[2013] 30 taxmann.com 262 (Article)
Your queries on service tax
 Vineet Sodhani CA |  Deepshikha Sodhani CA |
SUPPLY OF CUSTOMISED SOFTWARE IS SERVICE
1. We are running a business. We have acquired a software from abroad required for various business purposes. Under the contract of acquisition of software, the foreign vendor was to supply already developed software (say, at Rs. 700), and also to install the same after customization (say, separate charges Rs. 1,000) and also to provide training to our employees (say, charges of Rs. 15). The contract provided that the software would be acceptable only after confirmation in acceptance test carried out in India. As the place of provision of the services of customization and training, was, in India, we have paid service tax under reverse charge on Rs. 1,015 (Rs. 1,000 + Rs. 15). The Central Excise Department is insisting upon payment of service tax on Rs. 700 as well, while as we are of the view that the same being goods, is not liable to service tax. Please clarify.
The reply to your query can be divided into following parts :
| A. | In view of principles of taxation - Composite Transaction - Sale or Service : |
| ♦ | In this case, the transaction involved is comprised of a bundle of features and acts. | |
| ♦ | In this case where it is a single supply it would be deemed like this some element(s) would constitute the 'principal' supply, while as others would be 'ancillary'. | |
| ♦ | If two or more elements or acts supplied by the taxable person to the customer are so closely linked that they objectively form a single indivisible economic supply, which it would be artificial to split up, then all those elements would constitute a "single supply" for the levy of tax. | |
| ♦ | The fact that separate prices have been contractually stipulated for various acts is not decisive. | |
| ♦ | Further, such single complex supply is to be classified as a supply of services or supply of goods, based on predominant element of that supply. Such predominant element can be identified based on the extent, duration, usefulness and cost of the elements. | |
| ♦ | The real economic purpose, i.e., the intention of the parties is also relevant to determine whether it is 'sale' or 'service' ? |
| B. | Your transaction is a single transaction with 'service' element being pre-dominant : |
| ♦ | The economic purpose of transaction between you and your vendor is the supply of functional software, specifically customised to the suit your requirement. | |
| ♦ | It would be artificial to say that you, first of all, purchased basic software (which was of no use to you) and, subsequently, the customisation made that software useful to you. | |
| ♦ | The supply of basic software and subsequent customisation were so closely linked that they were, in principle, a single transaction; the separate pricing of those elements would not affect this conclusion. | |
| ♦ | Secondly, in this single transaction, the customisation of the basic software made the software useful to you. | |
| ♦ | The extent, duration and cost of customisation were higher as compared to the basic software. | |
| ♦ | Thus, in all elements, the customisation predominated because of its decisive importance in enabling you to use the software. | |
| ♦ | Hence, transaction is wholly a 'service' and is liable to service tax. |
| C. | Legal Context : |
| ♦ | As per section 65B(44) of the Finance Act, 1994, "service" means any activity carried out by a person for another for consideration… but shall not include an activity which constitutes merely a transfer of title in goods or immovable property, by way of sale, gift or in any other manner. In this case, the transaction carried out by you doesn't amount to "merely a transfer of title in goods", as transaction involves customisation and training as well. Hence, it is not altogether excluded from the definition of a service. | |
| ♦ | Further, as per section 66E(d) of the Finance Act, 1994, "development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software" is a declared service. | |
| ♦ | CBEC Guidance Note - Customized softwares are not goods - Liable to service tax : In case contract is given for customized development of software and the customized software so developed is delivered to the client on media like a CD, then, although the software is finally delivered in the form of goods, since the contract is essentially for design and development of software it would fall in the declared list entry and would be liable to service tax. Such a transaction would be in the nature of composite transaction involving an element of provision of a service, inasmuch as the contract is for design and development of software and also an element of transfer of title in goods, inasmuch as property in CD containing the developed software is transferred to the client. However, the CD remains only a media to transmit or deliver the outcome of which is essentially and predominantly a contract of service. Therefore, such a transaction would not be excluded from the ambit of the definition of a 'service', as the transaction does not involve 'only' transfer of title in goods and dominant nature of the transaction is that of provision of service. |
| D. | Conclusion : | |
| Hence, in our considered view, you are liable to pay service tax on the whole of the amount of Rs. 1,715 (1000 + 700 + 15). |
ONSITE DEVELOPMENT OF SOFTWARE IS A SERVICE
2. We own a big corporate house and have asked a foreign company to develop and provide us with software to fulfil our business needs. The foreign company deputed its officials in India and developed a software onsite. After successful testing and installation, the software controls were handed over to us and payment was made. We have not paid any service tax under reverse charge on the charges paid by us to the foreign company, as we are of the view that same amounts to supply of goods. As soon as software was ready, it became goods and such supply could not be charged to service tax. Department is insisting on payment of service tax. Please clarify.
