M/S
Progressive Financers, Madras Vs. The Additional Commissioner of
Income Tax, Madras [1997] INSC 207 (20 February 1997)
S.C.
AGRAWAL, G.T. NANAVATI NANAVATI,
J.
ACT:
HEAD NOTE:
WITH CIVIL
APPEAL NOS. 2439-39A OF 1981
The
appellant in these three appeals is M/s.
Progressive
Financers, a partnership firm. It came into existence with execution of a
partnership deed on 1.7.67. It consisted of five partners. Out of them Sunitha Pratap
was minor and, therefore, she was admitted to benefits of partnership. The
capital of the partnership was fixed at Rs.5 lacs and each partner had to
contribute as follows
1.
M.R. Rajakrishna ... Rs. 1,25,000/-
2.
Minor Sunitha Pratap ... Rs. 1,87,500/-
3.
W.S. Parthasarathy ... Rs. 62,500/-
4.
W.S. Sethunarayan Babu ... Rs. 62,500/-
5.
M.S. Rajeswari ... Rs. 62,500/- For the assessment year 1967-68 it applied for
registration to the Income Tax Officer (for short the 'ITO') under Section 184
of the Income Tax Act, 1961 (for short the 'Act') on 31.3.68. For the
assessment years 1969-70 and 1970-71 it applied for renewal of registration.
The ITO rejected the application for registration on 30.6.71. On the same day,
he passed an assessment order for the assessment year 1968-69 treating the
status of the appellant as Association of Persons. Applications for renewal of
registration for the assessment years 1969-70 and 1970-71 were rejected on
13.3.72 and the assessment orders for those years were again passed treating
the appellant as Association of Persons.
The
appellant's application for registration was rejected by the ITO on the ground
that through in the opening paragraph of the partnership deed it was mentioned
that Sunitha Partap, a minor, was admitted to the benefits of partnership, the
relevant clauses in the partnership deed indicated that she was taken as a full
partner and, therefore, the contract of partnership was void ab-initio.
The
ITO arrived at this conclusion as he noticed that the partnership deed was
signed by Mrs. Sridevi Pratap, the guardian of minor Sunitha Pratap; that Sunitha
had contributed the maximum capital; that it was not stated in the partnership
deed how i.e. the manner in which, the loss, if any, was to be apportioned;
that all partners were entitled to operate bank accounts individually; that all
matters of importance were to be decided by majority of partners holding more
than 75% of capital; and, that on dissolution, all the assets of the firm
including goodwill were to be converted into money and distributed amongst the
partners in proportion to their shares in the capital.
Against
this order of the ITO the appellant preferred an appeal to the Appellate
Assistant Commissioner. Following the decision of the Andhra Pradesh High Court
in Addepally Nageswara Rao & Brothers vs. Commissioner of Income Tax, 79
ITR 306, the Appellant Assistant Commissioner held that the instrument of
partnership was required to be construed harmoniously and as the minor was
admitted only to the benefits of partnership there was admitted only of her
being made liable for the losses. He, therefore, allowed the appeal holding
that the firm was entitled to registration.
The
Revenue went in appeal to the Income Tax Appellate Tribunal.
Construing
the partnership deed in the light of the decisions of this court in
Commissioner of Income-Tax, Mysore vs. Shah Mohandas Sadhuram 57 ITR 415 and
Commissioner of Income-Tax, Mysore vs. Shah Jethaji Phulchand 57 ITR 588 and
the decision of the Andhra pradesh high Court in Addepally Nageswara Rao
(supra) the Tribunal held that minor Sunitha was admitted merely to the
benefits to partnership and it was not correct to say that she was made a
full-fledged partner. The Tribunal also held that the minor was not to be
burdened with losses and they were to be borne by the other partners. It
further held that though the instrument of partnership did not specifically
provide how the losses were to be borne by the partners the rule that in such
cases losses are to be shared in the same proportion as profits became
applicable and since the partnership deed was capable of being construed in
that manner, the firm was entitled to registration. It, therefore, dismissed
the appeal.
The
Revenue sought a reference to the High Court and the Tribunal thought it fit to
refer the following question to the High Court for its decision:-
"Whether, on the facts and in the circumstances of the case and a true
construction of the terms of the partnership deed, the assessee is entitled to
the benefit of registration under Section 185 of the Income-tax Act, 1961, for
the assessment year 1968-69" Against the orders passed by the ITO refusing
renewal or continuation of registration for the assessment years 1969-70 and
1970-71 the appellant had preferred two separate appeals to the Appellate
Assistant Commissioner. the were allowed. The appeals filed by the Revenue
against the said appellate orders were dismissed by the Tribunal. At the
instance of the Revenue, for the said two assessment years the following
question was referred to the High Court:- "Whether on the facts and in the
circumstances of the case and on a true construction of the terms of the
partnership deed the assesses is entitled to the continuation of registration
for the assessment year 1969-70 and 1970-71." The High Court referred to
the decision of the Gujarat High Court in Thacker & Co. vs. CIT 61 ITR 540
and two decisions of the Kerala High Court in C.I.T. vs. Ithappiri & George
88 ITR 332 and United Hardwares vs. C.I.T. 96 ITR 348 wherein it has been held
that in view of the clear language of Section 184 it is necessary that sharing
of the losses also has to be specifically provided in the partnership deed and
there is no scope for applying any principle or rule of law for discerning the
proportion in which the losses are to be shared. It then held that the decision
of this Court in Mandyala Govindu & Co. vs. Commissioner of Income-Tax.
