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Commissioner of Income-tax Vs. Smt. Allareddy Sudarsanamma and ors. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAndhra Pradesh High Court
Decided On
Case NumberCase Referred No. 56 of 1968
Judge
Reported in[1972]83ITR759(AP)
ActsIncome Tax Act, 1961 - Sections 182 and 183; Income Tax Act, 1922 - Sections 23(5)
AppellantCommissioner of Income-tax
RespondentSmt. Allareddy Sudarsanamma and ors.
Appellant AdvocateP. Rama Rao, Adv.
Respondent AdvocateS. Dasaratharama Reddy, Adv.
Excerpt:
.....much less a business transaction, in respect of which the receipt of interest by the firm from the partners is chargeable to income-tax. it is now well-settled that there can he transactions such as sale, mortgage, borrowal, etc. however, we are satisfied that there is no merit in this contention of the assessees and the doctrine of real income has, in fact, no application to the present case where actually we hold that there was a business transaction which actually earned profit to the firm on the borrowals made by the assessees for meeting their personal expenses which were ultimately after apportionment allocated to the partners as their share income. , both in the hands of the firm as well as the partners......order to give effect to the principle that an assessee can only be taxed in respect of his or her real income. the first two facts of the submission of the assessees did not find favour with the income-tax appellate tribunal. however, the tribunal holding that the share income received by the assessee from the firm could not be treated as her real income to the extent it consisted only in a return of a portion of the interest income of the firm which she herself contributed, directed the income-tax officer to exempt the amount of interest received by each of the partners from the firm after its ascertainment and partly allowed the appeals to the extent indicated above. at the request of the commissioner of income-tax who was aggrieved by the decision of the tribunal, the following.....
Judgment:

Kondaiah, J.

1. This is a reference by the Income-tax Appellate Tribunal, Hyderabad Bench, under Section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as 'the Act'). In order to appreciate the scope of the reference, it is necessary to refer to the material facts : For the assessment year 1962-63 corresponding to the accounting year ended on March 31, 1962, the respondents-assessees were partners in a firm styled M/s. Seetharama Mining Company, Gudur, having one-third share each in the profit or loss of the firm. The assessees bad capital accounts in the books maintained by the firm. The partners individually withdrew substantial amounts from the firm for the purpose of meeting their personal expenses. The terms of the deed of partnership did not provide for payment of any interest on the capital investments of the partners, but they had to pay interest to the firm in respect of their drawings. In the accounting year in question, A. Sudarsanamma, A. Jayalakshmamma and M. Sulochanamma, the assessees-partners, have paid Rs. 12,356, Rs. 12,598 and Rs. 11,30.6, respectively, towards interest on their withdrawals from the firm. The claim made by the assessees that these amounts of interest paid by them be deducted from their other income was negatived by the Income-tax Officer and the Appellate Assistant Commissioner on appeal. In the appeals to the Appellate Tribunal, the submission of the assessees was three-fold--firstly, that the payment of interest was allowable under Section 37(1) of the Act on the ground that it was laid out wholly and exclusively for the purpose of carrying on their business as partners of the firm or to earn the share income; secondly, that the payments made by the assessees were treated as part of the income of the firm and assessed to tax in its hands and, therefore, it would be inequitable to tax the partner's share of the interest in their hands once again; and, thirdly, that the payment of interest by a partner to a firm was really a payment to oneself and it was entirely notional and, therefore, the share income should be reduced to the proportion of the partner's share in the firm in order to give effect to the principle that an assessee can only be taxed in respect of his or her real income. The first two facts of the submission of the assessees did not find favour with the Income-tax Appellate Tribunal. However, the Tribunal holding that the share income received by the assessee from the firm could not be treated as her real income to the extent it consisted only in a return of a portion of the interest income of the firm which she herself contributed, directed the Income-tax Officer to exempt the amount of interest received by each of the partners from the firm after its ascertainment and partly allowed the appeals to the extent indicated above. At the request of the Commissioner of Income-tax who was aggrieved by the decision of the Tribunal, the following question has been referred for our opinion under Section 256V of the Act by the Tribunal which submitted a consolidated statement of case for all the three cases as the question that arises out of the orders of the Tribunal is one and the same:

'Whether, on the facts and in the circumstances of the case, the assessee is entitled to deduct one-third of the amount of interest paid by her to the firm from the share income allocated to her '

2. It was contended by Sri P. Rama Rao, the learned counsel for the revenue, that the doctrine of real income has been misconstrued and misapplied by the Appellate Tribunal to the facts of the present case and that the assessecs in the instant case are not entitled to claim any portion of the amount paid by them to the firm towards borrowals made by them for the purpose of their personal expenses as they are not permissible under any of the provisions of the Act. This claim of the department was resisted by Sri Dasaratharama Reddy, the learned counsel appearing for the assessees, contending, inter alia, that there is complete identity between the partners and the firm and there can be no transaction, much less a business transaction between the partners and the firm relating to the withdrawal of the amounts from the firm for the purpose of meeting their personal expenses, and, in substance, it is only an adjustment by the same entity and, hence, the decision of the Tribunal is perfectly valid and justified.

