1. At the instance of the Commissioner of Income-tax, Kerala-I, the Income-tax Appellate Tribunal, Cochin Bench, has referred the following question of law for the decision of this court :
'Whether, on the facts and in the circumstances of the case, the assessee-firm is not entitled to registration for the assessment year 1973-74 and continuation thereof for the assessment year 1974-75, despite the fact that it is a genuine and lawfully constituted firm ?'
2. The assessee, respondent in these proceedings, is a firm consisting of five partners, namely, Sri. K. C. Thomas, Smt. Aniyamma Sebastian, Sri Ouseph Varkey, Sri M. J. Varkey and Sri Joseph James. The firm was constituted by a deed dated May 10, 1972, to take effect from April 1, 1972 (annex. A). We are in these proceedings concerned with the registration of the firm for the year 1973-74 and its continuance for the year 1974-75. Clause 13 of the deed is as follows :
'For the sake of convenience and to facilitate the obtaining of works by tenders, etc., contracts of allied activities may in appropriate cases be taken in the name of the firm or in the joint or individual name or names of the partners. No partner shall have individual business of the like nature as long as he is a partner in the firm.' (underlining* by us),
3. The firm applied for registration for the year 1973-74. The ITO by his order dated February 25, 1975, held as follows :
'After having gone through the deed of partnership and also the accounts produced before me at the time of examination, I am satisfied that there was a genuine firm in existence during the previous year and I grant registration to the firm for the assessment year 1973-74.'
(Enclosure to assessment order for the year 1973-74. Annexure B dated February 25, 1975).
4. The assessment was made on the assessee as a registered firm. The total income determined was Rs. 1,02,690. For the assessment year 1974-75 the assessee filed a declaration under Section 184(7) of the I.T. Act praying for the continuation of registration. It is seen from the assessment order for 1974-75 (annex, C) dated August 26, 1975, that the ITO found that the declaration filed was in order and within time and continuance of registration was granted. The Commissioner of Income-tax in exercise of his powers under Section 263 of the I.T. Act initiated suo motu revision proceedings for both the years 1973-74 and 1974-75. He took the view that theregistration granted to the firm for the year 1973-74 and the order granting continuance of registration for the assessment year 1974-75, were erroneous and that the said orders were prejudicial to the interests of Revenue. In his order dated February 1, 1977 (annex, D), the Commissioner noticed that Sri K.C. Thomas, the managing partner of the firm, had taken up contract work in his individual capacity and had admitted income from his own contract business in the income-tax returns filed by him for the assessment years 1973-74 and 1974-75. He was of opinion that in view of Clause 13 of the partnership deed (annex. A) and Section 16(b) of the Partnership Act, such individual income earned by Shri K.C. Thomas, the managing partner, should also be taken as the income of the assessee-firm and since the assessee-firm had not done so, it was not entitled to be granted registration. The contention of the assessee that Clause 13 of the partnership deed was varied with the mutual consent of all the partners, as a result of which Sri Thomas was allowed to carry on the contract business in his individual capacity and hence the income derived by him from such business could not be considered as the income of the assessee-firm was not accepted. The Commissioner held that violation of Clause 13 of the deed would affect the income of the firm and that the provisions thereof could be varied by mutual consent of the partners orally, but for the purpose of the I.T. Act such alteration could be effected only by written instrument. This not having been done, the grant of registration to the firm for the assessment year 1973-74 and continuance thereof for the assessment year 1974-75 were not in order. So, by order dated February 1, 1977, he directed the cancellation of registration for the assessment year 1973-74 as also the continuance of registration for the year 1974-75. It was ordered that the firm may be treated as an unregistered firm and assessments be modified accordingly.
5. The assessee filed appeals before the Income-tax Appellate Tribunal and assailed the order of the Commissioner. The Appellate Tribunal disagreed with the views expressed by the Commissioner. The Appellate Tribunal held in para. 8 of its order as follows :
'It is not the case of the Department that the assessee-firm is not a genuine firm. Nor is it the case of the Department that it is unlawfully constituted. Clause 13 of the deed, no doubt, provides that no partner shall have individual business of the like nature as long as he is a partner in the firm. It is true that under Section 16(b) of the Partnership Act, if a partner carries on any business of the same nature and competing with that of the firm, he is to account for and pay to the firm all the profits made by him in that busineSections The case of the assessee is that the provisions of Clause 13 were varied by mutual consent by and under which the managing partner was allowed to carry on similar business in his individual capacity. Even assuming that it was not so, we fail to understandhow registration can be denied when once it is found that the assessee-firm is a genuine firm and has been lawfully constituted. It may be that the partners could claim that the income derived by Shri K. C. Thomas by carrying on similar contract works should also be made available for being divided amongst them. It may also be possible to consider such income as the income of the assessee-firm for income-tax purposes (we are not to be understood as deciding this question in this appeal). If it is so considered, such income may be included in the assessment of the, firm and the same has to be allocated amongst the partners in the ratio in which the regular income of the firm is to be allocated. The fact that the assessee-firm has not offered such income for assessment and the fact that such income has not been allocated between the partners does not have the effect of making the firm itself a non-genuine one or unlawfully constituted one.'
