Deloitte Haskins - Firm Exceeding 20 Partners or Not

[CA DEV KUMAR KOTHARI]

Learning from M/s Deloitte Haskins & Sells V/s. Deputy Commissioner of Income Tax (ITAT Delhi) – AO to decide whether number of partners exceeded 20 rendering firm as illegal Association of persons- some important contentions missed by assessee.

M/s Deloitte Haskins & Sells Versus The Deputy Commissioner of Income Tax 2013 (8) TMI 222 - ITAT CHENNAI

G. K. Choksi & Company Versus Commissioner of Income Tax, Gujarat 2007 (11) TMI 7 – Supreme Court of India

Section 2(13), 2(36), 40 of Income –tax Act ,1961.

Section 11 of the companies Act 1956.

Section 464 of the companies Act 2013.

Section 2 (b) and 4 of the Indian Partnership Act, 1932

Summary:

In case before Tribunal CIT had held that the partnership consisted of 21 partners – twenty individuals and one another firm. As per author view can be taken that in such situation, number of partners will be 20 individual partners of firm and all uncommon partners of another firm which has been made a partner through one of individual partner as representing that firm. The author take such a view because by the arrangement all partners of Deloitte, Mumbai will also share profit though indirectly.

However, in view of author restrictions on number of partners will not be applicable in case of a CA firm which is engaged in a profession and not in a business. There is clear difference in business and profession. Furthermore firms of CA are also governed by ICAI Act and ICAI Regulations. This contention was not raised by assessee, however, it can be raised now before the AO.

Case of Deloitte (supra.):

In this case dispute arose as to whether the partnership firm of Chartered Accountants having more than 20 partners is an illegal association and cannot be assessed as partnership but has to be assessed as AOP.

The case was that the firm had twenty individual partners in their individual capacity. One Shri Mukund Dharmadhikari, already a partner of the firm in his individual capacity, was added once again as partner in a representative capacity, representing M/s Deloitte Haskins & Sells, Mumbai.

Thus another partnership firm of CA was made a partner through one out of twenty individual partners.

Authors view of number of partners:

In this way, in fact, partners of M/s Deloitte Haskins & Sells, Mumbai became entitled to share profit of the assessee firm. Therefore, I in view of author the firm became partnership of large number of individuals that is all individual partners of assessee firm and also all individual partners of   M/s Deloitte Haskins & Sells, Mumbai and at best common individual partners of two firms can be counted as one individual partner. So naturally total number of partners will be much more than 20 and not only 21.

The firm contended that a firm is not a person, and therefore, only 20 individuals are partners and the firm is valid one.

The provisions of Income-tax Act, 1961 were under consideration. Assessee was assessed as partnership firm. The CIT in exercise of powers under section 263 set aside the assessment and held that the assessment as firm was erroneous, deductions for remuneration paid to working partners was wrongly allowed. CIT directed to make assessment in status of AOP and to disallow deduction of remuneration paid to working partners.

On appeal before Tribunal the Tribunal considered and observed that assessee was a renowned CA firm and was well aware that number of partners cannot exceed 20. It is a well settled principle of law that what is permissible is tax planning, but not evasion. When an attempt is made by a concern to evade tax using subtle camouflages, bounden duty of the authorities is to find out the real intention. It is the duty of the Court in every case, where ingenuity is expended to avoid taxing and welfare legislations, to get behind the smoke screen and discover the true state of affairs - assessee was indirectly trying to bring in M/s Deloitte Haskins & Sells, Mumbai, another firm, which was already a participating firm, as its partner, circumventing the limit of maximum 20 members. It is also obvious that Assessing Officer despite having the amendment deed with him, had not gone into these aspects. Assessment order is a crisp one accepting the income returned by the assessee. Assessee has not been able to place any record to show that Assessing Officer had called for any details regarding the number of partners during the course of assessment.

A crisp order by itself might not show that Assessing Officer had not applied his mind. But, when the circumstances show that despite availability of materials, is that Assessing Officer had not looked into such aspects nor applied his mind. Assessee had claimed substantial amount as remuneration to its partners under Section 40(b) of the Act and this was allowed as such without considering the crucial aspect of the legality of its claim of status as a firm.

