THE COMMISSIONER OF INCOME TAX, vs. M/S H. R. DODDANNAVAR

: 1 : IN THE HIGH COURT OF KARNATAKA DHARWAD BENCH ON THE 23RD DAY OF JULY, 2015 BEFORE THE HON’BLE MR.JUSTICE RAVI MALIMATH AND THE HON’BLE MR.JUSTICE P.S. DINESH KUMAR I.T.A.NO.5021/2011 (INCOME TAX) BETWEEN 1. THE COMMISSIONER OF INCOME TAX BELGAUM 2. THE ACIT RANGE-2, BELGAUM ... APPELLANTS (By Sri. Y V RAVIRAJ, ADV.,) AND M/s H. R. DODDANNAVAR DODDANNAVAR TRADE CENTRE P.B. ROAD, FORT ROAD BELGAUM ... RESPONDENT (By Sri MALHARAO & Sri H.R. KAMBIYAVAR, ADVs., FOR Sri S. PARTHASARATHI, ADV.,) THIS ITA FILED U/SEC.260A OF THE INCOME TAX ACT, 1961 AGAINST ORDER PASSED IN ITA.NO.28/PNJ/2010 DTD: 12-04-2011 ON THE FILE OF THE INCOME TAX APPELLATE TRIBUNAL, PANAJI BENCH, PANAJI, ALLOWING THE APPEAL FILED BY AN ASSESSEE.

: 2 : RESERVED ON 29.06.2015 PRONOUNCED ON 23.07.2015 THIS APPEAL COMING ON THIS DAY, P.S.DINESH KUMAR J., DELIVERED THE FOLLOWING: JUDGMENT The revenue is in appeal challenging the order dated 12.4.2011 in ITA No.28/PNJ/2010 passed by the Income Tax Appellate Tribunal, Panaji Bench, Panaji. This appeal was admitted on 21.2.2012 to examine the following questions of law raised by the appellants:- 1. Whether the ITAT has not erred in law and on the facts of the case in not considering that the payment of Rs.1,80,76,676/- as compensation was on account of private dispute between partners of a dissolved firm not in existence and relating to an earlier year and therefore, payment is not an allowable expenditure in the hands of the assessee under Section 37 of the Income Tax Act, 1961? 2. Whether the Tribunal is correct in holding that the payment of compensation was made by the assessee to protect its business and as such incidental to the business even thought he assessee was not liable to discharge liability arising between the partners of the dissolved firm with regard to low grade iron ore stock not maketable and also which was not taken over by the newly formed assessee firm?

: 3 : 3. Whether the Tribunal was right in law in holding that the payment of compensation was in the nature of revenue expenditure when the main object of compensation was unrelated to trading activity of the assessee but was to make good of loss to the source of income which was damaging due to dispute between the old partners and as such the said expenditure is capital in nature? 4. Whether on the facts and circumstances of the case, the Tribunal is justified in coming to the conclusion that the compensation was paid voluntarily under “commercial expediency” without considering the material fact that the assessee has sustained loss in this year and subsequent year and as such no profit has been earned so as to consider commercial expediency? 2. Briefly stated the facts of the case are, the assessee filed a return of Income on 30.10.2006 declaring a loss of Rs.45,99,763/- along with tax audit report under Section 44AB of the Income Tax Act, 1961 [‘Act’ for short]. The assessee’s case was taken up for scrutiny and notices under Sections 143(2) and 142(1) were issued along with a questionnaire calling upon the assessee to furnish various information sought for. Assessee’s Chartered Accountant appeared before the authority with the

: 4 : Books of Accounts and other documents and furnished certain details. It was noticed by the authorities that a sum of Rs.1,80,76,676/- was shown as compensation paid in terms of a Court order in the profit and loss account and a legal expenses of Rs.6,74,362/- was debited towards the legal fees to the Advocate. 3. The assessee in its communication dated 27.11.2008 contended as follows:- “We have paid compensation of Rs.1,80,76,676/- to Deshbhushan Hirachand Doddanavar as per the decree of the Court. The copy of the Court Decree is enclosed. The payment made to Shri. Deshbhushan Doddannavar is in the course of business and the TDS provisions are not applicable. The payment is neither out of part profits of the business of the firm, nor it is interest or payment by way of brokerage, commission etc.” 4. The assessee also filed opinions of two experts in support of its defence. By a communication dated 27.11.2008, a detailed questionnaire was issued to the assessee by the Department to furnish further information.

