U.L. Bhat, J.
1. The petitioner is a firm doing business in pepper. The firm filed income-tax returns under the I.T. Act, 1961 (for short 'the Act') for the assessment year 1975-76. After a few adjournments, the case stood posted to December 13, 1976, in regard to which a notice was sent to the petitioner, received by him on December 8, 1976. He and his auditor did not put in appearance. The first respondent, ITO, made a best of judgment assessment under Section 144 of the Act and also refused registration to the firm, as seen from Ex. P-l order. Two revisions were filed before the 2nd respondent, Commissioner of Income-tax. Under Ex. P-3 order, the revision petition challenging the refusal to register the name of the firm was dismissed. Under Ex. P-2 order, the best of judgment assessment made was partly modified and the case sent back for passing a fresh order. Thereafter, the first respondent passed a fresh order, Ex. P-4, fixing the tax liability of the petitioner.
2. According to the petitioner, both the statutory authorities, respondents 1 and 2, committed serious error of law in regard to the refusal of registration of the firm under Section 185(5) of the I.T. Act, 1961. The petitioner would contend that the statutory authorities did not exercise their discretion in regard to this matter but proceeded on the misconception that refusal of registration is an automatic consequence of failure under Section 144 of the Act. The learned standing counsel for the Revenue rebutted these submissions and contended that both the authorities have exercised their discretion and in a proper manner and the same was not liable to be interfered with.
3. There were parallel provisions in the Indian I.T. Act, 1922. Section 23(4) of that Act provided :
' If any person failed to make the return required by any notice given under Sub-section (2) of Section 22 and has not made a return or a revised return under Sub-section (3) of the same section or fails to comply with all the terms of a notice issued under Sub-section (4) of the same section or, having made a return, fails to comply with all the terms of a notice issued under Sub-section (2) of this section, the Income-tax Officer shall make the assessment to the best of his judgment and determine the sum payable by the assessee on the basis of such assessment and, in the case of a firm, may refuse to register it or may cancel its registration if it is already registered....'
4. This provision came up for consideration in the decisions in CIT v. Krishnamma & Co. : 28ITR273(AP) , J.M. Sheth v. CIT : 56ITR293(Mad) and Trivandrum Tobacco Combines v. CIT : 63ITR813(Ker) .
5. In the first of these cases, : 28ITR273(AP) , the ITO had observed that he was unable to register the firm inasmuch as the assessment had been made under Section 23(4) of the Act. A Division Bench of the then Andhra High Court considered Section 23(4) and, speaking through Subba Rao C.J., as he then was, observed as follows (p. 279) :
' A perusal of the entire order clearly shows that the Income-tax Officer refused registration as, in his view, the provisions of Rule 4 of the Income-tax Rules were not complied with. He did not exercise his discretion under Section 23(4), but made only a casual observation in regard to his power under that section. Section 23(4) does not purport to prescribe an automatic refusal of registration. Under that section, discretionary power is conferred on the Income-tax Officer to refuse registration in case an assessment is made under that section and, in this case, he did not pur-port to exercise his discretion one way or the other. The order must, therefore,be deemed to have been made under Section 26A(1), having regard to the provisions of Rule 4 of the Income-tax Rules.'
6. In J.M. Sheth's case : 56ITR293(Mad) , a Division Bench of the Madras High Court explained the position in the following manner (p. 296):
' Refusal to register, however, does not appear to be an inevitable statutory consequence resulting from the defaults enumerated in Section 23(4). The use of the words 'may refuse' in Section 23(4) would rather indicate that the Income-tax Officer has a discretion not to refuse registration or cancel registration even in spite of default of the assessee. Significantly, the statute uses the words ' shall make the assessment to the best of his judgment' in the first part of the section. If the words 'shall' and 'may' are found in two different limbs of the same section, there cannot be a better legislative pointer to indicate that the first is obligatory and the second is Miscretionary. We have no doubt that the statute does not compel the officer to deprive the assessee of the benefit of registration under the last part of Section 23(4). In other words, it would be wrong to assume that the defaults listed in Section 23(4) of the Act would lead to a twofold penal consequence: (1) a best judgment assessment, and (2) in the case of firms, refusal to register or cancellation of the existing registration, if any. It is, therefore, incumbent upon the Income-tax Officer to consider the question of registration on the materials available before him instead of refusing registration on the ground that a different conclusion would be illogical or not self-consistent.'
7. In Trivandrum Tobacco Combines' case : 63ITR813(Ker) , a Division Bench of this court held that an order to the effect 'in view of the fact that the assessment is completed under Section 23(4), I would have refused registration under Section 26A' is not sustainable since the ITO had not exercised his discretion. This court followed the reasoning adopted in the two decisions referred to above.
