M/S Adarsh Constructions,, Hyderabad vs Department Of Income Tax

This Revenue's appeal was filed against the order of the Commissioner of Income Tax(Appeals), Vijayawada dated 30-11-2012. The issue in this appeal is with reference to rate of estimation of income in the hands of the firm and allowance of deduction towards interest and remuneration paid to partners u/s.40(b).

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2. Briefly stated, assessee is carrying on business of construction and sale of flats and also construction of houses on contract basis. The Assessing Officer in the scrutiny assessment disallowed 10% of the cost of construction claimed as possible inflation and further, 5% of the closing stock towards estimated suppression. He also disallowed certain payments through bearer cheques u/s.40A(3) of the Income Tax Act (Act). In addition to that, Assessing Officer also disallowed amounts paid towards work contracts on the reason that TDS was not disallowed u/s.40(a)(ia). Even the depreciation was also partly disallowed. Thus, as against the income returned at Rs.6,36,055/-, the total income was determined at Rs.96,21,910/-.

3. The Ld.CIT(A) after considering the detailed submissions of the assessee held that the additions/disallowances made by the Assessing Officer are not justified. The Revenue is not in appeal on the issue of deletion of additions or disallowances made by the Assessing Officer. The Ld.CIT(A) while holding that the disallowance and additions cannot be sustained as they are not based on facts but on presumptions however, rejected the Books of Accounts and estimated the income at 8% of the turnover and allowed interest on partner's capital and remuneration paid to partners. He accordingly determined the total income at Rs.15,90,638/- in his order. Revenue is aggrieved on the rate of estimation of income and allowing deduction towards interest and remuneration paid to partners u/s.40(b).

4. Ld.DR submitted that estimation of income at 8% is very low and further based on the decision of the Hon'ble High Court in the case of Indwell Constructions (232 ITR 776), deduction towards interest and remuneration cannot be allowed.

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5. Ld.Counsel, however, submitted that order of the CIT(A) is reasonable, as income was correctly estimated at 8% being in the business of construction of houses and further submitted that the judgment of Indwell Constructions was before the amendment to the act and co-ordinate bench in the case of M/s. C.Eswara Reddy & Co., distinguished the same. Further, relying on the Special Bench decision in the case of Arihant Builders [291 ITR 41 AT(SB)], it was submitted that the estimation at 8% is correct.

6 We have considered the issue and perused the rival arguments. In this case, even though Assessing Officer has made various additions/disallowances and has not rejected the Books of Accounts, Ld.CIT(A) rejected the Books of Accounts and resorted to estimation of income. Revenue has not raised any ground on rejection of Books of Accounts nor assessee is contesting the same by way of cross-appeal. Consequently, the issue of rejection of Books of Accounts is not disputed by either of parties. Whereas assessee has not disputed the estimation at 8% and allowance of interest on remuneration to the partners by the CIT(A) in his order, Revenue has raised the grounds contesting the estimation at 8% as well as allowance of deduction particulars, interest and remuneration paid to partners.

7. As far as estimation of income at 8% is concerned, there cannot be any hard and fast rule of fixing a ratio in estimating the profits. The Tribunal is generally estimating the incomes from 8% to 12.5% depending on the factual situation. In the co-ordinate Bench decision of Krishnamohan Constructions in ITA No.116 & 117/Hyd/2007 for AYs.1993-94 and 1994-95, the Tribunal estimated the profit at 8% even though the profit was estimated at 12.5% for AY.1991-92. This itself shows that for each year, the profit has to be estimated depending upon :- 4 -: I.T.A. No. 164/Hyd/2013 M/s. Adarsh Constructions

the factors which prevail in the business. In the case of Arihant Builders (supra), the Special Bench estimated the profit at 8% for main contracts. The Special Bench took into consideration the provisions of Section 44AD of the Act in arriving at the profit at 8% of the gross receipts. No doubt, the provisions of Section 44AD are applicable for those cases where the turnover/total contract receipts does not exceed Rs.40 Lakhs up to AY.2010-11 (which was subsequently modified to Rs.60 lakhs and now w.e.f. 01-04-2013 stood at Rs.1 Crore). These indicate that rate of profit cannot be a fixed figure for each year. It would vary depending upon various factual situations/factors. It cannot be fixed on the basis of the Tribunal or judgment of the High Court. In our opinion, the decision of the Tribunal or judgment of the High Court may be one of the guiding factors for fixing the profit ratio for particular assessee in a particular year. In this case, as seen from assessee's P&L A/c assessee's sales stood at Rs.2.71 Crores, whereas its closing stock was at Rs.2.88 Crores. Construction cost during the year is about Rs.3.81 Crores. This indicate that the project has not yet been completed or partly completed. However, as seen from the P&L A/c placed on record which was basis for the Assessing Officer to make disallowances, assessee has earned gross profit at 15% and Net Profit 5.4%. Assessee has major liability in the form of interest on term loans for reduction in profit from 15% gross to 5% net. Keeping these factors and also the fact that assessee paid Rs.14,51,871/- as interest on the term loans, apart from other expenditure to indicate that estimation by the CIT(A) at 8% on the gross receipts is reasonable. Revenue has not brought on record anything to counter how this estimation is less on the given set of facts. In view of this, we uphold the estimation at 8%.

