Himachal Pardesh High court in an important recent Judgment namely M/s Durga Dass Devki Nandan.V Income-tax Officer, Palampur decided on 11-03-2011 has held the circular No 739 dated 25-03-1996 of CBDT as invalid. The said circular is on the issue of availability of deduction to a partnership firm in relation to remuneration available to partners of a firm u/s 40(b)(v) of Income Tax Act 1961. The said circular stated that the deduction u/s 40(b)(v) will be available only if the remuneration to partners is authorized by the partnership deed by way of specification of amount of remuneration therein or by way of quantification of remuneration.
Brief facts of the case: The assessee, a firm, provided by the partnership deed that its partners would be “working partners within the meaning of s. 40(b)” and “be paid a monthly salary as per the income-tax provisions”. The AO relied CBDT Circular No. 739 dated 25.3.1996 and held that because the deed did not specify the amount of remuneration payable to the partner or lay down the manner of quantifying such remuneration, the deduction was not admissible. This was reversed by the CIT (A). However, the Tribunal upheld the AO on the ground that the agreement did not meet with the requirements of the circular and so deduction of salary paid to the partners was not admissible
Verdict: S. 40(b)(v) allows a deduction of payment of remuneration to a working partner if it authorized by the partnership deed and not in excess of the limits. S. 40(b)(v) does not lay-down any condition that the partnership deed should fix the remuneration or the method of quantifying remuneration. Accordingly, CBDT circular No. 739 dated 25.3.1996 which requires that either the amount of remuneration payable to each individual should be fixed in the agreement or the partnership agreement deed should lay down the manner of quantifying such remuneration goes beyond s. 40(b)(v). The CBDT cannot issue a circular which goes against the provisions of the Act. The CBDT can only clarify issues but cannot insert terms and conditions which are not part of the main statute. A partnership deed which provides that the remuneration would be as per the provisions of the Act meaning thereby that the remuneration would not exceed the maximum remuneration provided in the Act is valid and deduction is admissible.
Thus as per the above Judgment even if no quantification of remunerationhas been made or no specific amount of remuneration is mentioned in the Partnership deed, even then the deduction u/s 40(b)(v) should be available.
Interesting Fact: One interesting thing is here to be noted that on this similar point earlier HP High court in Commissioner of Income Tax Versus M/s. Anil Hardware Store [2010] 323 ITR 368 (HP) had decided the matter on the basis of the above circular holding that if the remuneration in the partnership deed was mentioned on the lines of section 40(b)(v) then this is a valid quantification as per the circular No 739 of CBDT. In this case the words mentioned in the partnership deed regarding remuneration to partners were “profits upto Rs.75,000/-, upto Rs.50,000/- or 90% of the book profits” and it was argued by the revenue that use of these words show that the partnership deed does not exactly determine the remuneration of the partners but it was held as valid quantification by the Hon'ble High Court as per the above mentioned circular of CBDT.
In the said case nothing was decided by Hon'ble HP High court on the question of validity of the said CBDT circular instead the matter was decided on the basis of that very circular.
But now in this Durga Dass Devki Nandan case the circular has been declared as invalid. Although it’s a decision of the HP High Court but it gives a valid reasoning behind declaration of the circular No 739 as invalid and should work as a guiding force for the departmental and appellate authorities while deciding similar matters.
The Full Judgement is produced herebelow for ready Reference:
IN THE HIGH COURT OF HIMACHAL PRADESH, SHIMLA
Income-tax Appeal No. 4 of 2005
Reserved on: 4.3.2011.
Date of decision:11.3.2011.
M/s Durga Dass Devki Nandan …Appellant.
Versus
Income-tax Officer, Palampur …Respondent.
Coram
The Hon’ble Mr.Justice Deepak Gupta, J.
The Hon’ble Mr. Justice Sanjay Karol, J.
Whether approved for reporting? . Yes.
For the appellant: Mr. Goverdhan Sharma with Mr. Vayur
Gautam, Advocate.
For the respondent: Mr. Vinay Kuthiala, Advocate.
Per Deepak Gupta, J.
1. This Income-tax Appeal was admitted on the following
questions of law:-
a) Whether Circular No. 739 dated 25.3.1996 issued by
CBDT can exceed the domain of operation as permitted
under the provisions of the Act i.e. Sections 28 to 40?
b) Whether circular No. 739 dated 25.3.1996 over-rides the
provisions of Section 40(b)(v)(i)(ii) of the Income-tax Act,
1961 so as to disallow the salary actually paid and
recorded in the books of accounts?
c) Whether the learned Assessing Officer was legally
justified in disallowing the salary actually paid monthly
and debited regularly in the books of accounts as an
expense, just on the basis of the circular No. 739 dated
25.3.1996 surpassing the provisions of the Income-tax
Act, 1961 which otherwise permits the allowing of
expenses actual and regularly made and also clause 3 of
the Circular referred to above?
d) Whether the circular so issued by CBDT being a
guideline for framing the assessment to the authorities
concerned is also being on the assessee surpassing the
provisions of the Act?
