AO Cannot Impute Partner Interest to Curtail Section 10AA Deduction: ITAT Surat

ACIT Vs Desire Jewellery (ITAT Surat)

The ITAT Surat dismissed the Revenue’s appeal against the order of the Commissioner of Income Tax (Appeals) deleting the disallowance made by the Assessing Officer under Section 80IA(10) read with Section 10AA(9) of the Income Tax Act for Assessment Year 2013-14. The assessee, Desire Jewellery, a partnership firm engaged in manufacturing and export of diamond-studded jewellery from a Special Economic Zone (SEZ), filed its return declaring nil income after claiming a deduction of ₹3.37 crore under Section 10AA. During assessment, the Assessing Officer observed that the assessee had not provided for interest on partners’ capital contributions or remuneration to partners and issued a show-cause notice proposing to reduce the eligible deduction by computing notional interest and remuneration. The Assessing Officer invoked Section 80IA(10), calculated partners’ remuneration and interest aggregating to ₹2.08 crore, and consequently restricted the Section 10AA deduction to ₹1.28 crore.

Before the Commissioner (Appeals), the assessee contended that the partnership deed did not authorize payment of interest on partners’ capital or remuneration to partners. It relied on CBDT Circular No. 739 dated 25 March 1996, which clarified that deduction under Section 40(b)(v) is admissible only where the partnership deed specifies the remuneration payable or prescribes the manner of its quantification. The assessee submitted that, since the partnership deed expressly excluded such payments, the Assessing Officer could not compel the firm to claim notional interest or remuneration for the purpose of reducing the deduction under Section 10AA. The Commissioner (Appeals), after examining the partnership deed and relying on the decision of the jurisdictional High Court in Pr. Commissioner of Income Tax v. Alidhra Taxspin Engineers and the Ahmedabad Bench decision in M/s Al Reza Food v. ITO, directed the Assessing Officer to delete the disallowance and allow the deduction as claimed.

Before the Tribunal, the Revenue argued that deduction under Section 10AA is allowable only on net income and that the assessee had structured the partnership deed to omit clauses relating to interest and remuneration, thereby inflating eligible profits. It contended that the Assessing Officer had correctly invoked Section 80IA(10) after finding that the arrangement resulted in excessive profits from the eligible business. The assessee, in response, submitted that Clause (8) of the partnership deed specifically provided that partners would not charge any interest on their capital contributions and Clause (9) expressly stated that no partner would be entitled to remuneration. It further argued that these contractual terms were valid, that tax planning permissible under law could not be equated with tax avoidance, and that the issue stood covered by the jurisdictional High Court’s decision in Alidhra Taxspin Engineers.

After considering the rival submissions, the Tribunal observed that the Assessing Officer had reduced the deduction under Section 10AA solely by imputing notional remuneration and interest payable to partners. It noted that the Commissioner (Appeals) had granted relief by following the binding decision of the jurisdictional High Court in Alidhra Taxspin Engineers, which held that the mere existence of provisions relating to partners’ interest or remuneration does not make such payments mandatory. The Tribunal also referred to CBDT Circular No. 739 of 1996, which clarifies that deduction under Section 40(b)(v) is available only where the partnership deed specifically authorizes such remuneration or prescribes the method for determining it. In the present case, the Tribunal found that the partnership deed expressly prohibited payment of both interest on partners’ capital contributions and remuneration to partners. It held that the Commissioner (Appeals) had correctly appreciated the facts and applied the jurisdictional High Court’s decision. As no contrary facts or legal authority were placed before it, the Tribunal upheld the order of the Commissioner (Appeals) and dismissed the Revenue’s appeal.

