TaxTMI 
TaxTMI 
2023 (6) TMI 1110
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.... of interest on capital paid to the partner. 2. The Assessing Officer and the ld. CIT(A) have failed to appreciate that the expenditure on interest payment is for the purpose of business and has been incurred on account of commercial expediency. 3. The Assessing Officer and the ld. CIT(A) should have appreciated that the revaluation of assets and consequent credit to the accounts of the retiring partners, as also the payment of interest on capital of the existing partner is in accordance with the accounting principles and in terms of the Partnership Deed. 4. The appellant craves leave to add, alter, substitute or delete any or all of the grounds of appeal urged above. 2. The facts of the case are that the assessees herein are partnership firms in Real Estate business and filed returns of income for these assessment years as follows: (i) Century Shelters, Bangalore: Sl. No. Assessment year Declared income (Loss) (Rs.) Claim of payment of interest (Rs.) 1. 2013-14 (-)7,31,59,321/- 4,80,00,000/- 2. 2014-15 (-) 8,19,56,557/- 4,89,13,370/- 3. 2015-16 (-) 9,15,43,286/- 5,36,92,085/- ....
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.... Ashwin Pai and Shri Ravindra Pai, who are also the Directors in the said company. Thus, the assessee firm was used as a conduit to transfer the money from M/s Century Real Estate Holdings Pvt Ltd to its Directors Shri Ashwin Pai and Shri Ravindra Pai. The payment of interest by the firm to the retired partners was a colourable device to transfer the money and also reduce tax liability in the hands of the firm. AO has also taken note of the fact that a firm and its partners are separate entities for the purpose of taxation; and therefore, regardless of an amount being offered as income in the hands of partners, an expenditure not allowable in the hands of the firm has to be disallowed. On these facts, AO has found that this amount of Rs. 40 Crore which was transferred to the retiring partners, has not been utilized wholly and exclusively for the purpose of the business. Therefore, the proportionate interest of Rs. 4,80,00,000/- on the said capital cannot be said to be incurred wholly and exclusively for the purpose of business. Therefore, AO has held that the interest expenditure of Rs. 4,80,00,000/- was not allowable, under section 37(1) or section 36(1)(iii), as the expenditure w....
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.... partners of the firm in the profit sharing ratio fixed as per the existing partnership deed, and not only to the accounts of Shri P. Ravindra Pai, Shri P. Ashwin Pai. (ii) The purpose of said revaluation, as stated in the valuation report, was to assess the Fair Market Value of the properties. However, the fact remains that both the properties, being vacant pieces of land, continued to remain vested with the firm even long after such revaluation. There appears to be no rationale for such revaluation of vacant land, when there was no plan, either in the near future or on long term, to sell the land or develop any residential or commercial project thereon. (iii) Shri A. Ramkrishna had contributed one of the residentially converted immovable property (bearing Survey No 107/2 and Survey No 116/2 totally measuring 1 Acre 20 Gunthas) as capital to the assessee firm. However, it is ironical that upon revaluation of the properties vested with the firm (which included the property contributed by Shri A. Ramkrishna), no amount from the Revaluation account was transferred to the current or capital account of Shri A. Ramkrishna, though he was continuing as partner to the fir....
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....A) observed that the distinction between legitimate tax planning and use of colourable devices has been summed up by Hon'ble Supreme Court, in the landmark judgement delivered by five-judge bench in case of Mc Dowell and Company Ltd Vs CTO (1985) (154 ITR 148) (SC), in following words (per the judgement authored by Justice Ranganath Misra), - "Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges." 3.5 The ld. CIT(A) further observed that Justice Chinnappa Reddy, while concurring with the judgement proposed to be delivered by Justice Ranganath Misra in the aforesaid case, has also made very pertinent observations regarding the consequences of tax avoidance and duty of Courts to intervene therein;- "The evil consequence of tax avoidance are manifold: (i) there is substantial loss of much needed public revenue particularly in a welfare State like ours;....
