Shri Vishnu Anant Mahajan v ACIT ITA No.3002/Ahd/2009 (Ahmedabad Special Bench)

Background and facts of the case

• The assessee is an individual and derives income by way of share of profit from the firm of M/s.Mahajan & Amar Doshi, capital gains, interest, dividend and house property.
• The assessee derives 76% of professional income as share from the firm and the balance amount by way of remuneration and interest income from the firm.
• The AO allocated the expenses to the income not includible under Section 10(2A). Thus, the business income by way of remuneration and interest from the firm has been taxed in the hands of the assessee under section 28(v) after allowing 24% of the expenditure. Thus, 76% of the expenditure has been disallowed. 
• The assessee had disallowed suo motu 1/10th of depreciation allowance

Assessee’s contentions

• A firm is a compendium name of all the partners who join together for conducting a business or a profession, share its profits and act as agent of one another. Although the definition of the term “person” includes within its ambit an individual and a firm also under Section 2(31), but the provision contained in section 2(23) should not be lost sight of while interpreting section 14A.
• The decisions rendered in the case of limited companies regarding the applicability of section 14A, will not be applicable in respect of assessment of the partnership firm, as one cannot equate partners with
  shareholders and the firm does not have any legal persona as it is merely a compendium name of all the partners. Thus, the share income received by a partner from the firm cannot be said to be an income which has been excluded from the total income.
• The assessee placed reliance on rulings of Mumbai Tribunal in the case of Sudhir Kapadia & Hitesh Gajaria wherein it was held that the share of profits is not altogether a tax-free income as the same is taxed in the hands of the firm.
• It has also been submitted that irrespective of rates of tax, there will be no loss to the Revenue, if the expenditure is allowed in the case of the partner or in the case of firm.

Tax Authorities’ arguments

• Under the Act, the firm and the partners are treated separately, which also flows from the definition of term “person” in section 2(31). While a firm is a transparent vehicle under the Partnership Act, it is a translucent vehicle under the I.T. Act, the reason being that two are taxed on their separate incomes and what is taxed in the hands of the firm is not further taxed in the hands of the partners.
• Relied on various decisions considered in the case of (Dhamasingh M. Popat 127 TTJ 63 (Mum) in arriving at the conclusion.

HELD:

• A firm is somewhat translucent vehicle under the Act. This requires a combined reading of the provisions contained in sections 2(23) and 2(31) of the Act.
• Whenever the field is occupied by the tax law, the provision contained therein will become applicable,
  but where the field is left vacant, we will have to take assistance from the provisions contained in the Partnership Act for filling the vacuum under the tax law.
• In so far as the taxation is concerned, the firm is not a pass-through vehicle. It is a translucent vehicle, as only the salary and interest paid to the partners are taxable under Section 28(v) as business income.
• When section 10(2A) speaks of its exclusion from the total income, it means, the total income of the person whose case is under consideration. The instant case is that of the partner and therefore what is to be examined is whether the share income is excluded from his total income. The answer is obviously in the affirmative. In such a situation, provision contained in section 14A will come into operation and any expenditure incurred in earning the share income will have to be disallowed.
• Regarding depreciation being an expenditure or not, it has been held in the case of Hoshang D. Nanavati ITA No.3567/Mum/2007 (Mum ITAT) that section 14A deals only with the expenditure and not any statutory allowance admissible to the assessee. A statutory allowance under section 32 is not an expenditure.

Conclusion

Given that this decision has been rendered by Ahmedabad Special Bench, the rulings of Mumbai Tribunal in the case of Sudhir Kapadia & Hitesh Gajaria will no longer be helpful for the assessee and therefore, partner’s share of profits will be considered as an income which does not form part of total income for the purpose of section 14A.

Also, this decision affirms the legal stand that depreciation cannot be disallowed under section 14A since it is not an ‘expenditure’ but a statutory allowance.