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Challa Appalaswamy Vs. Commissioner of Income-tax - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAndhra Pradesh High Court
Decided On
Case NumberCase Referred No. 29 of 1966
Judge
Reported in[1971]82ITR731(AP)
ActsIndian Income Tax Act, 1922 - Sections 26A; Indian Income Tax Rules, 1922 - Rules 2 and 4
AppellantChalla Appalaswamy
RespondentCommissioner of Income-tax
Appellant AdvocateY.V. Anjaneyalu and ;K.N. Raju, Advs.
Respondent AdvocateP. Ramarao, Adv.
Excerpt:
.....tax act, 1922 and rules 2 and 4 of indian income tax rules, 1922 - tribunal refused to register assessee firm on ground that profits were not divided in accordance with manner contemplated in partnership deed - partnership deed provided minor would be entitled to profit but not losses if one of two businesses resulted in loss and other profit - agreement among major partners that minor not be liable personally for losses not in contravention of deed - held, registration wrongly refused. - - in such a case the income-tax officer, under rule 4 of the income-tax rules, if satisfied that there was a firm in existence as' shown in the instrument of partnership and that the application has been properly made, is bound to grant registration to the assessee-firm. this is a case where the..........in the instrument of partnership.9. we have do doubt that the 'total income' includes the income, profits and gains from whatsoever source available and the total income of the previous year is the profit after deduction of losses incurred. we accept that the principles stated above are the correct principles which have to be kept in view for the purpose of the taxation. the manner in which the profits have been divided by the assessee-firm has not been accepted by the department as correct. as a matter of fact, we are told that the manner in which the profits and losses have actually been divided by the assessee-firm is more beneficial to the revenue than it would have otherwise been if they were in divided accordance with the manner the department requires the assessee to do......
Judgment:

Sriramulu, J.

1. At the instance of the assessee-firm, the Income-tax Appellate Tribunal, Hyderabad Bench, has referred the following question of law for our opinion :

'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in upholding the refusal of registration of the assessee-firm for the assessment years 1960-61 to 1962-63 ?'

2. The material facts leading to this reference may briefly be stated :

The assessee-firm, which came into existence on April, 1 1959, was constituted by an instrument of partnership dated February 20, 1959. The partnership consisted of three partners, Mr. Narayana Rao and Venkateswararao, sons of Challa Appalaswamy and Kannamma, widow of Appalaswamy. Kumari Satyavathi, minor daughter of Narayana Rao was admitted to the benefits of the partnership. The partnership was formed to continue the aluminium vessels business run under the name and style of Challa Appalaswamy Sons, and the graphite crucible business run under the name of Narayan Graphite Crucible Works, which were originally run by the deceased Challa Appalaswamy. The shares of the partners in the profits were 9: 4: 2: 1 in a rupee and in case of loss the major partners alone agreed to share the same in the ratio of 9: 4: 2. The assessee-firm applied for registration to the Income-tax Officer for the assessment years 1960-61, 1961-62 and 1962-63. The income-tax authorities refused registration to the assessee-firm. On second appeal filed by the assessee-firm the Income-tax Appellate Tribunal upheld the refusal of the registration, on the ground that instead of dividing the profits to the year from both the businesses taken together, the assessee-firm had divided the profits of the crucibles business and the loss in aluminum business separately ; in other words, it did not divide the profits in accordance with the shares, specified in the instrument of partnership. In the view taken by it the Appellate Tribunal did not consider the other ground on which the Appellate Assistant Commissioner had upheld the refusal registration to the assessee-firm. Aggrieved by the above order of the Tribunal, the assessee-firm required the Appellate Tribunal to state a case to the High Court. Finding that a question of law arises out of the Tribunal's order, the Appellate Tribunal accepted the assessee's application and referred the question stated above for our opinion under Section 66(1) of the Indian Income-tax Act, 1922, for the assessment year 1960-61 and 1961-62 and under Section 256(1) of the Income-tax Act, 1961, for the assessment year 1962-63.

3. The question, for its answer, depends upon the interpretation of the relevant clauses of the instrument of partnership. They are clauses 2 and 6 of the Instrument of partnership, which read as follows :

' CLAUSE 2 :

It is hereby agreed that the shares of the partners in the business of the firm carried on under the above-mentioned names shall be :

(a)Challa Narayana Rao0-9-0 in a rupee(b)Challa Venkateswarao0-4-0 do.(c)Challa Kannamma0-2-0do.(d)Challa Satyavathi0-1-0do.

