Income Tax | Partnership | Salary

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section40(b) - : Section 40(b) of the Income Tax Act, 1961, as it stood at the relevant time, prohibited deduction of interest, salary, bonus, commission or remuneration paid by the firm to the partner. Explanation 1 introduced thereto by the Taxation Laws (Amendment) Act, 1984, which took effect from 1st April, 1985, provided that where interest is paid by a firm to a partner who has also paid interest to the firm, the amount of interest to be disallowed shall be limited to the net amount of interest paid by the firm to the partner.

Circular No. 33D(XXV-24) of 1965 issued by the Central Board of Direct Taxes provided that where a firm pays interest to as well as receives interest from the same partner, only the net interest can be stated to have been received or paid by the firm.

The assessee-appellant, a registered partnership firm, in the accounting year for the assessment year 1975-76, paid interest to the partners on the amounts standing to their respective credits. It also received from the partners interest on their borrowings from the firm. The Income-tax Officer 244

CIT. The Appellate Tribunal affirmed the appellate order. (b) the extent of the embargo under s. 40(b) was.ners did not set-off the interest received from them on their borrowings. 10(4)(b) of the 1922 Act on the disallowance of interest paid to a partner was judicially interpreted and ascertained in Sri Ram Mahadeo Prasad v. to enable the assessment of the 'real income' of the firm and did not require or compel the exclusion of the cross-interest paid by a partner in determining the quantum to be disallowed. 40(b) of the 1961 Act in substantially the same terms. having regard to the special features and legal incidents of a partnership. and when the legislature re-enacted those provisions in s. The Appellate Assistant Commissioner allowed the claim of the appellants that only the net inter. The High Court an. In these appeals by special leave it was contended for the appellants that: (a) the sole object of s.swered the reference in favour of the Revenue on the view that the Tribunal was not justified in holding that net interest should be disallowed under s.est paid to the partners after setting-off the interest received from them was to be disallowed.while disallowing the amount of interest paid to the part. 24 ITR 176 All. 40(b) of the Act. legislature must be held .

40(b). . and (e) the amendment of 1984 inserting Explanation 1 in s. 40(b). if any. (d) the circular of the Central Board of Direct Taxes. constitutes a legisla.cial exposition. (c) the interest paid to a partner on the capital brought in by him and the interest received from a partner on his borrowings from the firm were both integral parts of a method adopted by the partners for adjusting the division of profits and in that sense both payments partook of the same character and it would be permissible to take both the payments into consideration in quantifying the interest and treat only such excess. paid by the firm as susceptible to the exclusionary rule in s. which was statutory in character.to have used that expression with the same implications attributed to it by the earlier judi. though later in point of time. was binding on the authorities and the High Court was in error in taking a view of the legal position different from the one indicated in it. 40(b) in their application to the earlier years as well.tive exposition of the correct import of the provision and so construed offers a guide to the correct understanding of the provisions in s.

The supposed intention of the legislature cannot then be ap. bonus. HELD: 1. Union of India. resort to any interpretative process to unfold the legislative intent becomes impermissible. 1961 opens with the nonobstante clause and directs that outgoings such as interest. [255E-F] Doypack Systems Pvt. [1988] 2 SCC 299.Allowing the appeals.2 Section 40 of the Income Tax Act. Ltd. If the intendment is not in the words used it is nowhere else. (b) shall not be deducted in computing the income chargeable under the head "profits and gains of business or profession".pealed to whittle down the statutory 245 language. The words used therein on their . 1. commission or remuneration specifically enumerated in cl.tory language.1 As long as there is no ambiguity in the statu. the Court. v. salary. referred to.

interest received from one partner on some other dealings between him and the firm against interest paid to another partner on his or her capital contribution and thus lead to positions and results. 256B] 1. are out of place where the legislation has a fiscal mission. therefore. It must not. Cooley: Law of Taxation. 1.tion of the burdens of the community to sustain social services.tion of s.own terms. Vol. whose dimensions and implications are not fully explored. be applied as they stand.mental . therefore.3 Artificial and unduly latitudinarian rules of con.payer the breaks'. referred to. are plain and unambiguous. 2. with their general tendency to 'give the tax.struction. Taxation is regarded as a potent fiscal tool of State policy to achieve equitable distribu. They manifest the intention of the legislature and must.4 The test of 'real income' as one on which the opera. [255D-E. be called in aid to defeat the funda. It might on its own extended logic validate a set off of the interest paid to one partner against interest received from another and likewise. F-G. [256C-D] Thomas M. 40(b) could be sought to be limited is not a reliable one.

