In a significant interpretation of the Income Tax Act, the Supreme Court has ruled that a fixed payout received by a member of an Association of Persons (AOP), irrespective of the actual profits earned by the venture, cannot escape taxation by being labelled as a “share of profit.”
The verdict came in a dispute involving Sanand Properties Private Ltd (SPPL), which had entered into an AOP arrangement with Raviraj Kothari & Co. for a housing development project under an agreement executed in April 2003.
At the centre of the controversy was Clause 7 of the agreement. It stipulated that all money collected from flat buyers would first flow into the AOP. From those collections, SPPL would automatically receive 35% of the gross receipts, while the remaining 65% would stay with the AOP to cover project expenses and liabilities.
The Income Tax Department argued that this arrangement effectively guaranteed SPPL a slice of revenue at the very moment collections were made, regardless of whether the project generated profit or suffered losses. According to the department, such receipts were business income and therefore taxable.
SPPL, however, maintained that the amount represented its exempt share of income from the AOP under Section 86 read with Section 167B(2) of the Income Tax Act. Earlier, both the Income Tax Appellate Tribunal and the Bombay High Court had accepted that argument.
The Supreme Court overturned those findings.
A bench comprising Justice JB Pardiwala and Justice KV Viswanathan held that the payment structure revealed something far different from a conventional profit-sharing arrangement.
The Court noted that SPPL’s entitlement was tied directly to gross collections and not to the net financial outcome of the project. Since the company neither bore business expenditure nor shared losses, the amount lacked the defining characteristics of “profit.”
The judgment emphasised that a genuine share of profit emerges only after expenses and liabilities are accounted for. In this case, SPPL’s 35% entitlement arose immediately upon receipt of sale proceeds and could be withdrawn without waiting for the project’s final accounting.
The bench observed that the AOP merely acted as a conduit for disbursing that portion of money to SPPL. It described the arrangement as a case of “diversion of income by overriding title,” meaning the amount never truly became income of the AOP before being redirected to SPPL.
Relying on the precedent in CIT v. Sitaldas Tirathdas, the Court explained that when income is intercepted at source because of a pre-existing legal right, the nature of the receipt must be examined independently rather than treated automatically as exempt profit-sharing.
The Court ultimately concluded that the 35% amount received by SPPL during Assessment Years 2008-09 and 2009-10 constituted taxable business receipts in the company’s hands.
The ruling is expected to have wider implications for tax structures involving joint ventures, consortiums and AOP arrangements where members are assured fixed returns detached from the venture’s actual profitability.