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.... terms of section 36(1)(iii) of the Act. The contention of the assessee is based on a wrong appreciation of statutory provisions, as applicable on facts of the case. In this regard, the ld. CIT(A) briefly analysed the relevant statutory provisions. Section 30 to Section 38 provide for various deduction while computing the income under the head profits or gains from business or profession. Section 40 is an overriding section, which provides that notwithstanding anything contained in section 30 to section 38, certain specified amounts shall not be deductible in computing income under the head profits or gains from business or profession. In particular, clause (b) of section 40 provides that any payment of interest, bonus, commission, remuneration etc. shall not be deductible if the same is paid to a nonworking partner, or not authorized by the partnership deed, or relates to some other period, or exceeds certain prescribed monetary limit etc. The issue at hand in the instant case is the admissibility or otherwise of interest expenditure on capital in the hands of partnership firm. It is clear from the overall scheme of the provisions under Chapter IV (Computation of Business Income) ....
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....under one of the sections between Sections 30 to 38 and in the case 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 it was not disentitled to claim such deduction on account of 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 Section 40 is a limitation on that deduction. It is important to 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 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 exceed....
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....h firm: Provided that where any interest, salary, bonus, commission or remuneration. by whatever name called, or any part thereof has not been allowed to be deducted under clause (b) of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted." 3.9 Thus, the ld. CIT(A) observed that it is evident on a plain reading, that the proviso to section 28(v) would only apply where any interest etc. has been disallowed in the hands of the partnership firm, by virtue of applicability of clause (b) of section 40. In the instant case, proportionate interest expenditure on capital has been disallowed in the hands of the partnership firm, to the extent the capital was not utilized for business purpose, both under the specific provisions of section 36(1)(iii) and general provisions of section 37. Therefore, no corresponding adjustment of interest income assessable in the hands of partners of the firm is permissible in the instant case, as the disallowance of interest has not been made under clause (b) of section 40 and as such, proviso to section 28(v) does not apply. This view has been upheld by ITAT, Ahmedabad Bench in case ....
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....ri P. Ashwin Pai and Shri. P. Ravindra Pai as partner. The partnership was constituted to carry on the business of buying, selling and developing immovable property. On 07/08/2007 the firm was reconstituted with the retirement of Shri. Ashwin Pai and induction of M/s Century real estate holdings Pvt. Ltd. as the new partner. The new partner brought in capital, on which interest at 12% was paid as authorised by the partnership deed. This interest has been disallowed by lower authorities. 4.2 According to the assessing officer interest paid is not for business purpose. He made this observation without appreciating that interest paid to partners i.e M/s Century Real Estate holdings Pvt. Ltd. is for the business purpose since the same is authorised by sec 40(b)(iv) of Income tax act and was incorporated by Finance Act 1992 and said section puts limitation on the deduction under section 30 to 38 therefore same cannot be disallowed in any other sec that is 36(i)(iii) or sec 37 of the Act and further sec 40 is an overriding section which provides that notwithstanding anything contained in sec 30 to sec 38. Hence clause (b) of the sec 40 provides that any payment of interest, bonus, rem....
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.... of such interest is only in reference to section 40(b) of the Act and not u/s 36(1)(iii) or 37 of the Act. This also gives a clue that deduction towards interest is regulated only u/s 40(b) of the Act and deduction of such interest to partners is out of the purview of section 36 or 37 of the Act. Notably, there has been no amendment in the general law provided under Partnership Act, 1932, the amendment to section 40(b) of the Act as referred herein above has only altered the mode of taxation. Needless to say, the partnership firm is not a separate legal entity under the Partnership Act. It is not within the purview of the Income Tax Act to change or alter the basic law governing partnership. Interest or salary is paid to partners remains distribution of business income. 4.6 Relevant here to refer decision of Hon'ble Supreme Court in the case of CIT Vs. R.M. Chidambaram (1977) 106 ITR 292 (SC), wherein held as under: "11.4 Section 4 of the Indian Partnership Act 1932 defines the terms partnership, partner, firm and firm name as under : "Partnership" is the relation between persons, who have agreed to share the profits of a business, carried on by all or any of the partn....
