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TMI Blog2016 (2) TMI 170X X X X Extracts X X X X X X X X Extracts X X X X ..... apital to the tune of 12,66,679/- u/s 14A of the Act read with Rule 8D(2)(ii) of Income Tax Rules,1962.. We further hold that these allowance / deduction of expenditure of 12,66,679/- against the exempt income u/s 14A of the Act or in other disallowance u/s 14A of the Act, will not entitle the partner to claim relief in their individual return of income which shall be chargeable to tax as per the existing and applicable provisions of Section 28(v) of the Act read with Section 2(24)(ve) of the Act after including the afore-said interest income in the hands of the partners. Further, the AO has computed disallowance of 20,357/- under Section 14A of the Act read with Rule 8D(2)(i) of Income Tax Rules, 1962 being direct expenses incurred by the assessee firm having being incurred on STT paid of 18,633/- and PMS charges of 1,724/- paid to portfolio managers which is admitted to be paid by the assessee firm in relation to the earning of the exempt income, which disallowance we uphold . The AO has computed deemed expenses @0.5% of average investment under Section 14A of the Act read with Rule 8D(2)(iii) of Income Tax Rules, 1962 as per method vide formula laid down under Rule 8D(2)(iii) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... predecessor) for Assessment Year 2009- 10 had confirmed the similar disallowance in an order for Assessment Year 2009-10 without appreciating that (i) Appellant was in appeal against said disallowance before Hon'ble ITAT which appeal was pending. (ii) That every assessment year is an independent assessment & therefore the concerned authority has to consider the facts of that year and the case laws relied upon. 3. Without prejudice to the above The appellant submits that Learned Assessing Officer has erred in holding that interest payable to partners on their capital u/s. 40 (b) is an expenditure of the firm instead of holding same as an allowance claimed by the assessee & therefore and does not fall within the ambit of section 14-A. 4. The Appellants crave leave to add, amend alter and / or vary any of the grounds at the time or before the hearing of this appeal. 5. The Appellants therefore pray that disallowance of ₹ 15,36,264/- uls. 14 A made by the Learned Assessing Officer & confirmed by the Learned CIT (A) may please be deleted." 3. The brief facts of the case are that the assessee firm is a partnership firm engaged in the business of manufacturi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that interest paid to partners on capital is not an expenditure but forms part of appropriation account and thus as per principles of accountancy it goes below the line. In this case of partnership firm , profit(loss) is arrived at before paying interest and remuneration to partners which is considered as actual profit earned by a firm and it is only thereafter that the interest and/or profit is payable to partners. The assessee firm relied upon decision of the Ahmedabad Tribunal-Special Bench in the case of Sh. Vishnu Anant Mahajan v. ACIT in ITA No. 3002/Ahd./2009 dated 25-05-2012 to contend that depreciation was held to be statutory allowance and shall not be considered for disallowance u/s 14A of the Act as Section 14A of the Act deals with only expenditure incurred and not any statutory allowances and depreciation is a statutory allowance u/s 32 of the Act relying upon the decision of Hon'ble Supreme Court in the case of Nectar Beverages Private Limited v. DCIT (2009) 314 ITR 314(SC). 5. The AO rejected the contentions of the assessee firm and held that the basic objective of introduction of section 14A into the Act is to disallow the direct and indirect expenditure incurre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 962 for which adequate reasons has been given by the AO and Rule 8D of Income Tax Rules, 1962 is applicable from the assessment year 2008-09 and same has to be applied in the case of the assessee firm . The CIT(A) held that there is no change in the position during the year vis-à-vis the preceding assessment year and the facts relating to the disallowance remains the same which was confirmed by the CIT(A) vide orders dated 30.12.2013. 7.Aggrieved by the orders of the CIT(A) dated 30.12.2013, the assessee firm filed the appeal before the Tribunal. 8.The assessee firm reiterated its submissions as made before the authorities below which are not repeated for sake of brevity. The assessee firm also submitted that disallowance of the interest paid on partners capital is to be deleted as the same is not covered u/s. 14A of the Act as the issue is squarely covered by the decision of Mumbai Tribunal dated 11.03.2015 in assessee firm's own case in the immediately preceding assessment year i.e. 2009-10 in ITA No. 6870/Mum/2012. The assessee firm contended that disallowance was deleted by the Mumbai Tribunal to the extent of disallowance u/s 14A of the Act on account of interest paid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Act ?. Whether it is an 'expenditure' as is referred to in Section 14A of the Act incurred and attributable to in relation to earning of an exempt income?. Whether it falls within the definition of Section 36(1)(iii) of the Act being an expenditure or it falls u/s 40(b) of the Act being an statutory allowance claimed by the assessee and therefore does not fall within ambit of 'expenditure' as envisaged under Section 14A of the Act ? . The Mumbai Tribunal in ITA No 6870/Mum/2012 vide orders dated 11.03.2015 in assessee firm's own case, has held that the addition to the extent of disallowance u/s 14A of the Act on account of interest expenditure on capital contributed by the partner and which is not on borrowed funds but on the capital contributed by the partners of the assessee firm cannot be disallowed u/s 14A of the Act read with Rule 8D of Income Tax Rules, 1962 as there is a direct relation between share in the profit of the firm and the interest on capital of the partners and hence the interest cannot be treated as an expenditure to be attributable for earning the dividend income . The Tribunal vide its orders dated 11.03.2015 has deleted the addition to the extent of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h only the Supreme Court's Judgments are binding on all Courts within India. The Bombay High Court in the case of CIT v. Thane Electricity Supply Ltd. [1994] 206 ITR 727overruled the Judgment in the above case of Godavari Saraf(supra) holding that the decision of one High Court was not a binding precedent for another High Court or Lower Courts outside the jurisdiction. Under the above background , we are now proceeding to adjudicate the issue in this appeal which, in our considered view, majorily deals purely with a legal issue being question of law as detailed by us. The assessee firm has raised capital from the partners, on which interest of ₹ 1.39 crores was paid. The assessee firm has made investments in Mutual Funds to the tune of ₹ 4.75 crores , income of which would be exempt from tax. The AO by invoking Section 14A of the Act read with Rule 8D of Income Tax Rules, 1962 has disallowed the interest expenditure paid to the partners of ₹ 12,66,679/- incurred by the assessee