Holding

Section 40(b) is not a stand‑alone provision; it operates as a limitation (proviso) on deductions under Sections 30‑38, and the assessee is entitled to deduction under Section 36(1)(iii) read with Section 40(b)(iv) where the conditions are satisfied.

Summary

Munjal Sales Corporation appealed against disallowances of interest deductions claimed under Section 36(1)(iii) of the Income Tax Act, 1961. The Assessing Officer held that interest-free advances given to sister concerns were funded by interest‑bearing loans and thus barred by Section 40(b)(iv). The Tribunal initially allowed the deduction for the years 1992‑93 and 1993‑94 but later disallowed it for subsequent years. The Supreme Court examined whether Section 40(b) is a stand‑alone provision or a limitation on deductions under Sections 30‑38, particularly after the Finance Act 1992. It held that Section 40(b) is a proviso that limits deductions under Sections 30‑38 and that a taxpayer must first establish entitlement to deduction under those sections before invoking Section 40(b)(iv). Applying this, the Court found that the loans were made from the firm’s own funds, the interest did not exceed 18% per annum, and therefore the deduction under Section 36(1)(iii) read with Section 40(b)(iv) was permissible. The appeals were allowed and the High Court judgments set aside.

Issues considered

Whether Section 40(b) of the Income Tax Act, 1961 is a stand‑alone provision or a limitation to deductions under Sections 30‑38.
Whether interest paid on capital borrowed for business purposes is deductible under Section 36(1)(iii) when the interest rate does not exceed 18% per annum and the advances are made from the firm’s own funds.
Whether the assessee must first establish entitlement to deduction under Sections 30‑38 before the applicability of Section 40(b)(iv) can be examined.

Legislation cited

Finance Act, 1992
Income Tax Act, 1961s. 30, s. 31, s. 32, s. 33, s. 34, s. 35, s. 36, s. 36(1)(iii), s. 37, s. 38, s. 40(b), s. 40(b)(iv)

Subjects

Income TaxSection 40(b)Section 36(1)(iii)deduction of interestFinance Act 1992firm and partnerinterest‑free advancesassessment yeartax deduction limitation

Judgment

[2008] 2 S.C.R. 1169

j- MIS. MUNJAL SALES CORPORATION A
v.
COMMISSIONER OF INCOME TAX, LUDHIANA AND ANR.
(Civil Appeal No. 1378 of 2008)
FEBRUARY 19, 2008
B
[S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.]
y
.,
Income Tax Act, 1961: ss.36(i)(iii) and 40(b)(iv) -
Deduction of interest under s. 36(i)(iii) and applicability of
s.40(b)(iv) - Held: s.40(b) is not a stand alone section - It c
operates as a limitation to deduction under ss. 30 to 38 - ,
Assessee including a firm is required to establish in the first
instance, its right to claim deduction under one section between
.; ss. 30 to 38 and in case of firm if it claims special deduction it
has also to prove that it is not disentitled to claim deduction
D
, by reason of applicability of s.40(b)(iv) - Object of s.40 is to

' put limitation on amount of deduction which the assessee. is
entitled to under ss.30 to 38 - On facts, loans granted by
assessee-firm in August 1991 which continued uptoA. Y 1997-
98 - Said Joans were advanced for business purpose and
interest paid thereon did not exceed 18112% p.a. -Assessee E
entitled to deductions under s. 36(i)(iii) r. w. s.40(b)(iv) - Finance
Act, 1992.
In August/September 1991, appellant-assessee
'f. granted interest free advances to its sister concerns which F
were disallowed by the Department on the ground that
"' the said advances were not given from the firm's Own
Funds but from interest bearing loans taken by the
assessee-firm from third parties. Accordingly, the
assessee's claim for deduction under s.36(1 )(iii) of Income
'G
Tax Act, 1961 was disallowed by the Department for the
-- ,.. AY 1992-93. However, by order dated ~.1.03, the Tribunal
deleted the disallowance saying that the assessee had
given such advance from its Own Funds. In the next AY
1169 H
1170 SUPREME COURT REPORTS [2008] 2 S.C.R.