: 5 : 5. A reply dated 1.12.2008 was filed by the assessee stating inter alia that Sri Deshbhushan Doddannavar s/o Hirachand Doddannavar (Deshbhushan for short) was a partner in a firm called M/s. H.R.Doddanavar. The said firm was in the business of mining and the mining lease was in the name of Sri. Hirachand R. Doddanavar. On 13.10.2003, the firm was dissolved. As per Dissolution Deed, entire assets and liabilities of the firm came to the partner who was holding the mining lease i.e., Sri. Hirachand R. Doddanavar. Subsequently, on 19.1.2004 a firm again in the name and style M/s. H.R. Doddanavar was constituted. Sri Hirachand R. Doddanavar, the owner of the mining lease, allowed the assessee, the new firm as per clause 4(e) of the partnership deed to undertake mining operations. Thus, the partnership got rights of mining. Subsequently, Deshbhushan claiming to be a partner in M/s. H R Doddanavar(Old) started questioning the disssolution of the old firm and commenced some litigation in that behalf. In order to settle the said disputes, Deshbhushan was paid a sum of Rs.1.80 crores. The assessing authority called upon the assessee to substantiate its claim of

: 6 : expenditure in the nature of revenue expenses incidental to its business and as it was noticed from the records that Deshbhushan had nothing to do with the assessee – firm and he was having a debit balance in the partnership firm. Therefore, question of making payment of compensation, which is in the nature of capital expenditure, would not have arisen at all. The assessee putforth a defence that the said compensation was paid to Deshbhushan as per a decree of the Court which was incurred in the course of the business. The assessing authority came to the conclusion that the compensation was not a liability of the assessee firm. With regard to the payment, the assessing authority came to the conclusion that there was no direction by any Court to pay the amount of compensation and thus held that liability did not arise out of any decree of the Court, but it was in terms of a compromise arrived between Sri Hirachand R. Doddanavar and his son Deshbhushan. The assessing authority on verification of deed of dissolution came to the conclusion that the assessee was not liable to pay any compensation and the liability arose on account of a dispute related with the dissolution

: 7 : of erstwhile partnership firm and not to the business of the assessee. Thus, the Assessing Authority held that payment was not made within the course of business for the profit of the firm and it could not be allowed under Section 37(1) of the Act. Aggrieved by the order of the Assessing Authority, assesee filed an appeal before the Commissioner (Appeals) who dismissed the same vide order dated 13.11.2009 which was challenged in No.ITA No.28/PNJ/2010 before the Income Tax Appellate Tribunal, Panaji Bench, Panaji [‘ITAT’ for short]. ITAT by its order dated 12.4.2011 allowed the same. Hence, this Appeal. 6. We have heard Sri Y.V. Raviraj, learned standing Counsel for Income Tax Department and Sri Malharao for Sri S. Parthasarathi, learned Counsel for the respondent. 7. Learned Counsel for the Revenue contends that the amount of Rs.1,80,79,676/- was paid by the partnership firm M/s. H.R. Doddanavar to Deshbhushan son of Sri H.R.Doddanavar Deshbhushan, who was a partner in the erstwhile firm dissolved on 13.10.2003. He submits that collusive

: 8 : suits were instituted by the son and a compromise petition was filed in a writ appeal, wherein, it is stated that a sum of Rs.1,80,00,000/- has been paid to Deshbhushan. In sum and substance, it is the case of the revenue that there was absolutely no reason for the assessee to pay any money to Deshbhushan as was rightly held by the Assessing Authority and first Appellate Authority and therefore the order of ITAT is unsustainable in law giving rise to questions of law framed hereinabove. 8. Learned Counsel for the appellants has produced copies of various documents such as Partnership Deed dated 20.5.1976; Deed of Dissolution dated 13.10.2003; Judgment and Order dated 29.9.2005 in WA No.2669/2005 c/w 2671/2005 (GM-MMS); Compromise Petition; Judgment and Order dated 1.4.2005 in W.P.No.45966/2004; Memo dated 9.11.2004 issued by the Director, Department of Mines & Geology and Judgment and Order dated 15.4.2005 in W.P.No.52860/2003 for perusal of this Court.

: 9 : 9. In reply, learned Counsel for the assessee strenuously contends that the iron – ore produced in the mine owned by Sri H.R. Doddanavar was of very inferior quality. The erstwhile firm came to be dissolved on 13.10.2003. Subsequently, assessee – partnership firm commenced its business. Looking into the prospects of the new partnership firm, Deshbhushan started litigations in various forums. He also managed to obtain Mineral Despatch Permit from the office of the Senior Geologist, Dharwad on 26.10.2004 representing himself as partner of M/s. H.R. Doddanavar(old). The said order came to be withdrawn and Deshbhushan challenged the order of withdrawal in W.P.No.45966/2004 (GM-MMS), in which, this Court quashed the order impugend therein and directed the Director of Mines & Geology to pass appropriate orders in accordance with law after hearing all the parties concerned. Aggrieved by the said order, H.R. Doddannavar in his capacity as Proprietor challenged the order of the learned Single Judge in W.A.No.2669/2005 c/w. 2671/2005 (GM-MMS), which came to be disposed of by order dated 29.9.2005 in terms of compromise

