HARDAYAL HARDY J. - This income-tax reference under section 66(1) of the Income-tax Act, 1922 (hereinafter referred to as 'the Act'), consists of four reference applications which were consolidated and disposed of by a common order of the Income-tax Appellate Tribunal, having regard to the same question being involved in all the references.
The four assessment years are 1958-59, 1959-60, 1960-61 and 1961-62 of which the relevant accounting years ended on June 28, 1957, June 19, 1958, July 17, 1959, and June 25, 1960, respectively. The applicant, Panna Lal Girdhari Lal, who will hereafter be referred to as the assessed, is a registered firm consisting of five partners, each having an equal share. The assessed carries on business of manufacture of copper wire and also of gota, tila and zari goods and is being assessed on a substantial income from year to year. The firm was formed during the previous year for 1942-43 assessment year, for which it was granted registration under section 26A of the Act. Since then renewal of registration is being granted to the firm year after year. Before 1942-43 assessment year, the same business was being carried on by a Hindu undivided family of the same name.
On September 4, 1956, the assessed entered into an agreement with each of the five partners whereby they were paid salaries shown below in the four years with which we are concerned in this case :
5. Devi Charan
The said amounts were claimed by the assessed as a permissible deduction in arriving at the net income from its business assessable under section 10 of the Act. The Income-tax Officer who dealt with the assessment for the years in question disallowed the claim as, according to him, salary paid to a partner was clearly inadmissible in view of the specific provision of section 10(4) (b) of the Act. On September 29, 1962, the Income-tax Officer passed an assessment order for the year 1958-59 disallowing the claim for salaries. He passed separate orders for 1959-60 and 1960-61 on January 2, 1963, and for the year 1961-62 he passed another separate order on April 30, 1963. In all that years also the salaries paid to the partners were disallowed by the Income-tax Officer for reasons discussed by him in the assessment order for the year 1958-59. The assessed went up in appeal before the Appellate Assistant Commissioner and challenged the decision of the Income-tax Officer. Appeals for the first two years, namely, 1958-59 and 1959-60, were heard by one Appellate Assistant Commissioner who passed a consolidated order for these two years on June 7, 1964, dismissing the assesseds claim. Appeals for the subsequent two years came up before another Appellate Assistant Commissioner who passed two order on June 1, 1966, for the years 1960-61 and 1961-62 confirming the disallowance of salaries for reasons discussed by him in his order in respect of the assessment year 1960-61.
Being dissatisfied with the decision of the Appellate Assistant Commissioner, the assessed took a second appeal to the Income-tax Appellate Tribunal and challenged the decision of the authorities below. It was pointed out that it was in dispute that the five persons were partners of the assessed-firm in their representative capacity as kartas of their respective Hindu undivided families and the funds belonging to the families were invested in the firm by way of capital on which not only interest was being received, but share of profit was also received, both of which were shown as income of the family. It was, however, contended that as the salary was specifically made payable to each of the five partners for services rendered by them in their individual capacity as contained in the written agreement dated September 4, 1956, such salaries were income of the partners in their individual capacity and not in their representative capacity as the karta of their respective Hindu undivided families and hence it was urged that the salary should have been allowed as a deduction in computing the income of the assessed from its business. The part assigned to each partner was specifically mentioned before the Appellate Assistant Commissioner concerned.
