Quality Industries, Thane V. Joint Commissioner of Income-tax,

ITA 2000/PUN/2014

• Counselvise Citation: [2016] 131 COUNSELVISE.COM (IT) 1042 (ITAT-PUNE)
• Duration Of Justice: 1 year(s) 9 month(s) 28 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 09-09-2016
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: B
• Next Hearing Date: 26-07-2016
• Assessment Year: 2010-2011
• Appeal Filed On: 11-11-2014
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: P S KUREEL
• Keywords: Capital asset; Business income; Business expenditure; Earning of tax free income; Proportionate interest; Revenue expenditure
• Section: 143(3); 14A; 37; 6

Judgement Text

] ]] ] IN THE INCOME TAX APPELLATE TRIBUNAL PUNE BENCH B, PUNE , !', $ % BEFORE SHRI VIKAS AWASTHY, JM AND SHRI PRADIP KUMAR KEDIA, AM ITA NO.2000/PN/2014 ASSESSMENT YEAR : 2010-11 QUALITY INDUSTRIES, W-50, M.I.D.C., PHASE- II, MANPADA ROAD, DOMBIVLI (E), THANE 421 204. PAN : AAAFQ0728P . APPELLANT VS. THE JT. COMMISSIONER OF INCOME TAX, RANGE- 2, NASHIK. . RESPONDENT / APPELLANT BY : SHRI SACHIN AMDEKAR / RESPONDENT BY : SHRI P. S. KUREEL / DATE OF HEARING : 26.07.2016 / DATE OF PRONOUNCEMENT: 09.09.2016 & / ORDER PER PRADIP KUMAR KEDIA, AM : THE CAPTIONED APPEAL FILED BY THE ASSESSEE IS AGAIN ST THE ORDER OF CIT(A)-2, NASHIK DATED 05.09.2014 RELATING TO ASSES SMENT YEAR 2010-11 PASSED UNDER SECTION 143(3) OF THE INCOME-TAX ACT, 1961 (IN SHORT THE ACT). 2. IN THIS APPEAL, THE ASSESSEE HAS IMPUGNED THE AC TION OF THE ASSESSING OFFICER IN INVOKING THE PROVISIONS OF SECTION 14A A ND CONSEQUENTLY MAKING DISALLOWANCE OF INTEREST AND OTHER COMMON EXPENSES BY HOLDING THAT SUCH EXPENSES ARE ATTRIBUTABLE TO THE DIVIDEND INCOME EX EMPT FROM TAXATION. THE GROUNDS RAISED BY THE ASSESSEE ARE REPRODUCED HEREU NDER :- 1. THE LEARNED, CIT(A) HAS NOT CONSIDERED ANY MERI T IN DISALLOWING RS.29,25,362/- UNDER SECTION 14A RULE 8D OF THE INC OME TAX ACT,1961. 2 ITA NO.2000/PN/2014 2. THE LEARNED, CIT(A) HAS NOT CONSIDERED THE FACT THAT THE INVESTMENT MADE BY ASSESSEE ARE FROM RETAINED SURPLUS. AND NO CAPITAL WAS INTRODUCED FOR INVESTMENT PURPOS E. SO DISALLOWANCE OF INTEREST ON CAPITAL WAS UNJUSTIFIED. 3. INTEREST ON PARTNER'S CAPITAL IS NOT EXPENDITURE REFER IN SEC 14A , IT IS ALLOWANCE GIVEN TO PARTNERSHIP FIRM. THIS INTEREST ON CAPITAL IS TAXABLE IN HANDS OF PAR TNERS AND DISALLOWANCE WILL LEAD TO DOUBLE TAXATION IN HANDS OF PARTNER AS WELL AS FIRM. 4. THE APPELLANT CRAVES LEAVE TO ADD, ALTER, AMEND OR DELETE ANY OF THE ABOVE GROUNDS OF APPEAL. 