1. All these appeals by Revenue and cross-objections by assessee are directed against orders of learned CIT(A)-II, Nagpur, dt. 18th June, 2004 in an appeal against assessment order framed under Section 143(3) r/w Section 147 of the IT Act (the Act).
2. All the assessees are relatives and partners in a firm M/s Arun Automobiles, having equal share therein. Original assessments were completed under Section 143(1)(a) of the Act. Later on the AO found that the firm M/s Arun Automobiles is crediting the accounts of partners by way of interest and remuneration to the extent due to them based on mercantile system of accounting. However, when it comes to the hands of partners; the partners are offering the same only to the extent of amount withdrawn from such firm. It is the contention of the assessee partners that since they are following cash system of accounting, such interest income from firm is offered for taxation in the year of receipt and not in the year of credit to their accounts.
The AO found that since the firm is crediting accounts of partners to the extent of amount due which is accumulated over years and again interest is paid on such capital account including interest of earlier years credited, it amounts to payment and hence the partners should have offered the income by way of interest credited to their account.
He accordingly issued notice under Section 148 dt. 30th May, 2002 to reassess the income of partners. The assessee objected to proceedings under Section 148. The AO after considering the objection by the assessee held that when the liability to pay tax is evaded by one method or the other, there is escapement of assessment. The term "escaped assessment" includes non-assessment as well as under-assessment. Since the income was not correctly disclosed, it can be said that there was no full and true disclosure and hence reopening of assessment is justified.
3. In the reassessment proceedings, the AO held that the assessee followed mercantile system of accounting upto asst. yr. 1997-98 in respect of such interest income from firm. There are specific provisions for taxation of firm and its partners and there is no relation of employer and employee between the firm and partner. The share income from the firm is exempt but the salary and interest from the firm are taxable under the head "Income from business or profession". The partners who were hitherto offering income on mercantile system have conveniently changed the system with an intention to avoid tax. The assessee has shown capital account and not loan account with the firm. Hence, it is clear that when the interest was due, the firm had shown entire income and claimed deduction in its return. Thus, in one way the money has been received by the partner from firm. He further held that there is no prohibition in partnership deed that interest amount credited by the firm cannot be withdrawn by the partner. Once the share of partner of the firm is determined by way of claiming deduction of payment of interest and then the shares are allocated to the partners, the AO is bound to accept the allocation of share by the firm. As per AS-II issued by Central Government in exercise of power conferred under Section 145(2) of the Act, such standards are to be followed by all assessees following mercantile system of accounting. A change in accounting policy shall be made only if the adoption of different accounting policy is required by statute or if it is considered that change would result in a more appropriate preparation or presentation of financial statement. The, interest paid to the partners which has been deducted by the firms year after year but the partners have not shown the same in their income. This shows their intention to avoid the tax. Mere withdrawal from the firm is not a method of accounting and hence what is credited in the accounts of the partners by the firm is deemed to have been received by the partners. This amounts to adoption of a colourable device and it is not a legitimate tax planning but is a method to avoid tax. Such colourable device cannot be part of tax planning and hence applying the ratio laid down by Hon'ble Supreme Court in the case of McDowell & Co. Ltd. v. CTO , the interest income credited to the account of partner by the firm is assessable as income received by the partner.
Such sum was accordingly brought to tax.
4. Learned CIT(A) held that there is no bar to an individual to choose his method of accounting and the method of accounting followed by the firm is not binding on the partners. In a case where a company owned by directors follows mercantile system of accounting and claimed expenditure on such basis but the directors offering such income on cash basis, such method has to be accepted as held in the case of Dr.
N.K. Brahmachan v. CIT (1992) 104 CTR (Cal) 209. The assessee is allowed to choose and follow cash system of accounting and income should be determined on the basis of method regularly followed. The ratio of Hon'ble Supreme Court in McDowell & Co. (supra) will not apply in view of the subsequent decision of the Supreme Court in the case of Union of India and Anr. v. Azadi Bachao Andolan and Anr. (2003) 184 CTR (SC) 450 : (2003) 263 ITR 706 (SC). The ground relating to reopening of assessment was not adjudicated as the same was held to be of academic interest. Interest charged under Sections 234A and 234B is held consequential in nature.
5. Whereas the Revenue challenges deletion of addition in respect of interest income, in the cross-objections the assessee challenges reopening of assessment and charging of interest under Sections 234A and 234B of the Act.
