Income Tax Appellate Tribunal - Chandigarh
Amar Electronics, , Patiala vs Department Of Income Tax on 24 June, 2009
IN THE INCOME TAX APPELLATE TRIBUNAL
CHANDIGARH BENCH 'A', CHANDIGARH
BEFORE SHRI G. S.PANNU, ACCOUNTANT MEMBER
AND MS.SUSHMA CHOWLA, JUDICIAL MEMBER
ITA No.884/Chandi/2009
( A.Y. 2006-07 )
A.C.I.T., Vs. M/s Amar Electronics,
Circle Patiala Dharam Pura Bazar,
Patiala.
PAN: AABFA 5972A
(Appellant) (Respondent)
Appellant by : Shri N.K.Saini
Respondent by : Shri I.C.Verma
O R D E R
Per G. S. PANNU, AM :
This appeal by the Revenue is directed against the order of the Commissioner of Income-tax (A) dated 24.06.2009 pertaining to assessment year 2006-07. Although the Revenue has raised multiple Grounds of appeal but essentially the solitary dispute relates to an addition of Rs.35,14,011/- made by the Assessing Officer out of interest paid to the partners. The addition made by the Assessing Officer has since been deleted by the Commissioner of Income-tax (A), against which the Revenue is in appeal before us.
2
2. In brief, the relevant facts are that the assessee is a partnership firm engaged in the business of wholesale trading of electronic and electric goods. The return of income was filed for the stated assessment year on 30.10.2006 declaring an income of Rs.1,29,48,947/-. In the course of assessment proceedings, the Assessing Officer noted that the assessee had paid interest to its partners amounting to Rs.1,01,49,026/-. The Assessing Officer disallowed a portion of interest paid to the partners amounting to Rs.35,14,011/- on the ground that the capital borrowed from the partners was not utilized for the purposes of business. The Assessing Officer has given varied reasons to make the disallowance. Primarily, the Assessing Officer noted that the assessee borrowed capital from the partners on which 12% interest was being paid, whereas the same was diverted to non-business purposes i.e. invested in FDRs with the bank which carried interest @ 6% to 7%. The Assessing Officer also noted that by paying interest at a higher rate (i.e. 12%) on capital borrowed from the partners while investing the surplus fund in FDRs carrying interest rate of 6% to 7% only the assessee reduced its tax liability by diverting the income to the partners. The Assessing Officer has made a detailed discussion at pages 24 to 37 of the assessment order. As per the Assessing Officer, a modus operandi has been adopted by the assessee to evade taxes by raising capital from the partners which was not utilized for 3 business but invested in FDRs earning 6% interest whereas it paid interest to the partners @ 12%. As per the Assessing Officer, there was no distinction between capital contributed by the partners and monies borrowed from any one else. As per the Assessing Officer, section 40(b)(iv) of the Income-tax Act, 1961 (in short 'the Act') permits deduction of interest paid to the partners only if it is exclusively used for the business. For all the above reasons, the Assessing Officer held that out of the total capital contributed by the partners as on 31.3.2006 amounting to Rs.10,05,83,281/-, a sum of Rs.5,85,66,853/- had not been used for the purposes of assessee's business. Therefore, differential rate of interest @ 6% (i.e. rate of interest @12% paid to the partners minus rate of interest earned on FDRs @ 6%) was to be disallowed, which was computed at Rs.35,14,011/-. Thus, out of the total interest paid to the partners amounting to Rs.1,01,49,026/-, an amount of Rs.35,14,011/- has been disallowed.
