GRANDHI ANUPAMA,VISAKHAPATNAM vs. THE ASSISTANT COMMISSIONER OF INCOME TAX, CIRCLE-4(1), , VISAKHAPATNAM

Per Shri D.S.Sunder Singh, Accountant Member : This appeal is filed by the assessee against the order of the Commissioner of Income Tax (Appeals)-6, Hyderabad in Appeal No. 0002/2015-16/B2/CIT(A)-6 dated 15.03.2019 for the Assessment Year (A.Y.) 2012-13.

2 I.T.A. No.266/Viz/2019, A.Y.2012-13 Smt.Grandhi Anupama, Visakhapatnam 2. In this case, all the grounds of appeal are related to sustaining the addition of Rs.12,71,348/- out of the total addition of Rs.16,41,509/- made by the Assessing Officer (AO) towards the disallowance of interest. The assessee is a partner in M/s Sri Tirumala Steel Enterprises, filed her return of income on 29.10.2012 declaring taxable income of Rs.19,70,970/-. The case was taken up for scrutiny and during the course of assessment proceedings, the AO found that the assessee had received the interest of Rs.22,98,853/- on capital contribution from the partnership firm. From the said interest income, the assessee claimed the deduction of Rs.16,41,509/- representing the interest payment on loans and admitted the balance amount of Rs.6,57,344/- as income from business. The AO found that the assessee was not maintaining the books of accounts and apart from the contribution to capital in the partnership firm the assessee also made the investments in a company M/s Tirumala Steel Rolling Mills Pvt. Ltd. and given loans and advances to various persons, thus, held that there is no clear nexus between earning of interest and the interest payment, hence, disallowed the entire interest of Rs.16,41,509/- and added back to the total income.

3 I.T.A. No.266/Viz/2019, A.Y.2012-13 Smt.Grandhi Anupama, Visakhapatnam maintenance of books of accounts. The assessee submitted before the Ld.CIT(A) that by mistake, the accountant of the assessee stated that the assessee was not maintaining books of accounts, though she has maintained the books of accounts regularly. She filed the details of loans availed from the bank and other outside lenders and submitted the details of loans availed and investment made in the partnership firm, Sri Tirumala Enterprises before the CIT(A) as an additional evidence. She further stated before the Ld.CIT(A) that the entire loans taken from various lenders were invested in the partnership firm and there is a clear nexus between the income earned from the partnership firm and the interest on loans, hence, requested the Ld.CIT(A) to admit the additional evidence. The Ld.CIT(A) admitted the additional evidence and examined the contention of the assessee with regard to sources of investments made in the partnership firm and the borrowings of the assessee. The assessee also furnished the statement of account of Union Bank of India, highlighting the utilization of funds and investment in capital account. After having examined the facts, the Ld.CIT(A) satisfied that there was a nexus for the income received and the unsecured loans. However, the Ld.CIT(A) observed that out of the investment made by the assessee in the partnership firm, the assessee had received two streams of income from the partnership firm, i.e interest on

4 I.T.A. No.266/Viz/2019, A.Y.2012-13 Smt.Grandhi Anupama, Visakhapatnam capital of Rs.22,98,853/- and the share of profit from the firm of Rs.78,94,246/-. Thus, the Ld.CIT(A) viewed that the share of profit from the firm being exempt u/s 10(2A), the expenditure relatable to earning of the share income attracts the disallowance u/s 14A of the Act r.w.r.8D of the Income Tax Rules. A ccordingly, the Ld.CIT(A) placing reliance on section 14A r.w. Rule 8D and the decision of Vishnu Anant Mahajan Vs. ACIT (2012), 22 taxmann.com 88 (Ahmedabad Tribunal Special Bench), Paras Bhomraj Oswal Vs. ACIT (2016) 50 ITR(T)554 (Pune-Tribunal) and the decision of ACIT Vs. Vinay Sehgal (2012) 27 taxmann.com 136 held that the interest expenditure on unsecured loans required to be apportioned proportionately to the share of profit from the partnership firm and the interest received on capital account in proportion to the income earned by the assessee. Accordingly restricted the disallowance to Rs.12,71,348/- against actual disallowance of Rs.16,41,509/- and allowed the appeal of the assessee partly. Against which the assessee filed appeal before this Tribunal requesting for relief of balance amount of Rs. 12,71,348/- which was confirmed by the Ld.CIT(A).

