Salary to partners would be as mutually agreed between partners” & allowability of the same in the hands of the unregistered firm u/s 40(b)

Short Overview : There was no merit in the argument that while a partnership deed is to be registered, amendment thereto is not.  Amended salary clause being neither stamped nor registered, it was not admissible in evidence in a court of law, i.e., as a legally enforceable contract. Therefore, AO could not be faulted with for not giving cognizance to such a document and disallowance of remuneration paid to partner as made by AO was justified.

AO made disallowance of remuneration paid to partners, claimed in sum of Rs. 4,40,000 in computation of business income under section 28 by assessee-firm. The reason for disallowance was that the same was not admissible in view of section 40(b). The partnership deed dated 5-6-2007, mentioned that salary to partners would be as mutually agreed between partners. As per revenue, inasmuch as same did not either quantify remuneration to be allowed to working partners, specified by name, or the manner in which remuneration there to is to be quantified, the same did not satisfy the condition of section 40(b). Assessee’s case was that amendment to partnership deed was not required to be registered with Registrar of Firms and Societies. The resolution as on 1-4-2013, increasing salary of both the partners, despite being not registered under partnership law, was thus, valid in law.

It is held that : There was no merit in the argument that while a partnership deed is to be registered, amendment thereto is not. Amended salary clause being neither stamped nor registered, it was not admissible in evidence in a court of law, i.e., as a legally enforceable contract. Therefore, AO could not be faulted with for not giving cognizance to such a document and disallowance made by AO was justified.

Decision: Against the assessee.

Distinguished: Durga Dass Devki Nandan v. ITO (2011) 241 CTR (2012) 342 ITR 17 (HP) : 2011 TaxPub(DT) 974 (HP-HC) and Classic Law v. Asstt. CIT [ITA No. 340/Del/2016, dated 15-1-2018].

IN THE ITAT, AMRITSAR ‘SMC’ BENCH

SANJAY ARORA, A.M.

GRK Agencies v. ITO

ITA No. 412/Asr/2018

A.Y. 2014-15

10 April, 2019

Appellant by: Vipud Arora

Respondent by: Charon Dass

Sanjay Arora, A.M.

This is an appeal by the assessee directed against the order by the Commissioner (Appeals)-2, Amritsar (‘CIT(A)’ for short), dated 17-5-2018, dismissing the assessee’s appeal contesting its assessment under section 143(3) of the Income Tax Act, 1961 (‘the Act’ hereinafter), dated 13-12-2016 for the assessment year 2014-15.

2. The issue at large in the instant case is the validity in law, in the facts and circumstances of the case, of the disallowance of remuneration to partners, claimed in the sum of Rs. 4,40,000 in the computation of its business income under section 28 by the assessee-firm for the relevant year. The reason for the disallowance is that the same is not admissible in view of section 40(b) of the Act. The partnership deed, dated 5-6-2007, copy of which was furnished during the assessment proceedings, per clause 9 thereof, mentions that the salary to partners shall be as mutually agreed between the partners. As per the Revenue, inasmuch as the same does not either quantify the remuneration to be allowed to the working partners, specified by name, or the manner in which remuneration thereto is to be quantified, the same does not satisfy the condition of section 40(b), mandatory in nature, even as also explained by the Board Circular No. 739, dated 25-3-1996 ((1996) 131 CTR (St) 53).

3.1 Section 40(b) in its relevant part reads as under :–

‘40. Amounts not deductible.–Notwithstanding anything to the contrary in sections 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”,–

(a) in the case of any assessee–

(b) in the case of any firm assessable as such,–

(i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as “remuneration”) to any partner who is not a working partner; or

(ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorized by, or is not in accordance with, the terms of the partnership deed; or

(iii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is authorized by, and is in accordance with, the terms of the partnership deed, but which relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorized by, or is not in accordance with, any earlier partnership deed, so, however, that the period of authorization for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed; or

(iv) any payment of interest to any partner; or

(v) any payment of remuneration to any partner who is a working partner, which is authorized 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:’

