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2016 (10) TMI 56 - ITAT PUNE

2016 (10) TMI 56 - ITAT PUNE - TM - Addition u/s 14A - source of funds for investment made in mutual funds - interest paid to its partners - when loan taken from the partners would be held as own funds or borrowed funds for the purpose of Section 14A - since, interest on capital is taxable in hands of partners and disallowance will lead to double taxation in hands of partner as well as firm. - Held that:- It is clear from the above that firm and partners of the firm are not separate person under .....

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e firm from its partners does not arise at all and, therefore, section 36(1)(iii) is not at all applicable for the purposes of computation of interest to partners under section 40(b) of the Act. To put it differently, in view of section 40(b) of the Act, the Assessing Officer purportedly has no jurisdiction to apply the test laid down under section 36 of the Act to find out whether the capital was borrowed for the purposes of business or not. Thus, the question of allowability or otherwise of de .....

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ers is merely in the nature of contra items in the hands of the firms and partners. Consequently interest paid to its partners cannot be treated at par with the other interest payable to outside parties. - Thus, in substance, the revenue is not adversely affected at all by the claim of interest on capital employed with the firm by the partnership firm and partners put together. Thus, capital diverted in the mutual funds to generate alleged tax free income does not lead to any loss in revenu .....

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ver, the interest payable to parties other than partners, in our view, would be subjected to provisions of Rule 8D(2)(ii) of the Rules. Similarly, in the absence of any specific plea from assessee towards disallowance under Rule 8D(3), we hold it sustainable in view of express mandate of law. The matter is accordingly remanded back to the file of the Assessing Officer for re-computation of disallowance under Rule 8D r.w.s. 14A of the Act in terms of our opinion expressed hereinabove. - ITA No.20 .....

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nvoking the provisions of section 14A and consequently making disallowance of interest and other common expenses by holding that such expenses are attributable to the dividend income exempt from taxation. The Grounds raised by the assessee are reproduced hereunder :- 1. The learned, CIT(A) has not considered any merit in disallowing ₹ 29,25,362/- under section 14A rule 8D of the income Tax Act,1961. 2. The learned, CIT(A) has not considered the fact that the investment made by assessee are .....

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vant facts germane to the issue in brief are that the assessee is a partnership firm which is engaged in the business of manufacturing of chemicals etc. The assessee firm filed return of income for the relevant assessment year 2010-11 under section 139(1) of the Act declaring total income of ₹ 95,65,090/-. While making assessment under section 143(3), the Assessing Officer noticed that the assessee has inter-alia earned tax free dividend income amounting to Rs. ₹ 24,63,700/- from inv .....

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on which interest has been charged by them. The interest so paid to the partners have been claimed by the assessee against taxable income. Interest on bank loans amounting to ₹ 75,615/- and interest on partner s capital to the tune of ₹ 74,88,000/- aggregating to ₹ 75,63,615/- were charged against its taxable income. The Assessing Officer next observed that investment in mutual funds is made out of interest bearing funds which include interest bearing partner s capital also. In .....

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ded to disallow estimated expenditure incurred in relation to dividend income so earned in terms of formula provided under Rule 8D of the I T Rules. 4. In response to show-cause notice proposing disallowance under section 14A, it was submitted on behalf of the assessee that Rule 8D(2)(ii) concerning disallowance of proportionate interest attributable to interest bearing partners capital is not permissible in the facts of the case. It was inter-alia submitted that interest on partner s capital is .....

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as next contended that expenditure needs presence of two parties i.e. spender and earner. It was submitted that interest and salary to partners is not expenditure as in view of mutuality. The firm has no separate existence from its partners. The assessee firm is a separate entity under Income Tax Act only for taxation purposes. These is the very reason that deduction of interest and salary to partners is allowed as separate deduction and not as an expenditure under separate section from sections .....

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Officer discarded the various pleas of the assessee. He observed that the investments in mutual fund giving rise to tax free dividend income is sourced out of partner s capital and loans and consequently interest paid on partner s capital is also susceptible to Rule 8D(2)(ii) of the Rules. The Assessing Officer accordingly invoked Rule 8D of the Rules and computed disallowance of interest at ₹ 27,84,771/- in terms of Rule 8D(2) out of interest claims and ₹ 1,40,591/- to cover up com .....

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artners had introduced capital in the partnership firm which bears interest @12% per annum. The interest charged to the assessee firm has been claimed as revenue expenditure against taxable income. However, such interest is relatable to dividend income which does not form part of the total income. This being so, the provisions of section 14A are attracted and expenses incurred in relation to income which does not form part of total income requires to be disallowed. He accordingly confirmed the a .....

