Firm Not Required to Charge Interest/Salary per Partnership Deed: ITAT Surat

A Partnership firm engaged in tobacco product manufacturing and trading entered into a supplementary partnership agreement on June 19, 2014. This agreement stated that from April 1, 2014, onwards, no interest would be charged on the partners’ capital contributions nor would any remuneration be paid to them. However, the Assessing Officer, citing section 40(b) of the Income-tax Act, 1961, computed and subtracted notional interest and remuneration from the firm’s business profits eligible for the section 10AA deduction. This resulted in a partial disallowance of the firm’s deduction claim for the assessment year 2017-18, a decision later confirmed by the Commissioner (Appeals).

The Tribunal, upon reviewing the case, affirmed the firm’s eligibility for the section 10AA deduction, which it had claimed. The Tribunal observed that the partners, as per their mutual agreement in the partnership deed, could not be mandated to charge interest or remuneration. This stance aligns with the judgment of the Gujarat High Court in Pr. CIT v. Alidhra Taxspin Engineers. Additionally, the Tribunal examined the supplementary partnership deed submitted to the Assessing Officer for its authenticity. In conclusion, the Tribunal ruled in the firm’s favor, stating that deducting interest on capital and remuneration from the profits eligible for section 10AA deduction was unjustified. Therefore, the Tribunal instructed the Assessing Officer to fully honor the firm’s deduction claim under section 10AA, disregarding the earlier reductions.

1. Nature of the Firm: The assessee is a partnership firm involved in the manufacturing and trading of tobacco, gutka, and other tobacco-related products.
2. Supplementary Partnership Deed: On June 19, 2014, the firm executed a supplementary partnership deed. According to this deed, all partners mutually agreed not to charge any interest on their capital contributions or take any remuneration from April 1, 2014, onwards.
3. Claim for Deduction: The firm claimed a deduction under section 10AA of the Income-tax Act, 1961, for the period relevant to the assessment year 2017-18.
4. Assessing Officer’s Decision: The Assessing Officer, invoking the provisions of section 40(b) of the Income-tax Act, contended that the payment of interest on the capital of partners and remuneration to the working partner was due. Since the firm did not make such payments or provisions, the officer calculated the interest on the partners’ capital and remuneration. This amount was then deducted from the business profit calculation eligible for deduction under section 10AA, leading to a partial disallowance of the firm’s deduction claim.
5. Commissioner (Appeals) Confirmation: The decision of the Assessing Officer was upheld by the Commissioner (Appeals).
6. Tribunal’s Findings: On appeal, the Tribunal noted that the partners of the firm, as per their agreement in the supplementary partnership deed, were not obligated to charge interest or remuneration. The Tribunal found that the firm was indeed eligible for the deduction under section 10AA and should be allowed to claim the deduction without the reductions made by the Assessing Officer. This decision was influenced by a precedent set by the Gujarat High Court in Pr. CIT v. Alidhra Taxspin Engineers. The Tribunal directed the Assessing Officer to allow the full deduction claim to the assessee under section 10AA.

The decision held by the Tribunal in this case was as follows:

1. Eligibility for Deduction: The Tribunal recognized that the assessee, a partnership firm, was eligible for the deduction under section 10AA of the Income-tax Act, 1961, which it had claimed for the relevant period.
2. Non-compulsion of Interest or Remuneration: The Tribunal held that since the partners of the firm had agreed in their supplementary partnership deed not to charge any interest on their capital contributions or receive any remuneration, they could not be compelled to do so. This agreement was valid and binding.
3. Reference to a Judicial Precedent: The Tribunal’s decision was influenced by the judgment in the case of Pr. CIT v. Alidhra Taxspin Engineers by the Gujarat High Court. This precedent supported the notion that the incorporation of interest on partners’ capital and remuneration in the partnership deed does not imply that these are mandatory payments.
4. Verification of the Supplementary Partnership Deed: The Tribunal reviewed the supplementary partnership deed presented to the Assessing Officer, confirming its authenticity and relevance to the case.
5. Final Ruling: The Tribunal concluded that the reduction of notional interest on capital and remuneration from the firm’s profits, which were eligible for deduction under section 10AA, was incorrect. Therefore, the Tribunal directed the Assessing Officer to allow the full deduction claim to the assessee under section 10AA without the earlier imposed reductions.

