Rao and Sons Vs. the Commissioner of Income Tax - Court Judgment

Das, J.

1. This is a reference under Section 66(1) of the Indian Income-tax Act, 1922, made by the Income-tax Appellate Tribunal, referring the following question of law to this Court:

'Whether on the facts and circumstances of the case, registration of the firm should have been renewed for the assessment year 1959-60 under Section 26A of the Income Tax Act, 1922, read with Rules framed thereunder.'

2. The assessee is a partnership concern constituted by a registered deed of partnership dated 28-3-1958. The principal object of the firm was to carry on money-lending business. The firm consisted of the following five members and according to the terms of the partnership, they had to share the profit and loss of the business in the manner, stated below:

(1) M. Venkataswar Rao -- Four annas.

(2) M. Kartic Chandra Rao -- Four annas.

(3) M. Satyanarayan Rao- -- Four annas.

(4) M. Subba Rao -- Two annas.

(5) Sm. Sita Devi-- Two annas.

The first three partners are the sons of M. SubbaRao and Sm. Sita Devi is their mother. Theassessee filed an application for registration of theFirm under Section 26A of the Income-tax Act on thebasis of the aforesaid deed of partnership for theassessment year 1958-59 and the same was allowedby the income-tax Officer, Ward 'C', Cuttack on14-3-59. For the assessment year 1959-60, withwhich we are now concerned in this Reference, anapplication for renewal of the registration wasmade on 16-5-59, For the relevant accountingyear the Firm disclosed a net loss of Rs. 81,933/-and stated that the partners had actually dividedthe share of loss in accordance with the statementsmade in loose typed sheet mentioning the share ofloss of each partner.

3. The income-tax Officer was of the opinion that there was no proper division of the loss. The firm had not shown the loss in the business for the relevant year in any books of account, but in a loose sheet of paper and that the firm had not credited or debited the resultant effect of the trade in the individual accounts of the partners, as required under the law and accordingly he rejected the application for renewal on 28-7-1960.

4. On appeal by the Firm, the Appellate Assistant Commissioner, income-tax, Cuttack, by his order dated 18-6-61, maintained the order of the Income-tax Officer and rejected the application for registration. He referred to various clauses of the partnership deed. According to him the terms of the deed presuppose maintenance of proper account' and as no accounts such as cash-book and personal account of the parties were maintained to show the necessary adjustment of profit and loss, he held the partnership did not exist in conformity with the conditions of the deed of partnership.

5. On further appeal to the Income-tax Appellate Tribunal, the application of the aseeesees was also rejected. The findings of the Tribunal relevant for the purposes of this case as mentioned on the statement of this case, are given below:

'in the assessment year 1958-59 the tradingresult ended in a figure of profit. It was claimedthat the share of profit pertaining to each partnerwas paid over to him physically in cash and thatwas why no entries appeared in the accounts. Assumingthis to be a fact for the assessment year 1958-59, thisexplanation would not hold good for the assessment year 1959-60. According to the Profit andLoss account, the three sons suffered loss ofRs. 20,483/- each and the father and mother lose ofRs. 10,242 each. If there was a personal account of eachof the partners this amount would have been debitedto their personal accounts unless the corresponding amount was Introduced by each of the partnersto make good the loss. It is not the assessee's casethat the partners individually brought in the requisite cash to wipe out their share of loss. Theaccounts also do not show that the five partnersare indebted to the firm to the extent of the lossessuffered by them. It is not a mere case of defective accounting, losses having been divided otherwise.The above being the position, we must uphold thefinding of the Department that the loss of thefirm has not been actually distributed between thepartners as required by the Income-tax Rules. TheIncome-tax Officer was, therefore, justified in refusing to renew registration of the firm.'