A 1993-94, the same situation took place. Once again by .... .
order dated 1.1.03, the Tribunal deleted disallowance for '
AY 1993-94. The Department accepted the orders passed
by the Tribunal in favour of the assessee for both the AYs
1992-93 and 1993-94. The interest free advance given to
B the sister concern was repaid on year to year basis. The
said advance/loan got finally repaid in AY 1997-98. During
the AY 1994-95, no further advances were made by the "f '

assessee-firm in favour of its concerns. However, during /
AY 1995-96, a small interest free loan of Rs.5 lacs was
c advanced by the assessee-firm to its sister concern as
during the year in question the assessee had profits of
Rs.1.91 crores. For the AY 1994-95, Department disallowed
the claim for deduction under s.40(b)(iv) saying that in this
case there was diversion of funds by raising of interest
free loans. The AO did not accept the submission of the

-
D
assessee that advances made by the assessee were out
of income of the firm. According to the AO, the said ~
interest free advances to sister concerns were out of
monies borrowed by the firm from third parties on
payment of interest, hence the assessee was not entitled
E to deduction under s.40(b) of the 1961 Act. This view was
confirmed by the Tribunal. For the AYs 1995-96 and 1996-
J·
97, Tribunal held that during the said years, no interest
free advances to sister concerns were made and,

.E
therefore, there was no nexus between "interest bearing
F loans" taken and "interest free advances". However, the ,,..
Tribunal found that there was no material to show that
advances were made to sister concerns out of the fir.m's
own income and, therefore, the assessee was not entitled
to deduction under s.40(b)(iv) of the 1961 Act.
G
The question for consideration in these appeals is
whether s.40(b) of the 1961 Act is a stand-alone section --< ~
or whether it operates as a limitation to the deduction
under ss. 30 to 38 of the 1961 Act.

H Allowing the appeals, the Court
--'-
M/S. MUNJAL SALES CORPN. v. COMMNR. OF 1171
INCOME TAX, LUDHIANA & ANR.

-j.
HELD: 1.1 Prior to FA 1992, payment of interest to A
the partner was an item of Business Disallowance.
However, after FA 1992, s.40(b) of the Income Tax Act, 1961
puts limitations on the deductions under ss. 30 to 38 from
which it follows that s.40 is not a stand-alone section. 5.40,
before and after FA 1992, has remained the same in the 8
sense that it begins with a non-obstante clause. It starts
., with the words "Notwithstanding anything to the contrary
in ss. 30 to 38" which shows that even if an expenditure
or allowance comes within the purview of ss. 30 to 38 of
the 1961 Act, the assessee could lose the benefit of c
deduction if the case falls under s.40. Every assessee
including a firm has to establish, in the first instance, its
right to claim deduction under one of the sections
between ss. 30 to 38 and in the case of the firm if it claims
special deduction it has also to prove that it is not
D
disentitled to claim deduction by reason of applicability
/
)'
of s.40(b)(iv). 5s. 30 to 38 are deductions which are limited
by s.40. Therefore, even if an assessee is entitled to
deduction under s.36(1 )(iii), the assessee(firm) will not be
entitled to claim deduction for interest payment exceeding
18/12% per annum. [Para 14] [1179-D-H; 1180-A, 8, C] E

Commissioner of Income-tax v. Abishek Industries Ltd.
(2006) 286 ITR 1 (P&H) - referred to.
1.2 After the enactment of FA 1992, s.40(b)(iv) was
brought to the statute book not only to avoid double F
'-f
taxation but also to bring on par different assessees in
the matter of assessment. Therefore, the assessee-firm
was required to prove that it was entitled to claim
deduction for payment of interest on capital borrowed
under s.36(1 )(iii) and that it was not disentitled under G
s.40(b)(iv). The object of s.40 is to put limitation on the
- ).- amount of deduction which the assessee is entitled to
under ss. 30 to 38. 5.40 is a corollary to ss. 30 to 38
and, therefore, s.40 is not a stand-alone section. [Para 15]
[1180-E-G; 1181-A] H
-l
I