3.2 The assessee, in this respect, relies on the decision by the Tribunal in Asstt. CIT v. Suman Constructions (2009) 20 DTR (Pune)(Trib) 450 : 2009 TaxPub(DT) 1242 (Pune-Trib) (copy on record). The Tribunal per the same has held that the words ‘in accordance with’ occurring in section 40(b) cannot be construed to imply ‘quantification’ or the ‘manner of quantification’ of the remuneration, as interpreted by the Board per its Circular No. 739 supra, which has, in so interpreting the provision, travelled beyond the scope of the words ‘in accordance with’ in section 40(b). Board circulars, it is well-settled, even as they may bind the Revenue authorities, are not binding on the appellate authorities. Further, the learned counsel for the assessee, Shri Arora, would, on a query by the Bench, clarify that an amendment to the partnership deed is not required to be registered with the Registrar of Firms and Societies. The resolution as on 1-4-2013, increasing the salary of both the partners, namely, Vikram Kundra and Gautam Kundra, from Rs. 1.20 lacs per annum each (vide resolution, dated-not specified), to Rs. 2.20 lacs per annum each, despite being not registered under partnership law, is, thus, valid in law. Two, on being asked about any contemporaneous record exhibiting that the salary was indeed enhanced on 1-4-2013, i.e., the date from which it is made effective-the said resolution being recorded on the letter-head of the firm, with in fact the partners signing the same (i.e., the resolution as on 1-4-2013 having not put any date alongside their signature, Shri Arora would furnish the capital account of both the partners (copy on record). The same bear credit (for salary) to the capital account of the partners at Rs. 15,000 per month (for the first four months) and at Rs. 20,000 per month thereafter. This, in his view, would show that the resolution increasing the salary was indeed passed on 1-4-2013, and the said resolution is not back-dated. In fact, the salary prior to its increase, Shri Arora would continue, was at Rs. 1.20 lacs per annum for both the partners and, accordingly, credited to the partners account in that sum. The assessing officer, however, has not even allowed the same. Further, again in response to a query by the Bench, he would, with reference to section 10 of the Indian Contract Act, 1872 submit that there is no requirement therein for witnessing a contract. As such, the non-signing of the resolution passed on 1-4-2013, or the earlier on the resolution, dated (not specified), by any witness, does not breach either the Contract Act or the Partnership Act.

3.3 The learned Departmental Representative, Shri Charan Dass, would on the other hand, submit that the resolution, said to be passed on 1-4-2013, is clearly an afterthought. Why, the same was not furnished by the assessee even along with the partnership deed, dated 5-6-2007 submitted to the assessing officer during assessment proceedings. It was only when the assessing officer, on the perusal of the partnership deed furnished, enquired of the basis of the debit of the partners’ salary in the partnership accounts, that the assessee submitted the copy of the resolution on its letter-head, which cannot be in any case regarded as a part of the partnership deed. The Board circular correctly explains the legislative intent, i.e., that only salary in terms of the partnership deed could be validly allowed by the partnership and,-further, allowed in computing its business income, subject of course to the limit stipulated under section 40(b)(v).

4. I have heard the parties, and perused the material on record.

4.1 The first question that arises and, therefore, is to be answered, is if the relevant clause of the partnership deed, dated 5-6-2007, in pursuance of which the partners are said to have passed a resolution earlier (date not specified), fixing the salary of both the partners at Rs. 1.20 lacs per annum each, and which stands further enhanced, with effect from 1-4-2013, to Rs. 2.20 lacs per annum each, is a valid clause. The relevant clause of the partnership deed (at PB pp. 1-2) reads as under :–

The salary/remuneration be paid every month/year as may be mutually agreed between the partners from time to time. The partners may agree to change the quantum of the salary/remuneration by a separate agreement or supplementary deed.’

The same, as apparent is not an agreement for a particular sum, either fixed or variable, as with reference to the profits of the firm, as remuneration to the partners, nor does it specify as to who of the two partners, i.e., by name, or both the partners, shall be the working partners. The assessee itself agrees to this, and which explains the need to pass a resolution/s specifying the amount of salary as well as the partners to whom it is payable, and which is stated to have been passed, in modification of an earlier resolution, on 1-4-2013, i.e., the first day of the relevant previous year. In other words, it is an agreement agreeing to pay salary, and nothing more. That is, it could at best be regarded as an authorization by the partnership to pay salary to the partners. I say, ‘at best’, as it is equally valid to contend that the authorization has to be qua both, i.e., the partner/s to whom, and the sum at which salary is to be allowed by the partnership, and an authorization wherein any of these elements is missing cannot be regarded as a proper authorization, or one as contemplated by section 40(b)(ii). The said provision, however, by including the words ‘in accordance with’ in conjunction with the words ‘authorized by’ in section 40(b)(ii), removes any ambiguity in law, making the discussion or debate on the scope of the words ‘authorized by’ redundant. It could be argued that the words ‘authorized by’ in section 40(b)(ii) are to be read broadly, signifying that the remuneration for their services is to be paid to the working partners. This is as the same is essentially a part of the profit of the firm, which is to be appropriated between the partners, and the salary clause only modifies the said appropriation to that extent, inasmuch as it is to be charged, as agreed to, prior to the profit being shared in the defined ratio. Again, ‘as agreed to’, implies an agreement a priori However, as afore-stated, the words ‘in accordance with’ leave one in no manner of any doubt that the identification of the partner/s and the quantification of remuneration is a prerequisite for deduction. How else, one may ask and, rather, even without the words ‘in accordance with’, salary allowed, which has, to constitute a proper charge to the profits of the firms, be specific both qua the person and the amount. And only the balance profit, i.e., after providing for the remuneration and/or interest, if any, similarly authorized, or, as the case may be, loss, appropriated between the partners. In sum, the remuneration being a part of the profit of the firm, agreed to be allowed to the working partner/s, the manner in which it is to be, even if not at a constant amount, but with reference to the profit of the firm, is to be well defined. The Board Circular (supra), reproduced as under, thus, explains the provision correctly :–