It is a settled position of law that pre-packaged or canned software which is put on a media is in the nature of goods [Supreme Court's judgment in the case of Tata Consultancy Services v. State of Andhra Pradesh 141 Taxman 132 (SC) refers]. Sale of pre-packaged or canned software is, therefore, in the nature of sale of goods and is not a service.
But, on site development of software did not involve any goods, as the software was never put on a media for being supplied; the software was supplied in the course of its development. In fact, development, design, programming and implementation of software are also covered under declared service under section 66E(d) of the Finance Act, 1994.
Hence, the charges paid by you for onsite development of software are on a service and are liable to service tax (under reverse charge, in your case).
ADVISE, CONSULTANCY, ETC., IN RELATION TO SOFTWARE LIABLE TO SERVICE TAX
3. We own a professional firm providing guidance to interested buyers in the field of selection and procurement of information technology software developed by other clients. Are we liable to service tax?
As per section 66E(d) of the Finance Act, 1994, "development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software" is a declared service.
Though advise and consultancy provided by you do not fall under section 66E(d), nonetheless they are services provided, as these activities are carried out for a consideration. Therefore, the services provided by you are liable to service tax.
ONLINE SUPPLY OF SOFTWARE IS A SERVICE
4. We are running a Website in India, which supplies software developed by us by way of online downloads. We receive payments in Indian currencies. The software is meant for compliance in relation to income-tax in India. We are of the view that such supply is supply of software being goods and not liable to service tax in India, while as the department is insisting on payment of service tax. Please clarify the correct legal position.
If software is put on media like computer disks before sale, it would be "goods" and would not be liable to service tax.
But, if software or any programme is delivered online or is down loaded on the internet the same would not be treated as "goods" (only pre-packaged softwares put on a media before sale are goods).
Delivery of content online would also not amount to a transaction in goods, as the content has not been put on a media before sale. It is a taxable service.
Hence, charges for supply of software by you will be liable to service tax.
SUPPLY OF DIGITIZED CONTENT - TAXABLE AT PLACE OF LOCATION OF SERVICE PROVIDER
5. We are renowned publishers in the field of tax law. We have developed a Website of our own and are providing various books and journals (also published by us) online. Sale of books/journals is not a service and supply of digitized content via Website should also not amount to service in that view. However, department is insisting on payment of service tax on supply of books/journal online and also on Website related services. Nearly 25% of our clients are located outside India and charges from them are received in US Dollars. Are we liable to pay any service tax ? If yes, on what amount ? Are the considerations received by us in US Dollars for supplies made to clients located outside India also liable to service tax or is it eligible for export benefit ? Please clarify, citing appropriate provisions of law.
The reply to your query is divided into following parts :
A. Supply of digitized content is a service - Supply of digitized content of books or journals is not 'goods', because the knowledge has not been expressed on any media. Since there is no media involved, there are no goods. Hence, supplies made by you online are services.
B. Services provided by you are "online information and database access or retrieval services" - As per Rule 2(l) of the Place of Provision of Services Rules, 2012, "online information and database access or retrieval services" means -
| ♦ | providing data or information, | |
| ♦ | retrievable or otherwise, | |
| ♦ | to any person, | |
| ♦ | in electronic form | |
| ♦ | through a computer network. |
CBEC, TRU Guidance Note clarifies that the said services are essentially delivered over the internet or an electronic network which relies on the internet or similar network. They are completely automated and require minimal human intervention.
The CBEC, TRU Guidance Note further illustrates the types of services covered and provides that digitized content of books and other electronic publications, subscription of online newspapers and journals, online news, flight information and weather reports, etc., including web-based services providing access or download of digital content shall be covered under "online information and database access or retrieval services".
Accordingly, services provided by you are "online information and database access or retrieval services".
C. Place of provision of services provided by you is place of location of service provider, viz., place of your location - As per Rule 9(b) of the Place of Provision of Services Rules, 2012, the place of provision of online information and database access or retrieval services is the place of location of the service provider. Since your location is in India, all these services are deemed to be provided in India.
