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TMI Blog2009 (1) TMI 297X X X X Extracts X X X X X X X X Extracts X X X X ..... HELD THAT:- The Hon ble Supreme Court in three Judge Bench decision in case of CIT vs. A.W. Figgies Co. Ors.[ 1953 (9) TMI 2 - SUPREME COURT] held that as per the law, partnership firm had no legal existence apart from its partners, however, under the IT Act, position was somewhat different, hence, technical view of the nature of a partnership under English law or Indian law could not be taken in applying the law of income-tax. Thus, in this case, in our humble opinion, the Hon ble Supreme Court recognized the dichotomy between the general partnership law and IT Act and if a situation was taken care of by specific provisions of IT Act, then, such provisions were to prevail over the provisions of general law. In the case of Hon ble Supreme Court (three Judge Bench) in Dulichand Laxminarayan vs. CIT [ 1956 (2) TMI 4 - SUPREME COURT] it is again noted that, when the provisions of income-tax itself defined the firm or partnership as contemplated under Indian Partnership Act, 1932 and no other specific provisions existed as regard to the legal status of a partnership firm, the Hon ble Supreme Court decided the issue on the basis of provisions of general law, i.e., Indian Partnership Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nificance now, hence, this contention of the assessee does not help the cause of the assessee in any manner. That, New scheme as applicable from AY 1993-94 was merely a scheme of assessment and it did not change the various facets of partnership firm as per general law. However, in our view the scheme of assessment is not merely a procedural aspect but it also includes computation of income of partnership firm as well as of its partners. This view is well supported by the decision of Hon ble Supreme Court in the case of C.A. Abraham vs. ITO Anr.[ 1960 (11) TMI 20 - SUPREME COURT] ,held that expression assessment included both the computation as well as declaration and imposition of tax liability and the machinery for enforcement thereof. Applicability of provisions of s. 14A - HELD THAT:- Provisions of s.14A are applicable and, in our view, the impugned expenditure can be considered as incurred by the assessee for earning salary as well as share in profits of the partnership firm. AO has disallowed proportionately with reference to share of profits and salary. However, in our view, the same has to be worked out as per the provisions of r. 8D of the IT Rules, 1962 as the said rule h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... however, held that the explanations given by the assessee were not acceptable and since the assessee did not allocate expenses against the income earned as salary from the firm and income earned as share of profit from the firm, hence, the same was to be done now and for this purpose he analysed the break-up of expenditure of Rs. 14,27,819 and found that it comprised of following: (i) Expenses on study tour Rs. 10,40,879 (ii) Depreciation Rs. 1,01,040 (iii) Legal books, magazine and subscription Rs. 2,41,243 The AO also found that though the assessee spent more than Rs. 10 lacs on study tour and because of that the firm could obtain professional fee of Rs. 1.07 crores as stated by the assessee in his letter dt. 22nd Jan., 2003 whereas he was given salary of only Rs. 13,26,000 only. Thereafter, the AO drew support from various decisions to hold that the assessee could not be allowed to follow the laws which suited to the assessee and dose his eyes to the laws which did not suit him. Finally, he held that assessee's share of profit at Rs. 40,25,600 worked out to 75 per cent of total amount received by the assessee from the firm by way of share in profit and salary, hence, 75 p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f IT Act, the income in question should not form part of total income, It has been emphasized that s. 14A of IT Act did not specifically mention the total income of the appellant implying that the income in question need not necessarily form part of total income of the firm. I am not inclined to agree with the appellant on this issue. The provisions of any section when applied to san assessee are directed towards that assessee only. Simply because the words 'of the assessee' are not mentioned in the section, it cannot be said that the section shall not apply to the appellant. I would be stretching it too far if the interpretation of the appellant is to be accepted. Obviously, when applied in the case of appellant. s. 14A of IT Act meant that the income in question should not form part of the total income of the appellant. The reliance by the appellant on the decision in the case of Phiroze H. Kudianavala vs. CIT 1978 CTR (Bom) 374 : (1978) 113 ITR 873 (Bom) is out of context in as much as that for the period to which the decision relates, the share of profit of the partner from the partnership firm was taxable and was not exempt. The exemption under s. 10(2A) of the IT Act is avail ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t from asst. yr. 1993-94 a new scheme of taxation/assessment had been introduced but it did not mean that the basic character of partnership firm or profits of such partnership business had been done away with, i.e., the object of such scheme was to tax the total profit of partnership firm either at the hands of the firm and its partners in respect of interest, salaries paid to the