2023 (12) TMI 55 - AT - Income Tax

Revision u/s 263 - as per CIT there is Default computing deduction u/s 40(b)(v) towards partners remuneration - Interest income be excluded from book profit while computing permissible remuneration u/s 40(b)(v) - CIT setaside the assessment for misplacing explanation 3 in arriving eligible amount of book profit for the purpose of clause (v) of sub-section (b) of 40 - HELD THAT - Section 40(b)(v) restricts a partnership firm from claiming deduction towards remuneration paid to its working partner exceeding certain limits of book profit . The explanation 3 defines the term book profit, means the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit. The present issue is squarely covered by the judgement of CIT Vs J J Industries 2013 (7) TMI 577 - GUJARAT HIGH COURT and Md. Serajuddin Bros. 2012 (8) TMI 104 - CALCUTTA HIGH COURT any interest earned from the funds deployed which arose out business activity by no stretch of imagination can it be categorized under the head income from other sources. Further in similar facts and circumstance in Lok Holdings 2008 (1) TMI 365 - BOMBAY HIGH COURT has categorically held that interest earned from deposit of funds linked to any business activity is income from business profession and thus, cannot be categorized as income arising from other sources. It is a settled principle of law now that, income for the purpose of ascertaining ceiling on the basis of book profit, the profit shall be as appearing in the profit and loss account. The interest income, thus, cannot notionally be excluded while determining allowable of deduction of remuneration to partners u/s 40(b)(v) of the Act. In the extent case, the interest income shall form part of business income for the purpose of computing admissible deduction u/s 40(b)(v) of the Act. CBDT vide para (iv) of Circular No. 12/2019 dt. 19/06/2019 instruction to exclude all incomes such as capital gain, interest, rental income, income from other sources etc. which do not fall under the head 'profit or gain of business or profession', from the figure of book profit for the purpose of section 40(b)(v) shall failed make its application in the present case for two reasons that; (1) Firstly, circular although binding but in no case shall override aforestated judicial precedents (2) Secondly, assessment as well impugned revisionary order were framed anterior to circular coming into effect. Decided in favour of assessee.

Summary

Issues involved: Appeal against order of Principal Commissioner of Income Tax under section 263 of the Income-tax Act, 1961 regarding computation of book profit for deduction under section 40(b)(v) of the Act.

Issue 1: Misinterpretation of Explanation 3 in computing book profit

The assessee, a partnership firm engaged in real estate development and civil contracting, filed its return declaring total income after claiming a deduction under section 40(b)(v) of the Act. The assessment order was passed by the Income Tax Officer, which was later set aside by the Principal Commissioner of Income Tax under section 263 of the Act due to misplacement of Explanation 3 in determining the eligible amount of book profit. The assessee challenged this revisionary order on legal and merit grounds.

Issue 2: Treatment of interest income for computing book profit

The main issue revolved around whether the interest income earned by the assessee from investing surplus funds should be excluded from the book profit while calculating permissible remuneration under section 40(b)(v) of the Act. The Tribunal analyzed the relevant provisions and legal precedents to determine the treatment of such interest income.

Judgment Summary:

The Tribunal referred to section 40(b)(v) which restricts a partnership firm from claiming deduction towards remuneration exceeding certain limits of 'book profit'. The Explanation 3 defines 'book profit' as the net profit shown in the profit and loss account, increased by the aggregate amount of remuneration paid to partners. The Tribunal cited a judgment of the Gujarat High Court which emphasized that the net profit in the profit and loss account includes income from all sources, not just business income. Similar rulings from the Calcutta High Court and the Bombay High Court supported the inclusion of interest income from business-related funds in the computation of book profit.

Based on these legal precedents, the Tribunal held that interest income earned from business activities should be considered as business income and not income from other sources. Therefore, the interest income should not be excluded while determining the deduction of remuneration to partners under section 40(b)(v) of the Act. The Tribunal concluded that the revisionary order setting aside the assessment was unjustified and quashed the order accordingly.

Additionally, the Tribunal noted that the circular issued by the CBDT instructing the exclusion of certain incomes from book profit did not apply in this case due to existing judicial precedents and the timing of the assessment and revisionary orders.

In conclusion, the Tribunal allowed the appeal and pronounced the order in open court.