2019 (3) TMI 332 - AT - Income Tax

Tribunal allows deduction for payment to legal heirs as per partnership deed

The Tribunal allowed the appeal filed by the assessee, overturning the disallowance of the payment of Rs. 19,45,455 to the legal heirs of a deceased ... Diversion of income by overriding title - diversion of income at source - application of income - doctrine of real income - deductibility of payments to legal heirs - clause 23 of the partnership deed - wholly and exclusively for the purpose of businessDiversion of income by overriding title - clause 23 of the partnership deed - deductibility of payments to legal heirs - diversion of income at source - application of income - doctrine of real income - Whether the payment of Rs. 19,45,455 made to the legal heirs of a deceased partner is allowable as a deduction on the ground of diversion of income by virtue of the partnership deed. - HELD THAT: - The Tribunal held that the CIT(A) erred in focusing solely on clause 24 of the partnership deed and in rejecting the claim without considering clause 23, which creates an entitlement to a lumpsum payment where a partner dies after attaining 65. The court applied the established test for diversion by overriding title: if an obligation operates at the source so that the amount never becomes the assessee's income, the amount is deductible; by contrast, obligations to apply income after it reaches the assessee constitute application of income and remain taxable. Reliance was placed on authoritative decisions recognizing that diversion at source and the doctrine of real income operate to exclude such sums from the assessee's taxable income. The Tribunal found clause 23 effected an overriding title in favour of the legal heirs for the partner's share of earnings up to death; consequently the amount did not accrue as income of the firm but was diverted at source. The Tribunal also noted consistent precedent of Tribunals and High Courts to the effect that payments payable to deceased or retired partners (or their legal heirs) under contractual obligation are diversion of income by overriding title and are not assessable as the firm's income. Applying these principles to the facts and the partnership deed, the Tribunal allowed the deduction of the amount claimed. [Paras 8, 9]The sum of Rs. 19,45,455 paid to the legal heirs is deductible as diversion of income by overriding title under clause 23 of the partnership deed; the appeal is allowed.Final Conclusion: The Tribunal allowed the assessee's appeal, holding that the payment to the legal heirs was a diversion of income by overriding title under the partnership deed and therefore deductible for assessment year 2010-2011. Issues Involved:1. Whether the CIT(A) was right in confirming the assessment order disallowing the amount of Rs. 19,45,455 paid to the legal heirs of a deceased partner.Issue-wise Detailed Analysis:1. Confirmation of Assessment Order Disallowing Rs. 19,45,455:The core issue revolves around the disallowance of Rs. 19,45,455 paid to the legal heirs of a deceased partner by the assessee-firm. The CIT(A) upheld the Assessing Officer's (A.O.) decision, which was based on the premise that this payment was a diversion of income and not an expenditure incurred for the business purposes of the assessee-firm. The A.O. had argued that the payment did not qualify as a business expense under Section 37 of the I.T. Act, as it was not incurred wholly and exclusively for the purpose of business.2. Assessee's Appeal and Grounds:The assessee contested the CIT(A)'s decision on several grounds, primarily arguing that the payment was in accordance with the partnership deed and constituted a diversion of income by overriding title. The assessee emphasized that the payment was an allowable deduction as per clauses 23 and 24 of the partnership deed dated 31.12.2007, which obligated the firm to make such payments to the legal heirs of a deceased partner.3. Examination of Partnership Deed Clauses:The Tribunal scrutinized clauses 23 and 24 of the partnership deed. Clause 23 stated that a retiring or deceased partner (or their legal heirs) is entitled to a lump sum payment equivalent to two years' share of net earnings if the partner retires or dies after the age of sixty-five. Clause 24 added that if a partner dies while still a partner, their legal heirs are entitled to the monies in the deceased partner's accounts and a pension if the partner had completed at least 15 years of service before attaining the age of 65.4. Legal Precedents and Doctrine of Overriding Title:The Tribunal referred to multiple legal precedents, including the Supreme Court's ruling in CIT v. Sitaldas Tirathdas and the Bombay High Court's decision in CIT v. Mulla & Mulla & Craigie Blunt & Careo. These cases established that if an income is diverted before it reaches the assessee due to an overriding title, it is deductible. The Tribunal noted that the payment in question was a diversion of income by overriding title, as it was an obligation imposed by the partnership deed before the income reached the assessee.5. Mumbai Tribunal and High Court Decisions:The Tribunal also cited similar cases, such as ACIT v. Deloitte Haskins & Sells, where payments to ex-partners and legal heirs were deemed diversions of income by overriding title. The Mumbai High Court in CIT v. Kanga & Co. confirmed that payments to retired or deceased partners' legal heirs constituted a diversion of income by overriding title.Conclusion:Based on the analysis of the partnership deed, relevant legal precedents, and the doctrine of overriding title, the Tribunal concluded that the payment of Rs. 19,45,455 to the legal heirs of the deceased partner was indeed a diversion of income by overriding title. Therefore, it should be allowed as a deduction in the assessee-firm's case. The appeal filed by the assessee was allowed, and the disallowance by the CIT(A) was overturned.Order Pronouncement:The order was pronounced on the 1st of March, 2019, allowing the appeal filed by the assessee.