D. No export - Since the place of provision of services provided by you is in India, no part of the services provided by you can be treated as an export under Rule 6A of the Service Tax Rules, 1994, whereunder it is a mandatory requirement that place of provision must be outside India. Hence, even if 25% of your clients are located outside India, the transaction shall not amount to export of service.
E. Conclusion - Fully taxable - Hence, whole of the services by way of supply of digitized content provided by you are liable to service tax.
PLACE OF PROVISION OF SERVICES OF REPAIR OF SOFTWARE
6. We have provided services in relation to repair of software supplied to our clients located abroad. The repair services were provided online. We are not paying any service tax on the consideration received for such repair services, while as the department is insisting on that the services are taxable in India in view of Rule 9(b) of the Place of Provision of Services Rules, 2012.
Your query can be replied in following parts
A. Rule 9(b) does not apply - As per Rule 9(b) of the Place of Provision of Services Rules, 2012, the place of provision of online information and database access or retrieval services is the place of location of service provider.
As per Rule 2(l) of the Place of Provision of Services Rules, 2012, "online information and database access or retrieval services" means providing data or information, retrievable or otherwise, to any person, in electronic form through a computer network.
Since you are not providing any data or information but are carrying out repair of software, the services cannot amount to "online information and database access or retrieval services". Our view finds its support from the CBEC's Guidance Note on the subject.
B. Services fall under Rule 4(a) - Your services appear to fall under Rule 4(a) of the Place of Provision of Services Rules, 2012. Rule 4(a) ibid covers services provided in respect of goods that are required to be made physically available by the recipient of service to the provider of service, or to a person acting on behalf of the provider of service, in order to provide the service.
As per proviso to Rule 4(a) ibid, if such services are provided from a remote location by way of electronic means, then the place of provision of such services shall be the location where goods are situated at the time of provision of service.
Since software is located outside India at the time of provision of online repair service, as per Rule 4(a) ibid the place of provision of such services shall be outside India and shall not be liable to service tax.
C. Conclusion - Services provided by you are not liable to service tax. Even otherwise, as per Rule 3 of the Place of Provision of Services Rules, 2012, since the recipient of service is located outside India, the services are deemed to be provided outside India and are not, therefore, liable to service tax.
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• ST
IT- AO can't insist on charging interest paid to partners from net profit remaining after charging the depreciation
IT : For working out disallowance under section 40(b)(iv), in absence of any clear cut guidance that charging of interest has to be on percentage of book profit revenue cannot insist that depreciation being a charge on profit has to be deducted first before considering any interest payment on capital of firm
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[2013] 33 taxmann.com 360 (Madras)
HIGH COURT OF MADRAS
Sri Venkateswara Photo Studio
v.
Assistant Commissioner of Income-tax*
MRS. CHITRA VENKATARAMAN AND K. RAVICHANDRA BAABU, JJ.
Tax Case (Appeal) Nos. 1062 to 1066 of 2005
APRIL 24, 2012
Section 40(b) of the Income-tax Act, 1961 - Business disallowance - Interest, salary etc. paid by firm to partner [Interest] - Assessment years 1996-97 to 2000-01 - Assessee claimed deduction under section 40(b) towards payment of interest to partners on capital balances - Assessing Officer pointed out that assessee had apportioned interest in profit and loss account without claiming depreciation; and that since depreciation is a charge on profit of company, charging of interest has to be on book profit of company or firm, i.e., net profit, after working out depreciation - Whether there being no restriction placed on working of interest before working out depreciation as has been provided in case of salary that payment of salary to partners for purpose of deduction has to be worked out on percentage of book profit, revenue cannot insist that depreciation being a charge on profit, had to be deducted first before considering any interest payment on capital of firm - Held, yes [Paras 12 & 13][In favour of assessee]
FACTS
| ■ | The assessee claimed deduction under section 40(b) towards the payment of interest to the partners on the balances in the capital accounts in terms of the partnership deed. | |
| ■ | The Assessing Authority pointed out that the assessee had apportioned the interest in the profit and loss account, without claiming depreciation. He pointed out that since depreciation is a charge on the profit of the company, charging of interest has to be on the book profit of the company or firm. | |