The Tribunal dismissed the appeals of all the four years holding that the issue before the Tribunal was not whether the salaries paid to the five partners were to be assessed in their hands as individuals of were to be included in the income of their respective Hindu undivided families. The Tribunal was informed by the counsel for the assessed that these salaries had been included in the assessment of the respective Hindu undivided families although the partners had also filed separate returns in their individual status showing their income form salaries only. Protective assessments have thereforee been made on the individual partners separately. The Tribunal thereforee held that when the appeals relating to that particular point would come up before it, the Tribunal will have occasion to decide whether in view of the agreement dated September 4, 1956, the salary income should be treated as the income of the joint Hindu family or that of the partners in their individual capacity, but so far as the assessed firm is concerned its income is assessable under section 10 of the Act. Section 10(2) (xv) of the Act provides for the allowance of the expenditure not being an allowance of the nature described in clauses (i) to (xiv) inclusive and not being in the nature of capital expenditure or personal expenses of the assessed, laid out or expended wholly and exclusively for the purposes of such business, profession or vocation. Salaries paid to the five partners would ordinarily be claimable by them as a permissible deduction under section 10(xv) of the Act, but for the specific prohibition in section 10(4) (b) which is to the following effect :
'Nothing in clause (ix) or clause (xv) of sub-section (2) shall be deemed to authorise the allowance of any sum paid on account of any cess, rate or tax levied on the profits or gains of any business, profession or vocation or assessed at a proportion of or otherwise on the basis of any such profits or gains and nothing in clause (xv) of sub-section (2) shall be deemed to authorise -
(b) any allowance in respect of any payment by way of interest, salary, commission or remuneration made by a firm to any partner of the firm.'
In interpreting the meaning of section 10(4) (b) of the Act, the Tribunal relied upon the principle enunciated by the High Court of Madras in the case of A. S. K. Rathnaswami Nadar Firm v. Commissioner of Income-tax. The Tribunal also relied upon a decision of the Supreme Court in Commissioner of Income-tax v. Kalu Babu Lal Chand.
At the instance of the assessed, the following question of law has been referred to this court as arising out of the order of the Tribunal for our opinion :
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the payment of salary to each of the five partners was hit by the prohibition contained in section 10(4) (b) of the Indian Income-tax Act, 1922, and was not allowable under section 10(2) (xv) of the Act even in spite of the written agreement dated September 4, 1956.'
Mr. Kirpa Ram Bajaj, learned counsel for the assessed, has invited our attention to pages 92 to 96 of the account maintained by the assessed for the assessment year 1959-60 which shows the capital account of each of the five partners. At pages 98 the details of the salaries paid by the assessed to each of the five partners for the assessment years in question have been mentioned. According to Mr. Bajaj, apart from the amount to capital invested by each partner which clearly showed that the investment was made by him in this representative capacity as a karta of his Hindu undivided family, the salary account clearly shows that the payment of salary was being made to each partner in his individual capacity and had nothing to do with his being a karta of the family. Each partner was required to carry out a specific job and was, thereforee, entitled to be remunerated for the job done by him. It is true that each partner was, in a way, a proprietor of the firm but he was also an employee of the firm in the sense that he actually worked for the firm as any other employee who the sense that he actually worked for the firm as any other employee who was an utter stranger to the firm would also work for it if and when he had been employed by the firm. There is no reason why a partner of the firm who, besides investing money, also works for the firm should not be remunerated for the services rendered by him. The dual capacity of a partner who has not only invested money in the firm and is, thereforee, entitled to the profits and losses arising out of the business but is also is partner who is working for the firm, is not something unknown to law. In this connection our attention was invited to section 13(a) of the Indian Partnership Act, 1932, which lays down :
'Subject to contract between the partners -
(a) a partner is not entitled to receive remuneration for taking part in the conduct of the business.'
This clearly shows that if there is a contract between the partners providing for payment of remuneration to all or any of the partners of the firm for taking part in the conduct of the business, the provision is quite consistent with the policy of law.
Mr. Bajaj further submitted that as the salary was specifically made payable to each of the five partners for services rendered in their individual capacity as contained in the written agreement dated September 4, 1956, such salaries were the income of the partners in their individual capacities and not in their representative capacity as the karta of their respective Hindu undivided families. He, thereforee, contended that the salary should have been allowed as a deduction in computing the income of the assessed-firm from its business.
We told Mr. Bajaj that the question falling for determination in this case was not whether each of the five partners was entitled to the payment of salary. The fact that salary had been paid to the partners was beyond question. How far that salary would be treated as the income of each of the partners as an individual or as a karta of the Hindu undivided family which he represented as a partner in the firm, would have to be decided in the appeals filed by them. What we are called upon to decide in the present case is whether the payer of the salary, namely, the assessed-firm, was entitled to claim deduction for the payment made by it to the partners constituting the firm.