6. Thereafter, the Commissioner filed R.As. 139 and 140 (Cochin) 1978-79 and required the Tribunal to refer the question of law set out in the applications for the decision of this court. In pursuance thereto, the Tribunal referred the question of law set out in para. 1 (supra) as per the statement of the case dated February 20, 1979. Before us Mr. P. K. Ravindra-natha Menon, counsel for the Revenue, stressed the latter portion of Clause 13 of annex. A, partnership deed, which is to the following effect :
'No partner shall have individual business of the like nature as long as he is a partner of the firm.'
7. The counsel then referred to Section 184(1) and Section 185(1) of the I.T. Act, which read as follows :
'184. (1) An application for registration of a firm for the purposes of this Act may be made to the Income-tax Officer on behalf of any firm, if--
(i) the partnership is evidenced by an instrument; and
(ii) the individual shares of the partners are specified in that instrument.'
'185. (1) On receipt of an application for the registration of a firm, the Income-tax Officer shall inquire into the genuineness of the firm and its constitution as specified in the instrument of partnership, and--
(a) if he is satisfied that there is or was during the previous year in existence a genuine firm with the constitution so specified, he shall pass an order in writing registering the firm for the assessment year :
(b) if he is not so satisfied, he shall pass an order in writing refusing to register the firm.' (emphasis* supplied)
8. According to counsel, the ITO shall enquire into the genuineness of the firm and its constitution as specified in the instrument of partnership, and soif under Clause 13 of the deed of partnership, it was interdicted that no partner shall have an individual business of the like nature as long as he is a partner in the 8rm, and it turns out that the managing partner had business of the nature carried on by the firm in his individual capacity and derived income therefrom, then 'the constitution of the assessee-firm as specified in the instrument of partnership', ceases to exist. In such a case, the firm is not entitled to registration since its constitution is not as specified in the instrument of partnership, In support thereof, counsel relied on the decision in R.C. Mitter & Sons v. CIT : 36ITR194(SC) , and stressed the following passage occurring at p. 198 :
'It is manifest that for a true and proper construction of the relevant provisions of the Act, relating to registration of firms, Sections 26, 26A and 28, and the rules summarized above, have to be read together. So read, it is reasonably clear that the following essential conditions must be fulfilled in order that a firm may be held entitled to registration :
(1) That the firm should be constituted under an instrument of partnership, specifying the individual shares of the partners;
(2) That an application on behalf of, and signed by, all the partners, containing all the particulars as set out in the Rules, has been made ;
(3) That the application has been made before the assessment of the income of the firm, made under Section 23 of the Act (omitting the words not necessary for our present purpose), for that particular year ;
(4) That the profits (or loss, if any) of the business relating to the previous year, that is to say, the relevant accounting year, should have been divided or credited, as the case may be, in accordance with the terms of the instrument; and lastly,
(5) That the partnership must have been genuine, and must actually have existed in conformity with the terms and conditions of the instrument.'
9. The argument of Mr. Ravindranatha Menon was that though the firm is genuine, it cannot be said that it has actually existed in conformity with the terms and conditions of the partnership deed (vide condition No. 5 supra). In such circumstances, it was contended that in view of the decision of the Supreme Court in Y. Narayana Chetty v. ITO : 35ITR388(SC) , it was open to the ITO acting under Rule 6(b) of the Rules under the Indian I.T. Act, 1922, corresponding to Section 186 of the I.T. Act of 1961, to review his own decision in the matter of the registration of the firm when he discovers that his earlier decision proceeded on a wrong assumption about the existence of the firm. Reliance was also placed on the decision in CIT v. Dwarkadas Khetan & Co. : 41ITR528(SC) , to contend that the partnership is not valid and so is not to be consideredfor registration. Counsel relied on a passage occurring in CIT v. Dwarkadas Khetan & Co. : 41ITR528(SC) , to the following effect :
'Registration can only be granted of a document between persons who are parties to it and on the covenants set out in it.'
