Ita/1132/2008 Of M/S Hotel Roopa v. Commissioner Of Income Tax

1 IN THB HIGH COURT OF KARNATAKA AT BANGALOREDATEBD THIS THE 1 DAY OF NOVEMBER, 2014 “PRESENT: THE HON’BLE MR. JUSTICE N.KUMAR| AND THE HON’BLE MR. JUSTICE B.MANOHAR| ITA NO.1132/2008 BETWEEN M/S. HOTEL ROOPA,BALMATTA ROAD,MANGALORE,REPRESENTED BY|ITS PARTNER,SRI VINAY CHANDRA SUVARNA.APPELLANT (BY SRI S.P.BHAT & SRI C.BASAVAIAH, ADVS.) AND 1.COMMISSIONER OF INCOME TAX, C.R.BUILDING, ATTAVR,MANGALORE.|C.R.BUILDING, ATTAVR,MANGALORE.|2.ASST. COMMISSIONER,|OF INCOME TAX CIRCLE-1(1)MANGALORE.|MRE SPONDENTSOF INCOME TAX CIRCLE-1(1)MANGALORE.|MRE SPONDENTS (BY SRI JEEVAN.J.NEERALGI, STANDING COUNSEL) THIS ITA IS FILED UNDER SECTION 260-A OF THE!INCOME TAX ACT, 1961, ARISING OUT OF ORDER DATED08.08.2008 PASSED IN ITA NO.1176/BNG/2007, FOR THE|ASSKSSMEBNTYRBRA2002-2003,PRAYING|TO.(I)FORMULATE THE SUBSTANTIAL QUESTIONS OF LAW|STATED THEREIN (IJ) ALLOW THE APPEAL AND SET ASIDETHE ORDER PASSED BY THE ITAT, BANGALORE IN ITA NO.1176/BNG/2007, DATED 08.08.2008 CONFIRM THE|ORDER OF CIT(A) AND THE ASSESSING AUTHORITY. THIS ITA COMING ON FOR FINAL HBARING THIS.DAY,N.KRUMAR J,5 DELIVERED THE FOLLOWING: JU DBiGMENT Assessee has preferred this appeal challenging theconcurrent findings recorded by three Authorities thatthe interest paid on the borrowing is not for the purposeof business and theretore same is not deductable under|section 36(1)(111) of the Income Tax Act, 1961. 2 |The assessee is a partnership firm which isrunning boarding and lodging by name Hotel Roopa inMangalore. Originally it consisted four partners and on06.10.2000, one more partner was inducted as apartner. On 20.10.2001, three partners retired from thepartnership firm and the business was continued onlywith the remaining two partners. The assessee firmborrowed a sum of Rs.75,00,000/- from the Bank forthe purpose of settling the account to the retiringpartners and the claim deducted of Rs.9,04,803/-under Section 36(1)(111) towards interest on the borrowalmade to be Bank. The Assessing Officer rejected the 3 claim of the assessee on the ground that the borrowalhas been made for the purpose of discharging thepersonal liability for the continuing partners of the firmand the payment made to the retiring partners hasnothing to do with the business of the firm. Therefore,borrowing cannot be considered has having been madefor the purpose of business of the firm. Aggrieved by thesaid order, the assessee preferred this appeal to theCommissioner of Income-Tax (Appeals) who dismissedthe appeal. In second appeal before the Tribunal,arguments of the assessee did not find favour.Therefore, appeal came to be dismissed. Aggrieved bythese three orders, the assessee is before this Court. | 2 |This appeal came to be admitted onconsidering the following substantial questions of lawon 09.03.2009, which reads as under: “1.|Whether, on the facts and circumstances|of the case, the tribunal is Justified in|rejecting the assessee’s claim of interestof Rs.5,04,803/- on the borrowed funds|of Rs.75,00,000/- from the Bank under| 4 section 36(1)(ul) of the Income Tax Act,|1961? 2. Whether on the facts and circumstances|of the case, the tribunal is Justified inholding that borrowing was not made fortheDUT POSEofthebusinessandthereforethe|interestclaimedasdeduction under Section 36(1)(ul) of theAct 1s not qn aqlloiwwable deductio 3.Whether on the facts and circumstances|of the case, the conclusion of the tribunal|thatthepaymentstothe|retiringpartners by the continuing partners had|been made only because of increase in|their shares is based on any materials? 4 Whethertheorderpassedby|thetribunal is vitiated on account of non-consideration of the various contentions|raised by the petitioner firm in itssubmission made before it? 5. Whether the tribunal in coming to its|conclusionhas|acted.judiciallyinaccordance with the principles laid downby the Supreme Court in 66 ITR 714?"