3. Before the Commissioner of Income-tax (A), assessee contended that the Assessing Officer was not justified in making the impugned disallowance either on facts or in law. In law, it was contended that the disallowance contemplated in terms of section 36(1)(iii) of the Act could not be applied to interest paid by a firm to its partners in terms of Partnership Deed, the admissibility of which was governed by section 40(b)(iv) of the Act. According to the assessee, the capital 4 contributed by the partners is quite different from a borrowed loaned capital in as much as the capital contribution by the partners alongwith the accumulated profits standing to the credit of the partners do not constitute borrowed capital and, therefore, provisions of section 36(1)(iii) of the Act could not be invoked to disallow interest paid on the partner's capital. In this regard, reliance was placed on the decision of the Lucknow Bench of Tribunal in the case of Saroj Nursing Home Vs. DCIT (2005) 98 TTJ 1051 (Lucknow) and also the judgment of the Hon'ble Supreme Court in the case of CIT Vs. Bazpur Co-operative Sugar Factory Ltd., 177 ITR 469 (SC) and that of the Hon'ble Madras High Court in the case of CIT Vs. Sri Rajagopal Transports (Pvt.) Ltd., 144 ITR 573 (Mad). On facts also, it was contended that the FDRs placed with the bank represented business receipts in as much as the same were pledged with the bank, whenever needed to obtain overdraft limit or term loans. It was thus contended that the FDRs were maintained for commercial expediency and the same could not be considered as non-business assets, as done by the Assessing Officer. Alternatively, it was pointed out to the Commissioner of Income-tax (A) that the capital contributed by the partners in the past years has not been utilized to make the impugned FDRs. Thirdly, it was also submitted that the interest was paid to the partners at the same rate as in the earlier years and in the assessments framed u/s 143(3) of the Act in the past years, there has been no such disallowance. The Commissioner of Income-tax (A) verified the 5 Partnership Deed, copies of income-tax returns of the partners and copies of FDRs pledged with the bank for obtaining overdraft limit, etc. After verifying the material and obtaining the comments of the Assessing Officer, the Commissioner of Income-tax (A) has observed that the interest in question has been paid to the partners in terms of Partnership Deed and even the partners were earning taxable income which fell in the highest tax bracket i.e. 30% and the partners were paying tax on the entire amount of interest received from the assessee firm. Accordingly, the Commissioner of Income-tax (A) has concluded that there could not be any motive of tax evasion by diverting the income of the firm by paying 12% interest to the partners. The Commissioner of Income-tax (A) has also concluded that the investment of funds for FDRs with the bank proved the business use thereof. In para 3.10 of the order the issue has been concluded as under :-
"3.10 Considering the totality of f ac t s and c i r c u ms t a n c e s o f t h e c a s e , I a m o f t h e o p i n i o n t h a t there wa s no attempt to divert the i n c o me by a l l o wi n g 1 2 % i n t e r e s t t o t h e p a r t n e r s , n o r t h e r e c o u l d b e a n y mo t i v e f o r t h a t . On the other hand the interest wa s paid in accordance wi t h the p r o v i s i o n s o f t h e A c t a n d t h e t e r m s o f i n s t r u me n t s o f p a r t n e r s h i p a n d wa s r e a s o n a b l e . Moreover, the i n t e r e s t p a i d a t t h e s a me r a t e w a s a l l o we d b y t h e A . O . i n t h e e a r l i e r y e a r s e v e n i n t h e a s s e s s me n t s f r a me d u / s 1 4 3 ( 3 ) a n d t h e r e b e i n g n o c h a n g e i n the f acts and c i r c u ms t a n c e s of the case as 6 c o m p a r e d t o t h o s e o f t h e e a r l i e r y e a r s t h e r e wa s no reason for deviating from that action. Of course, the principle of res judicata is not a p p l i c a b l e i n I n c o me T a x m a t t e r s b u t a s h a s b e e n held by the judicial and appellate authorities, the r u l e o f c o n s i s t e n c y mu s t b e f o l l o we d e s p e c i a l l y i n s u c h a c a s e a s t h a t o f t h e a s s e s s e e wh e r e t h e r e was no change in the f acts of the case as c o m p a r e d t o t h e e a r l i e r y e a r wh e n t h e i n t e r e s t a t t h e s a me r a t e w a s a l l o we d b y t h e A . O . Theref ore, o n f a c t s a l s o , t h e d i s a l l o wa n c e m a d e b y t h e L d .
Assessing Officer is unwarranted and
unjustif ied."
4. Furthermore, the Commissioner of Income-tax (A) has
noted that the capital contribution made by the partners did not constitute borrowed capital as envisaged in section 36(1)(iii) of the Act. It was further held that allowability of interest paid to the partners is not governed by section 36(1)(iii) of the Act but by section 40(b)(iv) of the Act read alongwith the relevant terms of the Partnership Deed. The relevant conclusion in this regard is contained in para 3.6 of the impugned order which reads as under :-
"3.6 I have heard both the parties and perused the relevant records and evidence produced bef ore the A.O. as well as bef ore me.
