1. This is an appeal filed by the revenue objecting to the order of the Commissioner (Appeals) directing the ITO to grant registration to the assessee-firm under Section 185(1)(a) of the Income-tax Act, 1961 ('the Act') for the assessment year 1977-78.
2. The assessee, Gagrat & Co., is a firm of lawyers practising at Delhi. It consists of the following five partners : This firm is evidenced by a deed of partnership dated 22-11-1976. The assessee applied for registration in Form No. 11 on 5-1-1977 on the strength of the above said partnership deed for the assessment year 1977-78 relevant for the previous year ended 31-3-1977. The ITO after examining the various clauses of the partnership deed came to the conclusion that the relationship of partnership was not intended to be brought about among the five partners and that, therefore, the assessee-firm was not entitled to registration. He was further of the view that the profits of the firm were also not distributed as specified in the deed of partnership. In support of these conclusions the ITO relied on the various clauses of the deed of partnership and the decision of the Supreme Court in M.P. Davis v. CAIT  35 ITR 3. The assessee preferred an appeal objecting to this order of the ITO.The Commissioner (Appeals) disagreed with the reasonings and conclusions of the ITO and held that the assessee-firm had been held to be a genuine firm and granted registration throughout in all the earlier assessment years and that the mere fact that a new deed was drawn up in the year under appeal with some adjustments in the various clauses which did not detract, from the relevant provisions of the Partnership Act or the Income tax Act, could not entitle the ITO to refuse registration to the assessee in the year under appeal. He rejected the ITO's conclusion that the share of profit of each partner being variable from year to year, the percentage of losses to be shared by them was not clear. He pointed out that the partnership clearly laid down that losses were to be shared by four of the five partners in proportion to their shares in the profits of the firm which shares were clearly, specified. He also held that the decision of the Supreme Court in the case of M.P. Davis (supra), relied on by the ITO, was distinguishable and that the ITO had completely ignored the submissions made on behalf of the assessee and had nothing to say as to why the later decision of the Supreme Court in K.D. Kamath & Co. v. CIT  82 ITR 680 would not apply to the facts of the present case. He further observed that it was settled law that bare suspicion will not be sufficient to justify the inference of fact that a partnership is not genuine-Krishna Flour Mills v. CIT  44 ITR 501 (SC) and Umacharan Shaw & Bros. v. CIT  37 ITR 271 (SC). He further observed that the mere fact that a former employee was taken up as a partner, or that he did not bring in any capital or that a partner occupied a dominant position and is in control of the business would not constitute evidence or a finding that the partnership is not genuine. In support of this, he relied on a number of decisions mentioned in para 10 of his order. He, therefore, held that the ITO was not justified in refusing registration to the assessee-firm and, accordingly, directed the ITO to grant registration to the assessee-firm for this year. Aggrieved by this order of the Commissioner (Appeals) the revenue has come up in appeal to the Tribunal.
4. Before us Shri S.C. Tiwari, the learned departmental representative, relied on the various clauses of the deed of partnership dated 22-11-1976 and contended that partnership is not a matter of mere form but of real substance ; that we should look at the true character and relationship of Shri J. Lal with the other partners of the firm, and that J. Lal was acting as a partner with respect to outside world will be of no consequence at all nor his designation or his signing the partnership deed as a partner would be of any relevance or consequence.
He contended that we should confine ourselves to his relationship vis-a-vis his other partners. He pointed out (i) that according to Clause 2 of the deed of partnership, Shri J. Lal had no right to dissolve the assessee-firm, (ii) that according to Clause 4, the name, goodwill and other assets of the firm belonged to Mr. Gagrat and later to his son, Shri J.R. Gagrat ; (in) that according to clause 6, Mr. J.Lal had no right to contribute to the capital of the firm ; (iv) that clause 7 clearly indicated that J. Lal had no say in classification of expenditure as capital or revenue ; and (v) that he had also no say in respect of the expenses and allowances specified in the said clause.
Shri Tiwari pointed out that according to clause 8, Mr. Lal was entitled to one month's leave subject to the approval of his partner, Mr. B.R. Agarwala. He emphasised with reference to Clause 11 that share of J. Lal was fixed and determined and it sounds like an annual salary to an employee. He pointed out that J. Lal had nothing to do with the sharing of the fortunes made by the firm or in the losses of the firm.
He further pointed out that in Clause 13, J. Lal was conspicuous by his absence since he would not have any share. He also pointed out that according to Clause 16, L Lal could not operate any bank account or any other account of the firm. Shri Tiwari heavily relied on Clause 18 of the partnership deed to emphasise that Mr. Lal had to act under the direction and supervision of Mr. B.R. Agarwala which clearly established that Mr. Lal was only a subordinate of Mr. B.R. Agarwala.