8. According to learned standing counsel for the Revenue, the Supreme Court had taken a different view in Y. Narayana Chetty v. ITO : 35ITR388(SC) . The case dealt with a best of judgment assessment under Section 23(4) of the Act and cancellation of registration under Rule 6B of the Rules. Registration had been granted earlier under Section 26A. It was argued that cancellation could be made only in the contingencies prescribed under Section 23(4) of the Act and not under Rule 6B which provided for cancellation in case the ITO was satisfied that certificate had been obtained without there being a genuine firm in existence and that the Rule was inconsistent with the statute. This argument was repelled by the Supreme Court in the following words (p. 397) :
' We have no doubt that this argument is fallacious. The cancellation of registration under Section 23(4) is in the nature of a penalty and the penalty can be imposed against a firm if it is guilty of any of the defaults mentioned in the said Sub-section. It would be noticed that where registration is cancelled under Section 23(4), there is no doubt that the application for registration had been properly granted. The basis of an order under Section 23(4) is not that the firm which had been registered was a fictitious one, but that, though the registered firm was genuine, by its failure to comply with the requirements of law it had incurred the penalty of having its registration cancelled. That is the effect of the provisions of Section 23(4). On the other hand, Rule 6B deals with cases where the Income-tax Officer is satisfied that a certificate of registration has been granted under Rule 4 or under Rule 6A without there being a genuine firm in existence ; that is to say, an application for registration had been made in the name of a firm which really did not exist ; and on that ground the Income-tax Officer proposes to set right the matter by cancelling the certificate which should never have been granted to the alleged firm. That being the effect of Rule 6B it is impossible to accede to the argument that the provisions of this Rule are inconsistent with the provisions of Section 23(4) of the Act....'
9. The Supreme Court has not laid down any principle contrary to the position taken in the cases referred to above. The Supreme Court was dealing with an altogether different matter. The observation that penalty of cancellation 'can be' imposed under Section 23(4) supports the view that the power of cancellation is discretionary and not imperative.
10. The provisions in Section 23(4) of the Indian I.T. Act, 1922, have been split up and incorporated in different sections of the I.T. Act, 1961, namely, Sections 144, 185(5) as also 186(2). Section 144 deals with the circumstances under which best of judgment assessment has to be made. It is on lines with the corresponding provisions of Section 23(4) of the earlier Act. The provision dealing with refusal to register the firm found in Section 23(4) of the earlier Act is now found in Section 185(5) of the present Act. Similarly, the provision regarding cancellation of registration obtaining in Section 23(4) of the earlier Act is now incorporated in Section 186(2) of the present Act. It appears, on a comparison of the corresponding provisions of the two Acts, that no significant change has been brought about in regard to the circumstances under which registration could be refused or cancelled. Under the present Act also the consequence of any failure mentioned in Section 144 is best of judgment assessment, expressed as 'shall make the assessment of the total income or loss to the best of his judgment and determine the sum payable etc......' The provision regarding the refusal of registration to a firmexpressed in Section 185(5) is in the following terms :
' ......where, in respect of any assessment year, there is, on the partof a firm, any such failure as is mentioned in Section 144, the Income-tax Officer may refuse to register the firm for the assessment year.'
11. In other words, the broad scheme of the provisions in the earlier Act has been retained in the present Act. The mandatory consequence of failure to submit return, etc., is best of judgment assessment. The refusal or cancellation of registration is not an inevitable statutory consequence of the failure mentioned in Section 144 (corresponding to Section 23(4) of the earlier Act). The interpretation given in the above decisions to the parallel provisions in the prior Act would apply with equal force to the provisions in the present Act.
