No s. 14A disallowance if loan utilized for capital contribution in Partnership Firm

IN THE ITAT MUMBAI

Assistant Commissioner of Income-tax 12(3)

V/s.

Novel Enterprises

IT APPEAL NO. 1328 (MUM.) OF 2009

[ASSESSMENT YEAR 2005-06]

JUNE 13, 2012

ORDER

Vivek Varma, Judicial Member

The appeal filed by the department emanates from the order of the CIT(A)-XII, Mumbai, dated 16.12.2008.

2. The grounds raised by the department are as under :-

 1.  “On the facts and circumstances of the case and in law, the ld. CIT(A) erred in directing the A.O. to delete the addition of Rs. 33,08,179/- u/s 14A made on account of notional interest of paid to Reliance Capital Ltd. ignoring the facts that:

  a.  There was a nexus between the capital contribution and the share of profits of partners.

  b.  The assessee has earned both taxable as well as exempt income in the form of interest & share of profit from M/s Shreenath Enterprises.

  c.  The assessee has earned exempt income also on account of the capital introduced in the firm and this capital has come from the loan taken from Reliance Capital Ltd. on which it is paying interest, the addition made by the AO by invoking the provisions of section 14A is correct.”

3. The basic facts of the case are :

The appellant is a trust engaged in the business of shares and securities and a partner of a partnership firm M/s Shreenath Enterprises. During the year under reference, the Appellant had obtained loan from Reliance Capital Ltd (RCL) and was utilized for the purpose of business of trading in shares securities and also its loan/contribution to capital to Shreenath Enterprises. The appellant has paid interest to RCL and also received interest from Shreenath Enterprises. M/s. Shreenath Enterprises was formed as a partnership firm vide partnership deed dated 24th July, 2000. The assessee was admitted as a partner in the said Shreenath Enterprises vide agreement dated 1.1.2004. Clause (5) of the admission agreement sets out the profit sharing ratio amongst the partners including the assessee. On perusal of the said clause, it is seen that the contribution of capital or profit by way of loan were not the conditions while admitting the assessee in the partnership firm. The partners are entitled to their share of profits as per the partnership deed and such, share of profit is not dependent on contribution of funds made by the partners. The AO has estimated and apportioned interest expenses of Rs. 33,08,179 towards earning of exempt income and accordingly computed income after disallowing u/s 14A.

4. The A.O. took up the assessment proceeding and sought an explanation from the assessee that when interest payment is more than interest received and moreover interest free income in the form of share of profits from partnership firm is received then why suitable disallowance u/s.14A of the I.T. Act, 1961 be not made. The assessee made detailed submissions vide submission dated 26.11.2007. After considering the submissions of the assessee, the A.O. makes the following observations :

As per agreement dt. 1-1-2004 between the three partners of M/s Shreenath Enterprises i.e. M/s Deite Enterprises Pvt Ltd, M/s Radian Texfab Pvt. Ltd and the assessee point no.5 states that the net profit / loss of the partnership will be shared between the partners in the ratio of 1:1:98. On going through the capital account of all the three partners in M/s Shreenath Enterprises, it is seen that the assessee has an opening balance of Rs. 332,13,49,642 and has made an addition of Rs. 322,79,00,000 during the year. Whereas Delite Enterprises has an opening balance of Rs. 31,90,09,749 and Radian Texfab Pvt. Ltd. has an opening balance of Rs. 31,90,34,792 and no capital has been introduced by these partners during the financial year 2004-05. Thus, if total capital contribution is to be measured in percentage terms, the following facts will be observed:

Thus it can be seen while the profit sharing ratio is 1:1:98 the ratio of capital contribution is 4.44 : 4.44 : 91.12′ showing high degree of correlation between the capital contribution and profits shared.

The assessee has used the borrowed funds from M/s Reliance Capital Limited to invest in M/s Shreenath Enterprises and various shares and securities. The total sales in various shares and securities are to the tune of Rs. 56,77,14,5191- while profits on investment in partnership firm is Rs. 2,20,29,243/- and interest income is Rs. 10,38,04,143/-. The nexus between capital contribution and profits from M/s Shreenath Enterprises has already been, proved above. Thus, interest paid to M/s Reliance Capital Ltd should be distributed proportionately. amongst the total of sale of shares & securities (Rs. 56,77,14,519), ‘interest received from partnership,, firm (Rs. 10,38,04,143) and share of profit from partnership firm (Rs. 2.20,29,243).

