TDS credit must follow income, allowed to partners under s.199 despite deductee mismatch and procedural Rule 37BA(2)(i)

ITAT Hyderabad-AT held that where rental income from a property, though subject to TDS in the name of the assessee-firm, is ultimately assessable in the hands of its partners as co-owners pursuant to earlier ITAT directions, the corresponding TDS credit must be allowed to those partners. Interpreting s.199 as a substantive provision, the Tribunal ruled that TDS credit follows the income and is to be treated as tax paid on behalf of the person whose income is assessed, irrespective of the deductee's name. Rule 37BA(2)(i), being procedural, cannot deny such statutory entitlement. The AO was directed to grant TDS credit to the respective partners.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether credit/refund of tax deducted at source on rental income, reflected in the firm's PAN but not offered as income by the firm, can be denied to the firm where such income is, in law and on facts, assessable and has been offered in the hands of the partners as co-owners under section 26.

1.2 How section 199 of the Income-tax Act, 1961 and Rule 37BA of the Income-tax Rules, 1962 operate in allocating TDS credit where the deductee and the person in whose hands the income is assessable are different, and whether non-compliance with the proviso to Rule 37BA(2)(i) can defeat the substantive right under section 199.

1.3 Whether, in light of earlier Tribunal directions holding that rental income from the subject property is assessable in the hands of partners under section 26, the credit of TDS on such income is to be allowed to the firm or to the partners, and what directions should issue to the Assessing Officer in this regard.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 & 2: Entitlement to TDS credit/refund where income is assessed in partners' hands; interplay of section 199 and Rule 37BA

Legal framework (as discussed by the Tribunal)

2.1 The Tribunal extracted and considered section 199(1)-(3) of the Act, which provides that any deduction of tax at source and payment to the Central Government shall be treated as payment of tax on behalf of the person from whose income the deduction was made, or of the owner of the property, security, deposit, unit-holder or shareholder, as the case may be, and authorises the Board to make rules for giving such credit.

2.2 The Tribunal also extracted and analysed Rule 37BA(1)-(4) of the Rules, which: (i) provides generally that credit for TDS shall be given to the "deductee" (the person to whom payment is made or credit is given); (ii) in Rule 37BA(2)(i) provides that where, under any provision of the Act, the income on which TDS has been made is assessable in the hands of a person other than the deductee, TDS credit shall be given to such other person and not to the deductee, subject to the proviso requiring a declaration by the deductee and corresponding reporting by the deductor; and (iii) links grant of credit to information furnished by the deductor and the claim in the return of income.

Interpretation and reasoning

2.3 The Tribunal noted that in earlier years it had held that there was no valid partnership in the absence of any business activity, and that rental income from the subject property was to be assessed under section 26 as "Income from house property" in the hands of the partners as co-owners, and not in the hands of the firm. Those directions were followed for subsequent years, and partners had filed their returns offering their respective shares of such rental income and paying tax thereon.

2.4 For the year in appeal, the firm filed a return admitting nil income (in line with the earlier Tribunal orders) and claimed refund of TDS of Rs. 20,57,372/- appearing in its Form 26AS, while the corresponding rental income was offered by the partners individually. CPC denied the TDS credit on the ground that the firm had not offered the corresponding income.

2.5 The Tribunal held that, in view of its earlier binding decisions, the rental income from the subject property is, as on date, to be assessed in the hands of the respective partners as co-owners under section 26. The partners are therefore the "right persons" to be assessed qua such income.

2.6 Analysing section 199, the Tribunal held that it is a substantive provision which unequivocally provides that TDS shall be treated as payment of tax on behalf of the person from whose income the deduction was made, or the owner of the property, etc. Thus, conceptually, the person in whose hands the income is assessable should get the TDS credit.

2.7 The Tribunal examined Rule 37BA(2)(i) which specifically contemplates a situation where income on which tax has been deducted is assessable in the hands of a person other than the deductee, and mandates that credit for TDS shall be given to such other person and not to the deductee. However, the proviso to Rule 37BA(2)(i) requires the deductee to file a declaration with the deductor, and the deductor to report the TDS in the name of the other person in its TDS statement.

