income-tax Officer Vs. Maleh Narasimhaiah Setty - Court Judgment

Excerpt:
1. this appeal by the revenue relates to the assessment year 1982-83.the assessee is an individual. the only source of income was from the partnership of laxminarasimha fertilisers, gadwal, a firm which was constituted under an instrument of partnership, dated 11-7-1979.according to the deed, the assessee was the partner of the second part, the other partners being m. laxmidevamma and m. nagamani. laxmidevamma contributed capital of rs. 6,000 and nagamani contributed capital of rs. 5,000. the assessee did not contribute any capital in money. clause 5 of the partnership deed provided that laxmidevamma would have a share in profit and loss of 40 per cent, nagamani 40 per cent and the assessee 20 per cent. there was a further clause, i.e., clause 6, which reads as under- the party of the.....

Judgment:
1. This appeal by the revenue relates to the assessment year 1982-83.

The assessee is an individual. The only source of income was from the partnership of Laxminarasimha Fertilisers, Gadwal, a firm which was constituted under an instrument of partnership, dated 11-7-1979.

According to the deed, the assessee was the partner of the second part, the other partners being M. Laxmidevamma and M. Nagamani. Laxmidevamma contributed capital of Rs. 6,000 and Nagamani contributed capital of Rs. 5,000. The assessee did not contribute any capital in money. Clause 5 of the partnership deed provided that Laxmidevamma would have a share in profit and loss of 40 per cent, Nagamani 40 per cent and the assessee 20 per cent. There was a further clause, i.e., Clause 6, which reads as under- The party of the second part is the working partner and he shall look after the day-to-day business affairs of the partnership, for which he is entitled to a remuneration of Rs. 250 (Rupees two hundred and fifty only) per month. The said remuneration to the party of the second part may be increased or decreased with the mutual consent of all the parties from year to year.

2. For the previous year ended 31-3-1982, relevant to the assessment year 1982-83, now under consideration, the assessee furnished a return showing total income of Rs. 15,960 which was arrived at as under : 20 per cent share income from Laxminarasimha Fertilisers, Gadwal, as per the firm's return (GIR No. 303).

The ITO framed the assessment order, observing as under :Present : Shri B. Prahalad, Rs. 3. The assessee appealed and contended before the AAC that standard deduction should have been allowed under the provisions of Section 16(i) of the Income-tax Act, 1961 ('the Act'). The AAC directed this allowance to be made following his appellate order in the case of another assessee, Maleh Pedda Kistaiah. (In his order, by mistake, the AAC has mentioned the name of the firm in which the assessee is a partner, as Maleh Narasimhaiah Setty instead of Laxminarasimha Fertilisers.) In the appellate order, on which reliance was placed by the AAC, standard deduction under Section 16(i) was directed in similar circumstances, following the decision of the Tribunal in the case of Mohamad Ibrahim Shahdad v. ITO. The AAC observed that the terms of Section 67 of the Act made it clear that a partner can draw salary from a firm. The revenue contests the conclusion of the AAC that the assessee is entitled to standard deduction in respect of the amount received from the firm declared to be salary.

4. The Bench, before which the appeal originally came up, noticed that there was a conflict between the decisions of the Tribunal. The Pune Bench in IT Appeal Nos. 779 and 787 (Pune) of 1981, dated 16-6-1983, had also taken a view similar to that expressed in the earlier decision referred to. However, the Chandigarh Bench in the case of Harbans Singh v. ITO [1983] 4 ITD 395, had taken a contrary view, viz., that standard deduction is not admissible from any amount received by a partner from the firm though described as 'salary'. The Chandigarh Bench had based its decision having reference to the judgment of the Supreme Court in the case of CIT v. R.M. Chidambaram Pillai [1977] 106 ITR 292. The Bench, therefore, referred the matter to the President under the provisions of Section 255(3) of the Act for constitution of a larger Bench. The President has, accordingly, constituted this Special Bench for hearing the appeal.