The Tribunal's finding was also to the effect thatnotwithstanding the filing of a certificate In theprescribed form there had been no division of thelosses of Rs. 81,933/-, between the partners whetherfactually or by appropriate accounting entries andas such the requirement of the law was not fulfilled.The Tribunal further held that their finding wouldnormally be a question of fact. But in view of thedecision of the Patna High Court reported in Sahabuddin Mohammad Raza v. Commr, of Income-tax : [1962]46ITR203(Patna) and as thequestion involved interpretation of Rule 6 of theincome-tax Rules, on an application made by thefirm, they referred the question of law as statedbefore.

6. The main question for consideration in this case is whether the renewal of the registration under Section 26A of the Act has been rightly rejected by the Tribunal. It is now necessary to examine the relevant provision of the Act and the rules made thereunder. Section 26A (1) of the Indian Income-tax Act, 1922 (hereinafter referred to as 'the Act') states as follows :

'26A (1) Application may be made to the Income Tax Officer on behalf of any firm, constituted under an agreement of partnership specifying the individual shares of the partners, for registration for the purpose of this Act, and of any other enactment for the time being In force relating to income-tax or supertax.

(2) The application shall be made by such person or persons and at such time and shall contain such particulars and shall be in such form and shallbe verified in such manner as may be prescribed, and it shall be dealt with by the Income-tax Officer in such manner as may be prescribed.'

In exercise of the powers conferred bar Section 59 of the Act the Central Board of Revenue made some Rules and prescribed the form in accordance with which applications for registration have to be made. Rule 2 lays down the procedure to be followed in making such application for registration. Among other things such application is required to be signed by all the parties and made before the income of the firm is assessed for any year under Section 23 of the Act. Rule 3 requires the application referred to in Rule 2 to be made in the form annexed to the Rule and to be accompanied by the original instrument of partnership. Clause (3)of the Form requires a certificate to be given by the applicant to the effect that the profit (or loss, if any) of the previous year were divided or credited as shown in Section B of the schedule attached to the form. Section B requires that the particulars of the apportionment of the income, profit or gain (or loss) of the business in the previous years between the partners who in that previous year were entitled to a share therein.

Rule 4 provides that if on receipt of the application the Income-tax officer is satisfied that there Is or was a firm in existence constituted as shown to the partnership instrument and that the application has been properly made, he shall enter in writing at the foot of the instrument certificate that the firm has been registered under Section 26A of the Act and that the certificate of registration shall have effect for the assessment year specified therein. Under Rule 5 the Certificate of Registration granted under Rule 4 shall have effect only for the assessment year mentioned therein. Rule 6 makes provisions for the renewal of the certificate in any subsequent year on an application being made in that behalf according to the preceding Rules. The assessee was duly registered for the assessment year 1958-59, but when he made an application under Rule 6 for a renewal for the year 1959-60, his application was rejected. It is not the case of the Tribunal that there was no firm in existence as shown in the Instrument of Partnership. In fact, the partnership was accepted in the previous year and, registration allowed, but the renewal of registration was refused by the Tribunal mainly on the ground that the loss of the Firm had not been actually distributed between the partners as required by the Income-tax Rules.

7. Before we proceed to examine the legal question, it is necessary to examine if there la any provision in the Instrument of Partnership regarding the mode of division of the losses between the partners. Clause (5) of the deed provides that at the end of each year a statement of profits and losses will be made up and any partner is at liberty to withdraw the whole or part of his share of profits. According to Clause (9) if any partner does not withdraw his share of profits or puts any money of his own, he will be entitled to interest at the rate of six per cent per annum thereon. We are not concerned in this case with any other clause of the deed. As already seen, Clause (8) of the Partnership instrument requires that at the end of each year a statement of profits and losses will be made up and any partner is at liberty to withdraw the whole or part of his share of profit. It is the case of the assessee that according to Clause (8) of the partnership deed, they prepared a statement, in a typed sheet of paper, showing how the total loss of Rs. 81,933/- was distributed amongst the partners in proportion of their share and the specific amounts were duly debited to the account of each partner. According to the profit and loss statement sheet, the three sons suffered loss of Rs. 20,483/- each and the father and mother each suffered a loss of Rs. 10,242/-. Though the loss was actually shown and debited in the shape of a statement of account, the Tribunal was of the view that there should have been a personal account of each of the partners and the amounts should have been debited to such personal accounts unless a corresponding amount was introduced by each of the partners to make good the loss. They held that the loss of the firm had not been actually distributed between the partners as required under the rules.