referred to.2 However. Vol. 256A. 234 at 250. It is the task of the court to decide which one. 2. ought to prevail. [257G] H. The interpretative criteria apposite in a given situation may. by themselves. p. they 246 are mere aid to construction and constitute some broad pointers. [258E-F] . 257D1 State Bank of Travancore v. Lulloobhoy Mottichund. the rules of interpretation are not rules of law.H. 256G. be mutually irreconcilable.principles of the law of income tax. referred to. [257 A. CIT. Ruckmaboye v. Moore's Indian Appeals. [1986] 158 ITR 102 at 155. 5. 2.1 When words acquire a particular meaning or sense because of their authoritative construction by superior courts. they are presumed to have been used In the same sense when used In a subsequent legislation In the same or similar context. in the light of all relevant circumstances.

therefore. out of place.s. [258D-E] 3. Olins. It did not rest on any special or technical connotation of the word 'interest' nor any special legal sense which that word could be said to have acquired by the earlier judicial ascertainment of its amplitude. the latter can not be invoked to displace the effect of the statute. 10(4)(b) of the 1922 Act and on what the High Court considered as affording to the assessee a fair treatment. [261F-H] . [1987] 3 SCR 317 at 330.e. CIT. [1975] 1 All ER 16 and Utkal Contrac. State of Orissa. (24 ITR 176 All.tors & Joinery v. But if there is no such statutory departure the general principle operating in that branch of law would determine the nature of legal relationship. referred to. The appeal to this principle of construction in the instant case is.3 The decision in Sri Ram Mahadeo Prasad v.Maunsell v. 2.) proceeded on a construction of the relevant provision i.1 To the extent the statute expressly or by necessary implication departs from the general law.

cannot be displaced by probing into the substance of the transaction. [262C-D.Sir Francis Bennion. 263A-B] Sargaison v. referred to. The Court. Krishtappa. [1966] 3 SCR 400. 350. the incidents of the general law of partners would be attracted to ascertain the legal nature and character of a transaction. p. Chidambaram. Roberts. This is quite apart from distinguishing the 'substance' of the transaction from its 'form'. however. In the case of partners. [1969] 45 Tax Cases 612. [1977] 106 . CIT v. on Statutory Interpretation. CIT v. Narayanappa v. therefore.. Gillanders Arbuthnot & Co. 87 ITR 407. 354. is not precluded from treating what the transaction is in point of fact as one in point of law also. But the legal effect of a transaction. to the extent not prohibited by s. 40(b) of the Act.

[1985] 2 SCR 119 and Ellis v. are mere variations of the method of adjustment of the profits.ITR 292. received from the partner are mere expressions of the application of the funds or profits of the partnership and which. Regional Director Employees State Insurance Corporation. in general law they admit of being so treated. in 247 turn. Trichur v.est. referred to. they could be treated as part of the same transaction if. having regard to the community of interest of the partners.ship they .2 If interest paid by the firm to a partner and the inter. [263B-D] If instead of the transactions being reflected in two separate or distinct accounts in the books of the partner.) p. Joseph Ellis & Co. Ramanuja Match Industries. 30. otherwise.. (14th Edn. 3. Lindley on Partnership. The provisions of s. 40(b) do not exclude or prohibit such an approach. [1905] 1 KB 324.

which presupposes a duality of entities may be out of place in the very nature of the relationship between a firm and its partners where the former is a mere compendious reference to the latter. the idea of set-off may be invoked in view of the mutuality implicit in the putative duality inherent in deeming the firm as a distinct . to the extent of interest on drawings of the partner. stand attenuated. The mere fact that the transactions were split into or spread over to two or more accounts would not by itself make any difference if. otherwise. Lakshmikutty. the substance of the transaction was the same. [1981] 2 SCR 349. referred to. But even to the extent the income tax law which identifies the firm as a distinct entity and unit of assessment goes.were in one account. the quantum of interest paid by the firm to the partner would. Even the idea of a set-off itself. [263D-E] Official Liquidator v.

