Capital Account Credit From Partnership Firm Write-Back Not Taxable as Cash Credit: ITAT Mumbai

ITAT rules that write-back of long-outstanding loan constitutes a consequential entry and not an unexplained cash credit; deletes addition under Section 68

Summary: The dispute arose from a substantial increase in a partner’s capital account due to the write-back of an old unsecured loan in the books of a partnership firm. The Assessing Officer treated the credit in the partner’s capital account as unexplained cash credit under Section 68 and taxed it under Section 115BBE, alleging lack of lender details and questioning the genuineness of the firm. The appellate authority deleted the addition, holding that the credit was merely a book entry consequential to adjustments in the firm’s accounts and not a fresh receipt by the partner. The Tribunal upheld this view, emphasizing that a partnership firm is a separate taxable entity under the Income-tax Act and any income, if taxable, must be assessed in the hands of the firm, not the partner. It further held that Section 68 applies only to fresh credits of the relevant year and cannot be invoked on opening or prior-period balances. Allegations of sham transactions and alternative taxation under Section 41(1) were rejected for lack of evidence.

Facts:

• The assessee, Ms. Antara Tushar Motiwala, is an individual. She filed her return of income for Assessment Year 2017–18 on 01.08.2017, declaring a total income of ₹19,05,920. The return was processed under section 143(1) of the Income-tax Act, 1961.
• The case was selected for limited scrutiny under CASS on the issue of large increase in capital during the year. During the course of assessment proceedings, the Assessing Officer noticed a substantial increase in the capital account of the assessee during the relevant previous year.
• In response to notices issued under section 142(1), the assessee explained that no fresh capital was introduced during the year and that the increase in capital amounting to ₹8,38,44,023 was on account of a prior period adjustment. It was explained that the adjustment arose from the assessee’s capital account in a partnership firm, M/s Lotus Investment, in which the assessee held a 34% share. It was further explained that the partnership firm had written back an old unsecured loan, and corresponding credit was given to the partners’ capital accounts.
• The assessee furnished details stating that M/s Lotus Investment had obtained an unsecured loan of ₹26,50,00,000 from Swan Finance Management Pvt. Ltd., which had become time-barred under the Limitation Act and was written back unilaterally in the books of the firm during Financial Year 2016–17. The assessee’s share of the loan written back was ₹9,01,00,000, which, after adjusting prior period losses and tax adjustments, resulted in a net credit of ₹8,38,44,023 in her capital account.
• The Assessing Officer issued notice under section 133(6) to the partnership firm and called for details of the lender, loan agreement, and confirmation. According to the Assessing Officer, neither the assessee nor the firm could furnish complete particulars such as PAN, address, and other details of the lender. The Assessing Officer further observed that the partnership firm was stated to have come into existence on 17.04.2006, whereas the loan was claimed to have been taken earlier. It was also observed that no interest was paid on the loan and no interest was charged on partners’ drawings. The Assessing Officer concluded that the firm was allegedly used as a special purpose vehicle to route unaccounted money into the books of the partners.
• Rejecting the explanation of the assessee, the Assessing Officer held that the increase in capital represented unexplained cash credit in the hands of the assessee. Accordingly, an addition of ₹8,38,44,023 was made under section 68 and taxed under section 115BBE of the Act.
• The assessee preferred an appeal before the Commissioner of Income-tax (Appeals). Before the CIT(A), the assessee reiterated that the credit in the capital account was consequential to entries in the books of the partnership firm and that section 68, if at all applicable, could be invoked only in the hands of the firm and not in the hands of the partner. It was clarified that the loan was taken in Financial Year 2006–07, and reference to Financial Year 2005–06 was an inadvertent error. It was further submitted that the partnership firm had been assessed under section 143(3) in multiple years and the loan stood accepted.
• The CIT(A) recorded that section 68 can be invoked only in the year in which the credit arises, that opening balances or prior period credits cannot be taxed under section 68 in a subsequent year, that the entry in the assessee’s capital account was only a book entry corresponding to adjustments in the firm’s books, and that the write-back of the loan was a capital receipt, being a unilateral act, and that expiry of limitation does not extinguish the debt but merely bars its enforcement. On these findings, the CIT(A) deleted the addition.

