By TIOL News Service:

AHMEDABAD, JULY 13, 2016: THE issue is - Whether a partnership firm can be held liable for not disclosing amended partnership deed, where the AO himself has accepted the declaration in the return and has failed to question the firm regarding non-payment of interest & remuneration to the partners even as per previous partnership deed, at the time of making assessment. NO is the answer.

Facts of the case:

The assessee is a partnership firm and is engaged in the business of manufacturing and exporting gold jewellery through a unit which is situated in SEZ, Surat. It had claimed 100% deduction on the profits and gains derived from such business u/s 10AA. Consequent to filing of assessee's return for the A.Y 2008-09, the same was taken up for scrutiny by the AO who after detailed examination of the various claims made by the assessee framed scrutiny assessment u/s 143(3) and accepted the declaration of income as per the return. Subsequently, in order to reopen such assessment, the AO issued impugned reopening notice, by recording reasons that as per the convents of the partnership deed, the partners of the assessee firm were eligible for interest on the balance of their capital account at the maximum rates permissible u/s 40(b)(iv) i.e. @12% per annum. However, the assessee had not provided for the interest to the partners during the year under consideration. Thus, by not providing for the interest and remuneration to the partners, the assessee firm had more profits than reasonable profits which would have accrued to the firm and consequently into higher claim of deduction u/s 10AA. This attracted the provisions section 80IA(10) r.w.s. 10AA(9). Thus, the assessee firm had made more profits than reasonable profits, which would have accrued resulting into higher claim of deduction u/s 10AA. This being resulted into underassessment of income of Rs 30,66,68,434/-. Hence, the income chargeable to tax to the extent of Rs 69,15,09,161/- had escaped assessment for the A.Y 2008-09 due to the omission or failure on the part of the assessee to disclose fully and truly all material facts necessary for assessment. The assessee upon being supplied such reasons, raised detailed objections, which were however rejected by the AO.

After hearing the parties, the High Court had held,

++ the assessee which is in the business of manufacturing an export of gold and diamond jewellery, was a partnership firm comprising of two partners viz. AEL and AAPL which had profit/loss sharing ratio of 99:1% respectively. The reasons cite two different grounds for the AO to form a belief that income chargeable to tax has escaped assessment. First was that, as per the partnership deed, the partners would receive simple interest at the rate of 9% per annum or such other rates as may be prescribed u/s 40(b)(iv) on the balance amount to the credit on the capital or current account of the firm. Despite this covenant, the assessee firm did not pay any interest to its partners which had the effect of increasing the assessee's profit from the eligible business. Thus, the assessee claimed higher deduction than what was justified. The second ground was that the assessee firm had made purchases of gold on various occasions from its sister concern and partner i.e. AEL. According to the AO, such purchases were at a rate lower than the prevailing market rate, thus, once again inflating the assessee's profit from the eligible business. This would attract section 80IA(10) r/w/s 10AA(9). With this background, we have perused the original files pertaining to the queries raised by the audit party. We notice that the AO, after taking note of the detailed objections of the audit party on these two issues had conveyed that the objections raised by the audit party are acceptable and that therefore the assessment is required to be reopened. However, this file also contains other correspondence between the audit party and the AO which raises some doubt about the opinion of the AO being free. The audit party had written to the AO regarding the purchase price of gold and pointed out that through such purchases, AEL had made less profit in its individual capacity, reducing its tax liability. However, the profit of the assessee firm which was exempt from tax was routed back to the AEL since AEL shares 99% profit of the assessee partnership firm. The AO was requested to verify these aspects and offer his comments. The immediate response of the AO to this letter is not known, and atleast at one stage, the AO was convinced that the audit objection was not valid;

++ it is by now well settled that if the AO has recorded his own reasons uninfluenced by audit objection, such action would not be bad in law merely because certain issues were brought to his notice by the audit party. It is equally well settled that when the AO does not accept the audit objections, but has issued the notice for reopening based solely on the audit objections, such action would not be valid. Coming to the remaining issues, we may recall that the notices for reopening were issued in both cases beyond the period of four years from relevant A.Y. Here also, both the assessments proceeded more or less along similar lines. With respect to non payment of interest to the partners on the borrowed capital, counsel for the assessee submitted that though the original partnership deed provided for such interest, this deed was amended, which deleted any reference to payment of interest to the partners. It is not clear whether this amended deed was on record before the AO during the original assessment. However, whether same was produced or not, in our opinion, would make no difference. If such amendment was not produced, it would imply that the AO was guided by a partnership deed which made a specific provision for payment of interest to the partners for the borrowed capital. The fact that despite said covenant in the partnership firm, no such interest was paid was very much before him during the original assessment. On the other hand, if the amended partnership deed was produced, he could still have questioned the assessee about nonpayment of interest to a partner who had 99% profit sharing stake in the partnership business. He could have questioned the assessee within the purview of section 80IA(10) r/w/s 10AA(9). This would be relevant since the notice for reopening is issued beyond a period of four years from the end of relevant A.Y. In any case therefore, there was no failure on the part of the assessee to disclose truly and fully all material facts in this regard;

++ coming to the question of purchase of gold from AEL at a rate lower than the prevailing market rate, counsel for the assessee would argue that there was no failure on part of the assessee to disclose truly and fully all material facts. On the other hand, the counsel of the Revenue would refer to the explanation 1 to section 147 which provides that production before the AO of books of accounts from which material evidence with due diligence could have been discovered by the AO will not necessarily amount to disclosure within the meaning of the proviso to section 147. However, we need not go into this controversy since the perusal of the record would reveal that during the original assessment, this question was examined by the AO. We have reproduced the portions of the assessee's communications to the AO. Particularly, the assessee pointed out that the firm had purchased gold bar from AEL. The assessee submitted sample copy of comparable purchases and sale invoices of gold bar of AEL and the purchases the AEL had made from the overseas buyers. On the basis of such material, the assessee had contended that the transactions were at the ALP. Thus, according to the assessee, the supply of gold by AEL to the assessee firm was at the prevailing market price. This explanation had to have relation only to the question of proper pricing of gold purchased by the assessee from AEL. This issue thus, was examined by the AO during the original assessment. It would thereafter, not be open for the AO to reopen the assessment on this ground particularly after four years. Under the circumstances, impugned notices are quashed.

(See 2016-TIOL-1356-HC-AHM-IT)