5. The learned departmental representative has referred to one more order of the Tribunal, viz., that in IT Appeal Nos. 1325 and 1324 (Hyd.) of 1978-79, dated 29-4-1980, of the Hyderabad Bench where the view taken was in favour of the department, viz., that standard deduction was not admissible under the provisions of Section 16 from amounts received by a partner described as 'salary' from the firm.

6. The main plank of the argument of the learned departmental representative was the ratio of the judgment of the Supreme Court in R.M. Chidambaram Pillai's case (supra). He submitted that this decision was authority for the proposition that though a firm had some attributes of personality, it was not a legal person and though it was a unit of assessment in terms of the special provisions of the Act, it was not in law a full person. Since the firm was not a full person, it could not enter into a contract of employment with one of its partner.

Therefore, there was no employer-employee relationship. What was described as 'salary' paid to a partner, was nothing but a special share of the profits and partook of the same character as the income of the firm. Elaborating further, attention was drawn to the provisions of Section 40(6) of the Act, which provided : Notwithstanding anything to the contrary in Sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',- (b) in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm; It was emphasised that the payments contemplated under Section 40(6) were inadmissible deductions and when disallowed formed part of the profits and gains of business or profession of the firm. Therefore, the payment described as 'salary to partner', when not allowed as deduction, formed part of the profits and gains of business or profession of the firm. Section 67, the learned departmental representative stated, prescribed the manner of computing the partner's share in the income of the firm. Under Section 67(l)(a), salary and other items referred to in Section 40(6) were to be deducted from the total income of the firm and the balance ascertained and apportioned among the partners. Under Section 67(1)(b), to the apportioned share to each partner, was to be added back the amount relatable to such partner which had been carved out under Section 67(l)(a) and such aggregate amount became the share income of that particular partner. To elucidate, if the total income of a firm was Rs. 100 and it consisted of three partners A, B and C, who share equally, and A was entitled to payment described as salary of Rs. 10, then, under the provisions of Section 67(l)(a), Rs. 10 was to be excluded and the balance of Rs. 90 was to be divided equally between A, B and C. Under the provisions of Section 67(l)(b), the amount of Rs. 10 was to be added to the apportioned share of Rs. 30 in the case of A making a total of Rs. 40 and B and C would have as their share Rs. 30 each. At this stage, Section 67(2) would operate, which reads as under : (2) The share of a partner in the income or loss of the firm, as computed under Sub-section (1) shall, for the purposes of assessment, be apportioned under the various heads of income in the same manner in which the income or loss of the firm has been determined under each head of income.

The submission of the learned departmental representative was that as far as A was concerned, the amount of Rs. 40 would represent income under the head 'Profits and gains of business or profession' only since that was the head of income in the case of the firm and for the purposes of assessment, would have to be apportioned under that particular head. He stated that whether the whole of such apportioned income should be assessed in the hands of partner A in his individual capacity or part of it, which represented remuneration in the hands of partner A, should be assessed in the hands of partner A and the balance of profits should be assessed in the hands of any separate entity such as the HUF, of which A was the karta, etc., would be dependent on the facts of each case. However, as far as the assessment made in the individual case of A was concerned, he submitted that what was assessable was part of the share of profits alone from business or profession, be it described as 'salary' or 'share income'. He then referred us to the provisions of Section 16 and submitted that standard deduction was permissible under Section 16(i) only from income "chargeable under the head 'Salaries'." The income which was chargeable to income-tax under the head 'Salaries', it is stated, was fully set out in Section 15 of the Act and the various criteria enunciated therein specified in each case that the amount should have been received from an employer or a former employer. Since any amount received by a partner from the firm could not partake of the nature of receipt from an employer, since a partner was not an employee of the firm following the ratio of the judgment of the Supreme Court in the case of R.M. Chidambaram Pillai {supra), the learned departmental representative submitted that such remuneration could not partake of the nature of income chargeable under the head 'Salaries' and since such receipt was not chargeable under the head 'Salaries', deduction provided under Section 16(0, viz., standard deduction would not be admissible.

