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2009 (10) TMI 676 - AT - Income TaxClaim for payment to a retired partner of the firm u/s 37 (1) - CIT (A) rejects the claim - whether the income to the extent of the remuneration paid to the retired partner in pursuance of clause 8.4 of the deed of partnership is diverted and it has never reached in the hands of the assessee-firm - HELD THAT - In the present case The assessee is a firm of chartered accountants. In the assessment year 2004-05 the assessee has claimed the sum of Rs. 10, 00, 000 towards the contractual payment made to the retiring partner as per the terms of the deed of partnership. it is the contractual obligation on the assessee-firm to pay the retirement benefits for the period of five years in terms of clause 8.4. It is pertinent to note here that the retired partner has nothing to do with the profit earned or losses suffered by the assessee-firm but the quantum of the retirement benefits has been fixed. In pursuance of clause 8.4 there is a charge on the profits of the assessee-firm and hence in our opinion if we examine the facts of this case in the backdrop of the legal principles in the precedents cited above there is a diversion of income to the extent of the retirement benefits paid by the assessee-firm as per terms of clause 8.4 to the retired partner. We therefore hold that the retirement benefit paid in terms of clause 8.4 cannot be included in the total income of the assessee-firm as to that extent the income has never reached in the hands of the assessee. We accordingly allow the grounds taken by the assessee. In the result the assessee s appeal is allowed.
Issues Involved:
1. Rejection of appellant's claim for payment to a retired partner. 2. Determination of whether the payment constitutes a diversion of income by overriding title. Issue-wise Detailed Analysis: 1. Rejection of Appellant's Claim for Payment to a Retired Partner: The appellant, a firm of chartered accountants, challenged the order of the Commissioner of Income-tax (Appeals) (CIT(A)) which rejected the firm's claim for a deduction of Rs. 10,00,000 paid to a retired partner, Mr. Rakesh Khanna, under section 37(1) of the Income-tax Act. The payment was made as per clause 8.4 of the partnership deed dated July 4, 2002, which stipulated that a retiring partner over the age of 50 would be entitled to 25% of his average earnings for five years, payable in quarterly installments. The CIT(A) upheld the Assessing Officer's (AO) decision, viewing the payment as an application of funds rather than a diversion of income by overriding title. 2. Determination of Whether the Payment Constitutes a Diversion of Income by Overriding Title: The core issue was whether the payment to the retired partner was a diversion of income by overriding title, which would mean the income never reached the assessee. The appellant argued that clause 8.4 created a charge on the firm's income, diverting it before it reached the assessee. The CIT(A) referenced the Supreme Court's decision in CIT v. Sitaldas Tirathdas [1961] 41 ITR 367 (SC), which distinguished between an obligation to pay out of one's income and an obligation that diverts income before it reaches the assessee. The Tribunal considered several precedents: - CIT v. Sitaldas Tirathdas [1961] 41 ITR 367 (SC): The Supreme Court held that the decisive factor is the nature of the obligation. If the income is diverted before it reaches the assessee, it is deductible. - CIT v. C. N. Patuck [1969] 71 ITR 713 (Bom): The Bombay High Court ruled that a charge on income, even without specific wording, indicates an overriding title, making the income not taxable in the hands of the assessee. - CIT v. Nariman B. Bharucha and Sons [1981] 130 ITR 863 (Bom): The court held that an overriding charge on income, as created by a partnership deed, means the income is diverted before reaching the partners. - CIT v. Crawford Bayley and Co. [1977] 106 ITR 884 (Bom): The court found that an obligation to pay a retired partner's widow, irrespective of profits, constituted an overriding title, diverting income before it accrued to the firm. Applying these principles, the Tribunal concluded that clause 8.4 of the partnership deed created a charge on the firm's income, diverting it before it reached the assessee. The retirement benefit paid to Mr. Khanna was thus not part of the firm's taxable income. The Tribunal allowed the appeal, ruling that the payment was a diversion of income by overriding title. Conclusion: The Tribunal held that the payment of Rs. 10,00,000 to the retired partner, as per clause 8.4 of the partnership deed, constituted a diversion of income by overriding title. Therefore, it was not taxable in the hands of the assessee-firm. The appeal was allowed, overturning the CIT(A)'s decision. The order was pronounced in the open court on October 12, 2009.
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