This appeal by the assessee for the assessment year 1994-95 is directed against the order of the Commissioner (Appeals) upholding disallowance of remuneration paid to the partner by the assessee-firm.
The facts of the case are that assessee-firm in the period under consideration paid remuneration of Rs. 4,34,000 to Shri Dilip G. Shah, the working partner against Rs, 42,000 paid in the immediately preceding assessment year. The assessing officer took the statement of Shri Dilip Shah and other facts and circumstances of the case and held that remuneration paid was excessive and was liable to be disallowed under section 40A0(b) of the Income Tax Act. The assessing officer further observed that as per partnership deed dated 1st April, 1992, remuneration payable to the partner, was to be decided by mutual consent at the end of the year. The assessing officer further noted the following circumstances for allowing remuneration to the partner at Rs. 42,000 and disallowing the balance under the provisions mentioned above : (1) The partnership deed dated 1st Feb., 1994, specifies the maximum limit of remuneration to be allowed to the partners. It does not 'fix the amount of salary of working partners.
(2) No separate agreement is executed fixing the salary of working partners in each year.
(3) No fresh partnership deed authorising more amount of salary to working partner was executed in the year under reference.
(4) No extra labour/work has been put in by working partner in the year under reference. This fact is also admitted by working partner in his statement recorded on 17th March, 1997, vide answer to question Nos. 13 and 14.
(5) Working partner Shri Dilipkumar G. Shah in his reply to question No. 17 in the statement recorded on 17th March, 1997, has admitted that the rise given to him in salary is not reasonable. He also admitted that there is no reason to give such rise in salary, (6) On making disclosure of Rs. 10 lakhs, working partner has not made.
Any extra efforts or extra work which may entitle him such a huge rise in his salary.
(7) No doubt his income falls under higher bracket of taxation, but after exclusion of salary from his total income, his income will be below taxable limit. He has availed of maximum exemption limits available in the case of individual assessee. Had this salary rise was not given, the extra income offered was taxable in the hands of the assessee-firm and it would have fetched 40 per cent tax without giving any exemption.
(8) No doubt disclosure made was for the profit before deduction of salary and interest to partners, but it does not give rights to the assessee to give abnormally high salary to working partner.
(9) Partners of the firm are specified persons and payment of salary for the services rendered by them are to be judged in normal way and if any abnormaley is noticed excess payment has to be disallowed in view of section 40A0(b) of the Income Tax Act.
The assessee impugned the above disallowance in appeal but remained unsuccessful. The learned Commissioner (Appeals) confirmed the disallowance with following observation : "2.5. I have considered the rival submissions. The facts and circumstances of the case under consideration are identical to that of the case viz. Mls Chhaganlal Dharamchand Shah, (Appeal No. Commissioner (Appeals)/M11/Cir. 1(i)/3/97-98-, assessment year 1994-951. For the reasons discussed in the appellate order dated 19th Aug., 1999, assessing officer's decision is upheld. Therefore, this ground of appeal fails." The assessee has come up in appeal. We have heard Shri S.N. Soparkar, the learned counsel on behalf of the assessee and Shri R.K. Gupta on behalf of the revenue . The learned counsel for the assessee drew our attention to instrument of partnership executed between the partners on 1st April, 1992, and stated that relevant clause relating to payment of remuneration was clause (8). The English translation of that clause is as under "(8) From Ist April, 1992, in the said firm, the following working partners will be paid remuneration.
After the end of the accounting year and as per the Income Tax Act, maximum permissible remuneration will be paid and debited to the book of the firm as per the mutual understanding of the partners. If the firm makes any loss no remuneration will be paid. Upon the mutual understanding of the partners, the remuneration paid to the partners can be modified within the scope of the Income Tax Act. " As per the above clause, the maximum salary as permitted under the Income Tax Act could be paid to the working partner. Remuneration in this case was paid as per the above clause and having regard to provision of * section 40(b)(5). The assessing officer had no right to disallow any part of remuneration. The maximum limit upto which remuneration could be paid was fixed by the legislature and, therefore, the assessing officer had no discretion in the matter. Shri Soparkar drew our attention to decisions in the case of Ganesh Factory v. CIT (1989) 79 CTR (P&H) 48 : (1989) 180 ITR 416 (P&H) and in the case of CIT v. Yoganand Textiles (1993) 113 CTR (Guj) 234 : (1993) 202 ITR 869 (Guj).
The learned departmental Representative argued that both the statutory provisions i.e. sections 40(b)(5) and 40A(2) were existing simultaneously and were to be applied. In fact, provision of section 40A(2) was overriding provision. The assessing officer, therefore, had full power to go into the question of reasonableness of salary. There was no justification for enhancing salary from Rs. 42,000 to Rs. 4,34,000 in the period under consideration. He further submitted that assessment at a higher figure was made on account of surrender made by the assessee. The higher income was not attributable to the efforts made by the working partners or for services rendered by him.
Therefore, on facts, disallowance of salary in the light of provision of section 40A(2) is fully justified.