6. Learned special counsel for Revenue Shri Jaiswal, narrating the facts submitted that the firm M/s Arun Automobiles is following mercantile system of accounting. The interest payable on amount of capital borrowed from partners is credited to the account of partners of the firm. Such capital includes the interest on profit credited for earlier years. However, the partners are stated to have followed cash system of accounting in respect of such interest income. As per Section 28(v) any interest, salary, bonus, commission or remuneration due to or received by a partner of a firm from such firm shall be assessed under the head "Profit and gains of business or profession". As per proviso to Section 28(v) where any interest, salary, etc. has not been allowed to be deducted under Clause (b) of Section 40, the income under Section 28(v) shall be adjusted to the extent of amount not so allowed to be deducted. Thus the provision of section is clear to the extent of same that any amount even due to the partners though not withdrawn is to be charged to tax. As per Section 145(1), the income under the head "Profits and gains of business or profession" or "Income from other sources" is to be computed in accordance with either cash or mercantile system of accounting regularly employed. Thus the provisions of law are clear and unambiguous. If the above provisions of Section 28(v) and Section 145 are read together harmoniously, there is no clash between two. Since what is taxable under Section 28(v) is also amount "due to" to the partners such income has to be assessed in the hands of the partner in the year in which such amount is made unconditionally available to the partners by crediting to their account. The withdrawals by the partner cannot be considered as method of accounting. He invited our attention to the decision of Supreme Court in Union of India v. Hansohdevi and Ors. . The Supreme Court observed as under: Before we embark upon an inquiry as to what would be the correct interpretation of Section 28A, we think it appropriate to bear in mind certain basic principles of interpretation of statute. The rule stated by Tindal, C.J. in Sussex Peerage (1844) 11 Cl and F 85, still holds the field. The aforesaid rule is to the effect: If the words of the statute are in themselves precise and unambiguous, then no more can be necessary than to expound those words in their natural and ordinary sense. The words themselves do alone in such cases best declare the intent of the law giver.
It is a cardinal principle of construction of statute that when language of the statute is plain and unambiguous, then the Court must give effect to the words used in the statute and it would not be open to the Courts to adopt a hypothetical construction on the ground that such construction is more consistent with the alleged object and policy of the Act. In Ktikness v. John Hudson & Co. Ltd. 1955 (2) All ER 345, Lord Reid pointed out as to what is the meaning of 'ambiguous' and held that a provision is not ambiguous merely because it contains a word which in different context is capable of different meanings and it would be hard to find anywhere a sentence of any length which does not contain such a word. A provision is, in my judgment, ambiguous only if it contains a word or phrase which in that particular context is capable of having more than one meaning.
It is no doubt true that if on going through the plain meaning of the language of statute, it leads to anomalies, injustice and absurdities, then the Court may look into the purpose for which the statute has been brought and would try to give a meaning, which would adhere to the purpose of the statute. Patanjali Sastri, C.J. in the case of Aswim Kumar Ghose v. Arabinda Bose 1953 SCR 1 had held that it is not a sound principle of construction to brush aside words in a statute as being inapposite surplusage, if they can have appropriate application in circumstances conceivably within the contemplation of the statute. In Quebec. Railway Light Heat & Power Co. v. Vandray AIR 1920 PC 181, it had been observed that the legislature is deemed not to waste its words or to say anything in vain and a construction which attributes redundancy to the legislature will not be accepted except for compelling reasons.
Shri Jaiswal submitted that this principle is reiterated even in taxing statutes in the case of Mohammad Ali Khan v. CWT (1997) 139 CTR (SC) 335 : AIR 1997 SC 1165. Hon'ble Supreme Court observed thus: It is a cardinal principle of construction that the words of a statute are first understood in their natural, ordinary or popular sense and phrase and sentences are constructed according to their grammatical meaning unless that leads to some absurdity or unless there is something in the context or in the object of the statute to suggest the contrary. It has been often held that the intention of the legislature is primarily to be gathered from the language used, which means that attention should be paid to what has been said as also to what has not been said. As a consequence of construction which requires for its support, addition or substitution of words or which results in rejection of words as meaningless has to be avoided. Obviously the aforesaid rule of construction is subject to exceptions. Just as it is not permissible to add words or to fill in a gap of lacuna, similarly it is of universal application that effort should be made to give meaning to each and every word used by the legislature. In J.K. Cotton Spinning & Weaving Company Ltd. v. State of UP , it was observed by this Court: The Courts always presume that the legislature inserted every part thereof for a purpose and the legislative intention is that every part of statute should have'effect.
