TMI Blog2016 (2) TMI 170X X X X Extracts X X X X X X X X Extracts X X X X ..... l income of the assessee firm under the Act , and shall be allowed as deduction from the dividend income from Mutual Funds earned by the assesse firm as envisaged u/s 14A of the Act and shall go to reduce the exempt income earned by the assessee firm from dividend income from Mutual Funds as computed by the AO after applying provisions of Section 14A of the Act read with Rule 8D of Income Tax Rules, 1962 or in 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll take up assessee firm s appeal and the Grounds of Appeal raised by the assessee firm in its appeal in the memo of appeal filed with the Tribunal being ITA No.994/Mum/2014 read as under: 1. The Learned Commissioner of Income Tax (A) has erred in confirming the disallowance of ₹ 15,36,264/- uls. 14-A of the Act without properly considering the facts of the case in totality as well case law relied upon by the appellant. 2. Without prejudice to the above the appellant submits that Learned CIT (A) has erred in confirming the disallowance merely on the ground that in appellants' case Learned CIT(A) (his 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k Brokers (P) Ltd (2010) 326 ITR-1(SC) wherein the Hon ble Supreme Court held that expenditure referred to in Section 14A of the Act refers to expenditure on rent, taxes, salaries, interest etc in respect of which allowances are provided for u/s Section. 30 to 37 of the Act and every payout is not entitled to disallowances for deduction. The assessee firm submitted that since, interest paid on capital of partners is only a statutory allowance allowable under the provision of sec. 40(b) of the Act, same cannot be held as an expenditure incurred for earning of an exempt income under the ambit of Section 14A of the Act. The assessee firm submitted 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has not incurred any expenditure of whatsoever nature for earning the exempt income , thus the question of any disallowance does not arise. The assessee firm submitted that no disallowance was made u/s 14A of the Act in the assessment year 2006-07 to 2008-09, but in the assessment year 2009-10 , a sum of ₹ 11,73,949/- was disallowed by the AO and confirmed by the CIT(A), against which the appeal is pending before the Tribunal . The CIT(A) held that for the assessment year 2009-10 , The CIT(A) has held that the AO was justifying in invoking the provisions of Section 14A of the Act and working out disallowance as per the Rule 8D of Income Tax Rules, 1962 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- -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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... allowance u/s 14A on account of interest expenditure which is not on the borrowed fund but on the capital contributed by the partners. Accordingly, this ground of the assessee s appeal is partly allowed. The major issue in dispute in the instant appeal is purely a legal issue requiring us to adjudicate question of law and is with respect to the treatment of interest paid by the assessee firm to its partners on the capital contributed by the partners, i.e. whether it is an expenditure under the provisions of the Act or part of the profit distributable to Partners being merely appropriation of profits chargeable to tax in the hands of the partners u/s 28(v) of 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the impact on the taxability of partnership firm and its partners and settled the controversy , brought in by the substantial amendments made by the Finance Act,1992. We are also fully aware that law declared by Hon ble Supreme Court is binding on all courts within the territory of India under Article 141 of Constitution of India which is binding on us and we are bound to follow the same. In the case of CIT v. Smt. Godavari Saraf [1978] 113 ITR 589 (Bom.), the Bombay High Court held that the Judgment of non-Jurisdictional High Court was binding on the Tribunal if there were no contrary judgments .The above Judgment runs contrary to Article 141 of the Constitution as per which 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 p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fference, viz., that for the purpose of the Income-tax Act, partner includes a minor admitted to the benefits of partnership. The relationship between the partners and the incidence of the partnership are, thus, mainly governed according to the provisions of the Indian Partnership Act, 1932 and are subject to the conditions and formalities laid down under the provisions of the Income-tax Act and the rules made there-under. Salary ,commission and interest payable to partners The legal position as it existed prior to the amendment made by the Finance Act, 1992, was that any amount paid as remuneration to the partners, whether called salary, bonus, commission or by any other name 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 de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... firms. This type of assessment is available only when the firm fulfils the requirements as stated in section 184 of the Income-tax Act. HISTORICAL BACKGROUND The position under the 1922 Act was that where a firm was unregistered, the tax payable by the firm itself was determined, as in the case of any other distinct entity and the levy was made on the firm itself. On the other hand, where a firm was registered, the firm itself did not pay any tax but each partner s share of profit was added to his other income and the tax payable by each partner on the basis of his total income was determined and the levy was made on the partners individually. There was, thus, no double taxation in this case. