Mere Change in profit sharing ratio would not change constitution of Partnership firm

Brief of the case:

ITAT Delhi in DCIT Vs Deepsons Southend held that if the assessee had filed an application u/r 46A with the request to admit the additional evidences annexed with the supporting documents like of balance sheet, IT returns etc. and moreover all the conditions of rule 46A were fulfilled and were necessary to go to the root of the matter while deciding the issues to which they relate.

If further held that if there is change in the profit sharing ratio of the partnership and all the partners remain same in the new partnership deed then that would not be change in the constitution of the firm so the loss of the firm could be carried forward.

If further held that the expense can be booked in the year in which the quantum of liability has been fixed irrespective of the year of rendering of services because until the liability has been fixed the same could not be booked in the books of account.

If further held that any penalty in the form of compensatory penalty should be allowed because the same was not for breaking the law.

If further held that, if the facts of the case have been changed from the earlier years in which the decision was announced by the appellate authority then the rule of consistency should not be followed. Fresh judgment should be framed.

If further held that if the creditworthiness of the creditor from whom loan had been taken had been proved by the assessee then addition u/s 68 could not be made.

Facts of the case:

The assessee was a partnership firm and was carrying on the business of trading in readymade garments and accessories. Assessee filed return of income declaring NIL income. The case was selected for scrutiny and AO made certain additions which were challenged by assessee with CIT(A) who had deleted the additions, then revenue filed an appeal with ITAT on the following grounds:

1. “Whether the CIT(A) is justified in admitting the additional evidences filed by the assessee at appellate stage in spite of the fact that assessee does not fulfill the mandatory conditions of rule 46A.
2. Whether the CIT(A) has erred in the facts and circumstances of the case in holding that the case of assessee is not a case where new firm had been constituted or had taken over any old firm and carry

forward and set off brought forward losses/unabsorbed depreciation.

Whether in the facts and circumstances of case the CIT(A) is justified in deleting the addition of Rs.3,00,000/- made on account of disallowance of expenses claimed for representing the case of

assessee in block assessment proceedings.

Whether in the facts and circumstances of case the CIT(A) is justified in deleting the addition of Rs.16,04,832/- holding that the expense claimed was not towards penalty.

Whether in the facts and circumstances of case the CIT(A) is justified in deleting the addition of Rs.60,79,928/- made u/s. 36(1)(iii).

Whether in the facts and circumstances of case the CIT(A) is justified in deleting the addition of Rs.26,00,000/- made u/s. 68 of the I T Act, 1961.”

Contention of the assessee:

Assessee was of the view that:

1. It had made an application u/r 46A and had fulfilled all the conditions of rule 46A by submitting all the required supporting like of balance sheet, IT return, PAN of the creditor etc. So the additional evidences should be accepted.
2. There was only change in the profit sharing ratio of the partners which was merely a change in the term and conditions of the partnership as the same partners continued to carry on the business. So, this was not a case of re-constitution of the firm.
3. The block assessment was still pending with ITAT and therefore the amount paid to the consulting firm could not be said not for the business purpose Moreover, as the quantum of liability was not fixed by the consulting firm so provision was not made. So in the year under consideration in which it had issued the bill the same had been booked in the accounts.
4. The payment made to the MCD was towards the laws of government and was in connection of business and was not for the illegal and unauthorized construction.
5. The interest was also paid by the assessee in the preceding assessment years 2002-2003 to 2006 to 2007 which was allowed in the proceeding so the same should be allowed following the rule of consistency.
6. The creditworthiness of the creditors had been proved by sending the documents by speed post to the AO and also furnished the same before the Ld CIT(A) along with application for admitting additional evidences which stood admitted. So addition u/s 68 should not be made.

Contention of the revenue:

Revenue was of the view that:

1. The assessee had not fulfilled the conditions of rule 46A so additional evidences should not be accepted. Moreover AO had made the additions on cogent reasons. So, addition should be made.
2. The Assessing Officer observed that the profit sharing ratio in the new partnership deed executed on 02.04.2007 was different from the profit sharing ratio of the earlier firm having the same name and
3. there was a new source of income in the hands of the new firm which shows existence of a new firm on 02.04.2007, irrespective of the fact that the name and partners of both the firms were same. He, therefore, observed that the case of the assessee was not covered by the provisions of section 187 and the brought forward losses of another firm was not allowed to be set off in terms of section 78 of the Income Tax Act.
4. The block assessment proceedings, initiated as a result of search dated 26.02.02, stood completed on 27.02.2004 and even the appeal before the CIT(A) stood disposed of on 20.12.2004. Therefore, there was no reason to make payment in the A.Y. 2009-10 with respect to such proceedings which stood completed 3-4 years back. So addition should be made of the same.
5. The payment made to MCD was towards the penalty imposed by MCD for illegal and unauthorized construction. So, the penalty paid should not be allowed to the assessee.
6. The funds borrowed from the bank had been given to the partners which, was confirmed by the increase in the debit balance from year to year. So, as the same had not been used for the business so, the interest paid on the borrowed funds should be disallowed. It was of no relevance that the interest was allowed in the earlier years.
7. As the creditworthiness of the creditor and genuineness of the transaction stood unproved so, the amount received from the creditor should be added to the income of the assessee.

Held by ITAT:

1. ITAT held that the additional evidences were relevant to go to root of the matter while deciding the issue to which it related. So CIT(A) was justified in accepting the additional evidences. So appeal of the revenue stood dismissed.
2. The CIT(A) had rightly allowed the appeal of the assessee on this issue because mere change in the profit sharing ratio would not amount to reconstitution of the partnership for the purpose of section 78 of the Act. It was not in dispute that all the partners after reconstitution of firm remained same and there was no instance of any incoming or outgoing partner. So the appeal of the revenue was dismissed.
3. ITAT held that as the assessee maintains accounts on mercantile system and until amount of liability was not fixed, the expense could not be booked in the accounts, so the booking of expense in the year under consideration was justified. So appeal of the revenue was dismissed.
4. ITAT held that as the payment made to the MCD was not in the form of penalty for infringement of law but, were based on the laws of the government and was in connection of the business. So the appeal of revenue was dismissed.
5. ITAT held that it was irrelevant that the bank interest was allowed in the assessment of the earlier years, facts of the current case had to be taken care of. So as in the above the case the debit balances of the capital accounts were increasing giving indication that the borrowed funds had been transferred to the partners. So, finally file had been remanded back to the AO to make the fresh assessment in the light of the information available. So, the appeal of the revenue was allowed for statistical purpose.
6. ITAT held that as the IT return of the creditor had been presented which justifies the loan taken by the assessee from creditor. Moreover it was old creditor in the books of account. So, as the creditworthiness of the creditor had been proved so the appeal of the revenue was dismissed.