3. THE RELEVANT FACTS GERMANE TO THE ISSUE IN BRIEF ARE THAT THE ASSESSEE IS A PARTNERSHIP FIRM WHICH IS ENGAGED IN THE BUSINESS O F MANUFACTURING OF CHEMICALS ETC. THE ASSESSEE FIRM FILED RETURN OF IN COME FOR THE RELEVANT ASSESSMENT YEAR 2010-11 UNDER SECTION 139(1) OF THE ACT DECLARING TOTAL INCOME OF RS.95,65,090/-. WHILE MAKING ASSESSMENT UNDER SECTION 143(3), THE ASSESSING OFFICER NOTICED THAT THE ASSESSEE HAS INTER-ALIA EARNED TAX FREE DIVIDEND INCOME AMOUNTING TO RS. RS.24,63,700/- FRO M INVESTMENT IN MUTUAL FUNDS WHICH WAS CLAIMED AS EXEMPT INCOME UNDER SECT ION 10(35) OF THE ACT. THE ASSESSING OFFICER IN A SEQUEL THERETO, ALSO NOT ED THAT THE ASSESSEE HAS SHOWN INVESTMENT OF RS.4,41,88,955/- HELD IN VARIOU S MUTUAL FUNDS AS ON 31.03.2010. THE CORRESPONDING INVESTMENT IN THE MU TUAL FUND AS ON THE LAST DAY OF THE PRECEDING FINANCIAL YEAR I.E. 31.03.2009 WAS STATED TO BE RS.3,18,39,548/-. IT WAS THEREAFTER OBSERVED THAT T HE ASSESSEE HAS INTRODUCED CERTAIN CAPITAL IN THE FIRM ON WHICH INTEREST HAS B EEN CHARGED BY THEM. THE INTEREST SO PAID TO THE PARTNERS HAVE BEEN CLAIMED BY THE ASSESSEE AGAINST TAXABLE INCOME. INTEREST ON BANK LOANS AMOUNTING TO RS.75,615/- AND INTEREST ON PARTNERS CAPITAL TO THE TUNE OF RS.74,88,000/- AGGREGATING TO RS.75,63,615/- WERE CHARGED AGAINST ITS TAXABLE INCOME. THE ASSES SING OFFICER NEXT OBSERVED THAT INVESTMENT IN MUTUAL FUNDS IS MADE OUT OF INTE REST BEARING FUNDS WHICH INCLUDE INTEREST BEARING PARTNERS CAPITAL ALSO. I N THESE FACTUAL BACKGROUND, THE ASSESSING OFFICER WAS OF THE VIEW THAT ASSESSEE HAS INCURRED EXPENDITURE INCLUDING INTEREST EXPENSES WHICH ARE ATTRIBUTABLE TO EARNING DIVIDEND INCOME FROM INVESTMENT IN MUTUAL FUNDS WHICH IS EXEMPT AND NOT INCLUDIBLE IN TOTAL INCOME. THUS, THE EXPENDITURE SO INCURRED IS REQUIR ED TO BE DISALLOWED IN 3 ITA NO.2000/PN/2014 APPROPRIATE PROPORTION. AS A SEQUEL THERETO, HE INV OKED PROVISIONS OF SECTION 14A OF THE ACT R.W. RULE 8D OF THE INCOME TAX RULES , 1962 (IN SHORT THE RULES) AND PROCEEDED TO DISALLOW ESTIMATED EXPENDI TURE INCURRED IN RELATION TO DIVIDEND INCOME SO EARNED IN TERMS OF FORMULA PROVI DED UNDER RULE 8D OF THE I T RULES. 4. IN RESPONSE TO SHOW-CAUSE NOTICE PROPOSING DISAL LOWANCE UNDER SECTION 14A, IT WAS SUBMITTED ON BEHALF OF THE ASSESSEE THA T RULE 8D(2)(II) CONCERNING DISALLOWANCE OF PROPORTIONATE INTEREST ATTRIBUTABLE TO INTEREST BEARING PARTNERS CAPITAL IS NOT PERMISSIBLE IN THE FACTS OF THE CASE . IT WAS INTER-ALIA SUBMITTED THAT INTEREST ON PARTNERS CAPITAL IS NOT AN EXPEN DITURE PER SE BUT IS IN THE NATURE OF A DEDUCTION UNDER SECTION 40(B) JUST AS D EPRECIATION ON BUSINESS CAPITAL ASSET IS AN ALLOWANCE AND NOT EXPENDITURE. 