In the case of taxing statute it has been held by this Court in several cases that one must have regard to the strict letter of the law and if the Revenue satisfies the Court that the case falls strictly in the provisions of law, the subject can be taxed.
Referring to the provision of Indian Partnership Act, 1932, Shri Jaiswal submitted that the partnership is the relation between the persons who have agreed to share the profits of the business carried on by all or any of them acting for all. As per Section 2(23) of the IT Act, 'firm', 'partner' and 'partnership' have the meanings respectively assigned to them in the Indian Partnership Act, 1932. The assessees who are partners, are related to each other and have total control over the affairs of the firm. There is no prohibition in the partnership deed for withdrawing any sum standing to the credit of such partner's account. The assessee is merely required to withdraw and such withdrawal cannot be considered as received but the moment the amount is credited to their account, it is as good as receipt by the partner.
The assessees have conveniently allowed to swell their accounts from year to year and there is no material to show that such funds are not available to the individual partners. He further submitted that the decision of Hon'ble Supreme Court in CIT v. A. Gajapathy Naidu (1964) 53 JTR 114 (SC) and CIT v. Chunilal V. Mehta & Sons (P) Ltd. relied upon by learned CIT(A) will not apply to the present set of facts. Summarising his arguments, Shri Jaiswal submitted that since the firm has credited the interest to the account of partners who themselves are managing affairs of the firm, mere non-withdrawal of such interest actually cannot be considered as non-receipt of income in the hands of partners. Thus the amount made unconditionally available to the partners is to be taxed as received by the partners even under the cash system of accounting.
7. Learned Counsel for assessee, Shri Rajesh Loya submitted that under the scheme of IT Act the firm and partners are separate taxable entities. There is no express provision in the Act prohibiting different method of accounting followed by the firm and partner. Though under Section 28(v) the income by way of interest and remuneration from the firm in which such assessee is a partner is assessable under the head "Profits and gains of business or profession", such computation is subject to the provision contained in Section 145 of the Act. Section 145 provides that the income chargeable under the head "Profits and gains of business or profession" is to be computed as per the method of accounting regularly employed by the assessee. The choice of method of accounting is with the assessee and the AO cannot thrust upon such method. The words "due to" in Section 28(v) are not finding place for the first time in the Act. Even under Clause (ii) of Section 28 any compensation due to or received by any person is taxable under the head "Profits and gains of business or profession". Similarly there is similar provision in Clause (iiib) or (iiic) of Section 28. Thus even though the amount due to the partner is taxable as profits of business, such income is to be computed only on the basis of method of accounting regularly employed. Hon'ble Supreme Court in the case of Chunnilal V.Mehta & Sons (supra) held thus: Now, coming to the second question, the answer to the same depends upon the interpretation to be placed on Section 10(5A). Earlier, we have set out that provision to the extent necessary for our present purpose. That section takes in "payment due to or received". In the matter of payments, there are two aspects, viz., (1) payments due, and (2) payments received. The mercantile system of accountancy takes note of "payments due" whereas the cash system of accountancy recognizes only payments received. Mercantile system of accountancy, a double entry system, is maintained on the basis of accrual of rights to receive or liability to pay a certain sum of money, unlike in the case of cash system of accountancy which merely takes note of actual receipts or disbursements.
As per Section 145 as amended w.e.f. 1st April, 1997 the assessee can follow either the mercantile system or cash system of accounting. The assessee was following mercantile system of accounting till asst. yr.
1997-98. The assessee changed the system of accounting in respect of interest and remuneration from firm by switching over to cash system.
