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TMI Blog2014 (3) TMI 219X X X X Extracts X X X X X X X X Extracts X X X X ..... hat it is entitled to claim exemption under sub-section (2A) of Section 10 of the Act on its share of profit as partner of the firm income inclusive of the income, which is exempted from tax under sub-section (34) of Sections 10 and sub-section (35) of Section 10 of the Act. In substance, a declaration is sought to the effect that the total income referred in sub-section (2A) of Section 10 of the Act does not include income of the partnership firm which is exempted from tax. Having regard to the aforesaid prayers, the petitioner has filed this writ petition under Articles 226 and 227 of the Constitution. FACTS 2. The facts in brief are that the petitioner is a private limited company and the petitioner-company is a partner in the partnership firm of M/s.Prazim Traders, entitled to a share of 30% in the profit of the firm. Petitioner filed its Return of Income for the Assessment Year 2010-11 declaring a loss of Rs.87,293/-. The assessment was selected for scrutiny under sub-section (2) of Section 143 of the Act. The petitioner furnished details as called for by the Assessing Officer and by its letter dated 7/2/2013 stating that sub-section (2A) of Section 10 was inserted to the Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the share of a partner in a firm has to be computed by dividing the taxable profits of the firm in the same proportion as the profit sharing ratio mentioned in the partnership firm. According to the Revenue, the income of the partner is exempted from tax only to the extent that the same is subjected to tax in the hands of the partnership firm. But the exempted income in the hands of the firm is not exempted from tax in the hands of the partner. It is contended that the challenge made to the constitutional validity of the explanation to sub-section (2A) of Section 10 of the Act is misplaced. The language of the section speaks of the share in the total income and therefore, the exemption has been accorded to the extent of the share in the total income of the firm as against the share claimed in the book profits. That there is no discrimination or violation of Article 14 of the Constitution. That the 1993 amendment seeks to recognize a partner as a distinct entity from the firm so as to provide a benefit of exemption to the extent of the income that falls within the ambit of the term total income in the hands of the firm. Defending the Assessment Order passed by the fourth responde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions 115-O, 115-R and sub-section (38) of Section 10 of the Act. That the aforesaid provisions provide for relief in the hands of the recipient i.e., the partnership firm in the instant case. But when that amount is transferred to the hands of the partner such as the petitioner herein, it is a share in the profit which is taxable. The partnership firm has not been taxed on the aforesaid sources of income on the principle that the company paying dividend or company dealing with units of mutual fund would have paid taxes or in the case of long term capital gains, the security transaction tax would have been paid. But when that income is distributed to the partners of the firm, the exemption cannot be claimed by the partner. Contending that the assessments are in order and that there is no discrimination as against the petitioner, which has received income as a partner in a firm vis-à-vis an individual who would have received similar income namely, dividend income, income from mutual funds and profits of share transfer, the fourth respondent has sought for disposal of the writ petition. 6. Rejoinder to the statement of objections has been filed by the petitioner by reiterati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 10 of the Act would now have to be interpreted, by referring to the expression "total income" appearing in sub-section (2A) of Section 10 of the Act and the definition of total income in sub-section (45) of Section 2 of the Act. On the aforesaid premise, the petitioner sought interpretation of sub-section (2A) of Section 10 of the Act, particularly, the explanation thereto and has also sought for striking down the explanation. 9. Countering the aforesaid arguments, learned Senior Counsel for the respondents with reference to the statement of objections, contended that there is no ambiguity in sub-section (2A) of Section 10 or the Explanation thereto and that the challenge made to the Explanation in this writ petition is wholly unwarranted. That the Explanation only clarifies what is stated in subsection (2A) of Section 10 of the Act. That the share of a partner in a firm has to be computed by dividing the taxable profits of the firm in the same proportion as the profit sharing ratio mentioned in the partnership deed. The income of the partner is exempted from tax only to the extent that the same is subjected to tax in the hands of the partnership firm but the income exempted in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f share profit which were deducted in the hands of the firm. In substance, income was taxed at two stages. One in the hands of the firm at a specified rate and the second, after its allocation in the hands of the partners of the firm. Therefore, the income received by the partnership firm was subject to tax in the hands of the firm and subsequently in the hands of the partner on its allocation. But in case of interest, salary, commission or other remuneration paid to the partners of the firm, the same were allowed as deductions in the hands of the firm. But in the hands of the partners it suffered single tax. 12. In the "Budget Speech of Minister of Finance for 1992-93" held on 29-2-1992, reference has been made to Chelliah Committee Report, which stressed that double taxation of the partnership firms as well as the partners should be avoided. It was stated that the partners would not be taxed on their share in the income of the firm though they will be liable to pay tax on salary and interest income derived from the firm. Salary