We have considered the submissions of both the parties. and considered the relevant clauses of the deed (English translation) which was accepted by both the parties as also Circular of the Board No. 739, dated 25th March, 1996. (published at (1996) 131 CTR (St) 531.
In order to resolve the controversy whether both the provisions of Income Tax Act i.e. sections 40(b)(v) and 40A(2) could be applied simultaneously, or one provision was overriding the other, we are to take into account the history and background of the two provisions.
Clause (b) of section 40 came in operation right from the enforcement of Income Tax Act, 1961, and provided as under i "40(b). In the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm." By virtue of above clause (b), the payment of the items mentioned in the clause was prohibited and by virtue of non obstante clause it had an overriding effect. Sec. 40A with its different clauses was brought on statute book with effect from Ist April, 1968. It also contained a non obstante clause saying that this section shall have effect notwithstanding anything to the contrary contained in any other provision of the Act relating to computation of income under the head "profits and gains of business or profession". Sub-s. (2), clause (a) of section 40A provides as under ~ "40A(2)(a). Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Income Tax Officer is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefore, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction." In the case of Ganesh Factory v. CIT (supra), it was contended on behalf of the assessee that salary paid by a firm to its partner should be allowed under section 40AQ) as said section was an overriding section and has to be applied in preference to provision of section 40(b) for a case relating to assessment year 1974-75. Their Lordships of the Punjab & Haryana High Court after considering both the provisions referred to above repelled the contention with the following observation : A reading of the aforesaid quotation shows that payment of salary to a partner of the firm, who may be working whole time for the assessee-firm, would not come within the ambit of services as the services provided under section 40A are as noticed in the aforesaid quotation and not as an employee, i.e., relationship of master and servant.
Moreover, the legislature was aware of the meaning of "salary" in contradistinction to the services which may be rendered for carrying on business by a person. Here, in the statement of the case, it is mentioned that total salary of Rs. 18,000 was paid to three of the partners of the firm and the word "salary" is clearly covered by section 40(b) and does not come within the ambit of section 40A.Therefore, we are of the opinion that such a matter is not covered by section 40A and would be covered only under section 40. Since salary has been paid by the assessee-firm to its partners, the same has to be disallowed by virtue of clause (b) of section 40 of the Act and the Tribunal and the officers below were right in disallowing the entire salary paid to the partners of the firm." In the case of CIT v. Yoganand Textiles (supra) in a case relating to assessment year 1976-77 their Lordships of Hon'ble Gujarat High Court repelled a similar contention with the following observation (as per headnote) : ............ The provisions of sub-section (2) of section 40A cannot be construed so as to read that the deductions which are made impermissible under section 40(b) should be read as permissible under section 40A. It is clear that the payments made to a partner which are covered by section 40A(b) are of the nature other than those which are prohibited by clause (b) of section 40. In other words, it is in cases where payments other than those which are covered by clause (b) of section 40, are made to the partner that the question of excessiveness or unreasonableness of payments may arise which would be governed by the provisions of section 40A(c). " It is thus clear from the above decisions that sections 40(b) and 40A(2) are/were operating in different fields. In the light of total prohibition under section 40(b) on the allowance of salary, bonus, commission, etc. to the partner by the firm, the other provision of section 40A where reasonableness and market value of services offered would apply only in a field or cases where section 40(b) had no application. Therefore, it is not right to contend that provision of section 40A must override provisions of section 40(b) of the Income Tax Act. The provisions of section 40(b) were amended by Finance Act, 1992, with effect from 1-4-1993, and remuneration paid by a firm to its working partner has been allowed as a deduction provided it is within the limit prescribed. The relevant sub-clause (v) of clause (b) of section 40 is as under ~ "(v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder : (1) In case of a firm carrying on a profession referred to in section 44AA or which is notified for the purpose of that section : Rs. 50,000 or at the rate of 90 per cent of the book profit, whichever is more., Rs. 50,000 or at the rate of 90 per cent of the book profit, whichever is more., Provided that in relation to any payment under this clause to the partner during the previous year relevant to the assessment year commencing on the Ist day of April, 1993, the terms of the partnership deed may, at any time during the said previous year, provide for such payment.
Explanation 1 :-Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as 'partner in a representative 'capacity' and 'person so represented', respectively) : (i) interest paid by the firm to such individual otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of this clause , (ii) interest paid by the firm to such individual as partner in a representative capacity and interest paid by the firm to the person so represented shall be taken into account for the purposes of this clause.
Explanation 2. Where an individual is a partner in a firm otherwise than as partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf,, or for the benefit, of any other person.
Explanation 3 : For the purposes of this clause, 'book-profit' means the net profit, as shown in the P&L a/c for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.
Explanation 4 : For the purposes of this clause, "working partner" means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner." On reading of the above section, it is clear that legislature has not only allowed deduction of remuneration paid to the partner but has also laid down the limit and extent to which it can be paid. The amended provision does not suggest that earlier scheme when this provision was independent of provision of section 40A has been altered or modified.
