ASHOKA OIL MILS vs. COMMISSIONER OF IT

This appeal has been preferred by the appellant assessee under section 260A of the Income Tax Act, 1961 (in short, “the Act”) against the order dated 11.3.2005, Annexure A.1 passed by the Income Tax Appellate Tribunal, Amritsar Bench, Amritsar (in short, “the Tribunal”) in ITA No.227/ASR/2001 for the assessment year 1997-98. It was admitted on 31.7.2006 to consider following substantial question of law:- “Whether on the facts and in the circumstances of the case, the addition sustained by the Income Tax Appellate Tribunal on account of interest paid to the partners due to non charging of depreciation to profit and loss account was justified in law and is legally sustainable?”

A few facts relevant for the decision of the controversy involved as narrated in the appeal may be noticed. The appellant is a GURBAX SINGH 2014.10.13 11:12 integrity of this document High Court Chandigarh partnership firm consisting of three partners namely S/Shri Ashok Kumar Kansal,Vijay Kumar Kansal sons of Shri Girdhari Lal Kansal and Smt.Naresh Kansal wife of Shri Prem Paul Kansal with 50%, 30% and 20% shares respectively, constituted vide partnership deed dated 1.4.1990. However, in order to incorporate changes as necessitated on account of change in the mode of assessment of firms vide Finance Act, 1992 w.e.f 1.4.1993, a fresh partnership deed was executed amongst the partners w.e.f 1.4.1992 inter alia providing for interest to be paid to the partners on their investment with the firm at the rate of 18% per annum. As per uniform regular system of accounting being followed as Hybrid system and accepted by the department, depreciation as allowable as per provisions of the Act was not being charged to profit and loss account but was being claimed in the computation sheet filed alongwith the return. The returns of income for the assessment year 1993-94 and upto the assessment year 1996-97 were filed by providing interest to the partners as per their capital accounts with the firm as on 31.3.1993 and onwards upto the year ending 31.3.1996 at the rate of 18% per annum and charging the same to profit and loss account for the respective years which was accepted as such by the department. The return of income for the assessment year 1997-98 was filed on the same basis by claiming interest paid to the partners amounting to ` 1,87,119/- as an allowable expenditure qua the income of the firm for the captioned year. The Assessing officer after processing the return took up the case for scrutiny. The Assessing officer held that depreciation was not provided in the books but separately claimed in the return of income. By this method, the capital of the partners stood artificially inflated and hence interest paid GURBAX SINGH 2014.10.13 11:12 integrity of this document High Court Chandigarh to them amounting to ` 187119/- could not be allowed as an expenditure and disallowed the same while computing the income of the appellant for the assessment year in question vide order dated 31.3.2000, Annexure A.

Aggrieved by the order, the assessee filed appeal before the Commissioner of Income Tax (Appeals) [CIT(A)].Vide order dated 14.3.2001, Annexure A.5, the CIT(A) partly allowed the appeal and sustained the disallowance of interest paid to the partners on the basis of inflated capital of the partners because of non charging of depreciation in the profit and loss account which was obligatory to be given effect to as per Chapter IV-D of the Act. The 2014.10.13 11:12 integrity of this document High Court Chandigarh books of account shall not disentitle the assessee to such claim.

On the other hand, learned counsel for the revenue besides supporting the order of the Tribunal submitted that the Assessing Officer, CIT(A) and the Tribunal have concurrently arrived at the correct conclusion that the assessee had inflated the capital accounts of the partners by not debiting the depreciation on the assets and therefore, the interest at the rate of 18% on capital contribution by the partners was on the higher side.

After hearing learned counsel for the parties, we do not find any merit in the appeal.

The Tribunal after appreciating the material on record had come to the specific finding that it was not a case where the assessee had revaluated the assets and credited the difference in the market value over the written down value to the capital accounts of the partners. It was a case where the excess amount had been credited to the partners' capital accounts without taking into account the amount of depreciation being claimed in the income tax returns. Further, it was noticed that even in the partnership deed, it was nowhere provided that while crediting profit to the partners capital account, the depreciation claimed in the returns shall not be charged to the profit or loss account or shall not be considered for payment of interest on capital employed by the partners. It was held as under:- “6. We have heard both the parties and carefully considered the rival submissions, perused the material and evidence placed on record and the orders of the authorities below. A copy of the partnership deed is placed at pages 1 and 2 of the paper book. As per clause 7 of the said partnership deed, it was provided that partner shall be entitled to charge interest at the rate of 18% per annum on their investment in the firm. Nowhere, the GURBAX SINGH 2014.10.13 11:12 integrity of this document High Court Chandigarh partnership deed provides that while crediting profit to the partners capital account, the depreciation claimed in the income tax return was not charged to profit and loss account or the same shall not be considered. It is also not disputed by the assessee that depreciation though not charged to profit and loss account yet the same was claimed in the return as per statement of income. Now as per provisions of section 40(b) (iv), the assessee is entitled to deduction of interest paid to partners, which was authorized by, and was in accordance with the terms of the partnership deed. No doubt clause 7 of the partnership deed provides for charging of interest @ 18% on the capital invested by the partners. But there is no clause that for the purpose has not to be considered. Explanation 3 to section 40 (b) explains the meaning of “book profit” as per which the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV D as increased by the aggregate amount of the remuneration paid or payable to all partners of the firm, if such amount has been deducted while computing the net profit. Thus, depreciation, which forms part of the Chapter IV D has to be taken into account for the purpose of arriving at the book profit. The action of the assessee in not charging depreciation to the profit and loss account though claimed in the return is neither authorised by the partnership deed nor is in conformity with the provisions of the Act. The capital account of the partners showing accretion includes the amount of depreciation. In other words, there is excess credit to the capital accounts of the partners represented by the amount of depreciation, which is not correct. Moreover, clause 7 of the partnership deed provides for interest at the rate of 18% on capital contributed by the partners. The amount represented by depreciation claimed in the returns but not charged to profit and loss account is not a capital contributed by the partners. Therefore, assessee is not entitled to deduction of interest paid on such amount. It is not a GURBAX SINGH 2014.10.13 11:12 integrity of this document High Court Chandigarh case where the assessee has revalued the assets and credited the difference in the market value over the WDV to the capital accounts of the partners. It is a case where the excess amount has been credited to the partner's capital accounts without AO for disallowing interest of ` 1,87,119/- is upheld. We confirm his order and reject all the grounds of appeal of the assessee.”

The findings recorded by the Tribunal have not been shown to be illegal or perverse in any manner. Adverting to judgment in Kedarnath Jute Manufacturing Co. Limited's case (supra) on which reliance has been placed by learned counsel for the appellant-assessee, it was held that an assessee who follows the mercantile system of accounting is entitled to deduct from the profits and gains of the business such liability which had accrued during the period for which the profits and gains were being GURBAX SINGH 2014.10.13 11:12 integrity of this document High Court Chandigarh computed even though it had to be discharged at a future date. Such is not the situation in the present case. Thus, the assessee cannot derive any advantage from this decision. Consequently, the substantial question of law is answered against the assessee. The appeal stands dismissed. (Ajay Kumar Mittal) Judge September 01, 2014 (Fateh Deep Singh) 'gs' Judge GURBAX SINGH 2014.10.13 11:12 integrity of this document High Court Chandigarh