Sood Brij & Associates vs The Commissioner Of ...
2011 Latest Caselaw 5345 Del

*         IN THE HIGH COURT OF DELHI AT NEW DELHI

+             Income Tax Appeal No. 1154 of 2011

                              Reserved on: 17th October, 2011
%                        Date of Decision: 4th November, 2011

Sood Brij & Associates                             ....Appellant
                   Through       Mr. Ajay Vohra, Mr. Amit Sachdeva and
                                 Mr. Somnath Shukla, Advocates.

                     Versus

The Commissioner of Income-tax-XIII, New Delhi ...Respondents
                 Through     Mr. N P Sahni and Mr. Ruchesh Sinha,
                             Advocates.


CORAM:
HON'BLE MR. JUSTICE SANJIV KHANNA
HON'BLE MR. JUSTICE R. V. EASWAR

1. Whether Reporters of local papers may be allowed to see the judgment?
2. To be referred to the Reporter or not ?                         Yes.
3. Whether the judgment should be reported in the Digest ?         Yes.

SANJIV KHANNA, J.

The present appeal under Section 260A of the Income Tax

Act, 1961 (Act, for short) has been preferred by Sood Brij & Associates,

a partnership firm, consisting of two partners namely A.K. Sood and

B.M. Gupta, who are practicing Chartered Accountants. In their return

for the assessment year 2007-08, Rs.21,40,000/- was claimed as a

deduction towards salary/remuneration paid to the partners. This was

disallowed by the Assessing Officer on the ground of violation of

Section 40(b)(v). The appellant-assessee has been unsuccessful in

ITA No. 1154/2011 1 of 11 appeals before the Commissioner of Income Tax (Appeals) and the

Income Tax Appellate Tribunal, Delhi (tribunal, for short). The impugned

order of the tribunal is dated 29th October, 2010.

2. After hearing the counsel, the following substantial question of

law is framed:-

" Whether on reading of clause 7 of the partnership deed dated 1st May,1976 and clauses 1 and 2 of the supplementary partnership deed dated 1st April,1992, the tribunal was right in holding that remuneration of Rs.21,40,000/- paid to the two partners cannot allowed as a deduction under Section 40(b)(v) of the Act?"

3. Relevant part of Section 40 of the Act reads as under:-

"40. Amounts not deductible.--Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",--

X X X

(b) in the case of any firm assessable as such,--

(i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as remuneration) to any partner who is not a working partner; or

(ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorised by, or is not in accordance with, the terms of the partnership deed; or

(iii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is authorised by, and is in accordance with, the terms of the partnership deed, but which relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorised by, or is not in accordance with, any earlier partnership deed, so, however, that the period of authorisation for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed; or

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(iv) any payment of interest to any 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 such amount exceeds the amount calculated at the rate of *twelve per cent. simple interest per annum; or

(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 the case of a firm carrying on a profession referred to in section 44AA or which is notified for the purpose of that section--

(a) on the first Rs. 1,00,000 of the book-profit or in case of a loss Rs. 50,000 or at the rate of 90 per cent. of the book-profit, whichever is more;

(b) on the next Rs. 1,00,000 of the book-profit at the rate of 60 per cent.;

(c) on the balance of the book-profit at the rate of 40 per cent.;

(2) in the case of any other firm--

(a) on the first Rs. 75,000 of the book-profit or in case of a loss Rs. 50,000 or at the rate of 90 per cent. of the book-profit, whichever is more;

(b) on the next Rs. 75,000 of the book-profit at the rate of 60 per cent.;

(c) on the balance of the book-profit at the rate of 40 per cent.;

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 1st 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),--

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(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 profit and loss account 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."

