1 ITA No.3002(Ahd)/2009
IN THE INCOME TAX APPELLATE TRIBUNAL AT AHMEDABAD,
"SPECIAL BENCH"
BEFORE S/SHRI G.E. VEERABHADRAPPA, PRESIDENT,
G.C. GUPTA, VICE-PRESIDENT AND
K.G. BANSAL, ACCOUNTANT MEMBER)
ITA No.3002/Ahd/2009
[Asstt.Year : 2006-2007]
Shri Vishnu Anant Mahajan /Vs. ACIT, Cir.5
Mahajan Lane Baroda.
Raopura, Vadodara.
Appellant) Respondent)
Assessee by : Shri Sunil H. Talati
Revenue by : Shri S.K. Gupta, CIT-DR with
Shri Kartarsingh, CIT-DR
Date of Hearing : 19th April, 2012
Date of Pronouncement : 25th May, 2012
PER BENCH :
Vide order dated 18-01-2012, the Hon'ble President, Income Tax Appellate Tribunal,
referred the following question to this Special Bench in the case of Shri Vishnu Anant Mahajan
Vs. Asstt.Commissioner of Income-tax.
"Whether the ld.CIT(A) was justified in disallowing 76% of the
depreciation and other related expenses by apportioning them in the
ratio of exempt to taxable income by applying provisions of section 14A
2 ITA No.3002(Ahd)/2009
of the Act on the share income from the firm which is exempt from tax
u/s.10(2A) of the Act ?"
2. The assessee is an individual and derives income by way of share of profit
from the firm of M/s.Mahajan & Amar Doshi, capital gains, interest, dividend and
house property. The findings of the AO are that the assessee is a separate and
distinct legal entity from the partnership firm. Although, the assessee is the legal
owner of the motor car, but that does mean that the expenditure so incurred is for
earning the business income. The earning of other incomes apart from share in the
partnership firm does not advance the case of the assessee regarding the claim of
the expenditure. The assessee has also disallowed suo motu 1/10th of depreciation
allowance which indicates that the asset has been used for personal purpose.
2.1 The learned CIT(A) considered the facts of the case and rival submissions.
His interpretation about the view of the AO is that the expenses and depreciation
allowance do not pertain to the assessee as an individual, but pertain to the
partnership firm in which he is a partner. The share income from the firm is not to
be included in the total income of the assessee by dint of provision contained in
Section 10(2A). Therefore, the provision contained in Section 14A regarding
"expenditure incurred in relation to income not included in total income" becomes
applicable. The assessee derives 76% of professional income as share from the
firm and the balance amount by way of remuneration and interest income from the
firm. He, therefore, allocated the expenses to the income not includible under
Section 10(2A). Thus, the business income by way of remuneration and interest
from the firm has been taxed in the hands of the assessee under section 28(v) after
allowing 24% of the expenditure. Thus, 76% of the expenditure has been
disallowed.
2.2 Before proceeding with determination of the main issue, it may be
mentioned that the learned CIT-DR submitted that the basic finding of the AO is
3 ITA No.3002(Ahd)/2009
that the expenditure does not pertain to the assessee. The learned CIT-DR has not
furnished any finding on this issue, but he has proceeded straight away to examine
admissibility of the expenditure and its disallowance under section 14A. We are
of the view that this question can be decided by the Division Bench. Therefore,
we proceed to determine-whether, the expenditure incurred by the assessee, a
partner in a firm, is entitled to claim expenditure incurred on motor car even if the
whole or part of the income from the firm is not includible in his total income
under section 10(2A) of the Act?
3. Before us, the learned counsel for the assessee submits that a firm is a
compendium name of all the partners who join together for conducting a business
or a profession, share its profits and act as agent of one another. This concept
has been incorporated in the Act as "firm", "partners" and "partnership" have
been assigned under Section 2(23) of the Act the same meaning as assigned to
them under the Indian Partnership Act, 1932. Although the definition of the term
"person" includes within its ambit an individual and a firm also under Section
2(31), but the provision contained in section 2(23) should not be lost sight of
while interpreting section 14A.