5 I.T.A. No.266/Viz/2019, A.Y.2012-13 Smt.Grandhi Anupama, Visakhapatnam the entire share of profit cannot be attributed to only investment, the Ld.AR argued that it is unjustified to attribute the entire profit to the capital contribution and make the disallowance of interest proportionately, since other activities were also involved in carrying on business such as marketing, distribution, sales etc, he argued that the reasonable disallowance may be made u/s 14A instead of making the proportionate disallowance on the basis of the income received by the assessee.

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disallowance proportionately to the exempt income as well as taxable income for which the unsecured loans were contributed as investment. For the sake of clarity and convenience, we extract relevant part of the order of the Ld.CIT(A), which reads as under :

“7.10. I have considered the objections/comments of the AO and examined the same in the light of the facts emanating from the assessment order and other evidence placed on record, At the outset, it is important to note that the main contention of the assessee that she was not provided with proper opportunity of being heard before finalization of the assessment order has not been commented upon by the AO. In the normal course during the remand proceedings, it is imperative on the part of the AO to verify the assessment record and to cull out the evidence to demonstrate that the issue of disallowance of interest expenditure was discussed with the. assessee or AR of the assessee, before the finalisation of the assessment order, by way of order sheet noting and issuing show cause notice proposing the addition/ disallowaice intended to be made by the AO. In the instant case, the AO has failed to adduce such evidence while submitting the report on the admissibility of additional evidence filed by the assessee, Under the circumstances, I am of the considered opinion that the AO had completed the assessment without providing proper opportunity of being heard, before resorting to disallowance of interest expenditure. Accordingly, the provisions of Rule 46A(1)(d) of the -Act are attracted to the facts of the instant case, and, therefore, I deem it fit to admit the additional evidence for the purpose of adjudicating the grounds of appeal filed by the assessee. 7.11. Coming to the merits of the contentions made by the assessee, including the additional evidence, as seen from the report of the AO, it appears that the AO has not examined the additional evidence and contentions made thereof on the presumption that the said additional evidence would not be considered by the appellate authority. 7.12. Be that as it may, I have perused the additional evidence filed by the assessee which is nothing but the details of funds / loans in respect of which the assessee has paid interest and utilisation of such funds/loans for the purpose of making investment in capital of the firm M/s Sree Tirumala Enterprises. Further, the assessee has furnished the statement of Union Bank of India highlighting the utilisation of funds towards making investment in capital account. 7.13. After having examined the same, it is observed that, prima facie, there

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is a nexus between loans borrowed from banks and outside parties and investment made in the capital of the firm. However, it is -important to note that during the FY 2011-12 relevant to the impugned AY 2012-13, the assessee has actually received two streams of income from the partnership firm M/s Sree Tirumala Enterprises, as given below: (1) Interest on capital Rs. 22,98,S3/- (2) Share of profit from firm Rs. 78,94,246/- Total Rs.1,01,93,099/- 7.14. As seen from the above, it is quite clear that the assessee has received an aggregate amount of Rs,1,01,93,099/- as income from the partnership firm. At this juncture, it is not out of place to mention that the share of profit received by the assessee from the partnership firm is exempt from tax in the hands of the assessee u/s 10(2A) of the Act inasmuch as the same has already suffered tax in the hands of the firm, On the other hand, the interest on capital received by the assessee from the partnership firm is taxable under the head "Business or profession", Accordingly, out of the total income received by the assessee from the partnership firm of Rs.1,01,93,099/-, a major chunk of Rs.78,94,246/- is tax exempt in the hands of the assessee, which worked out to 77.45%. Further, the balance amount of Rs.22,98,853/- which is taxable in the hands of the assessee constitute only 22.55% of the total income received from the partnership firm. 7.15. In view of the above, in the instant case, the provisions of section 14A of the Act are attracted wherein the expenditure incurred by the assessee in relation to tax exempt income shall not be allowed as deduction against taxable sources of income of the assessee. Accordingly, the interest expenditure claimed by the assessee attributable to taxable streams/sources of income from the firm i.e., interest on capital is only eligible as allowable expenditure. As a natural corollary, the proportionate interest expenditure attributable to tax exempt stream/sources of income from the firm i.e. share of profit should be disallowed as envisaged u/s. 14A of the Act rwr 8D of the Rules. 7.16. At this juncture, it is worthwhile to understand the provision of section 14A of the Act and Rule 8D of the Rules, and the same are reproduced below for ready reference: "Expenditure incurred in relation to income not includible in total income 14A (I) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.

