AMBIKA STEEL DISTRIBUTERS,HYDERABAD vs. DCIT, CENTRAL CIRCLE-1(3), HYDERABAD

During the course of the assessment proceedings, the AO observed that capital of Rs. 4,80,13,593/- and Rs.1,06,50,000/- had been introduced by the partners of the assessee firm, viz., Shri Pankaj Agarwal and Smt. Mala Agarwal, respectively. On being queried, the assessee firm furnished the requisite details regarding the aforesaid additions in the capital accounts of the respective partners.

The AO observed that as per the details provided by the assessee firm, one of the partners, viz., Smt. Mala Agarwal had made a capital addition of Rs. 12 lakhs in cash. Upon being queried, the assessee firm claimed that Smt. Mala Agarwal, who was a proprietor of a concern, viz. M/s Amba Interiors, which was discontinued, had primarily sourced the subject addition to her capital account by withdrawing the amount from the above-mentioned concern and crediting the same to her capital account with the assessee firm. Elaborating further on its 3 contention, it was stated that the amount of Rs. 12 lakhs introduced by the aforementioned partner was sourced from: (i) cash balance available with M/s. Amba Interiors (proprietary concern) on 31/03/2017: Rs.6,05,038/-; (ii) profit for the Financial Year 2015-16: Rs.3,25,315/-; and (iii) profit for the Financial Year 2016-17: Rs.3,35,010/-.

As is discernible from the record, the assessee firm had furnished cash flow statement, fund flow statement, cash book, etc., depicting the cash withdrawn by the aforesaid partner from the aforesaid proprietary concern. However, the AO did not find the assessee firm's explanation regarding the source of the addition of Rs. 12 lac in cash in the capital account of the above-mentioned partner acceptable, as it was incomprehensible that she would have retained the said amount with her for such a long period. Accordingly, the AO, holding a firm conviction that the assessee firm had failed to discharge the onus cast upon it to explain the source of the capital addition of Rs. 12 lakhs in cash made in the capital account of its partner Smt. Mala Agarwal, held the same as an unexplained credit under section 68 of the Act and after making an addition of the said amount determined its income at Rs.24,71,830/-.

Aggrieved, the assessee firm carried the matter in appeal before the CIT(A) but without success.

The assessee firm, aggrieved with the order of the CIT(A), has carried the matter in appeal before us.

We have heard the Learned Authorized Representatives of both parties, perused the orders of the authorities below and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by the Learned Authorized Representative of the assessee firm to drive home his contentions.

Shri P Murali Mohan Rao, CA, Learned Authorized Representative (for short, “Ld.AR”) for the assessee firm, at the threshold of hearing of the appeal, submitted that the AO had grossly erred in law and facts of the case in making an addition of the capital introduced by the partner of the assessee firm as an unexplained cash credit in the hands of the assessee firm. Elaborating on his contention, the Ld. AR submitted that Smt. Mala Agarwal, the partner of the assessee firm, had in the course of the assessment proceedings submitted the details of the source of her capital introduced with the assessee firm amounting to Rs.1,06,50,000/-, which, inter alia, included the amount of Rs.12 lakhs that was stated by her to have been sourced out of, viz., (i) cash balance available with M/s. Amba Interiors (proprietary concern) as on 31/03/2017: Rs.6,05,038/-; (ii) profit for the Financial Year 2015-16: Rs.3,25,315/-; and (iii) profit for the Financial Year 2016-17: Rs.3,35,010/-. The Ld. AR, to buttress his aforesaid claim, had drawn our attention to the copy of the “remand report”, dated 25/08/2025, furnished by the Dy. Commissioner of Income Tax, Central Circle-1(3), Hyderabad (AO) to the CIT(A)-12, Hyderabad, which supported his aforesaid claim. 5

Elaborating further on his contention, the Ld. AR submitted that now when the aforementioned partner had duly accepted the capital contribution of Rs.12 lakhs made by her during the year under consideration, then no adverse inference regarding the source of the said amount could have been drawn in the hands of the assessee firm and held as an unexplained credit in its hands under section 68 of the Act. The Ld. AR submitted that in case the AO had any doubt regarding the source of capital introduced by the aforesaid partner, then the proper recourse available with him was to make necessary verification from the said partner. Carrying his contention further, the Ld. AR submitted that there was no justification for the AO to have treated the capital contribution, which the partner unequivocally accepted, as an unexplained cash credit in the hands of the assessee firm.

Per contra, Shri B Laxmi Kanth, Learned Senior Departmental Representative (for short, “Ld. Sr-DR”) relied upon the orders of the authorities below. It was submitted that as the assessee firm had failed to come forth with any explanation regarding the source of the capital contribution of Rs.12 lakhs in its books of account, the AO had rightly added the same as an unexplained cash credit under section 68 of the Act.

We have given thoughtful consideration to the contentions advanced by the Learned Authorized Representatives of both parties in the backdrop of the orders of the authorities below.

We find that the controversy involved in the present appeal lies in a narrow compass, i.e., sustainability of the addition of the capital contribution in cash of Rs.12 lacs made by Smt. Mala Agarwal, partner of the assessee firm, as an unexplained cash credit under section 68 of the Act in the hands of the assessee firm.

Before adverting to the aforesaid controversy, we deem it apposite to cull out the provisions of Section 68 of the Act, as was available on the statute during the year under consideration, as under: “68. Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year: Provided that where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless— (a) the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and (b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory: Provided further that nothing contained in the first proviso or second proviso shall apply if the person, in whose name the sum referred to therein is recorded, is a venture capital fund or a venture capital company as referred to in clause (23FB) of section 10.”