Mr. Bajaj contended that the only way in which such salary could be allowed as an admissible deduction was under section 10(2) (xv) of the Act and was thereforee ordinarily an allowable deduction, for the amount paid by the assessed was neither in the nature of capital expenditure nor for the personal expenses of the assessed but was an amount laid out or expended wholly and exclusively for the purpose of the assesseds business. The trouble in the way of the assessed was, however, created by the specific prohibition in section 10(4) (b) to which a reference has already been made above.
Mr. Bajaj contended that it was only in the cases recently decided by the Supreme Court that the question of dual capacity of a partner has been brought out.
In Prem Nath v. Commissioner of Income-tax, which was decided on August 12, 1970, Prem Nath had entered the firm of K. C. Raj and Co. as a karta of his Hindu undivided family. He was also a working partner and was allowed a salary at the rate of Rs. 700 per mensem. The question before the Supreme Court was whether the remuneration received by him as a working partner was the income of his family or his individual income. The High Court answered the question holding that the income was the income of the undivided family. On appeal to the Supreme Court it was held that the income received by him was remuneration for services rendered by him and there was no real and sufficient connection between the investment of joint family assets and the remuneration paid to him. The decision of the High Court was set aside and the question was answered in the negative.
This clearly brought out the distinction between the dual capacity of a partner, one in which he represents the family and the other when he represents none but himself.
Mr. Bajaj also invited our attention to a decision of Addison J. (Bhide J. concurring) in Electric and Dental Stores v. Commissioner of Income-tax, where it was held that if a particular partner or partners possess special qualifications for which they are paid salary, irrespective of existence of profits and over and above their share of profits, the payment of salaries could be allowed as a deduction. The dual capacity of a partner-cum-employee, though suspect, is possible, and to the extent that the person is in truth an employee, the salary is deductible from the profits of the partnership. The question had actually come before that Bench in the context of section 10(2) (ix) of the Income-tax Act, 1922, which was more or less identical with section 10(2) (xv) of the present Act and it was held that the remuneration payable to a partner was to be seen as to whether as a fact the particular partners are true employees of the firm or whether the payment of salaries to them is a advice to escape income-tax. That question no longer arises in the present case because there can be no doubt that under section 10(2) (xv) the remuneration payable to a partner is an admissible expenditure. The case thereforee does not afford any assistance to the learned counsel.
The case of S. Bhagwant Singh v. Commissioner of Income-tax is another case relied upon by Mr. Bajaj. S. Bhagwant Singh became a partner in a concern known as Sir Sobha Singh and Co. (Builders), Nagpur, after investing a sum of Rs. 1,50,000 as his capital in the said concern. He was to have 6 annas share in the partnership business and was to be paid a sum of Rs. 1,500 per mensem as his remuneration. In connection with his assessment to income-tax he filed two returns on October 31, 1951, one in the capacity of an individual declaring his share income from the firm at Rs. 31,348 and another in the status of a Hindu undivided family on an income of Rs. 22,454-7-0. On February 25, 1953, he filed a revised return for the Hindu undivided family of an income of Rs. 39,470. The Appellate Tribunal came to the conclusion that, for the purposes of entering into partnership, S. Bhagwant Singh had utilised family funds, that his income from the partnership business could not be regarded as other than joint family income and that the salary of Rs. 1,500 per mensem which he received from the firm and was doubtless earned with the aid of family funds could not be treated as a self-acquired property. One of the three questions referred to the High Court was whether, on the facts and in the circumstances of the case, the salary of Rs. 1,500 per mensem received by S. Bhagwant Singh from the firm styled as Sir Sobha Singh & Co. (Builders), Nagpur, was income of S. Bhagwant Singh in his individual capacity.
The question was answered against the assessed. In the judgment there is a reference to a passage from Lindleys Law of Partnership and to certain observations of Vice-Chancellor Willard in Caldwell v. Leiber. But it is not necessary to set out those passages in view of section 13(a) of the Partnership Act which makes it clear that if the contract so provides a partner may receive compensation for taking part in the conduct of the partnership business.