A.P. 102 ITR 1 squarely applied to the facts of this case.
Following
that case it held that it was not possible to determine on any principle of
inference, from the document itself, how the remaining two partners were to
share the losses and, therefore, the firm was not entitled to registration. The
reference was answered accordingly, in favour of the Revenue and against the assessee.
Following
that decision in Tax Case No. 336 of 1974 (Reference No. 149 of 1974) the High
Court answered the other two references (Tax Case Nos. 707 of 1976) also in favour
of the Revenue and against the assessee. The assessee has, therefore, filed
these three appeals against the judgment and orders passed by the High Court in
those three cases.
The
learned counsel for the appellant submitted that the view taken by the High
Court is wrong. The two decisions of the Kerala High Court which are relied
upon by the High Court have since been overruled by the Full Bench of the Kerala
High Court in Kerala Publicity Bureau vs. Commissioner of Income Tax 200 ITR
366. he also submitted that the instrument of partnership, if reasonable
construed, did indicate the method by which profits and losses were to be
shared by the partners. On the other hand, it was contended by the learned
counsel for the Revenue that as Section 184 of the Act confers a benefit which
would otherwise laid down therein are strictly complied with.
Therefore,
the said benefit can be claimed only if in the instrument of partnership itself
shares of the partners in profits and losses are specifically stated.
This
Court in Rao Bahadur Ravulu Subba Rao vs. CIT 30 ITR 163 and Patel (N.T.) and
Co. vs. CIT 42 ITR 224, interpreting Section 26-A of the earlier 1922 Act, held
that registration under that Section conferred a benefit on the partners which
the partners were not entitled to but for that Section and, therefore, that
right could have been claimed any in accordance with the statute and those who
claimed it had to bring their case strictly within the terms of that Section.
This view was reiterated subsequently by a 5- Judge Bench of this court in the
case of Kylasa Sarabhaiah vs. CIT 56 ITR 219. At the same time, this Court
disapproved mechanical application of the provision and held that "in
ascertaining whether the application is in conformity with the Rules, the deed
of partnership must be reasonably construed.". It was also held that the
word "specify" as used in that Section and the relevant rule meant
'mentioning, describing or defining in detail' and it did not mean 'expressly
setting out in factional or other shares'. In view of this decision the correct
legal position is that the assessing officer cannot reject an application for
registration merely because in the deed of partnership shares of the partners
are not expressly specified. The assessing officer will have to construe the
instrument of partnership as a whole and if reasonably the shares of the
partners in profits and losses can be ascertained, then to accept it as genuine
for the purpose of registration.
We
will now refer to the decision of this Court in Mandyala Govindu & Co. (102
ITR Page 1), which has been relied upon by the High Court and on the basis of
which it decided the question referred to it against the appellant.
That
case arose under Section 26-A of the 1922 Act.
Answering
the question whether it was a condition for registration under Section 26-A
that the instrument of partnership ought to have specified respective shares of
partners in losses it was held that "the Income-Tax Officer, before
allowing the application for registration, must be in a position to ascertain
the shares of the partners in the losses even if Section 26A did not require
the shares in the losses to the specified in the instrument of
partnership".
It
referred to the conflict of opinion in the High Courts on the point but did not
think if necessary to decide which view was correct as the assessee was bound
to fail on any view. What is significant to note is that this Court referred to
Rules 2 and 3 of the Rules framed under that Act and also the form of
application including the Schedule annexed to Rule 3. The form and the Scheldule
required the partners to state particulars of the apportionment of income and
profits or gains (or loss) and also to state if any partner, though entitled to
share in profits, was not liable to bear any loss. Thereafter it was observed
that "it does not appear to have been considered in this case whether the
application for registration made by the firm conforms to the prescribed
rules". Thus, this Court was of the view that even if the shares of the
partners were not expressly specified in the instrument of partnership but if
that could be ascertained by the Income Tax Officer from the application and
the required information supplied therewith then the requirements of Section
26-A could be said to have been satisfied. It is also significant to not e that
this court tacitly approved application of the principle contained in Section
13(b) of the Indian Partnership Act that the partners are entitled to share
equally to the losses sustained by the firm and also the rule that 'where the
shares in the profits are unequal, the losses must be shared in the same
proportion as the profits if there is no agreement as to how the losses are to
be apportioned'. On facts, it was held in that case that even after applying
those two principles, it was not possible to ascertain how the losses
pertaining to minor's share were to be apportioned amongst the adult partners.