partner which had been allowed deduction in the hands of the firm and, therefore, even after such changes in law, total profits received by the partner in the form of share and salary retained the same character and was not an exempt income. In this regard, he also contended that if a remuneration or interest paid to a partner was disallowed in the hands of the firm, then, such remuneration or interest was not taxable under s. 28(v) of the Act. The learned counsel further contended that it was a matter of convenience among the partners as to decide the mode of distribution of profits, but the same would not make an income already taxed as exempt income. The learned counsel further contended that apart from these two types of incomes, the assessee also earned sitting fee/arbitration fee in the capacity of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that scheme of assessment/taxation of partnership firm and partners has undergone change on a number of occasions. Initially, payment of salary, bonus or commission etc. by the firm to the partners was not allowable as an expenditure and share in the profits of a partnership firm was also taxable in the hands of partners subject to certain relief/rebates. Subsequently, with effect from asst. yr. 1993-94, the scheme of assessment for partnership firm is treated as an independent entity in a limited sense like a company for the purposes of IT Act, 1961. The expenditure by way of remuneration, interest. commission etc. paid to partners is also allowable in the hands of partnership firm subject to certain ceilings and share in the profit of a partnership firm is not taxable in the hands of partners, however, the interest and salary etc. allowed in the hands of partnership firm are taxable as business income in the hands of partners to that extent. It is also pertinent to note that provisions of s. 40(b) presuppose the allowability of such expenditure under s. 28(i) or 37(1) and further expenditure like rent paid to partner is allowable without any restriction of course subject to prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ature of a partnership under English law or Indian law could not be taken in applying the law of income-tax. The relevant findings of the Hon'ble Supreme Court are as under: "It is true that under the law of partnership a firm has no legal existence apart from its partners and it is merely a compendious name to describe its partners but it is also equally true that under that law there is no dissolution of the firm by the mere incoming or outgoing of partners. A partner can retire with the consent of the other partners and a person can be introduced in the partnership by the consent of the other partners. The reconstituted firm can carry on its business in the same firm's name till dissolution. The law with respect to retiring partners as enacted in the Partnership Act is to a certain extent a compromise between the strict doctrine of English Common Law which refuses to see anything in the firm but a collective name for individuals carrying on business in partnership and the mercantile usage which recognizes the firm as a distinct person or quasi corporation. But under the IT Act the position is somewhat different. A firm can be charged as a distinct assessable entity as distinct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it were a corporate body. The law of procedure has gone to the length of allowing a firm to sue or be sued by another firm having some common partners or even to sue or be sued by one or more of its own partners, as if the firm is an entity distinct from its partners. Again, in taking partnership accounts and in administering partnership assets, the law has, to some extent, adopted the mercantile view and the liabilities of the firm are regarded as the liabilities of the partners only in case they cannot be met and discharged by the firm out of its assets. The creditors of the firm are, in the first place, paid out of the partnership assets and if there is any surplus then the share of each partner in such surplus is applied in payment of his separate debts, if any, or paid to him. Conversely, separate property of a partner is applied first in the payment of his separate debts and the surplus, if any, is utilized in meeting the debts of the firm. In the Indian IT Act itself a firm is, by s. 3, which is the charging section, made a unit of assessment. It is clear from the foregoing discussion that the law, English as well as Indian, has, for some specific purposes, some of which are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r firm or HUF or individual. In holding so, the Hon'ble Supreme Court also reviewed the English law as well as provisions of CPC. 8,4 Thus, it is again noted that, when the provisions of income-tax itself defined the 'firm' or 'partnership' as contemplated under Indian Partnership Act, 1932 and no other specific provisions existed as regard to the legal status of a partnership firm, the Hon'ble Supreme Court decided the issue on the basis of provisions of general law, i.e., Indian Partnership Act, 1932 which was also held so by the Hon'ble Supreme Court in the case of CIT vs. A.W. Figgies & Co. & Ors. 8.5 Similar view was taken by the Hon'ble Supreme Court in the case of Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC), wherein the Hon'ble Supreme Court (three Judge Bench decision) held as under: "Having regard to the above discussion, it seems to us clear that a partnership firm under