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.

Headnote

Income Tax Act, 1961; Sections 147 and 148 – Reassessment – Reason to Believe – Tangible Material – Change of Opinion – Reopening of assessment is valid if the Assessing Officer possesses "tangible material" providing a "reason to believe" that income has escaped assessment - Mere production of account books or documents during original assessment does not necessarily amount to "full and true disclosure" if the assessee fails to bring the Assessing Officer's attention to specific relevant items or if subsequent fresh information exposes the falsity of earlier statements - In the present case, while the assessee disclosed the existence of the Association of Persons (AOP) and the income derived from it, the primary fact that the income was a 35% share of gross revenue (and not tax-exempt profit) came to light only through documents impounded during a subsequent survey and a director's statement recorded under Section 131 - Since the Assessing Officer had not formed a conscious opinion on the fundamental nature of this income during the original scrutiny assessment, the reopening did not constitute a mere "change of opinion" but was a valid exercise of jurisdiction based on fresh tangible material. [Paras 64, 70-71, 75-76, 82-83, 106-113, 116, 117]

Income Tax Act, 1961; Interpretation of Contracts – Revenue vs. Profit – Overriding Title – The interpretation of a contractual clause which is the foundation of the rights of parties is a question of law - Under Clause 7 of the AOP Agreement, the appellant was entitled to 35% of gross sale proceeds upfront, while all project expenses were to be met from the remaining 65% share of the collaborator - Since the appellant's share remained insulated from the expenses of the AOP, the receipt lacked the essential characteristics of "profit" (which is surplus after expenses) and was in substance a "share of revenue" - Such an arrangement creates an "overriding title" that diverts the income before it reaches the AOP, making it taxable in the hands of the member (assessee) as a business receipt and not exempt as a share of AOP profit under Section 86. [Relied on CIT v. Sitaldas Tirathdas, (1961) 41 ITR 367; Paras 82, 83, 94, 97-105, 119-126]

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

Citation : 2026 LiveLaw (SC) 488

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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.