2008 (8) TMI 419 - AT - Income Tax

Disallowance u/s 40(B) - Payment of interest @ 12 per cent on capital of partners as well as remuneration to the working partners - ld DR contended that the assessee has not complied (with) the terms of partnership and as such by virtue of provision of s. 185 of the Act, it was to be treated as an unregistered firm. HELD THAT - The perusal of deed of partnership reveals that the parties on mutual consent could add, amend, vary or alter any of the terms of partnership. This is found so spelled out in clause No. 11 of partnership deed and adopted in the supplementary deed as well. From this clause it is evident that the various clauses of partnership which authorised the partners to charge interest on their capitals and remuneration to the working partners could be varied or amended either verbally or even by conduct. It was not necessary for the parties to have reduced such terms in writing in case they desired not to charge any interest or remuneration as such. From the conduct of parties it is evident that they have acted in terms of clause No. 11 of the partnership deed. AO, therefore, could not have compelled the assessee to charge such interest or remuneration by invoking s. 40 (b)(v) of the Act more particularly when it is not mandatory but discretionary for the assessee to have made such a claim. Even otherwise, if this was to be taken as a case of contravention of provisions of s. 184 or s. 185 of the Act, then also, the amount of interest or salary payable to partners could not have been charged as their income in terms of cl. (v) of s. 28 of the Act. That being so, the finding reached by learned CIT(A) that the assessee has circumvented the tax liability by not claiming the deduction on account of salary and interest to partners so as to take benefit of set off of brought forward losses will not result into tax evasion but was merely on legitimate tax planning done by the appellant. Keeping in view the overall conspectus of the case, No justification found in the action of the learned CIT(A) in upholding the decision of ld AO in enforcing deduction of interest on capital and remuneration to working partners of the firm while computing the assessable income for the year under consideration. Therefore, by allowing the grounds in appeal, direct the assessing authority to modify the computation of income accordingly. In the result the assessee's appeal stands allowed.

Summary

Issues:
- Deduction for interest on capital contributed by partners and remuneration to working partners not claimed by the assessee in the return of income.

Analysis:
The appeal before the Appellate Tribunal ITAT Jodhpur challenged the decision allowing deduction for interest on capital and remuneration to working partners, even though the assessee did not claim the same in their income tax return. The assessing authority found that the partnership deed provided for payment of interest on partners' capital and remuneration to working partners, but the assessee did not account for these payments in their books. The AO calculated the interest and remuneration amounts and deducted them under section 40(b)(v) of the Act. The CIT(A) upheld this decision, considering it a case of tax avoidance.

The counsel for the assessee argued that the assessing authority should not allow deductions if not claimed by the assessee, citing legitimate tax planning as a valid reason. The Departmental Representative supported the lower authorities' findings, asserting non-compliance with partnership terms could lead to the firm being treated as unregistered. However, the Tribunal noted that the partnership deed allowed for amendments to partnership terms by mutual consent, even verbally or through conduct. It was discretionary for the assessee to claim deductions, and failure to do so did not amount to tax evasion. The Tribunal concluded that the CIT(A) erred in upholding the decision to enforce deductions for interest and remuneration, directing the assessing authority to modify the income computation accordingly.

In summary, the Tribunal allowed the assessee's appeal, emphasizing that not claiming deductions for interest and remuneration did not constitute tax evasion but rather legitimate tax planning. The Tribunal highlighted the discretionary nature of claiming deductions and the flexibility allowed under the partnership deed for varying terms, ultimately ruling in favor of the assessee and directing the modification of income computation.