10. On the other hand, counsel for the assessee, Mr. Kurien, contended that Clause 13 of the partnership deed has been varied orally, that the managing partner, Sri Thomas, was allowed to carry on contract business in his individual capacity and so the income derived by him from his individual business could not be considered as the income of the assessee-firm. According to him, the variation of the provisions of the partnership deed can be done even orally by mutual consent of the partners. The assessee's counsel also contended that even assuming that there has been no proper variation of Clause 13 of the deed that will not be a circumstance for denying registration to the firm. When once it is found that the assessee-firm is a genuine firm and has been lawfully constituted, it is entitled to registration. The fact that the partners can claim that the income derived by the managing partner, Sri K. C. Thomas, in his individual capacity on similar contract works also should be made available for being divided among them, considering such income as the income of the assessee-firm, will not alter or affect the constitution of the firm as specified in the instrument of partnership. The fact that such income has not been offered for the assessment of the firm or such income has not been allocated amongst the partners will not render the firm anything other than a genuine or a lawfully constituted firm.
11. On a consideration of the relevant clause in the partnership deed, and the provisions of law applicable to the case, we are of opinion that the decision of the Tribunal is right. The meaning of the crucial words 'Its constitution (firm's) as specified in the instrument of partnership' occurring in Section 185(f) of the I.T. Act, 1961, arises for consideration. We are of the view that when one of the partners carried on a business similar to the one carried on by the firm, even if it is not authorised by the deed of partnership, it will not be a case affecting the 'constitution of the firm' as specified in the instrument of pirtnership. As held by the Mysore High Court in the decision in C. Srinivasa Rao and Brothers v. CIT : 63ITR102(KAR) :
'The words 'constitution of a firm' have, according to their plain meaning, reference to the composition or the structure of the firm. Generally speaking, the composition of a firm is determined by the partners who constitute it and its constitution would get altered when there is an inclusion of a new partner or an old partner ceases to be one.'
12. In the said case, the question that arose was, whether in the absence of a provision for payment of salary to the partners in the partnership deed.payment of salary to some of the partners will effect a change in the constitution of the firm or will alter the share of profits, so as to refuse renewal of registration. The Mysore High Court answered the question in the negative and held that it will not do so. Their Lordships relied on a decision of the Calcutta High Court in In re Moolji Sicka : 6ITR234(Cal) , wherein Derbyshire C.J. said this:
'There is no question here of a firm having been newly constituted. The only question is whether a change has occurred in the constitution of a firm. There is no previous decision to guide us as to the meaning of 'change in the constitution of a firm'. The relevant explanation of the word 'constitution' given in the The New English Dictionary by Sir James Murray, vol. II, page 876, is 'The way in which anything is constituted or made up ; the arrangement or combination of its parts or elements, as determining its nature and character ; make, frame, composition. ' From a consideration of that definition a ' change in the constitution of a firm ' would suggest a change in its partners but not a change in the proportion in which the partners divided the profits.'
13. We are of opinion, the question as to whether the other partners consented to or agreed to the carrying on of such business by a partner or not is an irrelevant factor for the purposes of registration. Even if a partner makes some profits unauthorisedly or some secret profits it will not bring about a change in the constitution of the firm or in the profit-sharing ratio. The remedy for the partners aggrieved lies elsewhere and it is his or their personal right. That has nothing to do with the genuineness of the firm, and does not affect the legality of the firm. As held by the Supreme Court in CIT v. Sivakasi Match Exporting Co. : 53ITR204(SC) :
'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 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.' (Underlining* ours)
14. Though the provisions of Section 184 of the Act of 1961 have made certain slight changes compared to Section 26A of the Indian I.T. Act, 1922, the sub-stanttal requirements remain the same. The Appellate Tribunal in para. 8 of the order observed :
'It is not the case of the Department that the assessee-finn is not a genuine firm. Nor is it the case of the Department that it is unlawfully constituted.'