| ■ | The Commissioner (Appeals) pointed out that in absence of definition of profit in relation to clause (iv) of section 40(b), the assistance of Explanation 3 to clause (v) could be taken advantage to find out, how the interest paid to partners could be worked out. In the circumstances, the Commissioner (Appeals) confirmed the view of the Assessing Officer that without providing for depreciation, the partner's account could not be credited with any interest. | |
| ■ | The Tribunal confirmed the view of the Commissioner (Appeals). |
HELD
| ■ | A reading of the provisions of sections 40(b)(iv) and 40(b)(v) on interest and salary clearly shows the marked difference in the treatment of the said payments in the matter of granting deduction under section 40. | |
| ■ | Section 40(b)(iv) recognizes interest payment as deduction up to 18 per cent simple interest. For the purposes of disallowance of deduction on payment of interest, section 40(b)(iv) states that simple interest paid in excess of 18 per cent, would go for disallowance. The payment of interest, in any event, would be allowed as deduction only if it is authorised and is in accordance with the terms of partnership deed. The payment of interest may be either from the account of book profit or from the net profit. | |
| ■ | As regards deduction claim on the salary payment to partners, deduction on the payment to all partners is worked out at the percentage of book profit as given in the section itself. | |
| ■ | Explanation 3 defines what book profit means. It states that 'book profit' means the 'net profit' as shown in the profit and loss account computed in the manner laid down in Part IV-D relating to "profits and gain of business or profession", which means the net profit has to be necessarily worked out after giving such deductions and allowances as provided for in sections 28 to 44D. | |
| ■ | Taking into consideration that the legislature has consciously provided for such differential treatment in the matter of granting deduction and disallowance on the payment of interest and salary, it is difficult to be accept the plea of the revenue that section 40(b) disallowance has to be worked out only on the book profit, meaning thereby, the net profit after working out the depreciation. | |
| ■ | It is no doubt true that deprecation is given as a charge on the profit, but then, when working out section 40(b) disallowance, particularly with reference to clause (iv), when there is no specific reference to a book profit as a basis on which an interest has to be paid, unlike in the case of salary, the mere score that depreciation is made a charge on the profit, per se, would not justify the claim of the revenue that the granting of such relief on the gross profit would lead to distorted figures in the matter of working out the real income of the assessee for the purpose of taxation. [Para 10] | |
| ■ | The question is that, at what point could the interest be worked out and considered to be credited to the capital account of the partners for the purpose of considering the claim for deduction. | |
| ■ | Given the fact that the partnership deed provided for interest payment and what is disallowed under section 40(b)(iv) is the rate of interest exceeding 18 per cent simple interest, as it then stood, in the absence of any clear-cut guidance under the Act as has been provided in the case of salary, through Explanation that the payment of salary of all the partners for the purpose of deduction has to be worked out on the percentage of book profit computed in the manner laid down in Chapter IV-D the plea of the assessee that the method adopted by the assessee justifies the claim is to be accepted. | |
| ■ | It is no doubt true, as pointed out in the assessment order, that after working out the depreciation and expenses, practically, there might not be anything available at the hands of the firm for crediting any interest to the capital account, but then, as section 40(b)(iv) stands in contrast to section 40(b)(v), it is difficult to accept the case of the revenue that by reason of this figure alone, the accounts have to be rejected. [Para 12] | |
| ■ | Thus, going by the provisions under section 40(b)(iv), there being, no restriction placed on the working of interest before working out the depreciation, the revenue cannot insist on depreciation being a charge on profit, has to be deducted first before considering any interest payment on the capital of the firm. | |
| ■ | In the circumstances, the order of the Tribunal is to be set aside. [Para 13] |
CASES REFERRED TO
G.R. Govindarajulu Naidu v. CIT [1973] 90 ITR 13 (Mad.) (para 2), CIT v. &. Mahendra Mills [2000] 109 Taxman 225/243 ITR 56 (SC) (para 4), CIT v. Aircel Ltd. [2008] 296 ITR 85 (Mad.) (para 6) and CIT v. Sree Senhavalli Textiles (P.) Ltd. [2003] 259 ITR 77/134 Taxman 725 (Mad.) (para 6).
C.V. Rajan for the Appellant. T. Ravikumar for the Respondent.