3. To appreciate the rival contentions and to arrive at a correct solution of the problem, it is relevant and necessary to notice the material provisions of the Act and what exactly ' real profits' mean. Section 4 charges the total income of the previous year of every person at the rate or rates specified in the Finance Act applicable for the assessment year. Clause (31) of Section 2 defines ' person '. It includes an individual, a Hindu undivided family, a company, a firm, an association of persons or a body of individuals, whether incorporated or not, a local authority and every artificial juridical person not falling within any of the preceding sub-clauses. Hence, a firm and an individual are two distinct separate entities for the purpose of the Act. Similarly, so even under the Indian Income-tax Act, 1922. Under Section 23(5) of the old Act prior to the amendment of 1956, by Section 14 of the Finance Act, 1956, no tax was payable by a registered firm as there was no assessment of its liability. Each partner's share income was apportioned an$ added to his income and he was charged to tax on his total income as an individual. After 1956, the income of the registered firm also was liable to tax at a low rate, though not exigible to super-tax. The partners of the registered firm are still liable on their share income from the firm along with their other income to both income-tax and super-tax, subject to certain rebate permissible under section .I4(2)(aa). However, in the case of an unregistered firm, it was open to the income-tax authorities either to compute the tax payable by it us an entity or to tax the share incomes of the partners in the hands of the partners. Sections 182 and 183 of the present Act correspond to Section 23(5) of the 1922 Act except that there was no conesponding provision similar to Sub-section (4) of Section 182. Section 182 of the Act deals with the assessment of registered firms whereas Section 183 provides for assessing unregistered firms. Under Section 182(1)(i), the income-tax payable by the firm as an independent entity has to be determined after ascertaining its total income.

4. Thereafter, the share income has to be ascertained and allocated to the individual partners who are liable to tax under Clause (ii) of Sub-section (4) of Section 182. Their share income is chargeable to tax along with their other income assessable in their hands in the status of individuals. The scheme of the present Act as well as the old Act is that the firm and its partners are treated as separate and distinct entities for the purpose of assessment. Even prior to 1956, the firm was treated as a separate entity as far as the assessment was concerned though no liability to pay tax as such on the firm was created. After 1956, both the firm as well as the partners are assessed to tax at different rates in respect of the same income as it was specifically provided by the statute.

5. We shall now refer to what is meant by the doctrine of real profits, Profits may be real or notional. Book profits in a case where the assessee maintains his accounts on a mercantile system are only notional profits but not actual or real profits. To arrive at the net profits, the assessee would be entitled to deduct from the gross profits, all the business expenditure and deductions permissible under the Act. The book, profits arrived at as per the provisions of the taxing enactment are not the real or actual pro-profits. The real profits have to be arrived at on the application of commercial principles and only by making the permissible deductions as per the provisions of the Act. There is a catena of decided cases on the aspect. Suffice it to refer to a few leading cases. The earliest case to be noticed is Gresham Life Assurance Society v. Styles, [1892] A.C. 309, 315; 3 T.C. 185, 188 (H.L.) wherein Lord Chancellor Halsbury observed :

' The word ' profits ' I think is to be understood in its natural and proper sense--in a sense which no commercial man would misunderstand. But, when once an individual or a company has in that proper sense ascertained what are the profits of his business or his trade, the destination of those profits, or the charge which has been made on those profits by previous agreement or otherwise, is perfectly immaterial,, The tax is payable upon the profits realized, and the meaning to my mind is rendered plain by the words ' payable out of profits '. '

6. The aforesaid dictum has been approved by Lord Macmillan in Pondicherry Railway Co. Ltd. v. Commissioner of Income-tax, A.I.R. 1931 P.C. 165, 170. Here, we may notice the following observations of Greene M.R. in British Sugar . v. Harris, [1938] 2 K.B. 220; 21 T.C. 528, 548, 549-50; [1938] 1 All E.R. 149, 154, 156 ; [1939] 7 I.T.R, 101, 106, 108 (C.A.) :

' Once you realise that as a matter of construction the word ' profits ' may be used in one sense for one purpose and in another sense for another purpose, I think you have the real solution of the difficulties that have arisen in this case.'