He also referred to Clause 23 which showed that Mr. Lal had to work under the restrictions imposed by the sharing partners. He further relied on Clause 24 which specifically deprived Mr. J. Lal of any participation in the financial affairs of the firm. He also pointed out that according to Clause 25, J. Lal had no right to give notice nor entitled to get any share if any partner ceased to be a partner. Shri Tiwari further relied on the fact that Mr. Lal had filed his return of income claiming the income received from the partnership as salary income and not as share of profits and claimed deduction under Section 16. According to Mr. Tiwari this was not a light matter and not a matter for correction as held by the Commissioner (Appeals). He, therefore, contended that the assessee-firm had not discharged its burden of proof to show that there was in existence a genuine firm which was entitled to registration. According to him, the profit-sharing ratio was not specified and that similarly the share in losses were also not specified. He relied on the decision in M.P. Davis (supra), referred to by the ITO, and further contended that the decision of the Supreme Court in K.D. Kamath & Co. (supra) would not apply to the facts of the present case. According to Mr. Tiwari, the cumulative effect of all the circumstances clearly established that Mr.
J. Lal was only an employee and not a partner in the firm and that, therefore, the ITO was fully justified in refusing registration to the assessee-firm and that the Commissioner (Appeals) erred in reversing his order. He, therefore, contended that the order of the Commissioner (Appeals) should be reversed and that of the ITO should be restored.
5. Shri G.C. Sharma, the learned counsel for the assessee, agreed with Shri Tiwari that a partnership is not a matter of form only but a matter of substance. He vehemently contended that not a single circumstance had been pointed out by the departmental representative to show that the terms and conditions of the partnership deed in question had not been acted upon by the partners. He argued that the cumulative effect of all the clauses relied on by the learned departmental representative did not destroy the existence of a partnership but clearly established that there was a real relationship of partners among the five persons who had signed the deed of partnership. He pointed out that there was no standard form of partnership. He further submitted that Gagrat & Co., Delhi, was established with five partners in the year 1955 and that right from its inception up to and inclusive of the assessment year 1976-77, it had been accepted and held to be a genuine firm and granted registration by the ITO and that there was absolutely no justification for the department to refuse registration to the assessee-firm on mere suspicion, more so when the very same five partners had been carrying on their profession in a partnership under a deed dated 3-7-1971, from 2-7-1971 to 31-3-1976, and which firm had been granted registration as a genuine partnership from the assessment years 1972-73 to 1976-77. Shri Sharma relied on the decision in Stekel v. Ellice  1 All. ER 465, wherein it was held that the fact that a person was described as a salaried partner was not conclusive one way or the other of the question whether he was a partner in the true sense and that the question whether there was a partnership depended on the true nature of the relationship and not on the label attached to it.
Although the provisions for salary and the ownership of capital were not those usually found in a partnership agreement, the 1968 agreement in the said English case was very much more an agreement for a partnership than an agreement for employment ; in particular the parties were carrying on a business in common with a view of profit within Section 1(1) of the 1890 Act. Furthermore, the actual conduct of the parties after 1-10-1968 fully accorded with the concept of partnership. Accordingly, there was' a 'partnership entered into' for a fixed term for the purposes of Section 27 of the 1890 Act, and that was continued after 6-4-1969 without any express new agreement. That partnership was determined by mutual agreement in August 1970. That was a case of a partnership of two chartered accountants-one partner providing all capital and taking profits and the other partner was paid a fixed salary.