1172 SUPREME COURT REPORTS [2008] 2 S.C.R.

A 2. As far back as in August/September 1991, ...-
assessee had given interest free advances to its sister
concerns. These advances stood reduced over a period,
till AY 1997-98. Each year the balances stood reduced.
Further, by Order dt.3.1.03 the Tribunal held, for AY 1992-
B 93, that the assessee had given interest free loans from
its Own Funds and not from interest bearing loans taken
by the firm from third parties and consequently the "'
assessee was entitled to claim deduction under s.36(1 )(iii).
In other words, the Tribunal held that loans were given
c for business purposes. Similarly, for AY 1993-94, the
Tribunal had taken the view that the said loans given to
the firm's sister concerns were for business purposes.
Accordingly, the Tribunal had deleted the disallowances
during the AYs 1992~93 and 1993-94. It is equally true that
0 for the AY 1994-95 the Tribunal took a contrary view in
view of change in law brought about by Finance Act 1992.
Prior to 1.4.93 payment of interest to the partner had to be ~
added back to the assessable income of the firm whereas
after Finance Act 1992 such payment became an item of
E deduction for computing the assessable income of the
firm and it became part of the business income of the
partner. In view of this change of law, the Tribunal
disallowed payment of the interest for AYs 1994-95, 1995-
96, 1996-97 and 1997-98. However, the loans which were
F given in August/September 1991 to the sister concerns
got wiped out only in AY 1997-98. For AY 1992-93 and AY t"·
1993-94, the Tribunal held that the loans given to the sister
concerns were out of the firm's Funds and that they were
advanced for business purposes. Once it is found that
G the loans granted in August/September 1991 continued
upto AY 1997-98 and that the said loans were advanced
for business purposes and that interest paid thereon did -< ~
not exceed 18/12% per annum, the assessee was entitled
to deductions under s.36(1 )(iii) read with s.40(b)(iv) of the
H 1961 Act. [Para 16] (1181-B-H; 1182-A]
~-
M/S. MUNJAL SALES CORPN. v. COMMNR. OF 1173
INCOME TAX, LUDHIANA & ANR.

j.
3. During the AY 1995-96, apart from the loan given in A
August/September 1991, the assessee advanced interest
free loan to Us sister concern amounting to Rs.5 lacs.
According to the Tribunal, there was nothing on record
to show that the loans were given to the sister concern
by the assessee-firm out of its Own Funds and, therefore, B
it was not entitled to claim deduction under s.36(1 )(iii). This
finding is erroneous. The Opening Balance as on 1.4.94
was Rs.1.91 crores whereas the loan given to the sister
concern was a small amount of Rs.5 lacs. The profits
earned by the assessee during the relevant year were c
I
sufficient to cover the impugned loan of Rs.5 lacs.
[Para 17] [1182-B, C, DJ
4. The importance of the judgment is the clarification
required in the context of deductions under ss. 30 to 38
to be read with the limitation prescribed under s.40. Since D
there was some confusion with regard to the status of
-7 'r s.40, particularly, after enactment of Finance Act 1992, the
law is explained in the context of deductions under
Chapter IV-D of the 1961 Act. The submissions advanced
by the Addi. Solicitor General in that regard is accepted. E
However, the assessee succeeds in this batch of civil
appeals on the peculiar facts of this case. [Para 18]
[1182-D, E, F]
CIVILAPPELLATE JURISDICTION: Civil Appeal No. 1378
of 2008. F
'f
From the final Judgment and order dated 16/10/2006 of
the High Court of Punjab and Haryana at Chandigarh in I. T.A.
No. 667 of 2005.
WITH G

-" ~
Civil Appeal No. 1379, 1380, 1381 and 1382 of 2008.
S.Ganesh, Satyen Sethi and Rameshwar Prasad Goyal
for the Appellant.
H
1174 SUPREME COURT REPORTS [2008)2 S.C.R.
+-
A Parag P. Tripathi, A.S.G., Vikram Gulati, Arti Gupta and
B.V. Balaram Das for the Respondents. .../(

The Judgment of the Court was delivered by
KAPADIA, J. 1. Leave granted.
B 2. This batch of civil appeals filed by the assessee is
directed against judgments dated 12.10.06 and 16.10.06
passed by the Punjab and Haryana High Court whereby the High ..,..
Court has upheld the disallowance of interest claimed under
Section 36(1)(iii) of the Income-tax Act, 1961 ("1961 Act", for
c short), placing reliance on its judgment in the case of
Commissioner of Income-tax v. Abhishek Industries Ltd.
- (2006) 286 ITR 1 (P&H).
3. In this batch of civil appeals we are concerned with
Assessment Years 1993-94, 1994-95, 1995-96, 1996-97 and
D 1997-98.