8. The next contention is with reference to allowance of interest on partners' capitals and partners' remunerations. Assessee has claimed :- 5 -: I.T.A. No. 164/Hyd/2013 M/s. Adarsh Constructions

an amount of Rs.4,95,401/- as interest on partners' capitals and Rs.84,000/- as remuneration to the partners and arrived at Net Profit of Rs.8,87,273/-. Due to variation in the depreciation claims etc., the income offered by assessee as can be seen from the assessment order was at Rs.6,36,055/-. One of the deductions allowed by the CIT(A) is with reference to remuneration and interest to the partners which was contested by the Revenue as not allowable u/s.40(b) relying on the decision of the jurisdictional High Court in the case of Indwell Constructions Vs. CIT [232 ITR 776]. It was the contention of the Revenue that once the Books of Accounts were rejected and profit was estimated, all expenditures are deemed to have been allowed, therefore, there is no need for allowing depreciation, interest and salary to partners. Revenue is not contesting the issue of depreciation in this case as the CIT(A)'s order considered it as deemed allowance. The issue is only restricted to the statutory allowance of deduction u/s.40(b). Even though in the above referred case, the Hon'ble A.P. High Court considered the provisions and held that no further disallowances are required to be made once income is estimated, the said judgment relates to AY.1981-82. The provisions of Section 40(b) then existing provides for disallowance of payment of interest, salary, bonus commission or remuneration made by the firm to the partner. These amounts are not allowable as deduction in the assessment of a partnership firm then existing. At the relevant point of time up to the change of provisions with effect from 01-04-1993, the firms are classified as registered firms u/s.185 or as un-registered firms. The income of the registered firm was not taxed at the normal rates and the same was distributed among the partners in accordance with the provisions of Section 67 of the Act. While distributing the income among the partners interest, salary, commission or remuneration paid to partners are to be reduced from the gross income of the partnership firm. The balance is divided among the :- 6 -: I.T.A. No. 164/Hyd/2013 M/s. Adarsh Constructions

partners in their profit sharing ratio, the amounts paid to partners i.e., interest, salary, bonus, commission or remuneration are added to the income of the individual partner. The profits distributed were assessed in the assessment of the partners. However, the provisions with regard to the assessment of partnership firms have undergone change from 01-04-1993 i.e., for the AY.1993-94 onwards. Now, all firms are uniformly assessable as firms only and there is no difference in tax rates. The profit derived from the partnership firm is exempt in the assessment of the partners as the same is being taxed at normal rates in the assessment of the partnership firm itself. Only salary or interest paid to the partners is subject to tax in the assessment of the partners as the same is excluded from the assessment of the partnership firm. Provisions of Section 40(b) allows interest paid to partners and remuneration paid to the partners as an allowable deduction, subject to certain conditions mentioned in Section 40(b) of the Act. Therefore, there is a change in the provisions itself from a disallowance provisions to allowance provisions subject to restrictions. Thus, w.e.f. 1993-94, Section 40(b) is enabling a deduction towards interest and remuneration paid to the partners by way of statutory deduction. Therefore, jurisdictional High Court judgment given for AY.1981-82 in the context of the provisions then existing is no longer applicable to the revised assessment procedure. This same view was held by various co-ordinate Benches. In the case of M/s. C.Eswara Reddy and Co. in ITA No.668 & 670/Hyd/2009 and Cross-appeals in ITA No.685 & 686/Hyd/2009 for AYs.2003-04 & 2004-05, the co-ordinate Bench vide order dt.31-01- 2011 held as under:

15. We have carefully gone through the judgement of the jurisdictional High Court in the case of Indwell Construction (supra).

The assessment year under consideration before the jurisdictional High Court was assessment year 1981-82. Section 44AD was introduced in the statute book with effect from 1.4.1994. Therefore, :- 7 -: I.T.A. No. 164/Hyd/2013 M/s. Adarsh Constructions

the jurisdictional High Court had no occasion to consider the provisions of section 44AD as it is applicable for the assessment year under consideration and as it would be applicable with effect from 1.4.2011. In view of the provision of section 44AD as it is applicable for the assessment year under consideration and the amendment made with effect from 1.4.2011 it is obvious that the Legislature intended to allow the interest and salary separately from the estimated income. Therefore, the judgement of the jurisdictional High Court in the case of Indwell Constructions (supra) may not be of any assistance to the Revenue in this case. Accordingly we direct the Assessing Officer to allow the salary and interest paid to the partner subject to the limitation provided in section 40(b) of the Act.

