Income Tax Appellate Tribunal - Mumbai
A.H. Baldota vs Assistant Commissioner Of Income Tax on 31 March, 2006
Equivalent citations: (2006)103TTJ(MUM)517
ORDER
D.C. Agrawal, A.M.
1. In all the four appeals a common question is involved as to whether assessee is entitled to claim interest payment on borrowed capital invested in a partnership firm,, in which he was the partner in the relevant period, even though share of profits from the partnership is exempt under Section 10(2A).
2. The facts for the first three assessment years are identical. The return of income was filed late. They were regularised by issuing notice under Section 148(1). Relevant data is as under:
1994-95 1995-96 1996-97 Date of return 13.11.1996 13.11.1996 23.40.1997 Income/loss returned (-) 320570 (-) 13320 (+) 176200 Date of notice under Section 148(1) 17.2.2000 16.2.2000 16.2.2000 Date of letter issued by assessee to 18.2.2000 18/2/2000 18.2.2000 regularise the return Income assessed (+) 217006 (+) 433520 (+) 571710 Interest payment disallowed 537771 479045 395510
3. For the asst. yr. 1997-98, the return of income was filed on 30th Nov., 1998 on a total income of Rs. 2,84,075. It was processed under Section 143(1) on 28th Dec, 1999 accepting returned income. The case was picked up for scrutiny. Notice under Section 143(2) was issued. Interest payment of Rs. 3,01,788 was disallowed and income was assessed at Rs. 5,87,75.
4. Though the assessee had initially challenged the issue of notice under Section 148(1) for all these assessment years but during the course of hearing before us, the same was not pressed. Hence the ground relating thereto is treated as rejected. During the course of assessment proceedings, it was claimed before the AO that assessee has borrowed money from M/s Greater Bombay Co-op. Bank Ltd. and invested in the partnership firm M/s Baldota Brothers, wherein the assessee was a partner. Since the firm was making loss, there was debit balance in the account of the partners and to square up the debit balance, capital was invested by taking a loan of Rs. 25 lacs from M/s Greater Bombay Co-op. Bank Ltd. It was claimed that such payment of interest should have been legitimately deducted under the head 'income from profits and gains of business/profession'. But it was erroneously deducted under the head 'other sources' by the assessee in the return. But it is allowable under the head 'business'. He relied on the decision of Hon'ble Supreme Court in Rajasthan State Warehousing Corporation v. CIT for the proposition that assessee is entitled to claim deduction under a head irrespective of the fact whether there is a positive income or not under that head. The AO, however, disallowed the payment of interest on the grounds that :
(i) Interest payment cannot be allowed under Section 57 because it was not related to earning any interest. The loan taken from M/s Greater Bombay Co-op. Bank Ltd was utilised to reduce the debit balance in the partnership firm.
(ii) The CIT(A) has also disallowed the claim for the asst. yr. 1997-98 by holding that share income from the firm is exempt under Section 10(2A) and hence expenditure relating thereto will also not be allowed.
(iii) The question of allowability of whole of interest or part thereof against other business income would arise when loan borrowed is utilised in personal business, and income of one business is exempt. In the present case, entire capital borrowed is utilised in partnership firm where share income in the hands of the partner is exempt under Section 10(2A).
5. Before the CIT(A), same arguments as taken before the AO were taken. He confirmed the order of the AO for the asst. yrs. 1994-95, 1995-96 and 1996-97 on the basis of the order of the CIT for the asst. yr. 1997-98, wherein reliance was placed on Section 10(2A) to confirm the disallowance. In the asst. yr. 1997-98, the learned CIT(A) had observed as under:
I have carefully considered the submissions, but they are besides the point. In contending that interest should be allowed against business income, the learned Counsel seems to have lost sight of the fact that there could be no assessable business income of the appellant, firstly on account of the firm's recurring losses and secondly in view of the exemption of share income under Section 10(2A) of the IT Act. Therefore, the argument that interest should be allowed against business income does not carry conviction it being without force. Therefore, the claim of interest payment against income from business is totally misconceived and so is the reliance on the case of Smt. Aichana R. Dhanwatay (supra). There can be no dispute with the proposition that jurisdiction of the AO comprises in computing total income liable to charge in accordance with law. Going by the aforesaid ratio it cannot be said that the AO has either supported short of exercising his jurisdiction or exceeded it in the present case. In rejecting the claim of interest payment against income from other source, AO has only fulfilled his duty in bringing the correct amount to tax. Hence, I find no infirmity in the impugned order on this account. In the circumstances, the disallowance is confirmed, (no adjustment being required as regards the quantum of interest) and appeal dismissed.
