Compensation paid to retiring partner on family settlement allowed as deduction to firm

Compensation paid to retiring partner consequent to family settlement-Deduction allowed as capital of firm was kept intact and business was continued by other coparceners  partners.

ABCAUS Case Law Citation:
ABCAUS 2466 (2018) 08 ITAT

The instant appeal was filed by the assessee directed against CIT(A)’s order in sustaining the disallowance for compensation paid to retiring partner

The assessee was a partnership firm. The business of the partnership firm was a family business and the members of Hindu Undivided Family (HUF) were the partners in the firm.

One of the partners willingly retired from the partnership firm and his share in the capital asset of the firm and profit till retirement was paid to him consequent to a family settlement.

However, the Assessing Officer found that the same cannot be allowed as business expenditure while computing the taxable income of the assessee. Accordingly, the AO added the same to the income.

The CIT(A) confirmed the addition made.

The Tribunal opined that under normal circumstances, when the asset of the firm was distributed to the partners on retirement, it is liable for capital gain tax under Section 45 of the Income-tax Act, 1961 (Act). However, in the instant case, there was a family settlement by which all the coparceners agreed to pay to the retiring partner and his mother. This family settlement was to protect the family business among the coparceners of the Hindu Undivided Family. Therefore, there was no transfer of capital asset, hence, it is not taxable for capital gain tax.

The Tribunal further observed that it was not a payment made towards business expenditure or towards royalty, but it was only a distribution of asset of the partnership firm on retirement of the partner due to family settlement. Since the business and its assets were kept by the coparceners intact, retiring partner and his mother were compensated. Therefore, even though it cannot be construed as expenditure for business or for royalty, certainly it was a division / distribution of partnership firm’s asset by way of paying compensation to partners.

The Tribunal opined that since the capital of the assessee was kept intact and the business was continued by other coparceners / partners, the payment made consequent to family settlement, was allowable / deductible while computing the taxable income of the firm.

Accordingly, the orders of both the authorities below were set aside and the disallowance made by the Assessing Officer as confirmed by the CIT(Appeals) was deleted.

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