2025 (12) TMI 722 - AT - Income Tax

Firm's cash addition u/s69A r/w s.115BBE deleted; partner-funded land payments, no source-of-source proof required for AY 2017-18

ITAT Hyderabad-AT allowed the assessee-firm's appeal and deleted the addition made under s.69A r/w s.115BBE. It held that substantial payments for ... Additions against money introduced by the partner - Genuineness of the capital introduced by the partners - Unexplained money in the hands of the firm u/s 69A r/w section 115BBE - requirement of proving the “source of the source” - HELD THAT:- Substantial payments towards purchase of the lands from Smt. D. Poojitha were directly made by the partners from their respective bank accounts. These payments are duly recorded in the registered sale deeds. The assessee firm has also passed appropriate journal entries crediting the partners’ capital accounts. Thus, the observation of the AO that only a portion of the capital introduction was routed through the firm’s account is factually incorrect and does not capture the complete factual matrix. Even if the creditworthiness of the partners was not fully substantiated, the legal position is that any unexplained capital introduced by partners cannot be assessed in the hands of the firm. The requirement of proving “source of source” was brought into the statute by the Finance Act, 2022 by inserting additional conditions in section 68 with effect from 01.04.2023. The year under consideration is assessment year 2017–18. Therefore, the said requirement was not applicable during the relevant assessment year and cannot be applied retrospectively. Unexplained credits appearing in partners’ capital accounts must be assessed in the hands of the respective partners and not in the hands of the firm. We hold that the addition made by the Ld. AO under section 69A of the Act in the hands of the firm is unsustainable. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether the capital introduced by partners, including amounts paid directly by partners to the land seller and credited through journal entries, could be treated as unexplained money in the hands of the firm under section 69A read with section 115BBE. 1.2 Whether, for the assessment year 2017-18, the assessee-firm was required to establish the 'source of the source' of the capital introduced by partners in order to avoid addition as unexplained money. 1.3 Whether, assuming any part of the partners' capital contribution remained unexplained, such amount could be assessed as unexplained income in the hands of the firm rather than in the hands of the individual partners. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Addition under section 69A of capital introduced by partners Legal framework (as discussed) 2.1 The assessment was framed under section 143(3). The disputed addition was made by treating partners' capital introduction of Rs. 3,26,91,139/- as 'unexplained money' under section 69A read with section 115BBE. Interpretation and reasoning 2.2 The Tribunal examined registered sale deeds for purchase of land and found that substantial payments to the seller were made directly from partners' bank accounts and were specifically reflected in the sale deeds. 2.3 Partners' capital accounts in the firm's books and their bank statements were scrutinized. The firm had passed corresponding journal entries crediting partners' capital accounts for such payments made directly to the seller on behalf of the firm. 2.4 On this material, the Tribunal held that the Assessing Officer's finding that only a portion of the capital introduction came to the firm's accounts was factually incorrect and failed to capture the true transaction structure. 2.5 The Assessing Officer had doubted creditworthiness solely on the basis of comparatively low incomes returned by the partners for assessment years 2016-17 and 2017-18, without pointing out any discrepancy in bank statements, capital accounts or supporting documents. 2.6 The Tribunal noted the settled proposition, as also recognized in the order itself, that capital contribution can emanate from accumulated savings, borrowings, gifts, advances or sale of personal assets and need not be confined to current year income; in absence of any specific contrary material, the mere quantum of returned income could not justify the adverse inference. Conclusions 2.7 The factual assumption that only a fraction of partners' capital was routed through the firm's accounts was rejected as incorrect. 2.8 In view of the documentary evidence and absence of specific discrepancies, treating the partners' capital contribution of Rs. 3,26,91,139/- as unexplained money under section 69A in the hands of the firm was held to be unsustainable. Issue 2: Requirement to prove 'source of source' of partners' capital for AY 2017-18 Legal framework (as discussed) 2.9 The Departmental Representative argued that the assessee had failed to prove the 'source of the source' of the partners' capital contribution and justified the addition on that basis. 2.10 The Tribunal referred to the statutory position that the requirement to explain 'source of source' was introduced by the Finance Act, 2022 by inserting additional conditions in section 68 with effect from 01.04.2023. Interpretation and reasoning 2.11 The Tribunal noted that the assessment year in question was 2017-18, significantly prior to the effective date of the 2022 amendment to section 68. 2.12 It held that the statutory requirement to establish 'source of source' could not be applied retrospectively to earlier assessment years. Conclusions 2.13 The objection that the assessee was bound to prove 'source of the source' of partners' capital for assessment year 2017-18 was rejected as legally misconceived and inapplicable for the relevant year. Issue 3: Whether unexplained partners' capital, if any, is assessable in the hands of the firm Legal framework (as discussed) 2.14 The addition was made in the hands of the firm under section 69A in respect of capital credited in partners' capital accounts. 2.15 The Tribunal relied on the binding judgment of the jurisdictional High Court in Nova Medicare v. ITO, which, in turn, followed earlier High Court authorities including M. Venkateswara Rao and other decisions cited therein regarding the treatment of cash credits in partners' capital accounts under section 68. Interpretation and reasoning 2.16 The Tribunal reproduced and applied the ratio that contributions by partners towards capital constitute the substratum of the firm's business and, once explained as partners' capital, the firm is not required to further explain the partners' individual sources under section 68. 2.17 The jurisdictional High Court had held that any enquiry into the source of partners' capital must be undertaken in the hands of the individual partners; if they are assessees, they may be required to explain their sources, and if not, returns can be called for from them. Such enquiry cannot be shifted to the firm for the purpose of treating partners' capital as the firm's unexplained income. 2.18 The High Court decisions, as quoted, state that where cash credits are found in the books of a firm in the individual capital accounts of partners and it is established that cash was in fact received from the partners, such credits, in the absence of material indicating that they represent the firm's own profits, cannot be assessed as income of the firm but only, if warranted, in the hands of the partners. 2.19 Applying this binding ratio, the Tribunal held that even assuming, arguendo, that the partners' creditworthiness was not fully demonstrated, any unexplained element in their capital contributions could not lawfully be assessed in the hands of the firm. Conclusions 2.20 Unexplained capital introduced by partners, if any, is assessable, where permissible, in the hands of the respective partners and not in the hands of the firm. 2.21 Consequently, the addition of Rs. 3,26,91,139/- made in the firm's assessment under section 69A was held to be unsustainable in law and directed to be deleted in entirety, and the appeal was allowed.