“Circular No. 739, dated 25-3-1996

Subject: Provisions of section 40(b)(u) of the Income Tax Act, 1961, regarding admissibility of remuneration of working partner in the assessment of firms–Regarding.

The Board have received representations seeking clarification regarding disallowance of remuneration paid to the working partners as provided under section 40(b)(v) of the FT Act. In particular, the representations have referred to two types of clauses, which are generally incorporated in the partnership deeds. 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 FT Act, 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 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.

2. The Board have considered the representations. 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 a liberal approach may be taken for the initial years. 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 l(i) above.

3. 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 periods in such cases payment of remuneration to partners cannot be allowed as deduction in the computation of the firm’s income.

4. It is clarified that for the assessment years subsequent to the assessment year 1996-97, 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.

5. The above clarification may be brought to the notice of all the assessing officers of your region.

(F. No. 225/29/93/ITA-II)“

Para 4 is applicable for the current year, being an assessment year after assessment year 1996-97. In fact, even for earlier years it is only a clause of the type as stated at para 1(i), that could be regarded as meeting the requirement of law, and not that per para 1(ii), as obtains in the instant case.

4.2 The assessee has before me placed reliance on the decision in Suman Constructions (supra). The same has to be regarded as misplaced as the said Board circular has been, on a challenge thereto (in Writ Petn. No. 3765 of 1997), upheld by the Hon’ble jurisdictional High Court on 5-10-2011 in Sood Bhandari & Co. & Ors. v. CBDT & Anr. (2012) 246 CTR (P&H) 89 : 2012 TaxPub(DT) 0752 (P&H-HC). In fact, as the question of law raised before the Hon’ble Court would show, it also deciding a bunch of appeals along with, the disallowance of salary to partners was upheld even where made by way of an adjustment under section 143(l)(a) inasmuch as the same was clearly inadmissible where the salary, as claimed, was in pursuance of a clause of the type stated at para 1(ii) of the Board Circular (supra), i.e., to which type clause 9 of the partnership deed in the instant case belongs. Clause 9 envisages an agreement as to the amount of salary to be allowed to the partners, and towards which the assessee relies on the resolution afore-referred, which accordingly stands considered in the ensuing part of this order.

