2013 (7) TMI 577 - HC - Income Tax

Remuneration to partners - Deduction u/s 40(b) - Whether Tribunal was justified in taking view that whole income embedded in P & L account of assessee is to be taken into consideration for allowing deduction of remuneration paid to partners under section 40(b) without excluding interest income credited to P & L account even if it is not business income - Held that - From Section 40, it can be seen that where an assessee is a partnership firm, any payment of salary, bonus, commission or remuneration to its partners under certain circumstances, if it exceeds the limits set out in Clause B, deduction to the extent of excess cannot be claimed - Assessee is in the business of purchasing raw cotton and ginning the same. It is a seasonal business. The interest income was generated out of spare funds invested in the fixed deposit. Such income was declared as part of the business income and that is how even the Assessing Officer had accepted the same - Decided against Revenue.

Summary

Issues:
Ceiling of deduction on remuneration for a partnership firm under Section 40 of the Income Tax Act, 1961.

Analysis:
The judgment by the Gujarat High Court involved an appeal by the revenue against the Income Tax Appellate Tribunal's decision regarding the deduction of remuneration paid to partners by a partnership firm under Section 40(b) of the Income Tax Act, 1961. The main issue was whether the interest income credited to the Profit & Loss (P & L) account of the firm should be considered while determining the ceiling of deduction on remuneration. The respondent-assessee, a partnership firm engaged in the cotton business, had earned interest on fixed deposits, which the Assessing Officer included in the net profit. The Tribunal reversed the decision of the revenue authorities and allowed the assessee's appeal, stating that the interest income should not be excluded for determining the deduction of remuneration paid to partners.

The relevant provision of Section 40 of the Act deals with amounts not deductible in computing income under the head "Profits and gains of business or profession." It specifies conditions for deduction of remuneration paid to partners, setting limits based on the book profit of the firm. The ceiling for remuneration is prescribed in two slabs: a fixed amount or a percentage of the book profit, whichever is more, and a percentage for the balance of the book profit. The key question was whether the interest income earned by the firm should be excluded while calculating the book profit for determining the partners' remuneration ceiling.

The Tribunal's decision was based on the premise that the profit in the profit and loss account should not be classified into different heads of income under Section 40 of the Act when ascertaining the ceiling on partners' remuneration. The interest income, therefore, could not be excluded for calculating the allowable deduction of remuneration paid to partners. The Court noted that the interest income was generated from spare funds invested in fixed deposits, declared as part of business income, and accepted as such by the Assessing Officer. Since the firm was engaged in a seasonal cotton business, the interest income was considered part of the business income, leading to the conclusion that the interest income should not be excluded for determining the remuneration deduction ceiling.

In conclusion, the High Court dismissed the tax appeal, emphasizing that the interest income earned by the firm should be included in the calculation of the partners' remuneration deduction ceiling under Section 40(b) of the Income Tax Act, 1961.