Chitra Venkataraman, J.@mdashThe tax case (appeals) are filed at the instance of the assessee by raising the following questions of law relating to the asst. yrs. 1996-97 to 2000-01:
1. Whether the Tribunal was right in law in holding that the books of the assessee can be rewritten and capital accounts rewritten by the AO for the purposes of s. 40(b) of the IT Act?
2. Whether the Tribunal was right in law in holding that profits of the assessee firm should be reworked by deducting depreciation even though the same was not provided by the assessee in the P & L account/books of account? and
3. Whether the Tribunal was right in law in holding that the method of computation adopted by assessee is not in conformity with the accounting and legal principles ?
The facts leading to the filing of the tax case (appeals) are as follows:
(i) The assessee herein is a partnership firm engaged in the business of photography and videography. In the return of income filed for the asst. yrs. 1996-97 to 2000-01, the assessee claimed deduction under s. 40(b) of the IT Act (for short, "the Act"), towards the payment of interest to the partners on the balances in the capital accounts, which was done in terms of the partnership deed. The assessing authority pointed out that the assessee had apportioned the interest in the P & L a/c, without claiming depreciation and the assessee claimed the same in the adjustment statements enclosed to the return of income. A survey was conducted under s. 133A of the Act on the business premises of the assessee. This led to the reopening of the assessment by issuance of notice under s. 147 of the Act to recompute the profit after deducting depreciation and thereby, rework the capital balances of the partners. The assessee resisted the reopening by contending that the interest payable to the partners was rightly determined on the capital balance computed without providing for depreciation. The assessing authority, however, rejected the claim taking the view that if depreciation is directly deducted to the P & L a/c, the net profit would come down, thus, the profit available for sharing among the partners would be almost ''nil''. The officer pointed out that since depreciation is a charge on the profit of the company, charging of interest has to be on the book profit of the company or firm, which in turn has to necessarily work out the depreciation on the profit of the company. The officer, hence, viewed that crediting in the capital account, even before depreciation, would be contrary to the provisions of the Act. The assessing authority viewed that the method of accounting did not reflect the true profit and to that extent, the accounts were not to be relied on.
(ii) Aggrieved by this, the assessee went on appeals before the CIT(A). The appellate authority pointed out that the object of s. 40(b) of the Act is basically to prevent siphoning off the firm''s funds to the partners in order to reduce the tax liability in the hands of the firm. The claim under this section has to be in conformity with the other provisions of the Act. The CIT(A) pointed out that s. 40A of the Act has overriding effect on s. 40(b) of the Act in respect of matter not covered by s. 40(b) of the Act. Considering the object of s. 40(b) of the Act the first appellate authority confirmed the view of the officer that without providing for depreciation, the partner''s account could not be credited with any Interest. The appellate authority further pointed out that s. 40(b) of the Act does not define "profit" in relation to cl. (iv), which is with reference to payment of interest. However, cl. (v) relating to payment of salary is to be made with reference to the book profit. Explanation 3 to cl. (v) defines "book profit" to mean the net profit, as shown in the P & L a/c for the relevant previous year, computed in the manner laid down in Chapter IV-D. Profit means net profit. Going by this definition, the first appellate authority viewed that the book profit has to be computed only after deducting depreciation allowable under s. 32 of the Act. Even in the absence of definition of profit in relation to cl. (iv), the assistance of Expln. 3 could be taken advantage of to find out, how the interest paid to a partner could be worked out. In the circumstances, the first appellate authority held that before apportioning any interest to the partners'' accounts, the depreciation has to be worked out first and then only the partners would be entitled to have the interest credited to the capital account. Referring to the decision in
2. Mr. C.V. Rajan, learned counsel appearing for the assessee drew our attention to the provisions under s. 40(b)(iv) of the Act, which is in contrast to s. 40(b)(v) of the Act and pointed out that when considering the salary paid to a partner and the claim made for deduction, statute has specifically provided for the deduction to be allowed based on the results of book profit at a particular percentage. It is worthwhile to note that in the matter of granting deduction in respect of payment of interest, there is no reference at all for the deduction being allowed at a particular percentage of the book profit. Thus, when payment of interest and payment of salary to the partners are treated differently under the provisions of the Act, it is not open to the Revenue to borrow the provisions as are available under cl. (v), Expln. 3 for the purpose of considering the deduction under s. 40(b)(iv) of the Act.
3. Learned counsel for the assessee relied on the decision in
4. Learned counsel, further drew our attention to s. 32, Expln. 5 of the Act, which was introduced under the Finance Act, 2001, w.e.f. 1st April, 2002, wherein the Explanation provided that irrespective of whether an assessee claimed the deduction in respect of depreciation in computing his total income or not, the provision under s. 32 of the Act would apply. Thus, with no such provision available during the material assessment years under consideration viz., 1996-97 to 2000-01 and Expln. 5 effective from 1st April 2002, the AO erred in his view that the interest credited could be worked out only after considering the depreciation.