3.1 He further submits that the issue of disallowance of the expenditure
incurred by a partner has been discussed directly in a number of cases, which
support the aforesaid contention. In this connection, reference is made to the
decision on `C' Bench of Mumbai Tribunal in the case of Shri Sudhir Kapadia,
ITA No.7883/Mum/2003 for A.Y.2001-2002 dated 26-2-2007, a copy of which
has been placed on record. The facts are that the assessee was a Chartered
Accountant and a partner in a firm of Chartered Accountants. In his computation
of income deduction of Rs.3,95,500/- was claimed in respect of expenditure
incurred on motor car and depreciation allowance thereon. The AO applied the
provision contained in Section 14A since the share was not includible in the total
4 ITA No.3002(Ahd)/2009
income under Section 10(2A). Consequently he disallowed certain amount from
the overall expenditure which was attributed to the earning of share income. The
Tribunal came to the conclusion that it will not be feasible to hold that share
income in the hands of the partner is altogether tax free income. The share has
suffered tax in the hands of the firm. Section 10(2A) has been introduced to avoid
double taxation of the same income, once in the hands of the firm and then in the
hands of the partner. This view is fortified by the fact that any partner in the firm
is not allowed to claim any conveyance expenditure from the firm as provided in
the partnership deed. Further, it is submitted that this case has been followed by
`H' Bench of the Mumbai Tribunal in the case of Hitesh D. Gajaria, in ITA
No.983/Mum/2007 for A.Y.2003-2004 dated 14.11.2008, a copy of which has
been placed on record. It is also submitted that there is a contrary decision
rendered by the `H' Bench of the Mumbai Tribunal in the case of Hoshang D.
Nanavati Vs. ACIT, in ITA No.3567/Mum/2007 for A.Y.2003-2004 dated 18-3-
2011, a copy of which has been placed on record. The learned counsel for the
assessee in that case argued that there is a cleavage of opinion amongst co-
ordinate Benches and looking to the smallness of the tax effect, he would not like
to carry the matter to Special Bench, although, he is firmly of the view that the
assessee deserves to succeed on this issue. It was further argued that in any case,
the depreciation allowance is not an expenditure and therefore, this allowance is
not covered at all under Section 14A. The Tribunal mentioned that what can be
disallowed under Section 14A is only expenditure incurred and not any allowance
admissible to an assessee. Therefore, the depreciation allowance cannot be made
a subject matter of disallowance under Section 14A. The expenditure incurred by
the assessee is in the nature of business expenditure, which requires to be
apportioned between the income included in the total income and not included in
the total income. Thus, a proportionate disallowance was upheld with a remark
that the decision is rendered on peculiar facts of the case. The case of the ld.
5 ITA No.3002(Ahd)/2009
counsel is that since the question has been decided on the basis of concession
by the ld. counsel for the assessee, it may be ignored.
3.2. Similar issue also came before the Tribunal in the case of Dhamasingh M.
Popat, Vs. ACIT, (2010) 127 TTJ 63 (Mum). The question before the Tribunal in
that case was regarding the allowance of expenditure of Rs.10,70,864/- under
Section 14A. The assessee was engaged in legal profession in the year under
consideration. He received salary of Rs.13,26,000/- from the partnership firm and
share of profit of Rs.40,25,000/. Against this income, he claimed expenditure of
Rs.14,27,819/- leading to income of Rs.39,23,180/-. Out of this income, share of
profit of Rs.40,25,600/- was excluded under Section 10(2A) and thus, the loss of
Rs,1,01,819/- was computed. The major portion of the expenditure was incurred
on conference, seminar and court assignment abroad. The salary income from the
partnership firm was assessable as business income under Section 28(v). The
Tribunal considered a number of decisions while deciding this case. We think it
proper at this stage to discuss those cases which have been dealt with before us.
