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Third Income-tax Officer Vs. R. Srinivasan - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Madras
Decided On
Judge
Reported in(1985)12ITD321(Mad.)
AppellantThird Income-tax Officer
RespondentR. Srinivasan
Excerpt:
.....karta of the assessee in the present case, is a partner in a firm a.c.a. funds, tirunelveli. the firm paid a salary of rs. 10,000 to shri srinivasan in the assessment year 1981-82, and rs. 11,300 in the assessment year 1982-83. at the time of assessment, the assessee-huf claimed that the salary paid to shri srinivasan should not be assessed in its hands. according to the ito shri srinivasan was made a partner in the firm because of capital contribution by the family, and the salary received by him was nothing but one of the modes of return to the family for investment of family funds. the ito held that the salary paid was, therefore, directly related to investment of family funds. he further went on to hold that but for such investment, shri srinivasan would not have got the.....
Judgment:
1. These are two appeals by the revenue. The appeals relate to the assessment years 1981-82 and 1982-83. The assessee filed an application for adjournment. We do not consider it necessary to adjourn the appeals. Hence, we proceed to dispose of the appeals after hearing the learned departmental representative.

2. Shri R. Srinivasan, karta of the assessee in the present case, is a partner in a firm A.C.A. Funds, Tirunelveli. The firm paid a salary of Rs. 10,000 to Shri Srinivasan in the assessment year 1981-82, and Rs. 11,300 in the assessment year 1982-83. At the time of assessment, the assessee-HUF claimed that the salary paid to Shri Srinivasan should not be assessed in its hands. According to the ITO Shri Srinivasan was made a partner in the firm because of capital contribution by the family, and the salary received by him was nothing but one of the modes of return to the family for investment of family funds. The ITO held that the salary paid was, therefore, directly related to investment of family funds. He further went on to hold that but for such investment, Shri Srinivasan would not have got the remuneration. The ITO also observed that the fact that Shri Srinivasan had rendered some service, would not change the character of the receipt unless he possessed special qualifications and the services rendered were of a special nature. Except for the fact that service was rendered to the firm, the ITO stated, there was no evidence that Shri Srinivasan possessed any special qualification or that the service rendered by him was of a specialised nature. He, therefore, negatived the claim of the assessee.

3. In appeal, the AAC, after referring to the decision of the Supreme Court in CIT v. Gurunath V. Dhakappa [1969] 72 ITR 192 and Raj Kumar Singh Hukam Chandji v. CIT [1970] 78 ITR 30 held that the salary amounts had to be excluded from the relevant assessments. In coming to this conclusion, the AAC observed that Shri Srinivasan was fully engaged in the day-to-day management of the business of the firm which was running a chit fund. He also categorically found that Shri Srinivasan attended office everyday and devoted his time to chit collections and canvassing and further, he was experienced in the line of business. The other two partners, the AAC observed, were in Madras and salary was paid to Shri Srinivasan specifically for his attending to the business, which was in Tirunelveli.

4. The revenue is aggrieved with this finding. Apart from relying on the observations of the ITO, the learned departmental representative placed great reliance on the decision of the Supreme Court in the case of CIT v. R.M. Chidambaram Pillai [1977] 106 ITR 292. He submitted that what was termed as salary paid to a partner, would be only additional profit. Therefore, the share income was assessable in the hands of the HUF. According to him, the so-called salary income had also to be assessed in the hands of the HUF itself, and under the head 'Profits and gains of business or profession' as, it was stated, was done by the ITO. In the grounds of appeal, various judicial pronouncements have been referred to, which according to the revenue support its stand.

5. We have considered the submissions. The decision of the Madras High Court in the case of CIT v. Surendra Manilal Mehta [1984] 16 Taxman 427 is directly on the point. This decision is authority for the proposition that remuneration paid to the karta or a coparcener of the family by a firm, in which the family is a partner, cannot be assessed as the income of the family, unless there is a direct nexus between the investment of the fund of the family in the firm and the payment of the salary. In other words, unless such payment is to the detriment of the family funds invested in the firm, it cannot be treated as income of the family. Payment of remuneration for making available to the business of firm special skill would really be in the nature of compensation for services rendered by the exercise of such special or personal skill. In exercising such skills for the purpose of conduct of the business of firm, the detriment, if any, was personal to the partners and not to the undivided family or its properties or investment in the firm, and, therefore, the receipt would not partake the character of income of the HUF for purposes of tax treatment.

