Partner remuneration deduction under s.40(b) upheld; unregistered supplementary deed valid, firm's claim cannot be disallowed

ITAT Ahmedabad allowed the assessee-firm's claim for deduction of remuneration paid to partners under s.40(b), deleting the disallowance made by the Revenue. It held there is no legal requirement for a partnership or supplementary deed to be registered or notarized, so long as it is agreed by all partners and not disputed by them. Even assuming the supplementary deed was ingenuine, the original deed authorized the same total remuneration; only the partners' inter se shares would change, which could be examined in their individual assessments, not by disallowing the firm's claim.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether disallowance of Rs. 80,00,000/- out of remuneration paid to partners was justified under section 40(b) of the Income Tax Act on the ground that the supplementary partnership deed altering the distribution of remuneration was not genuine for want of notarization and alleged backdating.

1.2 Consequentially, whether the assessee-firm's claim for full deduction of remuneration to partners, limited to the ceiling prescribed under section 40(b) of the Income Tax Act, was allowable notwithstanding the dispute regarding the manner of distribution among partners.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of disallowance of partner's remuneration under section 40(b) on ground of non-notarized / allegedly backdated supplementary deed

(a) Legal framework (as discussed)

2.1 The Court proceeded on the basis of section 40(b) of the Income Tax Act, which prescribes the ceiling for allowable remuneration to partners of a firm. The Court also considered the legal character of a partnership deed and the absence of any statutory requirement for registration or notarization as a condition for its validity for income-tax purposes, in the absence of any contrary provision pointed out by the Revenue.

(b) Interpretation and reasoning

2.2 The assessee had an original partnership deed providing that remuneration was to be paid to all four partners to the extent allowable under section 40(b), in the ratio of 25% each.

2.3 During the relevant assessment year, remuneration was actually paid only to two partners, one receiving 75% and the other 25%. The partnership deed contained a clause requiring that any change in terms of remuneration be made by a supplementary deed.

2.4 The assessee produced a supplementary deed evidencing the changed distribution, which was initially not notarized. On the defect being pointed out, a notarized copy of the same supplementary deed was filed. The Assessing Officer rejected the first deed for want of notarization and the second as allegedly notarized on a back date, and held both to be not genuine.

2.5 The Court noted the contention of the assessee that there is no requirement in law for a partnership deed to be registered or notarized, and that an unnotarized deed is valid so long as it is approved by all partners and is not challenged by them. The Revenue could not point to any legal provision to the contrary.

2.6 On this basis, the Court held that the Revenue had no ground to deny the deduction of remuneration merely because the supplementary deed was not notarized, and that absence of notarization did not render the deed invalid or inoperative for tax purposes.

(c) Conclusions

2.7 The disallowance of Rs. 80,00,000/- on the ground that the supplementary deed was not notarized, or that notarization was allegedly backdated, was held to be unsustainable in law.

Issue 2: Effect of rejection of supplementary deed on quantum of deductible remuneration under section 40(b)

(a) Interpretation and reasoning

2.8 The Court further examined the position assuming, arguendo, that the supplementary deed was to be rejected as ingenuine.

2.9 It observed that under both the original deed and the supplementary deed, the total quantum of remuneration payable to partners was in all cases restricted to the amount allowable under section 40(b). The only variation was in the manner of distribution among individual partners.

2.10 The Court held that, even if the supplementary deed were ignored, remuneration would then be governed by the original deed, which still entitled the firm to pay (and claim deduction for) remuneration to the extent allowable under section 40(b). Thus, the total deductible remuneration at firm level remained the same under either deed.

2.11 The Court reasoned that rejection of the supplementary deed could at best affect the apportionment of remuneration in the hands of the individual partners (i.e., quantum taxable in each partner's hands), and any action, if warranted, should be considered in those individual assessments, not by way of disallowance at the firm level.

(b) Conclusions

2.12 Even on the assumption that the supplementary deed was not acceptable, the assessee-firm was entitled to deduction of the full remuneration up to the limit prescribed by section 40(b), as already claimed.

2.13 The disallowance of Rs. 80,00,000/- representing alleged "excess" remuneration was therefore held to be untenable and was directed to be deleted in full.

2.14 The appeal of the assessee was allowed, and the entire remuneration paid to partners, being within the statutory limit under section 40(b), was allowed as a deductible expenditure.

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