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TMI Blog2023 (6) TMI 1110X X X X Extracts X X X X X X X X Extracts X X X X ..... The Assessing Officer and the ld. CIT(A) have failed to appreciate that the expenditure on interest payment is for the purpose of business and has been incurred on account of commercial expediency. 3. The Assessing Officer and the ld. CIT(A) should have appreciated that the revaluation of assets and consequent credit to the accounts of the retiring partners, as also the payment of interest on capital of the existing partner is in accordance with the accounting principles and in terms of the Partnership Deed. 4. The appellant craves leave to add, alter, substitute or delete any or all of the grounds of appeal urged above. 2. The facts of the case are that the assessees herein are partnership firms in Real Estate business and filed returns of income for these assessment years as follows: (i) Century Shelters, Bangalore: Sl. No. Assessment year Declared income (Loss) (Rs.) Claim of payment of interest (Rs.) 1. 2013-14 (-)7,31,59,321/- 4,80,00,000/- 2. 2014-15 (-) 8,19,56,557/- 4,89,13,370/- 3. 2015-16 (-) 9,15,43,286/- 5,36,92,085/- Total 15,06,05,455/- (ii) Century Silicon City, Bangalore: Sl. No. Assessment year Declared income (Los ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y Real Estate Holdings Pvt Ltd to its Directors Shri Ashwin Pai and Shri Ravindra Pai. The payment of interest by the firm to the retired partners was a colourable device to transfer the money and also reduce tax liability in the hands of the firm. AO has also taken note of the fact that a firm and its partners are separate entities for the purpose of taxation; and therefore, regardless of an amount being offered as income in the hands of partners, an expenditure not allowable in the hands of the firm has to be disallowed. On these facts, AO has found that this amount of Rs. 40 Crore which was transferred to the retiring partners, has not been utilized wholly and exclusively for the purpose of the business. Therefore, the proportionate interest of Rs. 4,80,00,000/- on the said capital cannot be said to be incurred wholly and exclusively for the purpose of business. Therefore, AO has held that the interest expenditure of Rs. 4,80,00,000/- was not allowable, under section 37(1) or section 36(1)(iii), as the expenditure was not laid out wholly and exclusively for the purpose of business. 3.2 Same is the position in the case of M/s. Century Silicon City, Bangalore. Against this, asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The purpose of said revaluation, as stated in the valuation report, was to assess the Fair Market Value of the properties. However, the fact remains that both the properties, being vacant pieces of land, continued to remain vested with the firm even long after such revaluation. There appears to be no rationale for such revaluation of vacant land, when there was no plan, either in the near future or on long term, to sell the land or develop any residential or commercial project thereon. (iii) Shri A. Ramkrishna had contributed one of the residentially converted immovable property (bearing Survey No 107/2 and Survey No 116/2 totally measuring 1 Acre 20 Gunthas) as capital to the assessee firm. However, it is ironical that upon revaluation of the properties vested with the firm (which included the property contributed by Shri A. Ramkrishna), no amount from the Revaluation account was transferred to the current or capital account of Shri A. Ramkrishna, though he was continuing as partner to the firm as on the date of revaluation. (iv) The revaluation of properties was done on 01.04.2010. In the same Financial Year 2010-11, five partners of the firm, namely Shri P. Ravindra Pai, Shr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Mc Dowell and Company Ltd Vs CTO (1985) (154 ITR 148) (SC), in following words (per the judgement authored by Justice Ranganath Misra), - "Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges." 3.5 The ld. CIT(A) further observed that Justice Chinnappa Reddy, while concurring with the judgement proposed to be delivered by Justice Ranganath Misra in the aforesaid case, has also made very pertinent observations regarding the consequences of tax avoidance and duty of Courts to intervene therein;- "The evil consequence of tax avoidance are manifold: (i) there is substantial loss of much needed public revenue particularly in a welfare State like ours; (ii) there is the serious disturbance caused to the economy of the country by the piling up of mountains of black money directly causing inflation; (iii) there is "the large hidden loss" to the community by some of the be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 38 provide for various deduction while computing the income under the head profits or gains from business or profession. Section 40 is an overriding section, which provides that notwithstanding anything contained in section 30 to section 38, certain specified amounts shall not be deductible in computing income under the head profits or gains from business or profession. In particular, clause (b) of section 40 provides that any payment of interest, bonus, commission, remuneration etc. shall not be deductible if the same is paid to a nonworking partner, or not authorized by the partnership deed, or relates to some other period, or exceeds certain prescribed monetary limit etc. The issue at hand in the instant case is the admissibility or otherwise of interest expenditure on capital in the hands of partnership firm. It is clear from the overall scheme of the provisions under Chapter IV (Computation of Business Income) that the claim of deduction of interest on capital has to be examined first under the specific provisions of section 36(1)(iii), and then under the residuary provisions of section 37. In the event that the interest expenditure per se is found to be admissible under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... blish in the first instance that it was entitled to claim deduction under Section 36(1)(iii) and that it was not disentitled to claim such deduction on account of applicability of Section 40(b)(iv). It is important to note that Section 36(1) refers to Other Deductions whereas Section 40 comes under the heading Amounts not Deductible. Therefore, Sections 30 to 38 are Other Deductions whereas Section 40 is a limitation on that deduction. It is important to note that Section 28 to 43C essentially deal with Business Income. Sections 30 to 38 deal with Deductions. Sections 40A and 438 deal with Business Disallowances. Keeping in mind the said scheme the position is that Sections 30 to 38 are deductions which are limited by Section 40. Therefore, even if an assessee is entitled to deduction under Section 36(1)(iii), the assessee(firm) will not be entitled to claim deduction for interest payment exceeding 18/12% per se. This is because Section 40(b)(iv) puts a limitation on the amount of deduction under Section 36(1)(iii). 