Unreported Decisions – January 2022
By Ajay R. Singh, Advocate and CA Rohit Shah
1. Section 40(b)–Remuneration paid to partner– Interest incomes earned by assessee firm whether to be excluded for working out book profit so as to ascertain ceiling of partners remuneration
Assessee-firm was engaged in the manufacturing of aromatic chemicals. AO noted that the total income of assessee included dividend income of ₹ 377, interest on deposit of ₹ 4,51,820, interest on income-tax refund of ₹ 28,322 and interest on recurring deposit account of ₹ 42,602, which were covered under the head "Income from other sources". AO noted that these incomes were not directly related to business income of assessee but derived from other sources, therefore these amounts, aggregating to ₹ 5,23,121, were required to be deducted from net profit to compute book profit. Thus, the book profit was to be derived to ₹ 7,89,025 from which admissible remuneration as per under section 40(b)(v) would be at ₹ 3,68,110. However, AO noticed that the remuneration paid to partner was ₹ 5,92,357. So, there was an excess payment of remuneration amounting to ₹ 2,24,247 (₹ 5,92,357/- ₹ 3,68,110). Accordingly, AO made addition.
ITAT Held: It is abundantly clear that for the purpose of section 40(b)(v) read with Explanation, there cannot be separate method of accounting for ascertaining net profit and/or book profit. Therefore, interest income earned by assesseefirm from fixed deposit receipts should not be ignored for the purpose of working-out book profit to ascertain ceiling of partners remuneration. For the purpose of ascertaining such ceiling of the partners remuneration on the basis of book profit, profit would be in the profit and loss account and was not to be classified in different heads of income under section 40. Interest income, therefore, could not be excluded for the purposes of determining allowable deduction of remuneration paid to the partners under section 40B. For purpose of Explanation 3 to section 40(b)(v), assessee took into consideration its net profit as shown in the profit and loss account which included:– (1) Dividend income : (2) Interest on deposits : (3) Interest on Income Tax Refund : (4) Interest on recurring deposit : Although these incomes of assessee under consideration, were shown under different heading but same were classified under the heading as shown appearing in the matter of computation book profit in terms of Explanation 3 of section 40(b)(v) as said Explanation provides for taking the net profit as shown in the profit and loss account, and not the Profits computed under the head profit and gains on business or profession . Hence, these items were not be excluded while computing book profit for the purpose of partners remuneration. As per Explanation 3 of section 40(b), AO did not get jurisdiction to go behind net profit shown by Profit and Loss Account, except to the extent of the adjustments provided in the Explanation 3, nor he was empowered to decide under which head the income was to be taxed. The net profit as shown, was not to be allocated into different components. Accordingly, addition was deleted.
Mac Industries v. ITO [ITA No. 1036/Ahd/2016; dated 19-10-2020; A.Y. 2009-10]
Mac Industries2. S. 54: Cost of Improvement claimed – Partial amount allowed considering old flat required renovation to make it habitable:
The brief facts of the case are that the assessee has purchased and the expenditure of ₹ 23 lakhs was incurred for the purpose of renovating the house. The A.O asked the assessee to submit bills and vouchers for the above expenditure incurred by him. The assessee did not submit bills and vouchers and submitted that he has purchased an old flat and he renovated the house and incurred the above expenditure and submitted that same may be allowed. The A.O deputed the Inspector of Income Tax to make an enquiry about the house whether the assessee has carried any renovation work or not? Accordingly, Inspector has visited the house and made an enquiry and taken photographs and also, he made enquiry with the neighbors. Neighbors said that they were not aware of the improvements done by the assessee. On the basis of the reports submitted by the Inspector, the A.O came to the conclusion that the assessee has not carried out any improvement at the house purchased by the assessee and accordingly, he disallowed the entire amount.
On appeal, the Ld. CIT(A) held the following: Firstly, the AO appears to have not appreciated the fact that any new buyer of an undisputedly old house will carry out improvements to make the house habitable to his convenience and he should have taken into account this human nature while appreciating the facts to verify for which he should have also been better served to have referred the case to the departmental valuer for a more scientific valuation of the improvement than drawing an adverse inference on the basis of an Inspector’s report who was obviously not an expert in valuation matters. The AO also appears to have come to an arbitrary conclusion by taking pictures of a neighbor’s house and by comparing the same with the house of the assessee and then holding that since both the houses looked alike there had been no improvement at all except the shifting and in an arbitrary manner without any detailed investigation and enquiry and without any cross verification with the assessee / Builder as contended earlier thereby violating the principles of natural justice too and resulting in the addition of ₹ 23,00,000/- to the total income. The AO would therefore have done better to conduct basic enquiries with the Builder as to details of the cost of improvements as claimed in the matter rather than ascertain the same from neighbors / tenants who would have been hardly aware of any such development, much less the intricate details of the said improvement. It is also not in dispute that the improvement expenses incurred for making the house habitable also qualify for deduction under section 54. During the course of appellate proceedings, the appellant was called to furnish the documentation relating to the expenses on the aforesaid works and on a random test check of the same it is seen that the assessee was not in a position to produce satisfactory evidence relating to tile removing and relaying and painting works amounting approximately to 4.95 lakhs. Therefore, the Ld. CIT(A) disallowed an amount of ₹ 5,00,000/- and directed the A.O to allow the improvement cost to the extent of ₹ 18,00,000/-.
On being aggrieved, the Revenue carried the matter before the Tribunal. The Hon’ble ITAT upheld CIT Appeals Order and dismissed Revenue’s Appeal.
The ACIT vs. Shri Sambandam Dorairaj [ITA No.301/Chny/2020; dated 30-9-2021; Bench: C; AY 2013-14]