7. In the same case, Romer L.J, said :

' Is the payment that has to be made by the trader under the contract in question a mere division of profits with another party, or is it a payment to the other party, the amount of which is ascertained by reference to the profits ?'

8. Mackinnon L.J. stated in the aforesaid case thus :

'The whole question in this as in other cases, is whether this, which is an annual payment, is an annual payment to be taken into account in order to ascertain the profits, or is it an annual payment payable out of he profits after they have been ascertained . . . 'profits' as I think, quite clearly of a different .description from the annual profits or gains with which one is concerned in assessing the income tax.'

' It is apposite to refer in this context to the following observations of the Privy Council relating to the concept of real income in Raja Bejoy Singh Dudhuria v. Commissioner of Income-tax, [1933] 1 I.T.R. 135, 140 (P.C.):

' The Indian Income-tax Act makes no similar provisions for the deduction of tax at the source and the consequent reimbursement of the taxpayer in the case of such a charge as that to which the revenues of the appellant are subject.... that the omission from the Indian Act of any such provision points rather to an intention to tax, in Lord Davey's phrase, only ' the real income ' of the taxpayer, than to an intention to impose, without right of reimbursement, a tax on what is a charge upon his income.'

9. See also H.M. Kashiparekh & Co. Ltd, v. Commissioner of Income-tax, [1960] 39 I.T.R. 706, 707 (Bom.). We may notice the decision of the Supreme Court in Commissioner of Income-tax v. Sitaladas Tirathdas, : [1961]41ITR367(SC) where the following test was laid down lay Hidayatullah J. (as he then was), who spoke for the court, to determine what the real income is:

' In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible ; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment wliich can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessce, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable.'

10. We may also refer to another decision of the Supreme Court in Murlidhar Himatsingka v. Commissioner of Income-tax, : [1966]62ITR323(SC) wherein Sikri J. speaking for the court, while dealing with the provisions of Section 23(5), prior to 1956, observed thus:

' The object of Section 23(5)(a) is not tip assess the firm itself but to apportion the income among the various partners. After the income has been apportioned, the Income-tax Officer has to find whether it is the partner who is assessable or whether the income should be taken to be the real income of some other person. If it is the real income of another firm, it is that firm which is liable to be assessed under Section 23(5)(a) of the Act.'

11. See also Ratilal B. Daftari v. Commissioner of Income-tax, [1959] 36 I.T.R. 18, 24 (Bom.).

12. After reviewing the entire case law on the subject, the learned judge, Subba Rao J. (as he then was), succinctly laid down the law relating to the content and concept of ' real profits ' in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, : [1965]57ITR521(SC) :

' Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profit can be ascertained only by making the permissible deductions. There is a clear-cut distinction between the deductions made for ascertaining the profits and distributions made out of profits. In a given case whether the outgoings fall in one or the other of the heads is a question of fact to be found on the relevant circumstances, having regard to business principles. Another distinction that shall be borne in mind is that between the real and the statutory profits, i.e., between the commercial profits and statutory profits, the latter are statutorily fixed for a specified purpose. If we bear .in mind these two principles there will be no difficulty in answering the question raised.'

13. On the application of the aforesaid principles, it was held that the amounts credited by the appellant therein during the relevant accounting years to the consumers benefit reserve fund were only statutory profits but not commercial or Teal profits and to arrive at the taxable income of the assessee from the business under Section 10, those amounts have to be deducted from its total income.

14. In the light of the aforesaid discussion, we shall proceed to examine the contention of Sri Dasaratharama Reddy, that the amount of share income received by the partners from the firm to the extent of the amount of interest paid by them on their personal borrowings or withdrawals for meeting their personal expenses, is not real income but only the amount paid by the partners to the firm which was once again returned to them. We do not see any force in this contention of the assesses This argument is based on the misconception that the partners and the firm are one and the same legal entity for the purpose of tax. As pointed out earlier, the partners and the firm are indisputably different and distinct entities for the purpose of the Income-tax Act. Not only that they are assessable as separate entities but the income is chargeable to tax both in the hands of the firm as well as the partners as per the provisions of Section 182 read with Section 183 of the Act corresponding to Section 23 of the Income-tax Act, 1922.

