REMUNERATION BY A FIRM TO PARTNERS: SECTION 194J ATTRACTED?

From the remuneration payable by a
firm to its partners in pursuance of section 40(b) of the Income-tax Act, 1961
(‘the Act’), the firm does not deduct any tax at source (hereinafter also
referred to as ‘TDS’) under any provision of the Act. This position has been
undisputedly settled and accepted by the Income-tax Department for over 25
years since the new scheme of taxation of firms and partners was brought on the
statute book by the Finance Act, 1992 from the assessment year 1993-94.

But in a recent case I came across an
overzealous officer of the Income-tax Department adopting the stand that a firm
is liable to effect TDS u/s 194J of the Act @ 10% from the remuneration payable
to its partners as, in their view, the services rendered by the partners to the
firm are in the nature of ‘managerial services’ which fall within the scope of
the term ‘technical services’ employed in section 194J. Apart from a huge demand
of tax u/s 201(1), a substantial amount of interest u/s 201(1A) is also being
charged. This is playing havoc with the taxpayers, especially when the partners
have already paid tax on their remuneration in their respective individual
returns and the credit for such tax paid allowable under the first proviso
to sub-section (1) of section 201 is being denied on procedural technicalities.

Therefore, before proceeding further,
it is fervently pleaded that to alleviate the hardships faced by the taxpayers
and to avoid unnecessary litigation, the Central Board of Direct Taxes (‘CBDT’)
needs to urgently issue a circular clarifying the position on this subject, to
be followed (if necessary) by an appropriate legislative amendment in section
194J expressly excluding such remuneration from the purview of section 194J.

CLEAR LEGISLATIVE INTENT

Principally, it is submitted that the
remuneration payable by a firm to its partners cannot be subjected to TDS u/s
194J. In this regard the following propositions are submitted:

(1)  Firstly,
the legislative intent has always been clear beyond doubt that under the new
scheme of taxation of firms and partners, interest and remuneration payable by
a firm to its partners are not liable to TDS since by nature, character and
quality any such payment by a firm to its partners is nothing but a share in
the profits of the firm, though called interest or remuneration and though
deductible u/s 40(b). This legislative intent is manifestly evident from the
following:

ACCEPTED FOR OVER 25 YEARS

(a)  When
the new scheme of taxation of firms and partners was introduced by the Finance
Act, 1992 with effect from A.Y. 1993-94, section 194DD¹ was also
proposed to be inserted in the Act which provided for TDS² both from
interest and remuneration payable by a firm to its partners. But section 194DD
was dropped during the process of the Finance Bill, 1992 becoming an Act,
because the legislature was conscious that, conceptually, under the new scheme
of taxation of firms and partners, both interest and remuneration payable by a
firm to its partners are only a mode of transferring profits from the firm to
the partners for tax. This is fortified from the statutory provision that the
remuneration (as well as interest) received by a partner from the firm is treated
as business income in the individual hands of the partner u/s 28(v)³
of the Act⁴;

(b)  Explanation
2 below section 15 unambiguously provides that any salary, bonus, commission or
remuneration, by whatever name called, due to, or received by, a partner from
the firm shall not be regarded as ‘salary’. Consequently, provisions of section
192 relating to TDS from salaries are not attracted. This is statutory
recognition of the principle that there cannot be an employer-employee
relationship between a firm and its partners and as such no tax is required to
be deducted from such remuneration u/s 192;

(c)  Section
194A(3)(iv), likewise, expressly provides that no tax is to be deducted at
source from the interest payable by a firm to its partners;

(d) As
a matter of fact, any firm deducting tax at source under any provision of the
Act, including section 194J, from the remuneration payable to its partners is
unheard of in India and this position has been undisputedly, ungrudgingly and
eminently accepted by the Income-tax Department for over 25 years since the new
scheme of taxation of firms and partners came on the statute book;