poses. 3. referred to. [1899] 2 QB 158. More so. [263H-264B] 3. The fiction may have to be pushed to its logical conclusions. Carlton Bank. 156 ITR 323 and A. though equity and taxation are often strangers.V. E-F. Gotla.entity under the Act for certain pur.H.G.tion another construction. Therefore. attempts should be made that these do not remain always so. The duty of the Court is to give effect to the intention of the legislature. J. a taxing statute being not different from other statutes it is not to be construed differently. [264C. 265A] CITv.4 Accordingly. G-H.3 Where a strict literal construction leads to a result not intended to subserve the object of the legisla. permissible in the context should be adopted. where two or more transactions on which interest is paid to or received from the partner by the firm are .

S.T. A circular cannot even impose on the tax payer a burden higher than what the Act itself on a true interpreta. C.tion envisages. 157 ITR 300 A. overruled. v. v. approved. s. the interest..shown to have the element of mutuality and are referable to the funds of the 248 partnership as such.T.. O. if any paid to a partner by the firm in excess of what is received from the partner could alone be excluded from deduction under s.sion of the Income Tax Act by issuing circulars on the subject. 40(b). Sankaralinga Nadar & Co. 147. If that be so.V.P. T.I. 4..I.M. ITR 332 Mad. . Ramanaiah & Sons. The Central Board of Direct Taxes cannot pre-empt a judicial interpretation of the scope and ambit of a provi.S. [265B-C] C. 40(b) should not be so construed as to exclude in quantifying the interest on the basis of such mutuality.

mate aids to statutory construction.Nor can it detract from the Act. Since the circular of 1965 broadly accords with the view taken on the true scope and interpretation of s. There is no general theory as to the effect and intendment of the Explanation except that the purpose and intendment of the Explanation are determined by its own words. CIT. [266E-F] 5.. 265F.ferred to. [265E-F. The circulars do not bind them. 40(b) as regards qualification of interest it is unnecessary to examine whether or not such circulars are recognised legiti. An 'Explanation' is generally intended to explain the meaning of certain phrases and expressions contained in a statutory provision. The task of interpretation of the laws is the exclusive domain of the courts. G-H] State Bank of Travancore v. [1986] 158 ITR 102. re. An Explanation depending on its language. 266D. might supply or take away something from the contents of a .

40will take effect from 1st April.ment year 1985-86 and subsequent years. An Explanation may also be introduced by way of abundant caution in order to clear the meaning of a statutory provision and to place what the legislature considers to be the true meaning beyond controversy or doubt. the notes on clauses appended to the Taxation Laws (Amendment) Bill.nation 249 it is not necessary to examine its possible purpose any further. 1984 say that clause 10 which seeks to amend s. [267C-E] . [266G-267B] In the instant case. apply in relation to the assess. accordingly. 1985 and will.provision. In view of the express prospective operation and effectuation of the Expla.

: In all most all the partnership . Conditions are defined in section 40(b) of the income tax act.full amount of salary is not allowed as expenses in profit & loss account but salary is restricted to % of profit before salary to the partner.commission . 2.There are some conditions also which are to be complied to claim deduction of salary as expense in P & L account of partnership firm. 1. 2.But as per Income Tax Act . Salary must be written/authorised by the Partnership deed Salary should be related to the period after the partnership deed date. 3. Board has issued a circular also related to clause in partnership deed for salary to partners . 1. Salary must be with in limit of % of Book profit. Salary should be paid to working partner.provision for salary has been included and decided with mutual consent . Working partner: salary to sleeping partner is not allowed .remuneration (or any name whatever name called) Now detail of each condition.Salary must be written/authorised by the Partnership deed:To claim the expense of salary of partner in p& L salary should be authorised by the partnership deed and it should also be according to the conditions/terms defined in the partnership deed. y y Clause in partnership should be clear and amount should be defined. 4. Salary here means: salary .ANOTHER INFORMATION .and working partner definition has been given in explanation 4 of the section 40(b) y 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 From above definition it is clear that " full time" attendance to any or all of the tasks of the partnership .