12. When an assessee is in default of the nature falling within Section 144 of the Act, the consequence of best of judgment assessment is mandatory. That is because the assessee by his failure to submit returns or otherwise co-operate with the Revenue, cannot indefinitely put off the assessment and cannot be permitted to escape assessment. To that extent the provision is mandatory. When he commits a default of the nature contemplated in Section 144, besides being compelled to face best judgment assessment, he may also face a penalty. That is, the penalty of refusal of registration, under Section 185(5) of the Act. This penalty can be imposed only if there has been a default of the nature mentioned in Section 144. But the penalty need not follow in all cases of default. While best of judgment assessment under Section 144 follows as a matter of course in every case, penalty under Section 185(5) need not necessarily follow in every case ; it is not automatic, inevitable or mandatory. Whether such a penalty must be imposed in a given case would depend entirely on the facts and circumstances obtaining in that case. If, on a consideration of all the facts and circumstances, the assessing authority is satisfied that it is a fit case for imposing penalty under Section 185(5) it is open to the authority to do so and refuse registration. Similar is the position with regard to cancellation of registration. In other words, the assessing authority must be aware, while seeking to apply Section 185(5) of the Act, that it is discretionary to impose the penalty or refrain from imposing the penalty, that is, it is within his discretion to grant registration or refuse registration under that provision and it is bearing in mind this duality of power that the discretion must be exercised. If the assessing authority proceeds under the belief that the penalty of refusal of registration must inevitably follow the failure of the assessee to do anything as contemplated in Section 144, certainly, it cannot be said that the authority has exercised his discretion. It will be a case where the discretion has not been exercised. The discretion must be exercised one way or the other, not arbitrarily or capriciously, but in a lawful manner and consistent with judicial standards, on the basis of the materials and circumstances present in a given case. It has to be borne in mind that a firm, subject to the formalities and conditions prescribed, has a right to obtain registration certificate and enjoy the benefits flowing there from and cancellation made under Section 185(5) of the Act is in the nature of a penalty, depriving the assessee of the benefits flowing from registration.
13. There is certainly a difference between the penalty by way of best of judgment and penalty by way of refusal of registration. The best of judgment assessment can operate for the assessment year. The consequence of refusal of registration is to treat the partners of the firm as an association of individuals and the assessment will be made treating them as one unit or one entity, unlike the case of a registration of a firm. The consequence of refusal of registration is more serious for the assessee and that is why the levy of penalty has been made discretionary.
14. The question next arising for consideration is whether there has been an exercise of discretion in this case by the first respondent as contended by the learned standing counsel for the Revenue, or whether there has been no exercise of the discretion at all as contended for by the learned counsel for the petitioner. Paragraph 1 of Ex. P-1 order deals with the status of the assessee and states thus :
' An application in Form No. 11 was filed on 4-1-1975, together with two copies of an instrument of partnership. For the reasons mentioned elsewhere, the assessment is made ex parte. I am also not convinced that the assessee was prevented by sufficient cause from filing the original instrument of partnership. The status of the assessee is determined as that of an unregistered firm under Section 185(5) for 1975-76 assessment year.'
15. The next paragraph headed 'Business' deals with the assessment to be made and acceptability of the return submitted by the assessee. Learned standing counsel for the Revenue would contend that the reference in the first paragraph to the reasons mentioned elsewhere for the ex parte assessment are the reasons for refusing registration also and, therefore, this is a a case where the assessing authority had before him the entire circumstances of the case. The judicial exercise of the discretion, so goes the argument, is implicit in the paragraph quoted above.
16. I am afraid I am unable to agree with this submission of the learned standing counsel for the Revenue. The passage extracted above refers to assessment being made ex parte. It is incidentally mentioned that elsewhere in the order he has given reasons for making the assessment ex parte. That does not mean that the assessing authority had before him thesecircumstances while deciding on the question whether registration must be refused or granted. He has only mentioned that the reasons for making ex parte assessment have been given elsewhere. The passage does not make it clear that those reasons were considered by him or were found to be sufficient by him for refusing registration. In other words, this is a case where the statutory authority thought that if there are sufficient reasons for making an ex parte assessment, that by itself would be sufficient for refusing registration. This approach ignores the serious consequences the assessee had to suffer as a result of refusing registration. The impugned order would go to suggest that the assessing authority thought that whenever there are sufficient reasons to make an ex parte assessment, there should inevitably follow an order refusing registration also. The assessing authority appears to have proceeded on the basis that there did not vest in him any particular discretion to grant or refuse registration. This is evident from the passage extracted above. The present is a case where the assessing authority was apparently not conscious of the discretion vested in him and failed to exercise the discretion. I may incidentally mention that the assessing authority also thought that the failure to produce the original instrument of partnership was also sufficient to refuse registration, but this view has been found against by the Commissioner.
17. Under these circumstances, that part of Ex. P-1 order, dealing with refusal of registration, and also Ex. P-3 order are quashed. Consequently, the assessment made under Ex. P-4 may have to be revised suitably. The first respondent is directed to consider the question of grant or refusal of registration under Section 185 of the I.T. Act, 1961, afresh exercising his judicial discretion on the basis of the relevant materials already on record and such materials as the assessee may choose to produce hereafter. The petition is allowed in this manner and to the above extent. Under the circumstances, parties will bear their costs.