Cases Discussed:

• ACIT v. Meridian Impex – (2013) 37 taxmann.com 22 (ITAT Rajkot)
• Pr. Commissioner of Income Tax v. Alidhra Taxspin Engineers – Tax Appeal No. 265 of 2017 (Gujarat High Court, judgment dated 02.05.2017)
• M/s Al Reza Food v. ITO, Ward-2(4), Bhavnagar – 2017 (3) TMI 1237 (ITAT Ahmedabad)
• CBDT Circular No. 739 dated 25.03.1996 (regarding deduction of partners’ remuneration under section 40(b)(v))

FULL TEXT OF THE ORDER OF ITAT SURAT

1. This appeal by revenue is directed against the order of ld. Commissioner of Income tax (Appeals)-2 Surat dated 14.08.2017 for assessment year (AY) 2013-14. The Revenue has raised the following grounds of appeal:-

“1. Whether on the fact and circumstances of the case and in law, the Ld. CIT(A) was justified in deleting the disallowance made by the Assessing Officer by invoking provisions of Section 80(IA)(10) r.w.s. 10AA(9) in giving deductions of interest on Capital and Remuneration to partners of the assessee firm after finding that the assessee had taken undue benefits of Section 10AA by not claiming interest on Capital and Remuneration to partners which resulted increase in exempted profit of the assessee?

2. Whether on the facts and circumstances of the case and in law, the CIT(A) is justified in not appreciating the fact that buy not providing interest and remuneration to the partners, the firm has claimed higher profits leading to higher claim of deduction u/s 10AA of the Act and thus, devoiding the revenue from due amount of tax?

2. Brief facts of the case are that assessee is a partnership firm engaged in manufacturing and export of diamonds studded jewellery in Special Economic Zone (SEZ). The assessee filed its return of income for AY 2013-14 on 07.09.2013 declaring nil income. In the computation of income, the assessee claimed deduction under section 10AA of the Income Tax Act, 1961 (in short ‘the Act’) of Rs.3.37 crores. On perusal of record, the Assessing Officer noted that assessee has not claimed interest on capital contribution and remuneration to its partners from the business income. The Assessing Officer issued show cause notice, for allowance of remuneration to the partners and interest to their capital contribution. The assessee filed its reply dated 18.03.2016. The contents of the reply is extracted in para-2.1 in assessment order. In reply, the assessee claimed that the partners had not claimed interest on their capital interest and remuneration and that similar treatment was accepted in earlier years. For the day-to-day affairs of firm, the assessee has paid salary to their Manager so there is no need to claim notional expenses in profit and loss account and accordingly no such expenses on account of remuneration and interest on capital contribution of partners claim. The explanation furnished by the assessee was not accepted by the Assessing Officer. The Assessing Officer by invoking the provision of Section 80IA(10) worked out the remuneration and interest on capital contribution of Rs.2,08,76,390/- in the following manner:-

3. The A.O. thereby restricted the eligible deduction to the extent of Rs.1,28,29,529/-. Aggrieved by the disallowance on account of partners remuneration and interest on capital contribution the assessee field appeal before Ld. CIT(A). Before Ld. CIT(A) the assessee made detailed written submission. Detailed written submission of the assessee is recorded in para-5 of the order of Ld. CIT(A). In the written submission, the assessee stated that assessee is deriving income from manufacturing activity and claimed deduction under section 10AA of the Act of Rs.3.37 crores. The assessee has not debited interest on partners’ capital contribution and remuneration as partnership deed does not provide such provision for payment of interest and remuneration to partners. The Assessing Officer issued show cause notice on the basis of order of co-ordinate Bench of Rajkot Bench in the case of ACIT vs. Meridian Impex (37) Taxmnann.com 22 (2013). In reply to show cause notice, assessee is specifically contended that interest and remuneration of partners are not claimed by the assessee as the same is not authorized by or not in accordance with terms of partnership deed. The assessee also relied on the CBDT Circular No.739 of 1996 dated 25.03.1996, wherein it was clarified that no deduction under section 40(b)(v) will be admissible unless partnership deed either specified the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration. The assessee has shown their partnership deed that there is no such interest or remuneration is payable to the partners. The assessee also stated that Assessing Officer cannot compel the assessee to charge interest and remuneration by invoking the section 40(b)(v) of the Act well it is not mandatory but discretionary for the assessee who have made such claim. The Ld. CIT(A) after considering the submission of the assessee, contents of the partnership deed and decision of Hon’ble jurisdictional High Court in the case of Pr. Commissioner of income Tax vs. Alidhra Taxspin Engineers Tax Appeal No.265 of 2017 dated 02.05.2017, wherein it was held merely incorporation of interest on partners’ capital account and remuneration does not signify that same are in mandatory in nature. The Ld. CIT(A) also relied upon the order of ITAT Ahmedabad Benches in the case of M/s Al Reza Food vs. ITO Ward-2(4) Bhavnagar 2017 (3) TMI 1237 – ITAT Ahmedabad and directed the Assessing Officer to delete the disallowance made by the Assessing Officer for restricting the claim under section 10AA of the Act. aggrieved by the order of Ld. CIT(A) the Revenue has filed appeal before the Tribunal.

