Investment by firm through capital introduced by partners cannot be treated as unexplained

Investment made by firm through capital introduced by partners cannot be treated as unexplained investment in the hands of the partnership firm.

In a recent judgment, ITAT has held that investment made through capital introduced by the partners of the firm cannot be treated as unexplained investment in the hands of the partnership firm. If at all the Revenue entertains any doubt regarding the source of funds available with individual partners, the enquiry lies in the respective partner’s assessments and not in the assessment of the firm.

ABCAUS Case Law Citation:
5201 (2026) (08) abacus.in ITAT

In the instant case, the assessee had challenged the order passed by the CIT(A) in confirming addition made by the Assessing Officer (AO) on account of alleged unexplained investment u/s.69 of the Income Tax Act, 1961 (the Act).

The appellant assessee was a newly formed partnership firm doing business activities in real estate. During the relevant Financial Year, the assessee firm purchased an immovable property for the purpose of developing a residential project.

The assessee firm paid the purchase price from the partner’s individual account. The purchase was conditional purchase that this industrial land has to be converted into residential land by the seller, so that, the partnership firm can develop residential project on the land. However, due to some technical difficulties the seller could not able to get the land conversion and couple with the fact that the assessee firm was also not able to make payment on time to the seller. Therefore, the sale deed was cancelled. The seller repaid the consideration to the partners of the assessee firm.

The Assessing Officer issued a notice u/s 148 on the ground that the assessee firm failed to disclose the transfer of immovable property. Therefore, the assessee was issued with a show cause notice.

In response, the assessee filed copies of bank statement, capital a/c of Partners, balance-sheet and computation of income and informed that they made investments in immovable property and out of that only part payment was made during the financial year.

The subsequent show cause notice issued by the Assessing Officer was not responded by the assessee, which resulted in the AO making the addition of the entire sale consideration amount as the assessed income of the assessee. Penalty proceedings u/s 271F were also initiated.

On appeal the CIT(A) restricted the addition to the amount actually received by seller.

Before the Tribunal, the appellant inter alia contended that funds were paid by the Partners in their individual capacity. Thus, no addition can be made in the hands of the firm.

The Tribunal observed that the very basis for reopening of assessment, was that the assessee purchased immovable property during the Financial Year and not filed by return of income. During the reassessment proceedings, the assessee filed bank statement, capital accounts, balance-sheet and computation of income. The assessee also informed that during the financial year, it has paid only partly. The sale could not be materialized and therefore, since the seller could not convert the industrial land into residential plots, it was cancelled.

The Tribunal noted that as mentioned in the registered Sale Deed, the payments were made through cheques by the Partners in their individual capacity and introduced as capital of the Firm. Similarly, in the Cancellation Deed, sale consideration returned back to the assessee firm through banking channel.

The Tribunal noted that Hon’ble Supreme Court had held that where the Assessing Officer made addition to assessee firm’s income under section 68 in respect capital introduced by one partner of firm, in view of fact that amount received by assessee firm had been duly reflected in books of account maintained by concerned partner and he had also confirmed such contribution, impugned addition was to be set aside and SLP dismissed.

Similarly, the Hon’ble Madras High Court had held that The Assessing Officer cannot ask the assessee-firm to prove source of a source. Once the firm has offered an explanation and established that the capital was contributed by the partners, the same could not be assessable in the hands of the firm. Unless there are contradictions and inconsistencies in the statement of the partners, the credit cannot be treated as unexplained and cannot be added under section 68 in the hands of the assessee-firm.

Similarly, the Hon’ble Andhra Pradesh & Telangana High Court held that partnership firm is not required to explain source of income for partners regarding amount contributed by them towards capital of the Partnership firm. 

The Tribunal opined that the addition made by the Assessing Officer which were nothing but the contributions made by the Partners to purchase the immovable property in the name of the Partnership Firm was not liable to be taxed in the hands of the firm, following judicial precedents. Accordingly, the Tribunal held that the impugned investment cannot be treated as unexplained investment in the hands of the partnership firm. If at all the Revenue entertains any doubt regarding the source of funds available with individual partners, the enquiry lies in their respective assessments and not in the assessment of the assessee-firm.

Consequently, the addition was directed to be deleted. 

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