6. Before us, the learned Authorised Representative of the assessee submitted that the principles laid down by Hon'ble Supreme Court in Rajasthan State Warehousing Corporation case (supra) would be squarely applicable. For allowing the claim of interest under the head 'business1, it is not necessary that there should be any income. Only requirement is that the assessee should engage himself in the business. In the present case, the assessee is a partner in the firm, income therefrom is assessable under the head 'business'. Therefore, capital borrowed is utilised for the purposes of earning 'business income'. From partnership, there are three types of income namely share of profits, interest and remuneration. It is only the 'share of profits' which will fall under Section 10(2A). Other two items fall under the head 'business'. The learned Counsel for assessee relied on the decision in Santosh Kumar Agrawal v. Asstt. CTF (2001) 72 TTJ (Mumbai) 453 : (2001) 78 ITD 394 (Murnbai) for the proposition that where partner is receiving remuneration and interest from the firm then the interest paid on borrowed capital invested in the firm will be allowable deduction under the head 'business', where remuneration and interest received from the firm are assessed. He also relied on the decision of Hon'ble Supreme Court in C1T v. Rajendra Prasad Moody for the proposition that to allow a claim of interest under Section 57(iii), it is not necessary that there should be an income. All that Section 57(iii) speaks is that expenditure must have been laid out solely for the purposes of earning dividend income. Extending the analogy on this principle, the learned Counsel for assessee submitted that there may not be any income under any other head, what is required for allowing the claim is that expenditure should have been incurred solely for the purposes of earning that income. The learned Authorised Representative further submitted that the CIT(A) did not invoke Section 14A hence it could not be invoked now.
7. In addition to the above, the learned Counsel for assessee submitted that Section 10(2A) can be invoked only when there is an income which falls under that sub-section. When there is no income, i.e., when there is a loss from partnership firm, Section 10(2A) could not be invoked. In other words, when there is a loss from the partnership firm, it is assessable as a normal business loss under the head 'business' and it cannot be picked up to say that it is exempt under Section 10(2A). Thus, for the purposes of Section 10(2A) 'income' means only positive income and does not include 'loss'. Thus, once loss is assessable under the head 'business', then interest paid on borrowed capital utilised in that business should be allowed as deduction. The learned Counsel for assessee relied on the decision reported in ITO v. Expo Packaging (1995) 51 TTJ (Ahd) 174 in support of his proposition that under Section 10(2A), it is only 'income' which is covered and not 'loss' derived from partnership firm. The learned Counsel for assessee also submitted that capital gains on transfer of share of certain companies is exempt by virtue of Section 10(36) but long-term capital loss on account of transfer of shares of a company would be eligible for adjustment against other long-term capital gains under Section 74. From this point of view, it is only positive income received as share from the partnership firm will be exempt under Section 10(2A) and not the loss, which is liable to be adjusted against other income under the head 'business1.
8. On the other hand, the learned Departmental Representative submitted that it is incorrect to presume that assessee should have only positive income from partnership, which alone would be exempt under Section 10(2A). Whatever loss he received from the firm would also be out of computation by virtue of Section 10(2A). Income includes loss as has been held in several decisions.
9. Learned Departmental Representative submitted that the decision of Tribunal in Santosh Kumar Agrawal's case (supra) was delivered in the year 2000, when provisions of Section 14A were not in the statute. The orders were passed by the AO much before the day when that section was made effective. The AO did not have the benefit of examining the issue by applying Section 14A. The Tribunal in Santosh Kumar Agrawal's case relied by the learned Counsel for assessee was delivered without considering the effect of Section 14A. Further, on the facts of that case, that assessee had income from interest and remuneration from the firm, which could be safely said to be assessable under the head 'business' as share from partnership firm. But same is not the case with the present assessee. He does not have any other income from the firm except loss. Therefore, nothing is assessable under the head 'business', as the loss has also to be taken out from the computation by virtue of Section 10(2A). The interest was paid to earn an exempted income. Therefore, the same has to be disallowed. He also submitted that Section 14A was introduced in the statute by Finance Act, 2001, w.r.e.f. 1st April, 1962 making it possible for the AO to disallow claim of expenditure incurred in earning exempted income. Further, according to learned. Departmental Representative it is incorrect to say that provisions of Section 14A cannot be invoked at this stage, if AO/CIT(A) have not considered it. In fact, AO could not consider it as it was not in the statute book and CIT(A) thought it fit to confirm the order on the basis of order of his predecessor for the asst. yr. 1997-98. In any case, the provisions of Section 14A could be invoked even at this stage. The learned Departmental Representative also relied on the decision of Ahmedabad, Tribunal in 92 ITD 1 (sic) for the proposition that interest paid on borrowed capital utilised to earn exempted dividend income will not be allowed as deduction against dividend income. The learned Departmental Representative stressed that provision of Section 14A are substantive in nature and have to be followed.
