Somnath Iyer, J.
1. This reference sought by the assessee known as Vijayalakshmi Talkies, Bangalore, under section 66(1) of the Indian Income-tax Act, 1922, has for its source an application for registration made by the assessee under section 26A of the Act in respect of the assessment year 1961-62.
2. It is submitted that in the year 1953 a business in partnership under the name and style of Vijayalakshmi Talkies was commenced, and that partnership carried on business in the exhibition of films. The partners of that firm were two brothers, Krishna and Narasimhan. For the purpose of their business, they obtained on lease a theatre from a certain Mandakini Bai.
3. In the year 1957, three other brothers also became partners of the firm. Some time thereafter these five brothers decided to embark upon the business of hoteliers. For that purpose, calling themselves as Chidambaram Brothers, they borrowed three sums of money amounting in the aggregate to Rs. 50,000 from a certain Achaiah Chetty, and on April 28, 1960, they executed in his favour a promisory note for that amount.
4. On the same day, an instrument of partnership was executed between these five brothers and Achaiah Chetty and his son, Parthasarathy. That partnership deed provided, among other things, that the capital of the firm amounting to Rs. 50,000 should be contributed by Achaiah Chetty and his son and that the profits and losses of the firm should be distributed between the parties in a particular way. It was further provided that if any monies had to be borrowed for the partnership, that should be borrowed jointly, although the bank account had to be operated upon by Achaiah Chetty and his son.
5. But the more important provision in the partnership deed was that, immediately the firm earned a net profit of Rs. 1,00,000, the five brothers should retire from the partnership.
6. On the same day, an agreement was executed in relation to the sum of Rs. 50,000 borrowed by Chidambaram Brothers for the purpose of their hotel business. Among other matters, that collateral agreement provided that Chidambaram Brothers shall not be liable for any losses sustained in the business of the partnership and that Achaiah Chetty and his son should completely indemnify them against such losses.
7. There was a deed of assignment executed by the five brothers on May 1, 1960, in favour of the new partnership which was called Vijayalakshmi Talkies by which all the deposits made by the old partnership towards the rental of the premises which by then belonged to a certain Kelkar, and other outstandings amounting in the aggregate to Rs. 30,000 were assigned to the new partnership.
8. By another document of the same day, Chidambaram Brothers made a transfer to the new partnership for a consideration of Rs. 20,000 the right to the name and goodwill of the old partnership and transferred to it all the fittings, fixtures and other accessories.
9. On May 30, 1960, an application was made to the Registrar of Firms under the Partnership Act for registration of the new firm and that registration was made on July 25, 1960.
10. On June 27, 1960, on behalf of the new partnership, which was carrying on its business under the name and style of Vijayalakshmi Talkies, an application was made to the Income-tax Officer for registration of the firm under section 26A in respect of the assessment year 1961-62. The Income-tax Officer was of the view that there was no partnership composed of the seven partners to whom the instrument of partnership executed on April 28, 1960, refers, and that partnership was a partnership only between Achaiah Chetty and his son, Parthasarathy, and that the five brothers who called themselves Chidambaram Brothers did not become partners of that firm. The Appellate Assistant Commissioner, to whom there was an appeal, concurred in the view taken by the Income-tax Officer in the same way in which the Appellate Tribunal, to which there was a further appeal, found that the partnership upon which dependence was placed, did not exist.
11. The question of law, which is referred to us for our decision, at the instance of the assessee, reads :
'Whether, on the facts and in the circumstances of the case, the refusal to grant registration to the assesses firm for the assessment year 1961-62 was justified in la ?'
12. The Appellate Tribunal felt persuaded to say that the five brothers who called themselves Chidambaram Brothers did not become partners under the instrument of partnership which was executed on April 28, 1960, since there were many features of the arrangements which were reached between them on the one hand and Achaiah Chetty and his son on the other which precluded the view that there was any such partnership. The Tribunal thought that since Chidambaram Brothers made no contribution of capital and since they did not make themselves liable for losses and did not receive from the new partnership the real value of the goodwill pertaining to the old partnership, it was not possible to think that there was any real or genuine partnership.
