1. These are two consolidated references relating to the assessment years 1959-60 to 1961-62 in one case and to the last two years in the other. When they came up before a Division Bench to which one of us was a party, it was felt that Mathew Abraham v. Commr. of Income-tax, (1964) 51 ITR 467 (Mad) required reconsideration and they have been placed before us. The common question for decision in the references under Section 63(1) of the Indian Income-tax Act 1922, is:
"Whether the sums of Rs. 10045 In each of the two years received by Thangavelu of Rs. 7200, Rs. 10578 and Rs. 10578 received by Chidambaram in the three years from the two firms have been rightly brought to tax as (income-Ed.) from other sources. under the provisions of the Income-tax Act, 1922?"
The assessees were partners in two firms -- Kavukal Estates and Tuttapallam estates, which owned tea estates in the Nilgiris. In addition to their right to share the profits of the firms, the partners were, under the terms of the deed of partnership, entitled each to draw specified salaries for their services to the firms. Till the assessment years ending March 31. 1959, the total income of each firm was computed with reference to Section 10(4)(b) which was apportioned between agricultural and business income in accordance with Rule 24 of the Income-tax Rules. As the firms were registered under the provisions of the Act, the non-agricultural portion of the income was apportioned between the partners and brought to tax in their hands. For the assessment year 1959-60 the Income-tax Officer being of opinion that the income received by the assessees as salary from the firms would not constitute agricultural income but represented income from other sources, recomputed the income on that basis. As a result, the entire salaries paid to the partners were included In the total chargeable income of each of them. The Appellate Assistant Commissioner of Income-tax did not accept that basis, but proceeded to allow the appeals on the view that since a partner's share of the firm's profits would include any salary earned by him, only 40 per cent of such salary could be taxed in his hands. He did not agree that the immediate source of the income representing the salary was not agricultural land, but services rendered by the assessee to the firm. By the time the Tribunal disposed of the appeals (1964) 51 ITR 467 (Mad) had come, which it followed and allowed the appeals observing that the partners had nothing to do with agricultural operations, out drew the salaries for services rendered by them to the firms, and that, therefore. Rule 24 had no application to them.
2. The Division Bench in its order of reference to a Fuller Bench stated thus:
"The combined effect of Sections 10(4) (b) and 16(1) (b) and of Rule 24, as it seems to us, is an implied direction that only 40 per cent of the salary paid but increased or decreased by the share of profit or loss of the business of the firm doing the particular agricultural operation, can be charged to income-tax at the hands of the partner, notwithstanding the fact that the immediate source of the salary is the service to the firm, rather than its business. On this view, (1964) 51 ITR 467 (Mad) may require reconsideration-"'
We are of the view that the salary received by a partner of a firm for services rendered by him to it continues to bear, for purpose of charge at his hands the same character as part of the total income of the firm which has been shared between its partners and that the consequence of applying Rule 24 to the total income of the firm computed in accordance with Section 10(4) (b) is necessarily that only 40 per cent of the salary as referable to agricultural income can be taken as salary in computing the total (income of a partner of a firm in terms of Section 16(1) (b). This view seems to us to be supported not only by the relative provisions of the Income-tax Act, but is in accord with the basic principles of the partnership law.
3. A firm, partner and partnership, says Section 2(6B), have the same meanings respectively as in the Indian Partnership Act and the expression 'partner' included a minor admitted to the benefits of the partnership. For purpose of charge of income-tax a firm like other association of persons has been treated as an entity.
