Khanjan Lal Sewak Ram Vs. Commissioner
of Income Tax, U.P  INSC 226 (31 August 1971)
CITATION: 1972 AIR 61 1972 SCR (1) 502 1971
SCC (3) 662
F 1973 SC1445 (15) R 1973 SC2401 (4)
Income Tax Act (11 of 1922), s. 26A and rr.
6(3) and 6A of the Rules-Application for renewal of registration-Book Profits
distributed but black market profits not distributed-If firm entitled to
renewal of registration.
The assessee was a registered firm. The
partners applied to the Income-tax Officer for renewal of registration. To that
application they appended a certificate that the profits of the previous year
were divided or credited as shown. While the application was pending, the
partners fell out and the Income-tax Officer found, that the firm had earned
considerable black market profits which had not been credited in the account
books and had not been distributed among the partners in accordance with the
instrument of partnership. The Department, Tribunal and the High Court, on
reference, held that the firm was not entitled to renewal.
Dismissing the appeal to this Court,
HELD : Under s. 26A of the Income-tax Act,
1922, one of the conditions for registration and renewal is that the
application should contain such particulars as are prescribed in the Rules
under the Act.. Rule 6(3) provides that the partners should append a
certificate to the application for renewal that the profits (or loss if any) of
the previous year or period up to the date of dissolution were divided or
credited as shown. So long as the divisible profits had in fact been divided or
had been credited to the accounts of the partners, the requirements of the
provision must be held to have been complied with. But the certificate is not a
mere formality because, a registered firm is not taxable, but only the partner
and, if a portion of the profits earned by the firm was not actually divided
amongst the partners or credited to their accounts, to that extent the assessee
firm had evaded tax. In such a case the only course open to the Income-tax
Officer is not to register the firm but to tax the partners of the firm as an
association of persons. [506 B, G; 507 C-G] Since, in the present case, the
application for renewal of registration did not comply with the prescribed
conditions, under r. 6A, the Income-tax Officer was justified in refusing
renewal of registration. [507 F-G] Agarwal & Co. v. C. 1. T., U. P., 77 I.
T. R. 110 (S.C.), followed.
CIVIL APPELLATE JURISDICTION : Civil Appeal
No. 1947 of 1968.
Appeal from the judgment and decree dated
January 21, 1964 of the Allahabad High Court in Misc. Income-tax Reference No.
383 of 1958.
T. A. Ramachandran and A. G. Ratnaparkhi, for
B. Sen, J. Ramamurthy, R. N. Sachthey and B.
D. Sharma, for the respondent.
503 The Judgment of the Court was delivered
by Hegde, J. This is an appeal by certificate. It arises from.
a decision of the Allahabad High Court. The
appellant is the assessee and the concerned assessment year is 1948-49.
The assessee is a firm constituted under an
Instrument, of partnership dated April 30, 1947. The shares of the partners in,
the profit and loss' of the firm as mentioned in that deed are as follows :
1. L. Khanjan Lal--/4/-
2. L. Lalloo Ram- -/2/
3. L. Dwarka Prasad- -/2/-
4. L. Ram Lal- -/2/-
5. L. Sewak Ram- -/4/-
6. Smt. Jagrani Devi- -/2/- Lallu Ram, Dwarka
Prasad and Ram Lal are the children of- Khanjan Lad. Sewak Ram is the son of
Jagrani Devi. The first group has -/ 10/- share in the profit and loss of the
firm and the second group has -/6/- share.
The assesesee firm was registered for the
assessment year 1947-48. On July 12, 1949, the partners of the firm applied to
the Income-tax Officer for renewal of the registration for the assessment year
1948-49. That application was signed by all the partners. To that application
they appended a certificate to the. effect that "profits of the previous
year were divided or credited as shown below. . . " On November 5, 1949,
the partner-ship was dissolved under a deed of distribution dated November 9,
1949 One of the clauses in that deed provides :
"But if an amount which was not entered
in the books at the time of settlement is found then only that person will be
accountable for it through whom the money was received or paid.
None of the parties will have any objection
to it." On October 5, 1950, the first four partners made a disclosure
statement to the Income-tax Officer to the effect that the firm had' earned Rs.