Such change is allowable provided the change is bona fide and followed consistently thereafter. As per Sub-section (3) of Section 145 if the AO is not satisfied about the method of accounting followed by the assessee, the AO may make an assessment in the manner provided in Section 144. However, in the present case the assessment is not made under Section 144 but under Section 143(3). This implies that the AO is satisfied with the method of accounting. It is true that the assessees who were equal partners in the firm are exercising total control over the firm. However, the partners cannot withdraw the amount at their whims or fancies. In the case of Dr. N.K. Brahmachari (supra), in a case where director was controlling the affairs of the company was held eligible to follow different method of accounting than that followed by the company. Thus, merely because the assessees are exercising total control over the affairs of the firm, it cannot be said that they cannot follow different method of accounting than that followed by the firm. He also relied upon the decision of Tribunal, Bangalore in the case of Bajaj Ashok Chunnilal v. Dy. CIT (2005) 92 TTJ (Bang) 914 : (2005) 92 ITD 353 (Bang) wherein it was held that a minor receiving interest from the parent can follow different method of accounting than followed by his parents and for the purpose of applying clubbing provision of Section 64 it is only the income assessed in the hands of minor, as per the method of accounting employed can be clubbed and not as per the method employed by the parents. For asst. yr. 2004-05, though the interest credited by the firm was much less, the assessee withdrew much larger sum from the firm and the entire withdrawal was offered for taxation which was assessed as such. This proves the bona fides of assessee. He accordingly pleaded that the method of accounting regularly employed by the individual partners should be accepted as such and the income be computed only on such basis.
8. We have considered the rival submissions, relevant facts and the case laws cited. The case involves the assessment of partners in respect of their share by way of interest and remuneration from the firm in which they are partners. Admittedly the firm is following mercantile system of accounting and accordingly the interest and remuneration due to the partners in terms of partnership deed is credited to the accounts of partners under Section 28(v). Such interest and remuneration from the firm are assessable under the head "Profits and gains of business or profession". As per Section 145 the income under the head "Profits and gains of business or profession" is to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Such choice of method is at the discretion of assessee and not AO. As per Section 2(23) the words 'firm1, 'partner' and 'partnership' shall have meanings respectively assigned to them in the Indian Partnership Act, 1932. As per the Indian Partnership Act, 1932, the persons constituting the partnership are individually called partners and collectively called firm. Thus though under the IT Act, 1961, the firm and partners are separate assessable entities, the firm is not a separate juristic entity independent of its partners.
8.1 It is now settled law that the mercantile system of accountancy takes note of "payment due" whereas cash system of accounting recognizes only payment received. Under the cash system of accounting, only the actual receipts or disbursement are accounted for. The question, therefore, to be decided is whether the amount credited by the firm to the individual account of the partners in their capital account with firm can be said to have been received bythe partners or not. It is agreed fact that in the partnership deed there is no prohibition for the partner withdrawing the sum lying to the credit of his account with the firm. Thus it can be said that the firm has made the amount unconditionally available to the assessee partners. The partners are entitled to withdraw such amount at any point of time just like a deposit in the bank account. The partnership firm credits the interest on the basis of amount standing to the account of partners.
Such amount also includes the share of profit and interest due and payable for earlier years. The interest payable to the partners is an allowable deduction under Section 36(1)(iii) of the Act subject to the condition prescribed in Section 40(b) of the Act. As per Section 36(1)(iii) interest payable in respect of capital borrowed for the purpose of business is admissible deduction. Thus, when the partners claimed the deduction by way of interest in the hands of firm, it was held to be capital borrowed for the purpose of business. This proves that the share of profit and interest credited in earlier year becomes the capital borrowed in the subsequent year. This proves that the amount of interest was paid by the firm to its partners who in their turn have lent the amount to the firm in which they are partners. Thus it can be held that the amount of interest credited to the partners and which was made unconditionally available to the partners is to be treated as amount received by the partners. Hence even in the case where the partners are following cash system of accounting, such interest is deemed to have been received by the partners. Scope of total income provided in Section 5(1) includes all income received or deemed to be received. The withdrawal by the partner from the firm is their own action. The credit in the account of the partners by the firm implies payment and withdrawal by the partner in no way can be considered as the only amount received by such partner. Thus the action of withdrawal will not govern the provision of even the cash system of accounting which can be said to have been received by the partners.
Since the present case involves the partners and the partnership firm and the firm not being a separate juristic entity, the decision of Hon'ble Calcutta High Court in the case of Dr. N.K. Brahmachah (supra) will not apply. In the said case there was specific finding that the company was suffering from financial crisis and ultimately went into liquidation during the relevant assessment year itself. Similarly, the decision of Tribunal, Bangalore in the case of Bajaj Ashok Chunnilal (supra) will also not apply to the present set of facts. At this juncture it is relevant to consider the decision of Hon'ble Bombay High Court in the case of Motichand & Devidas, In re (1946) 14 TTR 534 (Bom). Following questions were referred for the opinion of Hon'ble High Court: (1) Whether, in the circumstances of the case, there was a discontinuance of the business or profession carried on by M/s.