and interest payments made to the partners by the firm would be treated as deduction in the income of the firm. The object was to have simplification fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... planation to sub-section (2A) of Section 10 of the Act. Partnership Firm and status of partners in a Firm: 14. Partnership is a relationship resulting from a contract expressed or implied, the partners commercially and legally or collectively referred to as an entity, distinct from its members and with independent rights and obligations. Consequently, where money is due to or from a partner he will be normally shown as a creditor or debtor of the firm and not as a creditor or debtor of his copartner. But legally speaking, the firm is generally not recognized as an entity distinct from the partners comprising it. Also central to an understanding of the law of partnership is the dual capacity in which a partner acts, i.e., both as a principal and an agent. (a) In Malbar Fisheries Co. v. CIT [(1979) 120 ITR 49], the Hon'ble Supreme Court discussed the nature and character of a partnership under the Indian Law and held that a partnership firm under the Indian Partnership Act, 1932, defined in sub-section (23) of Section 2 of the Act, is not a distinct legal entity apart from the partners constituting it and equally, in law the firm as such has no separate rights of its own in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntity, not a person. In income-tax law a firm is a unit of assessment, by special provisions, but is not a full person which leads to the next step that since a contract of employment requires two distinct persons, viz., the employer and the employee, there cannot be a contract of service, in strict law, between a firm and one of its partners. So that any agreement for remuneration of a partner for taking part in the conduct of the business must be regarded as portion of the profits being made over as a reward for the human capital brought in. Section 13 of the Partnership Act brings into focus this basis of partnership business. The legal ideology expressed itself in the Income-tax Act in section 10(4)(b) and section 16(1)(b). A firm, partner and partnership according to section 2(6B) of the Act, bear the same sense as in the Partnership Act". Referring to Addanki Narayanappa v. Bhaskara Krishnappa [AIR 1966 SC 1300], it was held that a partnership firm as only a collective of separate persons and not a legal person in itself, leads to the further conclusion that the salary stipulated to be paid to a partner from the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or business carried on by him. Thus, the income tax law in U.K. also recognizes that partnership is a relationship which subsists between persons carrying on business in common with a view of profit. [Source: Lindley on Banks on Partnership-7th Edition.] Legal Frame Work: 16. Before considering the respective contentions of the parties, it would be useful to refer to the following relevant provisions of the Act: Definitions: Section 2:- In this Act, unless the context otherwise requires,- x x x xx x x (23)(i) "firm" shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include a limited liability partnership as defined in the Limited Liability Partnership Act, 2008 (6 if 2009); (ii) "partner" shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include:- (a) any person who, being a minor, has been admitted to the benefits of partnership; and (b) a partner of a limited liability partnership as defined in the Limited Liability Partnership A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sident includes all income from whatever source derived which- (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year. Explanation 1.-Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India. Explanation 2.- For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India. xxxxxxxxx Chapter III Incomes not included in total income: Section 10:- In computing the total income of a previous year of any person, any income falling within any of the following clause shall not be included- xxxxxxxxx Section 10 (2A):- in the case of a person being a partner of a firm which is separately assessed as such, hi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nation- For the purposes of this clause, "equity oriented fund" means a fund- (i) where the investible funds are invested by way of equity shares in domestic companies to the extent of more than sixty-five per cent of the total proceeds of such fund; and (ii) which has been set up under a scheme of a Mutual Fund specified under clause (23D) Provided that the percentage of equity shareholding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures. xxxxxxxxx Section 14:- Save as otherwise provided by this Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following heads of income:- A. Salaries B. Interest on securities C. Income from house property D. Profits and gains of business or profession E. Capital gains F. Income from other sources xxxxxxxxx Section 28:- The following income shall be chargeable to income-tax under the head "Profits and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d avoid it, the rule is that the Court is entitled to look at the results of adopting each of the alternatives respectively, in its quest for the true intention of the Parliament. But when there is no alternative, the Court is bound to construe the words in their natural sense whatever the consequences; the danger of adopting any other course would make that Court into legislators instead of interpreters. 