3.3 In the case of CIT Vs. A.W. Figgies & Co., (1953) 24 ITR 405 (SC), it is
observed that change in the constitution of the firm does not amount to the
succession of the business. Therefore, the technical view of the firm under the
Partnership Act cannot be carried over to the I.T. Act. However, under the
Partnership Act, a firm has not separate or distinct existence. Thus, it is argued
before us that the business of the firm is the business of the partners. The income
has been taxed in the hands of the firm. Therefore, it cannot be said that the share
income received by the partner has not been subjected to tax or excluded from the
total income under Section 10(2A). This provision is only a safeguard against
double taxation of the same income in the hands of the firm and the assessee
partners.
6 ITA No.3002(Ahd)/2009
3.4 In the case of Dulichand Laxminarayan Vs. CIT, (1956) 29 ITR 535(SC), it
has been, inter alia, held that section 4 of 1932 Act contemplates only the nature
of the entity and whether such an entity can enter into another partnership with
any firm, HUF or individual. The general concept is that the firm is not an entity
or a person in law, but is merely an association of individuals. Therefore, the
registration cannot be granted to a partnership purporting to be one between three
firms, a Hindu undivided family and an individual as a firm under Section 26A of
the 1922 Act. On the basis of this decision, it is urged before us that since a
partnership firm is not a person under general law, it cannot enter into a
partnership with any one else. The partnership is a compendium name of the
partners. Therefore, income earned through its business by the partners gets
taxed in the hands of the firm under the IT Act.
3.5 In the case of Malabar Fisheries Co. Vs. CIT, 120 ITR 49 (SC) , it has,
inter alia, been held that it is not correct to say that distribution of assets of a
partnership firm leads to transfer of assets so as to attract the provision contained
in section 155(5) of the Act. What the partners get are their shares in surplus
which they already owned in the assets of the firm.
3.6 In the case of DCIT Vs. K. Kelukutty, 155 ITR 158 (SC), it has, inter alia,
been held that essentially a firm consists of three elements (a) persons, (b) a
business carried on by all of them or any of them acting for all, and (c) an
agreement between these persons to carry on such business and share its profits.
It is permissible to say that an agreement creates or defines relation of partnership
and, therefore, identifies the firm. If that conclusion be right, it is only a further
step to hold that each partnership agreement between same persons may constitute
a distinct and separate partnership. The question may have to be decided on the
basis of facts of each case taking into account commonality of management,
7 ITA No.3002(Ahd)/2009
interlacing of funds etc. But this does not mean that the firm is a distinct
person, separate and apart from the partners.
3.7 In the case of Bist & Sons Vs. CIT, 116 ITR 131 (SC), the facts are that a
HUF consisted of father and son. They were carrying on business of forest
contractors. Due to total disruption of the family, the separated members
constituted a firm and took over business as a running concern. The business of
erstwhile HUF consisted of three trucks on which deprecation had been allowed
and the WDV had come to NIL. The trucks were sold by the partnership firm.
The court came to the conclusion that the depreciation allowed to the HUF was a
step taken in the assessment of the HUF for determining its total income. That
does not mean that the depreciation allowed to the HUF could be regarded as
depreciation allowed to the partnership firm. Therefore, the sale proceeds
realized by the firm was not taxable as balancing charge. It is urged before us
that this case distinguishes between disrupted HUF and the firm subsequently
constituted and not between a firm and its partners.
3.8 In the case of CIT Vs. Chase Trading Co., 236 ITR 665 (Bom), it has, inter
alia, been held that under the Act, the partnership firm is an assessable entity. In
the course of its business, the firm may borrow or lend from or to its partners, sell
or purchase goods and other assets. These are commercial transactions. Such
transactions would not be amenable to the principle that one cannot trade with
oneself. It is urged that this case recognizes the transaction of a firm with its
partners, but in so far as the business of the firm itself is concerned, the same is
jointly carried out by the partners and its profits belong to the partners.
