COMMISSIONER OF INCOME TAX Vs. KAJAH COMPANY
LAWS(KER)-2003-3-59
HIGH COURT OF KERALA
Decided on March 28,2003

COMMISSIONER OF INCOME TAX Appellant
VERSUS
Kajah Company Respondents

JUDGEMENT

G.SIVARAJAN, J. - (1.) THE Income -tax Appellate Tribunal, Cochin Bench, has referred the following question of law under Section 256(1) of the Income -tax Act, 1961, for short 'the Act', for the decision of this court, at the instance of the Revenue : 'Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that for the purpose of Section 40(b) of the Income -tax Act, the remuneration payable to the partners in terms of Clause 13 of the partnership deed is to be worked out on the basis of the net profit without deducting the income -tax liability ?'
(2.) THE brief facts necessary for adjudication of this question are as follows. The respondent -assessee, M/s. Kajah Company, is a partnership firm carrying on the business in the manufacture and sale of beedies. In the assessment of firm for the year 1993 -94, the Assessing Officer disallowed a sum of Rs. 2,23,216 out of the remuneration payable to the partners under Section 40(b) of the Act. The assessee had claimed deduction of a total sum of Rs. 5,24,140 as remuneration paid to the working partners. As per Clause 13 of the partnership deed dated April 27,1982, two of the working partners were to be paid a remuneration to the extent of 2.5 per cent, of the net profits of the business. According to the Assessing Officer, the net profits of the business referred to in Clause 13 of the partnership deed has to be worked out after deducting the income -tax liability also. In appeal filed by the assessee, the Commissioner of Income -tax (Appeals), Cochin, noted that Clause (ii) of Section 40(b) will apply and since the partnership deed of the appellant -firm clearly stipulates that the working partners are to be paid remuneration of 2.5 per cent, of the net profits of the business, and that for this purpose, net profit meant profit after deducting all expenses. It was further observed that normally in any profit and loss account, the income -tax liability is debited as expenditure and the net profit is shown only after claiming the liability. The Commissioner of Income -tax (Appeals) accordingly held that the assessing authority is justified in allowing remuneration on the net profit after deducting the income -tax liability. He accordingly confirmed the order of the Assessing Officer. In further appeal by the assessee, the Tribunal allowed the claim of the assessee by holding that the remuneration payable to the partners in terms of Clause 13 is to be worked out on the basis of the net profit without deducting the income -tax liability. It is against this order the question of law set out in para. 1 is referred. We have heard learned Central Government standing counsel for taxes appearing for the applicant and Sri P. Balakrishnan, learned counsel appearing for the respondent. As already noted, the dispute is regarding the disallowance of Rs. 2,23,216. The two working partners were to be paid a total remuneration of Rs. 5,24,140 as provided under Clause '13 of the partnership deed dated April 27, 1982. The Assessing Officer has disallowed the claim under Section 40(b) of the Act. The first appellate authority, found that Clause (v) of Section 40(b) prescribes the maximum permissible remuneration which can be allowed, and that in the instant case, the remuneration paid to the working partner is well within the limits prescribed in Clause (v) of Section 40(b). However, the first appellate authority, relied on the provisions of Clause (ii) of Section 40(b) of the Act and referred to Clause 13 of the partnership deed to ascertain whether the remuneration worked out by the assessee was in accordance with Clause 13. In the above circumstances, it is necessary to refer to the provisions of Clause (ii) of Section 40(b) and Clause 13 of the partnership deed. Clause (ii) of Section 40(b) reads as follows : '40. Amounts not deductible. - - Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession', .... (b) in the case of any firm assessable as such, - -. . . . (ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorised by, or is not in accordance with, the terms of the partnership deed;' Clause 13 of the partnership deed reads as follows : '13. The parties of the first and second parts shall be in charge for the general conduct and management of the day -to -day business activities of the firm. Each of them shall be paid a remuneration of 2.5 per cent, of the net profits of the business and it shall be treated as an expenditure of the firm. Net profits for the purpose of working out the aforesaid remuneration shall mean the net profits worked out after deducting all expenses, including interest on loans as well as capital, but without deducting the remuneration to the parties of the first and second parts.'