4.1 IN ELABORATION, IT WAS SUBMITTED THAT PAYMENT O F INTEREST ON PARTNERS CAPITAL IS NOT AN EXPENDITURE PER SE AS SPECIFIED UNDER SECTION 14A OF THE ACT. IT WAS CONTENDED THAT EVEN INCOME TAX LAW UNDERSTAN DS IT THIS WAY AS SUCH INTEREST IN PARTNERS HAND IS TAXABLE AS PROFIT FR OM BUSINESS AND NOT AS INCOME FROM OTHER SOURCES. IT WAS NEXT CONTENDED THAT EXPENDITURE NEEDS PRESENCE OF TWO PARTIES I.E. SPENDER AND EARNER. I T WAS SUBMITTED THAT INTEREST AND SALARY TO PARTNERS IS NOT EXPENDITURE AS IN VIE W OF MUTUALITY. THE FIRM HAS NO SEPARATE EXISTENCE FROM ITS PARTNERS. THE ASSES SEE FIRM IS A SEPARATE ENTITY UNDER INCOME TAX ACT ONLY FOR TAXATION PURPOSES. T HESE IS THE VERY REASON THAT DEDUCTION OF INTEREST AND SALARY TO PARTNERS I S ALLOWED AS SEPARATE DEDUCTION AND NOT AS AN EXPENDITURE UNDER SEPARATE SECTION FROM SECTIONS 30 TO 43 OF THE ACT. THESE INTERESTS AND SALARIES TO PAR TNERS FOR THIS VERY REASON ARE NOT LIABLE FOR TDS PROVISIONS UNDER THE INCOME TAX ACT. IT WAS FURTHER SUBMITTED ON BEHALF OF THE ASSESSEE THAT SECTION 14 A COVERS AMOUNT IN THE NATURE OF EXPENDITURE AND NOT ALL STATUTORY ALLOW ANCES. 4 ITA NO.2000/PN/2014 4.2 THE ASSESSEE ALSO CONTENDED BEFORE THE ASSESSIN G OFFICER THAT NO CAPITAL WAS INTRODUCED FOR INVESTMENT PURPOSES AND THEREFOR E DISALLOWANCE OF INTEREST ON CAPITAL WAS NOT JUSTIFIED. 4.3 HOWEVER, THE ASSESSING OFFICER DISCARDED THE VA RIOUS PLEAS OF THE ASSESSEE. HE OBSERVED THAT THE INVESTMENTS IN MUTUA L FUND GIVING RISE TO TAX FREE DIVIDEND INCOME IS SOURCED OUT OF PARTNERS CA PITAL AND LOANS AND CONSEQUENTLY INTEREST PAID ON PARTNERS CAPITAL IS ALSO SUSCEPTIBLE TO RULE 8D(2)(II) OF THE RULES. THE ASSESSING OFFICER ACCOR DINGLY INVOKED RULE 8D OF THE RULES AND COMPUTED DISALLOWANCE OF INTEREST AT RS.27,84,771/- IN TERMS OF RULE 8D(2) OUT OF INTEREST CLAIMS AND RS.1,40,591/- TO COVER UP COMMON ADMINISTRATIVE EXPENSES ETC. AS PER RULE 8D(3). AGG REGATE DISALLOWANCE WAS THUS WORKED OUT TO RS.29,25,362/- IN TERMS OF RULE 8D OF THE I. T. RULES. 5. AGGRIEVED BY THE ACTION OF THE ASSESSING OFFICER , THE ASSESSEE PREFERRED AN APPEAL BEFORE THE CIT(A). 6. THE CIT(A) TOOK NOTE OF THE CONTENTS OF THE BALA NCE SHEET OF THE ASSESSEE FIRM FOR THE FINANCIAL YEAR RELEVANT TO AS SESSMENT YEAR 2010-11 AND NOTED THAT MAIN SOURCE OF INVESTMENT IN MUTUAL FUND S HAVE COME FROM PARTNERS CAPITAL. THE PARTNERS HAD INTRODUCED CAPI TAL IN THE PARTNERSHIP FIRM WHICH BEARS INTEREST @12% PER ANNUM. THE INTEREST C HARGED TO THE ASSESSEE FIRM HAS BEEN CLAIMED AS REVENUE EXPENDITURE AGAINS T TAXABLE INCOME. HOWEVER, SUCH INTEREST IS RELATABLE TO DIVIDEND INC OME WHICH DOES NOT FORM PART OF THE TOTAL INCOME. THIS BEING SO, THE PROVIS IONS OF SECTION 14A ARE ATTRACTED AND EXPENSES INCURRED IN RELATION TO INCO ME WHICH DOES NOT FORM PART OF TOTAL INCOME REQUIRES TO BE DISALLOWED. HE ACCOR DINGLY CONFIRMED THE ACTION OF THE ASSESSING OFFICER AND HIS WORKING OF DISALLO WANCE UNDER RULE 8D OF THE STATUTORY RULES. 7. AGGRIEVED BY THE ORDER OF THE CIT(A), THE ASSESS EE IS IN FURTHER APPEAL BEFORE THE TRIBUNAL. 