6. In the course of the judgment, the Madras High Court had considered two of the decisions on which reliance has been placed by the department, namely, the decision of the Supreme Court in V.D. Dhanwatey v. CIT [1968] 68 ITR 365 and the later case of M.D. Dhanwatey v. CIT [1968] 68 ITR 385. It is, therefore, not necessary for us to discuss the effect of these cases separately. The Court also considered the contention based on the decision of the Supreme Court in the case of R.M. Chidambaram Pillai {supra). In this regard, the Court observed : It only remains to consider the decision of the Supreme Court in R.M. Chidambaram Pillai's case (supra) relied on by the revenue. In that case, the controversy centred round the question whether the sums drawn as salaries by partners were wholly liable to income-tax or only to the extent of 40 per cent thereof, which fell within the non-agricultural income. In considering this question, the Supreme Court held that though paid as salary, such payment was treated as profits and enjoyed the same invulnerability to exigibility that Rule 24 of the Indian Income-tax Rules, 1922, confers on the agrarian portion. In our view, this decision of the Supreme Court does not in any manner assist in advancing the case of the revenue.

Besides, as the question relating to the applicability of Section 67(1)(b) has not been specifically made the subject-matter of these references, we are of the view that it is unnecessary on the facts and in the circumstances of this case having regard to the scope of the reference, to pursue this matter further.... (p. 433) There is the categoric finding of the Madras High Court that the decision of the Supreme Court did not assist in advancing the case of the revenue any further and this is binding on us. As the aspect of argument of Section 67(1)(b) of the Income-tax Act, 1961 ('the Act') was not further gone into because, it was outside the scope of reference ; we would also advert to the argument of the learned departmental representative with reference to the decision in the case of R.M. Chidambaram Pillai {supra) in some detail a little later.

Before doing so, however, we would say a few words about the other decisions relied on by the revenue. The decision in Jitmal Bhuramal v.CIT [1962] 44 1TR 887 of the Supreme Court was a case where the karta paid the junior members of the HUF an amount for services to the firm in which he was a partner. The payment of salary was held to be inadmissible in the case of the HUF since the salary was paid for service to a different entity, namely, the firm. The ratio of this decision has no application in the present case where the payment of salary is by the firm to one of the partners, namely, Shri Srinivasan.

The case of Jugal Kishore Baldeo Sahat v. CIT [1967] 63 ITR 238 (SC) has also no application because it is the case of payment of salary by the HUF to its karta for managing the family's business. The decision of the Allahabad High Court in the case of Gopinath Seth v. CIT [1982] 135 ITR 365 is yet another case where the salary was paid consequent to an agreement between the karta and his wife to the karta, for looking after the interests of the family. On the other hand, the relevant judicial pronouncements have been referred to in the decision of the Madras High Court to which we have adverted to already.

67. Method of computing a partner's share in the income of the firm.--(1) In computing the total income of an assessee who is a partner of a firm, whether the net result of the computation of total income of the firm is a profit or a loss, his share (whether a net profit or a net loss) shall be computed as follows : (a) any interest, salary, commission or other remuneration paid to any partner in respect of the previous year, and. where the firm is a registered firm or an unregistered firm assessed as a registered firm under Clause (b) of Section 183, the income-tax, if any, payable by it in respect of the total income of the previous year, shall be deducted from the total income of the firm and the balance ascertained and apportioned among the partners ; (b) where the amount apportioned to the partner under Clause (a) is a profit, any salary, interest, commission or other remuneration paid to the partner by the firm in respect of the previous year shall be added to that amount, and the result shall be treated as the partner's share in the income of the firm ; Apparently, the stand of the revenue is that whatever is apportioned under Section 67(1)(b), would be sacrosanct being the partner's share in the firm's income and would have to be assessed in toto in the hands of one assessee and, therefore, there is no scope for excluding the salary income and assessing the same in the hands of any different entity. The fact that whatever is apportioned under Section 67(1)(b), is not straightaway appertionable in toto, is evident from another statutory provision, namely, Section 67(3), which reads as under : (3) Any interest paid by a partner on capital borrowed by him for the purposes of investment in the firm shall, in computing his income chargeable under the head 'Profits and gains of business or profession' in respect of his share in the income of the firm, be deducted from the share.

