Commissioner of Income Tax and Another vs Great City Manufacturing Co.

The present appeal has been filed under s. 260A of the IT Act (hereinafter referred to as the Act) against the order dt. 6th March, 2009 passed by the Tribunal, Delhi Bench ''C''. New Delhi [reported as (2009) 33 SOT 31 The CIT had proposed the following substantial question of law said to be arising out of the order of the Tribunal:

Whether remuneration to partners should be allowed under s. 40(b)(v) only on the basis of declaration made in the partnership deed declaring them as working partners and inserting a clause for payment of remuneration to them without requiring the firm to prove that these partners are actively engaged in conducting the affairs of the business of firm to justify their status as working partners as per Expln. 4 below s. 40(b)(v)?

Briefly stated the facts giving rise to the present appeal are as follows:

The appeal relates to the asst. yr. 2005-06. The assessee opposite party is a partnership firm. It is engaged in the business of manufacture and export/sale of brass art ware. During the assessment year in question, the assessee opposite party filed its return of income on 31st Oct., 2005 declaring a total income of Rs. 57,68,627 along with audited accounts and tax audit report required under s. 44AB of the Act. The return was processed under s. 143(1) of the Act. The case was selected under scrutiny and also a notice was sent under s. 143(2) of the Act. The assessment was finalized on 28th Dec., 2007. During the course of assessment proceeding the AO noticed that the assessee had paid remuneration to its partners to the tune of Rs. 39,31,965 whereas it has paid total salary to its employees only Rs. 4,86,918. The submission is that the partnership deed does not specify the functions and duties in respect of working partners justifying the remuneration of Rs. 13,10,665 to each of its partners when barely a total salary of Rs. 4,86,918 was paid to all its employees. The remuneration paid to working partners was highly excessive and the cl. 8 introduced in the partnership deed for payment of salary to the maximum extent permissible was only with a view to divert income. On this point the AO allowed the remuneration of Rs. 4,00,000 per annum to each of the partners.

Feeling aggrieved the assessee preferred an appeal before the CIT(A), who vide order dt. 13th March, 2008 had partly allowed the appeal accepting the plea raised by the assessee and deleted the addition, Feeling aggrieved, the Revenue preferred an appeal before the Tribunal, The Tribunal by impugned order dismissed the appeal with the following findings:

We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that all the three partners to whom the impugned remuneration was paid were its working partners and this position was accepted even by the AO while allowing remuneration paid to them to the extent of Rs. 4 lakhs each. It is also not in dispute that there was a specific clause contained in the partnership deed of the assessee firm allowing payment of remuneration to the working partners and the quantum of such remuneration was agreed to be in accordance with the provisions of s. 40(b)(v). The remuneration paid by the assessee firm to its working partners for the year under consideration amounting to Rs. 39,31,165 was within the ceiling prescribed in the provisions of s. 40(b) and it is not the case of the Department that the said remuneration was in excess of such ceiling. The only contention raised by the learned Departmental Representative before us has been that the remuneration paid by the assessee firm to its working partners aggregating to Rs. 39,31,165 was highly excessive and unreasonable having regard to all the facts of the case as highlighted by the AO and such excessive portion of the said remuneration worked out by the AO at Rs. 27,31,965 was rightly disallowed by him invoking the provisions of s. 40A(2). In this regard, the learned counsel for the assessee has cited before us the decision of Ahmedabad Bench of Tribunal in the case of (2000) 69 TTJ 232 wherein it was held that the provisions of ss. 40(b) and 40A(2) operate in different fields and the provisions of s. 40A have no application in the cases where s. 40(b) has been applied. It was held by the Tribunal that the AO thus has no power to go into the question of reasonableness of remuneration paid by the firm to its partners and he can only examine whether the remuneration is not exceeding the prescribed limits as laid down in s. 40(b). To the similar effect is the decision of Hon''ble Karnataka High Court in the case of N.M. Anniah and Co. Vs. Commissioner of Income Tax, Mysore, cited by the learned counsel for the assessee wherein it was held that s. 40A has no application to the matters contained in s. 40(b) and the overriding effect given to s. 40A is only in respect of matters not covered by s. 40(b). In our opinion, the ratio of these two judicial pronouncements cited by the learned counsel for the assessee is directly applicable to the issue involved in the present case and respectfully following the same, we hold that the disallowance made by the AO on account of partners'' remuneration covered under s. 40(b) by invoking the provisions of s. 40A(2) was not sustainable. In that view of the matter, we uphold the impugned order of the learned CIT(A) deleting the said disallowance and dismiss this appeal filed by the Revenue.

We have heard Sri S. Chopra learned counsel for the appellant and Sri Piyush Kaushik, learned counsel on behalf of the respondent-assessee.

Sri Chopra submitted that in the partnership deed the terms and nature of the duties of each of the partners are not specified and therefore, if the AO has found that they have been paid excessive remuneration even though the partnership deed provided such payment he could have disallowed the same. He placed reliance upon s. 40A(2)(a) of the Act. He submitted that when the total payment of salary to all its employees was only Rs. 4,86,918 then there was no justification for payment of Rs. 39,31,165 as remuneration to the partners. The submission is wholly misconceived. It is not in dispute that all the three partners are Working partners in the assessee opposite party firm and the AO has himself allowed the remuneration of Rs. 4,00,000 per annum to each of the partners. It is also not in dispute that the terms of the partnership deed specifically provided the payment of remuneration to the working partners. Sec. 40(b)(v) of the Act prescribed limit of remuneration which can be allowed to its partner as deduction while computing the business income. It is not in dispute that the remuneration paid to the working partners was within the provision of cl. (v) of cl. (b) of s, 40 of the Act. The Parliament in its wisdom had fixed a limit on allowing the remuneration to the working partners and if the remuneration is within the ceiling limit provided then recourse to provision of s. 40A(2)(a) of the Act cannot be taken. The AO is only required to see as to whether the partners are the working partners mentioned in the partnership deed, the terms and conditions of the partnership deed provide for payment of remuneration to the working partners and whether the remuneration provided is within the limits prescribed under s. 40(b)(v) or not. If all the aforementioned conditions are fulfilled then he cannot disallow any part of the remuneration on the ground that it is excessive. Since in the present case, all the conditions required have been fulfilled the question of disallowance does not arise. In the present case, we find that the Tribunal has found all the three conditions are fulfilled and we do not find any illegally in the impugned order. Thus, the appeal fails and is dismissed.