5 ITA NO.2000/PN/2014 8. THE LD. AUTHORIZED REPRESENTATIVE (AR) FOR THE A SSESSEE SHRI SACHIN AMDEKAR ADVERTED OUR ATTENTION TO THE BALANCE SHEET AS ON 31.03.2010 RELEVANT TO ASSESSMENT YEAR 2010-11 AND SUBMITTED THAT THE A SSESSEE HAS OBTAINED FUNDS FROM PARTNERS WHICH ARE IN THE NATURE OF FIXED CAP ITAL AS WELL AS CURRENT CAPITAL. THE FIXED CAPITAL RECEIVED FROM PARTNER S AS APPEARING ON THE LAST DAY OF THE FINANCIAL YEAR STANDS AT RS.6,24,00,000/- ON WHICH INTEREST AT THE RATE OF 12% PER ANNUM HAS BEEN CHARGED TO THE PARTNERSHIP F IRM. THERE IS NO CHANGE IN THIS FIXED CAPITAL QUA THE PRECEDING YEAR. THE LD. AR THEREAFTER AVERRED THAT THE ASSESSEE FIRM HAS ALSO OBTAINED CURRENT OR FLUC TUATING CAPITAL FROM THE PARTNERS FROM TIME TO TIME ON WHICH NO INTEREST IS CHARGED. THE CURRENT CAPITAL AS ON LAST DAY OF THE FINANCIAL YEAR STANDS AT RS.1 ,14,35,375/-. IT WAS NEXT STATED THAT AN INVESTMENT OF RS.4,41,88,955/- IN MU TUAL FUNDS GIVING RISE TO TAX FREE DIVIDEND INCOME IS CORRESPONDINGLY REFLECTED A S AN ASSET OF THE PARTNERSHIP FIRM. INTEREST OF RS.74,88,000/- HAS ACCRUED OR ARI SEN TO THE CREDIT OF THE PARTNERS TOWARDS FIXED CAPITAL WHICH HAS BEEN CHARG ED TO PROFIT AND LOSS ACCOUNT OF THE PARTNERSHIP FIRM DURING THE YEAR. S IMILARLY, ANOTHER INTEREST EXPENDITURE OF RS.75,615/- HAS BEEN INCURRED ON CER TAIN LOANS FROM BANKS ETC. ON THESE FACTS, THE LD. AR RAISED A SUBSTANTIAL QUE STION IN RELATION TO DISALLOWANCE OF PROPORTIONATE INTEREST IN RELATION TO PARTNERS CAPITAL BY INVOKING RULE 8D(2)(II) OF THE ACT. IT WAS CONTENDE D ON BEHALF OF THE ASSESSEE THAT INTEREST PAYABLE ON FIXED CAPITAL RECEIVED FRO M ITS PARTNERS DOES NOT BEAR THE CHARACTERISTICS OF EXPENDITURE PER SE AS CONTEMPLATED UNDER S. 14A OF THE ACT . REFERENCE WAS INVITED TO S. 28(V) OF THE ACT AND I T WAS POINTED OUT THAT AS PER THE SCHEME OF TAXATION, THE PAYMENT TO THE CRED IT OF PARTNERS IN THE FORM OF INTEREST AND SALARY IS CHARGEABLE TO TAX IN THEIR R ESPECTIVE HANDS AS BUSINESS INCOME BY OPERATION OF LAW. HE MADE REFERENCE TO T HE DECISION OF THE HONBLE SUPREME COURT IN THE CASE OF CIT VS. R.M. CHIDAMBAR AM PILLAI REPORTED IN (1977) 106 ITR 292 (SC) AND SUBMITTED THAT PAYMENT OF SALARY TO PARTNERS REPRESENT AS SPECIAL SHARE OF PROFITS AND THEREFORE TAXABLE AS BUSINESS INCOME. HE THUS CONTENTED THAT ON THE SAME FOOTING, THE INT EREST ON PARTNERS CAPITAL IS A RETURN OF SHARE OF PROFIT BY THE FIRM TO THE PARTNE RS. BOTH INTEREST AND SALARY TO PARTNERS ARE NOT SUBJECTED TO TDS PROVISIONS AND BO TH FALL UNDER SECTION 40 OF 6 ITA NO.2000/PN/2014 THE ACT. THE LD. AR SUBMITTED THAT SECTION 40(B) I S NOT JUST A LIMITING SECTION NOTWITHSTANDING THE FACT THAT SOME FETTERS ON THE R ATE OF INTEREST HAVE BEEN PUT. IT WAS CONTENDED THAT SALARY TO PARTNERS AND INTERE ST PAID ON PARTNERS CAPITAL WAS MADE ALLOWABLE IN THE HANDS OF THE FIRM ONLY FR OM AY 1993-94 SUBJECT TO LIMITS AND RESTRICTIONS PLACED UNDER S. 40(B) OF TH E ACT. SALARY AND INTEREST TO PARTNERS WERE NOT