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Unexplained Initial capital deposited by partners: Assessment in hands of Firm?
In a partnership Firm, the partners make capital contributions to the Firm. The question is in case these contributions are unexplained by Firm/ Partner, under whose hands it shall be assessed- Firm or partners?
The facts above are similar to G.L. FOODS vs. INCOME TAX OFFICER where in the assessee firm received the capital contribution by the partners before starting its business that was unexplained. Court held that it cannot be said that the capital contributed by the partners was the income earned by the assessee firm from undisclosed sources and it cannot be added in the hands of the assessee firm. At the most it can be considered in the hands of the individual partners of the assessee-firm. Have a look at the case law:
G.L. FOODS vs. INCOME TAX OFFICER
H.L Karwa, Vice President & N.K. Saini, A.M.
ITA No. 302/Luck/2011; Asst. yr. 2004-05
Jul 11, 2011
(2011) 30 CCH 0366 LucknowTrib
(2012) 134 ITD 0159
Legislation Referred to
Case pertains to
Asst. Year 2004-05
Decision in favour of:
This is an appeal filed by the assessee against the order dt. 17th March, 2011 of CIT(A)-II, Lucknow relevant to asst. yr. 2004-05. In this appeal the assessee has raised the following grounds :
“1. That the learned CIT(As) has erred in law and on facts in failing to delete the illegal addition of Rs. 10,00,000, in respect of the initial capital which was introduced by the three partners in the first year before the commencement of the business of the firm, as income from undisclosed sources of the firm.
- That the learned CIT(A) has erred in law and on facts in failing to appreciate (while confirming the addition mentioned in ground No. 1), that all the three partners were having their independent sources of income before joining the firm and the gifts received through bank drafts in their individual bank accounts and later on cash from those bank accounts were withdrawn on subsequent dates and introduced the same as their share capital in the books of account of the firm.
- That the learned CIT(A) has erred in lap and on facts in ignoring the decisions of the jurisdictional Hon’ble Tribunal and the Hon’ble High Court of judicature of Allahabad which have been quoted in the written submission.
- That without prejudice to the averment in aforementioned grounds of appeal Nos. 1, 2 and 3, it is submitted that the learned CIT(A) has erred in law and on facts in sustaining the aforesaid addition of Rs. 10,00,000 because he has failed to appreciate that—
(i) the source of the cash deposits amounting to Rs. 3,00,000 have been duly proved as withdrawn from the bank account of the Shri Amit Kumar Agarwal, partner of the firm.
(ii) the source of the cash deposits amounting to Rs. 3,00,000 have been duly proved as withdrawn from the bank account of the Shri Anoop Kumar Agarwal partner of the firm
(iii) the source of the cash deposits amounting to Rs. 4,00,000 have been duly proved as withdrawn from the bank account of the Shri Ratan Kumar Agarwal partner of the firm.”
- From the above grounds it would be clear that the only grievance of the assessee relates to the confirmation of addition of Rs. 10,00,000 made by the AO on account of initial capital introduced by the three partners.
- The facts related to this issue, in brief, are that the year under consideration was the first year of the business of the assessee who was engaged in the production of rice, rice bran and husk. The assessee furnished the return of income on 26th Oct., 2004 declaring an income of Rs. 23,028. The case was selected for scrutiny. During the course of assessment proceedings, the AO noticed that the three partners of the assessee namely Shri Amit Kumar Agarwal, Shri Anoop Kumar Agarwal and Shri Ratan Kumar Agarwal introduced capitals of Rs. 5,50,000, Rs. 5,50,000 and Rs. 6,00,000 respectively. The source of introduction in the partners’ capital accounts are as under :
||Name of the Partner
||Amount of capital introduced
||Source of capital
||Amit Kr. Agarwal
||(i) Rs. 2,50,000 withdrawn from M/s Nikhil Trading Co., Gauriganj, Sultanpur
(ii) Rs. 1,50,0007 gift from Suman Agarwal, Kolkata
(iii) Rs. 1,50,000 gift from Manju Devi Bhagar, Kolkata
||Anoop Kr. Agarwal
||(i) Rs. 2,50,000 withdrawn from Anoop; Industries, Gauriganj, Sultanpur
(ii) Rs. 1,50,000 gift from Rani Agarwal, Kolkata
(iii) Rs. 1,50,000 gift from Suman Devi Bhagatm Kolkata
||Ratan Kr. Agarwal
||(i) Rs. 2,00,000 withdrawn from M/s Agarwal & Co.
(ii) Rs. 1,00,000 gift from Kalawati Devi Bhyagat, Kolkata
(iii) Rs. 2,00,006 gift from Rajesh Kumar Agarwal, Deoria.