4. Save for that purpose, there is nothing in Section 3 which qualifies or in any way modifies the legal position of a firm or the principles applicable to It under the Indian Partnership Act. The procedure for assessing a firm, however, varied under Section 23(5) according to whether it was registered or not. The head of the income of the firm depended on the character of its source. If the firm, as in these references, derived business income, such income should have to be computed after making the allowance permissible under Section 10(2) but subject to Section 10(4). In view of Clause (b) of Sub-section (4) of the Section any salary, commission or remuneration paid by a firm to any of its partners would not be entitled to deduction in the computation of the firm's income. The procedure for computing the total income of a partner of a firm is to be found in Section 16(1) (b), according to which, whether the firm has made a profit or a loss, his share shall be taken to be any salary, interest, commission or other remuneration payable to him by the firm in respect of the previous year increased or decreased respectively by his share in the balance of the profit or loss of the firm after the deduction of any interest, salary, commission or other remuneration payable to any partner in respect of the previous year. . It is implicit in this provision that what constitutes the total income of a partner of a firm is his share of the profit or loss of the firm and such share, be it noted, shall be taken to be the salary received by him as well as his share of income in 'the balance of the profit of the firm after deduction of the salary paid to the partner. Where, however, a firm incurs a loss, the partner's share of liability in it goes to decrease his share of income by way of salary. It seems to us, therefore, that Section 16(1)1 (b), consistent with Section 10(4) (b), which does not regard salary paid to a partner for his services to the firm as deductible expenditure, recognises logically that such salary is in principle but a part of his share of the profits of the firm. It is because of this conception of the character of the salary received by a partner that when the firm incurs a loss, a partner's share in such loss goes to reduce his salary received from the firm and he is allowed to set off or carry forward and set off the outstanding loss in accordance with the provisions of Section 24. If a firm sustains a loss in a year the liability towards payment of salary to its partner forms part of such loss which means that the partner entitled to receive salary is also proportionately charged with the liability in respect of it. That seems to be the rationale behind the particular manner of computation of the total income of an assessee Who is a partner of a firm and the liberty given to him to set off or carry forward his share in the loss of the firm. That, we think, is also the Justification for Section 10(4) (b). On this view of Section 10(4) (b) read with Section 16(1) (b). salary paid to a partner being treated as a component of his share of income in the firm, there is no reason to think that such salary has a source other than that of or different from his share in the income Including the salary. The total income of the firm as computed with reference to Section 10(4) (bi includes the salary paid to the partners and so too it is not separated from the share income of the partners as determined under Section 16(1) (b) and treated as springing from a different source than the share Income of the partner.
5. The statutory effect just mentioned is also in consonance with the principles of the law of partnership. Notwithstanding the fact that a firm like an association of persons is for the purpose of assessment treated as a separate entity, it is not a legal person having a corporate character distinct from that of its members. A firm is but a compendious expression of the relationship between the partners, who, by an agreement between them, embark on a commercial venture and contribute capital or labour and share profit and loss according to mutual understanding. In mercantile practice the trade seems to look upon the firm as a kind of a body distinct from its members and capable In its right of owning property and entering into dealings and creating rights and liabilities binding on the partners. But in law that clearly is not the position. The Indian Partnership Act by Section 4, defines 'partnership' as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all and that such persons collectively are called a firm and Individually as partners. It is true that looked at from certain circumstances permitted by the provisions of the Partnership Act, a firm may have the appearance or the trappings of a continuous body possessing somewhat a corporate character. For instance, by agreement to the contrary, the death of a partner may not affect the continuity of the firm. Nevertheless, the firm is brought about by a contract and is dissolved by the will of the partners and in the making of a firm, there is nothing like incorporation. We think that this is truly the position of a firm under the provisions of the Indian Partnership Act, which is fashioned after its English counterpart. Lindley on Partnership refers to merchants and lawyers having different notions respecting the nature of a firm, the former impersonifying a firm and the latter denying it. The legal view of a firm, as stated by Lindley at p. 28 is;
"The firm is not recognised by English lawyers as distinct from the members composing it. In taking partnership accounts and in administering partnership assets, courts have to some extent adopted the mercantile view, and actions may now, speaking generally, be brought by or against partners in the name of their firm; but speaking generally, the firm as such has no legal recognition. The law. Ignoring the firm, looks to the partners composing it; any change amongst them destroys the identity of the firm; what is called the property of the firm is their property; and what are called the debts and liabilities of the firm are their debts and liabilities. In point of law, a partner may be the debtor or the creditor of his co-partners, but he cannot be either debtor or creditor of the firm of which he is himself a member, nor can he be employed by his firm, for a man cannot be his own employer."
That precisely is the legal position of a firm under the Indian Partnership Act as well. The Scottish view of the firm being a legal entity has not been adopted by it in its entirety, for the exceptional features suggesting the unitary character of a firm are confined mostly to procedural matters, as for instance, the provisions of Order XXX. C. P. Code or Order XLVIII-A of the English Rules of Practice.
6. Bhagwanji v. Alembic Chemical Works Co.. Ltd., AIR 1948 PC 100 to which our attention has been invited by the Revenue, no doubt, stated:--
"It is true that the Indian Partnership Act goes further than the English Partnership Act, 1890, in recognising that a firm may possess a personality distinct from the persons constituting it; the law in India in that respect being more in accordance with the law of Scotland, than what (with) that of England."