The partners of this firm shall have the above-mentioned shares in the running business.

CLAUSE 6:

....If the firm incurs losses such losses are apportionable only between the first three partners and the fourth partner is entitled only to the profits regardless of such losses.'

4. For all the three assessment years under consideration the aluminium business ended in losses while the business in graphite crucibles ended in profits. The net result for each of the three assessment years was a profit. Instead of setting off the losses in aluminium business against the profit in graphite crucibles business every year and dividing the net profits in the proportion of 9 : 4 : 2 : 1, the assessee-firm divided the losses in alnminium business in the ratio of 9 : 4 : 2, amongst the major partners, and the profits in the graphite crucibles business for each year amongst the partners and the minor in the ratio of 9:4:2:1 ; the minor was not made liable for losses.

5. The learned counsel appearing for the assessee, Sri Anjaneyulu, on the strength of the decisions in Commissioner of Income-tax v. Sivakasi Match Exporting Co., : [1964]53ITR204(SC) . and S. C. Prashar v. Vasanlsen Dwarkadas, : [1963]49ITR1(SC) .contended that words 'regardless of such losses' occurring in Clause 6 of the instrument of partnership mean that the partners who admitted the minor to the benefits of the partnership had agreed that even the assets of the minor should not be made liable for losses. Such an agreement could be lawfully entered into by the partners and thence the manner in which the profits and losse were divided by the partners was in accordance with the shares specified in the instrument of partnership and the Income-tax authorities and the Tribunal were not justified in refusing registration for the assessee-firm. It was further contended that in case the Income-tax Officer found that a registered firm had not divided its profits in accordance with the respective shares of the partners he couldin the exercise of powers vested in him impose a penalty under Section 28 of the Indian Income-tax Act, 1922, but could not in any case refuse or cancel registration.

6. As against the above arguments, the learned counsel, Sri Ramarao, appearing for the department, relying upon the decisions in Commissioner of Income-tax v. S. M. Chitnavis, [1932] 2 Comp. Cas. 464 ; A.I.R. 1932 P.C. 178. and Calcutta Co. Ltd, v. Commissioner of Income-tax, : [1959]37ITR1(SC) . submitted that the profits of the previous year of a firm from whatever source that may be taken as a whole has to be charged to tax, and the manner in which the firm divided profits from one business and the losses from the other business separately is not the manner which is in accordance with the shares specified in the instrument of partnership. The English translation of the instrument of partnership is not correct. The income-tax authorities and the Tribunal were, therefore, right in refusing registration to the assessee-firm.

7. The correctness of the translation of the instrument of partnership, which was furnished by the assessee-firm, was not disputed by any of the departmental officers or by the Tribunal. We cannot, therefore, go behind the clauses as found in the translation of the deed and find out whether the translation was correct or not. We, therefore, proceed on the footing that the English translation of the instrument of partnership, filed before the income-tax authorities and relied upon before them and also before the Tribunal, is the correct translation. The procedure in regard to the registration of firms is laid down in Section 26A of the Indian Income-tax Act, 1922, and Rules 1 to 6 of the Indian Income-tax Rules, 1922. The combined effect of Section 26A and the rules has been expressed by the Hon'ble Justice Subba Rao of the Supreme Court in Commissioner of Income-tax v. Sivakasl Match Exporting Co., : [1964]53ITR204(SC) . thus :

'A combined effect of section 26A of the Act and the rules made thereunder is that if the application made by a firm gives the necessary particulars prescribed by the rules, the Income-tax Officer cannot reject it, if there is a firm in existence as shown in the instrument of partnership. A firm may be said to be not in existence if It is a bogus or not a genuine one, or if in law the constitution of the partnership is void. The jurisdiction of the Income-tax Officer is, therefore, confined to the ascertaining of the two facts, namely, (i) whether the application for registration is in conformity with the rules made under the Act, and (ii) whether the firm shown in the document presented for registration is a bogus one or has no legal existence. Further, the discretion conferred on him under Section 26A is a judicial one and he cannot refuse to register a firm on mere speculation, but he shall base his conclusion on relevant evidence.'