15,000/- by way of profits outside the books. In that disclosure statement,
they further stated that those profits had been divided between the partners.
On December 9, 1950, Sewak Ram, one of the partners stated on oath before the
Income-tax Officer that he and his mother Jagrani Devi were not given full'
share of the profits of the business earned by the firm in Sam v. year 2005. He
further stated that the entire profits earned in that business carried on in
the previous year were not recorded in 504 the books and the first four
partners had given to him and his mother only their shares of those profits
which were recorded in the books. Therein he sought to withdraw the application
for registration because all the profits earned had not been divided according
to the shares. According to Sewak Ram, the profits ,earned and not entered in
the accounts amounted to Rs. 1,13,571/-. From the aforementioned statements, it
s clear that the firm was trying to evade tax on a portion of the profits
.earned by it by not bringing the same into their books.
On March 31, 1951, Sewak Ram sued the first
four partners for rendition of accounts. In that suit he estimated his share of
profits in the amount that had not been entered in the account books at Rs.
50,0001. Ultimately the suit was compromised and Sewak Ram withdrew his suit.
In his application to withdraw the suit, he stated that he wanted to withdraw
the suit "in view of the circumstances of the above case", an
expression of utmost ambiguity. Therein he stated that he is not entitled to
get any more amount from the defendants.
On March 15, 1952, Sewak Ram and his mother
Jagrani Devi gave an application to the Income-tax Officer stating that they
are withdrawing their signatures on the application for renewal of registration
as the profits of the previous year were not distributed according to the deed
of partnership and the certificate of registration required under rule 4(1) of
the Income-tax Rules, 1922 (to be hereinafter referred to as "the
Rules") framed under the Indian Income-tax Act, 1922 (in brief 'the Act')
had never been granted as required by law on the back of the partnership deed.
Therein they further stated that as the certificate under rule 6 had not been
granted by the assessee in accordance with law, the firm was not entitled for
registration under rule 6 of the Rules.
On the basis of the material before him, the
Income-tax Officer came to the conclusion that the firm had earned considerable
black market profits, and the same had not been distributed amongst the
partners according to the partnership deed and therefore the firm was not
entitled for renewal of the registration. He further opined that the
application for registration had stood withdrawn. On the basis of those
conclusions, he refused to renew the registration of the firm and taxed the
firm in the status of association of persons. In appeal the Appellate Assistant
Commissioner, upheld the decision of the Income-tax Officer.
The assessee took the matter in appeal to the
Income-tax Appellate Tribunal. The two members who heard the appeal ,concurred
with the Income-tax Officer and the Appellate Assistant Commissioner that a
substantial portion of the profits earned by the firm had not been entered in
the books. They also held that those profits were not distributed amongst the
partners according 505 to the Instrument of partnership. On the basis of those
findings the Judicial member held that the firm was not entitled to the renewal
of registration asked for but the Accountant member opined that inasmuch as the
profits that had been entered in the books had been distributed, there was
compliance with the provisions of the "Act" as well as the,
"Rules". In view of this difference of opinion between the two
members, the matter was referred to the President of the Tribunal under s.
5A(7) of the Act. The President agreed with the Judicial Member that firm was
not entitled to have the renewal of the registration asked for. There- after at
the instance of the assessee, the Tribual submitted the following question to
the High Court under s. 66(1) of the Act.
"Whether the assessee firm which had
distributed its book profits amongst the partners according to the Instrument
of Partnership but which had not distributed the profits earned by it in the
black market amongst the six partners in accordance with the Instrument of
Partnership was entitled for renewal of registration for the assessment year
1948-49 ?" The High Court answered that question in favour of the
Department. Hence this appeal by the assessee firm.
Before examining the scope of the question
submitted to the High Court under s. 66(1) of the Act, we may mention that the
question whether the application for renewal of registration stood withdrawn or
not is not before us. On that question, the Judicial member of the Tribunal
took the view that the said application stood withdrawn but the Accountant
member did not agree with that view. The President of the Tribunal did not
express any opinion on that point.