We find on a careful perusal of Section 68 of the Act, as it stood applicable to the year under consideration, that it contemplates that where any sum is found credited in the books of an assessee maintained for any previous year and the assessee either offers no explanation about the nature and source thereof or the explanation offered is not, in the opinion of the AO, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

As observed by us hereinabove, the AO in his “remand report”, dated 25/08/2025 filed before the CIT(A)-12, Hyderabad, had observed that during the course of the assessment proceedings Smt. Mala Agarwal had submitted the details of the source of her investment with the assessee firm, amounting to Rs.1,06,50,000/-, which, inter alia, included the capital addition of Rs.12 lacs in question along with the source of the said addition. For the sake of clarity, we deem it apposite to cull out the relevant extract of the “remand report”, dated 25/08/2025, which reads as under:

We, based on the aforesaid observation of the AO, find that Smt. Mala Agarwal, partner of the assessee firm, had not only accepted the capital contribution of Rs. 12 lacs made to her capital account with the assessee firm, but had also provided an explanation regarding its source.

In our considered view, once the assessee-firm had explained that the impugned credit represented the capital contribution of the concerned partner, and such explanation stood corroborated by the admission of the partner herself, the initial burden cast upon the assessee-firm under Section 68 of the Act stood duly discharged. We are of a firm conviction that any further inquiry regarding the financial capacity of the partner from whom the funds originated would be a verification of the partner’s capital contribution and not the nature or source of the credits in the hands of the assessee-firm.

We may herein observe that as per the settled position of law, once the credits appearing in the books of the partnership firm are accepted to represent the capital contribution of the partners, any inquiry regarding the source from which the partners procured the funds can only be undertaken in their individual assessments and not in the assessment of the partnership firm. Our aforesaid view is supported by the judgment of the Hon’ble High Court of Madhya Pradesh in CIT v. Metachem Industries (2000) 245 ITR 160 (MP), wherein it was held that once it is established that the amount had been invested by a particular person, be he a partner or anybody else, the responsibility of the assessee-firm stands discharged. The Hon’ble High Court observed that if the source of such investment is not satisfactorily explained, the Revenue is at liberty to examine the matter in the hands of the concerned partner, but no addition under Section 68 can be made in the hands of the partnership firm merely because the partner fails to establish the source of his investment. Also, the aforesaid principle has been reiterated by the Hon’ble Jurisdictional High Court in CIT v. M. Venkateswara Rao (2015) 370 ITR 212 (Telangana & Andhra Pradesh), wherein it was held that once the credits appearing in the books of the firm are 10 accepted to represent the capital contribution of the partners, any enquiry regarding the source from where the partners procured the funds can only be undertaken in their individual assessments and not in the assessment of the partnership firm. The said principle had thereafter been reaffirmed by the Hon’ble High Court of Telangana in Nova Medicare v. ITO (2023) 459 ITR 477 (Telangana), wherein, after relying upon its earlier decision in CIT Vs. M. Venkateswara Rao (supra), the Court categorically held that where the credits represent investments made by the partners, the burden cast upon the partnership firm stands discharged once the partners own such investments, and any inquiry regarding the source or creditworthiness has to be directed against the concerned partners. Also, we find that the Hon’ble High Court of Allahabad in CIT v. Jaiswal Motor Finance (1983) 141 ITR 706 (All) laid down the principle that where the credits stand in the names of the partners and the partners own the investments, no addition under Section 68 can be made in the hands of the partnership firm unless there is material to establish that the amounts in fact belonged to the firm itself. We further find that the Hon’ble High Court of Rajasthan in CIT, Bikaner v. Kewal Krishan & Partners (2009) 18 DTR 121 (Raj), following the judgment of the Hon’ble High Court of Madhya Pradesh in CIT v. Metachem Industries (supra), held that unexplained capital introduced by the partners cannot ordinarily be assessed in the hands of the partnership firm once the partners have owned the investments. Also, the Hon’ble High Court of Punjab & Haryana in CIT v. Burma Electro Corporation (2001) 252 ITR 344 (P&H) adopted the same principle and held that once the partners acknowledge the capital contribution, any inquiry regarding the source of the funds has to be directed against the concerned partners.

We, thus, are of the firm conviction that in the backdrop of the aforesaid settled position of law, once the partner in the present case before us has admitted her capital contribution of Rs. 12 lacs, the true character of the receipts stood established. We are of the view that once Smt. Mala Agarwal, partner of the assessee firm, had accepted her capital contribution of Rs. 12 lacs; any further inquiry by the Revenue into the source of the amount would, in substance, amount to examining the source of the partner’s capital while framing the assessment of the partnership firm itself.

We are of a firm conviction that, where, as in the present case, viz. (i) the amount has been credited to the respective partner’s capital account; (ii) the concerned partner has unequivocally acknowledged the same as her capital contribution; and (iii) the assessee-firm has never claimed the said amounts as its own receipts, then any enquiry would pertain to the source of the partner’s investment and not to the unexplained income of the partnership firm. Consequently, any addition, if otherwise warranted on account of failure to establish the source of subject investments, would fall for consideration in the hands of the concerned partner and not in the hands of the assessee-firm under Section 68 of the Act.

We, thus, in terms of our aforesaid deliberations read in light of the settled position of law, are unable to persuade ourselves to uphold the addition of Rs.12,00,000/- made by the AO which thereafter has been sustained by the CIT(A), and thus set aside the CIT(A) order and direct the AO to vacate the said addition.

In the result, the appeal filed by the assessee firm is allowed in terms of our aforesaid observations.