7. The learned counsel for the assessee relied on the provisions of Section 2(31) of the Act, which defined 'person' as including a 'firm'.

His submission was that a firm was, therefore, a distinct entity under the Act. The firm having been designated to be a person under the Act, reliance was placed on the classic observations in the case of East End Dwellings Co. Ltd. v. Fins bury Borough Council [1952] AC 109, 130 (HL) on the scope of a deeming provision, which were : If you are bidden to treat an imaginary state of affairs as real, you must surely, unless prohibited from doing so, also imagine as real the consequences and incidence which, if the putative state of affairs had in fact existed, must inevitably have flowed from or accompanied it.... The statute says that you must imagine a certain state of affairs : it does not say that having done so, you must cause or permit your imagination to boggle when it comes to the inevitable corollaries of that state of affairs.

He, therefore, submitted that since the firm was a person under the Act and the Act spoke in Section 40(6) to disallowance of salary paid to a partner, it should be presumed, for the purposes of the Act, that when any amount was described as payment of salary to a partner, the term 'salary' had the meaning comprehended in the Act, viz., it was a receipt consequent to what the Act considered to be an employer-employee relationship. Therefore, what was disallowed in terms of Section 40(b) and which formed part of the computation in terms of Section 67 in determining the share of each partner, would continue to partake of the nature of income chargeable under the head 'Salaries' and, consequently, standard deduction under Section 16(0 would be admissible therefrom. The learned counsel submitted that a firm was not an assessee for the purposes of the Wealth-tax Act, 1957, but there was a reference to computation of the net wealth of the firm in the Rules under that Act and the Courts have held that it could be deemed that the net wealth of the firm has to be computed, assuming the firm to be an assessee in terms of the statute. This was the ratio of the decision of the Andhra Pradesh High Court in CWT v. Narendra Ranjalker [1981] 129 ITR 203. Another case referred to was the Full Bench decision of the Andhra Pradesh High Court in CIT v. G. Parthasarathy Naidu & Sons [1980] 121 ITR 97 in support of the provision that a firm could be construed to be a distinct legal entity, which has a separate personality and existence of its own de hors the partners. Another point made out was that the provisions of Section 67(2) laid down only an artificial method of computation of income and they did not affect the real nature of payments, which were described as 'salary'. The learned counsel also went on to clarify that though the assessee may not have contributed capital in the form of money but only gave his skill, it was considered that part of remuneration should be given as share of profits, viz., 20 per cent and part of remuneration should be paid as salary in terms of the deed of partnership. What was decided in terms of the deed to be two separate amounts, he submitted, could not be coalesced into an amount of a single nature for the purposes of assessment. For all these reasons, he pleaded for the finding of the AAC being upheld.8. We have carefully considered the rival submissions. The decision in the case of R.M. Chidambaram Pillai {supra) came to be considered in the context of deciding whether what was described as salary payment to an individual, who was a partner in a firm and represented a HUF of which he was the karta, would be assessable in the individual's hands separately and the rest of the share income assessable in the hands of the HUF, in the case of Laxman Das v. CIT [1982] 138 ITR 628 (All.) and CIT v. Atma Ram Budhia [1984] 146 ITR 240 (Pat.) (FB). Their Lordships came to the conclusion that the ratio in R.M. Chidambaram Pillai's case (supra) did not stand in the way of apportionment where called for between the individual and the HUF, which principle had been recognised by the Supreme Court in a number of cases most of which stand referred to in the decision of the Supreme Court in the case of Raj Kumar Singh Hukamchandji v. CIT [1970] 78 ITR 33. We would elucidate the position a little further.

9. It is well settled law that qua the firm, only an individual can be a partner. Even if the individual represents a HUF, the HUF qua the firm is not a partner. After the computation of total income of the firm is made and the said income is apportioned between the different persons who are the partners, the second stage arises, viz., in whose hands the apportioned share income is to be assessed. The apportioned income may include income described as 'payment of salary' by the firm.