firm in relation to earning of exempt income, which was sustained by the CIT(A) in the first apppeal. Now, the issue is before us for adjudication and the Mumbai Tribunal in assessee' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and interest paid to partners, was required to be disallowed and added back to the income of the partnership firm under the provision of section 40(b) of the Act of the preamended Act. The result was that any payment so made was, on the one hand, disallowed in the hands of partnership firm while, on the other hand, on allocation of the profits or losses in the hands of the partners, the amount so paid was added to the income of the respective partners and their shares in the registered firm were determined accordingly. The Finance Act, 1992 effected a material change in as much as the substituted section 184 of the Act permitted the payment of salary and commission to the partners subject to the condition that it was so authorised by the deed of partnership. The maximum percentage prescribed for payment of interest on the capital contributed by the partners or loan advanced by them to the firm has been prescribed at 18 per cent per annum (now reduced to 12 per cent per annum ) while salary, commission or any other remuneration payable to the partners has been limited to the specified percentage of book profit. The Finance Act, 1992 inserted a new clause (v) in section 28 of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Changes were effected by the Finance Act, 1956 whereby income-tax at a special low rate came to be assessed on registered firms and this came to be known as the registered firms' tax. The partners of such a firm were in addition liable to be taxed in their individual assessment in respect of their share in the firm's income. There was, thus, double taxation of the identical income, once in the hands of the registered firm and second time in the hands of the partners on allocation of the firm's income amongst them. This scheme of double taxation was criticized by the Law Commission in its 12th Report, 1958. The position under the 1961 Act was the same as existed after the 1956 amendment under the 1922 Act. Till 1969, rebate was permitted to a partner in respect of his share of the tax paid by the firm. From 1969 onwards, the provision for rebate was substituted by a method whereby the tax payable by the firm was straightway deducted from the total income of the firm before its apportionment amongst the partners. Further, the tax liability was dependent on the issue whether the firm was registered or not. In the case of a registered firm, the firm paid tax on its total income accord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mendment) Act, 1987, with suitable modifications to take care of the difficulties pointed out in the context of the 1987 scheme. The scheme contained in Direct Taxes Laws (Amendment) Act, 1987 sought to tax firms at the maximum marginal rate after allowing interest and remuneration to partners. Further there was a rigorous definition of "Whole time working partners" to whom alone remuneration was payable. The deduction for remuneration and interest allowable to partners and allowing remuneration to any partner or partners at the discretion of the firm, have been suitably restructured. 48.1 A firm will now onwards be taxed as a separate entity (sections 184 & 185). There will be no distinction between registered and unregistered firms, and clauses 39 and 48 of section 2 containing the definition of "registered firm" and "'unregistered firm" have been omitted. After allowing remuneration and interest to the partners, the balance income of the firms will be subject to maximum marginal rate of tax of income-tax, which will be 40% for assessment year 1993-94. The surcharge on income-tax will be at the rate of 12%, of the total tax, if the income exceeds ₹ 1,00,000. The earlier ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eration cannot be allowed to him for any period prior to the said date. However, as the financial year 1992-93 had already commenced, by the time the Bill received the Presidential assent, it would not have been possible for assessees to change the partnership deed with effect from 1-4-1992. Therefore, the Finance Act has provided that for the previous year 1992-93 interest or remuneration would be allowed if the partnership deed provides for such payment any time during the accounting period. Thus for the previous year 1992-93, relevant to assessment year 1993-94, the terms of the partnership deed may be amended to have retrospective operation. There is no restriction as to the number of times the terms of a partnership deed may be changed during a previous year in so far as payment of salary, bonus, commission or other remuneration to a working partner is concerned. It is also possible that a partner who is not a 'working partner' may become a 'working partner' at any point of time during a year (or vice versa). In such a situation also, the said terms of the deed may be suitably amended. 48.6 Of the aggregate payment to all partners by way of salary, bonus, commission or othe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , the firms are treated as a separate entity and the losses suffered by them would be allowed to be carried forward in their hand only. There would be cases where brought forward losses apportioned to a partner have not been set off in the hands of the partner prior to assessment year 1992-93. A provision has been made for dealing with brought forward losses pertaining to assessment years prior to assessment year 1993-94. In such cases, the carried forward losses of a partner will be allowed as a set off in the assessment income of the firm subject to the condition that the partner continued to remain a partner in the said firm (section 75). 48.10 Although, the distinction between a registered and unregistered firm has been removed, a partnership will be assessed as a firm only if- (i) the partnership is evidenced by an instrument; and (ii) the individual shares of the partners are specified in that instrument. A copy of the partnership instrument duly certified has to accompany the return of income for the relevant year for which assessment as a firm is first sought. Thereafter, assessment as a firm will continue to be made so long as the constitution of the firm remai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... locable profits to the firm. This argument of the assessee firm is misconceived and fallacious. The Hon'ble Apex Court in the case of Munjal Sales Corporation v. CIT (2008) 168 Taxman 43(SC) has elaborately discussed the provisions of Section 30 to 38 of the Act vis-à-vis Section 40(b) of the Act and has settled the controversy by holding that interest paid to partners is an expenditure whereby claim of deduction u/s 36(1)(iii) of Act is to be firstly established by the taxpayer, and then Section 40(b)(iv) of the Act is not a standalone section but is a corollary section to Section 36(1)(iii) of the Act , restricting the deduction as per provisions of Section 40(b)(iv) of the Act, as under: "9. The basic question which arises for determination is : whether section 40(b) of the 1961 Act is a stand-alone section or whether it operates as a limitation to the deduction under sections 30 to 38 of the 1961 Act? 10. On the above question of law, Mr. S. Ganesh, learned senior counsel appearing on behalf of assessee, contended that prior to 1-4-1993, section 40(b) referred to disallowances per se but after the Finance Act, 1992 the said section 40(b)( iv) allows deduction, subje ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stablish deductions under sections 30 to 38 and it has also to prove that it is not disentitled under section 40 of the 1961 Act, like any other assessee. 