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... they were again taxed at the appropriate rates. Further, the tax liability of a firm and its partners depended upon the question whether the firm was granted registration under the Income-tax Act or not. In the 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 assessment year 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 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , commission or remuneration due to or received by a partner in view of clause (v) to section 28 shall be chargeable to income-tax under the head Profits and gains of business or profession . 48.4 The payment of remuneration only to a working partner is allowable [defined in Explanation 4 to section 40(b)]. Only individuals are capable of being working partners. 48.5 The payment should be duly authorised by and in accordance with the terms of the partnership deed. These payments will be allowed as deduction only for a period beginning with the date of the partnership deed and not for any earlier period. Thus, if a partner is allowed a higher remuneration by varying the terms of the deed on a particular date, such higher remuneration 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officers so as to ensure that this power is not used in the case of small firms and even otherwise, it should be used sparingly. The Assessing Officers who invoke the provisions of section 40A(2) in any case, must keep in mind the assurance given by the Finance Minister to Parliament. 48.8 Interest paid to a partner would be allowed as a deduction in the hands of the firm. The payment of interest should be in pursuance of the partnership deed. The maximum rate of interest allowed would be 18% simple interest per annum [section 40(b)(iv)]. 48.9 Changes have been made in the scheme of set off and carry forward of losses. The existing provisions relating to firms and their partners in sections 76 and 77 have been omitted. Under the new scheme, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cheme of taxation of partnership firm. The firm shall be allowed as deduction of the interest paid to partner to the extent of 18/12 percent per annum even though there are no profits in the hands of the firm and the un-absorbed losses are allowed to be carried forward to the subsequent years by the partnership firm, while the partner income shall be computed after including interest paid to the partner to the extent allowed as deduction as per limit prescribed u/s 40(b)(iv) of the Act. The assessee firm has contended that the said interest is nothing but profit of the firm , as the interest to partners is not allowed as deduction under Section 30 to 37 of the Act but u/s 40(b) of the Act and hence interest on capital paid to partner is nothing but statutory allowance and is part of allocable 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- -vis Section 40(b) of the Act and has settled the controversy by holding that interest paid to partners is an expenditure whereby cla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 40(b)( iv) of the 1961 Act, which is in the nature of a proviso, it can no longer be said that sections 30 to 38 are not applicable to the firm as an assessee and that it will apply to all other assessees. That, prior to 1-4-1993, section 40(b)( iv) disallowed interest paid to the partners but after 1-4-1993 the firm has to establish its claim for deduction under sections 30 to 38 and that it was not disentitled under section 40(b) would apply. According to learned counsel, section 40 is in nature of a proviso to sections 30 to 38 and, therefore, even if the assessee establishes its claim for deduction under section 36(1)(iii), it has still to prove that it is not disentitled under section 40(b)( iv). Therefore, according to learned counsel, after Finance Act, 1992 the assessee has to establish 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 992 with effect from 1-4-1993 : 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 firm assessable as such,- (iv)any payment of interest to any partner which is authorized by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed insofar as such amount exceeds the amount calculated at the rate of eighteen per cent simple interest per annum; Issue 13. Whether the claim for special deduction made by the assessee exclusively came only under section 40(b)( iv) and that it never came under section 36(1)(iii) 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 section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iii ) applies to loan/borrowing. Conceptually, the position may be correct but we are concerned with the scheme of Chapter IV-D. After the enactment of Finance Act, 1992, section 40(b)( iv) was brought to the statute book not only to avoid double taxation but also to bring on par different assessees in the matter of assessment. Therefore, the assessee-firm, in the present case, was required to prove that it was entitled to claim deduction for payment of interest on capital borrowed under section 36(1)(iii) and that it was not disentitled under section 40(b)( iv). There is one more way of answering the above contention. Section 36(1)(iii) and section 40(b)(iv ) both deal with payment of interest by the firm, for which deduction could be claimed, therefore, keeping in mind the scheme of Chapter IV-D every assessee who claims deduction under 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, s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... viz. Section 36(1)(iii) of the Act and hence the contentions of the assessee firm that as per decision of Hon ble Supreme Court in the case of CIT v. Walfort Share and Stock Brokers Private Limited (2010) 192 taxman 211 (SC) interest paid to partner on capital contribution cannot be treated as an expenditure being incurred or attributable to earn exempt income u/s 14A of the Act as the said interest is itself not expenditure but a statutory allowance , cannot be accepted in view of the decision of the Hon ble Apex Court in Munjal Sales Corporation(supra). The