Under this provision, interest paid by a partner on borrowed capital for investment in the firm is deductible from the share in the income of a firm apportioned under Section 67(1)(b). It is also settled law that provisions of Section 67(3) are not exhaustive and deductions can be claimed according to other provisions of the Act also from the apportioned share income. One decision on point is that of the Andhra Pradesh High Court in CIT v. Smt. P. Janaki Bai [1973] 87 ITS. 645.

Therefore, in making an assessment, the apportioned income under Section 67(1)(b) has to be processed further.

8. In the case of CIT v. Kalu Babu Lal Chand [1959] 37 ITR 123 the Supreme Court has observed as under : It is now well settled that a Hindu undivided family cannot as such enter into a contract of partnership with another person or persons.

The karta of the Hindu undivided family, however, may and frequently does enter into partnership with outsiders on behalf and for the benefit of his joint family. But when he does so, the other members of the family do not, vis-a-vis the outsiders, become partners in the firm. They cannot interfere in the management of the firm or claim any account of the partnership business or exercise any of the rights of a partner. So far as the outsiders are concerned, it is the karta who alone is, and is in law recognised as, the partner.

Whether in entering into a partnership with outsiders, the karta acted in his individual capacity and for his own benefit or he did so as representing his joint family and for its benefit is a question of fact. If for the purpose of contribution of his share of the capital in the firm the karta brought in monies out of the till of the Hindu undivided family, then he must be regarded as having entered into the partnership for the benefit of the Hindu undivided family and as between him and the other members of his family he would be accountable for all profits received by him as his share out of the partnership profits and such profits would be assessable as income in the hands of the Hindu undivided family.... (p. 127) Again in the case of Ram Luxman Sugar Mills v. CIT [1967] 66 ITR 613, the Supreme Court observed as under : ...A Hindu undivided family is undoubtedly a 'person' within the meaning of the Indian Income-tax Act. It is, however, not a juristic person for all purposes, and cannot enter into an agreement of partnership with either another undivided family or individual. It is open to the manager of a joint Hindu family as representing the family to agree to become a partner with another person. The partnership agreement in that case is between the manager and the other person, and by the partnership agreement no member of the family except the manager acquires a right or interest in the partnership. The junior members of the family may make a claim against the manager for treating the income or profits received from the partnership as a joint family asset, but they cannot claim to exercise the rights of partners nor be liable as partners.

It is in the light of ratio of these and other decisions that the Gujarat High Court in CIT v. Sajjanraj Divanchand [1980] 126 ITR 654 has summed up the legal position as under : As a result of a series of decisions of the Supreme Court {vide Charandas Haridas v. CIT [1960] 39 ITR 202 and other decisions on the point), it is clear that an HUF cannot be a partner in a firm.

Only an individual person in his own right can be a partner in a firm. Since an HUF cannot be a partner in a firm, whoever represents the HUF in the firm is a partner for all practical purposes both of partnership law and income-tax law, and it is in the light of that legal position that the whole problem has to be considered....

(We may mention that a special leave petition against this decision of the Gujarat High Court stands dismissed by the Supreme Court--144 ITR (St.) 15.

9. From the aforesaid, it is clear that qua the firm, the partner is only the individual concerned. In the case, relied on by the learned departmental representative of R.M. Chidambaram PillaVs case (supra), the Supreme Court has held that payment of salary to a partner represents a special share of the profits and was, therefore, part of the profits taxable as such. The Court also further held : It is plain that salaries paid to partners are regarded by the Income-tax Act, as retaining the character of profits and not excludible from the tax net, whatever the reason behind it be....

They also stated that salaries are profits known by a different name and must be treated as such for taxation purposes, and finally the Court concluded : We regard this conclusion as unsound, the source of the error being a failure to appreciate that the salary of a partner is but an alias for the return, by way of profits, for the human capital--sweat, skill and toil are, in our socialist republic, productive investment--he has brought in for common benefit. The immediate reason for payment of salary was service contract but the causa causans is partnership.

