2020 (12) TMI 103 - AT - Income Tax

Characterization of income - consideration received by the partner of a firm upon retirement from the firm - retirement benefit - capital gain tax - HELD THAT - As compensation received by the assessee upon retirement from the partnership firm as his share in the assets of the partnership firm is not liable to tax as there is no transfer of assets involved. In the case of Addl. CIT vs. Mohanbhai Pamabhai 1987 (2) TMI 59 - SC ORDER - Court has affirmed the decision of the Hon ble Gujarat High Court 1971 (9) TMI 56 - GUJARAT HIGH COURT as held that any money received by the partner upon retirement from the partnership firm as his share in the assets of the partnership concern is not a consideration for transfer of his interest in the partnership to the continuing partners and there is no transfer within the meaning of section 2(47) of the Act. Hon ble Supreme Court in the case of CIT v. Tribhuvandas G. Patel 1977 (9) TMI 13 - BOMBAY HIGH COURT has held that any amount paid to the partner upon his retirement towards his share in assets is not a transfer within the meaning of section 47(ii) of the Act and not liable to capital gain - Even we find merit in the alternative plea taken by the assessee that if the computational provision of capital gain as provided under section 48 of the Act breaks down then the charging provision as provided under section 45 of the Act would also fail as held in the case of CIT vs. B.C. Srinivasa Setty 1981 (2) TMI 1 - SUPREME COURT - Decided in favour of assessee. Disallowance of finance charges - assessee submitted before the AO that the funds were borrowed during the preceding previous year for the purpose of business of the assessee which included hotel consultancy and trademark etc. - HELD THAT - As assessee has not utilised the borrowed money for the purpose of his business. The Ld. CIT(A) has given a finding of fact that share of profit was assessed to tax on the income under the head Income from other sources which comprised of interest income from loans and deposits. We are in agreement with the conclusion drawn by the Ld. CIT(A) as the assessee has failed to establish that these expenses were incurred for the purpose of business of the assessee. Accordingly, we are inclined to uphold the order of Ld. CIT(A) on this issue by dismissing the ground raised by the assessee. Disallowance u/s 14A read with rule 8D - HELD THAT - Assessee has incurred a total expenditure of ₹ 10,83,890/- which were incurred for the purpose of business of the assessee and none was having any connection to the exempt income ₹ 10,50,970/- -Thus the remaining expenditure out of the total expenditure was ₹ 32,920/- which can be only attributed to the exempt income. In our opinion, the disallowance can not exceed the actual expenditure incurred by the assessee. Partly allow the ground by directing the AO to restrict the disallowance accordingly.

Issues Involved:
1. Nature of consideration received by the assessee upon retirement from the partnership firm.
2. Disallowance of finance charges under Section 36(1)(iii) of the Income Tax Act.
3. Disallowance under Section 14A read with Rule 8D of the Income Tax Act.

Issue 1: Nature of Consideration Received Upon Retirement
The primary issue was whether the consideration received by the assessee upon retirement from a partnership firm should be treated as a retirement benefit or capital gains. The assessee retired from the partnership firm, receiving ?48.15 crore as full and final settlement of his account. The Assessing Officer (AO) treated this amount as taxable under Section 45(1) of the Act, arguing it was a long-term capital gain from the transfer of rights in the partnership properties. The AO's conclusion was based on the premise that the amount received was for the transfer of capital assets.

The Commissioner of Income Tax (Appeals) [CIT(A)] disagreed with the AO, holding that the amount received upon retirement was a retirement benefit and not subject to capital gains tax. The CIT(A) emphasized that the land in question was not owned by the assessee but by other partners who had already paid taxes on their shares. The CIT(A) also noted that the partnership firm continued to exist and the land remained with the firm, negating the AO's assertion of a capital asset transfer.

The Income Tax Appellate Tribunal (ITAT) upheld the CIT(A)'s decision, citing several precedents, including the Supreme Court's rulings in Addl. CIT v. Mohanbhai Pamabhai and CIT v. Lingamallu Raghu Kumar, which established that amounts received by a partner upon retirement do not constitute a transfer of interest in partnership assets and are not taxable as capital gains.

Issue 2: Disallowance of Finance Charges
The AO disallowed finance charges of ?2,74,462 claimed by the assessee under Section 36(1)(iii) of the Act, arguing that the borrowed funds were not used for business purposes. The CIT(A) upheld this disallowance, noting that the assessee had not utilized the borrowed funds for earning income and had accepted similar disallowances in earlier years.

The ITAT agreed with the CIT(A), finding that the assessee failed to establish that the borrowed funds were used for business purposes. Consequently, the disallowance of finance charges was upheld.

Issue 3: Disallowance Under Section 14A Read with Rule 8D
The AO disallowed ?3,59,793 under Section 14A read with Rule 8D, related to expenses incurred to earn exempt income. The CIT(A) upheld this disallowance, asserting that even if no expenditure was incurred to earn exempt income, a disallowance must be made under Section 14A read with Rule 8D2(iii).

The ITAT partially allowed the assessee's appeal on this issue. It noted that the total expenditure incurred by the assessee was ?10,83,890, of which ?10,50,970 was related to business expenses and not linked to exempt income. The ITAT directed the AO to restrict the disallowance to ?32,920, the remaining expenditure potentially related to exempt income, and delete the balance disallowance of ?3,26,873.

Judgment Summary:
The ITAT upheld the CIT(A)'s decision that the consideration received by the assessee upon retirement from the partnership firm was not taxable as capital gains. It also upheld the disallowance of finance charges under Section 36(1)(iii). However, the ITAT partially allowed the assessee's appeal regarding the disallowance under Section 14A read with Rule 8D, directing the AO to restrict the disallowance to ?32,920 and delete the balance of ?3,26,873.

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