But by this observation we do not think that Sir John Beaumont, who spoke for the Judicial Committee, meant to say that a firm under the Indian law is a legal entity distinct from its partners. In fact, the further observations in the judgment make this clear, namely:--
"The Indian Act, like the English Act, avoids making a firm a corporate body enjoying the right of perpetual succession."
As a matter of fact, the rule in that case was that when all the members who entered into a partnership originally ceased to be members of the firm by death or assignment, there was ho longer any privity such as to sustain the continued existence of the firm and that consequently upon the change in the membership of the firm the agreement came to an end.
7. In Dulichand Laxminarayan v. Commr. of Income-tax. Nagpur, the Supreme Court held that a firm was not a person
and as such was not entitled to enter into a partnership with another firm or a Hindu undivided family or individual. It was pointed out there (at D. 540 of ITR) -- (at p. 357 of AIR):--
"In some systems of law this separate personality of a firm apart from its members has received full and formal recognition as, for instance, in Scotland. That Be, however, not the English common law conception of a firm. English lawyers do not recognise a firm as an entity distinct from the members composing it. Our partnership law is based on English law and we have also adopted the notions of English lawyers as regards a partnership firm."
The Supreme Court then referred to the usages relating to a firm, the provisions of Order XXX. C. P. Code and the position in taking partnership accounts and administering partnership assets and the liabilities of the firm being regarded as the liabilities of the partners in certain circumstances. The Supreme Court further observed (page 541):--
"It is clear from the foregoing discussion that the law. English as well as Indian, has, for some specific purposes, some of which are referred to above relaxed its rigid notions and extended a limited personality to a firm. Nevertheless, the general concept of a partnership, firmly established in both systems of law, still is that a firm is not an entity or 'person' in law but is merely an association of individuals and a firm name is only a collective name of those individuals who constitute the firm. In other words, a firm name is merely an expression, only a compendious mode of designating the persons who have agreed to carry on business in partnership. According to the principles of English jurisprudence, which we have adopted, for the purposes of determining legal rights 'there is no such thing as a firm known to the law' as was said by James. L. J. in Ex parte Corbett In re Shand. (1880) 14 Ch D 122. at p. 126. In these circumstances, to import the definition of the word 'person' occurring in Section 3(42) of the General Clauses Act, 1897, into Section 4 of the Indian Partnership Act, will, according to lawyers, English or Indian be totally repugnant to the subject of partnership law as they know and understand it to be."
8. It was on this view that the Supreme Court held that that firm as such was not entitled to enter into partnership with another firm or individuals.
9. That a partnership collectively known as a firm has no legal existence has again been pointed out by the Supreme Court in Naravanappa v. Bhaskar Krishnappa, . The actual
decision in the case related to registration being unnecessary for a document recording the fact of dissolution of partnership and relinquishment of interest of a partner in a partnership asset by way of adjustment. This is on the view that the property brought into the firm by the partners became the Property of the firm and what the partners, on dissolution, would be entitled to was but a share in the money representing the value of the property. In saying that the Supreme Court observed at p. 493 of 1966-2 SCJ = (at p. 1303 of AIR):--
'No doubt, since a firm has no legal existence, the partnership property will vest in all the partners and in that sense every partner has an interest in the property of the partnership. During the subsistence of the partnership, however, no partner can deal with any portion of the property as his own. Nor can he assign his interest in a specific item of the partnership property to any one. His right is to obtain such profits, if any, as fall to his share from time to time and upon the dissolution of the firm to a share in the assets of the firm which remain after satisfying the liabilities set out in Clause (a) and Sub-clauses, (i) (ii) and (iii) of Clause (b) of Section 48."
It is because of the fact that a firm is not a legal person in India it should be taken as well settled that as a necessary implication in that position, the salary drawn' by a partner from the firm for his services rendered to it has not been treated as something different from his right to get an additional amount in the form of salary as his share of the firm's profits. Partnership being but merely expressive of the loose relationship between persons resulting from their agreement to venture on an enterprise and as the partners continue to retain their individuality in working under the relationship, no partner can naturally be his own servant, and in this view, though the partners may stipulate, that one or more for his or their share may draw salary from the firm, its payment, in reality and in the eye of law, is a mode of division of part of the firm's' profits.