CIT went over board when he directed the Assessing Officer to modify the assessment order by treating the assessee as an AOP and disallow the claim of remuneration to its partners. The CIT ought have simply set aside the order of A.O. for consideration of issue afresh, since it was erroneous insofar as it was prejudicial to the interests of Revenue and to this extent, order of ld. CIT required modification thus the matter was decided partly in favour of assessee.

Now the matter is before the AO who will decide issue. Some important points which require consideration , which seems not have been pressed earlier.

Business and profession:

As per general understanding of common men and general dictionary meanings, the term business, and profession and businessman and professional man have different meaning. Even a child studying in class 4 or 5 can easily distinguish these two categories. I asked few children under age of 10 years about this, answers were like uncle having grocery shop / fruit shop/ cake shop etc. are businessman and doctor uncle is a professional or father of his friend who is advocate or CA are professional. Thus the difference is clear and there cannot be a doubt.

In the context of various provisions of Income-tax Act also the Supreme Court has in G. K. Choksi and Co. v. C.I.T. 2007 (11) TMI 7 - Supreme Court of India held that a firm of CA is not carrying business and is not entitled to initial depreciation which is admissible on residential houses, in a business, for employees. Profession is not covered in business and language used , in provision confers benefit only to business.

In this case matter relating to initial depreciation on building for residence of low paid employees was considered. The assessee firm is a firm of chartered accountants engaged in “profession” of CA’s. As per the Supreme Court it does not carry on “business” and is therefore not entitled to initial depreciation on such building under section 32(1)(iv)of the Income-tax Act, 1961.

Supreme courts notes and held that the Legislature intended to have different scope for “business” and “profession” in section 32(1) of the Income-tax act, 1961 for consideration of normal depreciation. From the scheme of the section it is discernible that the various clauses operate on further specific conditions laid down in each specific clause. In clause (iv) the Legislature has used the word “business” only. This means that the Legislature was conscious of the fact that business and profession are different and separate and they cannot be used interchangeably.

Under clause (iv) the Legislature intended to restrict the benefit to the assessee carrying on business only and not to one carrying on a profession.

The court further held that wherever the Legislature intended that the benefit of a particular provision should be for both business and profession, it has used the words “business or profession” and wherever it intended to restrict the benefit to either business or profession the Legislature has used the word either “business” or “profession”, meaning thereby that it intended to extend the benefit to either “business” or ‘profession”, i.e., the one would not include the other.

Thus while affirming the Decision of the Gujarat High Court in G.K. Choksi and Co. v. CIT 2001 (8) TMI 103 - GUJARAT High Court held, that the appellant, a firm of chartered accountants, was not entitled to claim initial depreciation for the assessment year 1984-85 under section 32(1) (iv) in relation to a building constructed by it for the purpose of residence of its low paid employees, as the allowance was not available to professionals and was available only to an assessee carrying on a business.

Part D of chapter IV consists of sections 28 to 43 of the Act which deals with “Profits and gains of business or profession”. Though the phrase has been used in certain sections as “business or profession”, nowhere has the phrase been used as “business and profession”,. In fact, wherever the Legislature intended that the benefit of a particular provision should be for both business or profession, it has used the words “business or profession” and wherever it intended to restrict the benefit to either business or profession, then the Legislature has used the word either “business” or “profession”, meaning thereby that it intended to extend the benefit to either “business” or “profession”, i.e., the one would not include the other.

Prohibition on number of members in unregistered Associations:

As per authors reading he found that under the Indian Partnership Act, there seem no restrictions on the number of partners a firm can have. However we find restrictions on number of persons in any associations to be legal in the provisions of S. 11 of the Companies act, 1956. In this regard relevant provisions are reproduced below:

 From the Companies Act, 1956:

Section 11.

PROHIBITION OF ASSOCIATIONS AND PARTNERSHIPS EXCEEDING CERTAIN NUMBER.—

(1) No company, association or partnership consisting of more than ten persons shall be formed for the purpose of carrying on the business of banking, unless it is registered as a company under this Act, or is formed in pursuance of some other Indian law.

(2) No company, association or partnership consisting of more than twenty persons shall be

formed for the purpose of carrying on any other business that has for its object the acquisition of gain by the company, association or partnership, or by the individual members thereof, unless it is registered as a company under this Act, or is formed in pursuance of some other Indian law.