15. If that be so, the ITO cannot reject the application for registration, It is also not possible to hold that the constitution of the firm is not as specified in the deed of partnership. We are of the view that condition No. 5 specified by their Lordships of the Supreme Court in R. C. Mitter & Sons v. CIT : 36ITR194(SC) is satisfied in this case, namely, that the partnership in the instant case is admitted to be genuine and it has actually existed in conformity with the terms and conditions of the instrument. Further, this is not a case, as contended by the counsel for the Revenue, where the ITO has purported to exercise the powers in accordance with Section 186 of the Act similar to Rule 6B of the Rules under the 1922 Act, which fell for consideration in Y. Narayana Chetty v. ITO : 35ITR388(SC) , In the event of cancellation under Section 186 of the I.T. Act, the question that will fall for consideration is, as to whether in the opinion of the ITO, there was during the previous year a genuine firm in existence as registered. That section is hedged in by limitations specified therein. No such question falls to be considered in the instant case. Reliance placed by counsel for the Revenue in the decision in CIT v. Dwarkadas Khetan & Co. : 41ITR528(SC) , is also misplaced. That was a case where a minor was taken as a regular partner represented by his guardian and the plea made was that the document should be construed as showing only that the minor was admitted not as a full partner but to the benefits of the partnership. The Supreme Court held that since the document went beyond the terms of Section 30 of the Partnership Act, it could not be recorded as valid for the purpose of registration. It was pointed out that the registration can be granted only of a document between the parties who are parties to it and on a covenant set out in it and if the I.T. authorities register the partnership as between the adults only contrary to the terms of the document, a substantially new contract is made out. It is not open to the I.T. authorities to register a document which is different from the one actually executed and asked to be registered. That decision is clearly distinguishable and will not apply to the facts of this case. Here, the registration given was for the very document which was executed between the parties and there is no vitiating element in the said document. The deed is valid for all intents and purposes. The registration is given only for the document so executted by the parties. It may not be out of place to mention the circular letter of the Board of Direct Taxes, F. No. 26/3/ 65-II(AI), dated May 20, 1967 (Direct Taxes Circulars--Taxmanu, Vol. I--1977 edn., p. 522) wherein the Board has clarified the ground on which registration to a firm can be refused. After referring to a few decisions including C. Srinivasa Rao and Brothers v. CIT : 63ITR102(KAR) and CIT v. Sivakasi Match Exporting Co. : 53ITR204(SC) , referred to above, it is stated therein :
'Further, even if the payment of salary to a partner is prohibited by Section 13 of the Partnership Act, it would not effect a change in the sharing of the profits, unless there is evidence to show that the salary has been given as a camouflage for giving a larger share of profits to the partners to whom the salary has been paid......
Thus, the weight of authorities is in favour of the view that mere payment of salary or interest to the partners in the absence of any such provision for such payment in the instalment of partnership (or non-payment of the same despite a stipulation for such payment in the deed) does not alter the profit-sharing ratio laid down in the instrument and does not, by itself, disentitle the firm to registration either under the old Act or under the new Act unless there is some further evidence to show that the application is not properly made or that the partnership itself is not genuine.' (Underlining* ours)
16. As observed by this court in CIT v. B. M. Edward, India Sea Foods : 119ITR334(Ker) , the circular is binding on all officers and persons employed in the administration of the Act. This beneficient circular must be given effect to even if it is raised for the first time in this court--CIT v. Venkiteswaran : 120ITR675(Ker) and CWT v. Gammon India P. Ltd. : 130ITR471(Bom) .
17. Before closing, we may usefully refer to a decision of the Mysore High Court in Rajulbandi Venkaiah Ramaiah v. CIT : 52ITR824(KAR) . That, was a case where the deed of partnership tendered for registration under Section 26A of the Indian I.T. Act of 1922 did not include all the businesses carried on by the firm. It was discovered in the course of assessment by the ITO that the assessee-firm had not disclosed certain businesses carried on by it. The ITO refused registration of the firm. This decision was affirmed by the AAC and by the Appellate Tribunal. The question that arose was as to whether the assessee-firm was not entitled to registration under the corresponding provisions of the Indian I.T, Act, 1922, Section 26A. Speaking for the Bench, His Lordship, K. S. Hegde J. (as he then was), held at p. 828 as follows :
'It is not the case of the Department that the assessee has not complied either with the requirements of Section 26A or with the requirements of rules 1 to 4 of the rules framed. All that is said is that the partnership deed does not include all the partnership businesses, No pro-vision of law was brought to our notice giving the department authority to refuse registration of partnership on that ground. If it is the case of the Department that the partnership deed relates only to the business mentioned therein, then all that the Income-tax Officer should have done is to register that partnership deed in respect of the business mentioned in it and treat the other business as that of an unregistered firm. If, on the other hand, the Income-tax Officer's conclusion was that the partnership deed covers all the four businesses mentioned in the statement of the case, then he had to register the partnership deed produced and treat it as a deed relating to all the businesses. In either case, he could not have refused to register the deed in question.'
18. We are of opinion that, broadly, the said reasoning could be applied to the instant case also. We say 'broadly' because the observation that the business not mentioned in the deed should be treated as that of an unregistered firm is seen to have been commented by the editors of Kanga and Palkivala in Law of Practice of Income Tax, 1976 Edn., at p. 1017, as 'incorrect'.
19. In the light of the above discussion, we hold that the Income-tax Appellate Tribunal was justified in setting aside the order of the Commissioner oi Income-tax and in holding that the a lessee-firm was entitled to registration for the year 1973-74 and continuance of registration for the year 1974-75. We answer the question in the negative and in favour of the assessee and against the Revenue. There shall be no order as to costs.
20. A copy of this judgment will be sent to the Registrar, Income-tax Appellate Tribunal, Cochin Bench, in accordance with p. 260(1) of the I.T. Act.