6. The learned counsel, Shri Sharma, further pointed out that the assessee-firm was registered with the Registrar of Firms also. He further submitted that Shri J. Lal had filed a revised return on realising the mistake committed by him in returning the income received by him from the assessee-firm as salary income. He further relied on CIT v. R.M. Chidambaram PilLal  106 ITR 292, where in the Supreme Court held that a firm is not a legal person, even though it has some attributes of personality, that in income-tax law a firm is a unit of assessment, by special provisions, but is not a full person, that since a contract of employment requires two distinct persons, viz., the employer and the employee, there cannot be a contract of service, in strict law, between a firm and one of its partners, and that payment of salary to a partner represents a special share of the profits and that such salary paid to a partner retains the same character of the income of the firm. The Supreme Court further held that accordingly, the salary paid to a partner by a firm which grows and sells tea, is exempt from tax under Rule 24 of the Indian Income-tax Rules, 1922, to the extent of 60 per cent thereof representing agricultural income and is liable to tax only to the extent of 40 per cent. Shri Sharma relying on this decision contended that the description of Shri J. Lal as paid partner or his describing the share income -received by him as salary would not in any way militate against the genuineness of the assessee-firm. He, therefore, submitted that the order of the Commissioner (Appeals), following the decision of the Supreme Court in K.D. Kamath's case (supra), was perfectly right and that the same should be upheld.7. We have carefully considered the submissions urged on both sides in the light of the authorities relied on by them and the recitals in the deed of partnership dated 22-11-1976. In our view, the findings and the reasoning of the Commissioner (Appeals) are perfectly right and have to be upheld.8. In K.D. Kamath & Co. (supra), the Supreme Court held that the legal requirements, under Section 4 of the Partnership Act to constitute a partnership in law, are: (i) there must be an agreement to share the profits or losses of the business ; (li) the business must be carried on by all the partners or any of them acting for all ; and (Hi) there is implicit in the second requirement the principle of agency. Their Lordships further held that the control and management of the business of a firm can be left by agreement between the parties in the hands of one partner to be exercised on behalf of all the partners. Their Lordships further held that the provision in clause 9 of the deed was only an inter se arrangement entered into by the partners in and by which the working partners had agreed not to raise loans or pledge the firm's interest and that not only was the clause not destructive of the theory of partnership but it indicated that the theory of agency was recognised. In this decision, their Lordships have also explained their earlier decision in M.P. Davis (supra), relied on by the revenue before us.
9. When we examine the terms of the deed of partnership dated 22-11-1976 in the light of the above principles, laid down by the Supreme Court, we have no hesitation in holding the shares of the partners are specified in Clause 11 of the deed of partnership in the profits and losses of the firm. We set out below the said clause which has given rise to so much of controversy in the present appeal: 11. During the continuance of the partnership the profits of the firm shall be determined in the manner aforesaid. The profits so determined shall be shared as follows : (a) Mr. Lal shall be paid by way of his share in the net profits of the firm the following amounts :1-4-1976 to 31-3-1977 Rs. 1,600 per month1-4-1977 to 31-3-1978 Rs. 1,700 per month1-4-1978 to 31-3-1979 Rs. 1,800 per month1-4-1979 to 31-3-1980 Rs. 1,900 per month1-4-1980 to 31-3-1981 Rs. 2,000 per month (b) The balance of the profits of the firm for each year shall be divided between Mr. Gagrat, Mr. Mehta, Mr. Gagrat Junior and Mr.
Agarwala in the following manner : (c) If there are any losses in the firm, they shall be borne by Mr.
Gagrat, Mr. Mehta, Mr. Gagrat Junior and Mr. Agarwala in proportion of their share in the profits of the firm.
(d) The above shares will be revised at the end of 5 years, i.e., from 1-4-1981 as may be mutually determined between the sharing partners.
We are unable to appreciate the contention of the revenue that the shares of the partners in the profits and losses of the firm are not specified in the deed of partnership. On the contrary, we would refer to the following passage from the decision in M.P. Davis (supra) : . . . Similarly, in Raghunandan Nanu Kothare v. Hormasjee Bezonjee Bamjee  ILR 51 Bom. 342, after construing an agreement of partnership between two solicitors the High Court reversed the trial court's finding that the defendant was not a partner but was an agent of the plaintiff, and came to the conclusion that the agreement made the defendant a partner of the plaintiff. Under this agreement, in lieu of his share of profits the defendant was entitled to receive Rs. 500 per month and was not to be responsible for any losses or liabilities of the firm. The main reason which appears to have weighed with the High Court in upholding the plea of partnership was that it was 'almost absurd to think that two experienced solicitor's of our High Court should enter into a formal agreement to become partners, and then so far as the outside world goes and so far as the correspondence between them goes, act as partners for some six years and give the usual notices of dissolution and yet be told at the end that they were entirely mistaken as to their true legal position and that they did not know the elementary principles which go to constitute a partnership, although that was a matter on which they would be presumably advising their clients frequently'. It was thus an extreme case where the status and profession of the parties and their conduct spread over a long period were wholly inconsistent with the plea raised by the defendant that he was not a partner of the plaintiff.
. . .(pp. 807-08) It will be seen that the facts of the Bombay High Court case cited above were similar to the facts in Stekel (supra). In fact this decision of the Bombay High Court fully supports the case of the assessee to establish that it is a genuine partnership firm.
