TMI Blog2008 (12) TMI 437X X X X Extracts X X X X X X X X Extracts X X X X ..... ncome-tax Act, 1961, as held by the Hon ble Supreme Court in the case of Malhar Fisheries Co. v. CIT [1979] 120 ITR 49. ( iii ) The ld. CIT(A) further filed to appreciate that under the Indian Partnership Act, 1932, a partnership firm is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate right of its own. Moreover, the beneficiaries of the policy is not the assessee firm, but the nominees who are family members. ( iv ) The ld. CIT(A) also erred in not appreciating the fact that "Keyman" has to be person very important to the assessee whose premature death can cause irreparable loss to the assessee till a new "Keyman" is built or found. In the case of partnership firm such an eventuality would cause either dissolution or change in the constitution of the partnership firm." 3. The facts, in brief, are that the assessee is a partnership firm, consisting of 4 partners. The assessee, however, took Life Insurance Policy in respect of two partners and paid Insurance Premium on the said policies amounting to Rs. 34,62,952, which was claimed as expenditure. The Assessing Officer, after considering the provision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction between the partners and the firm because in section 2(31) of the Act a clear cut distinction had been made by recognizing the firm as a separate person. The Ld. CIT(A) also held that the allowability of the premium, after considering the fact that the amount receivable, being taxable, at the time or surrender or maturity, could not be doubted. The Ld. CIT(A) also held that both the cases, relied on by the Assessing Officer, were distinguishable on facts. Thereafter, the Ld. CIT(A) held that the conditions of section 37 were also satisfied because this expenditure amounted to have been incurred for the purpose of business. The Ld. CIT(A) also relied on the decision of the Tribunal in the case of Chemical Corpn. v. Dy. CIT [IT Appeal No. 2224 (Mum.) of 2003] wherein it was held that the Keyman Insurance Policy premium paid on the life of partner, was allowable in the hands of the Partnership Firm under section 37(1) of the Act. The Ld. CIT(A) also observed in the case of ITO v. Thakur Vaidynath Aiyar Co. [1984] 7 ITD 9 (Bom.) wherein it had been held that the premium on Keyman Insurance Policy was neither a personal expenditure nor capital expenditure. Accordingly, h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Tribunal in holding that this expenditure is allowable under section 37(1) of the Act. Though the Tribunal in the case of P.G. Electronics ( supra ) has held that in the case of partnership firm, the Keyman Insurance Policy premium paid by such firm was allowable as business expenditure, hence, the issue, prima facie, is covered in favour of assessee, however, since this issue is of recurring nature and wide importance, hence, we consider it pertinent to deal with the issue in a detailed manner. 6.1 In this background, the main issue which arises for our consideration is whether partnership firm is a separate entity for the purpose of Income-tax Act, 1961 or not and, whether, while computing the total income of partnership firm, any expenditure incurred by the partnership firm for the purpose of business though it may be incurred on its partner(s) is to be allowed or not. In this regard, it is to be noted 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 part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vant 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 Income-tax Act the position is somewhat different. A firm can be charged as a distinct assessable entity as distinct from its partners who can also be assessed individually. Section 3 which is the charging section is in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y ( see the Code of Civil Procedure, Order XXX, corresponding to Rules of the English Supreme Court Order XL VIII-A). 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 ( see order XXX, rule 9, of the Code of Civil Procedure), 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 ( see section 49 of the Indian Partnership Act, 1932). In the Indian Income-tax Act itse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Indian Partnership Act, 1932 and the General Clauses Act, 1897, held that the word "persons" in section 4 of Indian Partnership Act, 1932 contemplated only natural or artificial i.e., legal persons and since a firm was not a person and as such, it was not entitled to enter into partnership with another firm or HUF or individual. In holding so, the Hon ble Supreme Court also reviewed the English law as well as provisions of Code of Civil Procedure. 6.4 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 and i.e., Indian Partnership Act, 1932 which was also held so by the Hon ble Supreme Court in the case of A.W. Figgies Co. ( supra ). 6.5 Similar view was taken by the Hon ble Supreme Court in the case of Malabar Fisheries Co. ( supra ), 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ition required to be satisfied for attracting section 34(3)( b ) cannot be said to have been satisfied in the case. It is necessary that the sale or transfer of assets must be by the assessee to a person. Now every dissolution must in point of time be interior to the actual distribution, division or allotment of the assets that takes place after making up accounts and discharging the debts 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." 