8. Mr. Narasaraju learned counsel for the appellant, contended that for the purpose of registration, all that is necessary for the assessee to do, is to file an application in accordance with Section 26A and the Rules as aforesaid and to give a certificate regarding the division of profit or loss and it was not for the department at that stage to insist on a particular mode of accounting to show the actual division of the loss or profit. He urged that merely because no personal account of each of the partners was maintained and the respective losses were debited to that account is, by itself no ground to refuse registration. In support of his contention, he relied upon a decision of the Supreme Court reported in Commr. of Income-tax, Madras v. Sivakashi Match Exporting Co. : [1964]53ITR204(SC) where their Lordships held that the combined effect of Section 26A and the Rules made thereunder was that the income-tax officer could not reject an application made by a firm if it gave the necessary particulars prescribed by the Rules, and if there was a firm in existence as shown in the Instrument of Partnership. A firm might be said to be not in existence, if it was a bogus or not a genuine one or if in law the constitution, of the partnership was void. The jurisdiction of the Income-tax Officer, was there fore, confined to ascertaining the two facts viz., (1) Whether the application for registration was in conformity with the rules made under the Act, and (2) Whether the Firm shown in the documents presented for registration was a bogus one or had no legal existence. Further, the discretion conferred upon him under Article 26A was a judicial one and, he could not refuse to register a firm on a mere application, but has to base his conclusion on relevant evidence. In the case before us, there is no dispute that the partnership, on the face of it, is a genuine one and the application for registration was in conformity with the rules.

9. The decision of the Patna High Court reported in : AIR1964Pat414 in a case where the income-tax Appellate Tribunal refused registration on the ground that no separate capital accounts stood in the names of the partners and there was no allegation of definite shares between the partners, their Lordships held that the fact that there was no separate capital account of the partners or that no share capital was contributed by some of the partners originally is not a ground for refusing registration of a firm. The same was also the view taken by the High Courts of Andhra Pradesh, Bombay arid Madras.

10. The High Court of Andhra Pradesh in a case reported in Grand Hotel v. Commissioner of income-tax, Hyderabed : [1959]36ITR453(AP) took the view that the right of the assessee to employ a particular mode of accounting could not be questioned in an application, under Section 26A of the Income-tax Act and just because the system of accounting employed by the asseseee-did not commend itself to the departmental authorities, it is no ground for refusal of the registration of the firm under that section. They held that the accounts maintained by the assessee having shown that the profits according to his own method of accounting were determined and divided according to the shares of the partners, the Tribunal was wrong in refusing the registration. The position of course is different if the Income-tax Officer is satisfied that in reality there is no partnership on if the application for registration of the firm does not conform to the requirements of the registration. But if the provisions of the section and the rules are confirmed, he has no unfettered discretion to reject the registration.

11. The Bombay High Court in a case reported In Atma Ram Bhogi Lal v. Commr. of Income Tax Bombay : [1952]22ITR305(Bom) expressed the view that though it is the discretion of the Income-tax Officer to register or not to register a deed of partnership, yet such discretion is fettered by the provisions of Section 26A and the rules made thereunder and there is an obligation on him to register the partnership if he is satisfied that there was a firm in existence constituted as shown in the instrument of partnership and that the application has been properly made.

12. The Madras High Court in a case reported in S.S.K. Haja Allauddln Maracair v. Commr. of Income-tax, Madras : [1952]22ITR545(Mad) was dealing with a case where one of the grounds of the Tribunal to refuse registration was that there was no explanation offered by the assessee as to why capital was not distributed and that the mere fact that profits were distributed at the end of the year is not conclusive of the evidence of partnership. Their Lordships took the view that merely because no share capital was distributed, that is no ground to hold that there was no partnership in existence. They accordingly held that registration tinder Section 26A was wrongly refused.

