1987 (8) TMI 62 - HC - Income Tax

Summary

Issues:
1. Interpretation of partnership deed clause regarding city compensatory allowance.
2. Application of section 40(b) of the Income-tax Act, 1961 on the payment made to partners.
3. Determining the nature of city compensatory allowance and its treatment as a deduction.

Analysis:
The case involved a reference under section 256(1) of the Income-tax Act, 1961, regarding the treatment of a payment of Rs. 7,200 to two partners of a firm as city compensatory allowance. The firm, engaged in public transport business, had a partnership deed specifying the allowance as an expenditure incurred for the business. The Income-tax Officer disallowed the deduction, citing section 40(b) prohibition on certain partner payments. The Appellate Assistant Commissioner allowed the deduction, but the Tribunal reversed it, deeming the payment as part of firm income, not a business expense.

The central issue revolved around the character of the city compensatory allowance paid to the partners residing in different cities. Section 40(b) prohibits deductions for certain partner payments, including salary and commission. The court analyzed whether the allowance constituted remuneration falling under this provision. Despite the firm's argument that it was a business expense, the court concluded that the payment was indeed a form of remuneration to the partners, falling within the scope of section 40(b).

The court rejected the firm's contention that the allowance was a legitimate business expense, emphasizing that it was essentially a part of the partners' remuneration. The court highlighted the inconsistency in treating the payment as a business expense while not accounting for it as branch-specific expenditure. Ultimately, the court upheld the Tribunal's decision, affirming that the deduction of the payment was prohibited by section 40(b) of the Income-tax Act, 1961.

In conclusion, the court ruled against the assessee, upholding the disallowance of the deduction for the city compensatory allowance paid to the partners. The judgment clarified that such payments, even if labeled as allowances, could be considered as remuneration falling under the purview of section 40(b) restrictions.