Unexplained credits appearing in partner capital accounts cannot be taxed in hands of firm: ITAT

The case had been filed by a company named SPA Constructions, based in Hyderabad and having PAN ADFFS5436E, before the ITAT Hyderabad, against the Income Tax Department. The appellant challenged an order passed by the CIT(A), NFAC, Delhi, on June 14, 2025.

The company declared its income as NIL while filing its income tax return (ITR) for the assessment year 2017-18. The tax department selected the case for scrutiny and issued a notice on August 17, 2018, under section 143(2) of the Income Tax Act, 1961. During the assessment, the department noticed that the two pieces of land were purchased by the company during the FY. Partners declared the capital gains of Rs. 3,26,91,139 from these lands. The tax department treated this amount as unexplained money under sections 69A and 115BBE of the Act, on the grounds that the company failed to explain the source of this amount with proper evidence. The department concluded the assessment by declaring the total income of the company at Rs. 32,691,139.

The dissatisfied company approached the CIT(A); however, it endorsed the arguments served by the tax department and dismissed the appeal of company. Thereafter, the company filed an appeal before the ITAT; therein, the authorised representative of the company claimed that the tax department was wrong in treating the entire capital gain as an addition to the taxable income of the company. Further claimed that each partner had clearly documented payments and sources of their contributions. Capital can be generated from past savings, the sale of personal assets, borrowings, or gifts, not just current income. Any unexplained cash deposit by a partner should be assessed in the partner’s hands, not the firm’s. However, the Department argued that the partners had not proven the “source of the source” of their funds.

The Tribunal analysed the arguments of both sides and examined all the furnished documents and discovered that partners directly paid for land, and these were properly recorded in the firm’s accounts. The claim of the tax department that the partners lacked “creditworthiness” was incorrect, as there was no discrepancy in the bank statements or documents. Also, the “source of source” rule did not apply for the assessment year 2017-18; it was introduced only from the assessment year 2023-24.

To announce its final decision, the tribunal cited an earlier ruling of the High Court in the Nova Medicare case, where the court ruled that unexplained capital in partners’ accounts cannot be taxed in the hands of the firm; only the partners can be assessed individually. Hence, in the conclusion to the aforesaid findings, the tribunal deleted the addition of Rs. 3.27 crore made by the tax department and allowed the appeal of the company.