15. It is vehemently urged on behalf of the assessee that partner's capital is not a loan or borrowing in the hand of a firm. According to the assessee, Section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... " 3.9 Thus, the ld. CIT(A) observed that it is evident on a plain reading, that the proviso to section 28(v) would only apply where any interest etc. has been disallowed in the hands of the partnership firm, by virtue of applicability of clause (b) of section 40. In the instant case, proportionate interest expenditure on capital has been disallowed in the hands of the partnership firm, to the extent the capital was not utilized for business purpose, both under the specific provisions of section 36(1)(iii) and general provisions of section 37. Therefore, no corresponding adjustment of interest income assessable in the hands of partners of the firm is permissible in the instant case, as the disallowance of interest has not been made under clause (b) of section 40 and as such, proviso to section 28(v) does not apply. This view has been upheld by ITAT, Ahmedabad Bench in case of Shankar Chemicals Works Vs ACIT (2011) (12 taxmann.com 461) (Ahmedabad-Trib.). The relevant part of the judgement is reproduced as under, - "From the 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 han ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The new partner brought in capital, on which interest at 12% was paid as authorised by the partnership deed. This interest has been disallowed by lower authorities. 4.2 According to the assessing officer interest paid is not for business purpose. He made this observation without appreciating that interest paid to partners i.e M/s Century Real Estate holdings Pvt. Ltd. is for the business purpose since the same is authorised by sec 40(b)(iv) of Income tax act and was incorporated by Finance Act 1992 and said section puts limitation on the deduction under section 30 to 38 therefore same cannot be disallowed in any other sec that is 36(i)(iii) or sec 37 of the Act and further sec 40 is an overriding section which provides that notwithstanding anything contained in sec 30 to sec 38. Hence clause (b) of the sec 40 provides that any payment of interest, bonus, remuneration etc. shall be deductible if following conditions are satisfied and further to allow the payment of interest. a) It should be authorized by the partnership deed. b) It should not pertain to a period prior to partnership deed. c) It should not exceed the permissible limit. 4.3 Same is the position in the case o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provided under Partnership Act, 1932, the amendment to section 40(b) of the Act as referred herein above has only altered the mode of taxation. Needless to say, the partnership firm is not a separate legal entity under the Partnership Act. It is not within the purview of the Income Tax Act to change or alter the basic law governing partnership. Interest or salary is paid to partners remains distribution of business income. 4.6 Relevant here to refer decision of Hon'ble Supreme Court in the case of CIT Vs. R.M. Chidambaram (1977) 106 ITR 292 (SC), wherein held as under: "11.4 Section 4 of the Indian Partnership Act 1932 defines the terms partnership, partner, firm and firm name as under : "Partnership" is the relation between persons, who have agreed to share the profits of a business, carried on by all or any of the partners acting for all. Persons who have entered into partnership with one another are called individually '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 as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he interest payment to partners by these firms to be allowed as a deduction while computing the income of these firms. However, the same shall be limited to the extent of allowability u/s 40(b) of the Act. 4.8. (a) In the present case, it is admitted fact that in the case of M/s. Century Sheltors vide Deed of Reconstitution of Partnership dated 23.6.2008, clause No.14 reads as follows: "Clause 14. The partners shall be paid such other remuneration, interest and commission as may be mutually agreed to upon by the parties time to time." (b) Vide deed of Reconstitution and Retirement of partnership dated 18.1.2011, clause no.13 reads as follows: "Clause 13. The partners shall be paid such other remuneration, interest and commission as may be mutually agreed to upon by the parties time to time." 4.9. (a) In case of M/s. Century Silicon City, the partnership deed dated 21.3.2007 clause no.15 reads as follows: "Clause 15. In all matters not expressly provided for herein, the provisions of the Partnership Act, 1932 shall apply." (b) The deed of Retirement of Reconstitution of partnership dated 7.8.2007 clause no.15 reads as follows: "Clause 15. The partners shall be paid suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lance of the book profit at the rate of 60 per cent:] 4.10 Being so, the payment of interest to these partners by these firms was duly authorised by the partnership deed or Resolution mutually passed by the partners of that firm M/s. Century Silicon City Ltd. Hence, it cannot be said that the payment of interest is without any authority, however, it should be limited to the rate of interest at 12% p.a. as prescribed in section 40(b)(iv) of the Act. If it is paid within that limit, the interest paid to the partners by these firms respectively to be allowed as a deduction in computing the income of these assessees. Further, it has to be noted that the interest has been paid to the partners by these two firms on the opening balance standing at the beginning of the each assessment year and the quantification of the amount of respective partners of these firms are quantified not in these assessment years under consideration and which has been quantified when they brought in the capital to the firm either in cash or kind. As held by the jurisdictional High Court in the case of CIT Vs. Sridev Enterprises cited (supra) that status of the amount standing as outstanding on the first day o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs where there was no investments by the assessee. Therefore, the interest paid to deposit is not in relation to dividend income. Answering this issue raised by the assessee, the Tribunal held that: "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 utilized 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 of the Act 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 incurred for earning taxable dividend income and hence, it is allowable, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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