20. The second method of judicial approach to the construction of a statute namely, Golden Rule, states that all statutes must be construed in their grammatical and ordinary sense of the words, unless that would lead to some absurdity or inconsistency with the rest of the instrument, in which case the grammatical and ordinary sense of the words may be modified so as to avoid that absurdity and inconsistency, but no further. This Golden Rule is a corollary to the literal Rule. 21. When, to a judicial mind, words are not plain, then the object and scope of the Act has to be considered. This is popularly known as the Mischief Rule evolved in Heydon's case. Four things have to be considered under this Rule as stated in Heydon's case:- &nb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d booklore. This should be the approach in the instant case. (a) In K.P. Varghese v. Income-Tax Officer, Ernakulam, and another [1981 (131) ITR 597], it has been held that statutory provisions must be so construed, if possible, that absurdity and mischief may be avoided. Where the plain literal interpretation of a statutory provision produces a manifestly absurd and unjust result which could never have been intended by the legislature, the Court may modify the language used by the legislature or even do some violence to it, so as to achieve the obvious intention of the legislature and produce a rational construction. Speeches made by the members of the legislature on the floor of the House when the Bill is being debated are inadmissible for the purpose of interpreting the statutory provision but the speech made by the mover of the Bill explaining the reason for its introduction can certainly be referred to for the purpose of ascertaining the mischief sought to be remedied by the legislation and the object and purpose for which the legislation is enacted. This, according to the Hon'ble Supreme Court, is in accord with the recent trend in juristic thought ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssion "total income" in Section 2(45) has to be examined in the context of the expression "total income" in Chapter III. In Chapter III, incomes which do not form part of total income are enumerated. But in sub-section (45) of Section 2, ' total income' means, the total amount of income referred to in Section 5. Section 5 deals with the scope of total income. Total income has to be computed in the manner laid down in the Act. Chapter IV onwards deals with computation of total income commencing with Section 14. Therefore, Chapter III pertains to such of those incomes, which are outside the scope of computation of total income. Thus, while computing the total income in the context of sub-section (45) of Section 2 such of those incomes stated in Chapter III have to be excluded. In other words, Chapter III pertains to such of those incomes, which are exempt from computation of total income as defined in sub-section (45) of Section 2 of the Act. All these expressions have already been considered in several decisions of this Court as well as by the Hon'ble Supreme Court. (a) In Commissioner of Income-Tax v. Yokogawa India Ltd. [(2012) 341 ITR 385 (Kar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apply to Section 10 of the Act and relief under Section 10 has to be given before computation of ' total income' in Chapter IV. The exemption has to be first considered and then, the process of computation of profits and gains of business or profession would commence. Sub-section (2A) of Section 10 was inserted by the Finance Act of 1992 and 1993, the Parliament was conscious of placing it in Chapter-III of the Act, which deals with "incomes which do not form part of total income". Therefore, intention of the Parliament was to regard it as an exemption and not a deduction. This reasoning also applies to explanation to sub-section (2A) of Section 10 of the Act. Further, Chapter-VII specifically deals with incomes which form part of the total income on which no income-tax is payable. These are incomes exempted from charge, but included in the total income of the assessee. It was also held that though Section 10A used the word 'deduction', in substance, it was an exemption provision. The implication being that, an exemption is that particular income exempt from tax which does not e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat income is not "includable in total income". This Court further stated that the expression ' not includable' means not capable of being included. It cannot refer to an amount which already formed part of the total income. It refers to the classes of income, which Chapter III directs, ' shall not be included' in the total income of the assessee'. Thus, Incomes which are enumerated in Chapter III of the Act, are incomes which are exempt from tax. Section 10 groups in one place various incomes which are exempt from tax. The incomes enumerated in Section 10 are not only excluded from the taxable income of the assessee but also in total income of a person. The exemption embodied in Section 10 can be divided into two categories, namely, exemption to which certain classes of income from their very nature are entitled and the second category concerns exemption which the character of the assessee entitles him to claim. Giving examples of this, the Court held that in the first category is agricultural income whereas in the second category of exempted income is the income of local authorities and diplomatic officers. Also, there i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s that, the expression "total income" as defined in sub-section (25) of Section 2 of the Act is distinct from the expression total income used in Section 10 of the Act. Sub-section (45) of Section 2 defines total income in the context of Section 5 and as is computed in the manner laid down in the Act. Once the total income is determined, the tax would have to be paid in accordance with the rate envisaged. But what Section 10 states is that certain incomes do not form part of total income. In fact, the heading of Chapter-III itself states "incomes which do not form part of total income". Thus, the concept of total income has to be interpreted as income which is not includable for the purpose of computation of tax. 27. Keeping in mind the rules of interpretation elaborated above while considering sub-section (2A) of Section 10, along with the decisions discussed above, what surfaces is the fact that the Act intended that certain incomes cannot be included in the gross total income of a person while computing the tax payable thereunder. 