FACTS: ..,., ~

4. In August/September 1991, appellant assessee granted
interest free advances to its sister concerns which were
E disallowed by the Department on the ground that the said
advances were not given from the firm's Own Funds but from
interest bearing loans taken by the assessee-firm from third
parties. Accordingly, the assessee's claim for deduction under
Section 36(1 )(iii) was disallowed by the Department for the AY
F 1992-93. However, vide order dated 3.1.03, the Tribunal deleted
the disallowance saying that the assessee had given such }-
advance from its Own Funds.
5. In the next AY 1993-94, the same situation took place.
Once again vide order dated 1.1.03, the Tribunal deleted
G disallowance for AY 1993-94. It is important to note that the
Department accepted the orders passed by the Tribunal in favour
of the assessee for both the AYs 1992-93 and 1993-94. At the ~--
same time, we need to emphasise, at this stage, that the interest
free advance given to the sister concern was repc:dd on year
H to year basis. The said advance/loan got finally repaid in AY
M/S. MUNJAL SALES CORPN. v. COMMNR. OF 1175
INCOME TAX, LUDHIANA & ANR. [KAPADIA, J.]

1997-98. A
6. During the AY 1994-95 no further advances were made
by the assessee-firm in favour of its concerns. However, during
AY 1995-96, a small interest free loan of Rs.5 lacs was advanced
by the assessee-firm to its sister concern as during the year in ,
question the assessee had profits of Rs.1.91 crores. 8

7. At this stage, it may be noted that before Finance Act
1992, payment of interest to the partner was an item of
disallowance. Therefore, it had to be added back to the
assessable income of the firm. But, after 1.4.93, vide Finance c,
Act 1992, the said interest became an item of deduction,
provided that the amount of deduction does not exceed 18/12%
interest per annum [See: Section 40(b)(iv) of the 1961 Act]. For
the AY 1994-95, Department in this case, therefore, disallowed
the claim for deduction under Section 40(b)(iv) saying that in D
this case there was diversion of funds by raising of interest free
loans. The AO did not accept the submission of the assessee
that advance(s) made by the assessee-were out of income of
the firm. According to the AO, the said interest free advances to
sister concerns were out-of monies borrowed by the firm from E
third parties on payment of interest, hence the assessee was
not entitled to deduction under Section 40(b) of the 1961 Act.
This view was confirmed by the Tribunal.
8. For the AYs 1995-96 and 1996-97, Tribunal held that
during the said years, no interest free advances to sister F
concerns were made and, therefore, there was no nexus between
"interest bearing loans" taken and "interest free advances".
·However, the Tribunal found that there was no material to show
that advances were made to sister concerns out of the firm's
own income and, therefore, the assessee was not entitled to G
deduction under Section 40(b)(iv) of the 1961 Act.
9. The basic question which arises for determination is : ,
whether Section 40(b) of the 1961 Act is a stand-alone section
or whether it operates as a limitation to the deduction under
Sections 30 to 38 of the 1961 Act? ,H .
1176 SUPREME COURT REPORTS [2008] 2 S.C.R.

