Facts
The taxpayer, an individual, was a partner in a partnership firm. The taxpayer claimed exemption under section 10(2A) of the Income-tax Act, 1961 (the Act) in respect of his share of profit from the firm and offered to tax the remuneration and interest received from the firm.
The taxpayer also claimed deduction in respect of certain expenses against his income which included depreciation on motor car.
The Assessing Officer (AO) observed that the taxpayer is a separate and distinct legal entity from the partnership firm. Though the taxpayer was the legal owner of the motor car, it did not mean that the expenditure incurred was for earning the business income. Accordingly, the AO was of the view that the expenditure is not in relation to the income of the taxpayer.
The Commissioner of Income-tax (Appeals) observed that expenses and depreciation did not pertain to the taxpayer as an individual, but to the partnership firm. Since the share income from the firm was exempt under section 10(2A) of the Act, the provisions of section 14A are applicable. As the share of profit from the firm represented 76% of his total income, the CIT(A) directed the AO to disallow proportionate expenses which included depreciation.
Issue before the Special Bench of the Income-tax Appellate Tribunal, Ahmeabad (ITAT)
Whether proportionate depreciation and other related expenses incurred by the taxpayer could be disallowed under section 14A of the Act in relation to the exempt share of income from the partnership firm?
Observations and Ruling of the ITAT
The firm is a transparent vehicle under the Indian Partnership Act, 1932 whereas it is considered to be a separate and distinct entity apart from its partners under the Income-tax Act.
The firm and its partners are separately assessed on their total income notwithstanding the position in the Indian Partnership Act that the firm is a compendium or the collective name of the partners.
As far as taxation is concerned, the firm is a translucent vehicle as only the salary and interest paid to the partners are taxable under section 28(v) of the Act as business income. There cannot really be a relationship of employer and employee or debtor or creditor between the firm and the partners.
Changes were brought in taxation of firms in 1993 aimed at avoidance of double taxation. The firm is taxed at a flat rate of income after deduction of interest and salary paid to partners and the interest and salary are taxed in the hands of the partners as business income. Thus, the amount is taxed in the hands of the firm only and not taxed in the hands of the partners. This change has led to avoidance of double taxation because the firm does not have to pay tax on salary and interest income paid to the partners and the partners do not have to pay tax on share income allocated to them. Under section 10(2A), the share income shall not form part of the total income of the partners.
In view of section 10(2A) and the fact that the firm and partners are separately assessable entities, it will be difficult to hold that the share income is not excluded from the total income of the partner because the firm has already been taxed thereon.
In the instant case, the taxability of the partner is to be examined and whether the share income is excluded from his total income. In view thereof, any expenditure incurred in earning the share income will have to be disallowed.
Depreciation is not an expenditure but an „allowance‟ and hence disallowance under section 14A cannot be invoked in respect of the same.
Conclusion
Expenditure incurred by a partner relatable to share in profits of the firm attracts disallowance under section 14A.
Depreciation is an allowance and not expenditure and hence cannot be disallowed under section 14A.
Source: Shri Vishnu Anant Mahajan v. ACIT (Ahmedabad Special Bench) (ITA No.3002/Ahd/2009) order dated 25 May 2012
The taxpayer, an individual, was a partner in a partnership firm. The taxpayer claimed exemption under section 10(2A) of the Income-tax Act, 1961 (the Act) in respect of his share of profit from the firm and offered to tax the remuneration and interest received from the firm.
The taxpayer also claimed deduction in respect of certain expenses against his income which included depreciation on motor car.
The Assessing Officer (AO) observed that the taxpayer is a separate and distinct legal entity from the partnership firm. Though the taxpayer was the legal owner of the motor car, it did not mean that the expenditure incurred was for earning the business income. Accordingly, the AO was of the view that the expenditure is not in relation to the income of the taxpayer.
The Commissioner of Income-tax (Appeals) observed that expenses and depreciation did not pertain to the taxpayer as an individual, but to the partnership firm. Since the share income from the firm was exempt under section 10(2A) of the Act, the provisions of section 14A are applicable. As the share of profit from the firm represented 76% of his total income, the CIT(A) directed the AO to disallow proportionate expenses which included depreciation.
Issue before the Special Bench of the Income-tax Appellate Tribunal, Ahmeabad (ITAT)
Whether proportionate depreciation and other related expenses incurred by the taxpayer could be disallowed under section 14A of the Act in relation to the exempt share of income from the partnership firm?
Observations and Ruling of the ITAT
The firm is a transparent vehicle under the Indian Partnership Act, 1932 whereas it is considered to be a separate and distinct entity apart from its partners under the Income-tax Act.
The firm and its partners are separately assessed on their total income notwithstanding the position in the Indian Partnership Act that the firm is a compendium or the collective name of the partners.
As far as taxation is concerned, the firm is a translucent vehicle as only the salary and interest paid to the partners are taxable under section 28(v) of the Act as business income. There cannot really be a relationship of employer and employee or debtor or creditor between the firm and the partners.
Changes were brought in taxation of firms in 1993 aimed at avoidance of double taxation. The firm is taxed at a flat rate of income after deduction of interest and salary paid to partners and the interest and salary are taxed in the hands of the partners as business income. Thus, the amount is taxed in the hands of the firm only and not taxed in the hands of the partners. This change has led to avoidance of double taxation because the firm does not have to pay tax on salary and interest income paid to the partners and the partners do not have to pay tax on share income allocated to them. Under section 10(2A), the share income shall not form part of the total income of the partners.
In view of section 10(2A) and the fact that the firm and partners are separately assessable entities, it will be difficult to hold that the share income is not excluded from the total income of the partner because the firm has already been taxed thereon.
In the instant case, the taxability of the partner is to be examined and whether the share income is excluded from his total income. In view thereof, any expenditure incurred in earning the share income will have to be disallowed.
Depreciation is not an expenditure but an „allowance‟ and hence disallowance under section 14A cannot be invoked in respect of the same.
Conclusion
Expenditure incurred by a partner relatable to share in profits of the firm attracts disallowance under section 14A.
Depreciation is an allowance and not expenditure and hence cannot be disallowed under section 14A.
Source: Shri Vishnu Anant Mahajan v. ACIT (Ahmedabad Special Bench) (ITA No.3002/Ahd/2009) order dated 25 May 2012
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