2008 (12) TMI 671 - AT - Income Tax

Payment made to retiring partner - diversion of income or not? - assessee claimed before the CIT(A) that the said payment was an overriding charge on the income assets and properties of the firm under the partnership agreement and was admissible deduction while computing the taxable income of the firm - CIT(A) held that the payments were not allowable as a deduction in the hands of the firm. HELD THAT - Reading the terms of the agreement entered into between the parties on March 30 2000 in continuation with the agreement entered in to on March 30 2001 it transpires that certain events were taken care of as certainty by the parties. The retirement of Mr. Philip Mr. Merchant was a certainty as provided in clause 24(b) of the deed dated March 30 2000. Special terms were agreed between the parties in connection with the retirement of certain partners and in connection with the retirement of other partners of the firm. In respect of Mr. Philip and Mr. Merchant as per clause 21(b) and (c) the maximum annual payments were provided as is evident from the perusal of our observations in the paras hereinabove. In the circumstances where the assessee has by its own motion acted on certain terms and conditions with regard to the payments to be made to specified persons on the happening of an event on a particular date cannot be held to be a charge of its income. The parties cannot pre-determine every event and then claim that one of this event creates overriding charge especially so when such events were within their control. we are of the view that the payments made to the retiring partners in consensus with the terms and conditions agreed upon between the parties to the agreement are in the nature of an obligation voluntarily agreed to and such an obligation cannot be diversion by an overriding charge. Accordingly we hold that the payments made to the retiring partners is not allowable as a deduction while computing the profits of the firm being the payments made on capital account. The expenditure incurred by the assessee by way of payments to the retiring partners is only an application of its income which is on capital account and not allowable as a deduction. There is no merit in the claim of the assessee that it is diversion of income by overriding the charge. We find support from the judgment of the apex court in CIT v. Sitaldas Tirathdas 1960 (11) TMI 17 - SUPREME COURT wherein it has been held that only such payments where the obligation to pay flows out of an antecedent and independent title in the former it would be a case of diversion of income. But where the obligation is self imposed as gratuitous it is a case of application of income . The payment made by the assessee to its retiring partners in the facts of the case before us is a self imposed obligation being gratuitous and hence application of income. Accordingly we disallow the claim of the assessee in respect of the payments made to the retired partners. The ground of appeal raised by the assessee is thus dismissed.

Summary

Issues Involved:
1. Deductibility of payment to retired partners.
2. Disallowance of petty cash expenses.

Issue-wise Detailed Analysis:

1. Deductibility of Payment to Retired Partners:

The primary issue in the assessee's appeal was whether the sum of Rs. 16,18,140 paid to retired partners was deductible in computing the taxable income. The assessee, a firm of chartered accountants, claimed this amount under clause 22 of the partnership deed dated March 30, 2001, as an expenditure. The Assessing Officer disallowed this, treating it as goodwill, which is capital in nature. The Commissioner of Income-tax (Appeals) upheld this view, stating that the payment was not an overriding charge on the income, assets, and properties of the firm.

The assessee argued that the payment was an overriding charge on the firm's income, citing various clauses of the partnership deeds and several judicial precedents, including CIT v. Mulla and Mulla and Craigie, Blunt and Caroe [1991] 190 ITR 198 (Bom) and CIT v. C. N. Patuck [1969] 71 ITR 713 (Bom). The Departmental representative countered that such payments were not allowable under the amended provisions of the Income-tax Act, specifically section 40(b).

The Tribunal analyzed the relevant clauses of the partnership deeds dated March 30, 2000, and March 30, 2001, which provided for payments to retiring partners and created a charge on the firm's income and assets. The Tribunal referred to the principles laid down by the Supreme Court in CIT v. Sitaldas Tirathdas [1961] 41 ITR 367, which distinguished between diversion of income by overriding title and application of income. The Tribunal concluded that the payments to the retiring partners were a self-imposed obligation and thus an application of income, not a diversion by overriding charge. Therefore, these payments were not deductible while computing the firm's profits.

2. Disallowance of Petty Cash Expenses:

The only issue in the Revenue's appeal was the deletion of the addition of Rs. 5,70,000 out of petty cash expenses. The assessee had claimed Rs. 28,54,436 under "other expenses," which included cleaning, office charges, tea and coffee expenses, etc. The Assessing Officer disallowed 20% of these expenses on an ad hoc basis. The Commissioner of Income-tax (Appeals) deleted this disallowance, noting that no specific defect had been pointed out by the Assessing Officer.

The Departmental representative supported the Assessing Officer's decision, while the assessee's representative highlighted that the other expenses were only 1.046% of the gross receipts of Rs. 272,845,166. The Tribunal found no merit in the ad hoc disallowance, as no particular expense was identified as unrelated to the business. Thus, the Tribunal upheld the Commissioner of Income-tax (Appeals)'s decision to delete the disallowance.

Conclusion:

The Tribunal dismissed the assessee's appeal regarding the deductibility of payments to retired partners, concluding that these payments were not allowable as they were an application of income. The Tribunal also dismissed the Revenue's appeal, upholding the deletion of the ad hoc disallowance of petty cash expenses. The order was pronounced on December 19, 2008.