8. The assessee-firm has been constituted under an instrument of partnership, specifying the individual shares of the partners within the meaning of Section 26A(1) of the Indian Income-tax Act, 1922. It has, under Rule 2 of the Income-tax Rules, applied to the Income-tax Officer for the grant of registration within the time prescribed by those rules. That application has been signed by all the partners personally. In such a case the Income-tax Officer, under Rule 4 of the Income-tax Rules, if satisfied that there was a firm in existence as' shown in the instrument of partnership and that the application has been properly made, is bound to grant registration to the assessee-firm. The income-tax authorities have not disputed the genuineness of the assessee-firm, nor have they raised an objection that the shares of the partners have not been specified in the deed. The only objection raised by the income-tax authorities and the Tribunal was that the manner in which the profits were divided by the assessee-firm was not in accordance with the manner contemplated in the instrument of partnership.

9. We have do doubt that the 'total income' includes the income, profits and gains from whatsoever source available and the total income of the previous year is the profit after deduction of losses incurred. We accept that the principles stated above are the correct principles which have to be kept in view for the purpose of the taxation. The manner in which the profits have been divided by the assessee-firm has not been accepted by the department as correct. As a matter of fact, we are told that the manner in which the profits and losses have actually been divided by the assessee-firm is more beneficial to the revenue than it would have otherwise been if they were in divided accordance with the manner the department requires the assessee to do. In interpreting the relevant clauses in the instrument of partnership, care has to be taken to find out whether such clauses contravene the provisions of Section 30 of the Indian Partnership Act, the relevant portion of which reads as under :

'30. (1) A person who is a minor according to the law to which he is subject may not be a partner in a firm, but, with the consent of all the partners for the time being, he may be admitted to the benefits of partneship.

(2) Such minor has a right to such share of the property and of the profits of the firm as may be agreed upon, and he may have access to and inspect and copy any of the accounts of the firm.

(3) Such minor's share is liable for the acts of the firm, but theminor is not personally liable for any such act. ...'

10. On a plain reading of Section 30 it is evident that the profits can be divided between the partners as per the terms agreed upon by them under Section 30(2) of the Partnership Act. The aluminium business and thecrucibles business have been treated as separate units by the assessee-firm-Separate accounts have been maintained for each of the two businesses and profit and losses from each business have been worked out. The profits of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. The profit or loss in this case is capable of and has been computed from each business separately after deducting the expenditure from the receipts of that business. No flaw has been pointed out by the income-tax authorities or by the Tribunal against the computation of profit or loss from each business so determined by the assessee. The net profit of each transaction in a business cannot be ascertained, but the profit or loss of all the transactions put together of a business in the previous year can be computed. When two different sets are managed by an assessee and one results in a loss and the other in a profit, there is no doubt that the net result after adjusting the loss from one business against the profit of the other has to be brought to tax under Section 4(1) of the Indian Income-tax Act, 1922. That may be so under the Income-tax Act for the purpose of computation of tax. But, here, what we are concerned with is not the determination of the profit for the purpose of computation of tax. It is the Income-tax Officer that does the computation. What we are concerned with is whether the loss or profit has been divided in accordance with the shares specified in the instrument of partnership. This is a case where the major partners have agreed that the minor would not be liable personally for the losses as well as that her assets also would not be liable. Such an agreement is within their competence and the loss does not prohibit such an agreement between the partners, who admitted the minor to the benefits of the partnership. If that is so we do not find any flaw nor any difficulty . in interpreting Clause 6 of the instrument of partnership. The words 'regardless of such losses' can only mean that if one of the two businesses results in loss and the other in profit, the minor would be entitled to her share of the profits in the business which resulted in profit in accordance with the shares specified in the instrument of partnership, but not the losses suffered in the other business.

11. We are, therefore, unable to agree with the income-tax authorities or the Tribunal that the manner in which the partners have actually divided the profits and the losses in this case is not in accordance with the shares specified in the instrument of partnership. In our opinion, registration has been wrongly refused to the assessee-firm for all the assessment years. We, therefore, answer the question in the nagative and in fovour of the assessee. The department shall pay the costs of this reference to the assessee.


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