4. Section 40(b) relates to firms and the clauses (i) to (v) are

interconnected and have to be read harmoniously. The aforesaid

clauses prescribe the conditions, when and in what circumstances

remuneration paid to a partner are deductable as an expense from

income of the partnership firm. One of the prescribed requirements is

that payment of remuneration should be made to a working partner

and authorized by, and in accordance with the terms of the partnership

deed. The remuneration paid to the said partners must relate to the

period falling after the date of such partnership deed. Clause (iii) to

Section 40(b) specifically stipulates that remuneration paid in the

ITA No. 1154/2011 4 of 11 period pre and posts the partnership deed, are treated differently.

Former cannot be deducted from the income of the firm but payment

of remuneration to working partners post the partnership deed,

authorized by and in accordance with the terms of the deed can be

allowed as a deduction. The requirement for allowing deduction is that

the remuneration paid should be authorized and in terms of the

existing partnership deed. Both conditions must be satisfied. The

Section 40(b)(v) also fixes the upper limit of the deduction, which can

be claimed as a deduction by the partnership firm.

5. Clause (iii) and other clauses in Section 40(b) specifically use the

expression "in accordance with the terms of the partnership deed". This

clearly indicates and manifests the legislative mandate that the

quantum of remuneration or the manner of computing the quantum of

remuneration should be stipulated in the partnership deed. The

expression "in accordance with the terms of the partnership deed" read

with clause (iii) of section 40(b), requires and mandates that the

quantum of remuneration or the manner of computation of quantum of

remuneration should be stated in the partnership deed and should not

be left undetermined, undecided or to be determined or decided on a

future date.

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6. The question raised is whether the conditions stipulated in the

aforesaid Section are satisfied in the present case or not. This requires

examination of the relevant clauses of the partnership deed dated 1st

May, 1976 and the supplementary partnership deed dated 1st April,

1992.

7. Clauses 7 of the partnership deed dated 1st May, 1976 reads as

under:-

"7. That the profits or losses of the partnership, as the case may be, shall be divided amongst and borne by the partners equally."

8. Clauses 1 and 2 of the supplementary partnership deed dated 1st

April, 1992 read:

"1. That subject to mutual consent of the partners, and subject to the provisions of the Income Tax Act, 1961, the working partner or partners shall be paid such remuneration as may be mutually agreed between themselves, from time to time, and such remuneration shall be deductible expense before arriving at the share of the partners as allocable from the net profits.

2. That both the partners (hereinafter referred as working partners), shall devote their time and attention in the conduct of the affairs of the partnership firm, as the circumstances and need of the firms business may require. The total remuneration payable to the working partners shall be an amount permissible as remuneration to the working partners under the Income Tax Act, 1961 and as applicable from time to time."

9. The partnership as noticed above is between two partners and

under clause 7 of the partnership deed dated 1st May, 1976 profits and

ITA No. 1154/2011 6 of 11 losses of the partnership, as the case may be, are to be divided and

borne by the partners equally. Clause 1 of the supplementary

partnership deed dated 1st April, 1992, authorizes payment of

remuneration to the partners but does not quantify the same. It does

not prescribe any method or manner to calculate and compute the

remuneration. It states that the remuneration payable is to be

mutually agreed between the partners from time to time. Clause 1,

therefore, requires a mutual agreement in future. The aforesaid

clause, therefore, does not satisfy the requirement that the payment of

remuneration should be in accordance with the terms of the

partnership deed and that the remuneration should relate to payments

made in the period after the date of said partnership deed. The tribunal

is, therefore, right in their conclusion that clause 1 of the

supplementary partnership deed dated 1st April, 1992, does not satisfy

the requirements of Section 40(b)(v). From the said clause it is not

possible to ascertain the quantum or the amount of remuneration

which is payable in terms of the supplementary partnership deed.