In summary, the Tribunal ruled in favor of the assessee, allowing them to claim the full deduction under section 10AA, as the partners’ agreement not to charge interest or remuneration was valid and should be respected in the computation of eligible deductions.

ORDER UNDER SECTION 254(1) OF INCOME-TAX ACT

Pawan Singh, Judicial Member. – This appeal by the assessee is directed against the order of learned National Faceless Appeal Centre, Delhi (NFAC)/Commissioner of Income-tax (Appeals) (in short, the ld. CIT(A)) dated 20/02/2023 for the Assessment Year (AY) 2017-18. The assessee has raised following grounds of appeal:

2. Perusal of record shows that the impugned order was passed by the ld. CIT(A) on 20/02/2023, however, the present appeal is filed before the Tribunal on 29/05/2023. The Registry of this Tribunal has calculated the delay of 38 days in filing appeal. The assessee has filed application for condonation of delay which is supported by the affidavit of Shri Dinesh Malani, partner of assessee-firm. The learned Authorised Representative (ld. AR) of the assessee submits that the impugned order was passed by the ld. CIT(A) on 20/02/2023 in confirming the partial disallowance of deduction under section 10AA of the Income Tax Act, 1961 (in short, the Act), with regard to interest on capital and remuneration to partners. The assessee was exploring the legal advice and opinion either to file writ petition or appeal before the Tribunal. In seeking advice and taking final decision, the delay of 38 days occurred.

The delay is neither intentional nor deliberate. The delay occurred beyond the control of assessee and as the engagement of assessee was with legal expert. The assessee never intended to file appeal belatedly. The ld. AR of the assessee submits that one of the partner of assessee has filed affidavit explaining the cause of delay. The ld. AR of the assessee submits that there was no deliberate or intentional delay in filing appeal rather for the facts explained above. The assessee is not going to be benefitted. The assessee has good case on merit and is likely to succeed if one more opportunity is provided to the assessee. The assessee has not taken any recourse of law against the impugned order except of filing this appeal. Therefore, the ld. AR of the assessee prayed for condoning the delay.

3. On the other hand, the learned Commissioner of Income Tax-Departmental Representative (ld. CIT-DR) for the revenue submits that the Bench may take appropriate decision to condone the delay as per law.

4. We have considered the submissions of both the parties and find that there is no deliberate delay or mala fide on the part of assessee in causing delay. The delay is only of 38 days which may not be fatal to the revenue. The revenue is not going to be suffered if they have merit in their favour. Considering the facts and circumstances of the case and the submissions of the parties, we find that the assessee has shown reasonable cause for condoning the delay, therefore, the delay in filing appeal is condoned. Now adverting to the merit of the case.

5. Brief facts of the case are that the assessee is a partnership firm engaged in manufacturing and trading of Tobacco Gutka and other Tobacco products. The assessee filed its return of income on 29/08/2017declaring income of Rs. NIL. In the computation of total income, the assessee claimed deduction under section 10AA of the Act of Rs. 7.61 crores. The case was selected for complete scrutiny. During the assessment, the Assessing Officer noted that the partner of assessee firm has not claimed interest on capital contribution and remuneration to its partners. The Assessing Officer issued show cause notice that why the assessee has not claimed such allowable expenditure while claiming profit from eligible business, vide show cause notice dated 15/11/2019. The contents of show cause notice is recorded in para 3 of assessment order. In the show cause notice, the Assessing Officer mentioned that on verification of partnership deed dated 05/12/2013 wherein as per clause (5) of partnership deed, interest to the partners is payable @ 12% per annum. Further as per clause (6) of partnership deed, remuneration is also payable as per calculation of Section 40B of the Act. The assessee subsequently prepared a supplementary deed dated 19/06/2014 and clause related to interest and remuneration to partners was omitted. This was done with the intention to increase the exempt income. The Assessing Officer on the basis of original partnership deed dated 05/12/2013 worked out the remuneration and interest on capital to partners of Rs. 4.91 crores and asked the assessee as to why deduction to the extent of such amount should not be disallowed.