Ahmedabad Tribunal in the case of Shankar Chemicals Work v. DCIT (2011) 12 taxmann.com 461(Ahd.) has under identical facts and circumstances passed an elaborate and detailed order and held as under: 5. At the time of hearing before us, on behalf of the assessee, Shri S.N. Soparkar along 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 pag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... suffer taxation in the hands of the partner. Thus, if the interest is disallowed in case of the firm then it will not be taxed in the case of the partner. It may be noted that in case of the assessee firm, the partners to whom interest is paid are taxable at the maximum rate. He further submitted that amendment in the assessment of a firm has been made to avoid double taxation of the income. Interest paid to partners is distribution of profit allocated to the partners in the form of interest. Interest to partners can be taxed once either in the hands of the firm or in the partner's hand. It cannot be taxed in both places. Since, the partners have paid tax on interest received from the firm and all the conditions laid down in the provisions of section have been fulfilled, no portion of interest paid to partners can be disallowed. If it is disallowed, it 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rejected. 6.2 One more contention raised by the ld. Counsel of the assessee is that if at all any disallowance has to be made in the hands of the firm, direction should be given that, to that extent, interest income should not be taxed in the hands of concerned partners. In this regard, he drew our attention to the provisions of section 28(v), which reads as under : 28. (v) any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm : Provided that where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under clause (b) of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted. 6.3 From the above proviso 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 secti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n raised by him is this that interest paid to partners is distribution of profit allocated to the partners in the form of interest and hence interest to partners can be taxed once, either in the hands of the firm or in the hands of the partner and it cannot be taxed in both hands. It is also his contention that since the partners have paid tax on interest received by them from the firm, no portion of interest paid to partners can be disallowed and if it is disallowed, it will amount to double taxation. This contention of the ld. Counsel is also devoid of any merit because interest to partners by the firm is not distribution of profit by the firm because interest is payable to the partners, if it is so prescribed in the partnership deed, even if there is no profit in the hands of the firm. If the firm pays interest to the partners and the firm is having loss, loss 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 in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Assessing Officer disallowed the interest in proportion to amount of investment and total fund employed whereas it should be in proportion to taxable and non-taxable and payment of interest. This plea of the ld. Counsel of the assessee is also liable to be rejected because if any expenditure has been incurred for earning exempt income, the same has to be disallowed even if there is no actual earning of any exempt income. If interest-bearing borrowed funds are utilised for the purpose of investment in shares and there is no receipt of dividend income or if there is only meagre amount of dividend income, even then, the whole amount of interest expenditure incurred for this purpose will be subject to disallowance under section 14A because the same has been incurred for earning exempt income. Hence, the actual earning of exempt income is not relevant. In the earlier 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 incurr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 47 CTR 162(Del.) f) Kodak India Private Limited v. Addl. CIT (ITA No 7349/Mum/2012) g) ACIT v. SIL Investment Limited(2012) 50 SOT 54(Del.) h) CIT v. Hero Cycles Limited (2010) 323 ITR 518(P H.) We will now review all the above decisions in the light of our above discussions as above: a) CIT v. Walfort Share and Stock Brokers Private Limited (2010) 326 ITR 1(SC) , whereby the Hon ble Supreme Court held that expenditure incurred as is referred to in Section 14A of the Act refers to the expenditure in respect to which allowance are provided u/s 30 to 37 of the Act . We have already discussed that the claim of deduction of interest on capital paid to partner is to be allowable firstly if all the conditions as stipulated u/s 36(1)(iii) of the Act is complied with, and that Section 40(b)(iv) of the Act is not a stand alone section and is a corollary to Section 36(1)(iii) of the Act 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the extent relevant: 10. (1) The tax shall be payable by an assessee under the head 'Profits and gains of business, profession or vocation' in respect of the profits or gains of any business, profession or vocation carried on by him (4) Nothing in clause (ix) or clause (xv) of sub-section (2) shall be deemed to authorise the allowance of any sum paid on account of any cess, rate or tax levied on the profits or gains of any business, profession or vocation or assessed at a proportion of or otherwise on the basis of any such profits or gains; and nothing in clause (xv) of sub-section (2) shall be deemed to authorise- .. (b) any allowance in respect of any payment by way of interest, salary, commission or remuneration made by a firm to any partner of the firm; It is plain that salaries paid to partners are regarded by the 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Munjal Sales Corporation 168 taxmann 43 holding that the expenses on account of salary,commission,bonus or remuneration and interest to partner has to be firstly satisfy the requirements of Section 30 to 38 of the Act and then Section 40 is merely a corollary to Section 30 to 38 of the Act limiting the deduction as per Section 40 of the Act . Thus, decision in R M Chidambaram Pillai in 106 ITR 292 cannot be applied under the new changed law post Finance Act,1992 whereby the partnership firm is taxed as a separate entity. c d) Nectar Beverages Private Limited v. DCIT(2009) 314 ITR 314(SC) Vishnu Anant Mahajan v. ACIT in ITA no 3002/Ahd/2009(Ahd.