2011 (7) TMI 798 - AT - Income Tax

Addition - on account of capital contributed by the partners in the assessee-firm - Held that it is not in dispute that the assessee firm received the capital contribution by the partners before starting its business therefore it cannot be said that the capital contributed by the partners was the income earned by the assessee firm from undisclosed sources - Decided in favor of the assessee

Summary

Issues Involved:
1. Confirmation of addition of Rs. 10,00,000/- as income from undisclosed sources.
2. Validity of the initial capital introduced by the three partners before the commencement of the business.
3. The genuineness and creditworthiness of the gifts received by the partners and subsequently introduced as capital.

Issue-wise Detailed Analysis:

1. Confirmation of Addition of Rs. 10,00,000/- as Income from Undisclosed Sources:
The primary grievance of the assessee was the confirmation of the addition of Rs. 10,00,000/- made by the Assessing Officer (AO) on account of initial capital introduced by the three partners. The AO observed that the partners received gifts which were later transferred to the firm. The AO made the addition for reasons such as the unserved notices to donors, the non-assessment of donors to tax, unverifiable sources of income, lack of relationship between donors and donees, and the conclusion that the gifts were not genuine. The CIT(A) upheld the AO's decision, emphasizing that the appellant failed to establish the creditworthiness and genuineness of the transactions.

2. Validity of the Initial Capital Introduced by the Three Partners Before the Commencement of the Business:
The assessee argued that the capital contributions were made before the business commenced and thus could not be considered as income from undisclosed sources. The assessee cited several case laws to support this argument, including:
- CIT v. Jaiswal Motor Finance: Held that cash received by a firm from its partners, in the absence of any material indicating it was the firm's profits, could not be assessed in the firm's hands.
- India Rice Mills v. CIT: Held that unexplained deposits made before the firm started its business could not be the firm's income.
- CIT v. Md. Perwez Ahmed: Held that credits on account of partners' capital contributions should be assessed in the hands of the partners, not the firm.
- CIT v. Metachem Industries: Held that once the firm proves the investment by a partner, the firm's responsibility is over.
- CIT v. Burma Electro Corpn.: Held that unexplained investments should be assessed in the hands of the partners if permissible.

3. Genuineness and Creditworthiness of the Gifts Received by the Partners and Subsequently Introduced as Capital:
The AO and CIT(A) questioned the genuineness and creditworthiness of the gifts received by the partners, citing reasons such as the non-verifiability of donors' income, lack of relationship between donors and donees, and the improbability of gifts from individuals without taxable income. The assessee contended that the capital contributions were sourced from gifts received and bank withdrawals, and that the firm had provided sufficient evidence to establish the sources. The CIT(A) concluded that the assessee failed to prove the identity, creditworthiness, and genuineness of the donors and their gifts, justifying the addition in the firm's hands.

Conclusion:
The Tribunal concluded that the capital contributions were made before the business commenced, and thus could not be considered as the firm's income from undisclosed sources. It emphasized that even if the AO was not satisfied with the explanation, the addition should be considered in the hands of the individual partners, not the firm. The Tribunal cited several case laws supporting this view and ultimately deleted the addition made by the AO and confirmed by the CIT(A).

Result:
The appeal was allowed, and the addition of Rs. 10,00,000/- was deleted.