2019 (7) TMI 169 - AT - Income Tax

Payment made to retiring partner and legal heirs of the deceased - diversion of income or not? - whether the payment made by the assessee-firm to retiring partners and legal heirs of the deceased partners in terms of the Partnership Deed amounts to diversion of income by over riding title and thus, excludible from total income in the hands of the firm or not? - change in agreement clause - HELD THAT - From a perusal of clause No.16 of the old agreement and clause nos. 13 and 14 of the new agreement, it is amply clear that in sum and substance the only difference is that in old agreement amounts payable to the retiring partners and legal heirs were not quantified and it only prescribed a method for quantification of amount, whereas in the new agreement the amount to be paid to the partners on retirement and otherwise is duly quantified. Apart from the aforesaid, we do not find difference in the terms and conditions prescribed in the two agreements. The terms of the Partnership Deed dated 01.04.2001 are also in line with the old agreement except that the amount to be paid to the retiring partners and legal heirs have been quantified in the new agreement. Thus, when the fact situation remains the same, we do not find any reason for not following the decision of the Hon ble Bombay High Court in assessee s own case 1990 (9) TMI 32 - BOMBAY HIGH COURT . Since the Hon ble High Court has already considered the decision of CIT v. Sitaldas Tirathdas 1960 (11) TMI 17 - SUPREME COURT , we are not discussing the applicability of the said case to the facts of the present case; and, it would suffice to note that the Assessing Officer has erred in placing reliance on the aforesaid decision. New agreement clearly spells out that the liability to pay income tax on amount received by the retiring partners or beneficiary will be on them and not on the assessee-firm. Thus, liability to pay tax, if at all, in terms of the agreement also, is upon the partner or the beneficiary receiving such payment. As such, it is the partners or beneficiaries receiving such payment who should be taxed and not the assessee. Further, it is also observed from the terms of the agreement that the above payment were to be set-aside at the threshold from the receipts of the firm and will, thus, not reach the hands of the other partners of the firm and, therefore, cannot be treated as income of the assessee-firm who has merely acted as a pass through entity for this payment. We, accordingly, set-aside the order of CIT(A) and direct the Assessing Officer to allow the exclusion on account of payment made to retiring partners and legal heirs of the deceased partners. - Decided in favour of assessee.

Issues Involved
1. Whether the amount paid to retired partners and legal heirs of deceased partners is income of the appellant.
2. Whether the amount constitutes a diversion of income by overriding title.
3. Whether the amount is allowable as an expenditure under section 37 of the Income Tax Act.
4. Whether the amount should be allowed as a loss.
5. Charging of interest under sections 234A, 234B, and 234C of the Income Tax Act.
6. Continuation of penalty proceedings under section 271(1)(c) of the Income Tax Act.

Detailed Analysis

1. Income of the Appellant
The primary issue was whether the amount of ?19,58,337/- paid to retired partners and the legal heirs of deceased partners should be considered as income of the appellant. The Tribunal noted that the appellant, a partnership firm of practicing Advocates, Solicitors, and Notaries, had claimed the deduction of this amount in its return for the assessment year 2008-09. The Assessing Officer disallowed the payment, considering it an application of income rather than a diversion by overriding title. However, the Tribunal found that the payment was made as per the Partnership Deed dated 01.04.2001 and was consistent with previous years where similar payments were not considered as income of the firm. The Tribunal concluded that the amount should not be treated as income of the appellant.

2. Diversion of Income by Overriding Title
The appellant argued that the payment to retired partners and legal heirs was a diversion of income by overriding title, meaning the income never accrued to the firm but was always meant for the retired partners and legal heirs. The Tribunal referred to the decision of the Hon’ble Bombay High Court in the appellant’s own case for the assessment year 1969-70, which held that such payments were indeed a diversion of income by overriding title. The Tribunal found no substantial difference in the clauses of the Partnership Deed from the earlier years and the current year, thereby ruling in favor of the appellant.

3. Allowability as Expenditure under Section 37
The appellant also contended that the amount should be allowable as an expenditure under section 37 of the Income Tax Act. The Tribunal, however, clarified that the issue at hand was not about the deduction under any specific provision of the Act but whether the amount could be considered as income at all. Since the Tribunal concluded that it was a diversion of income by overriding title, the question of allowing it as an expenditure under section 37 did not arise.

4. Allowance as a Loss
The appellant argued that if the amount was not considered as expenditure, it should be allowed as a loss. The Tribunal did not find it necessary to address this issue separately since it had already concluded that the amount was not income of the appellant due to the diversion by overriding title.

5. Charging of Interest under Sections 234A, 234B, and 234C
The appellant contested the charging of interest under sections 234A, 234B, and 234C. The Tribunal did not provide a detailed analysis on this issue, but given that the primary contention regarding the non-inclusion of the amount as income was accepted, it implied that the interest charges would not stand.

6. Continuation of Penalty Proceedings under Section 271(1)(c)
The appellant challenged the continuation of penalty proceedings under section 271(1)(c). The Tribunal's decision to exclude the amount from the total income of the appellant would inherently affect the penalty proceedings, suggesting that the penalties would not be applicable.

Conclusion
The Tribunal ruled in favor of the appellant on all issues, concluding that the amount paid to retired partners and legal heirs of deceased partners was a diversion of income by overriding title and should not be included in the income of the appellant. Consequently, the appeals for the assessment years 2005-06, 2008-09, 2009-10, and 2010-11 were allowed.

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