-SB)-(2012) 22 taxmann.com 88 The reliance of the assessee firm on the above decisions to contend that since depreciation u/s 32 of the Act is held to be statutory allowance and cannot be considered 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 alread ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as the assessee firm has paid interest on capital to partners and the same funds are deployed to make investment in Mutual Fund and by applying Rule 8D (2)(ii) of Income Tax Rules, 1962 the proportionate disallowance as per formula provided in the said rule is made by the AO, the nexus of deployment of partner capital on which interest has been paid by the assessee firm in the Mutual Fund on which exempt income is to be earned is already proved by the AO. The said Rule 8D of Income Tax Rules, 1962 is held to be applicable w.e.f. assessment year 2008-09 by Hon ble Bombay High Court in Godrej and Boyce Manufacturing Company Limited (2010) 194 Taxman 203(Bom.), while impugned assessment year is 2010-11. Thus, this contention of the assessee firm is also rejected. We are bound by the decision of Hon ble Supreme Court in the case of Munjal Sales Corporation (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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dered as allowable expenditure only against the exempt income u/s 14A of the Act provided other conditions are fulfilled. Thus, we hold that the interest on partner s capital to the tune of ₹ 12,66,679/- as computed by the AO u/s 14A of the Act read with Rule 8D of the Income Tax Rules, 1962 is an expenditure , which is allowable as an expenditure being incurred by the assessee firm in relation to an income which does not form part of the total income of the assessee firm under the Act , and shall be allowed as deduction from the dividend income from Mutual Funds earned by the assesse firm as envisaged u/s 14A of the Act and shall go to reduce the exempt income earned by the assessee firm from dividend income from Mutual Funds as computed by the AO after applying provisions of Section 14A of the Act read with Rule 8D of Income Tax Rules, 1962 or in 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No. Name Amount 1. Tawfiq Ahmed Al Rasheed 90127 2. Mian Shafiq Ahmed Mushtaq 26946 3. K.T Varindani 505147 4. Doulat Aswani 2544625 5. Mahesh Rupani 109541 6. Bin Helabi Trading Est 117270 7. Al Moudi (Shafif) 50490 3444146 Less: Last year provision but not to pay 26020 Total 3418126 The AO observed that no tax was deducted at source by the assessee firm on such payments. The assessee firm was asked to explain why the expenses should not be disallowed u/s. 40(a)(i) of the Act The assessee firm submitted that circular No. 786 dated 07/02/2000 has clarified that in the case of non resident whose income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no part of it is attributable to Indian Territory. The assessee firm submitted that no technical/managerial services were involved since non-resident agents are merely commission agents appointed to procure sale orders for the assessee firm and have not rendered any technical/managerial services. The assessee firm submitted that the nature of service referred by the agent were as under as per the confirmation submitted by the agents :- In connection with the above and as requested by you we hereby confirm of having received a commission of $..... for acting as your commission agent in our country. We are acting as commission agent on your behalf canvassing your business, visit the customers and procure business of textile items after knowing requirements of various customers discussing with you telephonically / by e-mail, again communicating with customers here and then fix the price and thereafter place orders on behalf of the prospective buyers with you as per samples given to us. Sometimes, we get samples from you which we show to various customers and book orders on your behalf. It is also placed on record after the goods are shipped from India you send a duplicate copy of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t source, it is hit by the provisions of section 40(a)(i) of the Act and tax should have been deducted at source by the assessee firm u/s 195 of the Act or an application should have been made by the assessee firm for no deduction of tax at source u/s 195(2) of the Act . Thus the AO held that these payments to non-resident by assessee firm is income deemed to accrue or arise in India and chargeable to tax u/s 9(1)(vii) of the Act and as per the explanation to section 9(2) of the Act , the fees for technical services means any consideration for rendering of managerial , technical or consultancy services . The AO also held that as per explanation inserted to Section 9(2) by the Finance Act,2007 with retrospective effect from 01-06-1976 , the income of the non-resident is deemed to accrue or arise in India whether or not the non-resident has a resident or place of business or business connection in India. The AO relied upon the decision of the Hon ble Karnataka High Court in the case of CIT v. Samsung Electronics (2009) 320 ITR 209(Kar.) , the AO also relied on the decision of Mumbai Tribunal in the case of ACIT v. Anchor Health and Beauty Care Pvt. Ltd. in ITA No. 7164/Mum/2008 for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d