2006 (10) TMI 255 - AT - Income Tax

Disallowance of car expenses - incurred as partner of the partnership firm - Expenditure incurred in relation to income not includible in total income - theory of apportionment - HELD THAT - We find that car expenses have been incurred by the assessee either for the purpose of partnership business or for personal use. The source of business income is only one. Travelling in the car is either for personal use or for the purpose of his profession in the partnership. Therefore, in our opinion, it has to be held that car was used for the purpose of his profession which generated income partly exempt u/s 10(2A) and partly taxable. Therefore, the contention of the assessee that car was used only for earning remuneration from the partnership firm cannot be accepted. Similarly, other expenses related to the profession carried on by him and therefore, related to both types of income. Theory of apportionment - In our view, it would be reasonable to apportion the expenditure on the basis of the ratio of the income which is exempted and the income which is taxable. In the present case, a chart has been given in the statement of facts filed by the assessee before the CIT(A). According to this chart, the exempted income u/s 10(2A), while the remuneration received from the firm which is taxable as stated in the assessment order. Therefore, it would be reasonable to disallow on pro rata basis. The Order of the CIT(A) is, therefore, set aside and the Assessing Officer is directed to re-compute the disallowance accordingly. However, it is, clarified that assessee himself has disallowed 20% for personal use and therefore, the disallowance u/s 14A is to be made with reference to the balance 80% of the expenditure. In the result, appeal of the assessee stands dismissed while the appeal of the revenue is partly allowed.

Issues Involved:
1. Disallowance of car expenses incurred by the assessee as a partner of the partnership firm.
2. Deductibility of other expenses incurred by the assessee for earning professional income.
3. Application of Section 14A of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Disallowance of Car Expenses:
The primary issue in the cross appeals was the disallowance of car expenses incurred by the assessee, who is an Advocate and a partner in a partnership firm. The assessee claimed car expenses amounting to Rs. 3,59,327, of which he disallowed 20% for personal use and claimed the remaining Rs. 2,87,462 as a deduction against the salary received from the firm. The Assessing Officer (AO) disallowed the majority of the expenses, allowing only 20% for travel to and from the office. The CIT(A) restricted the disallowance to 10% of the total expenditure incurred by the assessee, considering the share of profit from the partnership firm was exempt from taxation under Section 10(2A).

2. Deductibility of Other Expenses:
The assessee also claimed other expenses related to entertainment, lease rental of a computer, purchase of law journals, and membership fees, totaling Rs. 4,73,966. The AO disallowed these expenses, arguing they were liabilities of the firm. The CIT(A) considered these expenses and allowed a portion, disallowing 10% for earning the share of profit. The assessee contended these expenses were necessary for ensuring higher professional income from the firm and should be allowed under Section 37(1) of the Income-tax Act.

3. Application of Section 14A:
The AO and CIT(A) both applied Section 14A, which disallows expenditure incurred in relation to income exempt from tax. The assessee argued that remuneration received from the partnership firm should be assessed as business income under Section 28, and thus all related expenses should be deductible. The Revenue contended that Section 14A, inserted with retrospective effect, mandates disallowance of expenses related to exempt income. The Tribunal noted that prior to Section 14A, the Supreme Court held that expenses for business purposes were deductible even if part of the income was exempt. However, with Section 14A, expenses related to exempt income must be disallowed. The Tribunal emphasized the need for a rational apportionment of expenses between taxable and exempt income.

Judgment:
The Tribunal concluded that car expenses and other professional expenses incurred by the assessee were related to both taxable remuneration and exempt profit from the partnership firm. Therefore, these expenses must be apportioned reasonably. The Tribunal directed the AO to re-compute the disallowance on a pro-rata basis, considering the ratio of exempt income to taxable income. The disallowance under Section 14A should be applied to 80% of the expenses, as the assessee already disallowed 20% for personal use.

Conclusion:
The appeal of the assessee was dismissed, and the appeal of the Revenue was partly allowed, with instructions for the AO to re-compute the disallowance in accordance with the Tribunal's directions.

← Previous Next →