10. In his rejoinder, the learned Authorised Representative took another line of argument that it is not that the share of the income from the firm is always exempt. The firm has to pay tax and, therefore, the income of the partner from the firm has suffered taxation. Taxes have been shifted from the partner to the firm. As firm is a composition of partners, the taxes paid by this firm is in fact taxes paid by the partners.
11. We have considered the rival submissions and perused the material on record, including the authorities relied on by the parties. First issue in the controversy is as to whether is it necessary to have some income before an expenditure can be allowed. It has been answered by Hon'ble Supreme Court in Rajendra Prasad Moody's case (supra) as under:
The plain natural construction of the language of Section 57(iii) of the IT Act, 1961, » irresistibly leads to the conclusion that to bring a case within that section it is not necessary that any income should in fact have been earned as a result of the expenditure. What Section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. The section does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction: it does not say that the expenditure shall be deductible only if any income is made or earned.
Where the assessee borrowed monies for the purpose of making investment in certain shares and paid interest thereon during the accounting period relevant to the assessment year but did not receive any dividend on the shares purchased with those monies : Held, accordingly, that the interest on monies borrowed for investment in shares which had not yielded any dividend was admissible as a deduction under Section 57(iii) of the IT Act, 1961, in computing its income from dividend under the head 'income from other sources'.
12. From the above ratio, it is clear that it is not necessary that there should be an income assessable under Section 57 for the expenditure to be allowed. The only requirement is that expenditure should have been incurred wholly and exclusively for the purpose of earning that income. Thus, incurring of expenditure and allowability thereof under the Act does not depend upon any income actually earned. Thus, in the present case also, it is not in dispute that investment in the firm was made to earn share of profit, which is assessable under the head 'business' but which is now exempt by virtue of Section 10(2A). This share of income is no longer part of the total income of the assessee. Various provisions of the Act from Section 15 to Section 59 prescribe how the expenditure is to be allowed. These expenditure have to be allowed with reference to income, in earning of which such expenditure has been wholly and solely incurred. Rajendra Prasad Moody's case (supra) does not lay down a principle that an expenditure incurred to earn an income assessable under one head enumerated under Section 14 can be allowed under any other head. Thus, there is no transgression of 'head' for allowing an expenditure. In other words, if expenditure is incurred to earn income under the head 'house property1 then it cannot be allowed under the head 'other sources' or 'business'. Even expenditure incurred to earn income from one source cannot be considered for allowability under other source under the same head. Thus, the expenditure incurred to earn share of profit from the firm can only be considered for allowability under the head 'business' and also under the same source, i.e., 'share profit from the firm1. Section 14 amply clarifies the scheme and intention of the legislature. There could be no such intention of the legislature to allow expenditure relating to income not forming part of total income. Hon'ble Supreme Court in Tuticorin Alkali Chemicals & Fertilisers Ltd. v. CIT , wherein it is held that interest expenditure in a business not commenced cannot be allowed as expenditure. The claim of expenditure can only be made in accordance with provisions of the Act. The headnotes from that decision are :
Under the IT Act, 1961, the total income of a company is chargeable to tax under Section 4. The total income has to be computed in accordance with the provisions of the Act. Section 14 lays down that for the purpose of computation, income of an assessee has to be classified under six heads, It is possible for a company to have six different sources of income, each one of which will be chargeable to income-tax. Profits and gains of business of profession is only one of the heads under which a company's income is liable to be assessed to tax. If a company has not commenced business, there cannot be any question of assessment of its profits and gains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. The company may keep the surplus funds in short-term deposits in order to earn interest. Such interests will be chargeable under Section 56.
Any set off or deduction of any expenditure can only be made in accordance with the provisions of the Act.
13. Intention of the legislature by inserting Section 14A was to make statutory what was so far obvious by virtue of Section 4. An expenditure can be allowed if it is spent to earn the income. Memorandum explaining the introduction of Section 14A shows the intention of the legislature. Such an intention has been clarified in the provisions of newly inserted Section 14A by the Finance Act, 2001, with retrospective effect from 1st April, 1962 and as well as in the memorandum explaining the Provisions, Notes on Clauses relating to the Finance Bill, 2001 and in the Board's Circular No. 14 of 2001, dt. 22nd Nov., 2001 [(2002) 172 CTR (St) 13] and Circular No. 8 of 2002, dt. 27th Aug., 2002 [(2002) 178 CTR (St) 9] in the following way:
Certain incomes are not includible while computing the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemptions to certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is against the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income.