hence the amount of commission is paid for booking of the orders and by stretch of no imagination these are managerial/management services rendered by the said foreign agents. These services abroad by a non-resident for which payment is made abroad , income there from cannot be said to have accrued in India and hence cannot be brought to tax in India. The assessee firm relied upon the decision of the Hon ble Delhi High Court in the case of CIT v/s. Eon Technology Pvt. Ltd. (343ITR266(Del.)) wherein similar issue was decided in favour of the taxpayer . The assessee also relied upon the decision of Mumbai Tribunal in the case of Armayesh Global v. ACIT in ITA No. 8822/Mum/2010 dated 04.05.2012 whereby Mumbai Tribunal held that the taxpayer was using services of overseas commission agents for procuring export orders it was only acting as an agent on commission basis and had not been providing any managerial/technical services. The assessee firm also furnished party-wise details of commission paid to nonresident agents for procuring business from 2006-07 to 2010-11, along with copies of P L Account and Balance Sheet for those year. The assessee firm submitted that for the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shment in India, amount in question did not accrue or arise in India and, thus, there was no need for deducting tax at source u/s. 195 of the Act . The CIT(A) referred to decision of the Mumbai Tribunal in the case of Yash Raj Films Private Limited (2013) 140 ITD 625. Thus, addition of ₹ 34,18,126/- made by the AO u/s 40(a)(i) of the Act was deleted by the CIT(A) vide orders dated 30.12.2013. 16. Aggrieved by the decision of the orders dated 30.12.2013 passed by the CIT(A), the Revenue filed the appeal with the Tribunal. 17.The ld. DR relied upon the order of the AO. 18. On the other hand, The Ld. Counsel of the assessee firm reiterated its submissions as were advanced before the authorities below which are not repeated for the sake of brevity. The ld. AR submitted that the decision of Hon ble Karnataka High Court in the case of Samsung Electronics(supra) has been over-ruled by the Hon ble Supreme Court in the case of GE India Technology Centre Private Limited (2010) 7 taxmann.com 18 (SC). The ld Counsel of the assessee firm submitted that amount has been paid by the assessee firm to the commission agents for procuring orders and the same was not allowed by the AO , ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nts for rendering services abroad in relation to sourcing of export orders and for collecting payments on behalf of the assessee firm, on which no tax was deducted at source by the assessee firm u/s 195 of the Act. The AO has disallowed the expenses of ₹ 34,18,126/- on account of export commission paid by the assessee firm u/s 40(i)(a) of the Act read with Section 195 of the Act by holding the said services to be managerial / technical services as defined under explanation 2 to Section 9(1)(vii) of the Act . The facts as emerging from records reveals that these foreign agents do not have any permanent establishment or any place of establishment in India .These foreign agents are operating in their respective countries and rendering services to the assessee firm from abroad and no part of the such income can be reasonably attributable to any operation carried out in India by these foreign brokers as per the facts which has emerged from records. The payments to said foreign brokers have been sent by the assessee firm from India directly to their bank accounts abroad through banking channels with the approval of Reserve Bank of India or payments are deducted by the foreign buyer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. The decision of Hon ble Delhi High Court is reproduced as under: The present appeal by the Revenue, which arises out of proceedings under Section 195/197 of the Income-tax Act, 1961 ('Act', for short), relating to assessment year 2010-11 on an application filed by Panalfa Autoelektrik Ltd. (assessee, for short), requires adjudication of the following substantial question of law:- Whether the ITAT was right in holding that the commission paid to Agenta World Trading and Consulting Establishment for procuring export orders, is not fee for technical services under Section 9(i)(vii) of the Income-tax Act, 1961? 2. For the sake of clarity, we record that the impugned order passed by the Income Tax Appellate Tribunal ('Tribunal', for short) is dated 25th October, 2013 and was passed in ITA 4654/Del/2012. 3. The assessee made an application dated 16th February, 2010 under Section 195(2) for authorization to remit Euro 1,40,055.53 as commission for arranging export sales and realizing payments to Agenta World Trading and Consulting Establishment, a nonresident company registered in Liechtenstein. There is no Double Taxation Avoidance Agreement be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Explanation-1 - For the purposes of this clause - (a) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India; ** ** ** Explanation 4 - For the removal of doubts, it is hereby clarified that the expression through shall mean and include and shall be deemed to have always meant and included by means of , in consequence of or by reason of . ** ** ** (vii) income by way of fees for technical services payable by- ** ** ** (b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or ** ** ** Explanation 2. - For the purposes of this clause, fees for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... #39; has been interpreted by the Supreme Court in the case of CIT v. R.D. Aggarwal Co. [1965] 56 ITR 20 and subsequently inBarendra Prasad Ray v. ITO [1981] 129 ITR 295/6 Taxman 19 (SC). We need not dwell on the said aspect in detail for several reasons, though Circular No. 23 dated 23rd July, 1969 issued by the Central Board of Direct Taxes would not be