In Raj Kumar Singh Hukam Chandji v. Commissioner of Income-tax, the Supreme Court laid down the various tests for the purpose of determination as to whether the remuneration received by a coparcener in substance, though not in form, was but one of the modes of return made to the family because of the investment of the family funds in the partnership business or whether it was a compensation made for the services rendered by the individual coparcener. It was said :
'If it is the former, it is an income of the Hindu undivided family, but if it is the latter then it is the income of the individual coparcener.'
All these cases however relate to that side of the problem which deals with the amount received by the karta of a family who joins the partnership business in his capacity as a representative of the family. The question considered in these cases is whether the income is the income of the family or of the individual - barring the case of Electric and Dental Stores, which alone deals with the income of a partner of the business from the point of view of the payer, namely, the firm in which the partner is employed. The law laid down in that decision has to be read in the light of section 10(4) (b) which imposes a specific prohibition in the matter of assessment of the firm.
The scope of section 10(4) (b) was considered by the High Court of Madras in A. S. K. Rathnaswami Nadar, to which a reference has already been made. It was held that the section enacts an absolute prohibition. It does not limit the operation of the Act to a remuneration paid to a partner as such but includes remuneration or salary paid to a partner in any capacity.
Mr. Bajaj contended that the distinction between the dual capacity of partner was not considered in that case. It seems to us that the distinction which Mr. Bajaj seeks to make is not warranted by the language of sub-section (4) (b) of section 10. The section, as we read it, prohibits a payment to a partner, whatever might to be capacity in which he might receive it. As was said by the learned judges of the Madras High Court 'the moment the payment is made to a partner, section 10(4) (b) springs into action.'
The same view was taken by the Calcutta High Court in Girdhari Lal Ghasiram v. Commissioner of Income-tax. In this case the following observations of the Supreme Court in Commissioner of Income-tax v. Kalu Babu Lal Chand were noticed :
'It is now well settled that a Hindu undivided family cannot as such enter into a contract of partnership with another person or persons. The karta of the Hindu undivided family, however, may and frequently does enter into partnership with outsiders on behalf and for the benefit of his joint family. But when he does so, the other members of the family do not, vis-a-vis the outsiders, become partners in the firm. They cannot interfere in the management of the firm or claim any account of the partnership business or exercise any of the rights of a partners So far as the outsiders are concerned it was the karta who alone is, and is in law recognised as, the partner.'
The assessed-firm is constituted by five persons and they were all there in their individual capacity. The relationship between the partnership and the karta partner was that of an individual appointed as a partner. And, thereforee, so far as the assessment of the firm is concerned, any payment made by it to a partner on account of salary is not an admissible expenditure in terms of section 10(4) (b) of the Act. It does not make the slightest difference whether the person joining the firm as a partner enters it as an individual or as a karta of the Hindu undivided family. The partnership is a contractual relationship between individuals. If there is a fiduciary capacity between the individual and the family that he represents, it is a matter entirely between that individual and his family. The firm as such has nothing to do with it.
It seems to us that the present agreements were entered into force on September 4, 1956, after the Finance Act of 1956 came into force on April 27, 1956, whereby section 10(4) (b) was added to the statute. Sub-section (5) of section 23 was amended with the result that registered firms became liable to payment of income-tax. In order to escape the effects of that amendment, the present agreements appear to have been entered into with the partners to avoid taxation; otherwise this very firm is stated to onwards and all the five partners had been devoting their whole time and attention to the affairs of the firm and no salary was being paid to any one of them. There was no special reason for making a departure in 1956. Be that as it may, in view of section 10(4) (b), the agreements have no effect and whatever salary was been paid to them is not an admissible expenditure.
Mr. Bajaj also sought to raise an additional point by contending that under section 10(1) the salaries of the partners have to be deducted in order to arrive at the real income of the assessed. The payment of salaries is a diversion of income at the source and, thereforee, comes within the rule laid down in Bejoy Singh Dudhuria v. Commissioner of Income-tax. The question was not raised before the Tribunal and thereforee does not arise out of its order. Even otherwise, we do not find any substance in it.
The result of the foregoing discussion is that the question is answered in favor of the revenue and against the assessed. The Commissioner will also have his costs of these proceedings. Counsels fee Rs. 300.
KAPUR J. - I agree.
Question answered in the affirmative.