It is proposed to insert a new Section 14A so as to clarify the intention of the legislature since the inception of the IT Act, 1961 that no deduction shall be made in respect of any expenditure incurred by the assessee in relation to income which does not form part of the total income under the IT Act.
Section 14A provides for disallowance of expenditure in relation to income which does not form part of the total income. It is assessee's own total income that is to be seen for applying the provisions of Section 14A and not that of somebody else. Admittedly by virtue of Section 10(2A) share income is not includible/included in total income of an assessee partner. In other words by virtue of Section 10(2A) it does not form part of the total income of partner and, therefore, the expenditure incurred by the partner in earning that income would not be allowable.
14. The share income is now exempt under Section 10(2A); therefore as a consequence thereof, interest paid on borrowed capital invested in the firm to earn such share income could not be allowed. It cannot be allowed against any other income because borrowed capital was not utilised for earning any other income. This is what is the Scheme of Act even without Section 14A. The argument of the learned Counsel for assessee that firm is taxed and therefore income coming into the hands of the partner is also claimed to have been taxed is not tenable because charge of tax is not on income but on the person. The firm and partners are two distinct entities on which tax is charged as per Section 2(31). Even otherwise, provision of Section 10(2A) is applicable only on the partner. The provision of this section cannot be made redundant by giving such an interpretation. The fact that legislature has thought it fit to consider the taxability of share in the hands of the partner separately and independently clearly shows that assessability of income in the hands of firm and in the hands of the partners have to be viewed independently. Earlier to Section 10(2A), the tax had to be levied on the firm as well as on the partners. Merely because tax has been levied on the firm, the taxability of share of income in the hands of partner could not be ignored as it is the legislative intent, which has to prevail. Earlier it wanted to tax the same income once in the hands of the firm and then as share in the hands of partner. Subsequently, Section 10(2A) has laid down different legislative intent. Share of profits taxed in the hands of the firm would not be taxable in the hands of partner. Therefore, the contention of the assessee that by virtue of firm having been taxed and hence partner is also taxed is rejected.
15. Now the issues arising for consideration is whether provisions of Section 10(2A) would be applicable only when there is positive share income from partnership firm and not where there is a share of loss. It has been held in several cases that 'income' includes 'loss' In CIT v. Harprasad & Co. (P) Ltd. , it was held by Hon'ble Supreme Court that in a year when capital gains was not subjected to tax as it did not form part of the 'total income', it was not required to be computed. And if loss is from a source or head of income not liable to tax or congenially exempt under the Act, the AO is not required to compute the loss and allow it to carry forward. The concept of set off of loss and carry forward does not go into vacuum. Thus, where loss arises from a source/head not chargeable to tax, it could not be set off. Hon'ble Supreme Court observed as under:
During the accounting period ending 30th April, 1954, relevant to the asst. yr. 1955-56, the assessee sold certain shares at a loss of Rs. 28,662, which it claimed as a revenue loss. Both the ITO and the AAC rejected the claim on the ground that the loss was a capital loss. On appeal, the Tribunal accepted the contention of the respondent raised for the first time that the capital loss of Rs. 28,662 should be carried forward and set off against capital gains, if any, in the future, even though tax was not chargeable under Section 12B of the Indian IT Act, 1922, on capital gains derived during 1st April, 1948, to 31st March, 1956. On a reference, the High Court held that if capital loss was incurred in a year in which capital gains did not attract tax under Section 12B such loss would still be loss under the head 'capital gains' and it could be carried forward and set off against capital gains in a subsequent year. On appeal to the Supreme Court by the CIT : Held, reversing the decision of the High Court that the capital loss could not be determined and the respondent was not entitled to the carry forward of the loss of Rs. 28,662. In the relevant previous year and the assessment year or even in the subsequent year, capital gains did not form part of the 'total income' of the respondent which could be brought to charge and were therefore not required to be computed under the Act. If the loss is from a source or head of income not liable to tax or congenially exempt from income-tax, neither the assessee is required to show the same in the return, nor is the ITO under any obligation to compute or assess it, much less for the purpose of 'carry forward'. During the period Section 12B did not make income under the head 'capital gains' chargeable, an assessee was neither required to show income under that head in his return, nor entitled to file return showing 'capital losses' merely for the purpose of getting the same computed and carried forward. Sub-section (2A) of Section 22 would not give him such a right because the operation of that sub-section is, in terms, confined to (i) a loss which is sustained "under the head 'profits and gains of business, profession or vocation'" and would ordinarily have been carried forward under Sub-section (2) of Section 24, and (ii) to 'income' which falls within the definition of 'total income'. The concept of carry forward of loss does not stand hi vacuo. It involves the notion of set off. Its sole purpose is to set off the loss against the profits of a subsequent year. It presupposes the permissibility and possibility of the carried forward loss being absorbed or set off against the profits and gains, if any, of the subsequent year. Set off implies that the tax is exigible and the assessee wants to adjust the loss against profit to reduce the tax demand. It follows that if such set off is not permissible or possible owing to the income or profits of the subsequent year being from a non-taxable source, there would be no point in allowing loss to be 'carried forward'. Conversely, if the loss arising in the previous year was under a head not chargeable to tax, it could not be allowed to be carried forward and absorbed against income in a subsequent year, from a taxable source.