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pital . The fixed capital received from partners as appearing on the last day of the financial year stands at ₹ 6,24,00,000/- on which interest at the rate of 12% per annum has been charged to the partnership firm. There is no change in this fixed capital qua the preceding year. The Ld. AR thereafter averred that the assessee firm has also obtained current or fluctuating capital from the partners from time to time on which no interest is charged. The current capital as on last day of the f .....

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curred on certain loans from banks etc. On these facts, the Ld. AR raised a substantial question in relation to disallowance of proportionate interest in relation to partners capital by invoking Rule 8D(2)(ii) of the Act. It was contended on behalf of the assessee that interest payable on fixed capital received from its partners does not bear the characteristics of expenditure per se as contemplated under S. 14A of the Act. Reference was invited to S. 28(v) of the Act and it was pointed out that .....

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e footing, the interest on partner s capital is a return of share of profit by the firm to the partners. Both interest and salary to partners are not subjected to TDS provisions and both fall under section 40 of the Act. The Ld. AR submitted that section 40(b) is not just a limiting section notwithstanding the fact that some fetters on the rate of interest have been put. It was contended that salary to partners and interest paid on partners capital was made allowable in the hands of the firm onl .....

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ng. He thereafter submitted that in the light of the scheme of the Act, section 14A is applicable only qua the expenditure incurred and not in respect of any and every deductions or allowances. The Ld. AR also emphasized that expenditure needs two parties which is absent in view of the mutuality present in a partner s firm. The firm has no separate existence from its partners and the firm is separate assessable entity only for the purposes of Income Tax Act. The Partnership Act, 1932 does not re .....

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interest on partner s capital under Rule 8D(2) of the I.T. Rules requires to be reversed. Without prejudice and in the alternative, it was contended that the assessee firm had certain amount of current capital at its disposal which was not subjected to any interest and therefore benefit as available to the assessee in respect of interest free capital lying at its disposal should be granted as per law. The Ld. AR, in conclusion, sought appropriate relief in accordance with law. 9. The Ld. Depart .....

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The pre-dominant question that arises for our consideration is whether payment of interest to the partners by the partnership firm toward use of partner s capital is in the nature of expenditure or not for the purposes of section 14A of the Act and consequently, whether interest on partners capital is amenable to section 14A or not in the hands of partnership firm. 11. In order to adjudicate this legal issue, we need to appreciate the nuances of the scheme of the taxation. We note that prior to .....

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capital in essence is not treated as allowable business expenditure except for the deduction available under S. 40(b) of the Act. 11.1 Ostensibly, with effect from assessment year 1993-94, partnership firms complying with the statutory requirements and assessed as such are allowed deduction in respect of interest to partners subject to the limits and conditions specified in section 40(b) of the Act. In turn, these items will be taxed in the hands of the partners as business income under s. 28(v .....

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a business receipt unlike different treatments given to similar receipts in the hands of entities other than partners. In this context, we also note that under proviso to section 28(v), the disallowance of such interest is only in reference to section 40(b) and not section 36 or S. 37. This also gives a clue that deduction towards interest is regulated only under section 40(b) and the deduction of such interest to partners is out of the purview of s. 36 or 37 of the Act. Notably, there has been .....

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me Court in the case of CIT vs. R.M. Chimbaram Pillai (1977) 106 ITR 292(SC) relied upon by the Assessee. Supreme Court has held in the case of R.M. Chidambaram Pillai, etc. (supra) held that: "A firm is not a legal person, even though it has some attributes of personality. In Income-tax law, a firm is a unit of assessment, by special provisions, but it is not a full person. Since a contract of employment requires two distinct persons, viz., the employeer and the employee, there cannot be a .....

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40 per cent." Supreme Court has also held in the case of CIT vs. Ramniklal Kothari (1969) 74 ITR 57 (SC) that the business of the firm is business of the partners of the firm and, hence, salary, interest and profits received by the partner from the firm is business income and, therefore, expenses incurred by the partners for the purpose of earning this income from the firm are admissible as deduction from such share income from the firm in which he is partner. Thus, the partnership firm and .....

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lly Partners and collectively a firm and the name under which their business is carried on is called the firm name. Thus, it is clear from the above that firm and partners of the firm are not separate person under Partnership Act although separate unit of assessment for tax purposes. There cannot therefore be a relationship inferred between partner and firm as that of lender of funds (capital) and borrowal of capital from the partners, hence section 36(1)(iii) is not applicable at all. Section 4 .....

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y has no jurisdiction to apply the test laid down under section 36 of the Act to find out whether the capital was borrowed for the purposes of business or not. Thus, the question of allowability or otherwise of deduction does not arise except for S. 40(b) of the Act. 11.5 As noted, as per the scheme of the Act, the interest paid by the firm and claimed as deduction is simultaneously susceptible to tax in the hands of its respective partners in the same manner. In the same vain, the firm is merel .....

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