applicable as it stands withdrawn with effect from 22nd October, 2009 vide Circular No.7 of 2009. Firstly, the Assessing Officer had not invoked the said provision; secondly, as per Explanation 1 clause (a) to Section 9, in case of a business of which all operations are not carried out in India, only such part of income as is reasonably attributable to the operations carried out in India is deemed to be accrued or arisen in India under clause 9(1)(i). By Finance Act, 2012, Explanation 4 has been added with retrospective effect from 1st April, 1962, clarifying the expression through to have always meant and included, by means of , in consequence of or by reason of . There is no finding by the Assessing Officer and there is no allegation that a non-resident was carrying on any operation whatsoever in India. Thus, there is no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid terms. The expression management services was elucidated upon by this Court in J.K. (Bombay) Ltd. v. CBDT, [1979] 118 ITR 312/1 Taxman 537 in the following terms:- '6. It may be asked whether management is not a technical service. According to an Article on Management Sciences , in 14 Encyclopaedia Britannica 747, the management in organisations include at least the following: (a) discovering, developing, defining and evaluating the goals of the organization and the alternative policies that will lead toward the goals, (b) getting the organization to adopt the policies, (c) scrutinizing the effectiveness of the policies that are adopted, (d) initiating steps to change policies when they are judged to be less effective than they ought to be. Management thus pervades all organisations. Traditionally administration was distinguished from management, but it is now recognised that management has a role even in civil services. According to the Fontana Dictionary of Modern Thought, page 366, management was traditionally identified with the running of business. Therefore, management as a process is practised throughout every organization fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evant portions thereof read as under:- 2. Appointment (1) PAL hereby appoint AGENTA as its commission agent for sale of its products within the territory to the purchaser(s) during the terms of this agreement, subject to and in accordance with terms and conditions set out herein and AGENTA agrees to and accepts the same. (2) It is agreed by and between the parties that AGENTA'S representations and acts on behalf and for PAL viz-a-viz any third party shall be legally binding on PAL only when the same are authorized by virtue of a written and signed authorisation executed by PAL in favour of AGENTA. ** ** ** 4. Commission (a) PAL agrees and AGENTA accepts that the amount of commission payable to it shall be the difference between consideration which PAL receives in terms of the purchase contract/order form the purchaser(s) and the pre determined guaranteed consideration settled and agreed between the parties, as described in Annexure 1 annexed hereto; (b) The parties agree that all the taxes applicable and required to be deducted in India to the transaction contemplated herein at the date of execution of this agreement and at any time in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ms (especially of a book or article) requiring special knowledge to be understood: a technical report. 2. of involving, or concerned with applied and industrial sciences: an important technical achievement. 3. resulting from mechanical failure: a technical fault. 4. according to a strict application or interpretation of the law or the rules: the arrest was a technical violation of the treaty. Having regard to the fact that the term is required to be understood in the context in which it is used, fee for technical services could only be meant to cover such things technical as are capable of being provided by way of service for a fee. The popular meaning associated with technical is involving or concerning applied and industrial science .' 19. The said term was also interpreted by this Court in case of Bharti Cellular Ltd. (supra) where emphasis was laid on the element of human intervention, but we are not concerned with the said aspect in the present case. The non-resident had not undertaken or performed technical services , where special skills or knowledge relating to a technical field were required. Technical field would mean applied sciences or craftsmanshi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e acquirer may use. The service must be rendered in the form of an advice or consultation given by the non-resident to the resident Indian payer. 22. In the present, case commission paid for arranging of export sales and recovery of payments cannot be regarded as consultancy service rendered by the non-resident. The nonresident had not rendered any consultation or advice to the respondent-assessee. The nonresident no doubt had acquired skill and expertise in the field of marketing and sale of automobile products, but in the facts, as notice by the Tribunal and the Commissioner of Income Tax (Appeals), the non-resident did not act as a consultant, who advised or rendered any counselling services. The skill, business acumen and knowledge acquired by the non-resident were for his own benefit and use. The non-resident procured orders on the basis of the said knowledge, information and expertise to secure their commission. It is a case of self-use and benefit, and not giving advice or consultation to the respondentassessee on any field, including how to procure export orders, how to market their products, procure payments etc. The respondent-assessee upon receipt of export order ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervice will not be a technical fee, however, unless that special skill or knowledge is required when the service is provided to the customer. For example, special skill or knowledge will be required to develop software and data used in a computer game that would subsequently be used in carrying on the business of allowing consumers to play this game on the internet for a fee. Similarly, special skill or knowledge is used to create a troubleshooting database that customers will pay to access over the Internet. In these examples, however, the relevant special skill or knowledge is not used when providing the service for which the fee is paid, i.e. allowing the consumer to play the computer game or consult the troubleshooting database. 