| 5 Whether on the facts and circumstances|of the case, the tribunal is Justified inholding that borrowing was not made fortheDUT POSEofthebusinessandthereforethe|interestclaimedasdeduction under Section 36(1)(ul) of theAct 1s not qn aqlloiwwable deductio 3.Whether on the facts and circumstances|of the case, the conclusion of the tribunal|thatthepaymentstothe|retiringpartners by the continuing partners had|been made only because of increase in|their shares is based on any materials? 4 Whethertheorderpassedby|thetribunal is vitiated on account of non-consideration of the various contentions|raised by the petitioner firm in itssubmission made before it? 5. Whether the tribunal in coming to its|conclusionhas|acted.judiciallyinaccordance with the principles laid downby the Supreme Court in 66 ITR 714?"| 5 4Learned Counsel for the assessee assailingthe impugned order contends that the borrowal of thefunds for the firm is for the purpose of discharging thelability of the firm to the retiring partners andtherefore, it falls under Section 37 of the PartnershipAct. Borrowal is only for the purpose of business. If thesaid amount has not been paid in terms of partnershipdeed, out going partners had right to proceed againstthe firm to recover the said amount, and in order toavoid such litigation and to protect the interest of thefirm, the aforesaid borrowal was undertaken andpayment was promptly made. The increase of the sharesof the continuing partners is not relevant in decidingwhether the borrowal is for the purpose of business ornot. The liability is that of the firm and not of anindividual partner. Therefore, he submits that, theassessment order is contrary to law and since both theappellate authorities have affirmed the impugned order,he is before this Court seeking for setting aside of theimpugned order. 6 5Per contra, learned Counsel for the revenue ©supports the impugned order passed and placesreliance to the Judgment of the Apex Court in the caseoT Madhav Prasad Jatia v. Commissioner of Income| Tax U.P.reported in (|I18 ITR 200). The Apex Courtwhile interpreting the provisions of Sections 10(2)(i11)and under Section 12(2) of the Income Tax Act, 1961.which deals with Section 36(1)(111) of the Act has heldthat: “Proceeding to consider the claim fordeduction made by the assessee under S.|10(2)(ut) or s.10(2)(xv), we may point out that|unders.10(2)|(111),threeconditionsarerequired to be satisfied in order to enable the|assessee to claim a deduction in respect of|interest on borrowed capital, namely, (a) thatmoney (capital) must have been borrowed bythe assessee, (b) that it must have been|borrowed for the purpose of business, and (c)|that the assessee must have paid interest on|the said amount and claimed it as qideduction. As regards the claim for deduction|in respect of expenditure under s.10(2)(xv),|the|aASSCSS CMUST|alsoSatisfy|three|conditions, namely, (a) it (the expenditure)| “Proceeding to consider the claim fordeduction made by the assessee under S.|10(2)(ut) or s.10(2)(xv), we may point out that|unders.10(2)|(111),threeconditionsarerequired to be satisfied in order to enable the|assessee to claim a deduction in respect of|interest on borrowed capital, namely, (a) thatmoney (capital) must have been borrowed bythe assessee, (b) that it must have been|borrowed for the purpose of business, and (c)|that the assessee must have paid interest on|the said amount and claimed it as qideduction. As regards the claim for deduction|in respect of expenditure under s.10(2)(xv),|the|aASSCSS CMUST|alsoSatisfy|three|conditions, namely, (a) it (the expenditure)| must not be an allowance of the nature|described in clauses (1) to (xiv), (b) it must not|be in the nature of capital expenditure or'personal expenses of the assessee, and (c) it|must have been laid out or expended wholly|and exclusively for the purpose of Ais|business. It cannot be disputed that the|expression ‘for the purpose of business"|occurring in s.10(2) (it) as also in s.10(2) (xv)|is wider in scope than the expression “for the|purpose of earning income, profits or gains"occurring in s.12(2) of the Act and, therefore,the scope for allowing a deduction