(3.) BY virtue of the provisions of Clause (ii) of Section 40(b), the remuneration paid to any partner who is a working partner should be authorised by or in accordance with the terms of the partnership deed. Clause 13 which is already extracted above is the relevant portion with reference to which remuneration payable to the working partner were worked out by the assessee. Clause 13 clearly provides for remuneration to the partner for the general conduct and management of the day -to -day business activities of the firm, remuneration of 2.5 per cent, of the net profits of the business to each of the partners. It also provides that such remuneration shall be treated as an expenditure of the firm. It is further stated that net profits for the purpose of working out the aforesaid remuneration meant the net profits worked out after deducting all expenses including interest on loans as well as capital, but without deducting the remuneration to the partners. According to the Assessing Officer and the first appellate authority, since remuneration paid to the partners alone is excluded from arriving at the net profits, income -tax liability is liable to be deducted for arriving at the net profit referred to in Clause 13. The first appellate authority has also observed that normally in any profit and loss account, the income -tax liability is debited as expenditure and the net profit is shown only after claiming the liability. The Tribunal according to us has rightly understood Clause 13 of the partnership deed and had clearly stated as follows: 'We do not agree with the Commissioner of Income -tax (Appeals) that income -tax liability is to be considered as an expenditure as normally understood in common parlance. Spending in the sense of paying out of money is the primary meaning of expenditure. Expense is what is paid out or paid away. Income -tax represents the levy by the Government after the net profit has been arrived at. It is a case of application of profit after it has been earned. In any case, the partners of the assessee -firm who signed the partnership deed understood the term 'net profits' as the profit of the business arrived at without deducting the income -tax liability. It was on that basis they computed the remuneration paid to the working partners. When the contractual agreement between the partners has been understood by the parties concerned in that way and also acted upon thus, it would not be correct for the Department to interpret Clause 13 in a different way, to insist that the net profit should have been worked out after deducting the tax liability. It appears that there was no dispute among the partners regarding the manner in which the remuneration payable to the working partners has been computed. All the partners had treated as if the payment of remuneration was in accordance with Clause 13 only. In the circumstances of this case, we do not uphold the order of the Commissioner of Income -tax (Appeals). In view of our finding that the remuneration payable to the partners in terms of Clause 13 is to be worked out on the basis of the net profit without deducting the income -tax liability. We hold that the Assessing Officer was not correct in making the disallowance under Section 40(b) of the Income -tax Act.' Clause 13 of the partnership deed only contemplated that though the net profit of the assessee is to be worked out after deducting all the expenditure including the remuneration payable to the two partners as per Clause 13, for the purpose of working out the remuneration, the remuneration payable to the partners shall not be included. In other words, net profit for the purpose of payment of remuneration has to be arrived at without deducting the remuneration payable to the partners under Clause 13. This does not mean that the income -tax liability which is charged on the total income must be deducted for arriving at the net profit. Net profit both under the provisions of the Income -tax Act and under the general law will not take in the statutory liability to pay income -tax. That apart, the executants of the partnership deed itself had understood Clause 13 of the partnership deed as if it does not provide for deducting the income -tax liability, for, the remuneration payable under Clause 13 itself was worked out by the assessee without deducting the income -tax liability. According to us, the Assessing Officer and the first appellate authority were not justified in interpreting Clause 13 of the partnership deed as if the expression 'net profit' used in Clause 13 is the profit after deducting the income -tax liability also. We are of the view that the Tribunal has correctly held that for the purpose of working out the remuneration, the expression net profit in Clause 13 cannot be arrived at after deducting the income -tax liability. We accordingly answer the question referred in the affirmative, that is, in favour of the assessee and against the Revenue.;


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