3.9 On the basis of aforesaid discussion, it is argued that the Tribunal erred in
coming to the conclusion in the case of Dharmasingh M. Popat that the scheme of
assessment as applicable from A.Y.1993-1994 is not merely procedural, but also
8 ITA No.3002(Ahd)/2009
includes the computation of income of partnership firm as well as its partners. In
this very connection, reliance is placed on Board circular no.636 dated 31-8-92,
198 ITR (St.) 1 wherein it is mentioned that change in the levy of tax on the firms
has been undertaken to avoid double taxation, as it happened prior to the change.
It is also urged that the decisions rendered in the case of limited companies
regarding the applicability of section 14A, will not be applicable in respect of
assessment of the partnership firm, as one cannot equate partners with
shareholders and the firm does not have any legal persona as it is merely a
compendium name of all the partners. Thus, the share income received by a
partner from the firm cannot be said to be an income which has been excluded
from the total income. It has also been submitted that irrespective of rates of tax,
there will be no loss to the Revenue, if the expenditure is allowed in the case of the
partner or in the case of firm.
4. In reply, the learned DR submits that motor car has not been used by the
assessee for his business. It may have been used for the purpose of business of
the firm. Therefore, as such, there is no question of allowing the expenditure in
the hands of the assessee. It is further submitted that earlier a partnership firm was
assessed at concessional rate of tax. The profit of the firm after deduction of tax
payable by it was distributed amongst the partners as per the partnership deed, and
the partners were liable to pay tax on such income allocated to them at normal
rates. It was this double taxation, for which the scheme of taxation was changed.
The Board Circular is relevant only in this context. Now, the firm is allowed to
deduct salary and interest paid to the partners as provided under Section 40(b) of
the Act and the balance amount is taxed in the hands of the firm at a flat rate. The
salary and interest allocated to the partners are taxed as business income under
Section 28(v) in the hands of the partners at normal rates applicable to them. This
shows that under the Act, the firm and the partners are treated separately, which
also flows from the definition of term "person" in section 2(31). Therefore, the
9 ITA No.3002(Ahd)/2009
concepts under the Act and under the Partnership Act are different. Thus, in effect
the arguments of the learned CIT-DR is that while a firm is a transparent vehicle
under the Partnership Act, it is a translucent vehicle under the I.T. Act, the reason
being that two are taxed on their separate incomes and what is taxed in the hands
of the firm is not further taxed in the hands of the partners.
4.1 He referred to various decisions considered in the case of Dharmasingh M.
Popat. The case of S.G.Investments & Industries Ltd., 89 ITD 44 (Kol) is
distinguishable in the sense that it deals with a limited company. Such is also the
case of Primer Conslidated Capital trust (I) Ltd., 4 SOT 793 (Mum).
4.2 In the case of Phiroze H. Kudianawala, 113 ITR 873 (Bom) the facts are
that the assessee, a partner in a firm of architects, incurred certain expenses.
The agreement provided that certain expenses will be incurred by partners. The
Court held that if business expediency is proved, a partner could claim
expenses incurred by him for earning share income. This decision has been
distinguished on the ground that it relates to the period when share income was
taxable in the hands of the partners and there was no provision corresponding to
section 10(2A). The decision in the case of R.M. Chidambram Pillai, 106 ITR 292
(SC) is not really applicable to the facts of the case because it was held that the
nature of income in the hands of the firm and partners remains the same. The
decision in the case of A.W. Figgies & Co. (supra) lays down that the change in
the constitution of the firm does not lead to succession to business. This decision
goes against the assessee. It has been mentioned in the decision that this view
to a certain extent is a compromise between 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. However, the firm may only be a quasi corporation. The
decision in the cased of Dulichand Laxminarayan merely lays down that a firm
10 ITA No.3002(Ahd)/2009
cannot enter into an agreement of partnership with any one else, as it is not a
legal entity under the Partnership Act. In the case of Malabar Fisheries Co., the
question was regarding distribution of assets on extinguishment of partnership and
it was held that there is no transfer. At the relevant point of time, there was no
provision to deal with such a situation under the I.T.Act, although, now it is
deemed to be a transfer. In the case of K. Kelukutty, it has been held that where
the tax law is silent, one will have refer to law on partnerships. Thus, it is clear
that where the field has been occupied by the tax law, there will be no necessity to
refer to the law applicable to the partnership firms. This decision has been
applied by the Tribunal in the case of Dharmasingh M. Popat . The question in the
case of Bist & Sons was totally different, regarding the value of trucks in the
hands of the partnership, which were earlier owned by the HUF and whose WDV
had become NIL. In the case of CIT Vs. Kaluram Puranmal, 119 ITR 564 (Bom),
the transactions between the partners and the firm are held to be transaction
between two separate legal entities which supports the case of the Revenue. In the
case of Chase Trading Co., similar proposition of law has been reiterated. The
decision in the case of C.A. Abraham Vs. ITO and Another , (1961) 41 ITR 425
(SC) has been applied by the Hon'ble Tribunal in the case of Dharmasingh M.