ALLOWABLE PRIOR THERETO WHICH SUP PORTS THE VIEW THAT S. 40(B) IS NOT MERELY MEANT FOR LIMITING THE DEDUCTION. HAD IT BEEN SO, THE INTEREST WOULD HAVE BEEN ALLOWED IN THE HANDS OF THE PARTNER SHIP FIRM SINCE THE BIRTH OF INCOME TAX LAWS. THE PAYMENT OF INTEREST TO PARTNER S IS ALLOWABLE IN THE HANDS OF PARTNERSHIP FIRM BY VIRTUE OF S. 40(B) OF THE ACT SUBJECT TO SOME CAPPING. HE THEREAFTER SUBMITTED THAT IN THE LIGHT OF THE SCHEME OF THE ACT, SECTION 14A IS APPLICABLE ONLY QUA THE EXPENDITURE INCURRED AND NOT IN RESPECT OF ANY AND EVERY DEDUCTIONS OR ALLOWANCES. THE LD. AR ALSO EMPHASIZED THAT EXPENDITURE NEEDS TWO PARTIES WHICH IS ABSENT IN VIEW OF THE MUTUALITY PRESENT IN A PARTNERS FIRM. THE FIRM HA S NO SEPARATE EXISTENCE FROM ITS PARTNERS AND THE FIRM IS SEPARATE ASSESSABLE EN TITY ONLY FOR THE PURPOSES OF INCOME TAX ACT. THE PARTNERSHIP ACT, 1932 DOES NOT RECOGNIZE THE FIRM AS A SEPARATE ENTITY. THE LD. AR ALSO SOUGHT TO CONTEND THAT ANY DISALLOWANCE OF INTEREST ON CAPITAL WOULD LEAD TO DOUBLE TAXATION O F THE SAME INCOME AS THE PARTNERS ARE ALREADY SUBJECTED TO TAX ON INTEREST O N CAPITAL IN THEIR RESPECTIVE PERSONAL RETURNS. HE ACCORDINGLY SUBMITTED THAT THE ACTION OF THE ASSESSING OFFICER IS CONTRARY TO LEGISLATIVE INTENTION AS WEL L AS STATUTORY EXPRESSIONS EMPLOYED IN SECTION 14A OF THE ACT. HE THEREFORE P LEADED THAT PROPORTIONATE DISALLOWANCE OF INTEREST ON PARTNERS CAPITAL UNDER RULE 8D(2) OF THE I.T. RULES REQUIRES TO BE REVERSED. WITHOUT PREJUDICE AND IN T HE ALTERNATIVE, IT WAS CONTENDED THAT THE ASSESSEE FIRM HAD CERTAIN AMOUNT OF CURRENT CAPITAL AT ITS DISPOSAL WHICH WAS NOT SUBJECTED TO ANY INTEREST AN D THEREFORE BENEFIT AS AVAILABLE TO THE ASSESSEE IN RESPECT OF INTEREST FR EE CAPITAL LYING AT ITS DISPOSAL SHOULD BE GRANTED AS PER LAW. THE LD. AR, IN CONCL USION, SOUGHT APPROPRIATE RELIEF IN ACCORDANCE WITH LAW. 7 ITA NO.2000/PN/2014 9. THE LD. DEPARTMENTAL REPRESENTATIVE (DR) FOR THE REVENUE, ON THE OTHER HAND, RELIED UPON THE ORDER OF THE CIT(A) AND IN FURTHERANCE SUBMITTED THAT WHILE MAKING THE ASSESSMENT OF THE FIRM, THE R EVENUE IS ENTITLED TO INVOKE SECTION 14A OF THE ACT TOGETHER WITH RULE 8D OF THE RULES TO DENY DEDUCTION IN RESPECT OF EXPENDITURE CLAIMED TOWARDS INTEREST ON PARTNERS CAPITAL. HE THEREFORE SUBMITTED THAT NO INTERFERENCE WITH THE O RDER OF THE CIT(A) IS CALLED FOR. 10. WE HAVE CAREFULLY CONSIDERED THE RIVAL SUBMISSI ONS. THE PRE-DOMINANT QUESTION THAT ARISES FOR OUR CONSIDERATION IS WHETH ER PAYMENT OF INTEREST TO THE PARTNERS BY THE PARTNERSHIP FIRM TOWARD USE OF PART NERS CAPITAL IS IN THE NATURE OF EXPENDITURE OR NOT FOR THE PURPOSES OF SECTION 14A OF THE ACT AND CONSEQUENTLY, WHETHER INTEREST ON PARTNERS CAPITAL IS AMENABLE TO SECTION 14A OR NOT IN THE HANDS OF PARTNERSHIP FIRM. 11. IN ORDER TO ADJUDICATE THIS LEGAL