The legal a r g u me n t s of the counsel have
substantial force. The contribution of capital
made by the partners of the f ir m did not constitu te b o r r o we d c a p i t a l a s e n v i s a g e d i n s e c t i o n 3 6 ( 1 ) ( i i i ) o f t h e I . T . A c t a n d a s s u c h t h e a l l o wa b i l i t y o f interest paid to the partners is not to be governed 7 by that section but by section 40(b)(iv) of the I . T . A c t r e a d wi t h r e l e v a n t t e r m s o f p a r t n e r s h i p deed. This vie w derives support from the d e c i s i o n s o f H o n ' b l e S u p r e me C o u r t a n d M a d r a s High Court and the issue involved is squarely covered by the decision of the Hon'ble Lucknow Bench (supra) which also supports the case of the a s s e s s e e a n d t h e r e l e v a n t e x t r a c t wh e r e o f h a s been reproduced by him in the wr i t t e n submissions. It is, theref ore, held that the d i s a l l o wa n c e o f i n t e r e s t m a d e b y t h e L d . A . O . u / s 36(1)(iii) out of interest paid to partners is not in a c c o r d a n c e wi t h t h e r e l e v a n t p r o v i s i o n s o f t h e A c t and as such it deserves to be deleted on this ground alone."
5. Against the aforesaid decision of the Commissioner of Income-tax (A), Revenue is in appeal before us.
6. Before us, the learned D.R. has reiterated the stand of the Assessing Officer by placing reliance on the assessment order. As per the learned D.R., the Commissioner of Income- tax (A) has erred in deleting the addition without appreciating the facts in appropriate perspective. The learned D.R. reiterated that the assessee had parked its surplus funds which included capital borrowed from the partners, in the FDRs which earned interest only @ 6% to 7%, whereas interest @ 12% was paid to the partners on the capital borrowed. Thus, there was no business expediency for payment of interest to the partners and in this regard, reliance was placed on the judgment of the High Court Jurisdictional High Court in the case of CIT Vs. Abhishek Industries Ltd., 286 ITR 8 1 (P&H). It is also argued by the learned D.R. that the Commissioner of Income-tax (A) was not correct in stating that the interest paid to the partners was allowable only in terms of section 40(b)(iv) of the Act and not in terms of section 36(1)(iii) of the Act. According to the learned D.R., section 40(b)(iv) of the Act was only restricting section and deduction on account of interest paid to the partners or to any other person was allowable only in section 36(1)(iii) of the Act. For these reasons, the learned D.R. has assailed the order of the Commissioner of Income-tax (A).
7. On the other hand, the learned counsel for respondent- assessee vehemently defended the order of the Commissioner of Income-tax (A). It is submitted that the Assessing Officer was not justified in equating the capital contributed by the partners with borrowed capital. It is submitted that the capital contributed by the partners does not constitute borrowed capital within the meaning of section 36(1)(iii) of the Act and as such, the allowance of interest paid to the partners cannot be governed by such provision. A reference was invited to the parity of reasoning laid down by the Hon'ble Supreme Court in the case of Bazpur Co-operative Sugar Factory Ltd. (supra) to point out that the capital contributed by the partners on which interest was being paid, will not show a relationship of borrower and lender between a partnership firm and its partners. Therefore, interest paid by a partnership firm to its partners was not covered by the 9 provisions of section 36(1)(iii) of the Act. In the course of hearing, reliance was also placed on the judgment of Hon'ble Madras High Court in the case of Sri Rajagopal Transports (Pvt.) Ltd. (supra). Thus, it was submitted that the interest paid @ 12% to the partners in terms of Partnership Deed was allowable in terms of section 40(b)(iv) of the Act and the provisions of section 36(1)(iii) are not applicable. Reliance was reiterated on the decision of the Hon'ble Lucknow High Court in the case of Saroj Nursing Home (supra). On facts also, it was contended by the learned counsel that no disallowance was merited. It was pointed out that even if the tests laid down u/s 36(1)(iii) are to be applied, no disallowance was called for since the entire borrowed capital was utilized for the purposes of business. It was also pointed out that there was no evasion of tax liability since the partnership firm and its partners were paying tax at the highest tax rate of 30%. The incidence of tax in both the cases was the same and, therefore, by paying interest to the partners @ 12% there was no diversion of income in as much as the total tax paid remained the same. For all the above reasons, it was submitted that the Commissioner of Income- tax (A) made no mistake in deleting the addition made by the Assessing Officer.
8. We have considered the rival submissions carefully. The first moot issue which arises for consideration is whether the interest paid by the assessee firm to its partners can be 10 subject to the tests laid down in section 36(1)(iii) of the Act. Section 36(1)(iii) of the Act allows deduction for interest paid in respect of the capital borrowed for the purposes of business or profession, while computing business income. As per the Revenue, even in respect of the capital borrowed from the partners, the provisions of section 36(1)(iii) apply in as much as the interest paid to the partners can be allowed only if it is utilized for the purposes of the business or profession.