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(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act. (3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does uniform part of the total income under this Act; Provided that nothing contained in this-section shall empower the Assessing Officer either to reassess under Section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee wider Section 154, for any assessment year beginning on or before the 1st day of April, 2001". (Emphasis supplied) Rule 8D: Method for determining amount of expenditure in relation to Income not includible in total income. 8D (I) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with - (a) the correctness of claim of expenditure made by the assesses; or (b) the claim made by the assessee that no expenditure has been incurred, in relation to income which does not form part of the total income under the Ac for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule(2) (2) The expenditure in relation to income which, does not form part of the total income shall be the aggregate of following amounts, namely. - (i) the amount of expenditure directly relating to income which does not form part of total income ; and (ii) an amount equal to one percent of the annual average of the- monthly averages of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income: (3) ** ** ** (emphasis supplied)

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7.17. Coming to the issue on hand, it is an admitted fact that the assessee, being a partner, has earned/received share of profit of Rs.78,94,2461- from the partnership firm M/s Sree Tirumala Enterprises and claimed exemption of the same from taxation u/s. 10(2A) of the Act. Further, the assessee has not apportioned interest expenditure claimed of Rs16,41,509/- towards share of profit, but claimed the entire interest expenditure against taxable income earned / received from the partnership firm i.e., interest on capital of Rs.22,98,853/-.

7.18. Accordingly, in terms of the provisions of section 14A rwr 8D of Rules, the assessee is eligible to claim interest expenditure as allowable deduction against the interest on capital in proportion of its contribution in the total amount of income received from the partnership firm M/s Sree Tirumala Enterprises i.e.,22.55% of the interest expenditure claimed of Rs,16,41,509/-. For the sake of ready reference, the proportionate interest expenditure attributable to tax exempt income i.e., share of profit and taxable income i.e. interest on capital are computed as under

1) Percentage of tax-exempt income i.e., share of profit opt of total income received from the partnership firm: 77.45%. Proportionate interest expenditure attributable to tax-exempt income i.e,, share of profit: 16,41,509 X 77.45% = Rs.12,71,348/-

2) Percentage of taxable income i.e., interest on capital out of total income received from the partnership firm : 22.55% 3) Percentage of taxable income i.e. interest on capital out of total income received from the partnership firm : 22.55% 4) Proportionate interest expenditure attributable to taxable income i.e. interest on capital : 16,41,509 x 22.55% = Rs.3,70,160/- As such, the assessee is eligible to claim only Rs.3,70,160/- as allowable interest expenditure against interest on capital received from the firm in place of Rs. 16,41,5091- claimed by the assessee. Thus, the excess amount of interest claimed of Rs.12,71,348/-, which is actually attributable to tax exempt income i.e., share of profit, is not allowable as deduction while computing the total income of the assessee.

7.19. In this regard, reliance is placed on following case laws wherein it has been held that provisions of section 14A of the Act are applicable in respect of share income of a partner from a partnership firm which is

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exempt from tax u/s 10(2A) of the Act, and, therefore, proportionate expenditure incurred in earning the share of profit from the firm should be disallowed:

