HIGH COURT OF PUNJAB AND HARYANA
Sood Bhandari & Co.
Central Board of Direct Taxes
CWP NO. 3765 OF 1997 ITR NO. 38 OF 1999 IT APPEAL NOS. 210 TO 212 OF 2002, 116 OF 2003, 43 & 80 OF 2004 AND 315 TO 317 OF 2005
Date of Decision – OCTOBER 5, 2011
Hemant Gupta, J. – This order shall dispose of afore mentioned writ petition; one reference under Section 256(1) of the Income Tax Act, 1961 and; nine Income Tax Appeals arising out of the factum of addition in the income either on account of payment of salary or interest on their capital to partners, when there is no prior agreement to pay either the determined amount of salary or rate of interest.
2. The question of law, as raised in ITR No. 38 of 1999, reads as under:
“Whether on the facts and circumstances of the case, the ITAT was right in law in allowing deduction of salary and interest paid to the partners on the ground that such an adjustment is not permitted under Section 143(1)(a), when the same is clearly inadmissible as per the provisions of Section 40(b) of the Income-tax Act, 1961?”
3. However, for facility of reference the facts are being taken from CWP No. 3765 of 1997, in which challenge is to the circular dated 25.03.1996 (Annexure P-5) issued by the Central Board of Direct Taxes (for short ‘the Board’) consequent to amendments in the Income Tax Act, 1961 (for short ‘the Act’) w.e.f. 01.04.1993 by Finance Act, 1992 whereas, in other cases questions of law have been framed on the same lines.
4. The petitioner filed its return of income in the status of a firm for the Assessment Year 1993-94 on 01.09.1993 declaring income of Rs. 1940/-. The return was accompanied with a copy of profit & loss account, balance-sheet and original agreement dated 01.04.1992 and copy of the partnership deed. The petitioner claimed deduction of salary and interest paid to the partners by virtue of agreement dated 01.04.1992 and having debited the same to the profit & loss account.
5. The Assessing Officer vide order dated 07.03.1996 (Annexure P-3) declined the registration of the firm under Section 184 of the Act for the reason that after commencement of Finance Act, 1992 w.e.f. 01.04.1993, the petitioner has not sought registration of firm with original partnership deed or the authenticated partnership deed as such deed is not signed by the partners. The Assessing Officer also found that the interest and salary is required to be authorized and should be in accordance with the terms of the partnership deed, which test is not satisfied by the petitioner. With the said finding, an addition of Rs. 92,421/- was made. The appeal against the said order was dismissed by the Commissioner of Income Tax (Appeals), Patiala on 13.12.1996. Since in the meantime, the Board has issued a circular on 25.3.1996 clarifying that where neither the amount of wages has been quantified nor even the limit of total remuneration has been specified and that the same has been left to be determined by the partners at the end of the accounting period, such payment of remuneration to partners cannot be allowed as deduction in the computation of the firm’s income. The said circular in its entirety reads as under:
Subject : Provisions of Section 40(b)(v) of the Income Tax Act, 1961, regarding admissibility of remuneration of working partner in the assessment of firms – regarding.
The Board have received representations seeking clarification regarding dis allowance of remuneration paid to the working partners as provided under Section 40(b)(v) of the Income Tax Act. In particular, the representations have referred to two types of clauses, which are generally incorporated in the partnership deeds. These are:
(i) The partners have agreed that the remuneration to a working partner will be the amount of remuneration allowable under the provisions of Section 40(b)(v) of the Income Tax Act; and
(ii) The amount of remuneration to working partner will be as may be mutually agreed upon between partners at the end of the year.
It has been represented that the Assessing Officer are not allowing deduction on the basis of these and similar clauses in the course of scrutiny assessments for the reason that they neither specify the amount of remuneration to each individual nor lay down the manner of quantifying such remuneration.
2. The Board have considered the representations. Since the amended provisions of Section 40(b) have been introduced only with effect from the assessment year 1993-94 and these may not have been understood correctly the Board are of the view that a liberal approach may be taken for the initial years. It has been decided that for the assessment years 1993-94 to 1996-97 deduction for remuneration to a working partner may be allowed on the basis of the clauses of the type mentioned at 1(i) above.
3. In cases, where neither the amount has been quantified nor even the limit of total remuneration has been specified but the same has been left to be determined by the partners at the end of the accounting period, in such cases payment of remuneration to partners cannot be allowed as deduction in the computation of the firm’s income.
4. It is clarified that for the assessment years subsequent to the assessment year 1996-97, no deduction under Section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.