According to the AO the partners received the gifts, which on later date had been transferred to the firm. The assessee filed the affidavits from the donors confirming the gifts. The AO made the impugned addition for the reasons mentioned in detail in the assessment order, which has been summarized by the learned CIT(A) in para 3.1 of the impugned order, which reads as under :
“(i) The notices sent to Mrs. Rani Agarwal and Suman Agarwal were received back unserved. All the six donors from Kolkata are not being assessed to tax. The donors do not have income chargeable to tax and their sources of income as shown are not verifiable;
(i) As regards gifts shown to be given by Smt. Kalawati Devi Bhagat, Smt. Manju Devi Bhagat and Smt. Suman Devi Bhagat, the drafts have been prepared on account of the amount transferred from one single bank account No. 12382 to the donors accounts. All other drafts made as gifts have been purchased in cash;
(ii) No relationship between the donors and the donee’s were established. Thus, it is amply clear that all the six donors do not have any capacity for giving gifts. All these gifts can in no way be said to be genuine because of the reasons firstly that a person who does not have taxable income of Rs. 50,000 in any year, then how he/she can make gift in lakh to any person with whom he/she does not have any near relationship, and secondly it appears that the gift of Rs. 8,00,000 made by the Kolkata based parties are the appellant’s own money which have been routed through account No. 12382 and partially through cash purchase of gifts. Since, the entire gift money has been utilized by the appellant firm, the total gift of Rs. 8,00,000 has been added in the hand of the firm treating it to be income from undisclosed sources;
(iii) As regards gift of Rs. 2,00,000 made by Shri Rajesh’ Kumar Agarwal, also the source of availability of funds to the tune of Rs. 2 lakhs has not been proved at all the relationship between the donors and donee has not been established. The donor has not furnished the copy of bank account. Hence, the capacity and genuineness of this gift of Rs. 2,00,000 remain unproved.”
- The assessee carried the matter to the learned CIT(A) and disputed the additions on the following reasons :
“(i) The AO is not justified in adding sum of Rs. 4,00,000; Rs. 3,00,000 and Rs. 4,00,000 as income of the appellant firm from undisclosed sources, the capital contributions made by the partners namely S/Shri Ratan Kumar Agrawal, Anoop Kumar Agrawal and Amit Kumar Agrawal, as gifts respectively;
“(ii) The AO is not justified in adding sum of Rs. 4,00,000; Rs. 3,00,000 and Rs. 4,00,000 as income of the appellant firm from undisclosed sources, the capital contributions made by the partners namely S/Shri Ratark Kumar Agarwal, Anoop Kumar Agarwal and Amit Kumar Agarwal, as gifts respectively;
(iii) The AO on the facts and in law, is unjustified in adding a sum of Rs. 10,00,000 treating it to be income from undisclosed sources on account of capacity and genuineness of the gift remain unproved. The gifted amount of Rs. 10,00,000 have been deposited in the partners’ bank account and from the account the partners have withdrawn the sums and deposited in personal account.
(iv) The business of the appellant firm has not been started and it was the period of construction. The AO erred in law and on facts in adding Rs. 10,00,000 in respect of the initial capital which was contributed by the partners in the first year before the commencement of the business of the firm as income from undisclosed sources of firm;
(v) The bulk of the capital contributed by the partners in this case has been utilized in the setting up the Mill arid starting the business activities. Even if the explanations in respect of the source of initial investment of the partners are not considered as satisfactory, no addition in the case of the firm is justifiable;
(vi) The entire capital contribution of all the three partners of the firm is evident from the copies of their capital accounts show that the partners have deposited cash in their capital accounts which was withdrawn from their bank accounts. For purpose of assessment the partners are separate entity. The appellant firm has proved even the source of the sources and the AO is not justified for making the addition of Rs. 10,00,000,
(vii) Hence, the impugned addition is liable to be deleted.”
4.1 The learned CIT(A), after considering the submissions of the assessee, confirmed the action of the AO by observing as under :
“3.3 I have gone through the contentions of appellant and also the facts of the case. At the outset, from the perusal of the capital account of the partners from the period 4th April, 2003 to 31st March, 2004 with M/s G.L Foods, it is noticed that the partners S/Shri Ratan Kumar Agrawal, Anoop Kumar Agrawal and Amit Kumar Agarwal have introduced capital in cash amounting to Rs. 5,35,000; Rs. 5,50,000 and Rs. 5,50,000 respectively. These capitals have not been deposited through banking channels. Further, it is also worth to be mentioned that the appellant firm has shown total turnover of Rs. 2,50,85,546 during the asst. yr. 2004-05. It shows that the appellant firm has carried out the business activities during the year under consideration. Hence, the contentions of the appellant that the capitals contributed by the partners were utilized for the construction of Mill do not change the nature and character of the introduction of capital. Further, for establishing any gifts as explained, three conditions e.g. identity of donor, his creditworthiness and genuineness of gift required to be proved. The onus is on the appellant to explain the entries of cash credit reflecting in its books of account. Since, the capitals shown as received in cash, the appellant has to explain the cash credits. If the appellant is contending that the partners have introduced the capitals, out of the gifts received, even then the onus is on the appellant firm to establish the identity of donors, their credit worthiness for giving the gifts and genuineness of the gift documents. But, the appellant failed to establish the creditworthiness and genuineness of the transactions. The appellant has also not furnished any conclusive proof to establish the identity of the donors. The appellant and its partners can easily produce the donors for confirming the gifts and sources of making the gifts. The AO is justified for making the addition in the hand of the appellant firm considering the facts of the case. To sum up, the appellant could not prove these gifts as genuine and the AO has correctly added the sum of Rs. 10,00,000 in the hand of the appellant as its income from undisclosed sources.”