15. We are unable to accede to the submission of the assessees that there was no transaction, much less a business transaction, in respect of which the receipt of interest by the firm from the partners is chargeable to income-tax. It is now well-settled that there can he transactions such as sale, mortgage, borrowal, etc., between a partner and the firm and the parties, if aggrieved under any such transactions, can establish their rights in a court of law against the other contracting party. In Commissioner of Income-tax v. W.L. Dahanukar, [1959] 36 I.T.R. 459 (Bom.) the assessee therein who contracted to purchase certain lands for Rs. 41,500, later entered into a partnership agreement with one Datar with a view to develop the land and sell it. The land agreed to be purchased by him for Rs. 41,500 was agreed to be taken over by the partnership for Rs. 90,000. The land was in fact conveyed by the vendor of the assessee directly to the partnership. When the assessee was sought to be taxed for the difference in price between Rs. 90,000 and Rs. 41,500, i.e., Rs. 48,500 on his transaction with the firm consisting of himself and Datar, it was contended that there could be no transaction between him, the partner, and the partnership which really earned profits liable to tax. The Bombay High Court repelled the contention of the assessee holding that it was competent to a person in law to sell his property to a partnership consisting of himself and another and such a transaction would have all the incidence of a legal and binding transaction of sale ana the profits earned out of such transaction was liable to tax as an adventure in the nature of trade. The Supreme Court in Chittoor Motor Transport Co, (P.) Ltd. v. Income-tax Officer, Chittoor, : [1966]59ITR238(SC) held that the transfer of buses including those in respect of which development rebate has been allowed by the Chittoor Motor Transport Company Pvt. Ltd. to a partnership firm composed of shareholders as pa'rtners for a sum of Rs. 2,52,000 was a sale for consideration of the buses by the company to the firm within the meaning of the Sale of Goods Act, irrespective of the fact whether such a transaction resulted in profit to the company or not. Such sale was held to fall within the purview of the latter part of Section 10(2)(vib) of the Income-tax Act, 1922.

16. Where the partner draws the funds belonging to the firm for meeting his personal expenses, he would be liable to pay interest thereon if the terms of the deed of partnership specifically provide for it. In the instant case, the partnership deed makes the partners liable to pay interest at 12% on the withdrawals made by them for personal expenses from the funds of the firm, although no interest was payable by the firm to the individual partners on their capital investments. In fact, all the three assessees have paid the sums which are now sought to be deducted from the computation of the taxable income towards interest to the firm. The firm's accounts disclose these amounts being received by it as interest for the amounts withdrawn by the partners. These amounts are, undoubtedly, not only book profits .but must be held to be commercial and real profits actually received by the firm in the year of account. These sums have been shown in computing the/profits of the firm and they have in fact been assessed to tax in the hands of the firm as per the provisions of Section 182. After the ascertainment of the taxable profits of the firm, the allocation of respective shares of the three partners, in the instant case, have been made. The share incomes received by the assessees have to be clubbed with their individual incomes received from other sources in order to arrive at the taxable profits received by or accrued to them in the year of account. The transaction relating to the payment of interest by the partners to the firm on the borrowals or withdrawals of the amounts belonging to the firm, whether looked at the substance or the form, is, undoubtedly, a commercial or business transaction which actually earned profits to the firm.