10. The various clauses of the partnership deed relied on by the learned departmental representative do not militate against the role of Shri J. Lal as a partner of the assessee-firm. They do not make him an employee of the firm. As rightly contended for the assessee, the five partners were experienced lawyers who know what they are doing. The various recitals in the deed of partnership represent the terms and conditions mutually agreed upon among the partners for the purpose of carrying on their profession of lawyers at Delhi. The first three partners are residing at Bombay while the remaining two reside at Delhi. It is for this reason that the two partners residing at Delhi, namely, Shri B.R. Agarwala and Shri J. Lai, are described as resident-partners of the assessee-firm. The further description of Shri J. Lal as a paid partner is fully justified as he was entitled to his share in the net profits at the specified rates provided in Clause 1 \(a) of the deed of partnership. This clause further shows that he is not liable for any losses. We may mention here that Clause 12 of the partnership deed entitles the other resident partner, Shri B.R.Agarwala, to a minimum guarantee at the rate of Rs, 3,000 per month towards his share of profits of the firm. Thus it would be clear that the amounts paid to these two resident partners at Delhi on monthly basis in the case of Shri J. Lal and also as a minimum guarantee in the case of Shri Agarwala only represented their share of the profits of the firm. We would like to emphasise that it is not for the revenue to dictate in what manner the partners of a firm shall agree to share their profits and losses of their business or profession. To our mind, the objection of the revenue on this ground is totally misconceived.
The, remaining clauses of the deed of partnership placing restrictions on Shri J. Lal are matters of internal management of the affairs of the assessee-firm. Apparently, these restrictions were placed on Shri J.Lal by the remaining four partners, who are more experienced in the profession of law, as J. Lal is comparatively a junior in the profession. These restrictions would in no way militate against the genuineness of the firm nor would they justify the inference that J.Lal was only an employee and not a partner. It is well settled that a partnership deed must be construed reasonably as held by the Supreme Court in CIT v. Shah Mohandas Sadhuram  57 ITR 415. We are, therefore, of the view that the department is not justified in reading the various clauses of the deed of partnership in isolation to draw an inference that J. Lal is an employee and not a partner. It is not disputed by the revenue that Shri J, Lal has been acting as a partner of the firm of Gagrat & Co. and that the outside world recognised and dealt with him as a partner of the assessee-firm. This circumstance would certainly negative the inference of the department that Shri J.Lal is an employee and not a partner in the assessee-firm. The history of the firm of Gagrat & Co. Delhi from 1955 shows that there have been a number of changes in the constitution of the firm since its inception. It will be opposed to all facts to say that a firm of lawyers, who advise their clients about formation of partnerships, did not understand their true relationship when they formed a partnership to carry on their profession and intended that one of them would only be an employee, in spite of the various recitals in the deed of partnership embodying the terms and conditions under which they had agreed to carry on their profession. In our view, such a conclusion would be a far-fetched one and cannot be supported either on facts or in law. The decision of the Supreme Court in K.D. Kamath (supra) relied on by the Commissioner (Appeals) directly applies to the facts of the present case. The other decision in R.M. Chidambaram Pillal's case (supra) relied on by the learned counsel for the assessee also supports the conclusion that the assessee-firm is a genuine partnership. The mere fact that Shri J. Lal had, by mistake, shown his share as salary income would not justify the conclusion that he was not a partner but only an employee. We cannot also ignore the revised return filed by Shri J. Lal when he realised his mistake. The decision of the Supreme Court in M.P. Davis (supra) has been explained by the Supreme Court in its later decision in K.D. Kamath & Co.'s case (supra). We have already quoted in para 9 above, the relevant passage from the said decision of the Supreme Court in the case of M.P. Davis (supra) which supports the case of the assessee. Further we may point out that in the case of M.P.Davis (supra), the case turned on its peculiar facts which clearly established that there was no relationship of partners between the two who were in the position of an employer-employee before formation of the partnership. But in the present case, Shri J. Lal joined the firm as a partner in the year 1971 under a deed of partnership dated 2-7-1971 and was recognised as such partner up to and inclusive of the assessment year 1976-77. There is no material which would justify an inference adverse to the assessee that Shri Lal is not a partner and that, therefore, the assessee is not a genuine firm. On the contrary, the cumulative effect of all the materials including the various recitals in the deed of partnership is that the assessee-firm is a genuine partnership which is entitled to registration under Section 185(1)(a) of the Act. We, therefore, agree with the reasoning and conclusion of the Commissioner (Appeals) that registration was refused on a mere suspicion. We, therefore, confirm the order of the Commissioner (Appeals) and dismiss this appeal.