Facts of the Case
The respondent Assessee was a partnership firm carrying out profession of law initially constituted with three partners Smt. Manju Vaish, Smt. Kali Vohra and Mr. Vinay Vaish. With effect from 1st April 2006 Smt. Manju Vaish and Smt. Kali Vohra retired from the partnership and Mr. Ajay Vohra and Mr. Bomi F. Daruwala joined the partnership. Afresh retirement-cum-partnership deed was executed on 22ndJune 2008 and made effective from 1stApril 2006. Clause 6(a) of the said deed reads as under:
“Each Partner shall be entitled to an annual salary equivalent to his percentage share of profits multiplied by “Allocable Profits”. Allocable Profits shall be calculated as per the provisions of Section 40(b)(v)(1) of the Income-tax Act, 1961. The monthly salary of a Partner shall beequivalent to annual salary divided by 12. Such salary shall be deemed to accrue from day to day and may be drawn out in arrears and the salary so paid shall be treated as working expenses of the partnership before the profits thereof are ascertained.”
AO taking the exception to the aforesaid Clause 6 of the partnership deed dated 22nd June 2008 as regards the formula for the computation of the salary of the partners not being in terms of Section 40(b)(v) of the Act, disallowed the remuneration paid to partners.Besidethis payment of Rs.19 lakhs made to the Indian Branch of the International Fiscal Association (“IFA”), was also disallowed.However, since the payment was recognised under Section 80 G of the Act, 50% was allowed to bededucted and 50% was added back to the income of the Assessee.
Contention of Revenue
The AO concluded that since the partnership deed “neither specified the amount of salary to be paid to each of the working partners nor has laid down a specific method of computation thereof” and has only mentioned “allocable profit” which has not been defined in the partnership deed, Section 40(b)(v) of the Act would not apply.Further, the payment made to IFA was not relatable to the business purposes of the Assessee.
Contention of the Assessee
The Assessee explained to the AO that in terms of the Section 40(b)(v) of the Act, the Assessee had paid 40% of the net profits in the ratio of partner’s share of profit to the partners respectively as salary.Further, the payment was made to the Indian Branch of the IFA on progressive basis towards the cost of constructing one of its meeting halls on the understanding that the hall would be named after the Assessee firm, hence related to the business purpose of the assessee.
Held by CIT(A)
The CIT (A) by the order dated 4th January 2013 upheld the order of the AO.
Held by ITAT
The ITAT came to theconclusion that the term “allocable profit” should be understood by applying the common meaning which would be “profits available for allocation”. Explanation 3 to Section 40(b)(v) of the Act defines the term “book profit”as the “net profit before remuneration”. The ITAT, therefore, concluded that“a plain reading of Clause 6(a) leads to a conclusion that the term’ allocable profits’ was used to mean ‘book profits’ as used in Section 40(b)(v)of the Act or otherwise the reference to the section in the Clause has no meaning. When the partners have understood and meant that the word “allocable profits” to mean surplus/book profits, prior to calculation of partner’s remuneration, and when such an understanding was manifest in it sactions, there was no reason why the Revenue authorities did not understand this term in the same sense.” Consequently, the disallowance was held to be bad in law. With respect to second issue, the ITAT has accepted the explanation of theAssessee that the IFA was a professional body and a non-profit organization engaged in the study of international tax laws and policies. It, inter alia,undertakes research, holds conferences and publishes materials for the use ofits members. Mr. Ajay Vohra, one of the partners of the Assessee firm, wasalso a member of the executive body of the IFA. In the facts andcircumstances, the contribution made by the Assessee to the IFA was held tobe for, inter alia, creating greater awareness of the Assessee firm’s activitiesand therefore, an expenditure incurred for the purposes of the profession ofthe Assessee. It was accordingly held to be allowable as a deduction underSection 37(1) of the Act.Further, since the Indian branch of IFA was a non-profit organisation registered under Section 12AA of the Act, its income was not taxable and the question of deducting tax at source from the payment made to it in terms of Section 40(a)(ia) did not arise.
Held by Delhi High Court
The Court didn’t find any reason to take a view differentfrom the one taken by the ITAT in the facts and circumstances of the case. It was held that clause 6(a) of the partnership deed dated 20thJune 2008 clearly indicatesthe methodology and the manner of computing the remuneration of partners.The remuneration of the partners has been computed in terms thereof. TheCourt additionally noted that under Section 28(v) of the Act, any salary orremuneration by whatever name called received by partners of a firm wouldbe chargeable to tax under the head profits and gains of business orprofession. The proviso to Section 28(v) states that where such salary has notbeen allowed to be deducted under Section 40(b)(v), the income shall beadjusted to the extent of the amount not so allowed to be deducted. FurtherSection 155 (1A) of the Act states that where in respect of a completedassessment of a partner in a firm, it is found on the assessment orreassessment of the firm that any remuneration to any partner is notdeductible under Section 40(b), the AO may amend the order of theassessment of the partner with a view to adjusting the income of the partnerto the extent of the amount not so deductible. A conspectus of theseprovisions makes the opinion the ITAT consistent with the legal position.There was no legal infirmity in the interpretation placed by the ITAT on clause 6(a) of the partnership deed to conclude that the salary paid to the partners was in accordance withSection 40(b)(v) of the Act and ought not to have been disallowed.Consequently, as regards this issue, no substantial question of law arises.On the second issue, the Court found that the decision of the ITAT hasturned on facts. That the contribution made by the Assessee to the Indianbranch of the IFA, in the manner and in the circumstances notedhereinbefore, would create greater awareness of the Assessee firm andtherefore for its business purposes, was a possible view to take. It was held that nosubstantial question of law arises as regards to this issue as well. The appeal was accordingly dismissed.