S.167 B(2) IT Act | Fixed Share Given To Member Of 'Association Of Persons' Regardless Of Profit Will Be Taxed As Income : Supreme Court

In an important ruling on a tax law, the Supreme Court on Tuesday (May 12) held that a member receiving a fixed percentage of gross receipts from an Association of Persons (AOP), without bearing business expenses or losses, cannot claim such receipts as a "share of profit” to claim exemption from income tax.

It is worthwhile to mention that taxation of members in an Association of Persons (AOP) or Body of Individuals (BOI) is governed by Section 86, read with Section 167B (2) of the Income Tax Act, 1961. The combined reading of these provisions says that when an AOP is taxed at the maximum marginal rate under Section 167B (2), usually because members' shares are unknown or high-income members exist, the share of income received by a member is excluded from their total income. This is to ensure that if the AOP is taxed at the highest rate, the member is not taxed again on the same income, to avoid double taxation.

The Case

The dispute arose from an AOP agreement executed on April 29, 2003, between the Respondent (Sanand Properties Private Ltd, Member of AOP) and Raviraj Kothari & Co. for the development of a housing project.

Clause 7 of the agreement provided that all sale proceeds from flat purchasers would first be received in the name of the AOP. Out of those receipts, SPPL (Sanand Properties Pvt Ltd) would immediately become entitled to 35% of the gross collections, while the remaining 65% would be retained for meeting all project-related expenses.

Only the balance remaining after expenses would ultimately accrue to the other member.

The Income Tax Department contended that SPPL's entitlement was not linked to actual profits of the AOP, but was instead a fixed share of gross revenue, making it taxable in SPPL's hands.

However, the ITAT and Bombay High Court had earlier accepted SPPL's argument that the amount represented an exempt “share of profit” from the AOP, prompting the department to appeal to the Supreme Court.

Decision

Allowing the revenue's appeal, a bench of Justice JB Pardiwala and Justice KV Viswanathan observed that the 35% share of profit received by the Respondent was a fixed share of gross revenue, making it a taxable income in the hands of the Respondent.

The court agreed with the revenue's argument that for claiming a benefit under Section 86 r/w Section 167B(2) of the Act, it is necessary that expenses need to be deducted from the Member's share to claim it as a 'share of profit', otherwise the same would amount to revenue, making it taxable.

In essence, the judgment authored by Justice Pardiwala observed that when the receipts to a Member are not contingent upon the AOP's profit, nor are the expenses accrued, then such receipts by a Member can't be termed as a “share in profit”, rather a revenue receipt assuming the character of an income.

“…we are certain that accrual of the SPPL's share, i.e. 35% of gross sale receipts of the AOP, was not contingent on the AOP's profit and the SPPL could withdraw such amount immediately. The entitlement of the SPPL is embedded in the very framework of the arrangement of Clause 7 of the AOP Agreement and attaches to the gross receipts at the point of their accrual, leaving no discretion with the AOP in the matter. To that extent, the AOP neither acquires nor retains any control over such portion of the receipts but merely holds and disburses the same on behalf of the SPPL. This is not a case of the AOP applying its income in discharge of an obligation; rather, it is a case where, by reason of a pre-existing and enforceable right created by the overriding title under Clause 7 of the AOP Agreement, the gross sale receipts to the extent of 35% is intercepted and diverted towards the SPPL before it could have even assumed the character of income in the hands of the AOP.”, the court observed.

Since SPPL's share was calculated before deduction of expenses, the Court held that it lacked the essential characteristics of “profit.”

“…we hold that the 35% share received by the SPPL from the AOP for Assessment Years 2008-09 and 2009-10 is taxable in the hands of the assessee as a business receipt.”, the court held.

The Court relied heavily on its ruling in CIT v. Sitaldas Tirathdas, (1961) 41 ITR 367, dealing with “diversion of income by overriding title.”

Under that principle, the Court explained, where income is diverted at source before it becomes part of the taxable income of an entity, such amount cannot be treated as the entity's own profit.

Applying the doctrine, the Court held that the AOP never truly acquired control over SPPL's 35% share because the entitlement was embedded in the agreement itself and attached directly to gross receipts.

“Since the SPPL's share remained insulated from the expenses of the AOP, the amount received by it lacks the essential characteristics of “profit” and is, in pith and substance, a business receipt arising from the surrender of development rights or a share of gross revenue.”, the court observed.

In terms of the aforesaid, the appeal was allowed.

Cause Title: COMMISSIONER OF INCOME TAX III VS. M/S. SANAND PROPERTIES PVT. LTD.

Citation : 2026 LiveLaw (SC) 488

Click here to download judgment

Appearance:

For Respondent(s) : Mrs. Anil Katiyar, AOR Ms. Manisha T Karia, Sr. Adv. Ms. Anita Bafna, AOR Ms. Shreya Gupta, Adv. Ms. Ananya Arora, Adv. Mr. Deepin Sahni, Adv. Mr. Vishal Navale, Adv. Mr. Varun Khetwani, Adv.

For Respondent(s) : Ms. Manisha T Karia, Sr. Adv. Ms. Shreya Gupta, Adv. Ms. Ananya Arora, Adv. Mr. Vishal Navale, Adv. Mr. Deepin Sahni, Adv. Mr. Varun Khetwani, Adv. Ms. Anita Bafna, AOR Mr. Raghavendra P Shankar, A.S.G. Mr. Raj Bahadur Yadav, AOR Mr. Karan Lahiri, Adv. Mr. Navanjay Mahapatra, Adv. Mr. Sarthak Karol, Adv. Mr. Priyanka Terdal, Adv. Ms. Manisha T. Karia, Sr. Adv. Mr. Vipin Kumar, AOR Mr. Deepin Deepak Sahni, Adv. 2 Ms. Shreya Gupta, Adv. Ms. Ananya Arora, Adv. Mr. Varun Khetwani, Adv.