1) Vishnu Anant Mahajan Vs ACIT [2012] 22 taxmann.com 88 (Ahmadabad Tribunal- Special Bench ): In this case; Special Bench of Hon'ble ITAT has held that - Share income of a partner from partnership firm is not liable to tax under section 10(2A) of the Act and, in such a case, provisions of section 14A of the Act apply to disallow expenditure incurred on earning said income. The relevant portion of the judgement is reproduced below for ready reference: “In so far as share income is concerned, the field is occupied by the tax law, as it is enacted that the share income shall not form part of total income of the partners. 'Therefore, in view of this specific provision 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. When section 10(2A) speaks of its exclusion from the total income, it means, the total income of the person whose case is under consideration. The instant case, is that of the partner and, therefore, what is to be examined is whether the share income is excluded from his total income. The answer is obviously in the affirmative. In such a situation, provision contained in section 14A will come into operation and any expenditure incurred in earning the share income will have to be disallowed. Thus, the Commissioner (Appeals) rightly held that the provision contained in section 14A is applicable to the facts of the case. Further, it has been held in the ease of Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 194 Taxman 203 (Bom.) that all facts may be taken into consideration for determining the quantum of disallowance, to be made. This portion of the judgment is applicable only in respect of determination of quantum of disallowance, The Commissioner (Appeals) has disallowed the expenditure in the ratio of income not included in the total income and the income received from the firm. In the absence of any argument regarding any error in this part of the decision, it is held that he was right in doing so.” [Para 7] (emphasis supplied)

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2) Paras Bhomraj Oswal Vs ACIT [2016] 50 ITR (T) 554 (Pune – Trib.) In this case, Hon'ble ITAT has held that - as per the provisions of 14A of the Act expenditure incurred for earning tax fee income should be disallowed while computing the total income of the assessee. Accordingly, in the case of partner of a partnership firm, as the share of profits is exempt from tax under section 10(2A) of the Act in the hands of the partner, disallowance under section 14A of the Act is attracted in respect of such income. The relevant portion of the judgement is reproduced below for ready reference: “8. The ground No. 3 raised by the assessee in appeal is with respect to disallowance of deduction u/s. 14A r. w: Rule 8D in respect of share of profit received by the assessee from partnership .firm. The assessee has received tax free income of Rs. 49,79,071/- from M/s. Tirupati Pooja Construction where the assessee has holding 60% share. The contention of the assessee Is that the income of the partnership firm is not tax free. Before distribution of profits, tax is paid on the income of partnership firm, therefore, no disallowance u/s. 14A should be made on the share of profit received from partnership firm. The Ld. Counsel has placed reliance on the Circular No. 8/2014 to support his contentions that once the tax has been paid by the firm the same is not liable to be taxed in the hands of the partners of the assessee. Therefore, no disallowance should be made in the hands of the assessee. We do not find merit in the submissions of the Ld.Counsel for the assessee. Disallowance u/s 14A is with respect to expenditure incurred for earning tax free income. The share of profits from partnership firm is exempt from tax u/s 10(2A) of the Act in the hands of the partner. Therefore, it is tax free income in the hands of the assessee. The assessee has not made any disallowance for earning tax free income. The Assessing Officer has rightly invoked the provisions of section 14A r.w.Rule 8D for making such disallowance. The Circular No.8/2014 rather clarifies the reason as to why the share of profits of a partnership firm is exempt from tax in the hands of partner. The same is reproduced hereunder:

'SECTION 10(2A) OF THE INCOME TAX ACT, 1961.-. FIRM - SHARE OF PROFITS TO PARTNER OF FIRM - CLARIFICATION ON INTERPRETATION OF PROVISIONS OF SECTION 1O(2A) IN CASES WHERE INCOME OF FIRM IS EXEMPT CIRCULAR NO. 8/2014 [F NO. 173/99/2013-ITA-I], DATED 31-3-2014

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A reference has been received in the Board in connection with the interpretation of provisions of section 10(2A) of the Income tax Act, 1961 (“Act”) seeking clarification as to what will be the amount exempt in the hands of the partners of a partnership firm in cases where the firm has claimed exemption/deduction under Chapter III or VI-A of the Act. 2. The matter has been examined. Sub section (2A) of section 10 was inserted by the Finance Act, 1992 w.ef 1-4-1993 due to a change in the scheme of taxation of partnership firms. Since assessment year 1993-94, a firm is assessed as such and is liable to pay tax on its total income. A partner is not liable to tax once again on his share in the said total income. 3. It is clarified that total income of the firm for sub section (2A) of section 10 of the Act, as interpreted contextually, includes income which is exempt or deductible under various provisions of the Act. It is, therefore, further clarified that the income of a firm is to be taxed in the hands of the firm only and the same can under no circumstances be taxed in the hands of its partners. Accordingly, the entire profit credited to the partners' accounts in the firm would be exempt from tax in the hands of such partners, even if the income chargeable to tax becomes NIL in the hands of the firm on account of any exemption or deduction as per the provisions of the Act. 4. This may be brought to the notice of all concerned" A perusal of circular would show that the interpretation drawn by Ld.Counsel for excluding share of partnership firm from scope of section 14A is not sustainable. We do not find any infirmity in the order of the Commissioner of Income Tax (Appeals) in upholding the disallowance made by the Assessing Officer. Accordingly, the ground No.3 raised by the assessee in its appeal is dismissed 3) ACIT Vs. Vinay Sehgal [2012] 27 taxmann.com 136 (Chandigarh Tribunal) : In this case, It has been held by the Hon'ble ITAT that - Where the assessee had invested 'borrowed funds in partnership firm from which he received share of profit not taxable in his hands, interest relatable to borrowed funds utilized in firm was to be disallowed under section 14A of the Act.