4.3 The next question that arises is if the resolution, stated to be passed on 1-4-2013, can be regarded as a part of the partnership deed, i.e., a supplementary or revised deed, amending the original partnership deed to that extent from that date. The same being not stamped, much less properly, nor registered, has not been regarded as valid; rather, as an afterthought, by the Revenue. The issue, before going into the technical question as to if it could in law be regarded as a valid partnership deed, i.e., if it would qualify as one, is of the genuineness of the document, seriously doubted by the Revenue, and, in my considered view, rightly so. There is nothing to show that it was passed on 1-4-2013 itself. The date assumes significance as a partnership, by definition, is an agreement between two or more persons to carry on business, severally or jointly, agreeing to share the profits or, as the case may be, losses of the partnership in a defined ratio. Such an agreement has therefore, per force the nature of the contract, to be arrived at before the partnership is formed. Inasmuch as salary or remuneration to a partner is a part of his share in the profit of the partnership, it has to be, i.e., to be valid, arrived at the beginning of the period for which it would obtain. The remuneration clause, salary being a charge on the profits of the firm as per the partnership agreement, would also accordingly require clarification as to the amount of salary, if any, in case of absence or inadequacy of profit, i.e., where with reference to a defined ratio of profit. Continuing our discussion with regard to the primary relevancy of the date, the same is also mandated by law (section 40(b) (iii)), so that it is not tenable to say that the salary clause would operate retrospectively. Further, being neither stamped nor registered, it is not admissible in evidence in a Court of law, i.e., as a legally enforceable contract. How could, then, the Revenue be faulted for not giving cognizance to such a document ? It may be argued that it could be stamped and registered at any time in future, rendering as it admissible for the period prior thereto. The argument would require being examined with reference to the relevant provisions/statutes, only whereupon it could be answered, towards which no reference has though been made. The fact of the matter, nevertheless, is that the document has not been stamped and, further, being not stamped, it could not be registered. Suffice to state that it cannot, in the present form, be regarded as valid, legally enforceable contract. The argument is in fact of no consequence inasmuch as there is nothing to demonstrate or prove that the document was indeed executed on 1-4-2013, which date assumes vital significance, both in the context of the Partnership law and the IT law. Even as explained by the Hon’ble jurisdictional High Court in Sood Bhandari & Co. (supra), the payment of salary and interest could not be left to the discretion of the partners, to be decided at the end of the year. As such, the question of the date from which the resolution-inasmuch as there is nothing to evidence the date of its execution, being a requirement of both, the partnership law as well as section 40(b) of the Act, so that the stipulation as to remuneration could only operate prospectively, continues. If indeed the same was, as contended, passed on 1-4-2013, why should the assessee, a registered firm (with the Registrar of Firms and Societies), not file the same by way of a supplementary deed with the said office qua which the assessee was specifically questioned. There is no merit in the argument that while a partnership deed is to be registered, the amendment thereto is not. The moot question, rather, is if it would stand to be registered in its present form, answer to which is an emphatic no. Again, it would similarly stand to be filed with the bank/s and the various other authorities and Government agencies with which the firm is, as a business entity, registered, i.e., apart from the income-tax, viz., sale-tax, excise, industries, pollution, etc. Being an amendment to the original partnership deed, it would consequently require being filed with the relevant authorities, i.e., where it has been already filed, being in fact only as it was in law obliged to. There is nothing on record to show, nor even a contention to that effect, of it being filed with any of the authorities. The question of whether it could be validly filed in the present form, continues, to again the same answer inasmuch as it cannot be regarded as a legally enforceable contract. Why, it was not even filed before the assessing officer in the first instance, and it is only on being specifically questioned in its respect, i.e., qua the remuneration clause, that the assessee furnished the same in the assessment proceedings. The assessee’s conduct, i.e., in first continuing with an impermissible clause (in the partnership deed) even years after clarification by the Board and, then, in not defining the manner of quantification, but passing resolutions, with no record as to the time when they were actually passed, stating to be valid amendment/s to the partnership agreement, itself betrays its case of having passed the resolutions on the date from which they are made effective, i.e., prospectively. The resolution/s also does not qualify the term ‘partners’ with the word ‘working’, so that in terms thereof, the salary is to be paid irrespective of whether a particular partner is a working partner or not, and which is not sustainable in view of section 40(b)(iii). The entries in the books of account, even otherwise not decisive of the matter, also do not support the assessee’s case. The said resolution, or the one stated to be passed earlier thereto, cannot, in view of the foregoing factual and legal incidents, be regarded as a valid partnership deed, i.e., as a valid instrument of partnership, or as a valid amendment to the partnership deed, dated 5-6-2007. One could argue that even ignoring the resolutions the total salary provided in the partnership accounts could be regarded as agreed to by the partners, i.e., from time to time. The same implies that there is no need for a separate written agreement, which cannot be accepted in view of the same being a requirement of law for a firm to be assessed as a firm (sections 184, 185).

4.4 The decision in Sumem Constructions (supra) as well as Asstt. CIT v. Kakkar Cold Storage (2004) 91 TTJ (Asr) 722 : 2004 TaxPub(DT) 0361 (Asr-Trib) which pertains to assessment year 1993-94 (for which exception has been made by the Board circular (supra) itself), would, accordingly, be of no consequence, as would be the assessee’s reliance on Durga Dass Devki Nandan v. ITO (2011) 241 CTR (2012) 342 ITR 17 (HP) : 2011 TaxPub(DT) 0974 (HP-HC) or, following it by the Tribunal in Classic Law v. Asstt. CIT (in ITA No. 340/Del/2016, dated 15-1-2018) would be of little assistance to the assessee. In fact the latter two decisions are distinguishable inasmuch as in these cases the partnership deed provided for allowance of salary to the working partners in terms of the relevant clause of the Act (section 40(b)(v)), and which is precise and definite, so that the salary could be quantified with reference thereto, even as explained in and therefore, consistent with the Board Circular (supra), upheld by the Hon’ble jurisdictional High Court. Section 40(b))(v) defines the maximum remuneration admissible to the working partners of a partnership firm, assessed as such. The said decisions are thus distinguishable on facts.

4.5 In view of the foregoing, I do not find1 any merit in law in the assessee’s claim qua the allowance of remuneration to the working partners, i.e., in the facts and circumstances of the case. The salary allowed having however been, as given to understand during hearing, assessed in the hands of the partners (to whom it stands allowed), they shall be allowed relief by the assessing officer in terms of section 155 of the Act. I decide accordingly.

5. In the result, the assessee’s appeal is dismissed.