A 10. On the above question of law, Mr. S. Ganesh, learned k"
senior counsel appearing on behalf of assessee, contended
that prior to 1.4.93, Section 40(b) referred to disallowances per
se but after the Finance Act 1992 the said Section 40(b)(iv)
allows deduction, subject to the above limit of 18/12% per
B annum. According to learned counsel, Section 40(b)(iv) talks
about statutory deduction and that the question of disallowance
comes in only to the extent that payment of interest to the partner
exceeds 12/18% per annum. In this case, according to learned
counsel, all the conditions of Sections 40(b)(iv) have been
c satisfied and, therefore, the assessee was entitled to the benefit
of deduction thereunder. In this connection, it was further argued 'I
that deduction under Section 40(b)(iv) is not for expenditure;
that it was a statutory deduction and that the contribution by the
partner to the firm cannot be equated to a loan to the firm and
that the former falls only under Section 40(b)(iv) and, therefore,
D
the said Section 40(b) was a stand-alone. section having no ,,.
connection with the provisions of Section 36(1 )(iii) of the 1961 "(
"
Act. Further, according to learned counsel, in this case Section
36(1)(iii) had no application as this was a case of payment of
interest to the partner on his capjtal contribution which cannot
E be equated to monies borrowed by the firm from third parties,
hence the present case fell only under Section 40(b)(iv) and not
under Section 36(1)(iii) of the 1961 Act.
11. Mr. Prag P. Tripathi, learned Addi. Solicitor General
F appearing for the Department, submitted that object behind
enactment of Finance Act 1992 is not only to avoid double
,.
taxation but also to put the firm as an assessee on par with
other assessees. In this connection, learned counsel submitted
that in view of the changed language of Section 40(b)(iv) of the
1961 Act, which is in the nature of a proviso, it can no longer be
G
said that Sections 30 to 38 are not applicable to the firm as an
-4 -
assessee and that it will apply to all other assessees. That, prior
to 1.4.93, Section 40(b)(iv) disallowed interest paid to the
partners but after 1.4.93 the firm has to establish its claim for
deduction under Sections 30 to 38 and that it was not disentitled
H
M/S. MUNJAL SALES CORPN. v. COMMNR. OF 1177
INCOME TAX, LUDHIANA & ANR. [KAPADIA, J.]

;" j.. under Section 40(b) would apply. According to learned counsel, A
Section 40 is in nature of a proviso to Sections 30 to 38 and,
therefore, even if the assessee establishes its claim for
deduction under Section 36(1 )(iii), it has still to prove that it is
not ~isentitled under Section 40(b)(iv). Therefore, according to
.... learned counsel, after Finance Act 1992 the assessee has to B
establish deductions under Sections 30 to 38 and it has also to
..., prove that it is not disentitled under Section 40 of the 1961 Act,
like any other assesses.
12. We quote hereinbelow Sections 36(1)(iii), 40(b) as it
existed before 1.4.93 and 40(b )(iv) after Finance Act 1992 w.e.f. c
'I 1.4.93 which read as follow:
"OTHER DEDUCTIONS
36.(1} The deductions provided for in the following clauses

- ,..
shall be allowed in respect of the matters dealt with therein,
in computing the income referred to in Section 28-
(iii} the amount of the interest paid in respect of capital
borrowed for the purposes of the business or profession.
D

Explanation : Recurring subscriptions paid periodically E
by share-holders, or subscribers in Mutual Benefit
Societies which fulfill such conditions as may be
prescribed, shall be deemed to be capital borrowed within
the meaning of this clause;
AMOUNTS NOT DEDUCTIBLE F

40. Notwithstanding anything to the contrary in Sections
30 to 38, the following amounts shall not be deducted in
computing the income chargeable under the head "Profits
and gains of business or profession", - G
-- ~
(b) in the case of any firm, any payment of interest, salary,
bonus, commission or rem1;1neration made by the firm to
any partner of the firm.
Explanation 1 : Where interest is· paid by a firm to any
H
+-
1178 SUPREME COURT REPORTS [2008] 2 S.C.R.

...,
A 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.
B Explanation 2 : Where an individual is a partner in a firm
on behalf, or for the benefit, of any other person (such y
partner and the other person being hereinafter referred to
as "partner in a representative capacity" and "person so
represented" respectively,)-
c ,,
(i) interest paid by the firm to such individual or by
such individual to the firm otherwise than as partner
in a representative capacity, shall not be taken into
account for the purposes of this clause;
D (ii) interest paid by the firm to such individual or by
such individual to the firm as partner in a
~
....
representative capacity and interest paid by the firm
to the person so represented or by the person so
represented to the firm, shall be taken into account
E for the purposes of this clause.
Explanation 3 : Where an individual is a partner in a firm
otherwise than as partner in a representative capacity,
interest paid by the firm to such individual shall not be

F
taken into account for the purposes of this clause, if such
interest is received by him on behalf, or for the benefit, of ,.
any other person;"
Section 40(b)(iv) after Finance Act 1992 w.e.f.1.4.93:
"AMOUNTS NOT DEDUCTIBLE
G
40. Notwithstanding anything to the contrary in Sections -.(~:
30 to 38, the following amounts shall not be deducted in
computing the income chargeable under the head "Profits
and gains of business or profession", -

H Xb) in the case of any firm assessable as such, -
M/S. MUNJAL SALES CORPN. v. COMMNR. OF 1179
INCOME TAX, LUDHIANA &ANR. [KAPADIA, J.]