17. We shall now turn to the decided cases relied upon by Mr. Dasaratha-rama Reddy. In Doughty v. Commissioner of Taxes, [1927] A.C. 327 (P.C.) two partners sold the entire assets including the goodwill of their partnership business to a limited company in which they were the only shareholders. Though the nominal value of the shares was more than the sum credited to the capital account of the partnership, it was held by the Privy Council that there was no separate sale of the stock and the transaction was only a mere readjustment of the business position of the partners which resulted in no profit. The Supreme Court in Sir Kikabhai Premchand v. Commissioner of Income-tax, : [1953]24ITR506(SC) wherein the stock-in-trade of a dealer in silver and shares was valued at cost price both in the beginning and at the end of the year and the stock was withdrawn and settled on trusts crediting the business with cost price of the stock in the books of account although the market ratewas higher, held the transaction to be not of a business nature resulting in income liable to be taxed. The assessee had not really made any profit on the date when he transferred the stock-in-trade at the cost price to the trusts. Though the market price on the date of the settlement of the stocks in favour of the trusts was higher than the cost price of the stocks shown in the accounts of the assessees. he did not in fact receive any profit sought to be taxed under the Act, In Commissioner of Income-tax v. Sir Homi Mehta's Executors, [1955] 28 I.T.R. 928 (Bom.) it was held by the Bombay High Court that income means real income but not fictional or technical income and transactions entered into by commercial men must be looked at from a commercial point of view for the purpose of income-tax. Judged from the commercial point of view, it was held that the transaction of transfer of the shares held by the assessee and his sons jointly in several joint stock companies to a private limited company formed by them at market price was not a business transaction to earn any profit, but it was only an adjustment to own the shares as the shares of the limited company instead of the same being jointly held by them as individuals. Another decision cited by the assessee's counsel is Commissioner of Income-tax v. Shoorji Vallabhdas and Co., : [1962]46ITR144(SC) wherein it was held that income-tax is a levy on income received or accrued and if there is no income there can be tio tax and the mere book entry showing notional or hypothetical income is not the basis for; tax. In that case, the Supreme Court had to consider the effect of book entries relating to commission accrued under an agreement; whether it was taxable as income. It was held that the assessee was liable to tax only on the amount actually received by him as remuneration towards the managing agency. In Commissioner of Income-tax v. Janab N. Hyath Batcha Sahib, : [1969]72ITR528(Mad) the handing over of lorries whose written down value was Rs. 2,558 by the assessee to the firm valuing them at Rs. 15,000 and crediting that sum being given to the assessee in his capital account with the firm was held by the Madras High Court not to be a transaction amounting -to sale or purchase resulting in actual or real profits. In that case, the assessee had contributed the lorries towards his capital account valuing them at Rs. 15,000 though their written down value on that day as per assessment records was Rs, 2,558. In those circumstances, it was held that no profit in fact had arisen to the assessee by the transaction.

18. All the decisions cited by the assessee relate to cases where it was found as a fact that there was no business transaction resulting in actual profit or earning any income liable to be taxed under the Act, and, hence, they are distinguishable from the facts of the case on band. For the applicability or otherwise of the theory of real income, there must invariably be income which further falls for decision whether it is real or unreal. How far the decision of the Madras High Court in Commissioner of Income-tax v. Janab N. Hyath Batcha Sahib, : [1969]72ITR528(Mad) is correct in view of the decision of the Supreme Court in Chittoor Motor Transport Co. (P.) Ltd. v. Income-tax Officer, Chittoor, : [1966]59ITR238(SC) is a matter of doubt. However, we are satisfied that there is no merit in this contention of the assessees and the doctrine of real income has, in fact, no application to the present case where actually we hold that there was a business transaction which actually earned profit to the firm on the borrowals made by the assessees for meeting their personal expenses which were ultimately after apportionment allocated to the partners as their share income.

19. It is next contended by Sri Dasaratharama Reddy that it is neither valid nor just to tax the income twice, i.e., both in the hands of the firm as well as the partners. This submission is based on the theory that no income receipt can be taxed twice. ' It is often said, but not always understood ', Rowlatt J. observed in Commissioners of Inland Revenue v. Frank Bernard Sanderson, [1921] 8 T.C. 38, 44, 45 (C.A.)' that in income tax the same income is not taxed twice. That means that you cannot tax it more than once on one passage of the money in the form of one sort of income.' The aforesaid dictum of Rowlatt J., consistently followed in India, is not applicable to cases where the taxing enactment specifically provides for taxing the passage of income more than once. There is no prohibition for double taxation under the Constitution. In Jain Brothers v. Union of India, : [1970]77ITR107(SC) the learned judge, Grover J., speaking for the court, ruled thus :

' The Constitution does not contain any prohibition against double taxation even if it be assumed that such a taxation is involved in the case of a firm and its partners after the amendment of Section 23(5) by the Act of 1956. Nor is there any other enactment which interdicts such taxation. It is true that Section 3 is the general charging section. . . .After 1956, therefore, so far as registered firms are concerned the tax payable by the firm itself has to be assessed and the share of each partner in the income of the firm has to be included in his total income and assessed to tax accordingly. If any double taxation is involved the legislature itself has, in express words, sanctioned it. It is not open to any one thereafter to invoke the general principles that the subject cannot be taxed twice over.'

20. In view of the aforesaid authoritative pronouncement of the Supreme Court, we must overrule this objection of the assessee as devoid of any merit.

21. For all these reasons, we must hold that the Tribunal erred in holding that the assessee is entitled to deduct one-third of the amount paid by her to the firm from the share income allocated to her. We, therefore, answer the question in the negative and against the assessee. The assessees shall pay the costs of this reference to the Commissioner of Income-tax. Advocate's fee is fixed at Rs. 300.


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