42. Many categories of e-commerce transactions similarly involve the provision of the use of, or access to, data and software (see, for example, categories 7, 8, 9, 11, 13, 15, 16, 20 and 21 in annex 2). The service of making such data and software, or functionality of that data or software, available for a fee is not, however, a service of a technical nature. The fact that the development of the necessary data and software might itself require su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, such as a professional, who has special qualifications allowing him to do so. It was recognised that this type of services overlapped the categories of technical and managerial services to the extent that the latter types of services could well be provided by a consultant.' We broadly agree with the aforesaid observations. However, in the case of selling agents, we add a note of caution that taxability would depend upon the nature of the character of services rendered and in a given factual matrix, the services rendered may possibly fall in the category of consultancy services. Paragraphs 41 and 42 do not emanate for consideration in the present case, and effect thereof can be examined in an appropriate case [However, see CIT v. Estel Communication (P.) Ltd. [2009] 318 ITR 185 (Del) and Skycell Communications Ltd. (supra)]. 25. Thus, the technical services consists of services of technical nature, when special skills or knowledge relating to technical field are required for their provision, managerial services are rendered for performing management functions and consultancy services relate to provision of advice by someone having special qualification that allow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... allowance under section 40(a)( ia) of the Act or not. We find that the CBDT by its recent Circular No. 7 dated 22-10-2009 withdrawn its earlier Circular Nos.23 dated 23-7-2009, 163 dated 29- 5-1975 and 786 dated 7-2-2000. The earlier circulars issued by the CBDT have clearly demonstrated the illustrations to explain that such commission payments can be paid without deduction of tax. Thus, the main thrust in such a situation is whether the commission made to overseas agents, who are non-resident entities, and who render services only at such particular place, is assessable to tax. Section 195 of the Act very clearly speaks that unless the income is liable to be taxed in India, there is no obligation to deduct tax. Now, in order to determine whether the Income could be deemed to be accrued or arisen in India, section 9 of the Act is the basis. This section, in our opinion, does not provide scope for taxing such payment because the basic criteria provided in the section is about genesis or accruing or arising in India, by virtue of connection with the property in India, control and management vested in India, which are not satisfied in the present cases. Under these circumstances, wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ission Corporation of AP Ltd. v. CIT (1999) 105 Taxman 742 (SC)and GE India Technology Centre Private Limited v. CIT ( 2010) 193 Taxman 234 (SC) has held that the obligation to deduct tax at source u/s 195 of the Act arises only when the payment is chargeable to tax under the provisions of the Act, in the hands of non-resident. Thus, determination of taxability of the income of the non-resident is governed by the provisions of the Act, rather than by the circulars issued by the CBDT. We have also observed that Mumbai Tribunal in the decisions of M/s. Indo Industries Ltd. v. ITO in ITA No. 183/Mum/2014, for the assessment year 2010-11 has 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 as under: 9. We have considered rival contentions, carefully gone through the orders of the authorities below and also deliberated on the judicial pronouncements cited before us in the context of factual matrix of the case. From the record we found that during th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a, the same cannot be made liable to be taxed in India insofar as payment was made to non-resident for the services rendered outside India as was held in the case of Dr. Reddy‟s Laboratory, 58 ITD 104 (Hyd.). 12. In the result, appeal of the assessee is allowed. We have also observed that the similar view have been taken by Delhi-Tribunal in the case of Welspring Universal v. JCIT, (2015) Taxmann.com 174(Del.-Trib.) for assessment year 2011-12 whereby the Tribunal held as under : This appeal by the assessee is directed against the order passed by the CIT u/s 263 of the Income-tax Act, 1961 (hereinafter also called 'the Act') on 8.7.14 in relation to the assessment year 2011-12. 