Popat (supra), in which it has been held that the word "assessment" includes
both computation, imposition of tax liability and the machinery for
enforcement thereof..
4.3 It has also been submitted that the case of ITO Vs. Daga Capital
Management P. Ltd., (2009) 117 ITD 169 (Mum)(SB), Wimco Seedling Ltd. Vs.
DCIT, 107 ITD 267 (Del)(TM) deal with the limited companies, and as such, are
not applicable to the facts of the instant case. The decision in the case of Godrej &
Boyce Mfg. Co. Ltd. Vs. DCIT, 328 ITR 81 (Bom) can be relevant to the extent
that it has been held that even prior to insertion of Rule 8D, all circumstances can
be considered and disallowance can be made on a reasonable basis.
11 ITA No.3002(Ahd)/2009
4.4 Finally, it is argued that the scheme of taxation of a firm and its partners is
that profit is taxed in the hands of the firm and, thus, the shares are excluded
from the total income of the partners. A firm and its partners are two separate
assessable entities and taxation of the profit of the firm in its hands does not lead
to a conclusion that it has been taxed in the hands of the partners on the ground
that the firm and its partners constitute only one entity. This field is occupied by
the IT. Act under which profit is taxable in the hands of the firm and it is
excluded from its total income of partners under Section 10(2A). The total
income of the firm is different from total income of the partners. Accordingly,
the learned CIT(A) rightly invoked the provisions contained in Section 14A and
disallowed the expenses on proportionate basis.
5. In the rejoinder, it is submitted that the statutory changes made in the year
1993 do not really make a difference in the legal position that the firm is a
compendium name of the partners. Therefore, when an income has been taxed in
the hands of the firm, it automatically means that the partners have paid tax on the
income because the profit allocated to them is from the amount left in the hands of
the firm after payment of tax. Any other interpretation would lead to double
taxation of the same income in the hands of the firm and partners.
6. We have considered facts of the case and submissions made before us. We
find that difficulty in deciding the issue arises from the fact that while a firm is a
transparent vehicle under the Partnership Act, it is considered to be a separate and
distinct entity apart from its partners under the I.T. Act. Further, while share
income is excluded from the total income of the partners under Section 10(2A),
salary and interest are taxable in their hands as business income under Section
28(v) of the Act. At the same time, "firm", "partner" and "partnership" have
meaning respectively assigned to them in the Indian Partnership Act, 1932. The
term "partner" also includes any person being a minor who has been admitted to
12 ITA No.3002(Ahd)/2009
the benefit of the partnership. Thus, the firm is somewhat translucent vehicle
under the Act. This requires a combined reading of the provisions contained in
sections 2(23) and 2(31) of the Act. Obviously, a firm cannot be equated with a
limited company, which has been granted a separate and distinct legal persona
under the Companies Act and which has been recognized under the Income Tax
Act as such.
