Asstt. Cit Vs. Laxmi Sailaja Traders - Court Judgment

Excerpt:
this appeal by the revenue is directed against the order of the cit (a)vi, hyderabad and it pertains to the assessment year 1997-98.the facts of the case in short are that the assessee-firm is engaged in the business of trading in cotton and food grains. in respect of previous year relevant to the assessment year 1997-98, the firm paid remuneration of rs. 2,53,000 to sri ch. ekambaram who served as a working partner representing his huf. as per the partnership deed, sri ch. ekambaram was described as a partner representing his huf with regard to the profit sharing ratio, the partnership deed specifies in clause 9 that the maximum remuneration allowable to the working partner, under section 40(b), shall be determined by the partners. on the strength of such partnership, the assessee.....

Judgment:
This appeal by the revenue is directed against the order of the CIT (A)VI, Hyderabad and it pertains to the assessment year 1997-98.

The facts of the case in short are that the assessee-firm is engaged in the business of trading in cotton and food grains. In respect of previous year relevant to the assessment year 1997-98, the firm paid remuneration of Rs. 2,53,000 to Sri Ch. Ekambaram who served as a working partner representing his HUF. As per the partnership deed, Sri Ch. Ekambaram was described as a partner representing his HUF With regard to the profit sharing ratio, the partnership deed specifies in clause 9 that the maximum remuneration allowable to the working partner, under section 40(b), shall be determined by the partners. On the strength of such partnership, the assessee claimed deduction of remuneration paid to one of the working partners under section 40(b) of the Act and the same was allowed while processing the return under section 143(1)(a) of the Act. At a subsequent point of time, internal audit raised an objection stating that as per the provisions of section 40(b)(v), remuneration paid to working partneras authorized by the partnership deed is allowable whereas in the instant case, Ch.

Ekambaram is not a partner in his individual capacity and hence he cannot be treated as a working partner. The audit party was of the opinion that remuneration paid to the working partner is not allowable as deduction in the light of the decision of the Supreme Court in the case of Rasikh Lal & Co. v. CIT (1998) 229 ITR 458 (SC). Without prejudice to the above, the audit party observed that the remuneration payable, to each individual working partner/manner of quantifying such remuneration, was not specified in the partnership deed and hence remuneration is not allowable under section 40(b)(v) in view of Boards Circular No. 739, dated 25-3-1996. The circular issued by the CBDT reads as under : "Clauses which are generally incorporated in the partnership deeds are : (i) the partners have agreed that the remuneration to a working partner will be the amount of 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 down the manner of quantifying such remuneration.

It has been decided that 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, liberal approach may be taken for the initial years. Thus, for the assessment years 1993-94 to 1996-97 deduction for remuneration to a working partner maybe allowed on the basis of the clauses of the type mentioned at (i) above.

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 firms income.

For the assessment years, subsequent to the assessment year 1996-97, no deduction under section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration-Circular No. 739, dated 25-3-1996." It appears that the audit objection is the basis for reopening the assessment. In response to the notice issued under section 148 of the Act, the assessee submitted that the reopening is bad and invalid and payment of remuneration was duly authorized by clause (i) of the partnership deed. The assessing officer observed that the Circular issued by the CBDT is binding on her and hence reopening is valid in law. She also observed that as per clauses 7 and 8 of the partnership deed the remuneration was made to Sri Ch. Ekambaram for the services rendered as representative of his HUF whereas the term working partner means an individual who is actually engaged in conducting the affairs of the business of the firm of which he is a partner. Since a working partner is necessarily an individual, according to Explanation 4, remuneration paid to the partner for the services rendered to a firm in a representative capacity cannot be said to have been paid to the working partner and hence cannot be qualified for deduction under section 40(b) of the Act.