Now turning to the question referred to the
High Court, that question is based on two findings of fact which are no more
open to question. Those findings are : (1) that the firm had distributed its
book profits amongst the partners according to the Instrument of partnership,
(2) but it had not distributed the profits earned by it in the black market amongst
the six partners in accordance with the Instrument of partnership.
Mr. Ramachandran, the learned Counsel for the
assessee sought to assail the correctness of those findings on the ground that
those findings are not supported by evidence, but we did not permit him to go
into the same as that question is not before us. We are bound by those
Having said that much, we shall now turn to
the relevant provisions in the Act and the Rules. Section 26 (A) of the Act
" 1. Application may be made to the
Income-tax Officer on behalf of any firm, constituted under an ins- 506 trument
of partnership specifying the individual shares of the partners, for
registration for the purposes of this Act and of any other enactment for the
time being in force relating to income-,tax or super-tax.
2. The application shall be made by such
person or persons and at such times and shall contain such particulars and
shall be in such form, and be 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." This Court has ruled in Agarwal & Co. v. Commissioner of
.Income-tax, U.P.(1) that the conditions of registration prescribed by s. 26-A
and the relevant Rules are :
1. On behalf of the firm, an application
should be made to the Income-tax Officer by such person and at such times and
containing such particulars, being in such form and verified in such manner as
are prescribed by the rules;
2. The firm should be constituted under an
instrument of partnership;
3. The instrument must specify the individual
shares of the partners and
4. The partnership must be valid and must
actually exist in the terms specified in the instrument.
Therein it was further laid down that if
those conditions are fulfilled, the Income-tax Officer is bound to register the
firm. The same rule will apply in the case of renewal of registration. In this
case we are primarily concerned with the question whether the application made
by the firm is in accordance with the rules prescribed. The rules with which we
are concerned in this appeal is paragraph 3 of rule 6 and rule 6-A. Paragraph 3
of rule 6 provides that the partners should append the following certificate to
their application for renewal of registration.
"We do hereby further certify that the
profits (or loss, if any) of the previous year or period upto the date of
dissolution were divided 'or credited as shown below........
Rule 6-A provides that " on receipt of
an application under rule 6, the Income-tax Officer may if he is satisfied that
the application is in order and that there is or was a firm in existence (1) 77
507 constituted as shown in the instrument of
partnership, grant to the assessee a certificate signed and dated by him in the
following form. . . . . It further provides :
"If the Income-tax Officer is not
satisfied he shall pass an order in writing refusing to renew the registration
of the firm." Now the sole question for decision is whether the
application made in this case complied with the requirements of paragraph 3 of
rule 6. If it did not comply with the requirements of rule 6, the Income-tax
Officer was within his powers in rejecting it. As seen earlier, the finding of
the Tribunal is that though the profits of the firm entered in its account
books had been distributed, the profits earned but not entered into the account
books have not been divided or credit in the account books. From that it
follows that the certificate given in the application for renewal of
registration is not a true certificate and further that a substantial portion
of the profits earned had not been divided.
The reason behind rule 6 was that at the
relevant time, the registered firm as such was not taxable. Only the partners
of a firm could be taxed. That being so, if 'a portion of the profits earned by
the firm was not divided amongst the partners or credited to their accounts, to
that extent, the profits earned by the firm escaped assessment. Therefore the
certificate contemplated by rule 6 is not a mere formality. It has a definite
purpose. If a portion of the profits earned by the firm was not actually
divided amongst the partners or credited to their accounts, then the only
course open to the Income-tax Officer was not to register that firm and to tax
the partners of the firm as an association of persons. By giving a false
certificate that the profits earned by the firm had been divided or credited in
the manner shown in the application, the assessee firm was trying to evade tax.
Hence we must hold that the application for renewal of registration made by the
assessee did not comply with conditions prescribed in paragraph 3 of rule 6.
Hence the Income-tax Officer was justified to refuse to renew the registration.
In resisting the above conclusion, Mr.
Ramachandran Counsel for the assessee relied on certain decisions of the High
Courts. The first decision relied on by him is that of the Bombay High Court in
Commissioner of Income-Tax, M. P.
Nagpur and Bhandaru v. D Costa Brothers(1).