7. We have given careful consideration to various cases relied upon by the
contesting parties. These cases inter-alia show that a firm can validly enter into an
agreement with a partner regarding purchase and sale of assets etc.[Kaluram
Puranmal; Chase Trading Co.]. Further it has been held that whenever the field
is occupied by the tax law, the provision contained therein will become applicable,
but where the field is left vacant, we will have to take assistance from the
provisions contained in the Partnership Act for filling the vacuum under the tax
law. [K. Kulakutty]. In so far as the issue before us is concerned, a firm and its
partners are assessable separately on their total income in their names,
notwithstanding the position of law under the Partnership Act that a firm is a
compendium or the collective name of the partners. Thus, in so far as the taxation
is concerned, the firm is not a pass-through vehicle. It is a translucent vehicle, as
only the salary and interest paid to the partners are taxable under Section 28(v) as
business income. It has been so provided because there cannot be really be a
relationship of employer and employee or debtor or creditor between the firm on
one hand and the partners on the other hand. Even earlier, the salary and interest
allocated to the partners were taxable as business income. The real change in the
scheme of taxation is that the firm is taxed at a flat rate of income after deduction
of interest and salary paid to the partners, and interest and salary are taxed in the
hands of the partners as business income. Thus, it is clear that the amount taxed
in the hands of the firm is not taxed again in the hands of the partners. This
change has led to avoidance of double taxation because the firm does not have to
pay tax on salary and interest income paid to the partners and the partners do not
13 ITA No.3002(Ahd)/2009
have to pay tax on share income allocated to them. This is achieved by insertion
of section 10(2A) and 28(v) in the Act. In so far as share income is concerned, the
field is occupied by the tax law, as it is enacted that the share income shall not
form part of total income of the partners. Therefore, in view of this specific
provision and the fact that the firm and partners are separately assessable entities,
it will be difficult to hold that the share income is not excluded from the total
income of the partner because the firm has already been taxed thereon. When
section 10(2A) speaks of its exclusion from the total income, it means, the total
income of the person whose case is under consideration. The instant case is that
of the partner and therefore what is to be examined is whether the share income is
excluded from his total income. The answer is obviously in the affirmative. In
such a situation, provision contained in section 14A will come into operation and
any expenditure incurred in earning the share income will have to be disallowed.
Thus, we agree with the learned CIT(A) that the provision contained in section
14A is applicable to the facts of the case. Further, it has been held in the case of
Godrej & Boyce Mfg. Co. Ltd. (supra) that all facts may be taken into
consideration for determining the quantum of disallowance to be made. This
portion of the judgment is applicable only in respect of determination of quantum
of disallowance. The learned CIT(A) has disallowed the expenditure in the ratio
of income not included in the total income and the income received from the firm.
In the absence of any argument regarding any error in this part of the decision, it is
held that he was right in doing so.
8. Coming to the question regarding depreciation being an expenditure or not,
it has been held in the case of Hoshang D. Nanavati (supra) that section 14A deals
only with the expenditure and not any statutory allowance admissible to the
assessee. The decision has been arrived at after considering the decision in the
case of Nectar Bebverages Pvt. Ltd. Vs. DCIT (2009) 314 ITR 314. The ld. CIT
(DR) has not been able to displace the ratio of these cases. Thus, on
consideration, we find that section 14A uses the words "expenditure incurred by
14 ITA No.3002(Ahd)/2009
the assessee in relation to income". A statutory allowance under section 32 is not
an expenditure. Therefore, we are in agreement with the decision of the Division
Bench in the case of Hoshang D. Nanavati.
9. Question referred to us is answered accordingly. The Division Bench shall
dispose of the appeal in conformity with this decision.
Order pronounced in Open Court on the date mentioned hereinabove.
Sd/- Sd/- Sd/-
(G.E. EERABHADRAPPA) (G.C. GUPTA) (K.G. BANSAL)
PRESIDENT VICE-PRESIDENT ACCOUNTANT MEMBER
Copy of the order forwarded to:
1) : Appellant
2) : Respondent
3) : CIT(A)
4) : CIT concerned
5) : DR, ITAT.
BY ORDER
DR/AR, ITAT, AHMEDABAD
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