At the stage of deciding in whose hands such apportioned income is to be assessed, the question arises as to what amount would be assessed in the hands of the individual and what amount in the hands of the HUF.The principles for deciding what portion should be assessed where, have been set out in a number of decisions of the Supreme Court which have been adverted to in the decision of the Supreme Court in Raj Kumar Singh Hukamchandji's case (supra). The principle is that if the remuneration is received by the coparcener as one of the modes of return made to the family because of investment of family funds in the business, it would be assessed in the hands of the family, but if it was compensation for services rendered by the individual coparcener, it would be assessed in his individual hands. These decisions, which lay down the criteria for demarcating how the apportioned amount is to be assessed, do not erode into the principles enunciated by the Supreme Court in the case of R.M. Chidambaram Pillai (supra) nor do they conflict with the ratio of the aforesaid decision. As observed by the Supreme Court itself in R.M. Chidambaram Pillai's case (supra), a fine point of law had been raised therein which lent itself to subtle spinning of gossamer webs of argument. The Supreme Court, in the aforesaid decision, had considered the provisions of Section 10(l)(b) of the Indian Income-tax Act, 1922 ('the 1922 Act'), which is in pari materia with those of Section 40(b) of the 1961 Act, as also the provisions of Section 16(1)(b) of the 1922 Act, which incorporates most of the principles enunciated in Section 67 of the 1961 Act. The Supreme Court emphasised that the provisions of the Act clearly designated that what was described as salary in the case of a partner who was a co-owner of a business, was nothing but profit. The special provisions did not, the Supreme Court states, change the true nature of what was described as 'salary', viz., that it was profits, but only stressed the same. The arguments put forth based on the use of the term 'salary' in Section 40(6) and Section 67 by the learned counsel for the assessee, cannot, therefore, in our view, advance the case of the assessee to establish that the payment would really partake of the true nature of salary, though it may be described as such as a matter of convenience.

10. The aspect that a firm had a distinct personality under the Act and, therefore, should be considered as an independent entity was one which had been canvassed before the Supreme Court in several cases.

Referring to such an argument, which had found a degree of acceptance by the Privy Council, the Supreme Court observed in the case of R.M.Chidambaram Pillai (supra) : ...Moreover, we are not persuaded by that ruling of the Privy Council, particularly since a pronouncement of this Court in Dulichand Laxminarayan v. CIT [1956] 29 ITR 535, 540, 541 ; [1956] SCR 154 (SC) strikes a contrary note. We quote : In some systems of law this separate personality of a firm apart from its members has received full and formal recognition as, for instance, in Scotland. That is, however, not the English common law conception of a firm. English lawyers do not recognise a firm as an entity distinct from the members composing it. Our partnership law is based on English law and we have also adopted the notions of English lawyers as regards a partnership firm.

The life of the Indian law of partnership depends on its own terms although habitually Courts, as a hangover of the past, have been referring to the English law on the point. The matter is concluded by the further observations of this Court : It is clear from the foregoing discussion that the law, English as well as, Indian, has, for some specific purposes, some of which are referred to above relaxed its rigid notions and extended a limited personality to a firm. Nevertheless, the general concept of a partnership, firmly established in both systems of law, still is that a firm is not an entity or 'person' in law but is merely an association of individuals and a firm name is only a collective name of those individuals who constitute the firm. In other words, a firm name is merely an expression, only a compendious mode of designating the persons who ,have agreed to carry on business in partnership.

According to the principles of English jurisprudence, which we have adopted, for the purposes of determining legal rights 'there is no such thing as a firm known to the law, as was said by James L.J. in ex parte Corbett: In re. Shand [1880] 14 Ch. D 122, 126 (CA). In these circumstances to import the definition of the word 'person' occurring in Section 3(42) of the General Clauses Act, 1897, into Section 4 of the Indian Partnership Act will, according to lawyers, English or Indian, be totally repugnant to the subject of partnership law as they know and understand it to be.In Addanki Narayanappa v. Bhaskara Krishnappa AIR 1966 SC 1300, 1303 the view taken by this Court accords with the position above stated.