13. Mr. Viswanatha Iyer contended, in our opinion rightly, that the Tribunal misdirected itself in thinking that the stipulation that only two partners shall share the losses or the covenant that the capital shall be produced by only two of the seven partners denuded the arrangement reached between the parties of the status of a partnership.
14. It is well settled that there is in law no prohibition to a stipulation between the partners against community of loss; nor is it necessary for every partner to produce capital, since a person who becomes a partner may contribute his capital or his skill or both, and that he does so is a sufficient consideration to support an agreement of partnership.
15. In regard to the criticism made by the Tribunal about the value of the goodwill to which the document executed on May 1, 1960, by Chidambaram Brothers in favour of the new partnership refers, it would be enough to say that there is no material on the basis of which the Tribunal could have come to the conclusion that the sum of Rs. 5,000, which was the price paid for the goodwill, was inadequate.
16. It is true that in the statement of the case transmitted to us, the Tribunal has pointed out that in the year 1957, the three brothers, who entered into the partnership, paid a sum of Rs. 18,000 towards the goodwill of the then existing partnership. But it is clear from what has been stated by the Assistant Commissioner in the course of his order and also from the material on record, that in the year 1960, when the new partnership was formed, Chidambaram Brothers were placed in a peculiar situation when they had embarked upon the business of hoteliers for which they needed some considerable financial accommodation which they were able to obtain from Achaiah Chetty on the execution of a promissory note.
17. It is recited in the instrument of partnership that they had found it difficult to bestow undivided attention over the conduct of the business of exhibitors of films and that so it was that they had agreed to enter into a partnership with Achaiah Chetty and his son. The question as to whether the goodwill of the partnership of Chidambaram Brothers was worth more than Rs. 5,000 is a question depending upon the market value of the goodwill, and, on the material which the Tribunal had before it, its conclusion that a sum of Rs. 5,000 was inadequate was no more than mere speculation. Further, the fact that Chidambaram Brothers received a smaller price for the goodwill, or that it was improvident on their part to do so, does not invalidate the partnership if they had really entered into it.
18. But the Tribunal, like the Appellate Assistant Commissioner, and the Income-tax Officer, found it possible to say that the partnership recorded in the instrument of partnership did not really bring into being any partnership and that what was recorded in it was some arrangement for the liquidation of the liability of Chidambaram Brothers in respect of the loan which had been advanced to them by Achaiah Chetty.
19. It is true that the instrument of partnership does contain a provision that the five brothers should retire from the partnership when the partnership earned a net profit of Rs. 1,00,000, although the actual date on which such retirement had to happen was postponed till the last day of the month in which that net profit had been earned. It is obvious that the date of the retirement of these persons from the partnership was so fixed by reason of the fact that out of Rs. 1,00,000 so earned as net profits, a sum of Rs. 50,000, which would represent the share of the five brothers, would be equal to the sum of Rs. 50,000 which had been advanced by Achaiah Chetty to them some time before the execution of the promissory note on April 28, 1960. It is seen from the other collateral agreement executed on that day that Achaiah Chetty and his son became entitled to appropriate those profits towards that loan and, once the loan was discharged in that way after the partnership had earned a net profit of Rs. 1,00,000, the five brothers became liberated from their indebtedness and could walk out of the partnership.
20. Indeed, as can be seen from the statement of the case, necessary entries in the books of accounts were made for that purpose in the books of the firm. Profits for the period commencing on May 1, 1960 and ending on March, 31, 1961, amounted to Rs. 67,147.50. Out of this sum of money, the five brothers were credited with a sum of Rs. 33,573.75 and another equal sum was credited in the names of Achaiah Chetty and his son. There remained still a sum of Rs. 16,426.25 to be earned by the five brothers in order to get themselves exonerated from the liability under the promissory note. By August 31, 1961, the profits of the firm amounted to Rs. 36,104.82. Rupees 16,426.25 out of this sum of money was distributed amongst the five brothers and so, with such distribution, they had earned that sum of Rs. 50,000 which they had to earn in order to get rid of their indebtedness.