JUDGMENT
Mrs. Chitra Venkataraman, J. - The tax case (appeals) are filed at the instance of the assessee by raising the following questions of law relating to the asst. yrs. 1996-97 to 2000-01 :
| "1. | Whether the Tribunal was right in law in holding that the books of the assessee can be rewritten and capital accounts rewritten by the AO for the purposes of s. 40(b) of the IT Act ? | |
| 2. | Whether the Tribunal was right in law in holding that profits of the assessee firm should be reworked by deducting depreciation even though the same was not provided by the assessee in the P&L account/books of account ? and | |
| 3. | Whether the Tribunal was right in law in holding that the method of computation adopted by assessee is not in conformity with the accounting and legal principles ?" |
2. The facts leading to the filing of the tax case (appeals) are as follows :
| (i) | The assessee herein is a partnership firm engaged in the business of photography and videography. In the return of income filed for the asst, yrs. 1996-97 to 2000-01, the assessee claimed deduction under s. 40(b) of the IT Act (for short, "the Act"), towards the payment of interest to the partners on the balances in the capital accounts, which was done in terms of the partnership deed. The assessing authority pointed out that the assessee had apportioned the interest in the P&L a/c, without claiming depreciation and the assessee claimed the same in the adjustment statements enclosed to the return of income. A survey was conducted under s. 133A of the Act on the business premises of the assessee. This led to the reopening of the assessment by issuance of notice under s. 147 of the Act to recompute the profit after deducting depreciation and thereby, rework the capital balances of the partners. The assessee resisted the reopening by contending that the interest payable to the partners was rightly determined on the capital balance computed without providing for depreciation. The assessing authority, however, rejected the claim taking the view that if depreciation is directly deducted to the P&L a/c, the net profit would come down, thus, the profit available for sharing among the partners would be almost 'nil'. The officer pointed out that since depreciation is a charge on the profit of the company, charging of interest has to be on the book profit of the company or firm, which in turn has to necessarily work out the depreciation on the profit of the company. The officer, hence, viewed that crediting in the capital account, even before depreciation, would be contrary to the provisions of the Act. The assessing authority viewed that the method of accounting did not reflect the true profit and to that extent, the accounts were not to be relied on. | |
| (ii) | Aggrieved by this, the assessee went on appeals before the CIT(A). The appellate authority pointed out that the object of s. 40(b) of the Act is basically to prevent siphoning off the firm's funds to the partners in order to reduce the tax liability in the hands of the firm. The claim under this section has to be in conformity with the other provisions of the Act. The CIT(A) pointed out that s. 40A of the Act has overriding effect on s. 40(b) of the Act in respect of matter not covered by s. 40(b) of the Act. Considering the object of s. 40(b) of the Act, the first appellate authority confirmed the view of the officer that without providing for depreciation, the partner's account could not be credited with any interest. The appellate authority further pointed out that s. 40(b) of the Act does not define "profit" in relation to cl. (iv), which is with reference to payment of interest. However, cl. (iv) relating to payment of salary is to be made with reference to the book profit. Explanation 3 to cl. (v) defines "book profit" to mean the net profit, as shown in the P&L a/c for the relevant previous year, computed in the manner laid down in Chapter IV-D. Profit means net profit. Going by this definition, the first appellate authority viewed that the book profit has to be computed only after deducting depreciation allowable under s. 32 of the Act. Even in the absence of definition of profit in relation to cl. (iv), the assistance of Expln 3 could be taken advantage of to find out, how the interest paid to a partner could be worked out. In the circumstances, the first appellate authority held that before apportioning any interest to the partners' accounts, the depreciation has to be worked out first and then only the partners would be entitled to have the interest credited to the capital account. Referring to the decision in G.R. Govindarajulu Naidu v. CIT [1973] 90 ITR 13 (Mad), the first appellate authority held that depreciation being a charge on the profit, if the same is not charged, the P&L a/c would show a distorted picture and only after adjustment of depreciation, whatever is remaining would be available for crediting any interest to the partners' accounts, thus, the first appellate authority dismissed the appeals, | |
| (iii) | Aggrieved by this, the assessee went on appeals before the Tribunal, which once again confirmed the view of the CIT(A) and the Tribunal held that the assessee's practice is improper so far it claimed depreciation in adjustment for income-tax purposes and not charging it to P&L a/c. Insofar as it resulted in inflating the capital account balance by claiming enhanced interest, the Tribunal rejected the said claim. Aggrieved by this, the assessee is on appeals before this Court. |
3. Mr. C.V. Rajan, learned counsel appearing for the assessee drew our attention to the provisions under s. 40(b)(iv) of the Act, which is in contrast to s. 40(b)(v) of the Act and pointed out that when considering the salary paid to a partner and the claim made for deduction, statute has specifically provided for the deduction to be allowed based on the results of book profit at a particular percentage. It is worthwhile to note that in the matter of granting deduction in respect of payment of interest, there is no reference at all for the deduction being allowed at a particular percentage of the book profit. Thus, when payment of interest and payment of salary to the partners are treated differently under the provisions of the Act, it is not open to the Revenue to borrow the provisions as are available under cl. (v), Expln. 3 for the purpose of considering the deduction under s. 40(b)(iv) of the Act.