ISSUE, WE NEE D TO APPRECIATE THE NUANCES OF THE SCHEME OF THE TAXATION. WE NOTE THAT PRIOR TO AMENDMENT OF TAXATION LAWS FROM AY 1993-94, THE INTEREST CHARGED ON PARTN ERS CAPITAL WAS NOT ALLOWED IN THE HANDS OF PARTNERSHIP FIRM WHILE IT W AS SIMULTANEOUSLY TAXABLE IN THE HANDS OF RESPECTIVE PARTNERS. AN AMENDMENT WAS INTER ALIA BROUGHT IN BY THE FINANCE ACT 1992 IN SECTION 40(B) TO ENABLE THE FIRM TO CLAIM DEDUCTION OF INTEREST OUTGO PAYABLE TO PARTNERS ON THEIR RESPECT IVE CAPITAL SUBJECT TO SOME UPPER LIMITS. HENCE, AS PER THE PRESENT SCHEME OF T AXATION, THE INTEREST PAYMENT ON PARTNERS CAPITAL IN ESSENCE IS NOT TREATED AS AL LOWABLE BUSINESS EXPENDITURE EXCEPT FOR THE DEDUCTION AVAILABLE UNDER S. 40(B) O F THE ACT. 11.1 OSTENSIBLY, WITH EFFECT FROM ASSESSMENT YEAR 1 993-94, PARTNERSHIP FIRMS COMPLYING WITH THE STATUTORY REQUIREMENTS AND ASSES SED AS SUCH ARE ALLOWED DEDUCTION IN RESPECT OF INTEREST TO PARTNERS SUBJEC T TO THE LIMITS AND CONDITIONS SPECIFIED IN SECTION 40(B) OF THE ACT. IN TURN, THE SE ITEMS WILL BE TAXED IN THE HANDS OF THE PARTNERS AS BUSINESS INCOME UNDER S. 2 8(V). SHARE OF PARTNERS IN THE INCOME OF THE FIRM IS EXEMPT FROM TAX UNDER SEC TION 10(2A). THUS, THE 8 ITA NO.2000/PN/2014 SHARE OF INCOME FROM FIRM IS ON A DIFFERENT FOOTING THAN THE INTEREST INCOME WHICH IS TAXABLE UNDER THE BUSINESS INCOME. 11.2 SIMILARLY, WE NOTE THAT INTEREST AND SALARY RE CEIVED BY THE PARTNERS ARE TREATED ON A DIFFERENT FOOTING BY THE ACT AND NOT I N ITS ORDINARY SENSE OF TERM. THE SECTION 28(V) TREATS THE PASSIVE INCOME ACCRUED BY WAY OF INTEREST AS ALSO SALARY RECEIVED BY A PARTNER OF THE FIRM AS A BUSI NESS RECEIPT UNLIKE DIFFERENT TREATMENTS GIVEN TO SIMILAR RECEIPTS IN THE HANDS O F ENTITIES OTHER THAN PARTNERS. IN THIS CONTEXT, WE ALSO NOTE THAT UNDER PROVISO TO SECTION 28(V), THE DISALLOWANCE OF SUCH INTEREST IS ONLY IN REFERENCE TO SECTION 40(B) AND NOT SECTION 36 OR S. 37. THIS ALSO GIVES A CLUE THAT DE DUCTION TOWARDS INTEREST IS REGULATED ONLY UNDER SECTION 40(B) AND THE DEDUCTIO N OF SUCH INTEREST TO PARTNERS IS OUT OF THE PURVIEW OF S. 36 OR 37 OF TH E ACT. NOTABLY, THERE HAS BEEN NO AMENDMENT IN THE GENERAL LAW PROVIDED UNDER PART NERSHIP ACT 1932. THE AMENDMENT TO SECTION 40(B) AS REFERRED HEREINABOVE HAS ONLY ALTERED THE MODE OF TAXATION. NEEDLESS TO SAY, THE PARTNERSHIP FIRM IS NOT A SEPARATE LEGAL ENTITY UNDER THE PARTNERSHIP ACT. IT IS NOT WITHIN THE PUR VIEW OF THE INCOME-TAX ACT TO CHANGE OR ALTER THE BASIC LAW GOVERNING PARTNERSHIP . INTEREST OR SALARY PAID TO PARTNERS REMAINS DISTRIBUTION OF BUSINESS INCOME. 