(iv) any payment of interest to any partner which is A
authorized by, and is in accordance with, the terms of the
partnership deed and relates to any period falling after the
date of such partnership deed insofar as such amount
exceeds the amount calculated at the rate of eighteen per
cent simple interest per annum;" B
ISSUE
13. Whether the claim for special deduction made by the
assessee exclusively came only under Section 40(b)(iv) and
that it never came under Section 36(1 )(iii) of the 1961 Act as c
argued on behalf of the assessee?
Legal Position Explained
14. Before enactment of FA 1992, broadly speaking,
payment of interest by the firm to any partner of the firm
0
constituted Business Disallowance per se. After FA 1992,
Section 40(b)(iv) of the 1961 Act places limitations on the
deductions under Sections 30 to 38. Prior to FA 1992, payment
of interest to the partner was an item of Business Disallowance.
However, after FA 1992 the said Section 40(b) puts limitations E
on the deductions under Sections 30 to 38 from which it follows
that Section 40 is not a stand-alone section. Section 40, before
and after FA 1992, has remained the same in the sense that it
begins with a non-obstante clause. It starts with the words
"Notwithstanding anything to the contrary in Sections 30 to 38"
which shows that even if an expenditure or allowance comes F
within the purview of Sections 30 to 38 of the 1961, the assessee
could lose the benefit of deduction if the case falls under Section
40. In other words, every assessee including a firm has to
establish, in the first instance, its right to claim deduction under
one of the sections between Sections 30 to 38 and in the case G
of the firm if it claims special deduction it has also to prove that
it is not disentitled to claim deduction by reason of applicability
of ·Section 40(b)(iv). Therefore, in the present case, the
assessee was required to establish in the first instance that it
was entitled to claim deduction under Section 36(1 )(iii) and that H
1l
~

1180 SUPREME COURT REPORTS [2008] 2 S.C.R.

A it was not disentitled to claim such deduction on account of J(

applicability of Section 40(b)(iv). It is important to note that
Section 36(1) refers to Other Deductions whereas Section
40 comes under the heading Amounts not Deductible. ~
Therefore, Sections 30 to 38 are Other Deductions whereas
B Section 40 is a limitation on that deduction. It is important to
t
note that Section 28 to 43C essentially deal with Business .,..
Income. Sections 30 to 38 deal with Deductions. Sections
40A and 438 deal with Business Disallowances. Keeping in
mind the said scheme the position is that Sections 30 to 38 are
c deductions which are limited by Section 40. Therefore, even if
an assessee is entitled to deduction under Section 36(1 )(iii),
the assessee(firm) will not be entitled to claim deduction for
interest payment exceeding 18/12% per se. This is because
Section 40(b)(iv) puts a limitation on the amount of deduction
under Section 36(1 )(iii).
D ;
.__
15. It is vehemently urged on behalf of the assessee that ?

partner's capital is not a loan or borrowing in the hand of a firm. """
According to the assessee, Section 40(b)(iv) applies to r
partner's capital whereas Section 36(1)(iii) applies to loan/
E borrowing. Conceptually, the position may be correct but we ·~
are concerned with the scheme of Chapter IV-D. After the '---
'•
enactment of FA 1992, Section 40(b)(iv) was brought to the
statute book not only to avoid double taxation but also to bring
on par different assesses in the matter of assessment. l.-
I

F Therefore, the assessee-firm, in the present case, was required )--
to prove that it was entitled to claim deduction for payment of
interest on capital borrowed under Section 36(1 )(iii) and that it
was not disentitled under Section 40(b)(iv). There is one more
way of answering the above contention. Section 36(1 )(iii) and
Section 40(b )(iv) both deal with payment of interest by the firm
G
for which deduction could be claimed, therefore, keeping in mind ~~
the scheme of Chapter IV-D every assessee who claims I

deduction under Sections 30 to 38 is also requires to establish ' \.
that it is not disentitled under Section 40. It is in this respect that
we have stated that the object of Section 40 is to put limitation
H

-~-
-4-
M/S. MUNJAL SALES CORPN. v. COMMNR. OF 1181
INCOME TAX, LUDHIANA & ANR. [KAPADIA, J.]