Therefore, the trend which runs throughout the observations is that salary is an additional payment to the partner concerned, for the human capital--sweat, skill and toil which he puts in. The observation of the Supreme Court from the case of Kalu Babu Lal Chand (supra) and Ram Luxman Sugar Mills (supra) which we have set out, show that though qua the firm the individual is the partner, the HUF would be entitled to require the individual to account to it for the share of profits, if he brought in monies of the HUF in becoming a partner. To this extent, the share of profit, which falls to the individual, would have to be assessed in the hands of the HUF. But if the individual got a share of profit which is relatable to something other than the capital given by the HUF and is independent of it, then the members of the HUF can have no claim to such additional share of profit, because such additional share of profit will not be the income of the HUF. As to what share of profit would have to be assessed in the hands of a HUF and what share of profit will not fall to be assessed in the hands of a HUF is a question which will have to be decided on the facts of each case, with reference to the pronouncements of the Supreme Court and the Madras High Court. In the case of Raj Kumar Singh Hukam Chandji (supra), the Supreme Court has set out the facts of various cases. One of the cases is CIT v. B.C. Shah [1969] 73 ITR 692 (SC), where the final conclusion of the Court was that the remuneration paid by the firm to a HUF, of which Shah was the karta, was the individual income of Shah and was not assessable as income of the HUF. Therefore, where one of the individual coparceners represents the HUF, it has to be decided what share of profit received by that individual as a partner in a firm, could be assessed in the hands of the HUF, and what share could be assessed separately. For determining this, the Supreme Court has laid down the requisite criteria and those are as under : At first sight there appears to be conflict between the two lines of decisions, namely Kalu Babu's case [1959] 37 ITR 123 (SC), Mathura Prasad's case [1960] 60 ITR 428 (SC), the two Dhanwatey's cases V.D. Dhanwatey [1968] 68 ITR 365 (SC) and M.D. Dhanwatey [1968] 68 ITR 385 (SC) and Krishna Iyer's case [1969] 73 ITR 539 (SC) and Palaniappa Chettiar's case [1968] 68 ITR 221 (SC), Dhakappa's case [1969] 72 ITR 192 (SC) and B.C. Shah's case [1969] 73 ITR 692 (SC) on the other. The line that demarcates these two lines of decisions is not very distinct but on a closer examination that line can be located. In order to find out whether a given income is that of the person to whom it was purported to have been given or that of his family, several tests have been enumerated in the aforementioned decisions but none of them excepting Kalu Babu's case makes reference to the observations of Lord Sumner in Gokul Chand's case [1921] L.R. 48 I.A. 162, AIR 1921 PC 35 that 'in considering whether gains are partible, there is no valid distinction between the direct use of the joint family funds and a use which qualifies the member to make the gains by his own efforts'. We think that that principle is no more valid. The other tests enumerated are : (1) whether the income received by a coparcener of a Hindu undivided family as remuneration had any real connection with the investment of the joint family funds ; (2) whether the income received was directly related to any utilization of family assets ; (3) whether the family had suffered any detriment in the process of realization of the income ; and (4) whether the income was received with the aid and assistance of the family funds.

In our opinion from these subsidiary principles, the broader principle that emerges is whether the remuneration received by the coparcener in substance though not in form was but one of the modes of return made to the family because of the investment of the family funds in the business or whether it was a compensation made for the services rendered by the individual coparcener. If it is the former, it is an income of the Hindu undivided family but if it is the latter then it is the income of the individual coparcener. If the income was essentially earned as a result of the funds invested the fact that a coparcener has rendered some service would not change the character of the receipt. But if on the other hand it is essentially a remuneration for the services rendered by a coparcener, the circumstance that his services were availed of because of the reason that he was a member of the family which had invested funds in that business or that he had obtained the qualification shares from out of the family funds would not make the receipt, the income of the Hindu undivided family....

We have set out the facts in the present case and the categorical finding by the AAC, which remains uncontroverted, is that Shri Srinivasan was fully engaged in the day-to-day management of the business, that he attended office everyday, devoted his time to chit collection and canvassing and is experienced in the line of business.

He was looking after the business, whereas the other partners of the firm were away in Madras. Shri Srinivasan, thus, devoted his whole time to the business and it is clear, therefore, that the amount paid as remuneration to him was nothing, but compensation for services rendered by the individual. It was not a return for investment of family funds.

Hence, the AAC was justified in directing the exclusion of that portion of the profits, namely, the amount stipulated as salary to Shri Srinivasan from the assessment of the assessee-HUF. The appeals of the department are accordingly, dismissed.


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