PAYMENT TO A RETIRED PARTNER IS CAPITAL EXPENDITURE

[Mr. M. GOVINDARAJAN]

A partnership firm is a type of business entity that is formed by the association of two or more members who have agreed to share the profits of the business, which is carried on by all partners or one partner acting for all.  The partnership firm is to registered under the Partnership Act in the concerned State.  A partnership deed to be registered between the partners is a mandatory one.  Partnership deed is a partnership agreement between the partners of the firm which outlines the terms and conditions of the partnership between the partners. The purpose of a partnership deed is to provide clear understanding of the roles of each partner, which ensures smooth running of the operations of the firm.

Withdrawal of a partner from the partnership with the consent of other partners or as per the provisions of the partnership deed or by giving notice of retirement is termed as retirement of a partner. A partner who cut his connection with the firm is called a retiring partner or outgoing partner.

A retiring partner is entitled to get his share of capital, interest on capital, revaluation profit, share of profit etc. up to the date of his retirement. Similarly he is liable for his share in all the losses like accumulated loss, revaluation loss, Drawings, interest on drawings, share of current year’s loss up to the date of retirement, drawings, interest on drawings etc. till the date of his retirement. He is not liable for any loss incurred by the firm after his retirement.

The partner who is retiring, his or her account is settled as per the terms and conditions of partnership deed, i.e., in lump sum instantly or in different installments, either with or without interest as consented or partly in cash directly and partially in installment at the consented intermissions.  The retiring partner is compensated for parting with the firm’s future profits in favor of the remaining partners.  The remaining partners shall contribute to such compensation to the retiring partner.

In  ITO, WARD-7 (1) , PUNE. VERSUS M/S. SARSAN DEVELOPERS, - 2023 (11) TMI 330 - ITAT PUNE  the assessee is a partnership firm engaged in the business of development of lands at Pune.  The partnership consists of Sarsan Developers Private Limited and Kumar Housing Corporation Limited.  During the period from 2009 to 2013 the real estate business was not much appreciated.  Therefore they did not show interest in developing the lands.  There came a deadlock.  Sarsad Developers Private Limited, one partner decided to remove Kumar Housing Corporation Limited.  The partnership deed provides for the payment of compensation to the outgoing partner in the event of the removal/exit of the partner before the completion of the project, as per the market price.  The assessee paid Rs.5.60 crores to the retiring partner towards settlement.   The assessee has transferred the said expenditure to capital work in progress.  The said cost will be treated as revenue expenditure once the properties are sold. 

The assessee filed its income tax return for assessment year 2014-15 on 29.11.2014 declaring NIL income.  The Assessing Officer assessed the return filed by the assessee on 23.12.2016.  In its order the Assessing Officer added Rs.5.60 crores to the income of the assessee as the said payment made to its retiring partner as settlement cannot be allowed as deduction and,

accordingly, added to the closing work-in-progress by disallowing the same as deduction u/s 37(1) of the Act.

The assessee filed appeal before the Commissioner of Income Tax (Appeals) against the order of Assessing Officer.  The Commissioner of Income Tax (Appeals) held that the provisions of section 45(4) of the Act has no application and, therefore, disallowance of payment by holding to be capital expenditure is not justified, it should be allowed as revenue expenditure.

The Revenue was aggrieved against the order of Commissioner of Income Tax (Appeals) and filed appeal before the Income Tax Appellate Tribunal.  The Revenue contended that the Commissioner of Income Tax (Appeals) wrongly held that the amount paid to the retiring partner is of revenue in nature without appreciating proper facts of the present case.  The assessee contended that the said amount was paid to the retiring partners towards the settlement arrived at between two partners towards the expenditure incurred at that time and, therefore, it is not the amount paid to the retiring partner

The ITAT considered the submissions made by both the parties and gone through the facts of case and also gone through the settlement deed.  The said amount was paid to the retiring partner in terms of settlement arrived at between two partners for giving up his interest in the partnership firm, there cannot be any dispute that the amount paid to a retiring partner for giving up his interest in the partnership firm is a capital expenditure.

The ITAT held that the Commissioner of Income Tax (Appeals) without appreciating proper facts of the case went on to hold that the payment of money to the retiring partner is revenue expenditure.  The ITAT did not accept the findings of the Commissioner of Income Tax (Appeals).  Therefore the ITAT allowed the appeal filed by the Revenue.