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....herent mutuality, when the partnership firm and its partners are seen holistically and in combined manner, the payment of interest to partners and its allowability in the hands of the partners does not lead to deriving of any additional advantage by a firm since the same interest is taxable in the hands of the partners simultaneously. Being so, in our opinion, the interest payment to partners by these firms to be allowed as a deduction while computing the income of these firms. However, the same shall be limited to the extent of allowability u/s 40(b) of the Act. 4.8. (a) In the present case, it is admitted fact that in the case of M/s. Century Sheltors vide Deed of Reconstitution of Partnership dated 23.6.2008, clause No.14 reads as follows: "Clause 14. The partners shall be paid such other remuneration, interest and commission as may be mutually agreed to upon by the parties time to time." (b) Vide deed of Reconstitution and Retirement of partnership dated 18.1.2011, clause no.13 reads as follows: "Clause 13. The partners shall be paid such other remuneration, interest and commission as may be mutually agreed to upon by the parties time to time." 4.9. (....
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.... 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 in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder:- (a) on the first Rs. 3,00,000 of the book profit or in case of a loss : Rs. 1,50,000 or at the rate profit, whichever is more; (b) on the balance of the book profit at the rate of 60 per cent:] 4.10 Being so, the payment of interest to these partners by these firms was duly authorised by the partnership deed or Resolution mutually passed by the partners of that firm M/s. Century Silicon City Ltd. Hence, it cannot be said that the payment of interest is without any authority, however, it should be limited to the rate of interest at 12% p.a. as prescribed in section 40(b)(iv) of the Act. If it is paid within that limit, the interest paid to the partners by these firms respectively to be allowed as a deduction in computing the income of these assessees. Further, it has to be noted that the interest has been paid to the partners by these two firms on the opening balance standing at....
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....s of the present case since in the case on our hand, the disallowance was made on account of interest payment on capital brought in by the partners. On the other hand, in the case of M/s. Shankar Chemicals Works, the assessee challenged the disallowance of expenditure incurred in relation to earning of exempted dividend income and taken a plea that the assessee has paid interest to its depositors from whom the deposits were obtained in earlier years where there was no investments by the assessee. Therefore, the interest paid to deposit is not in relation to dividend income. Answering this issue raised by the assessee, the Tribunal held that: "if any expenditure has been incurred for earning exempt income, the same has to be disallowed even if there is no actual earning of any exempt income. If interest bearing borrowed funds are utilized for the purpose of investment in shares and there is no receipt of dividend income or if there is only meagre amount of dividend income, even then, the whole amount of interest expenditure incurred for this purpose will be subject to disallowance under section 14A of the Act because the same has been incurred for earning exempt income. Hen....
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.... of section 40 of the Act. 4.15 In our opinion, the argument of the ld. A.R. is justified. Therefore, on this count also, we are of the opinion that since the amount has been taxed in the hands of partners u/s 28(v) of the Act same to be allowed in the hands of the assessee u/s 40(b) of the Act, otherwise it amounts to double taxation. 4.16 In the present case, it is not the case of either of the parties' interest payment is not exceeding the limit provided in section 40(b) of the Act. Hence, we direct the AO to allow the deduction to the extent of limit prescribed in section 40(b) of the Act. It is needless to mention herein that what is allowed in the hands of these assessees u/s 40(b)(iv) of the Act as a deduction, same to be taxed in the hands of the respective partners u/s 28(v) of the Act. In view of the above, we allow the grounds of appeals raised by both the assessees. Ordered accordingly. 5. In the result, the appeals of the assessees are allowed. Order pronounced in the open court on 10th Mar, 2023 ============= Document 1 We the Partners of M/S. CENTURY SILICON CITY do hereby on this the 1" day of April, 2010 mutually agree as follows: The Managin....