IT-Interest on FD created from idle funds forms part of book profit for calculation of partner’s salary

IT-Interest on FD created from idle funds forms part of book profit for calculation of partner's salary
IT : Interest from fixed deposit of spare fund cannot be excluded from
book profit for purpose of determining allowable deduction of
remuneration paid to partners
■■■
[2013] 35 taxmann.com 103 (Gujarat)
HIGH COURT OF GUJARAT
Commissioner of Income-tax - III
v.
J.J. Industries*
AKIL KURESHI AND MS. SONIA GOKANI, JJ.
TAX APPEAL NO. 316 OF 2013†
APRIL 25, 2013
Section 40(b) of the Income-tax Act, 1961 - Business disallowance -
Interest, salary, etc. paid by firm to partner [Book profit] -
Assessee-firm claimed to be engaged in seasonal business - Interest
income was generated out of spare funds invested in fixed deposit and
was declared as part of business income - Assessing Officer accepted
same - Whether interest income earned by assessee-firm from fixed
deposit receipts could not be ignored for purpose of working out book
profit to ascertain ceiling of partners remuneration - Held, yes [Para
8] [In favour of assessee]
Circulars & Notifications : Instruction No. 3/2011, dated 9-2-2011
FACTS

■ The assessment was as reopened under section 147 and question of
remuneration paid by the assessee firm to the partners was examined.
■ The Assessing Officer opined that ceiling of remuneration for claiming
deduction had to be computed after ignoring the interest income of the
assessee-firm earned on fixed deposits. He, thus, disallowed a part of
partners remuneration.
■ On appeal, the Commissioner (Appeals) affirmed the view of the Assessing
Officer. However on second appeal, the Tribunal allowed the assessee's
appeal.
■ On revenue's appeal:
HELD

■ The Tribunal has proceeded on the basis that for the purpose of
ascertaining ceiling on the basis of book profit, the profit shall be in profit and loss account and is not to be classified in different heads
of income under section 40 of the Act. The interest income, therefore
cannot be excluded for purpose of determining the allowable deduction of remuneration paid to the partners under section 40B. [Para 7]
■ 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 fixed deposit. Such
income was declared as part of business income and that is how even the
Assessing Officer had accepted the same. That being the position and the Assessing Officer in assessment taxed such income as business income,
no question of law arises. [Para 8]
K.M. Parikh for the Appellant.
ORDER

Akil Kureshi, J. - The revenue is in appeal against the judgment of the Income Tax Appellate Tribunal dated 07.09.2012 raising
following question for our consideration:
"Whether on the facts and in the circumstances of the case, the Tribunal was
justified in taking view that whole income embedded in P & L account of assessee is to be taken into consideration for allowing deduction of remuneration paid to partners under section 40(b) without excluding
interest income credited to P & L account even if it is not business income?"
2. 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).
3. Brief facts are that;
3.1 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
27.10.2004 declaring total income of Rs. 20.35 lacs (rounded off). The
Assessing Officer framed a scrutiny assessment on 27.10.2006 determining the total income of Rs. 20.46 lacs (rounded off). Such assessment was
subsequently reopened under Section 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 lacs
(rounded off). He thus concluded that there was excess remuneration to
the partners to the extent of Rs. 4.90 lacs (rounded off). He made
disallowances accordingly.
3.2 The assessee carried the matter in appeal. CIT(A)
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 following
observations:
"9. We have heard the rival submissions and perused the material on record. It is an undisputed fact that assessee has earned interest of Rs.
22,23,006/- on F.D.'s and paid interest of Rs. 10,40,234/- on money
borrowed. The net interest income of Rs. 11,82,769/- has been credited
to P & L 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 S.P. Equipment & Services (supra) after considering the various decisions has held as under:-
4. Section 40 of the Act pertains to amounts which are not deductible. 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:-
(a) On the first Rs.3,00,000 of the book-profit or in case of a loss Rs. 1,50,000 or at the rate of 90 per cent of the book-profit, whichever is more;
(b) On the balance of the book-profit At the rate of 60 per cent
5. 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 lacs on the book profit or
in case of loss such ceiling is Rs. 1,50,000/- or 90% of the book profit which ever is more. On the balance of the book profit such ceiling
prescribed is @ 60%.
6. 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.
7. 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 under Section 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 under Section 40B of the Act.
8. 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 deposit. 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, and 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.
9. Before closing we may record that though the tax
effect involve was below the minimum limit prescribed by the CBDT in its circular dated 09.02.2011, learned counsel for the revenue pointed out
that the case falls under one of the exception namely that it was an
appeal filed on the basis of audit objection.
Tax appeal is dismissed. SB