Now the assessee is in appeal.
- The learned counsel for the assessee reiterated the submissions made before the authorities below and further submitted that during the previous year under consideration the assessee started its rice mill only and commencement of the business activities started after completion of the building on 16th Oct., 2003. It was further stated that the purchases started on 1st Nov., 2003. A reference was made to page Nos. 17 and 18 of the assessee’s compilation. It was contended that the assessee firm received the capital contribution from the partners before starting the business, so there was no occasion to earn the income from undisclosed sources before starting the business. It was further stated that no addition could have been made in the hands of the firm on account of initial capital contributed by the partners. Reliance was placed on the following case laws :
(i) CIT vs. Jaiswal Motor Finance (1983) 37 CTR (All) 217 : (1983) 141 ITR 706 (All)
(ii) Tribunal. Lucknow, SMC Bench order in the case of Sapna Automobiles vs. ITO ITA No. 848/Luck/2004 order dt. 11th May, 2005
(iii) India Rice Mills vs. CIT (1996) 85 Taxman 227 (All)
(iv) CIT vs. Metachem Industries (2000) 161 CTR (MP) 444 : (2000) 245 ITR 160 (MP)
(v) CIT vs. Burma Electro Corporation (2002) 172 CTR (P&H) 541 : (2001) 252 ITR 344 (P&H).
- In his rival submissions the learned Departmental Representative strongly supported the orders of the authorities below.
- We have considered the rival submissions and carefully gone through the materials available on the record. In the present case, it is not in dispute that the assessee firm received the capital contribution by the partners before starting its business, therefore, it cannot be said that the capital contributed by the partners was the income earned by the assessee firm from undisclosed sources.
7.1 On a similar issue, the Hon’ble Allahabad High Court in the case of CIT vs. Jaiswal Motor Finance (supra) has held as under :
“If there are cash credit entries in the books of a firm, in which the accounts of the individual partners exist, and it is found as a facts and circumstances that cash was received by the firm from its partners, then, in the absence of any material to indicate that they were the profits of the firm, it could not be assessed in the hands of the firm.”
7.2 Similarly the Hon’ble Jurisdictional High Court in the case of India Rice Mills vs. CIT (supra) has held as under :
“The Tribunal should have taken note of the facts and circumstances that all the deposits represented the capital contribution of the partners in the firm and they were made before the firm started its business. It was for the partners to explain the source of the deposits and if they failed to discharge the onus then such deposits could be added in the hands of the partners only. The Tribunal erroneously came to the conclusion that the deposits represented the undisclosed income of the assessee firm. The CIT(A) had rightly held that unexplained deposits in no case could be the income of the assessee firm, because the firm started its business only after the credits had been made in its books.”
7.3 Similar view has been taken by the Hon’ble Patna High Court in the case of CIT & Anr. vs. Md. Perwez Ahmad & Ors. (2004) 268 ITR 381 (Pat) by holding as under :
“The Tribunal after having considered the materials on record has found that s. 68 of the IT Act, 1961, is not attracted in the case for the reason that in this case credit in the books of account of the assessee-firm is on account of introduction of capital by the partners and the firm has failed to prove the amount credited in the books of account and as such it would be assessed in the hands of the partners as unexplained investment.”
7.4 On a similar issue, the Hon’ble Madhya Pradesh High Court in the case of CIT vs. Metachem Industries (supra) has held as under :
“Once it is established that the amount has been invested by a particular person, be he a partner or an individual, then the responsibility of the assessee is over. Whether that person is an income-tax payer or not and where he had brought this money from, is not the responsibility of the firm. The moment the firm gives a satisfactory explanation and produces the person who has deposited the amount, then the burden of the firm is discharged and in that case that credit entry cannot be treated to be the income of the firm for the purposes of income-tax.”
7.5 On a similar issue the Hon’ble Punjab & Haryana High Court in the case of CIT vs. Burma Electro Corporation (supra) affirmed the view of the Tribunal by holding that :
“The Tribunal deleted the addition in the ground that thought there was no evidence to show that on the date of investment, the partners had sufficient funds in their possession to prove that the investments were made from that amount in the capital account, since these partners admitted to have made these investments in the assessee-firm and since there was no material to indicate that the cash credits were the profit of the firm, they could not be assessed as the firm’s income and that the unexplained investments could be assessed in the individual hands of the partners under s. 69 IT Act, if that was permissible.”
- In the present case also the amount in question was deposited by the partners as their initial capital before start of the business by the assessee firm, therefore, even if the AO was not satisfied with the explanation of the assessee, it cannot be added in the hands of the assessee firm. At the most it cannot be considered in the hands of the individual partners of the assessee-firm.
- We, therefore, considering the totality of the facts, as discussed herein above, are of the view that the learned CIT(A) was not justified in confirming the addition made by the AO on account of capital contributed by the partners in the assessee-firm. Accordingly, the addition made by the AO and confirmed by the learned CIT(A) is deleted.
- In the result, the appeal is allowed.