the Indian Partnership Act, 1932, 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 the partnership assets and when one talks of the firm's property or firm's assets all that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bts and liabilities and thereupon distribution, division or allotment of assets takes place inter se between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division or allotment of assets to the erstwhile partners, is not done by the dissolved firm. In this sense there is no transfer of assets by the assessee (dissolved firm) to any person. It is not possible to accept the view of the High Court that the distribution of assets effected by a deed takes place eo instanti with the dissolution or that it is effected by the dissolved firm." 8.6 Again it is seen that no specific provisions existed under the IT Act, 1961 as regard to the issue whether distribution of assets among partners on dissolution of firm would amount to transfer or not and in that situation, the Hon'ble Supreme Court held that as per the general law, partnership firm as such had no rights in assets of the firm even before dissolution, hence, how there could be a question of extinguishments of firm's right in the partnership assets amounting to a transfer of assets within the meaning of s. 2(47) of the Act. 8.8 Again, in the case of Dy. CST (Law) vs. K. Kelukutty (1985 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s partners under the provisions of IT Act, 1961. To put it differently, the concept of partnership firm, being a compendium of its partners is subject to the tax law modifying such concept of partnership law which means that if there exists no provision in the tax laws for a particular situation, then, the provisions of partnership law would be the guiding factor for adjudication of that issue. 8.10 Now, we consider it pertinent to refer to certain decisions where a view has been expressed that for computing the income of a partnership firm for the purpose of determining its income-tax liability, it was to be treated as distinct from its partners. 8.11 The Hon'ble Supreme Court (three Judge Bench) in the case of Bist & Sons. vs. CIT (1979) 8 CTR (SC) 152 : ([979) 116 ITR 131 (SC) was dealing with the issue where an HUF consisting of father and son carrying on business and the father and son firm which took over the business of HUF including trucks and later on the firm sold such trucks and earned a profit which was sought to be taxed in the hands of the firm as a deemed profit under second proviso to s. 10(2)(vii) as balancing charge, the Hon'ble Supreme Court held that it could ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, in law merely a compendious name for the totality of the partners, the ITO was in error in proceeding on the footing that there was a transaction a commercial transaction of sale of shares between the firm and its seven partners. Before us counsel for the Revenue as well as for the assessee have adopted the same extreme positions but it is not possible to agree with either. In income-tax law a partnership firm is a distinct assessable legal entity. From this, it would not follow that all transactions between the firm and its partners, whatever be their nature, whatever be the reasons therefor, are to be regarded as equivalent of ordinary transactions between two separate legal entities. Similarly, from the fact that in general jurisprudence a firm is not invested with legal personality it would not follow that any transaction between the firm and its partners will be required to be considered as an internal partnership arrangement and cannot be regarded as giving rise to legal consequences similar to a transaction between two separate entities. In the realities of commercial life one will find a firm borrowing from or lending to its partner, giving premises on lease to or goods ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... p firm was an independent entity than that of its partners for specific purposes under the IT Act. 8.13 Again, the Hon'ble Bombay High Court in the case of CIT vs. Chase Trading Co. (1998) 147 CTR (Bom) 228 : (1999) 236 ITR 665 (Bom) dealing with a case of business loss accruing to the firm on sale of shares to partners held that after following the Hon'ble. Bombay High Court earlier decision as mentioned in para 6.4 held that the transfer between the partnership firm and its partners, being a commercial transaction, the assessee must be allowed the loss suffered by it as a business loss. In this process, the Hon'ble Bombay High Court also referred to the decision of the Hon'ble Supreme Court in the case of Malabar Fisheries Co. and observed as under: "On behalf of the Revenue, reference was made to the decision of the Supreme Court in the case of Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC). The reliance placed upon the aforesaid decision is misconceived as the Supreme Court was dealing with the case of distribution of assets between the partners after dissolution of partners. The test applicable to the distribution of assets after a partnership ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... priate rates. Further, the tax liability of a firm and its partners depended upon the question whether the firm was granted registration under the IT Act or not. In case of a registered firm, the firm paid tax on its total income according to the rates prescribed in the schedule for registered firms. An unregistered firm was taxed at the rates