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Minnow Trading Company Pvt. Ltd. Vs. Ito - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided On
Judge
AppellantMinnow Trading Company Pvt. Ltd.
Respondentito
Excerpt:
.....the assessee company had contributed a sum of rs. 11,03,20,205/- by way of capital in all the 7 firms. the partnership deed of the seven firms provides in clause-7 thereof that any amount contributed or advanced as capital to the firm shall bear interest @ 18% per annum and such interest shall be treated as expenditure in determining the profit or loss of the firm. the ld. counsel for the assessee submitted that the seven partnership firms have amended clause-7 of the partnership deed and it was agreed between the partners of the firms that the chargeability of interest on the firm on capital brought in or loan advanced by partners, shall be postponed till the project commences. he contended that this amendment to partnership deed was accepted by the partners of the firms on 20.10.99,.....
Judgment:
1. This appeal by the assessee for the Assessment year 2003-04 is directed against the order of CIT(A). The grounds of appeal of the assessee are as under: 1. The ld. CIT(A) erred in upholding the assessment of Rs. 19857604/- in the hands of the appellant, which is opposed to the facts and circumstances and his order is contrary to established law.

2. The ld. CIT(A) erred in holding that the appellant had the right to receive interest at 18 % per annum on the capital contributed.

3. Such a right is based on unstated and unspecified accounting practices and legal principles and is not sustainable as all accounting practices and legal principles are contrary thereto.

4. The ld. Assessing Officer has assessed Rs. 19857604/-under the head "Profit from Business" under Section 28(v) rws 5(1)(c) - since no business was carried on, the application of Section 28(v) does not arise.

5. Both under the Partnership Act and under Clauses 7 & 8 of the partnership deed, the interest is a charge in determining the profits of the business. There being no profits, which fact is undisputed, the charge does not legally arise and may therefore be deleted.

6. The finding that the appellant has set up business which has commenced I factually incorrect and is not based on any evidence.

Hence the assessment may be annulled.

7. The agreement abut charging of interest is contained in Clause 7 & 8 of the Partnership deed. These Clauses have been modified by agreement among the partners. The proposition enunciated by the ld. CIT(A) that a change in the terms of the partnership can not brought about by exchange of letters in contrary to established case law is therefore not sustainable.

8. Once it is accepted that the agreement to levy interest on capital has been lawfully modified the assessment of interest on such capital is without any foundation and may be deleted.

9. The ld. CIT(A) has misconceived that income can arise by mere valuation of opening and closing stocks; anticipated profits byre-valuation do not give rise to income as held by counts.

Therefore, the assessment of Rs. 19857604/- is illegal and may be deleted.

10. The CIT(A) relying on Section 5 is also completely misconceived as it is opposed to all decided cases. The assessment on alleged accrual of income my therefore be deleted.

11. For 8 years, no assessment of income has been made despite returns of income having been filed. No reason having been cited for a change, the assessment is not sustainable.

12. for all these reasons, CIT erred in upholding the assessment of Rs. 19857604/- and the addition may be deleted.

2. The Ld. Counsel for the assessee submitted that the assessee is private limited company and is a partner in seven firms. The 7 firms in which the assessee company is a partner, have filed separate returns of income, disclosing NIL income. The assessee has also filed a return of income disclosing NIL income and no profit and loss account was prepared since the assessee could not conduct any business till the relevant period and all expenses are shown under the head "land development work in progress". The Ld. Counsel for the assessee submitted that the development work of the land could not commence due to litigation and legal disputes, which went up to the highest court of the land. The assessee company had contributed a sum of Rs. 11,03,20,205/- by way of capital in all the 7 firms. The Partnership Deed of the seven firms provides in Clause-7 thereof that any amount contributed or advanced as capital to the firm shall bear interest @ 18% per annum and such interest shall be treated as expenditure in determining the profit or loss of the firm. The Ld. Counsel for the assessee submitted that the seven partnership firms have amended Clause-7 of the Partnership Deed and it was agreed between the partners of the firms that the chargeability of interest on the firm on capital brought in or loan advanced by partners, shall be postponed till the project commences. He contended that this amendment to Partnership Deed was accepted by the partners of the firms on 20.10.99, a copy of which is filed in the compilation before the Tribunal. The Ld Counsel for the assessee submitted that the Assessing Officer has held that interest on such capital of the partners was due as per Clause-7 of the Partnership Deed and on the mercantile basis of accounting, the income by way of interest from the partnership firms has accrued to the assessee company, which ought to have been reflected in the returns of income and offered for taxation by the assessee. The CIT(A) has confirmed the order of the Assessing Officer. The Assessing Officer has doubted the authenticity of the agreement dt.20.10.99 between the partners of the firms amending Clause-7 of the original Partnership Deeds and has held the same as self-serving documents. The CIT(A) has upheld the addition on account of accrued interest from the partnership firms by holding that the terms of Partnership Deed could not be modified through exchange of letters between the partners of the firm. The CIT(A) has observed that lease hold land acquired for development by the partnership firms had increased in value and therefore, such increase should have been taken as income against which the interest should have been charged off as expenditure by the partnership firms.