4. We have heard the submissions of Ld. Senior Departmental Representative (DR) for the Revenue and Ld. Authorized Representative (AR) for the assessee. The ld. Sr. DR for the Revenue submits that ld. CIT(A) has not appreciating the fact in proper manner. The deduction under section 10AA of the Act is allowable on net income and not on gross income. The assessee has deliberately not incorporated such clauses in the partnership deed. The Assessing Officer has rightly apply the provision of section 80IA(10) by bringing the fact on record that assessee has made arrangement in the partnership deed which does not provide for interest or remuneration to the partners, which resulted in excessive profit of eligible business. The Ld. Sr. DR prayed for restoring the order of Assessing Officer.

5. On the other hand, Ld. AR for the assessee submits that the grounds of appeal raised by Revenue is covered by a series of decisions wherein the decision of Hon’ble jurisdictional High Court in the case of Alidhra Taxspin Engineers (supra) was followed. The Ld. AR for the assessee submits that he has placed on record the copy of partnership deed dated 01.04.2010. And as per clause (8) of the partnership deed, the partners mutually agreed not to charge any interest on their capital contribution. Further, clause (9) of the partnership deed prescribed that none of the partners shall be entitled to any remuneration. The Ld. AR for the assessee submits that there is no violation of law and the law authorize the assessee to make a tax planning. What is the only prohibition is avoidance of tax and not tax planning. The assessee has not avoided any tax rather made tax planning, which is permissible under law. Further no tax can be levied without the authority of law as mandated by Article 265 of the Constitution of India. The Ld. AR for the assessee submits that grounds of appeal raised by Revenue is in fact covered by the decision of Hon’ble jurisdictional High Court in the case of Alidhra Taxspin Engineers (supra) which is followed by Ld. CIT(A) while granting relief to the assessee.

6. We have considered the submission of both the parties and have gone through the orders of authorities below. The assessee claimed deduction of Rs. 3.37 Crore under section 10AA. We find that Assessing Officer while passing the assessment order restricted the deduction under section 10AA of the Act by making allowance of remuneration to partners and interest @ 12% on their capital contribution. The Assessing Officer worked out such allowance of Rs. 2.08 Crore thereby restricted the deduction under section 10AA to the extent of Rs. 1.28 Crore. We find that Ld. CIT(A) while granting relief to the assessee followed the decision of Hon’ble jurisdictional High Court in the case of Alidhra Taxspin Engineers (supra), wherein it was held that mere incorporation of interest on partner’s account and remuneration does not signify that same are mandatory in nature. We also find that Ld. CIT(A) also considered the CBDT’s Circular No.739 of 1996 dated 25.03.1996 wherein it has been clarified that no deduction under section 40(b)(v) of the Act is admissible under partnership deed either specified the amount of remuneration payable to each individual working partners or laid down the manner quantify of such remuneration. In the present case, the clauses of partnership deed specifically restrict not to charge payment of interest to partners on their capital contribution as well as remuneration. We find that ld. CIT(A) has decided the issue after proper appreciation of fact and following the decision of Hon’ble jurisdictional High Court in the case of Alidhra Taxspin Engineers (supra). No contrary fact or law is brought to our notice to take other view. In the result the grounds of appeal raised by the revenue are dismissed.

7. In the result, the appeal of the Revenue is dismissed.

Order pronounced in open court on 01/11/2021 by placing result on notice Board.