(e)  Section 194J was introduced in the Act by the
Finance Act, 1995 with effect from 1^st July, 1995 for TDS from fees
for professional services⁵  and fees for technical services⁶.
Later, by the Finance Act, 2012 a new category was added by inserting clause
(ba) in sub-section (1) of section 194J with effect from 1^st July,
2012 which mandates TDS from ‘any remuneration or fees or commission, by
whatever name called, other than those on which tax is deductible u/s 192, to a
director of a company’. Thus, whenever the legislature intended that tax should
be deducted u/s 194J from the remuneration payable, it has expressly provided
for it in so many words as is the case with clause (ba) above applicable to
remuneration payable by a company to its directors. But no such specific clause
is inserted with regard to the remuneration payable by a firm to its partners;
while inserting clause (ba), the Memorandum explaining the provisions in the
Finance Bill, 2012 ([2012] 342 ITR [St] 234, 241) visibly
acknowledges that there is no specific provision for deduction of tax on the
remuneration paid to a director which is not in the nature of salary.
Furthermore, it is also judicially held⁷  that prior to insertion of the above referred
clause (ba) with effect from 1^st July, 2012, no tax was deductible
u/s 194J from the commission / remuneration payable by a company to its
directors. It follows, therefore, that in the absence of any such specific
clause in section 194J postulating TDS from the remuneration payable by a firm
to its partners, the legislative intent is loud and clear – that no tax is
deductible u/s 194J by a firm from such remuneration.

A FIRM HAS NO LEGAL EXISTENCE

(2)  A
firm and its partners are treated as separate assessable entities for the
limited purpose of assessment under the Act, but, in law, as is settled
judicially for ages, a firm has no legal existence of its own, separate and
distinct from the partners constituting it, and the firm name is only a
compendious mode of describing the partners constituting the partnership. As
such, a person cannot render services to himself and there cannot be a contract
of service between a firm and its partners. Therefore, a firm cannot be
expected or made liable to deduct tax at source u/s 194J from such remuneration.

In CIT vs. R.M. Chidambaram
Pillai [1977] 106 ITR 292 (SC) the Apex Court observed that a firm is
not a legal person even though it has some attributes of a personality; and
that in income-tax law a firm is a unit of assessment by special provisions,
but not a full person.

The Supreme Court then unequivocally
held that since a contract of employment requires two distinct persons, viz.,
the employer and the employee, there cannot be a contract of service, in
strict law, between a firm and its partners⁸.

SHARE OF PROFITS OF THE FIRM

(3)  A
partner works for the firm since he is duty-bound to do so under the deed of
partnership as well as in terms of the provisions of the Indian Partnership
Act, 1932⁹  and therefore
there is no relationship of service provider or consultant and client between
the partners and the firm.

(4)  Under
the Indian Partnership Act, 1932 since there is a relationship of ‘mutual
agency’ among the partners, there cannot be a relationship between a firm and
its partners which could give rise to a liability to deduct tax at source u/s
194J.

(5)  Conceptually,
whatever may be the amount received by a partner from the firm, whether called
salary or remuneration, it is not expenditure of the firm (though allowed as
such u/s 40[b]), nor in the nature of compensation for services in the hands of
the partner, but it is in the nature of a share of profits from the firm as is
settled judicially, including by the Supreme Court. In CIT vs. R.M.
Chidambaram Pillai (Supra) it was categorically held that payment of
salary to a partner represents a special share of the profits of the
firm and salary paid to a partner retains the same character of the
income of
the firm.

(6)  Even
under the statutory provisions embodied in section 28(v) of the Act, both
interest and remuneration received by a partner from the firm are expressly
assessed as business income in the hands of the partner and as such interest
and remuneration both are statutorily recognised as in the nature of a share of
profits from the firm¹⁰.

RULE OF CONSISTENCY

(7)  Since
generally the remuneration payable to the partners is a percentage of the
profits of the firm determined at the end of the year, which keeps on varying with
the amount of profits and is not reckoned with with reference to the quantity
and quality of services rendered by the partners to the firm, the same is a
mode of transferring a share of the profits of the firm to the partners and not
a compensation for the services rendered by the partners to the firm, and hence
the question of invoking section 194J does not arise.

(8)  Inasmuch
as the position that no tax is required to be deducted by a firm from the
remuneration payable to its partners is undisputedly and consistently accepted
by the Income-tax Department for over a quarter of a century now, even the rule
of consistency¹¹ obligates
that this position should not be disturbed by the Income-tax Department at this
stage.