2.8 The Tribunal recorded that in the present case the pre-condition in the proviso to Rule 37BA(2)(i) (declaration by the deductee and corresponding reporting by the deductor) had not been complied with; thus, strictly on the rule's terms, reliance on that mechanism could not be placed.

2.9 Notwithstanding such non-compliance, the Tribunal reasoned that Rule 37BA is procedural in nature and subordinate to the substantive mandate of section 199(1). A procedural rule cannot be interpreted or applied so as to defeat the substantive statutory right of the person in whose hands the income is rightly assessable to obtain credit for the TDS on that income.

2.10 The Tribunal held that it cannot be presumed that, merely because the conditions in the proviso to Rule 37BA(2)(i) are not met, the "other person"-in whose hands the income is assessable-would be disentitled to credit for TDS relating to that income. Income and TDS must "go hand-in-hand": TDS credit must follow the person in whose hands the corresponding income is taxed.

2.11 In support, the Tribunal drew an analogy from the judgment of the Supreme Court in ITO, Lucknow v. Bachulal Kapoor (1966) 60 ITR 74 (SC), wherein, in the context of assessment of income of a Hindu Undivided Family (HUF), it was held that where income is ultimately assessed in the hands of another person, appropriate adjustments must be made in respect of tax already realised by the Revenue in relation to that income. By analogy, the Tribunal concluded that TDS on income assessable in the hands of the partners must be credited to them.

2.12 The Tribunal also relied on the Supreme Court judgment in ITO v. C.H. Atchaiah (1998) 218 ITR 239 (SC), which held that income must be assessed in the hands of the "right person and right person alone". Applying this, the Tribunal held that, the partners being the right persons to be assessed under section 26, they are correspondingly entitled, under section 199 and the principle in Bachulal Kapoor, to the TDS credit relating to that income.

Conclusions

2.13 The Tribunal held that, as the rental income from the subject property is mandatorily assessable under section 26 in the hands of the partners as co-owners and has been offered for tax by them, the substantive mandate of section 199(1) requires that the TDS on such income be treated as payment of tax on behalf of those partners.

2.14 Rule 37BA, being procedural, cannot be construed so as to deny TDS credit to the partners merely because the procedural steps in the proviso to Rule 37BA(2)(i) were not followed or the TDS appears in the firm's PAN. Non-satisfaction of the proviso does not override or curtail the substantive right under section 199 in favour of the right person.

2.15 Accordingly, the firm is not entitled to TDS credit/refund in respect of such rental income not assessable in its hands; instead, the TDS credit must be allowed in the hands of the partners to whom such income belongs and in whose hands it is assessable.

Issue 3: Effect of prior Tribunal directions and operative directions to the Assessing Officer

Interpretation and reasoning

2.16 The Tribunal noted that its earlier orders for A.Y. 2001-02 and subsequent years had conclusively held that: (i) there was no valid partnership due to absence of business activity; and (ii) rental receipts from the subject property must be assessed under section 26 in the hands of the partners as co-owners under the head "Income from house property". These findings governed the tax treatment of the same property and receipts in subsequent years.

2.17 In the present year, the firm's return showing nil income and the partners' returns offering their respective shares of the rental income were filed in compliance with those earlier Tribunal decisions. The Tribunal accepted that, following those decisions, the partners are the "right persons" for assessment of such income and, by extension, for TDS credit.

Conclusions and directions

2.18 The Tribunal set aside the order of the appellate authority upholding the CPC's denial of TDS credit to the firm.

2.19 The Assessing Officer was directed to allow credit of TDS relating to the rental income from the subject property in the hands of the respective partners (as co-owners), and not in the hands of the firm.

2.20 As a condition, the Tribunal directed that, in the set-aside proceedings, the Assessing Officer shall verify that the income from the subject property has in fact been offered to tax by the respective partners in their individual returns as co-owners under section 26. Upon such verification, corresponding TDS credit is to be duly granted to them.

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