, not of any assistance to the
appellants.
8. Re: Contention (c)
There are certain aspects of the legal relationship amongst par
tners which do impart a special complexion to the question under
consideration. The point raised in these appeals in confined to a situa
tion 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 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 D
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 E
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 partner
ship in which all the partners would have interest in propor
tion to their share in the joint venture of the business of the
partnership. The person who brought it in would, there- F
fore, 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 attributes
of personality. Partnership is a certain relation between H
260
SUPREME COURT REPORTS [1990j 1 S.C.R.
persons, the product of agreement to share the profits of a
business. 'Firm' is a collective noun, a compendious expre
ssion 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 contract 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 partner
ship business."
" ..... It is implicit that the share income of the partner
takes in his salary. The telling test is that where a firm
suffers Joss, 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."
~ ~·~
The pvsition as stated above was approved by this Court in
Chidabaram's case.
In Regional Director Employees State Insurance Corporation,
G 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 Jaw of partnership there can be no
such relationship as it would lead to the anomalous p'osiiion of the same
person being both the master and the servant. The following observa-
H tions of Justice Mathew in Ellis v. Joseph Ellis & Co., (1905] 1 KB 324
were referred to with approval:
)
(
KESHAVJI & CO. v. C.I.T. [VENKATACHALIAH, J.] Lbl
"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.,
pointed 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 C
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 o
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
wjth 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." E
(p. 127)
9. Sri Ramachandran's contention is that both the capital
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 partnership. This may be so. But in p
effectuating the consequences 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 Statutory Interpretation
observes:
"Unless the contrary intention appears, an enactment by H
262 SUPREME COURT REPORTS [ 1990] 1 S.C.R.
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
territory."
(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
distingu_ishing 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 distinguish bet
ween the substance of a transaction and the machinery used
to carry it through ..... "
" ..... "Substance" and "form" are words which must no
doubt be applied with caution in the field of statutory con
struction. 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.
"
G In Commissioner of Income-tax v. Ci/landers Arbuthnot & Co., 87 ITR
407 at 418, this Court said:
" ... 1 . The taidng 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
I
I
i
KESHAVJI & CO. v. C.I.T. (VENKATACHALIAH, J.) 263
!
the device and to determine the true character of the rela· A
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 transaction is B
in point of fact as one in point oflaw also.
10. How do these principles operate on the present controversy?
It appears to us that if in substance interest paid by the furn to a
partner and the interest, in tum, received from the partner are mere
expressions of the applications of the funds or profits of the partner
ship 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 approach. If instead of the transactions being reflected in two
separate or.distinct accounts in the books of the partnership 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. 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 principle of set-off
statutorily recognised in bankruptcy proceedings under Section 46 of F
the Provincial Insolvency Act and attracted also to proceedings for
winding-up of companies 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 G
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 provision and govern the situation. Indeed, even the idea of H
,,
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 Sankaralinga
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 consb:uction
leads to a result not intended to subserve the object of the legisl~tion,
another construction, permissible in the context, should no; be
adopted. In Commissioner of Income-tax v. J.H. Got/a, 156 ITR"V3,
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 con
struction. Though equity and taxation are often strangers,
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 counter
acting the effect only of attempts by the assessee to reduce
tax liability by transfer. ..... "
(p. 339-40)
G 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
)
{
KESHA VJ! & CO. v. C.1.1" [VENKATACHALIAH, J.] 265
differently from any other Act. The duty of the court is, in A
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 transac
tions 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 binding legal quality
incurs, quite obviously, the criticism of being too broadly stated. The
Board cannot pre-empt a judicial interpretation <'7 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 p
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 cor- G
responding 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 H
rigour of the Jaw. 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 Jaw in the light of the circular. There is, however, support
of certain judicial observations for the view that such circulars consti
tute external aids to construction.
In State Bank of Travancore v. C./. T., [1986] 158 ITR 102, how-
ever, this Court referring to certain circulars of the Board said: Ji
" ..... 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, used to
distinguish them from judicial pronouncements. The circulars referred ,)
to in that case were also of the Central Board of Direct Taxes and
E 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
F interpretation of Section 40(b) in so far as the quantification of the
interest 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 intended to be a mere legislative exposition
of what the law has always been. An 'Explanation', generally speak·
ing, is intended to explain the meaning of certain phrases and expres·
H sions contained in a statutory provision. There is no general theory as
~·
KESHAVJI & CO. v. C.I.T. [VENKATACHALIAH, ~.] 267
to the effect and intendment of an Explanation except that the ft
purposes and intendment of the 'Explanation· •are determined by its
own words. An Explanation, depending on its language, might .suppl)
or take away something from the contents of a provision. It is also true
that an Explanation may-this is what Sri Ramachandran ~uggests in
this case-be introduced by way of abundant-caution in order to clear
any mental cobwebs surrounding the meaning of a statutory provision B
spun by interpretative errors and to place what the legislature consi
ders to be the true meaning beyond controversy or doubt. Hypotheti
cally, that such can be the possible purpose of an 'Explanation· cannot
be doubted. But the question is whether in the present case, Explana
tion 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 !st April, 1985 and wmi accordingly,
apply in relation to the assessment year 1985-86 and subsequent years.
The express prospective operation and effectuation of the 'Explana
tion' might, perhaps, be a factor necessarily detracting from any D
evincement of the intent on the part of the legislature that the Expla
nation was intended more as a legislative-exposition or clarification 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 further.
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 opinion is answered in the affirmative in
terms of para 12 (supra). In the circumstances, there will be no orders F
as to the costs in these appeals.
P.S.S Appeals allowed.