16. In Aryasthan Corporation Ltd. v. CIT it was held that losses represent negative income. Both income and losses are revenue in character. In CIT v. J.H. Gotla , it was similarly held that word 'income includes 'loss' and therefore, share income of wife/children clubbed under Section 16(3) of IT Act, 1922 could be set off against losses of individual business. Hon'ble Supreme Court held as under:
The share income of the wife and minor children in the firm was included in the total income of the respondent under Section 16(3) of the Indian IT Act, 1922, for the asst. yrs. 1959-60, 1960-61 and 1961-62, and the question was whether the respondent was entitled under Section 24(2) to set off the losses, which were incurred in his individual business in earlier years and brought forward, against the share income of his wife and minor children. In those years, the respondent had continued to carry on business in purchase and sale of groundnut cake and oil on a small scale. The Tribunal held that though the respondent was continuing to carry on business of oil in general in those three years, he was not entitled to the set off, since he could not be said to be carrying on the business out of which the share income of the wife and minor children arose. On a reference, the High Court held that the respondent was entitled to the set off under Section 24(2). On appeal to the Supreme Court:
Held : affirming the decision of the High Court, that the respondent was entitled under Section 24(2) to set off the loss in his individual business which had been carried forward against the share income of the wife and minor children included in his total income under Section 16(3), as the share income had to be regarded as business income derived from business carried on by the respondent.
Where Section 16(3) operates, the profit or loss from a business of the wife or minor child included in the total income of the assessee should be treated as the profit or loss from a 'business carried on by him' for the purpose of carry forward and set off of loss under Section 24(2).
17. Similar propositions were laid out in CIT v. Karamchand Premchand Ltd. and CIT v. Elphinstone Spinning & Weaving Mills Co. Ltd. (1960) 40 ITR 142 (SC). It is held that loss is negative profit. Both positive and negative profits are of revenue character and will enter the computation of income.
18. But where specific provisions are provided in the Act, to treat the loss in a different manner, then those specific provisions will prevail over general provisions that income includes loss. Let us analyse Section 10(2A), which reads as under :
(2A) in the case of a person being a partner of a firm which is separately assessed as such, his share in the total income of the firm.
Explanation : For the purposes of this clause, the share of a partner in the total income of a firm separately assessed as such shall, notwithstanding anything contained in any other law, be an amount which bears to the total income of the firm the same proportion as the amount of his share in the profits of the firm in accordance with the partnership deed bears to such profits.
19. Main section provides that share of the partner in the total income of the firm will not be taken into account while computing his income. Normally income should include loss as we have understood from discussion held above, but Explanation attached to it restricts the area in which this exception would be applicable. It provides the mechanism of computation of such share of the partner in the income of the firm. Such computation is done 'notwithstanding anything contained in any other law'. It also lays down condition for such exception. One is when a firm is not assessed to or its income is exempt, then Section 10(2A) cannot be invoked in the case of the partner for claiming further exemption to the share. Second condition is that only that amount will be the share of the partner entitled for exemption, which bears the same ratio to the total income of the firm as his share in the profits of the firm bears to such profits. This part of the Explanation envisages that income of the firm may be different from the profits of the firm. From the profits earned by the firm, the interest, remuneration paid to the partners are excluded to arrive at assessable income as per Section 40(b), Hence, assessable income may be less than the profits of the firm. In some cases, assessable income may be higher than the profits of the firm by virtue of some disallowance made by the assessee himself or by the AO in the assessment of the firm. The share of the partner in the income of the firm will be the same as the share of that partner in the profits of the firm as per partnership deed. Income is therefore, not the same thing as profits. Therefore, profits do not mean and include loss like in the case of the definition of income, which includes loss. Profits, as opposed to loss, are always positive. When we want to indicate negative profits, we refer to it as loss. It has been held in Karmachari Union, Agra v. Union of India that the word 'profits' in the context of Section 17 is used only to carry an 'advantage' or 'gain' by receipt of any payment....