12. We quote herein below sections 36(1)(iii), 40(b ) as it existed before 1-4- 1993 and 40(b)( iv) after Finance Act, 1992 with effect from 1-4-1993 which read as follow : "36. Other deductions.-(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28- (i )and (ii)****** (iii)the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :- ****** Explanation.-Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause. 40. Amounts not deductible.-Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',- (a)****** (b)in the case of any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i) of the 1961 Act as argued on behalf of the assessee? Legal Position Explained 14. Before enactment of Finance Act, 1992, broadly speaking, payment of interest by the firm to any partner of the firm, constituted Business Disallowance per se. After Finance Act, 1992, section 40(b)( iv) of the 1961 Act places limitations on the deductions under sections 30 to 38. Prior to Finance Act, 1992, payment of interest to the partner was an item of Business Disallowance. However, after Finance Act, 1992, the said section 40(b) puts limitations on the deductions under sections 30 to 38 from which it follows that section 40 is not a stand-alone section. Section 40, before and after Finance Act, 1992, has remained the same in the sense that it begins with a non obstante clause. It starts with the words 'Notwithstanding anything to the contrary in sections 30 to 38' which shows that even if an expenditure or allowance comes within the purview of sections 30 to 38 of the 1961 Act, the assessee could lose the benefit of deduction if the case falls under section 40. In other words, every assessee including a firm has to establish, in the first instance, its right to claim deduction under one of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nder sections 30 to 38 is also requires to establish that it is not disentitled under section 40. It is in this respect that we have stated that the object of section 40 is to put limitation on the amount of deduction which the assessee is entitled to under sections 30 to 38. In our view, section 40 is a corollary to sections 30 to 38 and, therefore, section 40 is not a stand-alone section. ********* ********* 18. Before concluding, we may mention that the importance of the judgment is the clarification which we were required to give in the context of deductions under sections 30 to 38 to be read with the limitation prescribed under section 40. Since there was some confusion with regard to the status of section 40, particularly, after enactment of Finance Act, 1992, we have explained the law in the context of deductions under Chapter IV-D of the 1961 Act. We have accepted the submissions advanced by the learned Addl. Solicitor General in that regard. However, the assessee succeeds in this batch of civil appeals on the peculiar facts of this case. 19. Accordingly, the impugned judgments of the High Court are set aside and the civil appeals preferred by the assessee stand ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng with Shri Jaimin Gandhi appeared and filed a paper book containing 8 pages which, inter alia, include (1) submissions before CIT(A) - 1 to 4 pages, (2) Comparative tax working at page No. 5, (3) Balance-sheet & Profit & Loss A/c. at page Nos. 6 and 7 and (4) Alternative calculation of interest disallowance under section 14A at page No. 8. The first contention raised by the assessee is that no nexus is established. Therefore, following the decision of Hon'ble Gujarat High Court in the case of CIT v. Gujarat Power Corporation Ltd. [Tax Appeal No. 1587 of 2009, dated 28-3-2011] (unreported), the disallowance of ₹ 17,04,535 made under section 14A be deleted. As against this, the ld. D.R. pointed out that no interest-free funds were available to the assessee. Therefore, disallowance has rightly been made. It is pertinent to note that no interest-free funds were available. The investments were made from capital of the partners on which interest at the rate of 10.5 per cent per annum is paid. Therefore, this plea of the assessee's counsel is hereby rejected. 5.1 The second plea raised by the ld. Counsel of the assessee is that as per clause (v) of section 28 of the Inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t will amount to double taxation. 6. We have heard both the sides on various pleas but we are not satisfied. We decide each and every contention raised by the ld. Counsel of the assessee. The first contention raised by him has already been rejected by us in para No. 5 above. Regarding the second contention raised by him that any disallowance of interest under section 14A will amount to double disallowance, we would like to point out that this contention is also devoid of any merit. For the purpose of deciding this aspect, we first reproduce the provisions of sub-section (1) of section 14A, which is as under : "14A. (1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act." 6.1 As per the provisions contained in section 14A(1) as reproduced above, we find that the expenditure incurred for earning exempt income shall not be considered for computing total income under Chapter IV. It implies that such expenditures are to be allowed as deduction, while working out exempt income under Chapter II ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to section 28(v), it is seen that if there is any disallowance of interest in the hands of the firm due to clause (b) of section 40, income in the hands of the partner has to be adjusted to the extent of the amount not so allowed to be deducted in the hands of the firm. Hence, it is seen that the operation of the proviso to section 28(v) will come into play only if there is some disallowance in the hands of the firm under clause (b) of section 40 but in the present case, the disallowance is under section 14A and not under section 40(b) and therefore, the proviso to section 28(v) is not applicable and the partner of the assessee firm did not deserve any relief on this account. Moreover, before us is the assessee firm only and not the partners and hence, we do not give any direction on this aspect. 6.4 The ld. Counsel of the assessee also drew our attention to the provisions of sub-section (2A) of section 10 and its explanation and it has been contended that as per the provisions of this Explanation to section 10(2A), remuneration or interest, which is disallowed in the hands of the firm, will not suffer taxation in the hands of the partner. This contention of the ld. Counsel of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the firm will increase to that extent and it will be allowed to carry forward in the hands of the firm and therefore, payment of interest by the firm to its partners is not distribution of profits by the firm to the partners. We have also observed somewhere in above paragraphs that there is no disallowance as such of interest in the hands of the firm and only the manner of allowing deduction on account of interest or other expenses incurred for earning exempt income is specified in section 14A, as per which, deduction on account of expenses incurred for earning exempt income cannot be allowed for computing total income under Chapter IV and hence, impliedly, the same has to be deducted from the exempt income to be computed under Chapter III. This contention of ld. Counsel of the assessee is also rejected. 