6.6 Again, it is seen that no specific provisions existed under the Income-tax Act, 1961 as regard to the issue whether distribution of assets among partners on dissolution of firm would amount to transfer or not and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... p income. We do not think the principle goes beyond the purposes of that scheme. It does not confer a corporate personality on the firm Beyond the area within which that principle operates, the general law, that is to say, the partnership law, holds undisputed domain. Now, in every case when the assessee professes that it is a partnership firm and claims to be taxed in that status, the first duty of the Assessing Officer is to determine whether it is, in law and in fact, a partnership firm. The definition in the tax law defines an "assessee" or a "dealer" as including a firm. But for determining whether there is a firm, the Assessing Officer will apply the partnership law, subject of course, to any specific provision in that regard in the tax law modifying the partnership law. If the tax law is silent, it is the partnership law only to which he will refer. Having decided the legal identity of the assessee that it is a partnership firm, he will then turn to the tax law and apply its relevant provisions for assessing the partnership income. " [Emphasis supplied] 6.9 Thus, in our humble view, the conclusion which emerges from the above discussion is that though the partnership ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T v. A.W. Figgies and Co. [1953] 24 ITR 405 (SC). As an assessable entity it is also distinct from a HUF, which in itself is regard as a separate unit of assessment under section 3: Raja Bejoy Singh Dudhuria v. CIT [1933] 1 ITR 135 (PC). For the purposes of the question before us it recks little that the very individuals who constituted the HUF now constitute the appellant-firm. Depreciation allowance was allowed to the HUF in its assessment proceedings, it was a step taken in determining the taxable income of the family. The depreciation allowed to the family cannot be regarded as depreciation allowed to the appellant. We must ignore entirely the circumstance that depreciation has been allowed to the HUF in the past." 6.12 Further, the Hon ble Bombay, High Court in the case of CIT v. Kaluram Puranmal [1979] 119 ITR 564 while dealing with the issue of assessability of profit arising from transfer of the shares by the firm to the partners, the Hon ble Bombay High Court held as under : "It appears to us that it is not proper for us to go into the interesting question raised by Mr. Desai as they do not arise from the order of the Tribunal. It appears that both the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are of opinion that the transaction between the firm and its partners can not be looked at as the Tribunal has done and by itself is no ground for setting aside or striking down the additions made by the ITO. However, merely because shares having a market price higher than the purchase price have been distributed amongst the partners at the average purchase price it will not make the alleged notional or fictional profit automatically taxable in the hands of the assessee. This can only be done if there is necessary factual basis for coming to such conclusions as were urged by the Departmental Representative before the Tribunal or similar ones; and even then the contentions of the assessee earlier indicated would be required to be considered which we have not done since they do not arise from the order of the Tribunal. The same will be required to be considered by the Tribunal when the case goes back to it." From the perusal of the above observations, it is noted that the Hon ble Bombay High Court, in principle, affirmed the position that partnership firm was to be treated independent of its partners and there could be a profit or loss in transactions between them. It is also noted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evailing relevant provisions under the Income-tax Act, 1961 which can be summarized as under : 6.15 As noted earlier, there was a judicial opinion that on distribution of division or allotment of assets to partners by the firm on dissolution or otherwise there resulted no gain exigible to tax, however, by incorporating section 45(3) and 45(4), the Legislature has declared its intention in clear terms that partners and the firm are two independent entities not only for the purposes of assessment but also for the purpose of determining the charge of income-tax on the transactions entered into between them. Similarly, from assessment year 1993-94 partnership firms have been given a corporal personality in a limited sense by making necessary amendments in the provisions of sections 10(2A), 28( v ), 40( b ) and relevant procedural sections which also conclusively prove that partnership firm as such is independent from its partners as far as provisions of Income-tax Act, 1961 are concerned. In this regard, we consider it to reproduce the relevant portions of Circular No. 636 dated 31-8-1992 as reported in 1981 (St.) 1 wherein the CBDT explained the new procedure of taxation of firm s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rates of income-tax for professional and non-professional firms has been removed. Partners are not liable to tax in respect of the share of income from the firm. However, remuneration and interest allowed to partners will be charged to income-tax in their respective hands. The only distinction between professional and non-professional firms will be in respect of slabs for allowing deduction to firms in respect of remuneration. 