13. We have already seen that the genuineness of the partnership is not in dispute and the firm was registered In the previous year and the present reference arises out of the rejection of the application for renewal of the registration. There is no legal defect so far as the form of the application is concerned. The Tribunal was conscious of that position when they said that; 'Notwithstanding the filing of the certificate in the above form there had been no division of the losses of Rs. 81,932/- between the partners whether factually or by appropriate accounting entries'. According to them, there should have been a personal account of each of the partners and their respective losses carried to that account. There is, however, no dispute that the losses have been divided in the ratio of shares of the individual partners and shown in the account-sheet. A certificate declaring the division of losses amongst the partners has been filed by the assessee while making the application for registration. The typed statement also shows the distribution of the loss between the partners.

That being so, it cannot be said that there was no evidence of division of losses. I think this is a fit case where registration should have been allowed. It was open to the Department, at the stage of assessment, to further examine the question whether there was a genuine firm in existence and if in fact, there was actual division of losses and they might as well have cancelled the registration as provided under Rule 6B of the Income-tax Rules.

14. Mr. D. Mohanty, learned counsel for the Department urged that the registration of the firm is a matter of discretion with the Department and where the loss said to have been incurred by the individual partners of the firm was not duly accounted for, it was open to the tax authorities to refuse the registration of the firm, but as seen above the discretion is 'not an unfettered one' but is to be exercised within the limits of the provisions of Section 26A of the Act and the rules quoted above. Once there is a clear compliance of these provisions, the Department has a duty to register the firm. Mr. Mohanty relied upon a decision of the Supreme Court reported in R.C. Mitter and Sons v. Commissioner of Income-tax, West Bengal AIR 1959 SC 868 where their Lordships have laid down that the following five essential conditions must be fulfilled in order that a firm may be held entitled to registration.

(i) That the firm should be constituted under an instrument of Partnership, specifying the individual shares of the partners:

(ii) That an application on behalf of and signed by all the partners containing all the particulars as set out in the Rules has been made.

(iii) That the application has been made before the assessment of the income of the firm made under Section 23 of the Act for the particular year.

(iv) That the profits (losses or loss, if any) of the business relating to the previous year that its to say the relevant accounting year should have been debited or credited as the case may be, in accordance with the terms of the Instrument; and

(v) That the partnership must have been genuine and must have actually existed in conformity with the terms and conditions of the Instrument.

So far as the finding of the Tribunal goes, there is no dispute about the conditions 1, 2, 3 and 5 above, and the only point of controversy is condition No. 4 as the Tribunal has refused the registration on the ground that the loss of the Firm had not been shown to have been properly distributed between the partners. But If we look to the condition No. 4 as stated above, all that is necessary to show is that the profit or loss should have been debited or credited, as the case may be, in accordance with the terms of the instrument. We have already seen that In the partnership deed nothing has been said as to how the loss is to be accounted for. In the absence of any such term in the Instrument of partnership, the assessee prepared an account-sheet showing distribution of the loss amongst the different partners in accordance with their respective shares. There is nothing in the Rules to show that the losses were to be accounted for in any particular manner and in no other way. In that view of the matter I do not think it can be said that there was no compliance by the assessee about the fulfilment of this condition. That being the position, it must be held that the application for registration was in order and the registration should have been renewed for the assessment year 1959-60.

15. We therefore answer the question in the affirmative and hold that the registration of the firm should have been renewed for the assessment year 1959-60 under Section 26A, read with the Rules made under the Income-tax Act, 1922.

The Department shall pay a sum of Rs. 250/-(Rupees two hundred and fifty) to the assessee towards the cost of reference.

Narasimham, C.J.

16. I agree.