5. Learned counsel for the assessee also brought to our attention the decision of this Court in
6. Countering the claim of the assessee, Mr. T. Ravikumar, learned standing counsel appearing for the Revenue, however, pointed out the factual situation that the assessee has gone in for working out the depreciation deduction after deducting the expenses and interest charged to their capital account, which ultimately, resulted in the net loss. If depreciation is directly debited to the P & L a/c, ultimately, the assessee might not have had sufficient profit available to claim interest on the balance of the capital account. Since the method of accounting followed by the assessee gave a distorted figure, rightly the assessing authority disallowed the assesee''s claim.
7. Heard the learned counsel on either side and perused the materials available on record.
8. Before going into the rival contentions, it is necessary that the provisions of the Act relating to ss. 40(b)(iv) and 40(b)(v) of the Act, particularly, Explns. 1 to 4 need to be extracted, which are as follows:
40. Notwithstanding anything to the contrary in ss. 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'',-
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in the case of any firm assessable as such,-
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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 insofar as such amount exceeds the amount calculated at the rate of twelve per cent simple interest per annum; or
(''twelve'' substituted for ''eighteen'' by the Finance Act, 2002, w.e.f. 1st June, 2002).
(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 insofar as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder:
(1) in case of a firm carrying on a profession referred to in s. 44AA or which is notified for the purpose of that section-
(2) in the case of any other firm-
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).-
(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 P & L a/c 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.
9. A reading of the abovesaid provisions on interest and salary clearly shows the marked difference in the treatment of the said payments in the matter of granting deduction under s. 40 of the Act. Sec. 40(b)(iv) recognises interest payment as deduction upto 18 per cent simple interest. For the purposes of disallowance of deduction on payment of interest, s. 40(b)(iv) states that simple interest paid in excess of 18 per cent, would go for disallowance. The payment of interest, in any event, would be allowed as deduction only if it is authorised and is in accordance with the terms of partnership deed. The payment of interest may be either from the account of book profit or from the net profit. As regards deduction claim on the salary payment to partners, deduction on the payment to all partners is worked out at the percentage of book profit as given in the section itself. Explanation 3 defines what book profit means. It states that "book profit" means the "net profit" as shown in the P & L a/c computed in the manner laid down in Part IV-D relating to "Profits and gain of business or profession", which means the net profit has to be necessarily worked out after giving such deductions and allowances as provided for in ss. 28 to 44D. Taking into consideration that the legislature has consciously provided for such differential treatment in the matter of granting deduction and disallowance on the payment of interest and salary, it is difficult for us to accept the plea of the Revenue that s. 40(b) disallowance herein has to be worked out only on the book profit, meaning thereby, the net profit after working out the depreciation. It is no doubt true that depreciation is given as a charge on the profit, but then, when working out s. 40(b) disallowance, particularly with reference to cl. (iv), when there is no specific reference to a book profit as a basis on which an interest has to be paid, unlike in the case of salary, the mere score that depreciation is made a charge on the profit, per se, would not justify the claim of the Revenue that the granting of such relief on the gross profit would lead to distorted figures in the matter of working out the real income of the assessee for the purpose of taxation.
10. In the decision in CIT vs. Aircel Ltd. (supra), following the decision of the apex Court in CIT vs. Mohendra Mills (supra), this Court held that, where an assessee did not avail the benefit of depreciation that benefit could not be forced upon the assessee.
11. As far as the present case is concerned, the question is not as to whether the assessee desired depreciation or not. The question herein is that, at what point could the interest be worked out and considered to be credited to the capital account of the partners for the purpose of considering the claim for deduction. Given the fact that the partnership deed provided for interest payment and what is disallowed under s. 40(b)(iv) of the Act is the rate of interest exceeding 18 per cent simple interest as it then stood, in the absence of any clear-cut guidance under the Act as has been provided in the case of salary, through Explanation that the payment of salary of all the partners for the purpose of deduction has to be worked out on the percentage of book profit computed in the manner laid down in Chapter IV-D, we have no hesitation in accepting the plea of the assessee that the method adopted by the assessee justifies the claim. It is no doubt true, as pointed out in the assessment order, that after working out the depreciation and expenses, practically, there might not be anything available at the hands of the firm for crediting any interest to the capital account, but then, as s. 40(b)(iv) of the Act stands in contrast to s. 40(b)(v) of the Act, it is difficult to accept the case of the Revenue that by reason of this figure alone, the accounts have to be rejected. Thus, going by the provisions under s. 40(b)(iv) of the Act, there being, no restriction placed on the working of interest before working out the depreciation, we have no hesitation in accepting the plea of the assessee that the Revenue cannot insist on depreciation being a charge on profit, has to be deducted first, before considering any interest payment on the capital of the firm. In the circumstances, we set aside the order of the Tribunal and allow the tax case (appeals). These tax case (appeals) are allowed. Consequently, connected miscellaneous petitions are closed. There is no order as to costs.