2. Briefly stated, the facts of the case are that the assessee is engaged in manufacturing of engineering items. The AO observed during the course of assessment proceedings that a sum of ₹ 23,58,813/- was paid by the assessee as a foreign commission without deduction of tax at source. On being called upon to justify such non-deduction, the assessee tendered explanation which has been reproduced on pages 2-4 of the assessment order. Getting convinced with the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ived'. It refers to the annual accretion to the balance at the credit of an employee participating in a recognized provident fund; transferred balance in a RPF to some extent; and the contribution made by the Central Government or any other employer to the account of an employee under Pension Scheme referred to in section 80CCD. From the description of the contents of section 7, it can be seen that the commission received by a non-resident cannot be characterized as 'income deemed to be received' in India. The next ingredient of section 5(2) is the income which 'accrues or arises in India.' Since the chargeability to tax under this segment is attracted if the income accrues or arises to the non-resident in India, it becomes crucial to find out the place where income from export commission accrues or arises. In this regard, the source of accrual or arising of income cannot be relevant because the incidence of tax is attached with the place of accrual of income and not its source. Ordinarily, there can be several places involved in a transaction, such as, a place where an agreement is entered into or a place where services are actually performed or a place where t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India, the command of clause (i) of section 9(1) cannot apply. The other six clauses of section 9(1), namely, clauses (ii) (iii) dealing with income under the head 'Salaries'; clause (iv) dealing with 'Dividend'; clause (v) dealing with 'Interest'; clause (vi) dealing with 'Royalty'; and clause (vii) dealing with 'Fees for technical services', have no application to the facts and circumstances of the instant case. The amount of commission paid to the non-resident cannot be described as salary or dividend or interest or royalty or fees for technical services. 5. The argument of the ld. DR that Explanation below section 9(2) will bring the instant case within the fold of section 9(1), is devoid of any merit. This Explanation simply states that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clauses (v) or (vi) or (vii) of sub-section (1) and shall be included in the total income of the non-resident whether or not the non-resident has a residence or place of business or business connection in India or the non-resident has rendered services in India. A bare perusal of the Expla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such payment. Only if the amount is chargeable to tax in the hands of the recipient that the question of deducting any tax at source therefrom arises. In an earlier para, we have seen that the export commission is not chargeable to tax in the hands of non-resident in terms of section 5(2) of the Act. The natural outcome, which, therefore, emerges is that there can be no obligation of the assessee-payer to deduct tax at source on such commission payment to the non-resident. 8. Now, we turn to the amendment to section 195, which has been invoked by the ld. CIT to fortify his view that the assessee was required to deduct tax at source before making payment of commission to the non-resident. Before evaluating such a submission, it would be apposite to consider the prescription of the Explanation 2, as under:- Explanation 2. - For the removal of doubts, it is hereby clarified that the obligation to comply with sub-section (1) and to make deduction thereunder applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident, whether or not the non-resident person has - (i) a residence or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the commission payment to the non-resident and the consequential non-making of disallowance u/s 40(a)(i) of the Act. 10. The ld. DR vehemently accentuated on Circular no. 7 of 2009 to contend that with the withdrawal of the earlier benevolent circulars on this issue, the instant commission payment has become chargeable to tax in the hands of the payee and in the absence of the assessee having deducted tax at source, the ld. CIT was justified in setting aside the assessment order allowing deduction for such commission payment. 11. We do not find any force in this argument. It is relevant to note that Circular no 23 dt. 23/07/1969 clarified that no part of the income of a foreign agent of Indian exporter arises in India and hence such an agent is not liable to income-tax in India on the commission. Then circular no. 786 dt. 7/02/2000 further elaborated the consequence of Circular no. 23 by stating that since such commission income of foreign agent is not liable to tax in India, no tax is therefore, deductible at source undersection 195 and consequently the export commission payable to a non-resident for services rendered outside India is not disallowable u/s 40(a)(i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is not a solitary precedent available on the subject. The Hon'ble jurisdictional High Court in DIT v. Panalfa Auto Elektrik Ltd. [2004] 272 CTR (Delhi) 117, has held that the services rendered by non-resident agent for procuring export orders for the assessee cannot be held as fees for technical services u/s 9(1)(vii) of the Act. In this case, the assessee made an application u/s 195(2) for authorization to remit certain amount as commission for arranging export sales and realizing payment to non-resident company. The AO held that the commission payment was taxable as fees for technical services u/s 9(1)(vii) of the Act. That is how, when assailed, the Hon'ble High Court held that the payment of commission cannot be considered as fees for technical services in terms of section 9(1)(vii) so as to call for any deduction of tax at source. The Hon'ble Madras High Court in CIT v. Faizan Shoes (P) Ltd. [2014] 367 ITR 155/226 Taxman 115/48 taxmann.com 48, has also held that no disallowance can be made u/s 40a(i) in respect of commission paid to non-resident agent for providing services outside India. 14. At this juncture, it is pertinent to note that we are dealing wi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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