5. The above clarification may be brought to the notice of all the Assessing officer of your region.
Secretary, Central Board of Direct Taxes
(F. No. 225/29/93/ITA-II)”
6. Learned counsel for the petitioners has raised two-fold arguments that the registration to the petitioner firm has been wrongly declined, as the petitioner has submitted partnership deed along with return. It is contended that it is not a recent partnership deed, but the deed of the year 1988, therefore, the Assessing Officer should have accepted such partnership deed and should have granted registration to the petitioner under Section 184 of the Act, as was then applicable. It is also argued that the petitioner has furnished a supplementary agreement dated 01.04.1992 contemplating payment of salary at the rate mutually decided by all the partners, therefore, such agreement is in terms of Section 40(b)(ii) of the Act. Thus, the payment of salary and interest to the partners has been authorized within the meaning of Section 40(b)(ii) of the Act. The said provision reads as under:
“40. Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession” –
(b) in the case of any firm asses sable as such –
(i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as “remuneration”) to any partner who is not a working partner; or
(ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorized by, or is not in accordance with, the terms of the partnership deed; or
7. On the other hand, learned counsel for the Revenue pointed out that the petitioner filed its return after the provisions of Finance Act, 1992 came into force w.e.f. 01.04.1993. The said Finance Act has made changes in respect of procedure of assessment of registered firms. The provisions of Section 182 of the Act prior to amendment of Finance Act, 1992 has the effect of double taxation in the cases of firms, as the income tax was payable by the firm in terms of Section 182(1)(i), tax was payable as well as on the share of each partners’ income in terms of Section 182(1)(ii). After amendment w.e.f. 01.04.1993, a firm can be assessed as a firm for the purposes of this Act, if the partnership is evidenced by an instrument; and that the individual shares of the partners are specified in that instrument. The certified copy of instrument of partnership was required to accompany the return of income of the firm of the previous year relevant to the assessment year commencing on or after the 1st day of April, 1993 in respect of which assessment as a firm has been sought. Section 185 of the Act contemplates where a firm does not comply with the provisions of Section 184 for any assessment year, the firm shall be assessed for that assessment year in the manner as an association of persons.
8. In terms of the amended provisions of the Act by Finance Act, 1992, the petitioner was required to submit a certified copy of the instrument of partnership or copy of the partnership deed signed by all the partners specifying the individual share of partners. However, the petitioner has not filed such partnership deed, therefore, the petitioner does not satisfy the requirement of amended provisions of Section 184 of the Act. It may be noticed that it is not the case of the petitioner, though it may not be necessary in view of the amended provisions of Section 184 of the Act, that the petitioner was assessed to income tax, as a registered firm for any period prior to 01.04.1993. Once the petitioner was not registered as a firm prior to amendment of the Act by Finance Act, 1992, the petitioner has to comply with the requirement of Section 184 as amended by Finance Act, 1992.
9. The argument that the partnership deed authorizes the payment of salary and interest to the partners, therefore, such amount is deductible as expenditure, is misconceived. In terms of Section 40(b)(ii) of the Act, any payment of remuneration to any partner, who is a working partner, or payment of interest to any partner on his capital contribution, which is not authorized by, or is not in accordance with the terms of the partnership deed is not allowable as expenses.
10. In fact, there is no material distinction between the terms of the original partnership deed dated 16.05.1988 and the subsequent agreement dated 01.04.1992. In the original partnership deed dated 16.05.1988, the term is as under:
“8. That the partners of the firm shall be paid salary from time to time as may be mutually agreed upon by the partners of the firm for whole time work done by them for the running of the business of the partnership firm.”
Whereas, the agreement dated 01.04.1992 contains the following recitals:
“2. That all the three partners contributing capital for the proper running of the business of the partnership firm shall be paid interest on their capital contribution at the rate mutually fixed by all the three parties referred to above in this agreement from time to time.
3. That all the partners of the firm attending to the business of the firm, shall be paid salary from time to time at the rate mutually decided by all the parties in this agreement.”
A reading of the two extracts reproduced above, would show that there was no agreement in respect of quantification of the salary or the rate of interest on the capital contribution of the partners. Such payment was left to the discretion of the partners at the end of the financial year. Section 40(b)(ii) contemplates the authorization of remuneration or interest. The authorization does not mean an agreement to pay, but to quantify the amount of salary or the rate of interest payable to the partners. If the said aspects are not determined prior to the financial year, the same are capable of adjustment at the end of the financial year keeping in view the profits earned with a view to increase expenditure and reduce income. The circular issued by the Board explains the expression authorized in the aforesaid circular dated 25.03.1996. The said circular does not run counter to any of the provisions of the Act. Therefore, the circular being clarificatory in nature cannot be said to be beyond the powers of the Board conferred on it under Section 119 of the Act.
11. The reliance of the petitioner that liberal approach is required to be given while applying the provisions of Section 40(b) of the Act is again not tenable. The case of the petitioner falls in category (ii) of para 1 of the said circular as the amount of remuneration to working partner has not been fixed. In respect of the said issue, the Board has clarified in its para 3 that payment of remuneration to partners cannot be allowed, if the same has not been specified, but has been left to be determined by the partners at the end of the accounting period. The said circular is, in fact, in tune with the intention and language of Clause (ii) of Section 40(b) of the Act, as mentioned above.
12. In view of the above, the writ petition & appeals filed by the assessee are dismissed whereas the reference sought by the Revenue on the aforesaid question of law is answered in favor of the Revenue and against the assessee.