2019 (10) TMI 1170 - AT - Income Tax

Revision u/s 263 - AO did not made any inquiry,verifications and investigation before allowing interest payments paid to HUF as business deductions - HELD THAT - AO has not made any inquiry, verifications and investigation as to whether HUF is partner of the assessee firm or karta is partner of the assessee firm representing HUF. AO has allowed deduction of interest expenditure paid to M/s Ashok Kumar Fomra (HUF) as revenue expenses on advances appearing in books of accounts of the assessee having been received from said HUF, without going into aspect that HUF cannot be partner in partnership firm as per ratio of decision of Hon ble Supreme Court in the case of Rashik Lal Co 1997 (12) TMI 2 - SUPREME COURT . It is not inquired, verified or investigated by the AO whether Mr Ashok Kumar Fomra is partner in assessee firm in his individual capacity albeit representing HUF or HUF is partner in assessee firm. This fact finding has to be recorded by the AO to adjudicate dispute between rival parties. PCIT has rightly invoked his revisionary powers under provisions of Sec.263 of the 1961 Act and rightly cancelled assessment order dated 24.11.2016 passed by the AO u/s 143(3) by holding the same to be erroneous so far as is prejudicial to the interest of Revenue as the AO did not made any inquiry,verifications and investigation before allowing interest payments paid to HUF as business deductions. PCIT has rightly invoked extraordinary revisionary powers as are enshrined in Section 263 as no inquiry, verifications and ivestiigations were made by the AO before allowing deduction of interest expenditure payments to HUF. It is not brought on record by the AO whether Karta is partner in his individual capacity albeit representing HUF or instead HUF is partner in the assessee firm directly - Decided against assessee.

Issues Involved:
1. Whether the assessment order dated 24th November 2016 passed by the AO was erroneous and prejudicial to the interest of the Revenue.
2. The legality of HUF being a partner in a partnership firm.
3. The allowability of interest payments made to HUF as business deductions under Section 40(b) of the Income-tax Act, 1961.
4. The requirement for the AO to conduct inquiries, verifications, and investigations regarding the status of the partner in the partnership firm.

Issue-wise Detailed Analysis:

1. Erroneous and Prejudicial Assessment Order:
The Principal Commissioner of Income Tax (PCIT) held that the assessment order dated 24th November 2016 was erroneous and prejudicial to the interest of the Revenue. The PCIT observed that the AO did not inquire, verify, or investigate whether the HUF was a partner in the assessee firm or if the Karta of the HUF was a partner in his individual capacity. The AO allowed the deduction of interest paid to the HUF without proper scrutiny, leading the PCIT to cancel the assessment order and direct the AO to frame a fresh assessment.

2. Legality of HUF as a Partner:
The PCIT and the Tribunal referenced the Supreme Court decision in Rashik Lal & Co v. CIT, which established that an HUF cannot be a partner in a partnership firm. The Tribunal reiterated that a partnership is an association of individuals, and an HUF, being a fluctuating body of individuals, cannot enter into a partnership. The AO failed to investigate whether the Karta was a partner in his individual capacity, representing the HUF, or if the HUF itself was a partner, which is legally impermissible.

3. Allowability of Interest Payments to HUF:
The Tribunal noted that the AO allowed the deduction of interest payments made to the HUF without verifying the legal status of the HUF as a partner. According to Section 40(b) of the Income-tax Act, payments made to a partner are subject to disallowance. Since an HUF cannot be a partner in a partnership firm, any interest payments to the HUF should have been disallowed. The AO's failure to apply this legal principle rendered the assessment order erroneous and prejudicial to the interest of the Revenue.

4. Requirement for Inquiries, Verifications, and Investigations:
The Tribunal emphasized that the AO did not conduct necessary inquiries, verifications, and investigations to determine the status of the partner in the partnership firm. The AO's lack of diligence in verifying whether the Karta was a partner in his individual capacity or representing the HUF led to an erroneous assessment. The Tribunal upheld the PCIT's invocation of revisionary powers under Section 263 of the Income-tax Act, as the AO's failure to make necessary inquiries deemed the assessment order erroneous and prejudicial to the interest of the Revenue.

Conclusion:
The Tribunal dismissed the appeal filed by the assessee, upholding the PCIT's revisionary order. The Tribunal concluded that the AO's failure to inquire, verify, and investigate the status of the partner and the allowability of interest payments to the HUF rendered the assessment order erroneous and prejudicial to the interest of the Revenue. The Tribunal directed the AO to conduct a fresh assessment, considering the legal principles established by the Supreme Court and the provisions of the Income-tax Act. The appeal filed by the assessee was dismissed, and the revisionary order passed by the PCIT was upheld.

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