4. Learned counsel for the assessee relied on the decision in CIT v. &. Mahendra Mills [2000] 109 Taxman 225/243 ITR 56 (SC) for the proposition that in the matter of claiming depreciation, there is no gainsaying for the Revenue to contend that irrespective of claim made by the assessee, the same has to be worked out by the assessing authority to find out the distributable profit at the hands of the company. He further pointed out that there is no dispute on the proposition of law that depreciation is a charge on profit, yet, going by the decision of the apex Court, if the assessee had not claimed deduction of depreciation, there is no question of the assessing authority considering the deduction suo motu, since s. 32 of the Act, allows depreciation as a deduction, subject to provisions of s. 34 of the Act that only if prescribed particulars are available, the depreciation relief could be worked out.
5. Learned counsel, further drew our attention to s. 32, Expln. 5 of the Act, which was introduced under the Finance Act, 2001, w.e.f. 1st April, 2002, wherein the Explanation provided that irrespective of whether an assessee claimed the deduction in respect of depreciation in computing his total income or not, the provision under s. 32 of the Act would apply. Thus, with no such provision available during the material assessment years under consideration viz., 1996-97 to 2000-01 and Expln. 5 effective from 1st April, 2002, the AO erred in his view that the interest credited could be worked out only after considering the depreciation.
6. Learned counsel for the assessee also brought to our attention the decision of this Court in CIT v. Aircel Ltd. [2008] 296 ITR 85 and CIT v. Sree Senhavalli Textiles (P.) Ltd. [2003] 259 ITR 77/134 Taxman 725 (Mad.) on the question of considering the depreciation claim by the assessing authority, when no such claim was made in the accounts. In the background of the said decisions, learned counsel submitted that the denial of deduction under s. 40(b) of the Act is totally illegal and not supported by any provisions of the Act. The consideration of the claim of the assessee by the AO based on book profit is not supported by any provisions of the Act.
7. Countering the claim of the assessee, Mr. T. Ravikumar, learned standing counsel appearing for the Revenue, however, pointed out the factual situation that the assessee has gone in for working out the depreciation deduction after deducting the expenses and interest charged to their capital account, which ultimately, resulted in the net loss. If depreciation is directly debited to the P&L a/c, ultimately, the assessee might not have had sufficient profit available to claim interest on the balance of the capital account. Since the method of accounting followed by the assessee gave a distorted figure, rightly the assessing authority disallowed the assessee's claim.
8. Heard the learned counsel on either side and perused the materials available on record.
9. Before going into the rival contentions, it is necessary that the provisions of the Act relating to ss. 40(b)(iv) and 40(b)(v) of the Act, particularly, Explns. 1 to 4 need to be extracted, which are as follows :
"40. Notwithstanding anything to the contrary in ss. 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', -
| ** | ** | ** |
in the case of any firm assessable as such, -
| ** | ** | ** |
(iv) any payment of interest to any partner which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed insofar as such amount exceeds the amount calculated at the rate of twelve per cent simple interest per annum; or
('twelve' substituted for 'eighteen' by the Finance Act, 2002, w.e.f. 1st June, 2002).
(v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed insofar as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder :
(1) in case of a firm carrying on a profession referred to in s. 44AA or which is notified for the purpose of that section—
| (a) on the first Rs. 1,00,000 of the book profit or in case of a loss | Rs. 50,000 or @ 90% of the book profit, whichever is more; | |
| (b) on the next Rs. 1,00,000 of the book profit | @ 60%; | |
| (c) on the balance of the book profit | @ 40%; |
(2) in the case of any other firm -
| (a) on the first Rs. 75,000 of the book profit, or in case of a loss | Rs. 50,000 or @ 90% of the book profit, whichever is more; | |
| (b) on the next Rs. 75,000 of the book profit | @ 60%; | |
| (c) on the balance of the book profit | @ 40%; |
Provided that in relation to any payment under this clause to the partner during the previous year relevant to the assessment year commencing on the 1st day of April, 1993, the terms of the partnership deed may, at any time during the said previous year, provide for such payment.