11.3 RELEVANT HERE TO REFER TO DECISION OF HONBLE SUPREME COURT IN THE CASE OF CIT VS. R.M. CHIMBARAM PILLAI (1977) 106 ITR 292 (SC) RELIED UPON BY THE ASSESSEE. SUPREME COURT HAS HELD IN THE CASE OF R.M. CHIDAMBARAM PILLAI, ETC. (SUPRA) HELD THAT: 'A FIRM IS NOT A LEGAL PERSON, EVEN THOUGH IT HAS S OME ATTRIBUTES OF PERSONALITY. IN INCOME-TAX LAW, A FIRM IS A UNIT OF ASSESSMENT, BY SPECIAL PROVISIONS, BUT IT IS NOT A FULL PERSON. SINCE A CONTRACT OF EMPLOYMENT REQUIRES TWO DISTINCT PERSONS, VIZ., THE EMPLOYEER AND THE EMPLOYEE, THERE CANNOT BE A CONTR ACT OF SERVICE, IN STRICT LAW, BETWEEN A FIRM AND ONE OF ITS PARTNERS. PAYMENT OF SALARY TO A PARTNER REPRESENTS A SPECIAL SHARE OF THE PROFITS. SALARY PAID TO A PART NER RETAINS THE SAME CHARACTER OF THE INCOME OF THE FIRM. HELD ACCORDINGLY, THE SALARY PAID TO A PARTNER BY A FIRM WHICH GROWS AND SELLS TEA, IS EXEMPT FROM TAX, UNDER RULE 24 OF THE INDIAN INCOME -TAX RULES, 1922, TO THE EXTENT OF 60 PER CENT THEREOF, REPRESENTING AGRICULTURAL INCO ME AND IS LIABLE TO TAX ONLY TO THE EXTENT OF 40 PER CENT.' SUPREME COURT HAS ALSO HELD IN THE CASE OF CIT VS. RAMNIKLAL KOTHARI (1969) 74 ITR 57 (SC) THAT THE BUSINESS OF THE FIRM IS BUSINESS OF THE P ARTNERS OF THE FIRM AND, HENCE, 9 ITA NO.2000/PN/2014 SALARY, INTEREST AND PROFITS RECEIVED BY THE PARTNE R FROM THE FIRM IS BUSINESS INCOME AND, THEREFORE, EXPENSES INCURRED BY THE PARTNERS FOR TH E PURPOSE OF EARNING THIS INCOME FROM THE FIRM ARE ADMISSIBLE AS DEDUCTION FROM SUCH SHAR E INCOME FROM THE FIRM IN WHICH HE IS PARTNER. THUS, THE PARTNERSHIP FIRM AND PARTNERS HAVE BEEN COLLECTIVELY SEEN AND THE DISTINCTION BETWEEN THE TWO WAS BLURRED IN THE JUDI CIAL PRECEDENTS EVEN FOR TAXATION PURPOSES. 11.4 SECTION 4 OF THE INDIAN PARTNERSHIP ACT 1932 D EFINES THE TERMS PARTNERSHIP, PARTNER, FIRM AND FIRM NAME AS UNDER : PARTNERSHIP' IS THE RELATION BETWEEN PERSONS, WHO HAVE AGREED TO SHARE THE PROFITS OF A BUSINESS, CARRIED ON BY ALL OR ANY OF THE PART NERS ACTING FOR ALL. PERSONS WHO HAVE ENTERED INTO PARTNERSHIP WITH ONE ANOTHER ARE CALLED INDIVIDUALLY PARTNERS AND COLLECTIVELY A FIRM AND THE NAME UNDER WHICH THEIR BUSINESS IS CARRIED ON IS CALLED THE FIRM NAME. THUS, IT IS CLEAR FROM THE ABOVE THAT FIRM AND PART NERS OF THE FIRM ARE NOT SEPARATE PERSON UNDER PARTNERSHIP ACT ALTHOUGH SEPA RATE UNIT OF ASSESSMENT FOR TAX PURPOSES. THERE CANNOT THEREFORE BE A RELATIONS HIP INFERRED BETWEEN PARTNER AND FIRM AS THAT OF LENDER OF FUNDS (CAPITAL) AND B ORROWAL OF CAPITAL FROM THE PARTNERS, HENCE SECTION 36(1)(III) IS NOT APPLICABL E AT ALL. SECTION 40(B) IS THE ONLY SECTION GOVERNING DEDUCTION TOWARDS INTEREST T O PARTNERS. IN THE LIGHT OF WHAT IS ALREADY NOTED ABOVE THAT FIRM AND PARTNERS NOT BEING TWO SEPARATE PERSONS, THE QUESTION OF BORROWING CAPITAL BY THE F IRM FROM ITS PARTNERS DOES NOT ARISE AT ALL AND, THEREFORE, SECTION 36(1)(III) IS NOT AT ALL APPLICABLE FOR THE PURPOSES OF COMPUTATION OF INTEREST TO PARTNERS UND ER SECTION 40(B) OF THE ACT. TO PUT IT DIFFERENTLY, IN VIEW OF SECTION 40(B) OF THE