•(
(

(
~
on the amount of deduction which the assessee is entitled to A
under Sections 30 to 38. In our view, Section 40 is a corollary to
Sections 30 to 38 and, therefore, Section 40 is not a stand-
__1. alone section.
Application of the 1961 Act to the facts of this.case
B
16. As stated above, in this batch of civil appeals we are
concerned with the Assessment Years 1993-94, 1994-95, 1995-
96, 1996-97 and 1997-98. At this stage, it may be mentioned
that as far back as in August/September 1991 assessee herein
had given interest free advances to its sister concerns. These c
advances stood reduced over a period, till AY 1997-98. Each
year the balances stood reduced. Further, vide Order dt.3.1.03
the Tribunal held, for AY 1992-93, that the assessee had given
interest free loans from its Own Funds and not from interest
bearing loans taken by the firm from third parties and
D
consequently the assessee was entitled to claim deduction
°!'
~
under 36(1 )(iii). In other words, the Tribunal held that loans were
given for business purposes. Similarly, for AY 1993-94, the
Tribunal had taken the view that the said loans given to the firm's
sister concerns were for business purposes. Accordingly, the
Tribunal had deleted the disallowances during the AYs 1992-93 E
and 1993-94. It is equally true that for the AY 1994-95 the Tribunal
took a contrary view in view of change in law brought about by
Finance Act 1992. Prior to 1.4.93 payment of interest to the
partner had to be added back to the assessable income of the
firm whereas after Finance Act 1992 such payment became an F'
"' item of deduction for computing the assessable income of the
firm and it became part of the business income of the partner. In
view of this change of law, the Tribunal disallowed payment of
the interest in the present case for AYs 1994-95, 1995-96, 1996-
97 and 1997-98. However, the point which has been left out G
, -- >- from consideration is that the loans which were given in August/

•
September 1991 to the sister concerns got wiped out only in AY
1997-98. As stated above, for AY 1992-93 and AY 1993-94, the
Tribunal held that the loans given to the sister concerns were
out of the firm's Funds and that they were advanced for business H
1182 SUPREME COURT REPORTS [2008] 2 S.C?.R.

A purposes. Once it is found that the loans granted in August/
September 1991 continued upto AY 1997-98 and that the said
loans were advanced for business purposes and that interest
paid thereon did not exceed 18/12% per annum, the assessee
was entitled to deductions under Section 36(1 )(iii) read with
B Section 40(b)(iv) of the 1961 Act.
17. One aspect needs to be mentioned during theAY 1995-
96, apart from the loan given in August/September 1991, the
assessee advanced interest free loan to its sister concern
amounting to Rs.5 lacs. According to the Tribunal, there was
C nothing on record to show that the loans were given to the sister
concern by the assessee-firm out of its Own Funds and,
therefore, it was not entitled to claim deduction under Section
36(1 )(iii). This finding is erroneous: The Opening Balance as
on 1.4.94 was Rs.1.91 crores whereas the loan given to the
D sister concern was a small amount of Rs.5 lacs. In our view, the
profits earned by the assessee during the relevant year were
sufficient t~ cover the impugned loan of Rs.5 lacs.
18. Before concluding, we may mention that the
importance of the judgment is the clarification which we were
E required to give in the context of deductions under Sections 30
to 38 to be read with the limitation prescribed under Section
40. Since there was some confusion with regard to the status of
Section 40, particularly, after enactment of Finance Act 1992,
we have explained the law in the context of deductions under
F Chapter IV-D of the 1961 Act. We have accepted the ,..
submissions advanced by the learned Addi. Solicitor General
in that regard. However, the assessee succeeds in this batch of
civil appeals on the peculiar facts of this case.
G 19.Accordingly, the impugned judgments of the High Court
are set aside and the civil appeals preferred by the assessee
stand allowed with no order as to costs.
D.G. Appeals allowed.

H