3. The Ld Counsel for the assessee submitted that the business of the assessee could not commence due to litigation and adverse circumstance and therefore, no profit and loss account was prepared by the assessee as there was no profit earned by the assessee company or any of the seven firms in which the assessee company was a partner. The Ld.

Counsel for the assessee submitted that the Clause 7 of the Partnership Deed of the partnership firms have been amended by the partners on 20.10.99 and the chargeability of the interest on the firm had been postponed till the project commences. Learned Counsel for the assessee contended that even otherwise there being no profits to any of the firms, the partners were not entitled to any interest on the capital subscribed by them as per the provisions of Section 13(c) of the Indian Partnership Act, 1932. Learned Counsel for the assessee contended that only exception to this legal provision of Section 13(c) of the Indian Partnership Act, 1932 is where the Partnership Deed executed by the partners specifically provides that partners shall be entitled to interest on the capital subscribed by them, even if there are no profits to the partnership firm. Learned Counsel for the assessee referred to the relevant portions of the Director's report of the assessee company and audited balance sheet of partnership firms filed in the compilation before the Tribunal, in support of his plea that there was no profit to any of the firms or the assessee company.

Learned Counsel for the assessee relied on the decision of Hon'ble Madras High Court in the case of Somasundaram Chettiar v. Sevugan Chettiar and Anr. and of Madras Tribunal in First ITO v. Sree Tirupathi & Co. 40 ITD 456 (Mad.) and submitted that these decisions of Hon'ble Madras High Court and of Madras Tribunal covers the issue in the present appeal of the assessee wherein held that interest on capital was payable only out of profits of the partnership firm.

4. Ld. DR has opposed the submissions of the Ld. Counsel for the assessee. She submitted that the Clause 7 of the Original Partnership Deed clearly provides that any amount contributed/advanced as capital/loan or treated as contributed/advanced as capital/loan to the firm, shall bear interest @ 18% per annum and such interest shall be treated as an expenditure in determining the profits or losses of the partnership firms. She submitted that the amendment to the partnership deed by exchange of the simple letters dt.20.10.99 between the partners of the firms is merely self-serving documents and these letters have been exchanged by three related parties and is not on stamp paper and has no effect of amending the terms and conditions of the partnership deed executed between the partners. She submitted that whether any interest entry on the capital of the assessee company by the partnership firms is passed or not, is not relevant since the assessee is a company and the right to receive interest has accrued to the assessee from the partnership firms. She submitted that the partnership firms are very much in business of development of land as they have incurred certain expenses on land development, which were capitalized by them as per their statement of accounts filed with the department.

She contended that the provisions of Section 13(c) of the Indian Partnership Act, 1932 does not provide that the partners could not provide the allowance of interest on the amount of capital brought by them and in fact, in the case of the assessee the partnership Deeds of all the 7 firms specifically provides for crediting interest @ 18% per annum to the capital advanced by the partners thereof. She submitted that the market value of lease hold lands acquired for development has increased and therefore, the same should have been taken as income by the partnership firms against which interest to partners could have been charged off as expenditure. She contended that the principle of accrual of income could not be ignored in this case.

5. We have considered the rival submissions carefully. We find that the material facts of the case are not in dispute. The business of 7 firms could not start till the relevant accounting period and the partnership firms could not earn any profit from its activities. Learned Counsel for the assessee has stated at the Bar that the business of any of the partnership firms could not commence till date. There was a prolonged litigation, which went up to the highest court of the land and the assessee has filed documentary evidence in support of this fact of the litigation. The assessee has followed the Project Completion Method and some expenses incurred by the partnership firm were capitalized under the head "land development work in progress". The case of the department is that in accordance with principles of mercantile system of accounting, the interest on the capital of the partners in the firm was due as per Clause 7 of the partnership deed and therefore, the income by way of interest on capital has accrued to the assessee and ought to have been reflected in the its return of income filed with the department. We find that the plea of the assessee that the Clause-7 of the partnership deed stands amended with the agreement between the partners of the firms dt. 20.10.99, is not sustainable. We have perused the copies of the letters dt.20.10.99 exchanged between the partners of the firms.