6.7 One more contention has been raised by him that section 14A talks of disallowing expenditure incurred by the assessee in relation to exempt income and interest paid to partners is not an expenditure at all and it is a special deduction allowed to the firm under section 40(b). This contention of the ld. Counsel of the assessee is also devoid of any merit because there is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... period, when dividend income was not exempt, interest expenditure incurred on borrowed funds used for investment in shares was held to be fully allowable expenses, even if, there was no actual receipt of dividend or insufficient/meagre amount of dividend income. The logic was that the entire expenditure has been incurred for earning taxable dividend income and hence, it is allowable, even if there is nil or small amount of dividend income. This aspect has been approved by various courts and hence, the same judgment supports this view also that even in case of 'nil' or small amount of dividend income, the entire interest expenditure incurred for making investment in shares is to be considered as expenditure incurred for earning exempt income and the same has to be disallowed under section 14A. Hence, this plea is also rejected. 6.9 In view of the above discussion, we are of the view that no interference is called for in the orders of the ld. CIT(A), as per which, he has confirmed the disallowance of interest of ₹ 17,04,535 which was made by the Assessing Officer under section 14A of the Income-tax Act. We are, therefore, inclined to uphold the order of the ld. CIT(A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct and its object is to put limitation on the amount of deduction which the assessee firm is otherwise entitled to under Section 36(1)(iii) of the Act (Reference- decision of Hon'ble Supreme Court in the case of Munjal Sales Corp.(supra)). Hence, the reliance of the assessee firm on the decision of Walfort Share and Stock Brokers Private Limited(supra) is devoid of merit and is rejected. b) CIT v. R M Chidambaram Pillai (1977)106 ITR 292(SC) - This decision has been rendered by Hon'ble Supreme Court under the Indian Income Tax Act,1922 read with Indian Income Tax Rules, 1922 for assessment years 1956-60 and 1960-61 , while the instant appeal is for assessment year 2010- 11 whereby the scheme of taxation of partnership firm has gone substantial and major change by the Finance Act,1992 . The Hon'ble Supreme Court in 106 ITR 292 held that : "First principles plus the bare text of the statute furnish the best guide light to understanding the message and meaning of the provisions of law. Thereafter, the sophisticated exercises in precedents and booklore. Here the first thing that we must grasp is that a firm is not a legal person even though it has some attributes of personality. Pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Incometax Act, as retaining the character of profits and not excludible from the tax net, whatever the reason behind it be. The procedure for computation of the total income of a partner, found in section 16(1)(b) also fits into this understanding of the law behind the law. Section 16 (relevant part) reads thus: "16. (1) In computing the total income of an assessee-…. (b) when the assessee is a partner of a firm, then, whether the firm has made a profit or a loss, his share (whether a net profit or a net loss) shall be taken to be any salary, interest, commission or other remuneration payable to him by the firm in respect of the previous year increased or decreased respectively by his share in the balance of the profit or loss of the firm after the deduction of any interest, salary, commission or other remuneration payable to any partner in respect of the previous year; Provided that if his share so computed is a loss, such loss may be set off or carried forward and set off in accordance with the provisions of section 24;……." The anatomy of the provision is obvious, even if the explanation or motivation for it may be more than one. It is i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as an 'expenditure' as envisaged u/s 14A of the Act for disallowance and on the same analogy interest paid on partner capital by the partnership firm cannot be considered as an expenditure u/s 14A of the Act is again misconceived as we have already observed that Hon'ble Apex Court in Munjal Sales corporation , 168 taxman 43 has already held that interest on capital paid to partner has to firstly satisfy the mandate of Section 36(1)(iii) of the Act while Section 40(b)(iv) of the Act is not a standalone section and is a corollary to Section 36(1)(iii) of the Act limiting the deduction. Thus, the contention of the assessee firm that interest paid to partner is a statutory allowance and cannot be considered as an 'expenditure' as envisaged u/s 14A of the Act for disallowance cannot be accepted and is rejected. e &f) Maxopp Investment Limited & Ors. V. CIT (2012) 247 CTR 162(Del.) & Kodak India Private Limited v. Addl. CIT (ITA No 7349/Mum/2012)- The contention of the assessee firm that the AO should have recorded his dis-satisfaction with the correctness of the claim of the expenditure made by the assessee or with the correctness of the claim of the assesssee firm that no expendit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion (supra) and we also fully agree with the decision of Ahmedabad Tribunal in the case of Shankar Chemical Works(supra) . Moreover, under the new scheme of taxation of partnership firm introduced by the Finance Act,1992, the interest paid to the partner on capital has to be claimed as deduction u/s 36(1)(iii) read with Section 40(b) of the Act, from the income of the firm and if after allowing such interest , if the loss results in the hands of the firm, it will be allowed to be carried forward by the firm , while the partner shall be charged to tax for the total interest paid by the firm despite the fact that the firm could not claim the entire deduction due to absence of profits and resultant loss is to be carried forward to be set off against income of the subsequent years . Thus, we hold that interest paid by the assessee firm to the partners on capital contribution is covered as an 'expenditure' as envisaged u/s 36(1)(iii) of the Act and the assessee firm has to firstly establish its claim of deduction of interest on capital by satisfying the provisions of Section 36(1)(iii) of the Act and then, Section 40(b) of the Act puts limitation on allowability of interest once it pass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n other words we uphold the disallowance of interest on partners capital to the tune