Motichand & Devidas on 8th July, 1940, when Mr. Devidas died, so as to entitle the assessee to the relief provided by Sub-section (3) of Section 25 of the Indian IT Act, 1939? (2) Whether, in the circumstances of the case, the applicants were properly assessed on the "receipts" or "cash" basis? Dealing with the second question first, it appears to us clear that the ITO was entitled to adopt the method of receipts or cash basis, for assessing the income of the assessee firm. The fact that they had been assessed in the previous years on the footing of their withdrawals in each year, cannot make it "a method of accounting regularly employed by the assessee" as it was not a method of accounting at all. In practice, this should not work any injustice on the assessee because if they have not withdrawn the amounts in one year towards profits, they would withdraw it in another year. On the other hand, it must be conceded that withdrawals are not the test of profits. Under the Act, the question is what is the total income of the assessee? The answer that Rs so many were withdrawn by the partners is not an answer in accordance with the Act. The profits or income of a solicitor's firm, speaking broadly, are the profit costs of the firm, after defraying their expenses of keeping their office. For instance if in a particular year the firm had completed 200 transactions of conveyancing and received the profit costs for the work from their clients, the profits would be received in that year and earned in that year. If for any reason the partners did not consider it necessary to withdraw money from the firm during that year, it will be wrong to contend that the profits of the year were not the profit costs received by the firm during that year. It seems therefore that the conclusion of the Tribunal that the ITO was right in adopting the receipts or cash basis for ascertaining the income or profits of the firm is correct. The answer to the second question is in the affirmative.
From the above ratio laid down by Hon'ble Bombay High Court, it can be held that mere withdrawal by the partners cannot be considered to be a method of accounting and the amount is available to the partners by way of credit to their accounts can be considered as received by the partners even though such partners are following cash system of accounting.
In the end it can be summarized that the amount credited by the firm of which the assessees are partners to their account is received by the partners as the same was unconditionally available to the partners and mere withdrawal thereof cannot be considered as received based on the cash system of accounting. We accordingly reverse the finding of the learned CIT(A) and uphold that of AO.9. In the cross-objections the assessee challenges reopening of assessment under Section 147 of the Act. It is the contention of the assessee that when the original return was filed there was full and true disclosure. The fact that the assessee is following cash system of accounting in respect of interest and remuneration from the firm was also specifically mentioned by way of note. In absence of any fresh material coming to the knowledge of AO, the AO is not justified in reopening the completed assessment.
10. Learned special counsel for Revenue, on the other hand, relied upon assessment order. He submitted that the objection raised by the assessee during assessment proceedings was discussed and dismissed.
Thus the action of the AO has to be upheld. Alternatively it was submitted by both the counsel that if the main issue in appeal by Revenue is held in favour of assessee, this ground need not be adjudicated upon. However, if the same is decided otherwise, since the issue has not been decided by learned CIT(A), the same may be decided by the Tribunal.
11. We have considered the rival submissions. In the present case original assessment was completed under Section 143(1)(a). While computing the income under Section 143(1)(a) the AO has no power to vary the income declared in the return. In fact he formed no opinion on such return. However, when the accounts of the firm and partners were examined subsequently, it came to the knowledge of AO that though the firm is claiming deduction by way of interest payable to the partners, such sum is not offered for taxation by the partners. As per Expln. 1 to Section 147, production before the AO of account books or other evidence from which material evidence could with due diligence have been discovered by the AO will not necessarily amount to discover within the meaning of proviso to Section 147. However, in the present case since the original assessment was not completed under Section 143(3) the proviso to Section 147 will not apply. Thus to invoke provisions of Section 147 the AO should merely have reason to believe that any income chargeable to tax has escaped assessment. Since the AO has formed an opinion on the basis of facts available to him and in respect of which proper reasons are recorded, this ground raised by assessee in cross-objections is to fail.
12. The next ground in cross-objection is against charging of interest under Sections 234A and 234B of the Act. As held by various Courts, charging of interest is compensatory and mandatory in nature. The same is consequent to the assessment. The assessee is not denying his liability to file return of income. If the return is not filed within due date prescribed under Section 139(1), interest under Section 234A is chargeable. Similarly the assessee is not denying his liability to pay advance tax. Thus charging of interest under Section 234B is consequential in nature. This ground accordingly fails.
13. In the result, the appeals are allowed and the cross-objections are dismissed.,