under Ss.10(2) (ut) or 10(2) (xv) would be much wider|than the one available under s.12(2) of theAct. This Court in the case ofClIT v.Malayalam Plantations Ltd. [1964] 53 ITR|140 (SC)/} has explained that the former|expressionoccurringIn|S.10(2)(ut)and10(2)(xv), tts range being wide, may take in|not only the day-to-day running of a business|but|alsothe|rationalisationof|itsadministrationand.modernisationof|itsmachinery; it may include measures for the|preservation of the business and for theprotection of its assets and property fromexpropriation, coercive process or assertion ofhostile title; it may also comprehend payment| of statutory dues and taxes imposed as a pre-condition to commence or for the carrying on|of a business; it may comprehend many other|acts incidental to the carrying on of the|business but, however wide the meaning of|the expression may be, its limits are implicit|in it; the purpose shall be for the purposes ofbusiness, that is to say, the expenditure|incurred shall be for the carrying on of the|business and the assessee shall tncur it 1n'his capacity @S a person carrying on the|business”.. 6. From the aforesaid Judgment, it is clearthat, the claim for deduction in respect of interest onborrowed capital the assessee has to satisfy threeconditions: (i) that money must have been borrowed bythe assessee; (11) that it must have been borrowed forthe purpose of business; (ii) that the assessee musthave paid interest on the said amount and claimed it asa deduction. Similarly, from the aforesaid Judgment, itis also clear that for claiming the deduction in respect ofexpenditure under Section 10(2)(xv), the assessee has tosatisfy three conditions: (a) the expenditure must not bean allowance in the nature described in clauses (i) to (xiv); (b) it must not be in the nature of capitalexpenditure or personal expenses of the assessee; (c) itmust have been laid out or expended wholly andexclusively for the purpose of business. TS|IntheinstantCase,reconstitutedpartnershipdeed1S|producedwhich1S|dated19.10.2011 which provides that in consideration of asum of Rs.1,30,00,000/- payable to the retiringpartners, a sum of Rs.90,00,000./- has already beenpaid by the continuing partners to the retiring partners.The balance amount of Rs.75,00,000/- shall be paid bythe State Bank of India, Commercial Branch, out of theloan amount sanctioned to the firm. The continuingpartner shall pay the same within 15 days to theretiring partners from the date of the reconstitution,failing which the retiring partner shall recover the samewith an interest at 24% p.a. In consideration of the saidpaymentot Rs.1,30,00,000/-_retiringpartnersrelinquish all their right, title and interest in the assetsand liabilities of the firm and by virtue of the same, theretiring partners shall have no right of whatsoever nature against the firm or its assets thereafter. TheShare of the partners for such retirement is 75% andI5%. 8.|From a reading of the aforesaid recitals inthe reconstituted deed, it is clear that it is continuingpartners who are paying a sum of Rs.1,30,00,000/- tothe retiring partners. On the date of the reconstituteddeed,theyhadalreadybeenpaidaSUITOT Rs.55,00,000/-. The said amount is not out ofpartnership firm. The balance of Rs.75,00,Q000/- wasalso liable to be paid by the continuing partners to theretiring partners. Probably, as on such date, they didnot had requisite funds, they have borrowed a sum ofRs.75,00,000/- from the State Bank of India. The recitalmade in the reconstituted deed that the said amount otRs.75,00,000/- shall be paid by the Bank, out of theloan amount sanctioned to the firm. Further it casts an|obligation on the continuing partners to make paymentwithin 15 days. The amount is borrowed from the Bank.This recital that the balance amount of Rs.75,00,000/-.Shall be paid by State Bank of India, out of the loan Lisl account sanctioned to the firm to the retiring partnersdiscloses the real intention of the transactions between|the parties. Because the continuing partners agreed topay