of ₹ 12,66,679/- u/s 14A of the Act read with Rule 8D(2)(ii) of Income Tax Rules,1962.. We further hold that these allowance / deduction of expenditure of ₹ 12,66,679/- against the exempt income u/s 14A of the Act or in other disallowance u/s 14A of the Act, will not entitle the partner to claim relief in their individual return of income which shall be chargeable to tax as per the existing and applicable provisions of Section 28(v) of the Act read with Section 2(24)(ve) of the Act after including the afore-said interest income in the hands of the partners. Further, the AO has computed disallowance of ₹ 20,357/- under Section 14A of the Act read with Rule 8D(2)(i) of Income Tax Rules, 1962 being direct expenses incurred by the assessee firm having being incurred on STT paid of ₹ 18,633/- and PMS charges of ₹ 1,724/- paid to portfolio managers which is admitted to be paid by the assessee firm in relation to the earning of the exempt income, which disallowance we uphold . The AO has computed deemed expenses @0.5% of average investment under Section 14A of the Act read ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o tax is required to be deducted and the expenses on export commission and other related charges payable to a non-resident for services rendered outside India shall be allowed as deduction . The assessee firm submitted that CBDT has issued circular bearing no. 07/2009 dated 22.10.2009, whereby CBDT has withdrawn circular No. 23 dated 23.7.1969 as well as circular No. 786 dated 07.02.2000 . The said CBDT circular No. 7/2009 dated 22.10.2009 is applicable for the assessment year 2010-11 w.e.f. 22.10.2009 and not retrospectively and the instant assessment year is also 2010-11. The assessee firm relied upon the decision of Hyderabad Tribunal in the case of DCIT v. Divi's Laboratories Limited in appeal no 601 to 604/Hyd./2009 whereby it was held that commission paid to non-resident agent for services rendered outside India not being chargeable to tax in India could not be disallowed u/s 40(a)(ia) of the Act and Section 195 of the Act clearly speaks that unless the Income is liable to be taxed in India, there is no obligation to deduct tax at source and Section 9 of the Act does not provide scope for taxing such commission payment because the basic criteria provided in the section is ab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scussion with the customers, know their specific requirement, colors, designs and ensure your direct interaction with them. We further confirm that for all the above services rendered by us in your country we get from you commission @..... %. We confirm that we have neither any permanent establishment in India nor are assessed to tax in India." The AO observed that these foreign agents are doing the following activities on behalf of the assessee firm:- " (i) The agent helps the company to facilitate and secure the overseas orders and collect the payments from different overseas. (ii) He gets samples of products approved by the overseas buyers and book the new orders. (iii) He helps in the development of new customized products Apart from that he helps by providing market feedbacks, information samples etc.. (iv) He carries out liaison work on behalf of the assessee. (v) He coordinates with customers and follows up for payment if and when required. (v) He gives the information about the new developments in the markets, competition and their products. (vii) He facilitates the assessee's interaction with the customers during the visits to their respective ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of tax at source u/s 195 of the Act without obtaining clearance u/s. 195(2) of the Act. " Hence in the light of above discussions, the AO held that the services offered by the agents are covered under managerial services that are included in fee for technical services (defined in explanation 2 u/s 9(1)(vii) ) and since the assessee firm has not obtained the certificate u/s 195(2) of the Act, the payment made to foreign agent of ₹ 34,18,126/- was disallowed by the AO u/s 40(a)((i) of the Act , vide assessment orders dated 07-03-2013 passed u/s 143(3) of the Act. 15. Aggrieved by the assessment orders dated 07-03-2013 passed by the AO u/s 143(3) of the Act, the assessee firm filed the first appeal with the CIT(A) and submitted that the AO erred in terming the payment as management service charges while the payment were made to persons abroad purely for procuring the business at the rates and other terms of the assessee firm and they had no authority to either reduce the price or change any other term of the supply. The commission agents is helping in securing the overseas orders and help in collecting the payments from the customers, the commission is paid for procuring ord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8377; 34,18,126/- has been made to seven parties, out of which major payment of ₹ 25,44,625/- has been made to Shri Daulat Aswani a non-resident Indian, residing in Gambia, West Africa. Payment of commission to Aswani has been regularly made from financial year relevant to the assessment year 2006-07 onwards. In the assessment year 2009-10, payment of commission made was ₹ 34,95,099/-. Of the remaining six parties, from the details it was observed that the commission payment to five parties was found regularly made every year. There is only one party i.e. Tawfiq Ahmed Al Rasheed to whom payment of ₹ 90,127/- has been made for the first time. The CIT(A) observed that payment of commission was discussed in details in the appellate order for the assessment year 2009-10. The CIT(A) observed that the AO has given the findings which clearly shows that the agents did not render any managerial, technical or consultancy services including the provisions of services of technical or other personnel and they were made to facilitate and secure the overseas orders and to collect the payment from different overseas parties and to carry out liaison work, on behalf of the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rm also relied on the decisions of M/s. Indo Industries Ltd. v. ITO in ITA No. 183/Mum/2014, for the assessment year 2010-11 whereby the Tribunal allowed the claim of the taxpayer for deduction of commission paid to various non-residents foreign brokers for rendering services outside India in relation to export orders and recovery of sale proceeds, whereby the said foreign brokers did not have place of establishment in India . The assessee firm also contended that circular No. 07/2009 dated 22.10.2009 has been introduced prospectively and earlier circulars clearly stipulating no tax is to be deducted at source on payments of export commission to foreign brokers for services rendered outside India for sourcing export orders and for collecting payments which are withdrawn from 22.10.2009. The assessee firm submitted that these foreign agents did not have any PE in India and hence the disallowance cannot be made and assessee relied on the following decisions:- Sr.No. Particulars 1. Commissioner of Income Tax v. Faizan Shoes Pvt. Ltd. 364 ITR -155 (Madras High Court) 2. Commissioner of Income Tax v. Angelique International Ltd. 359 ITR - 9 (Delhi High Court) 3. Commissioner of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ices rendered