: 10 : arrived at between the parties. He submits that to give quietus to the litigation, it was agreed to pay Rs.1,80,00,000/- towards full and final settlement of all claims raised by Deshbhushan. Therefore, the payment made as per the said compromise was due to commercial expediency. He submits that the Assessing Authority and the first Appellate Authority had passed erroneous orders, which has been rightly set aside by the ITAT. In the circumstances, he prays for dismissal of the appeal. 10. We have given our anxious consideration to the submissions of the learned Counsel for the parties and examined the records. 11. The facts are not in dispute and in a very narrow compass. Initially a partnership firm in the name and style of M/s. Hirachand Ramchandra Doddanavar was founded on 20.5.1976. One of the Partners Sri H.R. Doddanavar was holding a mining lease to extract iron – ore. The partnership was at will. On 13.10.2003, the partnership was dissolved. Clause 4 of the Dissolution Deed reads as follows:-

: 11 : “4. That 1. SHRI ASHOK HIRACHAND DODDANAVAR, 2. SHRI DESHBHUSHAN HIRACHAND DODDANAVAR, 3. SHRI RAMESH HIRACHAND DODDANAVAR, 4. SHRI VINOD SURENDRA DODDANAVAR, 5. SOU. SHUBHADA RAJIV DODDANAVAR hereby declare that they do not have any right or interest in the assets of the firm and they shall not be responsible for payment of liabilities recorded in the books of accounts of the firm after 13th October, 2003.” 12. It is thus clear that after dissolution of the partnership, Deshbhushan did not have any right in the assets of the firm. Simultaneously with dissolution of the firm, Sri H.R. Doddannavar started acting in his capacity as a Proprietor. Subsequently, a new partnership firm was formed on 19.1.2004 in the name and style of M/s. H.R. Doddannavar, converting the proprietary concern into a partnership firm by taking new partners. Records reveal that H.R.Doddanavar in his capacity as Proprietor filed a writ petition in W.P.No.52680/2003 praying for a direction to the Mines Department and others, for renewal of

: 12 : his application in respect of his mine. The said writ petition came to be dismissed vide order dated 15.4.2005. 13. M/s Hirachand Ramachandra Doddanavar (firm bearing registration No.1143/76-77) represented by Deshbhushan filed a writ petition in W.P.45966/2004 contending that the Mines and Geology Department had initially directed for issuance of dispatch permit on 1.10.2004, in the name of the petitioner. Subsequently, on 26.10.2004, the Director of Mines and Geology had directed issuance of Mineral Dispatch Permits to Deshbhushan and withdrew the said directions. The order of withdrawal was subject matter of W.P.No.45966/2004. This Court vide order dated 1.4.2005 quashed the order impugned therein and directed the Mines Department to pass fresh orders in accordance with law. These two orders namely order dated 1.4.2005 in W.P.No.45966/2004 and order dated 15.4.2005 in W.P.No.52860/2003 were challenged in W.A.No.2669/2005 and W.A.No.2671/2005.

: 13 : 14. Both writ appeals were disposed of vide order dated 29.9.2005 in terms of a compromise in which a sum of Rs.1,80,00,000/- was paid to Deshbhushan towards full and final settlement for his claims. In paragraph No.9 of the Compromise Petition, details of litigation are furnished and it reads as follows:- “9. Sri Deshbhushan Hirachand Doddannavar has filed the following suits:- i) O.S.No.240/2004, ii) O.S.No.359/2004, iii) O.S.No.476/2005, iv) O.S.No.103/2005, v) O.S.No.572/2004 & vi) M.A.No.52/2004 and vii) M.A.No.53/2004 pending before Civil Courts at Belgaum and Gadag. Shri. Deshbhushan Hirachand Doddanavar undertakes to withdraw the above said suits and appeals within one week from today and further undertakes to withdraw all objections, applications, Complaints and Petitions filed before various authorities such as Registrar of Firms, Director of Mines and Geology, Karnataka Forest Departments and other authorities forthwith.” 15. Deshbhushan undertook to withdraw the suits and appeals within one week from the date of the compromise petition and also to withdraw all objections, applications, complaints and petitions filed before various authorities. It is