28. A perusal of Section 10 of the Income-tax Act would make it clear that the Parliament intended that certain incomes should not be included in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome of the firm would not mean the share of the partner in the taxable income of the firm. The share of the partner in the profits of the firm which is after taxation of the firm, would also include that portion of the income on which the firm would not have paid any tax on account of the firm also having the benefit of certain provisions of Chapter-III but which would nevertheless be part of the profits of the firm. The provision and the explanation under consideration can be better understood if they are related to the facts of the present case. 29. Annexure "E", is the return of income filed by the partnership firm M/s.Prazim Traders. On a perusal of the same, it is noted that income received by way of dividend, income received from mutual funds and profits earned from sale of long term capital assets are excluded from the computation of income of the firm. This is because, while applying Chapter-III to the computation of the income of partnership firm, the firm has the benefit of exemption of income earned by way of dividends referred to Section 115-O, under sub-section (34) of Section 10 of the Act; income arising from transfer of long-term capital asset, being an eligible eq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterpretation. The expression total income of a firm in the explanation would not mean taxable income of the firm but gross total income of a firm in which certain incomes would not be assessable to tax or exempted income. But it would nevertheless, form part of the profits of the firm. Therefore, total income of the firm cannot be equated with taxable income of the firm, as contended by the respondents, but, gross total receipts of the firm. 31. The reason as to why the partnership firm would not have paid any tax on the income received by way of dividends or from mutual funds or from sale of equity shares is because the company paying the dividends or income derived from mutual funds or company paying the amounts would have paid the tax on these incomes and the balance amounts are received by the partnership firm. Similarly, when the shares are transferred, tax is paid under the Security Transactions Act [long term capital assets] and the partnership firm in question would not have to pay tax on that amount once again. Thus, when the partnership firm itself would not pay any tax on the aforesaid three sources of income and when that income as profits, is divided between the part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... à-vis, the profits of the firm, which is distributed in the hands of the partners. It does not mean that income which is taxed in the hands of the firm is taxable in the hands of the partners and on the same principle, when the income is not taxed in the hands of the firm, it becomes taxable in the hands of the partner. The Assessing Officer is also not right in holding that the incomes which are excluded from the total income of the firm by operation of various clauses of Section 10 and which form part of the share of profits of the firm would have to be taxed in the hands of the partners, as only income which is taxed in the hands of the firm is exempted from tax in the hands of the partner. The Assessing Officer has focused his attention on income that is subjected to tax in the hands of the firm rather than income which is excludable from total income in the hands of the partner but which is a share in the profits of the firm. The Assessing Officer has given a literal interpretation to the explanation to sub-section (2A) of Section 10 of the Act, which is contrary to the object of the amendment made to Section 10 of the Act. However, having regard to the principles of st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ized as an entity distinct from the partners comprising it. 36. The analogy of a partner to partnership firm is found in a coparcener in relation to Hindu undivided family. Hindu undivided family is separately assessed to tax under the Act. Any sum received by a coparcener by an individual member of a Hindu undivided family where the income is paid out of the income of the family is not to be taxed once again in the hands of the individual member, otherwise, it would amount to double taxation. 37. Therefore, the explanation would not call for any striking down in the hands of this Court. The explanation has to be interpreted in light of the aforesaid discussion. It cannot be given a literal interpretation, so as to defeat the object of the amendment made to the Act. The object of the amendment is to make it clear that the distribution of profits and gains of a firm in the hands of the individual partners shall not be considered to be income of the partners and therefore, not includable while computing the total income of the partner under the Act. Such interpretation is also in line with the decisions of this Court as well as Delhi High Court and the Hon'ble Supreme Court. 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s.49,09,73,817, which has to be exempted under sub-section (2A) of Section 10 of the Act. The aforesaid calculation has been submitted by the Revenue in its written submissions as approximate figures. 40. In the result, the appeal is allowed in part in the following terms :- (1) The explanation to sub-section (2A) of Section 10 does not require any striking down as sought by the petitioner. That section has been interpreted in this order having regard to the object of the amendment and the principles of Partnership Law. (2) The Assessment Order dated 28/03/2013 for the year 2010-11 (Annexure "A") and the Notice of Demand, issued under Section 156 of the Act by fourth respondent, dated 28/03/2013 (Annexure "B"), are quashed. (3) The petitioner is entitled to claim exemption under sub-section (2A) of Section 10 of the Act, on the share of profit of the firm, inclusive of the income, which is exempted under sub-sections (34), (35) and (38) of ..... X X X X Extracts X X X X X X X X Extracts X X X X
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