by these foreign agents from India. In our considered view, these foreign agents have rendered services for sourcing export orders and for collecting payments for and on behalf of the assessee firm which is their business income not liable to tax in India . The other services such as sample approvals etc. are incidental to the main activity of sourcing of export orders by these foreign brokers for the assesssee firm . These services cannot be described as managerial, consultancy or technical services as contemplated under explanation 2 to Section 9(1)(vii) of the Act to come within deeming provisions of Section 9(1)(vii) of the Act, rather the foreign brokers have rendered services from abroad to the assessee firm for sourcing of export orders in favour of the assessee firm and collection of payments for the assessee firm. Under Section 9(1)(vii) of the Act , income is deemed to accrued or arise in India if fees payable for any technical services utilised in a business or profession in India or for earning any income from any source in India. Fees for technical services include managerial , technical or consultancy as stipulated in explanation 2 to Section 9(1)(vii) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Act. The initial direction that the tax should be deducted at source @ 20% recorded in the order dated 4th May, 2010, was modified/reduced to 10% vide order dated 8th November, 2010 after recording that deduction at a higher rate would not be applicable in the present case. 5. The Commissioner of Income Tax (Appeals), however, reversed the aforesaid finding holding that the commission payment in the present case was not in the nature of 'fee for technical service' and he distinguished the decision in the case of Wallace Pharmaceuticals P. Ltd. (supra). The said finding has been affirmed by the Tribunal in the impugned order. 6. In order to appreciate the controversy, we would first like to refer and interpret Sections 5(2), 9(1)(i) and 9(1)(vii) of the Act, though, the Assessing Officer in the present case had not invoked Section 9(1)(i) of the Act. The relevant provisions read as under:- '5. Scope of total income. - ** ** ** (2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which - (a) is received or is deemed to be received in India i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is received or deemed to be received in India in such year by or on behalf of such person; (b) accrues or arises in India; or (c) is deemed to accrue or arise in such year in India. Explanation 1 of the aforesaid section clarifies that income accruing or arising out of India shall not be deemed to be received in India by reason of the fact that it is taken into account in a balance sheet prepared in India. We are required to decide, whether the commission paid to non-resident would be income deemed to be earned in India. 8. Section 9, as is clear from the heading itself, does not deal with income which is received or accrued or has arisen in India but deals with income which does not fall under any of the aforesaid categories. Section 9 creates a deeming fiction of income which is not received in India or accrues or arises in India but is deemed to accrue or arise in India. While interpreting a deeming clause, the courts have to be cautious that they should not expand the scope beyond what is mandated and required by the deeming clause. The deeming clause by its very nature enacts a fiction to treat what is unreal as real and, therefore, unless the situation is covered under th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have been referred to and examined by the Commissioner of Income Tax (Appeals). But first, we examine Section 9(1)(vii) of the Act. 12. In the present case, clause (b) to Section 9(1)(vii) would be applicable as the respondent-assessee, the payer was a resident of India. The exceptions carved out under clause (b) are not applicable as it is not the case of the respondent-assessee that the fee paid was in respect of services to be utilised in business or profession carried out by the payer outside India, or for the purpose of making or earning of any income from any source outside India. The respondent-assessee's manufacturing unit was in India and it would be proper to hold that the source of income would be the manufacturing unit of the respondentassessee in India, even if the sale proceeds were on account of exports. 13. The main question and issue, which would arise is whether the payment made to the non-resident would be covered under the expression, "fee for technical services" as defined in Explanation 2 quoted above. There are three categories of technical services as per Explanation 2; managerial services, technical services and consultancy services, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erson or team in sports, entertainment, etc." It is, therefore, clear that a managerial service would be one which pertains to or has the characteristic of a manager. It is obvious that the expression "manager" and consequently "managerial service" has a definite human element attached to it. To put it bluntly, a machine cannot be a manager.' Reference can be also made to the decision of the Authority for Advance Rulings in Intertek Testing Services India (P.) Ltd., In re [2008] 307 ITR 418/175 Taxman 375, wherein it was elucidated:- 'First, about the connotation of the term "managerial". The adjective "managerial" relates to manager or management. Manager is a person who manages an industry or business or who deals with administration or a person who organizes other people's activity [New Shorter Oxford Dictionary]. As pointed out by the Supreme Court inR. Dalmia v. CIT [1977] 106 ITR 895, "management" includes the act of managing by direction, or regulation or superintendence. Thus, managerial service essentially involves controlling, directing or administering the business.' 15. The services rende ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as acting as an agent for procuring orders and not rendering managerial advice or management services. Further, the respondent-assessee was legally bound with the non-residents' representations and acts, only when there was a written and signed authorization issued by the respondent-assessee in favour of the non-resident. Thus, the respondent-assessee dictated and directed the non-resident. The Commissioner of Income Tax (Appeals) has also dealt with quantification of the commission and as per clause 4, the commission payable was the difference between the price stipulated in the agreement and the consideration that the respondent-assessee received in terms of the purchase contract or order, in addition to a predetermined guarantee consideration. Again, an indication contra to the contention that the non-resident was providing management service to the respondent-assessee. 