The learned CIT (A) however cancelled the assessment by observing in para 9 as under-- "On a perusal of the assessment order made for the assessment year 1997-98 under section 143(3) read with section 148 of the Income Tax Act, 1961, apparently, the reopening under section 147(b) has been invoked only for the limited purpose of disallowing payment made to the partner who is representing his HUF in the partnership firm. This is undoubtedly a legal issue which obviously has been brought to the knowledge of the assessing officer by the internal audit party of the Income Tax Department, As held by the Supreme Court in the case of Indian & Eastern Newspapers Society 119 ITR 996, it is held to be valid and reiterated by a subsequent judgment of the Calcutta High Court in the case of CIT v. Union Carbide Corporation is still valid and, therefore, the interpretation of law cannot be made by an authority which is not competent to do so. As could be seen from the judgment of the Supreme Court in 237 ITR 13 in the case of CIT v. PVS Beedies (P) Ltd., what the court held was that the reopening of an assessment is valid if it was based on factual errors pointed out by the internal audit but not interpretation of the law. Therefore, I hold that the reopening of the assessment invoking the provisions of section 147(b) is not valid in view of the decision referred to supra. Having held that the validity of the reopening is invalid, I do not think it necessary to deal with the issue regarding the payment of remuneration to the partner, Sri Ch. Ekambaram representing his HUF in the partnership firm, namely, M/s. Laxmi Shailaja Traders, Warangal." Aggrieved, the revenue is in appeal before the Tribunal. Learned Departmental Representative submitted that the first appellate authority has committed an error applying the old provisions to conclude that the reopening is bad in law; the learned CIT (A) has referred to the provisions of section 147(b) of the Act whereas with effect from 1-4-1989 section 147 does not contain clauses (a) and (b).

Prior to 1-4-1989 sub-clause (b) of section 147 speaks of reopening the assessment on the basis of information whereas under the new section there is no such clause. It was also submitted that practically it is not a case of reassessment inasmuch as assessment was not made earlier; return of income processed under section 143(1)(a) of the Act was later reopened by issuance of notice under section 148 of the Act. It was further submitted that internal audit party merely brought to the notice of the assessing officer the Circular issued by the CBDT as well as the clauses in the partnership deed and there is no interpretation of law involved in that. Placing reliance on the decision of Honble Madras High Court in the case of CIT v. Assembly Rooms (2000) 242 ITR 64 (Mad), the learned Departmental Representative submitted that even if the condition of having "information" only on factual matters is applicable, under the post amendment scenario still it can be said that reopening was in accordance with law inasmuch as the audit party merely brought to the notice of the assessing officer the facts on record as well as the Circular of the CBDT which is binding upon the assessing officer.

5A. On the other hand, the learned counsel for the assessee submitted that in the light of the decision of Honble Supreme Court in the case of Rasikh Lal & Co. (supra) Sri Ch. Ekambaram should be treated as partner in which event deduction is permissible under section 40(b) of the Act since the payment of remuneration is authorized as per the partnership agreement dated 1-6-1992. It was also submitted that the opinion expressed by the audit party would not constitute information inasmuch as the issue raised by them is based on the interpretation of the provisions of the Act i.e., 40(b)(v) of the Act. Placing reliance upon the decision of Honble Delhi High Court in the case of United Electrical Co. (P) Ltd. v. CIT (2002) 258 ITR 317 (Del). It was submitted that even with regard to the notices issued under the post-amended provisions the reopening should not be based on mere rumour or gossip and it should be based on some information and limited to fact. Reliance was also placed upon the decision of the Madras High Court in the case of CIT v. Golden Touch (2003) 263 ITR 261 (Mad), to submit that remuneration paid to working partner who represented his respective HUF is not hit by section 40(b) of the Act.

I have carefully considered the rival submissions and perused the record. As directed by the Bench, the learned Departmental Representative has also filed a copy of the order-sheet entry, audit objection memo and the letter dated 24-1-2000 of the Addl. CIT (Audit).

A careful scrutiny of the facts and circumstances reflect the casual approach of the tax authorities in handling the issue on hand, which is highlighted hereunder.

(a) In the year under consideration only Sri Ch. Ekambaram is the Managing Partner. The names of the partners were mentioned in the Profit & Loss A/c and Balance Sheet annexed to the return of income from which it could be seen that Sri Amrutlal B. Shah was not a partner of the firm in the year under consideration. In page-3 of the assessment order, the assessing officer claims to have extracted clause 7 of the partnership deed which finds mention of the partners i.e., Sri Ch. Ekambaram and Sri Amrutlal B. Shah. If Sri Amrutlal B. Shah is working partner and entitled to remuneration, as stated in page 3, the assessing officer did not even entertain a doubt while finalising the assessment as to why the remuneration was paid to Sri Amrutlal B. Shah and if remuneration is paid why it should not be disallowed in the same pattern in respect of the remuneration paid to Sri Ch. Ekambaram.

(b) The very basis of reopening the assessment was internal audit objection wherein it was stated as under : "The Supreme Court, in the case of Rasikh Lal & Company (1998) 96 Taxman 16 (SC), held that since HUF ... cannot be a partner, if karta or any other partner joins a partnership he can do so as an individual and as such commission paid by firm to a partner representing his HUF would have to be disallowed under section 40(b).

