S. 40(b): Appointment of an existing partner as representative partner for another party may circumvent the ceiling on number of partners

The assessee, a firm of Chartered Accountants, filed a return offering income of Rs. 17.70 crores which was accepted by the AO u/s 143(3). The CIT then passed an order u/s 263 stating that the assessee had amended its partnership deed pursuant to which Mr. Mukund Dharmadhikari, who was already a partner of the firm, was added once again as a partner in a representative capacity, to represent Deloitte Haskins & Sells, Mumbai. As Mr. Dharmadhikari had the right to share profit, both in the representative capacity as well as in his individual capacity, the CIT held that the number of partners exceeded 20, the maximum allowed under the Partnership Act, 1932, and that the assessee had, therefore, to be treated as an Association of Persons. He held that the assessee was not entitled to claim a deduction u/s 40(b) for the salaries paid to its’ partners.On appeal by the assessee to the Tribunal HELD:

A study of the partnership deed shows that Deloitte Haskins & Sells, Mumbai, which is the participating firm, is not a stranger to the assessee. The assessee can take policy decisions, which have a policy bearing on such firm, once there is an approval of the majority of the members of the “National Firm”. Mukund Dharmadhikari was representing Deloitte Haskins & Sells, Mumbai, and the endeavour of the assessee was to bring on board the participating firm, on which it had powers to make policy decision, so that they became entitled for a share of profit. In other words, the effort of the assessee was to bring indirectly into the partnership M/s Deloitte Haskins & Sells, Mumbai, which was already a participating firm. The assessee was a renowned partnership firm and was well aware that number of partners cannot exceed 20. It is a well settled principle of law that what is permissible is tax planning, but not evasion. When an attempt is made by a concern to evade tax using subtle camouflages, bounden duty of the authorities is to find out the real intention. It is the duty of the Court in every case, where ingenuity is expended to avoid taxing and welfare legislations, to get behind the smoke screen and discover the true state of affairs. The Court has to go into substance and not to be satisfied with the form. Though in Rashik Lal 229 ITR 458 (SC) & Bagyalakshmi 55 ITR 660 (SC) it was held that a partner may be a trustee or may enter into a sub-partnership with others, or can be a representative of a group of persons and that qua the partnership, he functions in his personal capacity, these decisions will not apply since the assessee was indirectly trying to bring in M/s Deloitte Haskins & Sells, Mumbai, another firm, which was already a participating firm, as its partner, circumventing the limit of maximum 20 members. The AO did not apply his mind and go into these aspects and so the CIT was justified in directing him to look into the issue.