2. The main question which arises for consideration is
whether as per the partnership deed in question, any
remuneration was fixed for payment to the partners of the
Firm. Relevant portion of Section 40(b)(v)(1) of the Income
Tax Act, 1961 (hereinafter referred to as “the Act”) reads as
follows:
“40. 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) xxxxxx xxxxxx xxxxxx
(b) in the case of any firm assessable as such, -
(i) xxxxx xxxxxx xxxxxxx
(ii) xxxxx xxxxxx xxxxxxx
(iii) xxxxx xxxxxx xxxxxxx
(iv) xxxxx xxxxxx xxxxxxx
(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 in so far as the amount of such
payment to all the partners during the previous year
exceeds the aggregate amount computed as hereunder:-
(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 –
(a) on the first Rs.1,00,000 of Rs.50,000 or at the
the book-profit or in case of rate of 90 per cent
a loss of the book-profit,
whichever is more;
(b) on the next Rs.1,00,000 of at the rate of 60
the book-profit per cent;
(c) on the balance of the book- at the rate of 40
Profit per cent;
3. This provision of law was the subject matter of a
number of conflicting decisions and, therefore, Central Board
of Direct Taxes (CBDT) issued circular No.739, dated
25.3.1996, wherein the Board clarified in para 4 of the circular
as follows:
“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.”
4. It would be pertinent to mention that for the earlier
assessment years 1993-94 to 1996-97, the Board took a lenient
view of the matter and decided that keeping in view the ambiguity
in the language of the Section even if the remuneration was not
fixed in the partnership deed, the firm shall be entitled to deduct the
amount payable under Section 40(b)(v). However, for the
assessment year 1996-97 and subsequent thereto, the circular
provided that unless the partnership deed specified the amount of
remuneration payable to each individual working partner or lays
down the manner of quantifying such remuneration, the benefit of
Section 40(b)(v) would not be available to the assessee Firm.
5. The relevant portion of the partnership deed reads as
follows:-
“That both the partners above mentioned shall
be the working partners within the meaning of
Section 40(b) of the Income-tax Act to be
actively engaged in looking after the affairs of
the business of the firm diligently and honestly
and each of them will be paid a monthly salary
as per the income-tax provisions and which can
be revised from time to time in the best interest of
the partnership.”
6. The Assessing Officer was of the opinion that the
partnership deed did not provide for payment of remuneration in
terms of CBDT circular No. 739 dated 25.3.1996 because it did not
specify the amount of remuneration payable to the individual
working partner or lays down the manner of quantifying such
remuneration. The Commissioner Income-tax held that the method
of quantifying the remuneration was fixed in the partnership deed
since the partnership deed clearly stated that the partners would be
entitled to monthly salary as per the provisions of the Income-tax
Act. However, the Income-tax Tribunal allowed the appeal of the
revenue and held that the clause in the agreement quoted
hereinabove did not meet with the requirements of the circular and
therefore, deduction of the salary paid to the partners was not
admissible.
7. It is settled law that the Central Board of Direct Taxes
cannot issue a circular which goes against the provisions of the Act.
The CBDT can only clarify issues but cannot insert terms and
conditions which are not part of the main statute. A delegate or
person authorized to issue delegated legislation cannot virtually set
at naught the provisions of the main statute. A reading of Section
40(b)(v) clearly shows that amount of remuneration which does not
exceed the amount given in the Income-tax Act is deductable. The
CBDT has provided that either the amount of remuneration payable
to each individual should be fixed in the agreement or the
partnership agreement deed should lay down the manner of
quantifying such remuneration. In the present case when the
partnership deed provides that the remuneration will be as per the
provisions of the Income-tax Act, it clearly means that the
remuneration payable to the partners shall be quantified as per the
provisions of the Act and shall not exceed the maximum
remuneration provided. In the present case, it is not disputed that
the partners were paid remuneration which was less than the
maximum provided by the Income-tax Act. None of the authorities
have doubted the payment of remuneration and in fact account
books of the assessee firm have been accepted to be correct.
Therefore, nobody has doubted the payment of remuneration to the
partners.
8. It has been urged by Shri Vinay Kuthiala, learned
counsel for the respondent that as per the CBDT circular the
partnership deed should specify the amount of remuneration or
should give a specific method of quantifying such remuneration,
otherwise deduction cannot be allowed. We are unable to accept
such contention. The circular has to be read alongwith Section
40(b)(v) and has to be made subject to Section 40(b)(v). This
section does not lay-down any condition of fixing the remuneration
or the method of remuneration in the partnership deed. All that the
Section provides is that in case the payment of remuneration made
to any working partner is in accordance with the terms of the
partnership deed and does not exceed the aggregate amount as laid
down in the subsequent portion of the Section the deduction is
permissible. Therefore, if in the partnership deed it was clearly
mentioned that the partners would get remuneration calculated as
per the provisions of the Income-tax Act which means that this
would not exceed the maximum amount provided under the Act.
9. In ITA 9 of 2005 decided on 2.9.2009 titled as
Commissioner of Income-tax, Shimla vs. M/s Anil Hardware
Store, Manali this Court was dealing with a partnership deed where
the provisions of the Income-tax Act itself had been incorporated in
the partnership deed. This Court held that this itself provides a
method of computation. In that case we had not gone into the
validity of the CBDT circular. The CBDT circular can only be held to
be valid if it is in terms of the main section. As held above, the
Section 40(b)(v) only lays down that either the working partner
should be paid an amount specified in the partnership deed or it
should not exceed the amount laid down in the Section. In the
present case the partners have been paid their remuneration/salary
strictly in accordance with the terms of the partnership deed and
this amount paid to the partners does not exceed the maximum
permissible amount and therefore, the assessee is entitled to the
deduction.
10. In view of the above discussion, the appeal is allowed
and the substantial questions of law are decided in favour of the
assessee and against the revenue. No costs.
( Deepak Gupta ), J.
11th March, 2011. ( Sanjay Karol ), J.
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