6. We find that no deed of amendment to the partnership deed was executed between the partners of the firms. The letter dt.20.10.99 exchanged between the partners is on plain paper and the revenue authorities are justified in doubting their authenticity. Moreover, the terms and conditions of the partnership deed executed between the partners of the firms and filed with the department, could not be amended by the partners of the firms by merely exchanging letter to this effect between themselves.

7. We find that the plea of the CIT(A) for confirming the notional addition of interest is that the lease hold land acquired for development by the partnership firms had increased in value and therefore, such increase should have been taken as income against which the interest should have been charged off as expenditure by the partnership firms, is not sustainable and has no force. It is an accepted principle of valuation of closing stock that the stock can be valued as per market price or cost, whichever is less. In this case, the partnership firms have valued the lease hold land acquired for development at its cost price, which is an accepted method of valuation; we hold that there is no mistake in valuing the lease hold land by the firms.

8. In this case, the statement of accounts of the assessee company as well as the partnership firms clearly establishes the fact that the partnership firms have not earned any profits during the relevant period. In these facts, we have given our careful thought to the second proposition convessed by the Learned Counsel for the assessee that the partners of the firms are not entitled to interest on the capital subscribed by them, when there are no profits with the partnership firms as per the provisions of Section 13(c) of the Indian Partnership Act, 1932 We find that the provisions of Section 13(c) of the Indian Partnership Act, 1932 provides- Subject to contract between the partners where a partner is entitled to interest on the capital subscribed by him, such interest shall be payable only out of profits.

The provisions of Section 13(c) of the Indian Partnership Act, 1932 being the law of the land, the partners of the firms are entitled to interest on the capital subscribed by them only when such interest could be paid out of profits of the partnership firms. It means that in view of our findings that there are no profits with any of the partnership firms, the partners are not entitled to interest on the capital subscribed by them. The only exception to this provision of law is provided in the opening words of Section 13(c) of the Indian Partnership Act, 1932 i.e. "Subject to contract between the parties".

Thus, where the terms and conditions of partnership deed executed between the partners expressly provides for payment of interest to the partners regardless of the profits, only then the interest shall be payable on the capital subscribed by the partners to them irrespective of the fact that there are no profits with the partnership firms. The Clause-7 of the Partnership Deed dt. 15.01.97 executed between the partners of the firms provides for interest payment @ 18% per annum on the amount of capital contributed by the partners, but it nowhere provides that the interest on capital contributed by the partners shall be payable to the partners regardless of profits to the partnership firms in question. In the case of the assessee, it can not be said that the partnership deed executed between the partners of the seven firms on 15.01.97 provides for interest on capital subscribed by the partners even if there is no profit with the partnership firms.

9. The issue before us with regard to interpretation of provision of Section 13(c) of the Indian Partnership Act, 1932 is covered with the decision of of Hon'ble Madras High Court in the case of Somasundaram Chettiar v. Sevugan Chettiar and Anr. and of Madras Tribunal in First ITO v. Sree Tirupathi & Co. 40 ITD 456 (Mad.).

Hon'ble Madras High Court held: "It is only out of the profits, if any, that the capital contributing partner can be expected to take his stipulated interest Under Section 13(c). This law may recognize an exception to this rule where the contract expressly provides for payment of interest regardless of profits." Hon'ble Madras High Court has further held that "It is only out of the profits, if any, of the business that the capital contributing partner could be expected to take his stipulated interest. This seems to be the principle adopted by the Indian Legislature in Section 13(c) of the Indian Partnership Act and by Parliament in Section 24, Clause 4 of the English Partnership Act. The law may recognize an exception to this rule where the contract expressly provides for payment of interest regardless of profits....

10. No contrary decision has been brought to our notice by the parties.

In these facts of the case and in the light of the decisions of Hon'ble Madras High Court in the case of Somasundaram Chettiar v. Sevugan Chettiar and Anr. (supra) and of Madras Tribunal in First ITO v. Sree Tirupathi & Co. (supra), we find that there being no Clause in the partnership deed of the partnership firms providing payment of interest to the partners regardless of profits to the firms, we hold that no interest is payable by the partnership firms to its partners and accordingly no right to receive interest from the partnership firms has accrued to the assessee company and therefore, the notional addition on account of accrued interest from the partnership firms is not sustainable and the addition made is deleted and the grounds of appeal of the assessee are allowed.


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