As the profits from the partnership firm of Rs. 2,20,29243 is exempt in the hands of the assessee, the proportionate interest cost incurred for the same is hereby disallowed under the provisions of section 14A of the I.T. Act, 1961 The disallowance on this account works out as under:

The AO, thus made a disallowance of Rs. 33,08,179/- as expenses attributable u/s 14A of the Income Tax Act.

5. Being aggrieved, the assessee moved its grievance before the CIT(A), who deleted the additions, wherein the CIT(A) observed :-

“3.3 I have considered the submissions made for the appellants and the assessment order. On careful consideration of the facts of the case and the provisions of the Act, I agree with the appellant that the provisions of section 14A are not applicable in the present case. The appellant had raised interest bearing loan from Reliance Capital Ltd. The said Loan had been utilized by the appellant for the purchase of shares and also for making capital contribution to M/s Shreenath Enterprises in which the appellant was a partner. Thus, to the extent the interest bearing loan has been used for making contribution, there is a direct nexus between the loan obtained from Reliance Capital Ltd. and contribution made to the partnership firm. In other words, there is a direct nexus between the amount taken and loan given in respect of funds borrowed from Reliance Capital to the appellant had incurred an interest expenditure of Rs. 10,41,51,584/- against which the appellant has received interest of Rs. 10,38,04,143/- from Shreenath Enterprises in respect of its capital contribution. Thus, there is a direct connection or nexus between the interest paid by the appellant and the interest received by the appellant. The only issue of dispute raised by the assessing officer is that the appellant has received income in two forms from M/s. Shreenath Enterprises viz., interest on contribution and share of profit. White the interest income is subject to the share of profit from the firm is exempt u/s. 10(2A) of the Act. According to the Assessing Officer the interest expenditure incurred by the appellant has resulted into taxable as well as tax free income and hence that portion of the interest expenditure which relates to the share of profit is Liable to be disallowed in terms of section 14A of the Income Tax Act, 1961. The Assessing Officer has given the details of capital contributed by all the three partners including the appellant in order to substantiate his contention that the share of profit received by the partner is directly in proportion to the capital contributed by the partners. On the other hand, the appellant is of the view that there is no connection between the funds contributed by the appellant and the share of profit received from the partnership firm. M/s. Shreenath Enterprises, being a partnership firm, is governed by the Indian Partnership Act, 1932. There is no provision in the said Act as regards the contribution of capital by the partners. In other words, the Act does not contemplate or stipulate capital contribution by the partner as one of the conditions for a partnership firm. Section 4 of the Indian Partnership Act defines partnership to mean the relation between the persons who have agreed to share profit of business carried on by all or any of them acting for all Therefore, the sharing of profit or losses is the determinative factor for the existence of the partnership firm. M/s. Shreenath Enterprises was formed as a Partnership firm vide Partnership Deed dated 24th July, 2000 and the appellant was admitted as a partner in the said partnership. firm vide admission agreement dated 1 January, 2004. Clause (5) of the admission agreement sets out the profit sharing ratio amongst the partners including the appellant. Nowhere in the said clause has it been stated that contribution of money towards capital or loan were the conditions of admittance of the new partners for sharing of profits by the partners Alt the partners, including the appellant, are entitled to the profit sharing as per the partnership deed and the same was not dependent on contribution of funds made by the partners. Clause (8) of the partnership deed deals with the, capita/loans introduced by the partners to the firm. It clearly states that the partners may introduce capital and or give Loan to the firm which shall carry interest @ 12% annum or any other rate has been mutually agreed upon”.

6. Against this decision of the CIT(A), the department is in appeal before the ITAT.

7. Before us, the DR relied on the assessment order and on being asked as to which is the exempt income which is being considered by the A.O. for the purposes of disallowance u/s 14A, the DR replied it was the share from the profit of firm which has been considered.

8. The AR on the other hand reiterated the submissions made before the CIT(A) and emphasized its submissions made before the revenue authorities.

9. We have gone through the submissions and also the orders of the Revenue authorities and we have no hesitation of accepting the decision of the CIT(A), to which we subscribe to.

10. In the result, the appeal filed by the department is dismissed.