17. The Revenue, which is the appellant before us, has not placed copy of the agreement to contend that the aforesaid clauses do not represent the true nature of the transaction. The Assessing Officer in his order had not bothered to refer and to examine the relevant clauses, which certainly was not the ri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s:- '14. Similarly, the word "consultancy" has been defined in the said Dictionary as "the work or position of a consultant; a department of consultants." "Consultant" itself has been defined, inter alia, as "a person who gives professional advice or services in a specialized field." It is obvious that the word "consultant" is a derivative of the word "consult" which entails deliberations, consideration, conferring with someone, conferring about or upon a matter. Consult has also been defined in the said Dictionary as "ask advice for, seek counsel or a professional opinion from; refer to (a source of information); seek permission or approval from for a proposed action". It is obvious that the service of consultancy also necessarily entails human intervention. The consultant, who provides the consultancy service, has to be a human being. A machine cannot be regarded as a consultant.' The AAR in the case of Advance Ruling P. No. 28 of 1999, In re [1999] 242 ITR 208/105 Taxman 218 (AAR - New Delhi) had observed:- "By technical services, we mean in this context services requiring expertise in te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esident consultant had to perform several services in the nature of attending meetings on mutually agreeable dates and providing advice and counselling, which were in the nature of consultancy services as they entailed support from a product team, compliance with all legal and administrative formalities, including registration and marketing strategy, creation of entry into new markets, development and distribution channels, etc. The work being rendered was in the nature of services as a consultant to the Indian assessee. It included an element of advice and was certainly recommendatory in nature. 24. The OECD Report on e-commerce titled, Tax Treaty Characterisation Issues arising from e-commerce: Report to Working Party No.1 of the OECD Committee on Fiscal Affairs dated 01st February 2001, has elucidated:- 'Technical services 39. For the Group, services are of technical nature when special skills or knowledge related to a technical field are required for the provision of such services. Whilst techniques related to applied science or craftsmanship would generally correspond to such special skills or knowledge, the provision of knowledge acquired in fields such as arts o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would not require more than having available such a database and the necessary software to access it. A payment relating to the provision of such access would not, therefore, relate to a service of a technical nature. Managerial services 43. The Group considers that services of a managerial nature are services rendered in performing management functions. The Group did not attempt to give a definition of management for that purpose but noted that this term should receive its normal business meaning. Thus, it would involve functions related to how a business is run as opposed to functions involved in carrying on that business. As an illustration, whilst the functions of hiring and training commercial agents would relate to management, the functions performed by these agents (i.e. selling) would not. 44. The comments in paragraphs 40 to 42 above are also relevant for the purposes of distinguishing managerial services from the service of making data and software (even if related to management), or functionality of that data or software, available for a fee. The fact that this data and software could be used by the customer in performing management functions or that the developmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d discussion, the substantial question of law mentioned above has to be answered in favour of the respondent-assessee and against the appellant-Revenue. The appeal is accordingly dismissed. There will be no order as to costs". Revenue has to bring on record cogent material to prove that the technical knowledge is made available to the assessee firm which could be used in future . In the absence of cogent material, it could not be said that the foreign brokers have any managerial expertise and the services rendered by them is for their self-use and their own benefit to maximize commission income. Thus in our considered view, no income of these foreign agents have accrued or arisen in India or deemed to have accrued or arisen in India as contemplated u/s 9 of the Act to bring in within the fold of chargeability of tax under the Act and hence the same cannot be brought to tax within the provisions of the Act. As the instant appeal is for assessment year 2010-11 whereby vide circular no 07/2009 dated 22.10.2009, CBDT has withdrawn circular no 23 dated 23-07-1969 and circular no 786 dated 07-02-2000, we have to see the effect in context of withdrawal of earlier circulars. The Hon'ble ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts in India and therefore the same is not received by him or on his behalf in India and such an overseas agent is not liable to income-tax in India on these commission payments. This view is fortified by the judgment of Apex Court in the case of Toshoku Ltd. (supra). 9. It is pertinent to note that the section 195 of the Act has to be read along with the charging sections 4, 5 and 9 of the Act. One should not read section 195 to mean that the moment there is a remittance; the obligation to deduct TDS automatically arises. If we were to accept such contention, it would mean that on mere payment in India, income would be said to arise or accrue in India. These are the observations made in the judgment of Apex Court in the case of GE India Technology Centre (P.) Ltd. (supra), relied on by the learned counsel for the assessee, for the proposition that provisions relating to deduction of tax applies only to those sums which are chargeable to tax under the Income-tax Act. If the contentions of the department, are to be taken as correct, that any person making payment to a non-resident is necessarily required to deduct tax, then the consequence would be that the department would be ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting in their respective countries. The said non-resident brokers are not liable to any tax in India insofar as it is also not the case of Revenue that services were rendered in India, therefore, neither there was accrual nor receipt of income in India. We found that the non-resident brokers have not rendered any services in India, therefore, commission income neither accrued nor arose in India in view of the decision of the Hon'ble Delhi High Court in the case of Eon Technology Pvt. Ltd., 343 ITR 366 (Del). There is no dispute to the well settled proposition that provisions of Section 195 does not apply when no income is found to be taxable in India, therefore, there was no reason for making any disallowance under provisions of Section 40(a)(i) in view of decision of the Hon'ble Supreme Court in the case of G.E.India Technology Centre Pvt. Ltd., 327 ITR 456. There are also judicial pronouncements supporting this proposition, which are reported in 10 ITR 501(Trib), 86 ITD 102 and 10 ITR 147(Trib). 