In view of the above, the remuneration claimed to have been paid to Sri Ch. Ekambaram (HUF) of Rs. 2,53,000 has to be disallowed." The very foundation of the audit objection is wrong inasmuch as the Apex Court in the case of Rasikh Lal & Company categorically observed that vis-a-vis the firm, the individual is considered as a partner even though he represents a body of individuals or a firm or a HUF. Thus as per the decision of the Apex Court (supra) Sri Ch. Ekambaram should be considered as a working partner in which event the deduction of remuneration claimed by the assessee is in accordance with law. Whereas the judgment of Supreme Court (supra) was misinterpreted by the internal audit part to say that it should be disallowed. The internal audit party has also interpreted the provisions of section 40(b) of the Act, based upon the Circular issued by the CBDT (Circular No. 739 dated 25-3-1996) to state that the partnership deed has not specified the amount of remuneration payable to each individual working partner and hence the remuneration claimed is not authorized by the partnership deed.

(c) Based upon audit objection the CIT appears to have given direction to initiate proceedings under section 147 of the Act to disallow remuneration as it is not authorized by partnership deed. The CIT appears to have understood the decision of the Supreme Court (supra) in the correct perspective. As could be seen from the letter dated 24-1-2000 addressed by the Addl. CIT (Audit) to Deputy Commissioner, Cir. 1, Warrangal, the above letter is silent on the first aspect mentioned in the audit objection but confined to the second aspect i.e., the clause in the partnership deed does not authorize payment of specific remuneration and thus contrary to Circular No. 739.

(d) Having received the letter dated 24-1-2000, the assessing officer should have recorded his reasons since the power is vested in him/her to reopen the assessment, only on the condition that there were reasons to believe that income chargeable to tax has escaped assessment. The words reason to believe cannot be stretched to mean reason to suspect.

The stress is upon the satisfaction of the assessing officer and not on somebody elses satisfaction. As could be seen from the order-sheet entry dated 3-2-2000 the assessing officer did not give any independent reason except mentioning about the letter dated 24-1-2000 addressed by the Addl. CIT, Audit. It may be relevant to extract the order-sheet entry dated 3-2-2000.

"Addl. CIT (Audit) letter No. IA-2/64/99-2000, dated 24-1-2000 received and placed on file.

As per the instruction contained in the above letter, notice under section 148 put up." As could be seen from the narration, the satisfaction of the assessing officer is completely absent-the reopening is based upon the instruction-contained in the letter dated 24-1-2000.

(e) Even if it is presumed that the reopening was made on the basis of the instruction contained in the letter dated 24-1-2000, the order of the assessing officer indicates that she has not understood the CITs direction in correct perspective. It is necessary to elaborate here that in the audit objection the judgment of Honble Supreme Court in the case of Rasikh Lal & Co. (supra) was taken as a basis to point out that the remuneration paid to an individual, who is representing the firm in a representative capacity, is not allowable as deduction under section 40(b) of the Act. As per the amended provisions payment made to a working partner is allowable as deduction subject to the limits provided under sub-clause (v). Having noticed the fact that the case of Rasikh Lal & Co. (supra) supports the stand of the assessee, the Addl.

CIT communicated the CITs direction by observing that the allowable remuneration has to be quantified with reference to section 40(b)(v)(2) of the Act. As per the decision in the case of Rasikh Lal & Co.

(supra), section 13 of the Partnership Act does not recognize the dual status of a partner; the person whose name is incorporated in the partnership deed would be treated as a partner and not the HUF. It follows that if the remuneration is paid to the partner who is termed as a working partner, applying the decision of Supreme Court in the case of Rasikh Lal & Co. (supra), remuneration is not disallowable. The assessing officer, however, discussed in detail to hold that Sri Ch.

Ekambaram was a partner in a representative capacity and hence remuneration paid to such partner is hit by the provisions of section 40(b) of the Act. There is no mention of the judgment of the Honble Supreme Court in the case of Rasikh Lal & Co. (supra) in the order of the assessing officer though the audit objection as well as the letter dated 24-1-2000 specifically makes the mention of the said judgment.

This shows that the assessing officer has merely applied a thumb rule to hold that the remuneration paid to Ch. Ehambaram is not allowable as deduction presumably because there is an audit objection.

(f) Though the disallowance mainly rests on the aforesaid point, at the end the assessing officer has also mentioned that the claim is not in accordance with the terms of partnership deed. This is apparently on the basis of the circular issued by the CBDT. The CBDT was of the opinion that the remuneration has to be specified and it cannot be left to the discretion of the partners in each year.

