FEBRUARY 13, 2017

By Lukose Joseph, CA & Anil P Nair, CA

CAN a partner of a firm claim deduction for expenses incurred to earn income from the firm in the nature of remuneration, interest and share of profit and is he liable to audit?

The Partner of a firm earna share of profit, if any, and at the same time earns interest on capital invested by him in the firm and is eligible for a remuneration as working partner subject to various provisions of the Income Tax Act, 1961 and clauses in the partnership deed.

According to Section 10 of the Income Tax Act, 1961 (the Act), in computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included-

"(2A) in the case of a person being a partner of a firm which is separately assessed as such, his share in the total income of the firm".

Thus share of profit is an exempted income.

In terms of section 28(v), such income of a Partner (Salary, interest on capital etc.) is taxable under the head "Profits & Gains from Business or Profession" under Chapter VI.

An extract of Section 28 says,  "The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession"...

 (v) Any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm…."

That is even if income is christened as remuneration and interest,they are not taxable under the heads Salary and Income from other source respectively but under the head "Profits & Gains from Business or Profession".

If so, how such income shall be computed?

Apparently, the answer is simple. It should be in the same way as income from any business or profession.Such income is eligible for deductions, as usual, subject to certain restrictions under the Act. There is actually nothing which differentiates such income from a firm with other business or profession income. Thus expenses incurred to earn such income can be claimed as deduction.

For example, interest incurred for amount borrowed for investment in partnership shall be treated as expense and will be allowed. The partner may also incur other expenses to earn the income like depreciation on personal vehicle he used as working partner.

Section 14A says, "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".

Section 14A and corresponding Rule 8D has been the subject of much litigation.

We already saw Section 10 (2A) exempt share of profit from firm in computation of total income. So any expenses incurred to earn 'share of profit' from firm will not be allowed as expenditure. In other words any expenditure incurred for earning income from partnership namely remuneration, interest and share of profit may be allocated in such ratio.Those expenses in proportion to share of profit from firm are to be disallowed.

Similar scenario came up in Shri Vishnu Anant Mahajan v ACIT - 2012-TIOL-311-ITAT-AHM-SB. The assessee was an individual and derived income by way of share of profit from the firm of M/s. Mahajan & Amar Doshi, capital gains, interest, dividend and house property. The assessee derives 76% of professional income as share from the firm and the balance amount by way of remuneration and interest income from the firm. The AO allocated the expenses to the income not includible under Section 10(2A). Thus, the business income by way of remuneration and interest from the firm has been taxed in the hands of the assessee under section 28(v) after allowing 24% of the expenditure. Thus, 76% of the expenditure was disallowed. The Tribunal confirmed this Order.

Since share of profit from firm is excluded from the total income of the partners, any part of expenditure incurred to earn that has to be disallowed as per Sec 14A.

What if Share from firm is a loss?

In the case of M/s Redington India Ltd - 2017-TIOL-62-HC-MAD-IT it is held that disallowance in terms of Section 14A r/w Rule 8D cannot be contemplated in a situation where no exempt income has been earned.

Is Depreciation an expense?

This matter too came up before the Tribunal In Shri Vishnu Anant Mahajan case (supra) - 2012-TIOL-311-ITAT-AHM-SB. The Honorable Bench observed that regarding depreciation being an expenditure or not, it has been held in the case of  Hoshang D. Nanavati -  2011-TIOL-953-ITAT-MUM that section 14A deals only with the expenditure and not any statutory allowance admissible to the assessee. A statutory allowance under section 32 is not expenditure.

Thus it was held that depreciation cannot be disallowed under section 14A since it is not 'expenditure' but a statutory allowance.

If remuneration and interest have the same treatment as any other business income whether section 44AB will be applicable for such income?

If gross receipt from partnership firm which is taxable under head business/ profession exceeds the threshold limit, audit under section 44AB will be applicable.

Income Tax Appellate Tribunal, Kolkata upheld this view in the case of Usha A Narayanan V Deputy Commissioner of Income Tax - 2013-TIOL-497-ITAT-KOL. The Tribunal confirmed the view of the Assessing Officer that the assessee ought to have obtained the audit report under section 44AB of the Income Tax Act and her failure to do so, invited penalty under section 271B of the Act.

Thus Section 44AB is attracted in case gross receipts taxable under the head "income from business or profession" received from partnership firm exceeds the threshold limit.

Hence it can be concluded that assessee may claim legitimate expenses incurred for earning Remuneration and Interest from any Partnership firmsubject to Section 14A but depreciation cannot be disallowed under section 14A since it is not expenditure but a statutory allowance and if such income exceeds the threshold limit under Section 44AB, the assessee should get an audit report under that Section.

We would welcome Netizens to share their views.