9. On the contrary, as per the respondent-assessee, which has also been upheld by the Commissioner of Income-tax (A), the credit balances in the capital accounts of the partners cannot be construed as a "capital borrowed" within the meaning of section 36(1)(iii) of the Act.
10. In the case of Bazpur Co-operative Sugar Factory Ltd. (supra), the assessee was a co-operative society which had received certain contributions from its members in a "Loss Equalization and Capital Redemption Reserve Fund". The Fund was used by the assessee for the purposes of its business and interest paid to the members on their credit balances standing in the said Fund was claimed as deduction u/s 36(1)(iii) of the Act. The claim of the assessee was that the Fund represented 'capital borrowed' by the assessee for the purposes of its business within the meaning of section 36(1)(iii) of the Act. As per the Hon'ble Supreme Court, the credit balances in the Reserve Fund could not be construed as a "borrowed money" within the meaning of section 36(1)(iii) of 11 the Act. According to the Hon'ble Supreme Court, in order that there be borrowed money, there must be a borrower and a lender relationship. That it should be considered whether in ordinary commercial usage, the relationship was that of a borrower and a lender and whether the transactions were loan transactions. The Hon'ble Supreme Court also noted that a loan transaction necessarily supposed a return of the money loaned. As per the Hon'ble Supreme Court, on the above principles, the receipt of money from the members in the Reserve Fund, could not be treated as "borrowed capital"
within the meaning of section 36(1)(iii) of the Act.
Considering the same parity of reasoning, the credit balances standing in the partner's capital account, cannot be construed as a loan transaction between a partnership firm and the partners. In fact, capital contributed by the partners does not necessarily suppose a return of the same, as is envisaged in a loan transaction. Therefore, the capital contributed by the partners including accumulation by way of profits earned thereon, cannot be considered as a "borrowed capital" within the meaning of section 36(1)(iii) of the Act. In fact, interest paid to the partners is governed by section 40(b)(iv) of the Act which reads as under :-
"40[(b) in the case of any f irm assessable as such,--
(i) --------------------------------------------------------------
(ii) --------------------------------------------------------------
(iii) --------------------------------------------------------------
( i v ) a n y p a y m e n t o f i n t e r e s t t o a n y p a r t n e r wh i c h i s a u t h o r i s e d b y , a n d i s i n a c c o r d a n c e wi t h , 12 t h e t e r ms o f t h e p a r t n e r s h i p d e e d a n d r e l a t e s t o a n y p e r i o d f a l l i n g af t e r t h e d a t e o f s u c h p a r t n e r s h i p d e e d i n s o f a r a s s u c h a mo u n t e x c e e d s t h e a mo u n t c a l c u l a t e d a t t h e r a t e o f [ t we l v e ] p e r c e n t s i m p l e i n t e r e s t p e r a n n u m"
11. The said provision has been explained by our Coordinate Bench in the case of Saroj Nursing Home (supra) as under :-
" F r o m a p e r u s a l o f t h e o v e r a l l s c h e me r e l a t e d t o t h e a s s e s s me n t o f : f i r m a s s e s s e d a s s u c h " , i t i s evident that payment of interest and r e mu n e r a t i o n , etc., to the partners amounts to apportionment of prof its of the f i r m, and the interest and remuneration to the partners so a p p o r t i o n e d i s a s s e s s a b l e a s i n c o me i n t h e h a n d s of the respective partners under s.28. As the interest and remuneration, etc., as paid to the partners have been made assessable in the hands o f t h e p a r t n e r s t h e ms e l v e s a s b u s i n e s s i n c o m e , the same are taken out of the taxable prof it of the f ir m so as to meet the long standing de mand of t h e t a x p a y e r s t h a t s a me i n c o m e s h o u l d n o t b e s u b j e c t e d t o t a x t wi c e ; o n c e i n t h e h a n d s o f t h e f ir m and ag ain in the hands of the partners. On this analogy itself , the prof its of t h e f i r m, as a r r i v e d a n d af t e r a p p o r t i o n me n t o f t h e s a me i s also not assessed in the hands of the partners, by virtue of s.10(2A) of the Act. From this analysis, i t f o l l o ws t h a t d e d u c t i o n o n a c c o u n t o f p a y m e n t o f interest is a l l o we d by virtue of the specially e n a c t e d p r o v i s i o n s o f s . 4 0 ( b ) o f t h e A c t , wh i c h c a me i n t o f o r c e w. e . f . 