(9) It
can also be contended that by nature the services rendered, if any, by a
partner to the firm do not fall within the connotation of either ‘professional
services’ or ‘technical services’ as defined and understood for the purposes of
section 194J.

(10) No tax is levied under the laws
relating to Goods and Services Tax (‘GST’) on the remuneration received by a
partner from the firm. Thus, the remuneration received by a partner from the
firm is not treated as consideration for the supply of services to the firm but
as a share of profits even under the GST laws.

One arm of the Union Government (the
Income-tax Department) cannot adopt a stand conflicting with the view accepted
by another arm of the same Union Government (GST Department). In Moouat
vs. Betts Motors Ltd. 1958 (3) All E R 402 (CA) it was held that two
departments of the government cannot, in law, adopt contrary or inconsistent
stands, or raise inconsistent contentions, or act at cross purposes. Lord
Denning in this case succinctly summed up the principle in his inimitable
style: ‘The right hand of the government cannot pretend to be unaware of what
the left hand is doing.’ To the same effect was the Supreme Court decision in M.G.
Abrol, Addl. Collector of Customs vs. M/s Shantilal Chhotelal & Co. AIR
1966 SC 197, holding, to the effect, that the customs authorities¹²
cannot, in law, take a stand or adopt a view which is contrary to that taken by
the licensing authority under the Export (Control) Order, 1954¹³.
This principle of law has been consistently applied for income-tax purposes as
well in a variety of contexts under the Act¹⁴.

In view of the foregoing discussion,
it is submitted that the remuneration payable by a firm to its partners cannot
suffer TDS u/s 194J of the Act.  

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1   Clause 74 of the Finance Bill, 1992: [1992]
194 ITR (St) 68-69

2   At the average rate of income-tax computed on the basis of the
rates in force for the financial year concerned

3   Read with section 2(24)(ve)

4      See
also CBDT Circular No. 636 dated 31^st August, 1992: [1992] 198
ITR (St) 1, 42-43

5   Clause (a) of sub-section (1) of section 194J

6   Clause (b) of sub-section (1) of section 194J

7      See, among others, Dy. CIT vs. ITC
Ltd. [2015] 154 ITD 136 (Kol.) and Dy. CIT vs. Kirloskar Oil
Engines Ltd. [2016] 158 ITD 309 (Pune). See also Bharat Forge
Ltd. vs. Addl. CIT [2013] 144 ITD 455 (Pune) (pre-2012 period) (sitting
fees to directors not ‘fees for professional services’ u/s 194J)

8   While reaching this conclusion, the Supreme
Court referred to, among others, Dulichand Laxminarayan vs. CIT [1956] 29
ITR 535 (SC); CIT vs. Ramniklal Kothari [1969] 74 ITR 57 (SC); and
Addanki Narayanappa vs. Bhaskara Krishnappa AIR 1966 SC 1300

9      See sub-sections (a) and (b) of section 12
along with sub-section (a) of section 13 of the Indian Partnership Act, 1932

10  See also CBDT Circular No. 636 dated 31^st
August, 1992: [1992] 198 ITR (St) 1, 42-43

11     The rule of consistency is settled by
countless judicial precedents. See, for example, Radhasoami Satsang vs.
CIT [1992] 193 ITR 321 (SC); Berger Paints India Ltd. vs. CIT [2004] 266 ITR 99
(SC); Bharat Sanchar Nigam Ltd. vs. UOI [2006] 282 ITR 273 (SC); CIT vs. Neo
Poly Pack (P) Ltd. [2000] 245 ITR 492 (Del.); CIT vs. Leader Valves Ltd. [2007]
295 ITR 273 (P & H); CIT vs. Darius Pandole [2011] 330 ITR 485 (Bom.);
and Pr. CIT vs. Quest Investment Advisors Pvt. Ltd. [2018] 409 ITR 545
(Bom.)

12  Under the Sea Customs Act, 1878

13  Issued under the Import and Export (Control)
Act, 1947