(g) While holding that the reassessment proceedings are valid, the assessing officer mentioned the provisions of section 147(b) of the Act overlooking the fact that the amended provisions do not contain sub-clause (b). in other words, in the pre-amended period an assessing officer is entitled to reopen the assessment under section 147(b) based upon information whereas under section 147(a) of the Act there should be escapement of income on account of non-disclosure of facts truly and fully. This procedure is done away with effect from 1-4-1989 and the amended section 147 did not contain clauses (a) and (b).

(h) The learned CIT (A) committed the same mistake of mentioning the provisions of section 147(b) of the Act to hold that the reopening is not valid and thus he did not go into other aspects of the matter.

In my considered opinion, reopening is bad in law because the assessing officer has not applied her mind to the issue before initiating proceedings under section 148 of the Act which is apparent from the fact that the order sheet noting merely mentions about the instructions contained in the letter dated 24-1-2000 which in turn is based upon the audit objection. The assessing officer has merely followed the instructions contained in the letter dated 24-1-2000 without independently recording any reasons to indicate that there were bona fide reasons to believe that the income assessable to tax has escaped assessment by virtue of excessive claim of deduction.

Even on merits, the disallowance of the claim of deduction is not in accordance with law. As per the decision of the Honble High Court in the case of Rasikh Lal & Co. (supra) even though a partner represents his HUF in the firm, so far as the firm is concerned, it recognizes only that individual as a partner whose name is recorded in the deed.

Therefore, in law only Sri Ch. Ekambaram has to be considered as a partner. The partnership deed having mentioned that he is working partner, salary paid to such working partner is in accordance with the provisions of section 40(b) of the Act, subject to the outer limits prescribed under sub-clause (v) thereof. It is not in dispute that Sri Ch. Ekambaram is actually engaged in conducting the affairs of the firm. Even as per Explanation 4, Sri Ch. Ekambaram has to be treated as a working partner.

The other contention of the learned Departmental Representative is that the remuneration paid to the partner is not in accordance with the terms of partnership deed. The assessment order does not contain the relevant clauses of partnership deed. However, in the internal audit objection note, clause 9 of the partnership deed was reproduced which is extracted for immediate reference.

"At the end of each year, the maximum remuneration allowable to the working partner, under section 49(b) of the Act, shall be determined by the partners and shall be paid/credited to capital account of the working partner Ch. Ekambaram. Meanwhile the working partner may make periodical withdrawals against remuneration payable to him. Any excess withdrawal over remuneration payable is deemed as capital withdrawal.

No remuneration shall be paid to working partner in case there are no profits available after charging interest on capital to partners. In case the available profits are insufficient to pay remuneration to the working partner at the maximum allowable under section 40(b), then the available profits shall be paid to the working partner, to the extent of making the firms income nil" Section 40 of the Income Tax Act speaks of amounts not deductible. As per section 40(b) of the Act, salary or remuneration paid to a partner is not allowable. However, exceptions were provided in the said clause whereby remuneration paid to working partner is allowable as deduction, subject to sub-clause (v), if such payment is authorized by and is in accordance with the partnership deed. Nowhere in sub-clause (b) of section 40 the mode of authorization is prescribed. However, the CBDT has issued a circular stating that if the deed does not specify the amount of remuneration to each individual, it cannot qualify for deduction under section 40(b) of the Act. No doubt the Circular issued by the CBDT is binding on the officers, it does not bind the courts or Tribunals particularly when it is contrary to the provision of the Act.

An assessee is always entitled to claim that the Circular issued by the CBDT is not in consonancen with the plain language of the section. In the instant case, clause 9 of the Partnership deed authorizes the partner to receive the remuneration and also authorizes the partners to determine the quantum of remuneration at the end of the previous year, subject to the maximum allowable tinder section 40(b)(v) of the Act.

Thus it cannot be said that the remuneration payable to the partner is not authorized by the partnership deed or the actual amount paid to the partner is not in accordance with the partnership deed. Similar view was taken by the ITAT, B-Bench, Ahmedabad in the case of Chhajed Steel Corporation v. Asstt. CIT (2001) 77 ITD 419 (Amd) wherein it was held that in a case the partnership deed specifies that the working partner would be entitled to receive remuneration subject to the maximum allowable under section 40(b)(v) of the Act, such payment cannot be disallowed under section 40(b) of the Act. In the light of the plain language of the section and also consistent with the view taken by the ITAT, Ahmedabad Bench (supra), I am of the view that the remuneration paid to the partner is in consonance with the terms of the partnership deed and accordingly allowable as deduction. Under these circumstances, the disallowance made by the assessing officer is set aside and the appeal filed by the revenue is dismissed.