6. The assessee filed its detailed reply dated 21/11/2019. The contents of reply is recorded in para 3.2 of assessment order. The assessing officre recorded that assessee in its reply submitted that the assessee firm has executed notarized supplementary partnership deed on 19/06/2014 wherein all the partners mutually agreed not to claim interest and remuneration w.e.f. 01/04/2014 onwards. Copy of supplementary partnership deed was filed. The assessee further stated that the business of partnership is governed as per contract of partnership. The firm has not paid any interest on capital or partners’ remuneration in accordance with partnership deed. The assessee cannot be compelled to charge such interest or remuneration by invoking provisions of Section 40B of the Act. The assessee also relied on various case laws including decision of Hon’ble Jurisdictional High Court in Pr. CIT v. Alidhra Taxspin Engineers and another in [Tax appeal No. 265 of 2017 dated 02/05/2017], decision of Surat Tribunal in Asstt. CIT v. Mukta Enterprise [2018] 100 taxmann.com 44/[2019] 174 ITD 259 (Surat – Trib.), Asstt. CIT v. Kiran Jewellery [ITA Nos. 192 and 193/Srt/2017, dated 6-6-2019].

7. The reply of assessee was not accepted by Assessing Officer. The Assessing Officer by referring various case laws that as per provisions of Section 40B of the Act, the payments of interest @ 12% in capital or partners and remuneration to the working of partner is payable. The assessee firm has not made any payment thereof to partners nor made any provisions of liability. The Assessing Officer reduced the amount of interest and remuneration from the computation of business profit allowable for deduction under section 10AA of the Act thereby disallowed Rs. 4.38 crores.

8. Aggrieved by the additions in the assessment order, the assessee filed appeal before the ld. CIT(A). Before the ld. CIT(A), the assessee filed detailed written submissions and reiterated almost all similar contentions as submitted before the Assessing Officer. The assessee also stated that they have paid tax under section 115JC of Rs. 1.62 crore.

9. The ld. CIT(A) after considering the submission of assessee, upheld the order of Assessing Officer by referring and relying upon the decision of Rajkot Tribunal in ITO v. Devine Impex [ITA No. 279/Rjt/2012, dated 24/01/2013] and Chandigarh Tribunal in ITO v. Shivam Industries [ITA No. 510/Chd/2012 and 616/Chd/2012]. Further aggrieved, the assessee has filed present appeal before the Tribunal.

10. We have heard the submissions of ld. AR of the assessee and the ld. CIT-DR for the revenue. The ld. AR of the assessee submits that the grounds of appeal raised by assessee are covered by the decision of Hon’ble Jurisdictional High Court in Alidhra Taxspin Engineers and another (supra) and in Pr. CIT v. Ruta Jewels in [Tax Appeal No. 165 of 2019 dated 24/06/2019]. The ld. AR of the assessee submits that the Hon’ble Jurisdictional High Court in Alidhra Taxspin Engineers (supra) made specific finding that mere incorporation of interest on partners’ capital account and remuneration does not signify that the same are mandatory in nature. Once the assessee has not charged any interest and remuneration as per partnership deed, therefore, the assessee cannot be compelled to charge interest or remuneration. The ld. AR of the assessee submits that the case is on better footing that the partner of assessee firm has agreed vide supplementary partnership deed dated 19/06/2014 for not to charge any interest on capital contribution and remuneration to the partners. Copy of partnership deed furnished to the Assessing Officer. The Assessing Officer wrongly recorded that supplementary partnership deed is notarized, rather a photo copy of said supplementary partnership deed, which was attested by notary public as true copy. The ld. AR of the assessee further submits that by following the decision of Hon’ble Jurisdictional High Court, Jurisdictional Tribunal in Mukta Enterprise (supra), and Ahmedabad Tribunal in Al Reza Food v. ITO [ITA No. 663/Ahd/2014 dated 23/03/2017] and Sagar Foods Mahuva v. ITO [ITA No. 750/Ahd/2014 dated 22/02/2017], allowed similar relief to those assessees. The ld. AR of the assessee submits that he has filed on record the copies of all the decisions. On the basis of aforesaid submissions, the ld. AR of the assessee submits that the grounds of appeal raised by assessee is in fact squarely covered in favour of assessee.