21. Thereafter, it is not disputed, that necessary adjustments were made, and the promissory note debt stood discharged.
22. In the statements which were recorded by the Income-tax Officer, some among the five brothers who were examined on that occasion, as also Achaiah Chetty, made no secret of the fact that the purpose for which the partnership was formed was to enter into an arrangement by which the indebtedness under the promissory note could be wiped out. But the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal were of the view that if that if that was the purpose of the constitution of the firm, it could not be said that a genuine firm came into being. We think that this view cannot be sustained.
23. The business which was carried on by the old partnership belonged to the five partners of that firm. When they commenced the adventure in the business of hoteliers, they requested Achaiah Chetty for financial assistance and secured it and so became indebted to Achaiah Chetty in the sum of Rs. 50,000. For the purpose of discharging this debt, if they agreed to become partners with Achaiah Chetty and his son and an arrangement was evolved by which the profits to which the five brothers became entitled under the instrument of partnership should be appropriated towards the discharge of the debt which they had borrowed, it could not be said that that purpose would make the partnership illegal or expose it to the suspicion that it was a subterfuge or an artifice to circumvent the law.
24. A person in indigent circumstances has the right to enter into a partnership with any who is willing to finance him and to enter into an agreement that his share in the profits of the partnership should be appropriated towards the debt which he owes to the other partner. That arrangement cannot invite the condemnation that it is a contrivance for the circumvention of the law. It is one of the usual mercantile transactions against which there is no legal prohibition, and there is no legal principle supporting a contrary view which would stop the wheels of a legitimate business adventure.
25. It is plain that the covenant for the liquidation of the debt out of the share of the profits of the five brothers is, on the contrary, what conferred on those brothers the status of partners. Such discharge is possible only if they owned a share in the profits of the firm and under the terms of the agreement, they could earn the profits in no other way than as partners.
26. The Tribunal, as rightly pointed out by Mr. Viswanatha Iyer, committed a mistake in thinking that a smaller share of the profit had been credited to the share of the five brothers in respect of the profits earned between March 31, 1961, and September 1, 1961. The Tribunal was of the view that whereas each of the brothers was entitled to Rs. 3,610 towards his share of the profits, what had been credited in the accounts amounted to no more than Rs. 3,285.25. What was overlooked by the Tribunal was that out of the aggregate sum of Rs. 36,104.82, which represented the profits, the five brothers were entitled to no more than Rs. 16,426.25 which remained to be earned by them in order to reach the figure of Rs. 50,000, before they could walk out of the partnership.
27. Mr. Rajasekhara Murthy urged that there was one other provision in the instrument of partnership which negatived a real partnership. He pointed out to us that in clause 10 of the instrument of partnership, the accounting year continues till March 31, whereas under clause 15 the five brothers ceased to be entitled to the profits of the firm on the day on which the firm earned a net profit of Rs. 1,00,000, even if that day fell somewhere during the middle of the month. The argument constructed was that the absence of the right to share in the profits between that day and the last day of the month on which they would retire was a sufficiently clear indication of the absence of the relationship of partners between them and the two others.
28. We do not agree that it is so. For the purpose of convenience, it may have been agreed between the partners that the last day of the month would be the date of retirement since other difficulties and complications might have arisen if their exit from the partnership was to be on the very day on which a net profit of Rs. 1,00,000 had been earned. However that may be, the fact that under the agreement it was agreed that the five brothers could take a half share in the aggregate profits is itself sufficient consideration for the agreement that the date of their retirement from the partnership should be postponed until the last day of the month.
29. In our opinion, there was a real and legal partnership entered into on April 28, 1960, between the five brothers and Achaiah Chetty and his son, Parthasarathy. Our answer to the question before us should, therefore, be in favour of the assessee and our answer is that the refusal of the registration of the assesses firm for the assessment year 1961-62 was not justified in law. The assessee will be entitled to the costs of this reference. Advocate's fee Rs. 250.