20. The dictionary meaning of the word 'profit' is also 'advantage' or 'benefit'. In the context of Section 80HHC where word 'profit' is used for allowing deduction, it is held in IPCA Laboratories Ltd. v. Dy. CIT that profit means positive profit and not 'loss'. Thus when after adjustment of profits/loss of export of manufactured goods and trading goods, there is a positive profit, and not loss, only then deduction under S..80HHC would be allowable. In an old case CIT v. Bengalee Urban Co-operative Credit Society Ltd. (1934) 2 ITR 121 (Rangoon), Hon'ble Court held 'profit' as positive profit. It has also been defined in Law dictionaries as under:
1. Profit : An advantage or benefit; the gain, the preliminary gain in any transaction, [Section 145(2), Cr.P.C. 1973 (2 of 1974)]
2. The residual amount that remains after expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. Any amount over and above that required to maintain the capital at the beginning of the period is profit (IAS. paras F. 105, F. 107)
3. What remains after production and sales costs have been deducted (Commerce)
4. At its most general, the surplus money, after all expenses have been met, generated by a company or enterprise in the course of one accounting period. [See gross profit; net profit. (International Accounting; Business Term)].
5. Profit implies a comparison between, the state of business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be, ascertained by a comparison of the assets of the business at the two dates. If the total assets of the business at the two dates be compared, the increase which they show at the later date as compared with the earlier date (due allowance, of course, being made for capital introduced into or taken out of the business in the meanwhile) represents, in strictness, the profits of the business during the period in question'. The legal meaning of profit is maintaining the capital intact and taking out the surplus of current year's receipts over expenses. Dent v. London Tramways Co. (1880) 16 Ch. D 344; Fisher v. Black & White Publishing Co. (1901) 1 Ch. D 174 (CA); Lawrence v. West Somerest Ry. Co. (1918) 2 Ch. D 250.
6. Advantage, avail, benefit emolument, expediency, gain, good, improvement, proceeds, receipts, return, returns, service, utility, value. (Webster's Comprehensive Dictionary, as cited in Karmachari Union, Agra v. Union of India .
21. Thus, on a combined reading of all those observation of the Courts and dictionary meaning we are of the considered view that profits means only positive profits and not loss. It is other than income, which would include loss.
22. Now the question comes is as to whether main Section 10(2A) can be read in isolation. The true meaning of Explanation is discussed by Hon'ble Kerala High Court in CIT v. Kerala Electric Lamp Works Ltd. as under:
The label Explanation is not decisive of the true meaning and scope of the provision. Ordinarily the purpose of an Explanation in a statute is to clarify or explain or settle any doubt or ambiguity or controversy. It may even widen the scope of the main provision in rare cases, The words used alone can reflect the true intent and they should be construed on their own terms.
23. In CYT v. Orissa Cement Ltd. Hon'ble Delhi High Court on the object of Explanation to a statutory provision observed as under:
The object of an Explanation to a statutory provision is : (a) to explain the meaning and intendment of the Act itself; (b) where there is any obscurity or vagueness in the main enactment, to clarify the same so as to make it consistent with the dominant object which it seems to sub-serve; (c) to provide an additional support to the dominant object of the Act in order to make it meaningful and purposeful; (d) An explanation cannot in any way interfere with or change the enactment or any part thereof; but where some gap is left which is relevant for the purpose, the Explanation, in order to suppress the mischief and advance the object of the Act, can help or assist the Court in interpreting the true purpose and intendment of the enactment, and the right with which any person under a statute has been clothed. It cannot set at naught the working of an Act by becoming a hindrance in the interpretation of the same.
24. In Cochin Co. v. CIT Hon'ble Kerala High Court observed that:
The proper function of an Explanation is to make plain or elucidate what is enacted and not to add to or subtract from it. An Explanation is different in nature from a proviso, for the latter excepts, excludes or restricts, while the former explains or clarifies.
