The Special Bench had to consider two issues: (i) given that a firm pays tax on its profits, whether the share of profit received by a partner from the firm, which is exempt in his hands u/s 10(2A), can be said to be not “tax-free” so as to not attract s. 14A and (ii) whether depreciation can be said to be “expenditure” so as to be disallowable u/s 14A.

HELD by the Special Bench:

(i) Though Disallowance Applies To Partner’s Share of Profits but Not To Depreciation US 14A a firm and its partners are not different entities in general law, under the Act, they are treated as separate entities. The salary and interest paid by the firm to the partners is deductible in the hands of the firm and taxable in the hands of the partners’ u/s 28(v). The balance profits are taxed in the hands of the firm and exempt in the hands of the partners u/s 10(2A). As s. 10(2A) provides that the share of profit of the partner shall not be included in his total income, it is not possible to hold that the share income is not excluded from the total income of the partner because the firm has already been taxed thereon. When s. 10(2A) speaks of its exclusion from the total income it means the total income of the person whose case is under consideration i.e. the partner. As the share income is excluded from his total income, s. 14A would apply and any expenditure incurred to earn the share income will have to be disallowed (Dhamasingh M. Popat 127 TTJ 63 (Mum) approved; Sudhir Kapadia & Hitesh Gajaria reversed);

(ii) However, s. 14A applies only to “expenditure” incurred by the assessee. Depreciation u/s 32 is an “allowance” and not “expenditure” and so cannot be disallowed u/s 14A (Hoshang D. Nanavati approved).

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