The necessary inference from the premise that a partnership is only a collective of separate persons and not a legal person in itself lends to the further conclusion that the salary stipulated to be paid to a partner from the firm is in reality a mode of division of the firm's profits, no person being his own servant in law since a contract of service postulates two different persons.

There is, therefore, the clear pronouncement of the Supreme Court that salary stipulated to be paid to a partner by a firm is in reality only a mode of division of the firm's profits, because no person could be his own servant in law and a contract of service postulates two different persons who do not exist when the contractual relationship of the firm and its partners is considered. The decision of the Supreme Court in R.M. Chidambaram Pillai's case (supra) is authority for the proposition that there cannot be an employer-employee relationship between a firm and its partners.

11. A controversy has sometimes arisen whether remuneration received by a director of a company would be assessable under the head 'Salaries' or under some other head. The Supreme Court has pointed out in the case of Ram Prashad v. CIT [1972] 86 ITR 122, which reviewed earlier decisions on the point, that a relationship of employer-employee or master-servant can be created between a company and a director either by a service agreement or by articles of association. Therefore, in such a case, the question arises whether remuneration received is assessable under the head 'Salaries' or not and the matter has to be examined further to determine whether there could be an employer-employee relationship. However, between a firm and a partner, the decision in the case of R.M. Chidambaram Pillai (supra) is an authority for the proposition that under no circumstances, can an employer-employee relationship come into being and, therefore, any amount paid by a firm to a partner would not partake of the true nature of 'salary'.

12. The relevant provisions of Section 16 provide for deduction by stating, "The income chargeable under the head 'Salaries' shall be computed after making the following deductions,..." We have, therefore, to ascertain what is chargeable under the head 'Salaries' and Section 15 enumerates in this regard : 15. The following income shall be chargeable to income-tax under the head 'Salaries'- (a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not; (b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him ; (c) any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.

Explanation : For the removal of doubts, it is hereby declared that where any salary paid in advance is included in the total income of any person for any previous year it shall not be included again in the total income of the person when the salary becomes due.

It is clear that what is chargeable under the head 'Salaries', would be only amount which emanated from an employer or a former employer to an assessee. The assessee, in the present case, is the individual before us. However, no amount has come to him from an employer or a former employer, for the firm, of which he is a partner, is not an employer following the ratio of the judgment of the Supreme Court referred to.

Therefore, no portion of the amount which has been received by the assessee-individual, whose case is before us, from the firm of which he is a partner, would be assessable under the head 'Salaries' in his hands. For the purposes of the present appeal, it is sufficient to state that no portion of the amount received by the assessee from the firm of which he is a partner, would be chargeable to tax under the head 'Salaries' and, therefore, the assessee would not be entitled to standard deduction under Section 16.

1. There is no contradiction in the decisions of the Supreme Court in the cases of Raj Kumar Singh Hukamchandji (supra) and R.M. Chidambaram Pillai (supra).

2. Where we have to determine, whether or not the remuneration received by a partner, representing his HUF in a firm, for the services rendered by him, is the income of his HUF, the test laid down in the case of Raj Kumar Singh Hukamchandji (supra) would apply. Where, however, the question for consideration relates to the determination of the head under which the remuneration received by the partner is to be assessed in his individual assessment, the principle laid down in the case of R.M. Chidambaram Pillai (supra), will have to be followed.

3. According to the decision of the Supreme Court in the case of R.M. Chidambaram Pillai (supra), there cannot be a contract of service, as employer and employee, between a firm and one of its partners and the payment of salary to a partner represents a special share of the profits. So the remuneration received by a partner for the services rendered by him to the firm is not assessable under the head 'Salaries' under Section 15. In this view of the matter, such an assessee is not entitled to standard deduction under Section 16(i).

14. On the facts, therefore, the computation made by the ITO assessing the entire income obtained from the firm as share income without making any bifurcation, is in order. Accordingly, the order of the AAC is reversed and the order of the ITO is restored.