11. On the other hand, the ld. CIT-DR for the revenue supported the orders of lower authorities. The ld. CIT-DR for the revenue submits that the assessee before the Assessing Officer claimed that a notarized supplementary deed was prepaid. Copy of such notarized deed was never shown or filed before the lower authorities.

12. We have considered the rival submissions of both the parties and have perused the orders of the lower authorities carefully. We have also deliberated on the various case laws relied by the ld. AR of the assessee. There is no dispute that the assessee is eligible for deduction under section 10AA of the Act. Further the assessee claimed deduction of Rs. 7.61 crores during the year. The Assessing Officer disallowed the part of claim by taking a view that the assessee has not charged any interest on capital contribution and remunerations to its partner. The Assessing Officer worked out the disallowance of interest on capital of partner and remuneration and restricted the claim of deduction under section 10AA of the Act by subtracting Rs…4.58 crore on account of remuneration to partners and Rs. 32,50,778/- on account of interest on capital contribution by partners. The ld. CIT(A) confirmed the action of Assessing Officer on the basis of decision of Rajkot Tribunal in Devine Impex (supra) ITA No. 279/Rjt/2012 dated 24/01/2013 and Chandigarh Tribunal in M/s Shivam Industries (supra) ITA No. 510/Ahd/2012 and 616/Chd/2012.

13. Before us, the ld. AR of the assessee vehemently relied upon the decision of Jurisdictional Tribunal as well as Jurisdictional High Court. The assessee also claimed that similar relief was claimed in A.Y. 2016-17 on the basis of supplementary partnership deed and the assessee was allowed similar deduction without disallowance of similar interest on partners’ contribution and remuneration. The assessee has also filed copy of intimation under section 143(1) wherein claim of deduction under section 10AA of the Act of Rs. 5.49 crore was allowed. The assessee has not charged any interest or remuneration as per their partnership deed, the assessee firm cannot be compelled to charge interest or remuneration. We find that the facts of present case is on better footing. The partner of assessee firm vide their supplementary partnership deed 19/06/2014 agreed not to charge any interest on their capital contribution and any remuneration to them.

14. We find that the grounds of appeal raised by assessee is covered by the decision of Hon’ble Jurisdictional High Court in Alidhra Taxspin Engineers and another (supra) wherein the Hon’ble High Court has clearly held that mere incorporation of interest on partners’ capital account and remuneration does not signify that the same are mandatory in nature.

15. The only objection of ld. CIT-DR for the revenue was that before the Assessing Officer, the assessee claimed notarized supplementary deed. On such objection, we directed the ld. AR of the assessee to show the original or supplementary partnership deed. Supplementary partnership deed was brought before the Bench and copy thereof was provided to the ld. CIT-DR for the revenue. On perusal of such supplementary partnership deed, we find that before assessing officer, the assessee has filed copy of said partnership deed attested by Notary Shri M.S. Ratnu, advocate, Jodhpur. On comparing the contents of supplementary partnership deed with copy thereof on record, original was returned to the assessee’s counsel.

16. In view of aforesaid factual and legal discussion, we are of the considered view that the grounds of appeal raised by assessee are covered in favour of assessee. Hence, the disallowance of interest capital and remuneration from the allowable profit under section 10AA, is deleted. Accordingly, the Assessing Officer is directed to allow full relief to the assessee. Hence, grounds No. 1 to 4 of the appeal are allowed.

17. Ground No. 5 of the appeal relates to confirming the action of Assessing officer in treating income of Rs. 19,178/- on payment of employee’s contribution of PF/ESI after due date. The ld AR for the assessee at the time of hearing submits that he is not pressing this ground of appeal. Considering the submissions of ld AR for the assessee, this ground of appeal is dismissed.

18. In the result, this appeal of assessee is partly allowed.