Commissioner of Income Tax vs J.J. Industries

Akil Kureshi, J.—The Revenue is in appeal against the judgment of the income tax Appellate Tribunal dated September 7, 2012--since reported in J.J. Industries v. Asst. CIT [2013] 1 ITR (Trib)-OL 614 (And.), raising the following question for our consideration: Whether, on the facts and in the circumstances of the case, the Tribunal was justified in taking the view that the whole income embedded in the profit and loss account of the assessee is to be taken into consideration for allowing the deduction of remuneration paid to the partners u/s 40(b) without excluding the interest income credited to the profit and loss account, even if it is not business income?

The issue pertains to the ceiling of deduction on remuneration on a partnership firm which can be claimed in terms of section 40 of the income tax Act, 1961 ("the Act" for short).

Brief facts are that:

2.1 The respondent-assessee is a partnership firm and is engaged in the business of purchasing raw cotton, ginning the same, making cotton beds and selling such cotton beds and cotton seeds. For the assessment year 2004-05, the assessee filed the return of income on October 27, 2004, declaring a total income of Rs. 20.35 lakhs (rounded off). The Assessing Officer framed a scrutiny assessment on October 27, 2006, determining the total income of Rs. 20.46 lakhs (rounded off). Such assessment was subsequently reopened u/s 147 of the Act. During such reassessment proceedings, the Assessing Officer examined the question of remuneration paid by the firm to the partners. He was of the opinion that the ceiling of such remuneration for the purpose of claiming deduction had to be computed after ignoring the interest income of the assessee-firm earned on fixed deposits which came to Rs. 11.82 lakhs (rounded off). He thus concluded that there was excess remuneration to the partners to the extent of Rs. 4.90 lakhs (rounded off). He made disallowances accordingly.

2.2 The assessee carried the matter in appeal. The Commissioner of income tax (Appeals) rejected the assessee''s appeal and confirmed the view of the Assessing Officer upon which, the assessee approached the Tribunal. The Tribunal, by the impugned judgment, reversed the decision of the Revenue authorities and allowed the assessee''s appeal making the following observations (page 617 of 1 ITR (Trib)-OL):

We have heard the rival submissions and perused the material on record. It is an undisputed fact that the assessee has earned interest of Rs. 22,23,006 on F.D.''s and paid interest of Rs. 10,40,237 on money borrowed. The net interest income of Rs. 11,82,769 has been credited to the profit and loss account and included in the net profit and the same has been considered as business income while framing assessment order u/s 143(3). The co-ordinate Bench in the case of (2010) 36 SOT 325 after considering the various decisions has held as under:

Section 40 of the Act pertains to amounts which are not deductible. The relevant portion of section 40 reads as under:

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'',--

(a) in the case of any assessee--...

(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 authorized 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 authorized 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 authorized by, or is not in accordance with, any earlier partnership deed, so, however, that the period of authorization for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed; or

(iv) any payment of interest to any partner which is authorized 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 authorized 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:

From the above provision, it can be seen that where an assessee is a partnership firm, any payment of salary, bonus, commission or remuneration to its partners under certain circumstances, if it exceeds the limits set out in clause B, deduction to the extent of excess cannot be claimed. In the present case, such ceiling is prescribed in two slabs. On the first Rs. 30 lakhs on the book profit or in case of loss such ceiling is Rs. 1,50,000 or 90 per cent. of the book profit, which ever is more. On the balance of the book profit such ceiling prescribed is at 60 per cent.

The question, therefore, arises whether the interest income earned by the assessee-firm from the fixed deposit receipts should be ignored for the purpose of working out the book profit to ascertain the ceiling of the partners'' remuneration.

The Tribunal has proceeded on the basis that for the purpose of ascertaining such ceiling on the basis of book profit, the profit shall be in the profit and loss account and is not to be classified in the different heads of income u/s 40 of the Act. The interest income, therefore, cannot be excluded for the purposes of determining the allowable deduction of remuneration paid to the partners u/s 40B of the Act.

Counsel for the revenue vehemently contended that for the purpose of ascertaining the limit, only business income would be relevant and not any other income. In the present case, however, we need not enter into such controversy. The assessee had held out that it is in the business of purchasing raw cotton and ginning the same. It is a seasonal business. The interest income was generated out of spare funds invested in the fixed deposits. Such income was declared as part of the business income and that is how even the Assessing Officer had accepted the same. That being the position, the Assessing Officer in the assessment taxed such income as business income, we do not see any question of law arising. The correctness of the Tribunal''s view on the specific issue may be gone into in an appropriate case.

Before closing we may record that though the tax effect involved was below the minimum limit prescribed by the Central Board of Direct Taxes in its circular dated February 9, 2011, learned counsel for the Revenue pointed out that the case falls under one of the exceptions, namely, that it was an appeal filed on the basis of audit objection. Tax appeal is dismissed.