a sum of Rs.1,30,00,000/- as consideration for theretiring partners to relinquish all their right title andinterest with the partnership firm and though they hadalready paid a sum of Rs.99,00,000/, on the date ofreconstituted deed and the balance amount payable isout of the loan sanctioned by the State Bank of India,the said amount of Rs.75,00,000/- has nothing to dowith business of the firm. But the said amount was|directly made over to the retiring partners as fullpayment of the balance consideration agreed to be paidby the continuing partners to the retiring partners fortheir relinquishment to the share which the retiringpartners had in the firm. The said amount do notrepresents the amount borrowed for the purpose ofbusiness. It is because of the payment of the saidamount, share of the continuing partner becomes 75%and 29%. This amount of Rs.1,30,00,000/- represents 12| consideration paid for the share of the retiring partners. It is not a liability of the partnership firm. OQ section 37 of the Partnership Act on which| reliance is placed reads thus: “RIGHTOF|OUTGOINGPARTNERIN|CERTAIN CASES TO SHARE SUBSEQUENTPROFITS. Where any member of a firm hasdied or otherwise ceased to be a partner,|and the surviving or continuing partnerscarry on the business of the firm with theproperty of the firm without any final|settlement of accounts as between them|and the outgoing partner or his estate,then, in the absence of a contract to thecontrary, the outgoing partner or his estateis entitled at the option of himself or his:representatives to such share of the profits:made since he ceased to be a partner asmay be attributable to the use of his shareof the property of the firm or to interest atthe rate of six per cent. per annum on theamount of his share in the property of thefirm : Provided that where by contract|between the partners an option is given toSUTUVIVINGOrcontinuingpartnerstopurchase the interest of a deceased or' 13| outgoing partner, and that option is dulyexercised, the estate of the deceasedpartner, or the outgoing partner of his|estate, as the case may be, 1s not entitledto any further or other share of profits, but)uf any partner assuming to act in exerciseof the option does not in all materialrespects comply with the terms thereof, he)is liable to account under the foregoingprovisions of this section”. Thus, in the absence of a contract to the contrary, theoutgoing partner or his estate is entitled at the option ofhimself or his representatives to such share of theprofits made since he ceased to be a partner as may beattributable to the use of his share of the property. 13| outgoing partner, and that option is dulyexercised, the estate of the deceasedpartner, or the outgoing partner of his|estate, as the case may be, 1s not entitledto any further or other share of profits, but)uf any partner assuming to act in exerciseof the option does not in all materialrespects comply with the terms thereof, he)is liable to account under the foregoingprovisions of this section”. Thus, in the absence of a contract to the contrary, theoutgoing partner or his estate is entitled at the option ofhimself or his representatives to such share of theprofits made since he ceased to be a partner as may beattributable to the use of his share of the property. 10.|The amount of Rs.1,30,00,000/- paid is nota Share of the profit of the retiring partner in thepartnership firm. Therefore, applying the law laid downby the Apex Court in the aforesaid Judgment, when theaforesaid amount of Rs.75,00,000/- is not borrowed bythe assessee for the purpose of business and does notlaid out expenditure wholly and exclusively for thepurpose of business of the firm, claim for deduction 14| under Section 36(1)(i11) was not justified. The Authoritieshave rightly disallowed deductions and therefore, we donot see any merit in this appeal. 11.)Accordingly, the substantial questions of laware answered in favour of the revenue and against theasseesee. No merit in this appeal and it is dismissed. Sd/-| JUDGE Sd/-. JUDGE| KSR