In an
earlier decision in the case of Parekh Wadilal Jivanbhai vs. CIT 63 ITR 485
this Court construed the partnership deed by reading it as a whole and "in
the context of the relevant circumstances of the case" and held that there
was specification of the individual shares of the partners in the profits
within the meaning of Section 26-A of the Act and the assessee-fire was
entitled to registration. The relevant circumstances which were taken into
account were (1) under clause 3 of the partnership deed the capital allotted to
each partner was equal (2) under clause 10 net profit or loss was to be divided
amongst all partners (3) in the application the three partners were shown to
share the profits equally and (4) in the books of accounts the profits were
apportioned equally among the three partners. Thus, it was laid down by this
Court in that case that the instrument of partnership has to be construed
reasonably by reading it as a whole and taking into consideration the relevant
circumstances disclosed by the instrument of partnership and the account books
for the relevant year and the statements made in that behalf in the
application.
In
this case, it appears that the High Court, without carefully examining the
facts and circumstances of the case, applied the decision of this Court in Mandyala
Govindu & Co.
(supra).
In the partnership deed the proportion in which the five partners including the
minor had to contribute the capital was clearly stated. It was also clearly
stated that net profits were to be divided between the partners in proportion
to their shares in the capital. The application made by the partners for
registration of the firm contained the statements required to be made therein
according to the prescribed form. The prescribed Schedule was also attached
with that application. The said Schedule read as under :- "S C H E D U L E
Name of Date of Interest Salary Share partner Address admittance on capital Commi-
in to partner- or loans if ssion bala ship. any or nce of other profit remune
loss;
ration
percen from tage firm
----------------------------------------------------------- (1) (2) (3) (4) (5)
(6) (7) ------------------------------------------------------------ 1.Mr. M.R.
Rajakrishna Vijaya Raga- vachari Road, Madras-17. 1.7.67 Nil Nil 25% of Profit
40% of loss 2.Miss Sunitha Pratap (Minor) Villa Enchantre, Ranjit Road, Kottur Adyar
Madras - 25 1.7.67 Nil Nil 37.5% of Profit No Share of loss 3.Mr.W.S. Parthasarathy
80, Harris Road, Madras-2 1.7.67 Nil Nil 12.5% of profit 20% of loss
4.Mr.W.S.Sethunaryana Babu, 80,Harris Road, Madras-2 1.7.67 Nil Nil 12.5% of
profit 20% of loss 5.W.S. Rajeswari 80, Harris Road, Madras-2. 1.7.67 Nil Nil
12.5% of profit 20% of loss".
As
minor Sunitha was admitted to the benefits of partnership it is obvious that
she had not to share any loss. The losses were to be distributed among the
major partners only. Since they were to share the profits in the proportion in
which they had contributed the capital it was implied that they were to share the
losses in the same ratio. This was the reasonable manner in which the
instrument of partnership was required to the construed, applying the second
principle referred to above while dealing with the case of mandyala Govindu
& Co. (supra).
Moreover,
the application made by the appellant in the prescribed form clearly disclosed
as to how the losses of the firm were to be distributed among the major
partners.
The
way they had worked out their share in the loss, if any, in the Schedule
attached to the application was quite consistent with the provisions made in
the instrument of partnership and the legal principles applicable in that
behalf. Accordingly Rajakrishna who was required to contribute 25% as share
capital had to bear 40% of the loss and the other three major partners who had
individually contributed 12.5% of the capital had to bear the loss in the ratio
of 20% each. The ITO had not considered these relevant circumstances as he was
of the view that the contract of partnership itself was void. The Appellate
Assistant Commissioner and the Tribunal did to refer to the application and
construing the partnership deed alone held that it was possible to ascertain
how the losses of the firm were to be distributed among the major partners.
If the
partnership deed is construed reasonably, as indicated above, then it has to be
held that it did, by necessary implication, provide for the proportion in which
the losses of the firm were to be shared by the major partners. The application
for registration made by the appellant fulfilled the conditions laid down by
Section 184 of the Act and, therefore, the ITO ought to have granted
registration and made assessment of the appellant for the relevant years on
that basis. The High Court was wrong in taking the contrary view. Therefore, we
allow these appeals, set aside the judgment and orders passed by the High Court
and answer the question referred to the High Court by holding that for the
assessment year 1968-69 the appellant was entitled to registration and for the
assessment years 1969-70 and 1970-71 it was entitled to renewal/continuation of
registration. In view of the facts and circumstances of the case, the parties
shall bear their own costs.
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