The contents of the provision like permitting Rs. 50,000 or 90 per cent of first Rs. 75,000 of book profit, or whichever figure is higher, clearly shows that legislature was permitting salary as high as 90 per cent of book profit. The argument that assessing officer can still examine reasonableness of remuneration paid by a firm to its partner is running counter to the expression "whichever is more" used in both sub-clause. (1) and (2) quoted above. The intention is not to restrict but to allow maximum amount as prescribed. In the light of language and context of the provision introduced with effect from 1st April, 1993, ~here is no scope to argue that assessing officer has power to go into the question of reasonableness of remuneration paid to a partner. Of course, he can only examine whether the remuneration paid is not exceeding the prescribed limits of the book-profit. But he has no power to scale it down from the above percentage by saying that working partner did not render services to earn profit of the partnership.
Accordingly, we hold that provision of section 40A had no application to a case governed by section 40(b) of the Income Tax Act. This intention is more clearly manifested after amendment of above provision with effect from 1st April, 1993. Even otherwise, section 40(b) is applicable only to the payment made by a firm to its partner whereas provision of section 40A(2) is of general nature applicable to several situations. It is settled law that a special provision governing a special situation has to be applied when that situation arises and not a general provision which governs several fields.
It is however, true that for getting deduction of remuneration paid to partner, the following conditions must be satisfied : (ii) The payment of remuneration should be authorised by terms of partnership deed for the period for which remuneration is claimed.
(iii) The remuneration should not exceed the amount provided in the provision.
The assessing officer while disallowing the remuneration observed that salary paid to Shri Dilip G. Shah was excessive under section 40A(2)(b) of the Income Tax Act. The other reasons given by revenue authorities are already noted. It has been further observed that no separate agreement for the year under consideration was executed fixing the salary payable to the working partner.
We have already given reasons for holding that provision of S.40A(2)(b) was not applicable in this case. We further disagree with the conclusion reached by revenue authorities on the construction of the partnership deed. We fully agree that remuneration or salary is nothing but profit of a partner known by different names. Justice V.R. Krishna Iyer called salary different label for profit in the context of partner's remuneration (see CIT v. R.M. Chidambaram Pillai, etc. 1977 CTR (SC) 71 : (1977) 106 ITR 292 (SC).
The above spirit is also reflected in Circular No. 739, dated 25th March, 1996, the relevant portion of which is quoted below : "The Board have received representations seeking clarification regarding disallowance of remuneration paid to the working partners as provided under section 40(b)(v) of the Income Tax Act. In particular, the representations have referred to in two types of clauses which are generally incorporated in the partnership deeds These are : (i) The partners have agreed that the remuneration to a working partner will be the amount (if remuneration allowable under the provisions of section 40(b)(v) of the Income Tax Act., and (ii) the amount of remuneration to working partner will be as may be mutually agreed upon between partners at the end of the year. It has been represented that the assessing officers are not allowing deduction on the basis of these and similar clauses in the course of scrutiny assessments for the reason that they neither specify the amount of remuneration to each individual nor lay down the manner of quantifying such remuneration.
2. The Board have considered the representations, Since the amended provisions of section 40(b) have been introduced only with effect from the assessment year 1993-94 and these may not have been understood correctly the Board are of the view that liberal approach may be taken for the initial years. It has been decided that for the assessment years 1993-94 to 1996-97 deduction for remuneration to a working partner may be allowed on the basis of the clauses of the type mentioned at 1(i) above.
3. In cases where neither the amount has been quantified nor even the limit of total remuneration has been specified but the same has been left to be determined by the partners at the end of the accounting period, in such cases payment of remuneration to partners cannot be allowed as deduction in the computation of firm's income." Having in mind the legal position stated above and the Circular of the Board No. 739 and on examination of provisions of partnership deed (relevant English translation agreed upon by parties quoted above), we are of the view that there is clear agreement between the parties to pay remuneration to the partner at minimum rate permissible under the Income Tax Act. The agreement suffers from no infirmity and cannot be treated as void or illegal. Under the agreement, the firm could pay maximum prescribed amount of the book-profit to the partner as remuneration. The provision which states, "upon the mutual understanding of the partners, the remuneration paid to the partner can be modified within the scope of the Income Tax Act" cannot be read as an agreement contrary to the provisions of the Income Tax Act, The last words "within the scope of the Income Tax Act" really restricts the agreement which can be mutually entered by the partners. The agreement can only be in writing and as per the partnership deed operating in the relevant period. It is nobody's case that remuneration paid to the partner exceeded prescribed percentage of the book-profit. To hold that there was no agreement between the partners to pay salary as paid is really to ignore the agreement between the partners that they could pay salary within the scope of the Income Tax Act. It is, therefore, not possible to construe and hold that agreement between the parties is going against the statutory provisions of the Income Tax Act. The agreement clearly provides that remuneration could be paid at the maximum rate permissible under the Income Tax Act and that is what has actually been done by the partners as per calculations placed on record. The remuneration is paid ale settled in the instrument of partnership, dated Ist April, 1992.
In the light of above decision, we do not see any good reason to uphold the disallowance of Rs. 4,34,000 out of remuneration paid to the partner. The same is directed to be allowed as claimed. Accordingly, we set aside the impugned orders of revenue authorities and direct the assessing officer to allow deduction remuneration by passing revised order.