1 s t A p r i l , 1 9 9 3 o n l y . It also f o l l o ws , s i d e b y s i d e , t h a t p a y m e n t m a d e t o t h e p a r t n e r s , b y wa y o f i n t e r e s t , i s n o t t r e a t e d a s p a y m e n t o f i n t e r e s t o n b o r r o wi n g s . Theref ore, 13 t h e c r i t e r i o n l a i d d o wn i n s . 3 6 ( 1 ) ( i i i ) wh i c h a l l o ws deduction of interest on b o r r o wi n g s , is not applicable here. From a perusal of the notice dt.20th Jan., 2005, as also the order dt.25th Feb., 2 0 0 5 wh i c h i s s u b j e c t - m a t t e r o f a p p e a l b e f o r e u s , i t i s n o t e d t h a t t h e l e a r n e d C IT h a s e q u a t e d t h e credit balances in the accounts of the partners, with the b o r r o we d funds in relation to wh i c h ad missibility of interest is governed by s.36(1)(iii). It is perhaps f or this reason that he has ref erred to various case l a ws wh e r e i n question of admissibility of interest under s.10(2)(iii) of the old Act, s.36(1)(iii) of the Act, corresponding to s.10(2)(iii) of the old Act wa s involved. It is held at the very outset that the credit balances in the account of the partners are n o t i n t h e n a t u r e o f b o r r o wi n g s o r d e b t d u e t o t h e f ir m and allo wab il ity of in terest in the cap ital accounts of the partners, are not governed by the provisions of s.36(1)(iii). ON the other hand, the contribution made by the partners, in the event of dissolution are applied f or payment of debts of the f irm and the partners are entitled to share the a s s e t o f t h e f i r m o n l y af t e r a s u r p l u s i s l e f t . This is amply borne out from s.49 of the Indian Partnership Act, wh i c h is fully applicable to i n c o me - t a x p r o c e e d i n g s a s we l l ; t h e r e a s o n b e i n g that the IT Act itself does not contain any d e f i n i t i o n o f t h e ' f i r m' ' p a r t n e r ' a n d ' p a r t n e r s h i p ' . Sub-s. (23) of s.2 says that "f irm", "partner" and "partnership" have the meaning respectively assigned to them in the Partnership Act, 1932. Thus, interest in the capital account of the p a r t n e r s wa s a d m i s s i b l e u n d e r s . 4 0 ( b ) o f t h e A c t , wh o l l y i n d e p e n d e n t o f t h e p r o v i s i o n s c o n t a i n e d i n s.36(1)(iii) of the Act."14
12. From the aforesaid, it is evident that the Commissioner of Income-tax (A) made no mistake in holding that the credit balances in the account of the partners are not in the nature of borrowings as understood for the purposes of section 36(1)(iii) of the Act. Thus, we find no merit in the plea of the Revenue that the tests envisaged in section 36(1)(iii) vis-à-vis the payment of interest are to be applied in the present case also. In the instant case, the interest in question is paid to the partners of the firm and the same is governed by the provisions of section 40(b)(iv) of the Act read with the Partnership Deed and cannot be subject to disallowance in terms of section 36(1)(iii) of the Act. There is no objection taken by the Revenue at any stage that the payment of impugned interest is not in accordance with the provisions of section 40(b)(iv) of the Act read with the Partnership Deed. Therefore, we find no justification to interfere with the conclusion of the Commissioner of Income-tax (A) in deleting the addition made by the Assessing Officer.
13. Apart from the aforesaid, we also find that the Commissioner of Income-tax (A) has noted, and to which there is no negation from the Revenue, that even in the assessments framed u/s 143(3) of the Act in the earlier years, interest was paid at the same rate and stood allowed by the Assessing Officer. The Commissioner of Income-tax (A) has further noted that there is no change in the facts and circumstances of the instant year as compared to those of the earlier years. 15 In the face of the aforesaid situation, we find no justification with the Revenue to deviate from the past history. The principles of consistency clearly support that the impugned disallowance is not justified.
14. Considered in the light of the material on record and the aforesaid discussion, we uphold the action of the Commissioner of Income-tax (A) in deleting the impugned addition and the appeal of the Revenue is hereby dismissed.
15. In the result, the appeal of the Revenue is dismissed. Order pronounced in the open court on ---------------
(SUSHMA CHOWLA) (G.S.PANNU) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated 25th February, 2010 *Rati*
Copy to: The Appellant/The Respondent/The CIT(A)/The CIT/The DR.