48.2 The share of the partner in the income of the firm will not be included in computing his total income. [Section 19(2A)]. However, interest, salary, bonus, commission or any other remuneration allowed by the firm to a partner will be liable to be taxed as business income in the partners hand. [Section 2( 24 )( ve ) and section 28( v )]. An explanation has been added to the newly inserted clause ( 2A ) of section 10 to make it clear that the remuneration or interest which is disallowed in the hand of the firm will not suffer taxation in the hands of the partner. In case any remuneration paid to a partner is disallowed in the hands of the firm or the amount is varied in subsequent proceedings, the partner s assessment can be rectified. [Section 155(1A).] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eduction only in cases were employer and employee relationship existed then, the amount received on maturity/surrender would have been made taxable only under the head Income from salary . Further, in this regard, the wordings of Explanation to section 10(10D) are also relevant wherein it has been mentioned that Keyman Insurance Policy a life insurance taken by the person on the life of another person who is or was the employee of a first mentioned person or is or was connected in any manner whatsoever with the business of the first mentioned person, hence, the Legislature has also envisaged various kinds of relationship which may exist between the person paying the premium and the person on who s life such Keyman Insurance Policy is taken. The CBDT vide its Circular No. 762, dated 18-2-1998 as reported in 230 ITR (St.) 12 explained the provisions of section 10(10D) as under : "Taxation of a sum received under the Keyman Insurance Policy. 14.1 A Keyman Insurance Policy of the life Insurance Corporation of India, etc. provides for an insurance policy taken by a business organization or a professional organization on the life of an employee, in order to protect the business a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ners, hence, even though the partnership firm may be a compendium of partners, but, in the present case it is so, of four partners and not of two partners, hence, the fact of Keyman Insurance Policy, being taken on the life of two working partners only, further justifies the claim of the assessee. 6.20 Thus, in the facts and circumstances of the case and in view of above discussion, we hold that Keyman Insurance Premium paid by the firm is allowable as business expenditure. Accordingly, we confirm the findings of the ld. CIT(A) on this issue. Thus, this ground of the revenue is dismissed. 7. Ground No. 2 reads as under : "2. ( i ) On the facts and in the circumstances of the case as well as in law, the learned CIT(A) erred in deleting the disallowance interest on the debit balance in the partners capital account. ( v ) The Ld. CIT(A) also failed to appreciate that clause 10 of the Partnership Deed provided that the partners were liable to pay interest in the debit balance in their capital A/c. ( vi ) The Ld. CIT(A) failed to appreciate that the assessee had not discharged the onus cast on, it by furnishing evidence to substantiate that the withdrawals made by the par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble Madhya Pradesh High Court in the case of CIT v. Alok Paper Industries [1982] 138 ITR 729 the ld. CIT(A) deleted the addition. The revenue, being aggrieved, is in appeal before us. 9. The Ld. Departmental Representative narrated the facts and relied on the Order of the Assessing Officer and on Grounds of Appeal. 10. The ld. Counsel for the assessee narrated the facts, argued the matter at length and placed strong reliance on the Order of the Ld. CIT(A). 11. We have considered the submissions made by both the parties, material on record and orders of the authorities below. It is noted that there is a provision for charging of interest on debit balances appearing in the Capital Accounts of the respective partners. It is also noted that there is a debit balance at the beginning of the year as well as at the end of year in the Capital Accounts of these partners. It is also noted that in a reply given to the Ld. CIT(A), the assessee has, categorically stated that these amounts had been utilized by these partners in respect of their other individual businesses, hence, in our opinion, amounts so withdrawn cannot be said to have been utilized for the purpose of business ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... factual background where it was not proved that amounts borrowed for the purpose of business were in any way spent for house-hold expenses whereas in the present case it is not a case of charging interest on amount withdrawn for house-hold purposes but it is a case of charging of interest on the debit balances appearing in the partner s account in accordance with the provisions of Partnership Deed, hence, the reliance placed by the ld. CIT(A) on this decision is also not correct. Accordingly, we hold that the decision of the Ld. CIT(A) is not correct in law in principle. However, exact computation of interest chargeable is to be made after giving credit of the salary payable to such partners on monthly basis, hence, we direct the Assessing Officer to work out the quantum of such disallowance after crediting the salary on monthly basis. It is needless to mention that the Assessing Officer shall grant an adequate opportunity of hearing to the assessee in doing so. Thus, this ground of Revenue is partly allowed. 12. In the result, the appeal, filed by the revenue, stands partly allowed. 13. Now, we shall take up the Cross Objection No. 283/Mum./2007, filed by the assessee. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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