10. This brings us to clause 2 of the supplementary deed dated 1st

April, 1992. The first sentence in clause 2 states that the two partners

will be the working partners. The second sentence in clause 2 stipulates

that the total remuneration payable to the working partners shall be

ITA No. 1154/2011 7 of 11 the amount permissible as remuneration to the working partners under

the Act, as applicable from time to time. The question is whether the

second sentence of clause 2 of the supplementary partnership deed

read with clause 7 of the partnership deed, which states that the profits

and losses will be equally divided and borne by the partners, satisfies

the requirements of Section 40(b)(v). In other words, whether the two

clauses read together quantify or stipulate the manner of quantifying

the remuneration that is payable to the partners? Having examined

the said clauses, we feel that on conjoint reading of clause 7 of the

partnership deed dated 1st May, 1976 and clauses 1 and 2 of the

supplementary partnership deed dated 1st April, 1992, conditions of

Section 40(b)(v) are not satisfied.

11. Clause 2 of the supplementary deed has to be read along with

clause 1 of the same deed. These two clauses have to be read

harmoniously and reasonably to understand the two covenants and

give effect to their true meaning. The second sentence of clause 2

neither quantifies nor lays down the manner of quantifying the total

remuneration payable to the partners. Clause 2 stipulates the maximum

amount that can be paid as remuneration to the two partners but does

not quantify the remuneration payable in a particular year. Quantum or

the amount of remuneration and the manner of computing is not

ITA No. 1154/2011 8 of 11 specified or stipulated but as noticed under clause 1 has been left to be

decided by a mutual agreement in future.

12. The appellant in actual practice has not read and understood

clause 2 as stipulating that the two partners are entitled to

remuneration equal to the maximum amount stipulated in Section

40(b)(v) of the Act. As per the return of income filed on 23rd August,

2007, the appellant firm had declared income of Rs.1,44,59,522/-. It is

prudent to note that as per the books and the Act Rs. 98,81,165/-

would be the maximum remuneration payable to the two partners but

the remuneration actually paid was Rs.21,40,000/-. This is admitted by

the appellant and further in grounds of appeal it is stated that

Rs.98,81,165/- represents the maximum amount payable under Section

40(b)(v) but not the amount that has been mutually agreed to be paid

as remuneration. In other words, the appellant has accepted that clause

2 does not quantify or provide the manner of computing remuneration

payable to the partners but stipulates the maximum amount payable.

Thus, the limits specified under Section 40(b)(v) are incorporated and

have become part and parcel of the partnership deed but not the

amount or the quantum of remuneration. This is left undecided,

unstipulated and left to the discretion of the two partners to be decided

at a future point in time. Therefore, payment of Rs.21,40,000/- was not

ITA No. 1154/2011 9 of 11 in accordance with the terms of the supplementary partnership deed

dated 1st April, 1992 though authorized by the said deed. The

remuneration was paid in terms of a subsequent understanding

between the two partners regarding the quantum and the amount to

be paid. The said understanding has not been brought on record and

probably was an oral understanding. The appellant has not relied on or

referred to any such "partnership deed" before the authorities, tribunal

or before us.

13. Ratio of the decision of the Himachal Pradesh High Court in

Commissioner of Income tax vs. Anil Hardware Store, [2010] 323 ITR

368 (HP), does not assist the stand and contention of the appellant. On

examining the partnership deed, it was held that the two partners were

entitled to 50% or equal amount as remuneration. The contention of

the Revenue that the partnership deed did not exactly determine the

remuneration payable to the partners, was rejected holding that the

requirement of the Section was that the partnership deed should

specify the amount payable or that the manner of quantifying the

remuneration should be specified. In the said case, the High Court held

that the manner of fixing the remuneration was specified in the

partnership deed.

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14. On reading the supplementary partnership deed, in the present

case, it is clear that the remuneration is not specified. The manner of

computing the remuneration is not specified. On the other hand, the

remuneration payable is left to future mutual agreement between the

partners who are entitled to decide and quantify the quantum.

Remuneration can be any amount or figure but not more than the

maximum amount stated in Section 40(b)(v) of the Act. Therefore, the

requirements of Section 40(b)(v) are not satisfied.

15. The question of law is answered in favour of the Revenue and

against the assessee. The appeal is dismissed. However, there will be

no orders as to costs.

(SANJIV KHANNA) JUDGE

( R. V. EASWAR ) JUDGE

November 4th, 2011 kkb

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