ACT, THE ASSESSING OFFICER PURPORTEDLY HAS NO JURISDICTION TO APPLY THE TEST L AID DOWN UNDER SECTION 36 OF THE ACT TO FIND OUT WHETHER THE CAPITAL WAS BORROWE D FOR THE PURPOSES OF BUSINESS OR NOT. THUS, THE QUESTION OF ALLOWABILITY OR OTHERWISE OF DEDUCTION DOES NOT ARISE EXCEPT FOR S. 40(B) OF THE ACT. 11.5 AS NOTED, AS PER THE SCHEME OF THE ACT, THE IN TEREST PAID BY THE FIRM AND CLAIMED AS DEDUCTION IS SIMULTANEOUSLY SUSCEPTIBLE TO TAX IN THE HANDS OF ITS 10 ITA NO.2000/PN/2014 RESPECTIVE PARTNERS IN THE SAME MANNER. IN THE SAME VAIN, THE FIRM IS MERELY A COMPENDIUM OF ITS PARTNERS AND ITS PARTNERS DO NOT HAVE SEPARATE LEGAL PERSONALITIES UNDER THE BASIC LAW AS DISCUSSED. THE INTEREST PAID TO PARTNERS AND SIMULTANEOUSLY GETTING SUBJECTED TO TAX IN THE HAND S OF ITS PARTNERS IS MERELY IN THE NATURE OF CONTRA ITEMS IN THE HANDS OF THE FIRM S AND PARTNERS. CONSEQUENTLY INTEREST PAID TO ITS PARTNERS CANNOT BE TREATED AT PAR WITH THE OTHER INTEREST PAYABLE TO OUTSIDE PARTIES. THUS, IN SUBSTANCE, THE REVENUE IS NOT ADVERSELY AFFECTED AT ALL BY THE CLAIM OF INTEREST ON CAPITAL EMPLOYED WITH THE FIRM BY THE PARTNERSHIP FIRM AND PARTNERS PUT TOGETHER. THUS, C APITAL DIVERTED IN THE MUTUAL FUNDS TO GENERATE ALLEGED TAX FREE INCOME DOES NOT LEAD TO ANY LOSS IN REVENUE BY THIS ACTION OF THE ASSESSEE. IN VIEW OF THE INHE RENT MUTUALITY, WHEN THE PARTNERSHIP FIRM AND ITS PARTNERS ARE SEEN HOLISTIC ALLY AND IN A COMBINED MANNER WITH COSTS TOWARDS INTEREST ELIMINATED IN CO NTRA, THE INVESTMENT IN MUTUAL FUNDS GENERATING TAX FREE INCOME BEARS THE C HARACTERISTIC OF AND ATTRIBUTABLE TO ITS OWN CAPITAL WHERE NO DISALLOWAN CE UNDER S. 14A READ WITH RULE 8D IS WARRANTED. CONSEQUENTLY, THE PLEA OF THE ASSESSEE IS MERITED IN SO FAR AS INTEREST ATTRIBUTABLE TO PARTNERS. HOWEVER, THE INTEREST PAYABLE TO PARTIES OTHER THAN PARTNERS, IN OUR VIEW, WOULD BE SUBJECTE D TO PROVISIONS OF RULE 8D(2)(II) OF THE RULES. SIMILARLY, IN THE ABSENCE OF ANY SPECIFIC PLEA FROM ASSESSEE TOWARDS DISALLOWANCE UNDER RULE 8D(3), WE HOLD IT SUSTAINABLE IN VIEW OF EXPRESS MANDATE OF LAW. THE MATTER IS ACCO RDINGLY REMANDED BACK TO THE FILE OF THE ASSESSING OFFICER FOR RE-COMPUTATIO N OF DISALLOWANCE UNDER RULE 8D R.W.S. 14A OF THE ACT IN TERMS OF OUR OPINION EX PRESSED HEREINABOVE. 12. IN THE RESULT, APPEAL OF THE ASSESSEE IS PARTLY ALLOWED. ORDER PRONOUNCED ON THIS 09 TH DAY OF SEPTEMBER, 2016. SD/- SD/- ( VIKAS AWASTHY ) ( PRADIP KUMAR KEDIA ) / JUDICIAL MEMBER $ / ACCOUNTANT MEMBER PUNE ; DATED : 09 TH SEPTEMBER, 2016. 11 ITA NO.2000/PN/2014 & ' () *+( / COPY OF THE ORDER IS FORWARDED TO : 1) THE ASSESSEE; 2) THE DEPARTMENT; 3) THE CIT(A)-2, NASHIK; 4) THE CIT-II, NASHIK; 5) THE DR B BENCH, I.T.A.T., PUNE; 6) GUARD FILE. &, / BY ORDER , ' # //TRUE COPY// $ %& # '( / SR. PRIVATE SECRETARY ) '* , / ITAT, PUNE