9. Similar view was also taken in the case of co-ordinate Bench decision in the case of Maruthi Constructions, Vijayawada Vs. ACIT in ITA No. 67 & 373/Vizag/12 dt.03-03-2014. The view expressed by the co-ordinate Benches is also consistent with the judgments of the Hon'ble High Court of Allahabad in the case of CIT Vs. Vijay Constructions [213 CTR 105] wherein on similar facts of rejection of Books of Accounts, it was held that statutory deductions allowable u/s.40(b) cannot be denied merely because its Books of Accounts have been rejected and best judgment assessment has been made. It was held:

"The procedure for making assessment in a matter where voluntary return submitted by the assessee under s.139(1) is not accepted by the AO has been given under s.143(3), whereas procedure for giving best judgment assessment is given under s.144. Merely because the procedures for such assessments have been separately provided in the aforesaid two section relating to an assessee where the voluntary return has not been found as acceptable by the AO and where the books of account have been rejected and best judgment assessment has been made, it would not in itself be sufficient to hold that the statutory deductions which are otherwise available to the assessee, would not be available to the assessee who has been assessed under best judgment assessment by the AO, unless, of course, any rule or provision of the Act expressly excludes the benefit of statutory deductions to such an assessee. If the interpretation given by :- 8 -: I.T.A. No. 164/Hyd/2013 M/s. Adarsh Constructions

the Revenue is accepted, it would mean that in a case where the assessee's books of account have been rejected or, for any other reason, whatsoever, best judgment assessment has been made that would entail penalty or adverse civil consequences of depriving the assessee from having the statutory deductions, which would have been otherwise available to him, in case his voluntary return filed under s.139(1) has been accepted or regular proceedings under s.143(3) were taken. This interpretation would lead to an anomalous situation, besides the same does not flow from the scheme of assessment under the Act. It is only the method of assessing the income of the assessee firm which either has to be done by accepting the voluntary return filed under s.139(1) or it has to be regularly assessed under s.143(3) or best judgment assessment is to be made under s.144. The final outcome of the assessment of the income of the assessee firm calls for consequential imposition of tax and realisation thereof. The statutory deductions thus which are available to the assessee firm cannot be taken away or snatched away from the firm merely because their books of account have been rejected and best judgment assessment has been made.

Salary and Interest, which is given to the partners in terms of the partnership deed, the tax liability of the said amount shifts upon the partners and cannot be taken as tax liability of the firm. The applicability of s.28(v) cannot be excluded in the matter of best judgment assessment in respect of an assessee firm. It was the specific case of the assessee that the partners were working partners and they were entitled to salary and interest, as per terms of the deed in accordance with s.40(b). In the absence of any material having brought by the Revenue in rebuttal and more so when no such plea was ever taken or raised in the appeal, as also no substantial question of law has been framed in this regard, the plea is bound to fail.

Conclusion:

Statutory deductions which are allowable under s.40(b) to the assessee firm cannot be denied merely because its books of account have been rejected and best judgment assessment has been made".

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10. On similar facts, even in a case where cash system of accounting was maintained, Hon'ble Punjab & Haryana High Court in the case of CIT Vs. Supreme Builders [303 ITR 1 (P&H)] held as under:

"The profit has been computed by application of flat rate on receipts, as the AO has rejected the results of the assessee by recording a finding of fact that the assessee has not maintained the regular books of accounts. The partnership deed is not disputed by the Revenue and as per this partnership deed, the remuneration of the partners was to be credited in the capital account of the parties in the end of the financial year. Since the assessee is maintaining its books of account under the cash system of accounting, deduction on account of salary and interest to be paid to the partners was allowable as per the partnership deed. In this regard, the assessee had also relied upon the Board Circular No. 739, dt. 25th March, 1996, which is not disputed by the Department. In regard to the assessment of income pertaining to difference in receipts, the profit having be determined by application of flat rate, the difference in payments does not justify the different treatment. It is not a case of an assessee who has maintained regular books of accounts and the result disclosed having been accepted by the Department in which case the difference in receipts would have been the impact of enhancing the income to the extent of such difference. Therefore, in the present case, regular books of accounts not having been maintained and a flat rate applied, the extra payment receipt by the assessee deserved the same treatment as other payments.

Conclusion:

Assessee's books having been rejected an dprofits arrived at by applying flat rate, salary and interest to partners of assessee following cash system of accounting was separately allowable as per deed of partnership, though not actually paid".

11. In view of the decision of the co-ordinate Benches as supported by the judgements of High Courts stated supra, we do not see any reason to interfere with the order of the CIT(A), which is consistent with the views :- 10 -: I.T.A. No. 164/Hyd/2013 M/s. Adarsh Constructions

expressed by the co-ordinate benches. Therefore, we do not see any merit in the grounds raised by the Revenue.

12. In the result, Revenue's appeal is dismissed.

Order pronounced in open Court on 31st March, 2015.

Sd/- Sd/- (D. MANMOHAN) (B. RAMAKOTAIAH) VICE PRESIDENT ACCOUNTANT MEMBER

Hyderabad, Dated 31st March, 2015

TNMM

Copy to :

1. Assistant Commissioner of Income Tax, Circle-9(1), 1st Floor, 'B' Block, Income Tax Towers, A.C.Guards, Hyderabad-4.

2. M/s. Adarsh Constructions, H.No.17-1-383/A/47, Vinay Nagar Colony, Saidabad, Hyderabad.

3. CIT(Appeals), Vijayawada

4. CIT-VI, Hyderabad

5. D.R. ITAT, Hyderabad.