2005 (8) TMI 324 - AT - Income Tax

Deduction of remuneration to partners u/s 40(b) - Salary To Partners from the income earn by the firm on bank interest income on FD - taxability in the hands of partner under head Profits and gain of business or profession Or Income from other sources - HELD THAT - It is crystal clear from the plain reading of the above provision that allowability of deduction of remuneration is dependent on provisions in the partnership deed as well as on the net profit as shown in the P L a/c. Under the scheme operative from asst. yr. 1993-94 the firm is taxed as separate entity under s. 184. There is now no provision for registration of a firm by the AO and there is no distinction between what was earlier termed as registered firm and unregistered firm . When a firm is assessed as a firm the same consequences follow. Sec. 40(b) operative from 1993-94 has lifted this ban partially and under the new scheme such payment is allowable within specified limits subject to fulfilment of specified conditions. After allowing such payments to partners upto specified limits the balance of income of the firm is subject to maximum marginal rate of tax. The earlier distinction between the rates of income-tax for professional and nonprofessional firms has been removed The partners are now not liable to tax in respect of the share of income from the firm. However remuneration and interest allowed to partners are to be charged to income-tax in their respective hands under the head Income from business or profession . Thus s. 40(b) imposes conditions and financial limitations for deduction of remuneration to partners. The section adopts the net profit as shown in the P L a/c of the firm as the base for working out the financial limits for deduction. It is in consonance with the provisions of the IT Act as well as the provisions of the Indian Partnership Act that for assessment of income from other sources which are assessable under other heads are also embedded in such net profit . In order to ensure that the figure of net profit is not artificially reduced by claiming deduction far in excess of limits permissible under ss. 30 to 43D s. 40(b) requires that net profit is worked out in accordance with Chapter IV-D. There is also no dispute to the legal position that whatever income is received by the partner from the firm in the name of interest salary bonus commission or remuneration by whatever name called is chargeable to income-tax under the head Profits and gains of business or profession under s. 28(v). Such remuneration received by partner is neither exempt nor entitled to any kind of deduction while computing total income of the partner in his individual hands. Such remuneration is allowed to the partner for actively participating in the conduct of firm s business and thereby putting the capital and other funds of firm for commercial exploitation. The profit earned by firm through such commercial exploitation of its resources is credited to the P L a/c and partner is made entitled to remuneration as per the clear stipulations in the partnership deed. Thus in view the legislative intent for providing remuneration to active partners who have contributed their efforts in earning different income credited in the P L a/c of the firm we are inclined to hold that the nature of income embedded in the net profit as appearing in the P L a/c in the instant case which are as per object clause of the partnership deed are entitled to be taken into consideration for allowing deduction on account of remuneration to partners without excluding interest income on deposit from bank. which has formed part of the book profit. In the result the appeal of the Revenue is dismissed.

Summary

Issues Involved:
1. Validity of reopening assessment under Section 148 of the IT Act.
2. Treatment of interest income on bank deposits as 'Income from other sources' versus 'Business income'.
3. Allowability of remuneration to partners based on interest income included in business profits.

Detailed Analysis:

1. Validity of Reopening Assessment:
The assessment was reopened under Section 148 on the grounds that there was an excess deduction for partner remuneration. The AO argued that only business profits should be considered for partner remuneration, not interest income from bank deposits, which should be taxed as 'Income from other sources'. The CIT(A) upheld the reopening, citing there was no indication that the AO had considered the disputed issue during the original assessment. The CIT(A) referenced the jurisdictional High Court decision in Praful Chunilal Patel & Ors. vs. M.J. Makwana, Asstt. CIT, which supports reopening in cases where an error or mistake is detected, not merely a change of opinion.

2. Treatment of Interest Income:
The AO relied on the Supreme Court decision in Tuticorin Alkali Chemicals & Fertilizers Ltd. vs. CIT, which states that interest from bank deposits is generally taxable as 'Income from other sources'. However, the CIT(A) disagreed, citing that the assessee had been in business for many years and invested surplus funds, which should be considered as 'Business income'. The CIT(A) referenced the Calcutta High Court decision in CIT vs. Tirupati Woollen Mills Ltd. and the Madras High Court decision in CIT vs. Madras Refineries Ltd., supporting that interest from surplus funds invested in the business context should be treated as 'Business income'.

3. Allowability of Remuneration to Partners:
The AO restricted partner remuneration by excluding interest income from business profits. The CIT(A) directed the AO to include interest income as 'Business income' for the purpose of calculating partner remuneration. The Department argued that interest income should not be considered 'Business income' based on the Supreme Court decision in Tuticorin Alkali Chemicals & Fertilizers Ltd. The assessee countered by citing consistent treatment of interest income as 'Business income' in previous and subsequent years and referenced the Supreme Court decision in Radhasoami Satsang vs. CIT, emphasizing the rule of consistency. The assessee also argued that the interest income was from the exploitation of commercial assets, supported by decisions from the Madras High Court and Calcutta High Court.

Conclusion:
The Tribunal considered the rival submissions and relevant case laws. It noted that Section 40(b) of the IT Act allows deduction for partner remuneration based on 'net profit' as shown in the P&L account, which includes all income, not just business income. The Tribunal emphasized the legislative intent to provide remuneration to active partners contributing to earning different incomes credited to the P&L account. It concluded that the interest income from bank deposits should be included in the 'book profit' for calculating partner remuneration. Consequently, the Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s decision to treat interest income as 'Business income' and allow partner remuneration accordingly.