The assessee, a partner in a firm, received ‘share of profit’ and ‘salary’ from the firm. While the ‘share of profit’ was exempt u/s 10(2A), the ‘salary’ was taxable as business income u/s 28 (v). The assessee claimed deduction for business expenditure incurred by him. The AO held that as the assessee had exempt income, s. 14A applied and a part of the expenditure had to be disallowed. This was confirmed by the CIT (A). Before the Tribunal, the assessee argued that as a partnership firm was merely a compendium of partners having no independent legal personality, the share of profit was not an exempt income in the hands of partner as the firm had paid tax thereon. HELD rejecting the plea:
(i) Though in general law, a firm and its partners are not distinct, this is subject to statutory exceptions. Under the scheme of assessment of firms applicable from AY. 1993-94 a firm is treated as an independent entity and the expenditure by way of remuneration, interest, commission etc. paid to partners is allowable to it as a deduction subject to ceilings and such interest, salary etc is taxable in the hands of the partners. A firm and its partners are consequently separate entities under the Act;
(ii) Accordingly, the fact that the profits are charged to tax in the hands of the firm does not mean that the share of such profits is non – exempt in the hands of the partner. The profits being exempt in the hands of the partner, s. 14-A does apply in computing his total income.
(iii) The disallowance has to be worked out as per Rule 8D in view of Daga Capital 119 TTJ 289 (Mum) having held it to be retrospective.
Note: A contrary view has earlier been taken by the Bombay Bench in Sudhir Kapadia vs. ITO & Hitesh Gajaria vs. ACIT. It was held that though a firm is an assessable entity, it is not a full person and though the share of profits is exempt from the levy of tax in the hands of the partner u/s 10 (2A), it was not all-together tax free as the profits had been subjected to tax in the hands of the firm. The exemption granted by s. 10 (2A) was not absolute but only to avoid double taxation. Consequently, s. 14A was not applicable.