(3) This section shall not apply to a joint family as such carrying on a business; and where a

business is carried on by two or more joint families, in computing the number of persons for the purposes of sub-sections (1) and (2), minor members of such families shall be excluded.

(4) Every member of a company, association or partnership carrying on business in contravention

of this section shall be personally liable for all liabilities incurred in such business.

(5) Every person who is a member of a company, association or partnership formed in contravension of this section shall be punishable with fine which may extend to ten thousand rupees.

Restriction is in relation to business and not profession:

We find that the restriction is on number of members of associations which are engaged in business only. This also become evident when we find that in case of banking business maximum number can be 10 and in case of other business maximum number can be 20. If the number of members is higher than the Association must be registered under the companies act.

Therefore the restriction of 20 partners is not applicable in case of a partnership firm of CA. However, it seems that this plea was not raised by Deloittee.

Similarly in the Companies Act 2013 also we find restriction vide provision of Section 464.

Companies Bill 2012 / Companies act 2013

464. (1) No association or partnership consisting of more than such number of persons as may be prescribed shall be formed for the purpose of carrying on any business that has for its object the acquisition of gain by the association or partnership or by the individual members thereof, unless it is registered as a company under this Act or is formed under any other law for the time being in force:

Provided that the number of persons which may be prescribed under this sub-section shall not exceed one hundred.

(2) Nothing in sub-section (1) shall apply to—

(a) a Hindu undivided family carrying on any business; or

(b) an association or partnership, if it is formed by professionals who are governed by special Acts.

(3) Every member of an association or partnership carrying on business in contravention of sub-section (1) shall be punishable with fine which may extend to one lakh rupees and shall also be personally liable for all liabilities incurred in such business.

In new provisions also we find restriction in relation to association carrying business and not profession. Furthermore, in case of associations of professionals the restriction is not applicable if such professionals are governed by special Acts. The firm of CA are governed by the provisions of the ICAI Act and Regulations. Therefore, in view of new provisions a firm of CA shall not be subject to restrictions on number of partners as per the companies Act 2013.

From Partnership Act, 1932

Section2

DEFINITIONS. In the Act, unless there is anything repugnant in the subject or context,

(b) "business" includes every trade, occupation and profession;

Section 4

DEFINITION OF "PARTNERSHIP", "PARTNER", "FIRM" AND "FIRM-NAME". "Partnership" is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.

Persons who have entered into partnership with one another are called individually, "partners" and collectively "a firm", and the name under which their business is carried on is called the "firm-name".

Number of partners as per Partnership act:

Since partnership is ‘agreement’ there must be minimum two partners. The Partnership Act does not put any restrictions on maximum number of partners. However, section 11 of Companies Act prohibits partnership consisting of more than 20 members, (10 in case of Banking Business) unless it is registered as a company or formed in pursuance of some other law.

In partnership Act the terms business includes profession. However, as stated earlier there is no restriction on number of partners in the Partnership Act. The restrictions provided in the companies act, 1956 are in relation to business and does not apply to profession. There is no definition of business in Partnership Act, and in ITA we find that there is marked difference between business and profession. And what is applicable to business, may not be applicable to profession, it depends to language used in particular provision. This is well settled by judgment of Supreme Court cited earlier.

Therefore, on conjoint reading of S.11 of Companies act and provisions of ITA about business and profession, it can be said that S.11 of the Companies Act 1956 is not applicable to professionals, Particularly so when profession is regulated by other enactment. This position has further been clarified by the provisions of the Companies act, 2013 as discussed earlier.

Learning from the case:

While making any arrangement, one must consider all related aspects as per law, and also as per common practices. There must be exercise to explore other possible ways and means. What view can be taken by concerned authorities must be considered? Attempt must be made to avoid controversy.

Suppose in this case ultimately it is held by courts that the firm was an illegal association in terms of S.11 of the Companies Act, 1956 then what will be consequences – whether the illegal association will be entitled for registration under ICAI Act and Regulations? Whether professional work (particularly audits and attestations can be considered as illegal?

We find from the list of partners that some of them are factually employees and share miniscule percentage of profit for example 0.0005% in case of one of partner. Such partners could continue as employee. For meeting requirement of capacity to undertake audits, another partnership firms could be formed. The parent firm could be provided returns by way of sharing fees in some assignments where the partners of parent firm had active role. Thus many ways could be found.