4) Hoshang D.Nanavati Vs. ACIT [2012 16 ITR(T) 614 (Mumbai – Trib): In this case, it has been held by the Hon'ble ITAT that- Where the assessee has earned income from profit share as also from remuneration from same firm expenses incurred by assessee in ratio which profit share in firm bore to total receipts from firm, i.e., on

13 I.T.A. No.266/Viz/2019, A.Y.2012-13 Smt.Grandhi Anupama, Visakhapatnam account of profit share as also remuneration, were to be disallowed under section 14A of the Act.

7.20. In view of the aforementioned factual matrix matrix and settled position of law, I am of the firm view that, in the instant case, the provisions of section 14A rwr 3D are squarely applicable. Accordingly, the AD is directed to restrict the disallowance of interest expenditure to the extent of RsJ2,71,348/-. Thus, the assessee would get a relief of Rs 3,70,160/-. Hence, the grounds appeal Filed by the assessee are partly allowed, 8.0. In the result, appeal for the AY 2012-13 is partly allowed.” 6.1. The Ld.AR submitted that the entire expenditure cannot not be allocated proportionately to the income earned on two different streams since, the income earned not only on account of capital contribution, but also on account of various services rendered by the firm. Therefore, requested to make the reasonable disallowance for capital contribution and also for other activities of earning the income. We have carefully considered the submissions of the Ld.AR and unable to convince with the argument of the Ld.AR, since, the share of profit is directly related to the capital contribution made by the assessee. For other services mentioned by the Ld.AR, the assessee is free to draw salary or remuneration as provided in the partnership deed. The Hon’ble Special Bench also confirmed the disallowance of expenditure in the ratio of income earned that is exempt and the taxable income. Therefore, we hold that the Ld.CIT(A) has fairly restricted the disallowance proportionately on the basis of income earned

14 I.T.A. No.266/Viz/2019, A.Y.2012-13 Smt.Grandhi Anupama, Visakhapatnam by the assessee with regard to exempt income as well as the taxable, thus, we do not find any reason to interfere with the order of the Ld.CIT(A) and the same is upheld.

Order pronounced in the open court on 15th November, 2019.

Sd/- Sd/- (िी.दुगाा राि) (धड.एस. सुन्दर धसंह) (V. DURGA RAO) (D.S. SUNDER SINGH) न्याधयक सदस्य/JUDICIAL MEMBER लेखा सदस्य/ACCOUNTANT MEMBER नवशधखधपटणम /Visakhapatnam नदनधंक /Dated : 15.11.2019 L.Rama, SPS आदेश की प्रतितिति अग्रेतिि/Copy of the order forwarded to:- 1. ननधधाऩरती/ The Assessee - Smt.Grandhi Anupama, D.No.26-08-62, R.R.M.R.Road, Visakhapatnam 2. रधजस्व/The Revenue - Asst.Commissioner of Income Tax , Circle-4(1), Visakhapatnam 3. The Principal Commissioner of Income Tax-2, Visakhapatnam 4. The Commissioner of Income Tax (Appeals)-6, Hyderabad 5. तिभागीय प्रतितिति, आयकर अिीिीय अतिकरण, तिशाखािटणम/DR, ITAT, Visakhapatnam 6.गार्ड फ़ाईि / Guard file

आदेशािुसार / BY ORDER // True Copy // Sr. Private Secretary ITAT, Visakhapatnam