Issues:

• Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the addition of Rs. 8,38,44,023/- on account of unexplained credit in the form of unaccounted money in the books of partner of the firm Lotus Investment u/s 68 of the Income tax Act, 1961.
• Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in allowing the assessee’s appeal without appreciating the crucial fact that both the assessee and the firm failed to submit any details with respect to lender Swan Finance Management Pvt. Ltd. resulting into non-establishment of identity and credit worthiness of the lender and genuineness of the loan taken.
• Whether on the facts and circumstances of the case and in Law, the Ld. CIT(A) has erred in allowing the Assessee’s appeal overlooking the glaring facts pertaining to the assessee and the firm; i) No amount either principal amount or interest amount related to loan was paid. ii) No remuneration interest was paid to its partners of the firm which proves that the firm was not genuine rather a make believe arrangement.
• Whether on the facts and circumstances of the case and in Law, the Ld. CIT(A) has erred in allowing the appeal of Assessee without appreciating the facts that the firm was actually incorporated by the assessee for special purpose vehicle to route introduction of unaccounted money of partners in their books of account.
• Whether on the facts and circumstances of the case and in Law, the Ld. CIT(A) has erred in allowing the appeal of Assessee without appreciating the facts that the written off loan will be treated as revenue of the partners and will be treated as deemed income u/s. 41 of the income tax act.

Observations:

• The Tribunal noted that the Revenue’s objection arose from the increase in the assessee’s capital account due to the write-back of a loan in the books of the partnership firm in which the assessee was a partner. It was found as an undisputed fact that the transaction related to the firm and not to the assessee individually. The firm had written back an old loan and corresponding entries were passed to the partners’ capital accounts in accordance with their profit-sharing ratio. No fresh money was received by the assessee during the year, and the credit reflected only an accounting consequence of entries made in the firm’s books. It is a settled position of law that though under the general law of partnership a firm is not a juristic person, under the Income-tax Act a firm is treated as a separate and distinct taxable entity. The Hon’ble Supreme Court in CIT v. A.W. Figgis & Co. (24 ITR 405) has categorically held that a firm is a distinct assessable unit, separate from its partners. Consequently, income which is assessable, if at all, in the hands of the firm cannot be brought to tax again in the hands of its partners merely because corresponding entries appear in the partners’ capital accounts. Since, no addition was made in the assessment of the firm and the amount was sought to be taxed only in the hands of the partner, the approach adopted by the Assessing Officer was held to be legally unsustainable.
• The Tribunal recorded that the loan in question had been taken in financial year 2006–07, remained outstanding for several years, and was written back in financial year 2016–17 on the ground that it had become time-barred. The firm had undergone scrutiny assessments in multiple earlier years, during which the existence of the loan had been accepted. It was observed that Section 68 can be applied only in respect of a credit appearing in the books of the assessee in the relevant previous year. Amounts representing opening balances or credits relating to earlier years cannot be brought to tax under Section 68 in a subsequent year. The credit under consideration did not represent a fresh credit of the relevant year but merely reflected the impact of earlier entries in the firm’s books. The Tribunal further held that the Assessing Officer’s reliance on the inability to furnish current details of the lender was misplaced. What was being examined was not a fresh loan transaction but the write-back of a loan that had existed for more than a decade and had already been accepted in earlier assessments. In such circumstances, mere non-availability of certain particulars, in the absence of any material showing the loan to be fictitious, could not justify an addition under Section 68.
• The Tribunal noted that the allegation regarding non-payment of interest on the loan and non-payment of interest or remuneration to partners was not sufficient, by itself, to establish that the transaction was non-genuine. It was observed that matters such as charging of interest on loans or on partners’ drawings depend upon the terms of the partnership arrangement and the commercial understanding between the parties. In the absence of any corroborative material, mere absence of interest could not lead to the conclusion that the firm was not genuine.
• The Tribunal considered the allegation that the partnership firm was used as a special purpose vehicle for routing unaccounted money of the partners. It was observed that such an allegation was based only on surrounding circumstances such as absence of interest payments. The Tribunal agreed with the CIT(A) that these factors, without supporting evidence, were insufficient to establish that the transaction was sham or that the firm was merely a façade.
• The Tribunal noted that the CIT(A) had held the write-back of a time-barred loan to be a capital receipt and had observed that expiry of the limitation period does not extinguish the debt but only bars its enforcement. It was further observed that the Revenue failed to place any material to show that the conditions prescribed under Section 41(1) or Section 28(iv) were satisfied. Since the Assessing Officer had made the addition under Section 68 and not under Section 41(1), the attempt to justify the addition on an alternative basis was found to be untenable.