10. Payment of brokerage to the said non-resident brokers for non technical services is the business income of the payee and therefore, not liable to tax in India as was held in the ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AO on this score was erroneous and prejudicial to the interests of the Revenue. In support of his conclusion, the ld. CIT also relied on the opinion of the Authority of Advance Ruling in SKF Boilers & Driers (P.) Ltd., Inre [2012] 343 ITR 385/206 Taxman 19/18 taxmann.com 325 (AAR - New Delhi) and Rajiv Malhotra, Inre [2006] 284 ITR 564/155 Taxman 101 (AAR - New Delhi). The assessee is aggrieved against the revisional order directing the AO to make disallowance u/s 40(a)(i) of the Act. 3. We have heard the rival submissions and perused the relevant material on record. There is no dispute on the factual aspect of the matter that the assessee paid commission to a non-resident for procuring export orders and such commission was paid without deducting tax at source. The assessee pleaded for the correctness of its action in not making such deduction u/s 195 by stating that the non-resident commission agent provided services outside India and, hence, the amount was not chargeable to tax in his hands. It goes without saying that liability for deduction of tax at source arises only when the amount is chargeable to tax in the hands of the payee. If the amount itself is not so chargeable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... should keep in mind the distinction between the accrual of income of exporter from exports and that of the foreign agent from commission. As a foreign agent of Indian exporter operates outside India for procuring export orders and further the goods in pursuance to such orders are also sold outside India, no part of his income can be said to accrue or arise in India. The last component of section 5(2) is income which 'is deemed to accrue or arise' in India. The expression - 'Income deemed to accrue or arise in India' - has been defined in section 9(1) of the Act. Sub-section (1) of section 9 has seven clauses. Clause (i) deals with income accruing or arising, whether directly or indirectly, through or from any business connection in India or from any property in India or through or from any asset or source of income in India or through the transfer of the capital asset situated in India. It is quite apparent that the commission income cannot be associated with the later contents of this clause, namely, any property or asset or source of income in India. At the most, it can be considered as having some 'business connection.' Explanation 3 to section 9(1)(i) p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ature of interest or royalty or fees for technical services. It is only in respect of these three categories of incomes that the deeming provision is attracted notwithstanding the non-resident not having a place of business in India or not rendering services in India. As the commission income of non-resident does not fall in any of these three clauses, namely, (v), (vi) or (vii) of section 9(1) of the Act, we hold that Explanation below section 9(2) cannot help the Revenue's case. 6. In view of the foregoing discussion, it is apparent that the commission income in the hands of the non-resident can neither be considered as received or deemed to be received in India or accruing or arising or deemed to accrue or arise to him in India in terms of section 5(2) of the Act. Once it is held that the commission income of a non-resident for rendering services outside India does not fall within the scope of his total income, it automatically implies that the same is not chargeable to tax in his hands. 7. Sub-section (1) of section 195 provides that any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o all the persons, resident or non-resident, whether or not the nonresident person has a residence or place of business or business connection in India or any other presence in any manner whatsoever in India. The Explanation simply clarifies that the obligation to deduct tax at source in terms of section 195(1) is not restricted only to the residents, but also extends to the non-residents irrespective of such non-resident not having a place of business or a business connection in India etc. Since the main part of sub-section (1) of section 195 casts obligation for withholding of tax at source on the payer, thus, it becomes axiomatic that the Explanation 2 amplifying the scope of subsection (1) of section 195 shall also apply to a payer and not a payee. As the extant assessee payer is a resident of India, it is even otherwise obliged to deduct tax at source from the payments made to non-resident in terms of the main sub-section (1), without applicability of the Explanation 2, if the requisite conditions as prescribed in the section are fulfilled. In other words, if a payment is made on account of any sum which is chargeable under the provisions of this Act, then, there will be an ob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot as if the export commission income of a foreign agent for soliciting export orders in countries outside India was earlier chargeable to tax, which was exempted by the CBDT through the above circulars and now with the withdrawal of such circulars, the hitherto income not chargeable to tax, has become taxable. The legal position remains the same de hors any circular in as much as such income of a foreign agent is not chargeable to tax in India because it neither arises in India nor is received by him in India nor any deeming provision of receipt or accrual is attracted. It is further relevant to note that the latter Circular simply withdraws the earlier circular, thereby throwing the issue once again open for consideration and does not state that either the export commission income has now become chargeable to tax in the hands of the foreign residents or the provisions of section 195 read with sec. 40(a)(i) are attracted for the failure of the payer to deduct tax at source on such payments. 12. Ex consequenti, we hold that the amount of commission income for rendering services in procuring export orders outside India is not chargeable to tax in the hands of the non resident age ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Court held that when two views are possible and the ITO has taken one view with which the CIT does not agree, it cannot be treated as an erroneous order prejudicial to the interest of the Revenue, unless the view taken by the ITO is unsustainable in law. Adverting to the facts of the instant case, it can be seen that the AO, after considering certain decisions relied by the assessee favouring nondeduction of tax at source in the present circumstances, accepted the assessee's contention. The fact that the decision of the Authority for Advance Ruling, relied by the ld. CIT, favours the Revenue's case, at the maximum, makes the issue about deduction of tax at source from foreign commission, a debatable one. In view of such a cleavage of opinion, this debatable issue goes outside the purview of section 263 in the light of the above referred two Supreme Court judgments. We, therefore, set aside the impugned order. 15. In the result, the appeal is allowed." Based on our above detailed discussions and reasoning, we hold that keeping in view the facts and circumstances of the instant appeal , the assessee firm is entitled for deduction of export commission of ₹ 34,18,126 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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