: 14 : relevant to note that Deshbhushan had filed the writ petition in W.P.No.52860/2003 in his capacity as a partner of erstwhile firm which stood dissolved as on 13.10.2003. Therefore, litigations instituted by Deshbhushan had no nexus with the assessee firm warranting payment of Rs.1,80,00,000/-. The prayers contained in the suit filed by Deshbhushan in O.S.No.240/2004 read as follows:- a) Restraining the partners of the defendant from taking any vital decisions in connection with the business activities of the said firm without the valid consent of the plaintiff in writing till the firm is not legally dissolved. b) Permitting the plaintiff to participate in the business of operations of the said firm including the legal right to check and inspect the books of accounts of the said firm and to scrutinize all the material documents and permitting the plaintiff to enter any office of the said firm and operate all the business activities till the firm is not legally dissolved and other reliefs. (sic) 16. Another suit in O.S.No.359/2004 was filed praying for an injunction to restrain the defendant namely,

: 15 : H.R. Doddannavar, registered Partnership Firm from shifting the stock of iron – ore stored at the Mines at Doni Village. 17. The third suit in O.S.No.476/2006 was filed against Shri Raju Surendra Doddannavar and H.R. Doddannavar with a prayer to declare the General Power of Attorney dated 14.10.2003 executed by H.R. Doddannavar in favour of Shri Raju Surendra Doddannavar as null and void and other incidental reliefs. 18. It is relevant to note that Deshbhushan had got an IA for impleadment in W.P.No.52860/2003. Vide order dated 3.9.2004, the learned Single Judge of this Court has held that he is not a necessary party to the writ petition and rejected the IA. 19. We have perused following ruling relied upon by the learned Counsel for the respondent.

: 16 : 1) In the case of SASSOON J. DAVID & CO. P. LTD. V. COMMISSIONER OF INCOME TAX reported in [(1979) 118 ITR 261 (SC)], the Hon’ble Supreme Court was considering a case in which the Company was neither dissolved nor its business undertaking sold; 2) In the case of COMMISSIONER OF INCOME TAX v. MANDOVI HOTEL (P) LTD, reported in [(2006)284 ITR 0129 (BOM))] , the Hon’ble Bombay High Court was considering a case in which certain sum was paid by the assessee to the retiring partner; 3) In the case of COMMISSIONER OF INCOME TAX v. RAJARAM BANDEKAR reported in [(1994) 208 ITR 503 (Bom)], the Hon’ble Bombay High Court was considering a case in which the terms of settlement had required one of the parties to supply certain specific quantities of iron ore, and the assessee firm had agreed to fulfill certain conditions.

: 17 : 4) In ITA No.5021/2009 decided on 6.1.2012 this Court was considering a case of payment made towards contribution for compensatory afforestation. Thus, the above rulings are not applicable to the facts of this case. 20. In the instant case, compromise was arrived at between father and son. Records do not disclose any compelling circumstances to enter into such compromise. The recipient of money was the partner of a dissolved firm. Even after dissolution, he had misrepresented himself as the partner of a firm which was not in existence. Therefore, he was not a party to the proceedings in writ appeal in his individual capacity. His application for impleadment as an individual was rejected in W.P.No.52860/2003 vide order dated 3.9.2004. Therefore, in law, recipient of money was a non-party to the proceedings. This is nothing but abuse of process of law. 21. Therefore, in our considered view, the Assessing Authority by its detailed order dated 29.12.2008 has disallowed the sum of Rs.1,80,79,676/- paid to Deshbhushan and Rs.6,74,362/- paid to the Advocates in the profit and loss

: 18 : Account. The amount paid to Deshbhushan as per the compromise is Rs.1,80,00,000/- and what is claimed before Income Tax Authorities and the deduction claimed under Section 37(1) is Rs.1,80,79,676/-. Thus, an excess deduction of Rs.79,676/- was claimed by the assessee. The ITAT has come to an erroneous conclusion that the payment was made to Deshbhushan on account of various disputes raised by him to put an end to the litigation and to give way to smooth operation of the business. It has also erroneously held that the payment was made as per “directions” of this Court, which is factually incorrect. There existed no “commercial expediency” to pay Rs.1,80,00,000/- much less was there any direction by this Court to pay any money to Deshbhushan. 22. In the circumstances, the substantial questions of law raised by the revenue richly merit consideration and accordingly answered in favour of the revenue.

: 19 : 23. In the result, we pass the following:- ORDER (i) The appeal is allowed; (ii) Order dated 12.4.2011 in ITA No.28/PNJ/2010 passed by the Income tax Appellate Tribunal, Panaji Bench, Panaji for the assessment year 2006-2007, is set aside; and (iii) Consequently, the assessment order dated 29.12.2008 passed by the Addl. Commissioner of Income Tax, Range – 2, Belgaum, is confirmed; Ordered accordingly. No costs. Sd/- JUDGE Sd/- JUDGE cp*