Therein the Court held that the Income-tax Officer was not entitled to reject
the application for registration of the deed of partnership of the assessee
firm on the ground that the house-hold expenses of the partners were debited to
the profit and loss account of the firm. Therein there was no (1) 49, I.T.R.
508 contention that all the profits earned
were not distributed.
The only question was whether the household
expenses could have been deducted before dividing the profits. In other words
the question was whether the household expenses was a proper deduction to be
made in the circumstances of that case before dividing the profits. Hence that
decision has no bearing on the question under consideration.
He next placed reliance on the decision of
the Punjab High Court in Commissioner of Income-tax, Simla v. Sat Ram Gian
Chand(1). Therein the partners first estimated the divisible profit and divided
the same. The Court held that the division of profit was a matter relating to
the internal affairs of the partnership and had no bearing on the genuineness
of the firm and that no question of law arose from the order of the Appellate
Tribunal. The ratio of that decision has no relevance for our present purpose.
Counsel for the assessee next relied on the
decision of the Madras High Court in N. S. S. Chokkalingam Chettiar- and Co. v.
C.I.T. Madras ( 2 ). In that case though there was no provision in the deed of
partnership for payment of salary to any of the partners, some of the partners
were paid a salary in addition to the shares to which they were entitled under
the terms of the partnership and the Income-tax Officer refused to register the
firm on the ground that the profits were not divided in accordance with the
partnership deed as some of the partners took an additional amount out of the profits
in the shape of salary. The court held that, as the partnership was found to be
a genuine one and the application for registration was also in due form, the
mere fact that some partners took some portion of the profits as salary was not
a ground for refusing registration. The question whether a partner should be
paid salary for the services rendered by him is a matter to be decided by the
partners of the firm : so long as their payment is bona fide one, the same has
to be deducted before the divisible profits are computed. Hence the ratio of
that decision also does not bear on the facts of the present case.
Reliance was next placed on the decision of
the Madhya Pradesh High Court in C.I.T., M.P. v. Mandanlal Chhagan Lal(3). In
that case the partnership deed provided that each partner will be entitled to
interest at 6 per cent per annum on his capita investment and that the profit
and loss will be divided equally among the partners after deducting the
interest payable on the capital advances made by the partners. When the
partners made an application for registration under s. 26A of the Act, the
Income-tax Officer refused to register it but the Court held that the
application was a valid one and the provision for payment of interest (1) 42,
ITR, 543. (2) 60, ITR, 671.
(3) 50, I.T.R. 477.
509 did not in any manner conflict with the
relevant provision. Here again there is no question of not dividing any portion
of, profits earned. That being so, that decision is irrelevant for our present
Lastly reliance was placed on the decision of
the Kerala High Court in St. Joseph's Provisions Store v. C.I.T., Kerala(1).
Therein the partners of the assessee firm resolved that the profits of the firm
as disclosed in the profit and loss account need not be divided and credited in
the profit and loss accounts of the partners, but should be credited to a
reserve account but each of the partners to have an equal share in that amount.
An application for registration of the firm was rejected on the ground that the
firm had not complied with the requirements of rule 6 of the Rules. The court
held that the absence of entries in the separate accounts of each partner was
not fatal; the requirement of rule 6 was met when the profit was taken into a
reserve fund showing the partners' shares therein and indicating what was the
contribution of each partner to the reserve fund. Therefore the application for
registration was not liable to be rejected on the ground that rule 6 had not
been complied with. Here again the profits earned had beep divided and they
were credited to the accounts of the partners though the same were credited to
a reserve fund.
Hence the rule laid down in that case is
inapplicable to the facts of the present case. As the above referred decisions
do not bear on the point in issue we have not gone into the question whether
all or any of them were correctly decided or not.
The apprehension of Mr. Ramachandra that our
decision might be taken advantage of by the Department for refusing
registration of firms whose return of income or claim for some allowance has
not been accepted by the Income-tax Officer for one reason or the other,
appears to us to have no basis. Herein we are merely considering the scope of
paragraph 3 of rule 6. So long as the divisible profits had been divided or had
been credited to the accounts of the partners, the requirement of that
provision was complied with.
In the result this appeal fails and the same
is dismissed with costs.
V.P.S. Appeal dismissed.
(1) 45, I.T.R. 380.