During the relevant accounting year, the assessee-company was engaged solely in the business of processing and export of fish. It fully satisfied the requirements of 'industrial company' contained in Section 2(7)(d) of the Finance Act, 1966. Therefore, it was liable to be taxed only at the concessional rate of fifty-five per cent. The Tribunal erred in holding that even if the assessee-company satisfied the main part of the definition of 'industrial company' still it had also to satisfy the requirements of the Explanation to the definition clause and that as its income from the business of manufacture or processing of goods was less than 51 per cent of its total income, the assessee was not entitled to the concessional rate of tax.
25. Role of Explanation appended to main enactment has also been explained by Justice G.P. Singh in his book "Principle of Statutory Interpretation (Eight Edn., 2001) p. 106 as under:
An explanation may be added to include something within or to exclude something from the ambit of the main enactment or the connotation of same words occurring in it.
26. Thus in our considered view though the main enactment 1O(2A) deals with exemption of income of the partner from the firm and it would mean both positive income and negative income but explanation restricts the scope to income, which is arrived at from the positive profit of the firm. In other words this Section 10(2A) would not be applicable where loss of the partner is arrived at from the loss of the firm, i.e., when the parties share the loss of the firm in loss-517 sharing ratio as per partnership deed (in contrast to sharing profits of the firm as per profit-sharing ratio as per partnership deed).
27. The next issue which arises for consideration is whether a partner to whom loss is allotted by the firm which has suffered the loss is entitled to get it assessed in his hands and then set off this loss against his income from other sources and/or under other head after the amendment made by Finance Act, 1992. This is relevant because unless a partner has share of loss assessable in his hands under the head "business", he cannot claim deductions of expenses incurred. Unless there is an income or loss received/receivable and assessable from a source expenditure relating thereto cannot be claimed. That is, if income or loss is exempt from taxation in the hands of an assessee the expenditure incurred thereon could not be claimed as deduction. Such expenditure will only increase the loss for accounting purposes. It has been held in CIT v. S.S. Thiagarajan deed by LR's that loss incurred by any assessee from a source, income therefrom is exempt cannot be set off against income from a different source or against income under a different head. Similar view has been taken in Dalmia Jain & Co. Ltd. v. CIT (1967) 65 ITR 408 (Pat) and CIT v. Haipiasad & Co. (P) Ltd. (supra) and J.P. Srivastava & Sons v. CIT , From this, it follows that loss receivable from the firm cannot be assessed in his hands.
28. In this context it is observed Section 75 provides for bringing back into firm the share of losses of the partners pertaining to years prior to asst. yr. 1992-93, which could not be set off in the hands of the partners due to non-availability of income in their hands, so that it can be set off against the income of the firm if that partner continues to be in the firm. Similar provisions are available in Kerala Agricultural IT Act. In this context, Hon'ble Kamataka Court in Shankaianarayana Construction Co. v. State of Kamataka , held that once there is no provision for reversion to the firm of unabsorbed losses allocated to partners, then same cannot also be set off against income of the partner. This decision followed an earlier decision of Kamataka High Court in Shankaranarayana Construction Co. v. State of Kamataka . From this it follows that unless there is a statutory provision, loss cannot be set off against income from another source or another head. Section 75 in IT Act as it existed prior to amendment by Finance Act, 1992, provided set off of the loss coming to the hands of partners, against their other income in the current year or allowed to carry forward for set off against their future individual income. The present provisions of Section 75 do not provide so. In other words, only the firm is entitled to set off the losses against income under other sources or under other head. Section 70 also does not make any distinction between a firm or any other assessee, i.e., firm is treated like any other assessee to set off its losses against other income in the same year or is allowed to carry forward to subsequent years to be set off against income of that year. Thus, a partner will not be entitled to get losses from the firm for setting it off against its other income either from another source or under other head. Thus where there is no loss available from the firm as share to the partner, he cannot increase this loss by expenses incurred thereon, such as payment of interest on borrowed capital or say salary paid to an employee to look after the affairs of partner in the firm. Even if it is done for accounting purposes, he will not be entitled to set off such loss or for that matter enhance loss (by adding interest on borrowed capital) against its individual income from other sources. This is so, because there is no specific provision in this behalf, to set off loss of the partner from the firm against his other income. 29. On the other hand intention of legislature is against such set off and carry forward by partner. As said earlier, earlier provision of Section 75 provided such set off and carry forward in the hands of partner but amended Section 75 provides the same only in the hands of the firm. Similarly, Section 78 suggests that losses have to be set off and carry forward in the hands of the firm as the loss of outgoing partner will not be set off and carry forward in the hands of the firm. Circular No. 703, dt. 18th April, 1995 further clarifies this intention:
To All Chief CITs All Directors-General of IT Sir, With effect from the asst. yr. 1993-94 a new procedure for taxation of firms has been introduced according to which the distinction between registered and unregistered firms has been done away with. Consequently the requirement of apportionment of losses among the partners for set off and carry forward has also been given up. In line with this procedure, Section 75 provides, w.e.f. 1st April, 1993, that if there are unabsorbed losses in the hands of the partners to whom such losses had been apportioned for the asst. yr. 1992-93 and earlier years, the same shall be brought back to the firm to be set off against the income of the firm subject to the condition that the partner continues to be a partner in the said firm and are to be carried forward for set off under Sections 70, 71, 72, 73, 74 and 74A.
