Madhya Pradesh High Court Chhotalal Keshavram vs Commissioner Of IncomeTax on 29 March, 1978 JUDGMENT A.P. Sen, C.J. 1. This is a composite reference under Section 66(1) and Section 256(1) of Indian Incometax Act, 1922, and the Incometax Act, 1961, respectively, made by the Incometax Appellate Tribunal, Nagpur Bench, Nagpur, at the instance of the assessee, requiring certain questions of law, said to arise from its orders in Incometax Appeals Nos. 521 of 196869 18691 and 18692 of 196667, 9688 and 19396 of 196768 dated March 31, 1971, pertaining to the assessment years 195960 to 196263 to the High Court for its opinion, namely: "(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that interest amounts of Rs. 31,447, Rs. 10,833, Rs. 19,200, Rs. 30,141 and Rs. 30,343 for the assessment years 195960, 196061 (two assessments), 196162 and 196263, respectively, charged on the debit balances in the accounts of two of the partners in the books of the firm constituted taxable income of the assessee ? (2) Whether, on the facts and in the circumstances of the case, in apportioning the total income of the firm between the several partners as required under Section 23(6) of the Act of 1922 and Section 158 of the Act of 1961, the interest adjusted on the debit balances of the accounts of the partners in the books of the firm is deductible from the share in profits of the respective partners ?" 2. The firm, styled "M/s. Chhotalal Keshavram, Rajnandgaon", constituted of two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, carrying on business of manufacture and sale of bidis, was reconstituted by a partnership deed dated December 29, 1954, whereby a third partner, Amrutlal Somabhai, was introduced as a financing partner. At the time when the business was taken over, the total liabilities of the firm amounted to Rs. 6,44,655. After adjusting certain assets of the firm, there was an excess of liabilities over the assets amounting to Rs. 4,09,628 and this amount was debited to the accounts of the two partners, Ghansliyamdas Chhotalal and Rameshchandra Chhotalal, in equal shares. 3. As provided by Clause 5 of the deed of partnership, funds were to be provided by Amrutlal Somabhai and he was made entirely responsible for managing the business. Clause 6 of the deed reads as follows : "6. Every year, at the time of the settlement of the partnership accounts, interest shall be credited to the partners' accounts on katmiti basis at 8 annas per cent. per month on the credit balance in the partners' capital accounts. Similarly, interest at the same rate shall be charged and debited to the partners' accounts on the sums standing to their debits. In this way, the partners shall get the amounts of interest adjusted to their accounts at the time of settlement of account between them." 4. The two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, who were indebted to the firm, were not allowed to draw their shares of profits till the amount due from each of them was paid off. They owned some immovable properties and agreed not to sell, gift or mortgage these properties till their accounts were cleared off. For breach of this agreement, they were liable to be removed from the partnership. The third partner, Amrutlal Somabhai, was not entitled to get any salary for managing the business, but the firm agreed to bear the expenses of his residence and messing. The constitution of the firm underwent a change by the execution of a partnership deed dated November 12, 1958, by introduction of new partners; but there was no other change in the terms and conditions of the earlier partnership deed dated December 29, 1954. There was a further change in the partnership with effect from March 15, 1959, when Ghanshyamdas Chhotalal and Rameshchandra Chhotalal went out and their minor sons, Jayshankar Ghanshyamdas and Himanshu Rameshchandra, were admittad to the benefits of the partnership. 5. During the assessment years in question, the personal accounts of the two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, in the account books of the firm were debited with Rs. 31,447, Rs. 10,833, Rs. 19,200, Rs. 30,141 and Rs. 30,343 on account of interest payable by them to the firm for the debit balances pending in their names, of Rs. 2,66,121 each. Similarly, the personal account of Amrutlal Somabhai, who furnished capital, for the going concern, was credited with interest on the amount of loan advanced by him to the firm. The amount of interest debited to the account of the two partners, Ghanshyamdas Chhotalal and Rameshchandra Chhotalal, as well as the amount of interest credited to the account of Amrutlal Somabhai, were included in the interest account maintained in the books of the firm, and the resultant amount went into the profit and loss account of the