Explanation 1. - Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as 'partner in a representative capacity' and 'person so represented', respectively).—
| (i) | interest paid by the firm to such individual otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of this clause; | |
| (ii) | interest paid by the firm to such individual as partner in a representative capacity and interest paid by the firm to the person so represented shall be taken into account for the purposes of this clause. |
Explanation 2. - Where an individual is a partner in a firm otherwise than as partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf, or for the benefit, of any other person.
Explanation 3 - For the purposes of this clause, 'book profit' means the net profit, as shown in the P&L a/c for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.
Explanation 4.- For the purposes of this clause, 'working partner' means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner."
10. A reading of the abovesaid provisions on interest and salary clearly shows the marked difference in the treatment of the said payments in the matter of granting deduction under s. 40 of the Act. Sec. 40(b)(iv) recognises interest payment as deduction up to 18 per cent simple interest. For the purposes of disallowance of deduction on payment of interest, s. 40(b)(iv) states that simple interest paid in excess of 18 per cent, would go for disallowance. The payment of interest, in any event, would be allowed as deduction only if it is authorised and is in accordance with the terms of partnership deed. The payment of interest may be either from the account of book profit or from the net profit. As regards deduction claim on the salary payment to partners, deduction on the payment to all partners is worked out at the percentage of book profit as given in the section itself. Explanation 3 defines what book profit means. It states that "book profit" means the "net profit" as shown in the P&L a/c computed in the manner laid down in Part IV-D relating to "Profits and gain of business or profession", which means the net profit has to be necessarily worked out after giving such deductions and allowances as provided for in ss 28 to 44D. Taking into consideration that the legislature has consciously provided for such differential treatment in the matter of granting deduction and disallowance on the payment of interest and salary, it is difficult for us to accept the plea of the Revenue that s. 40(b) disallowance herein has to be worked out only on the book profit, meaning thereby, the net profit after working out the depreciation. It is no doubt true that depreciation is given as a charge on the profit, but then, when working out s. 40(b) disallowance, particularly with reference to cl. (iv), when there is no specific reference to a book profit as a basis on which an interest has to be paid, unlike in the case of salary, the mere score that depreciation is made a charge on the profit, per se, would not justify the claim of the Revenue that the granting of such relief on the gross profit would lead to distorted figures in the matter of working out the real income of the assessee for the purpose of taxation.
11. In the decision in Aircel Ltd. (supra), following the decision of the apex Court in Mahendra Mills (supra), this Court held that, where an assessee did not avail the benefit of depreciation that benefit could not be forced upon the assessee.
12. As far as the present case is concerned, the question is not as to whether the assessee desired depreciation or not. The question herein is that, at what, point could the interest be worked out and considered to be credited to the capital account of the partners for the purpose of considering the claim for deduction. Given the fact that the partnership deed provided for interest payment and what is disallowed under s. 40(b)(iv) of the Act is the rate of interest exceeding 18 per cent simple interest, as it then stood, in the absence of any clear-cut guidance under the Act as has been provided in the case of salary, through Explanation that the payment of salary of all the partners for the purpose of deduction has to be worked out on the percentage of book profit computed in the manner laid down in Chapter IV-D, we have no hesitation in accepting the plea of the assessee that the method adopted by the assessee justifies the claim. It is no doubt true, as pointed out in the assessment order, that after working out the depreciation and expenses, practically, there might not be anything available at the hands of the firm for crediting any interest to the capital account, but then, as s. 40(b)(iv) of the Act stands in contrast to s. 40(b)(v) of the Act, it is difficult to accept the case of the Revenue that by reason of this figure alone, the accounts have to be rejected.
13. Thus, going by the provisions under s. 40(b)(iv) of the Act, there being, no restriction placed on the working of interest before working out the depreciation, we have no hesitation in accepting the plea of the assessee that the Revenue cannot insist on depreciation being a charge on profit, has to be deducted first, before considering any interest payment on the capital of the firm. In the circumstances, we set aside the order of the Tribunal and allow the tax case (appeals). These tax case (appeals) are allowed. Consequently, connected miscellaneous petitions are closed. There is no order as to costs.
Lata *In favour of assessee.
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