2. Doubts have been expressed in some quarters as to whether the unabsorbed business losses so brought back to the firm are available for set off against the income of the firm under all heads for the asst. yr. 1993-94. This doubt has arisen because, normally, under Section 72, the business losses brought forward are permitted to be set off only against the income under the head 'profits and gains of business or profession', and, that too, only if the business in respect of which the losses were incurred continues to be carried on in the year of set off.
3. A plain reading of Section 75 shows that the losses which remain unabsorbed in the hands of the partners "shall be allowed to be set off against the income of the firm subject to the condition that the partner continues in the said firm and to be carried forward for set off under Sections 70, 71, 72, 73, 74 and 74A". The expressions 'set off and 'carried forward and set off have been used in conjunction with Sections 70, 71, 72, etc., thereby implying that both set off and carry forward and set off, as envisaged in these sections, are permissible.
4. The Board has, therefore, decided that the set off envisaged under Sections 70 and 71 may be allowed for the asst. yr. 1993-94 in the hands of the firm in respect of the unabsorbed losses brought back to the firm.
5. This may be brought to the notice of all AO's working in your region.
(Sd.) Pravin Kumar, Under Secretary, ITA-II, Central Board of Direct Taxes
30. Thus, we hold that share of loss from the firm cannot be allowed to be set off against other income of the partner and also cannot be allowed to be carried forward to subsequent years. Once this is so, no expenditure incurred on earning share of loss can be allowed and added to the loss and be allowed to be set off against other income or allowed to be carried forward in the hands of the partner.
31. However the situation would be different if a partner is allotted salary/interest from the firm if such partner is a working partner. Then interest/remuneration received from the firm will be assessable in the hands of the partner under the head "business" under Section 28(iv). That is where partner has received salary/bonus/interest/commission from the firm and same has been allowed as deduction in the hands of the firm, then the partner has a source under the head "business" under which salary/bonus/interest/ commission will be assessable. Thereafter, any interest paid by the partner on borrowed capital invested in the firm can be debited and claimed as an expenditure. The prohibition is only on the income or loss which has been assessed in the hands of the firm but there is' no such prohibition in case of salary/bonus/commission/interest. For share of profits received from the firm, Section 10(2A) provides exemption, hence there is no source as such to claim expenditure (such as interest on borrowed capital). In case of loss, the same is allowed to be set off and carry forward only in the hands of the firm. Here again the partner does not get a source in which expenditure can be debited and claimed. But interest/bonus/salary/commission stand on a different footing. For then there is a 'source' under the head 'business' and therefore expenditure incurred on earning share from the firm (e.g. interest on borrowed capital) can be claimed as expenditure. Similar view has been taken by Tribunal 'J' Bench in Sudhji Dattaiam Patil v. Dy. CIT (2005) 2 SOT 678 (Mumbai).
32. As a result we hold that (i) section 10(2A) comes into operation only when the firm has a positive profit and the partner gets a share out of such profit, as per profit-sharing ratio mentioned in the partnership deed.
(ii) Only firm is entitled to set off and carry forward the loss. In absence of any specific provision in the statute, the loss allocated to partner, cannot be assessed, set off and carry forward in the hands of the partner. It may be done for accounting purpose only.
(iii) As a result in either situation, expenditure incurred by the partner cannot be allowed as a deduction and hence set off/carry forward.
(iv) If a partner gets any bonus/commission/remuneration/interest from the firm which is allowed as a deduction in its hands, then the partner has a source of income under the head 'business' against which expenditure incurred by the partner, e.g., interest paid on borrowed capital invested in the firm can be claimed as deduction.
33. In the present case it is not known as to whether the partner has any income from the firm like salary/bonus/commission/interest. We, therefore, restore the matter to the file of the AO to decide the allowability of interest paid on borrowed funds invested in the firm in the light of discussion made above.
34. The ground of the assessee is allowed for statistical purposes.