in such cases payment of remuneration to partners cannot be allowed as deduction in the computation of the firms income. In cases where neither the amount has been quantified nor even the limit of total remuneration has been specified but the same has been left to be determined by the partners at the end of the accounting period. Since the amended provisions of section 40(b) have been introduced only with effect from the assessment year 1993-94 and these may not have been understood correctly the Board are of the view that liberal approach may be taken for the initial years. the representations have referred to two types of clauses which are generally incorporated in the partnership deeds. It has been represented that the Assessing Officers are not allowing deduction on the basis of these and similar clauses in the course of scrutiny assessments for the reason that they neither specify the amount of remuneration to each individual nor lay down the manner of quantifying such remuneration. The Board have received representations seeking clarification regarding dis allowance of remuneration paid to the working partners as provided under section 40(b)(v) of the Income-tax Act. 4. These are : (i) The partners have agreed that the remuneration to a working partner will be the amount of remuneration allowable under the provisions of section 40(b)(v) of the Income-tax Act. 3. no deduction under section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration. 2. and (ii) The amount of remuneration to working partner will be as may be mutually agreed upon between partners at the end of the year. . It has been decided that for the assessment years 1993-94 to 1996-97 deduction for remuneration to a working partner may be allowed on the basis of the clauses of the type mentioned at 1(i) above. The Board have considered the representations. no deduction under section 40(b)(v) will be admissible unless partnership deed either specifies amount of remuneration payable to each individual working partner or lays down manner of quantifying such remuneration 1. In particular. It is clarified that for the assessment years subsequent to the assessment year 1996-97.Whether for assessment years subsequent to assessment year 1996-97.

Add back salary given to partners if debited in p& L earlier. director. engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration .: As per section following % has been defined with in which salary can be claimed for partners.Profession of Information Technology. editor.capital gain has been debited /credit then reverse back the such amount from profit & loss account. dialogue writer and dress designer). As the depreciation b/f is covered under section 32(2) . 3. suppose . dance director.% chart is given below Profession notified under section 44AA y legal.Salary should be related to the period after the partnership deed date: The salary as per partnership deed should be after the partnership deed. If expenses /Income of other head like house property or income from other sorcse .If payment is related to period earlier than the date of partnership deed . medical. 2.Circular : No. cameraman. dated 25-3-1996. Make adjustment for expenses allowed/disallowed as per section 28.from ay 1996-97 onwards amount should be defined in the partnership deed. The above circular is very clear so .profession of authorised representative. singer. 1.Salary must be with in limit of % of Book profit. lyricist. the profession of film artist (actor. screen play writer.44D. 4. 739. 3. Take profit as per P& L account. Calculation Of book Profit. 4. story writer.Profession of Company Secretary. art director. 5.so adjustment should be made for b/f depreciation to calculate the book profit but adjustment can be done only upto maximum of profit of current year before depreciation minus b/f loss of the previous years . music director.then it will be disallowed as exp.

if firm is not covered under above:any other firm On first 75000=90% of 100000=67500 On (109376-75000=34376) @ 60%=20986 Total allowed :67500+20986=88486 . 2.Profit as per P & L = 220850 Depreciation =111474.00 Net profit after depreciation =109376 salary of partner given =108000 Now salary allowed as per section 40(b) is given below Book profit=109376 y If firm is covered under 44AA(profession prescribed): 1. 2. On first 100000=90% of 100000=90000 On balance 9376 @ 60%=5626 Total allowed=90000+5626=95626 y 1.

Rs.000 or at the rate of 90 per cent of the book-profit.00.000 of the book.000 of the bookprofit. (a) (b) (c) on the balance of the book-profit (2)in the case of any other firm on the first Rs. at the rate of 40 per cent: . at the rate of 40 per cent.1) in case of a firm carrying on a profession referred to in section 44AA or which is notified for the purpose of that section on the first Rs. 50. at the rate of 60 per cent.00. or in case of a loss on the next Rs.000 of the bookprofit at the rate of 60 per cent. whichever is more. whichever is more. 75. 1.000 or at the rate of 90 per cent profit or in case of a loss of the book-profit. on the next Rs. 1. 75.000 of the bookprofit on the balance of the book-profit (a) (b) (c) Rs. 50.

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