applicable to individuals, with the share income included in the hands of the partners for rate purposes only. There has been a consistent demand for removal of the double taxation. A new scheme of assessment of firms has been introduced from asst. yr. 1993-94. the scheme is modelled after the scheme introduced by the Direct Tax Laws (Amendment) 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 Tax 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovisions mentioned hereinabove read with the impugned circular go to show that a firm is to be taxed as separate entity and as per para 48.3, the gross total income of the firm is to be determined in the normal way under different heads as in the case of any taxable entity, hence, any expenditure which has been incurred by firm for the purposes of its business is to be allowed as a deduction in computing the total income of the firm subject to any specific limitation/prohibition provided for the allowance of such expenditure. 8.17 Accordingly, having regard to judicial opinion as elaborated hereinabove and also the legislative changes in the Act, in our opinion, a partnership firm is a separate entity than that of its partners under the IT Act and if there exists any specific provision in the income-tax law modifying the partnership law then such specific provision shall be applied and if the tax law is silent on a specific issue, then a reference will have to be made to the provisions of partnership law for the adjudication of the same and in the present case, provisions of law sufficiently take care of the issue involved herein, hence, the issue is to be decided accordingly. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e decision of Hon'ble Supreme Court in the case of C.A. Abraham vs. ITO & Anr. (1961) 41 ITR 425 (SC), wherein the Hon'ble Court held that expression "assessment" included both the computation as well as declaration and imposition of tax liability and the machinery for enforcement thereof. The relevant findings of the Hon'ble Supreme Court are as under: "That the business of the firm was discontinued, because of the dissolution of the partnership is not disputed. It is urged, however, that a proceeding for imposition of penalty and a proceeding for assessment of income-tax are matters distinct, and s. 44 may be resorted to for assessing tax due and payable by a firm business whereof has been discontinued, but an order imposing penalty under s. 28 of the Act cannot by virtue of s. 44 be passed. Sec. 44 sets up machinery for assessing the tax liability of firms which have discontinued their business and provides for three consequences, (1) that on the discontinuance of the business of a firm, every person who was at the time of its discontinuance a partner is liable in respect of income, profits and gains of the firm to be assessed jointly and severally, (2) each partner is liable t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... me under s. 23 and not to the application of the procedure for declaration and imposition of tax liability and the machinery for enforcement thereof. Nor has the expression, 'all the provisions of Chapter IV shall so far as may be apply to such assessment' a restricted content: in terms it says that all the provisions of Chapter IV shall apply so far as may be to assessment of firms which have discontinued their business. By s. 28, the liability to pay additional tax which is designated penalty is imposed in view of the dishonest contumacious conduct of the assessee. It is true that this liability arises only if the ITO is satisfied about the existence of the conditions which give him jurisdiction and the quantum thereof depends upon the circumstances of the case. The penalty is not uniform and its imposition depends upon the exercise of discretion by the taxing authorities; but it is imposed as a part of the machinery for assessment of tax liability. The use of the expression 'so far as may be' in the last clause of s. 44 also does not restrict the application of the provisions of Chapter IV only to those which provide for computation of income. By the use of the expression 'so fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income from other sources and not as a business income and while computing the income from profession, the impugned expenditure has been claimed as a deduction therefrom as evident from statement of computation of income under the head profits and gains of business or profession as enclosed with the return of income, hence, on the face of it, this contention of the assessee is completely contradictory to the claims made by assessee himself originally, hence, rejected. Even otherwise, as per the provisions of s. 57(iii), this expenditure cannot be allowed as it cannot be said to have been incurred for earning such fee. 8.22 Now, coming to the question of the applicability of provisions of s. 14A, we have got no hesitation in holding that, in the facts of the case, the provisions of s. 14A are applicable and, in our view, the impugned expenditure can be considered as incurred by the assessee for earning salary as well as share in profits of the partnership firm. The AO has disallowed proportionately with reference to share of profits and salary. However, in our view, the same has to be worked out as per the provisions of r. 8D of the IT Rules, 1962 as the said rule has been held to ..... X X X X Extracts X X X X X X X X Extracts X X X X
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