10. This character of the partner's salary has been well brought out by the Australian Income-tax Law and Practice by F. C. Bock and F. F, Mannix, 1968, Edn. Vol. 3, at p. 3092. It is there stated--
"The decision of the High Court in Rose v . Federal Commissioner of Taxation, 1951-84 CLR 118 established that there is nothing in the relevant income-tax legislation to warrant treating a partnership as a distinct legal entity. A partner cannot, therefore, also be an employee of the partnership, for a man cannot be his own employer. Ellis v. Joseph Ellis and Co., (1905-1 KB 324). An agreement that one partner shall receive a 'salary' does no more than regulate the mode in which accounts are to be taken for the purpose of ascertaining the division of profits between the partners and does not affect the nature of any Dart of the partnership income, Ellis case, (1905-1 KB 324) (supra) per Mathews, L. J. at page 329 and see F. C. of T. v. Seville 1953-5 AITR 458 = 3 CTBR (NS) case 11. It follows that where the partnership income consists of income from property the salary is also income from property".
Not only payment of salary to a partner by the firm does ho more than regulate the mode in which accounts have to be taken for the purpose of division of profits between the partners and does not affect the nature of any part of the partnership income, but the income of the partnership retains its character in the assessments of the partners. The Australian authors in this connection rightly observe that "if the partnership income is derived from more than one source, such as from a business and from Government loan interest, the income is apportioned accordingly in the individual assessment of each partner". The contention for the Revenue in the references before us that the immediate source for the partner's salary is the service and not the share in the profits of the firm cannot, therefore, be accepted,
11. This view receives support from other decided cases. In Commr. of Income-tax v. B. S. Mines Co.. (1922) 1 ITC 176 (Mad) (FB) a Full Bench of this Court held with reference to the provisions of Income-tax Act, 1918. that the salaries paid to the partners of a firm were not admissible as deductions in the computation of the profits of the firm for income-tax purposes and so the partners' drawings were taxable. The entire judgment was only this:.
"On the facts stated we have no hesitation in answering that the drawings of the partners, by whatever name they are described, are part of the profits and therefore, taxable."
The ratio of this case is clearly that salary drawn by partners being part of the profits, it was assessable in the hands of the partner as part of his profits, that is to say. the salary drawn by a partner from the firm was not to be regarded as emanating from a source different from that from which he derived a share of the profits. Evidently this decision had been kept in view while enacting Section 10(4) (b) and Section 16(1) (b) in the Income-tax Act 1922. Venkatadri Somappa v. Venkataswamy Chetti, 9 ITR 284 - (AIR 1941 Mad 672) pointed out that when the income of a partnership was assessed to tax under the Income-tax Act, what was really assessed was nothing less than the Income of the individual partners. In the same way, the Supreme Court in Commr. of Income-tax v. Ramniklal Kothari, said
that the business carried on by a firm was business carried on by the partners, that the profits of the firm were profits earned by all the partners in carrying on the business and that the share of the partner was business income in his hands for the purpose of Section 10 (1) of the Indian Income-tax Act. 1922. It was held that if any expenditure was incurred by the partner in earning such share that was admissible for deduction in determining the total income under Section 10 (1).
12. The principle that a partner in a partnership could not be an employee of that partnership was recognised by the Bombay High Court in Magnus v. Commr. of Income-tax. and it was held that the salary and commission payable to the wife, who was one of the two partners the other being her husband, was received by her in her capacity as a partner and it. therefore, fell within the scope of Section 16 (3) (a) (i) of the Income-tax Act and should be included in the total income of her husband The underlying principle is that the salary received by a partner from the firm is but a part of his share of the profits and has no different source by any means.
13. Agricultural income being not chargeable to income-tax where the total income derived by an assessee is composite in character as it consists of partly agricultural and partly non-agricultural income. Section 59(2)(a) empowers the Central Board of Revenue, subject to the control of the Central Government, to make rules to prescribe the manner in which, and the procedure by which, the income, profits and gains should be arrived at in the case of incomes derived in part from agriculture and in part from business. Rule 24 of the Income-tax. Rules. 1922, is to the effect that--
"Income derived from the sale of tea grown and manufactured by the seller in the taxable territories shall be computed as if it were income derived from business, and 40 per cent of such income shall be deemed to be income, profits and gains liable to tax."
14. We are not here concerned with the proviso to the rule. This rule is applied the moment the total composite income is arrived at under Section 10(4) (b). Once by application of Rule 24 agricultural income from tea plantations is arrived at, only the rest of the income shall be treated as from business which is chargeable to tax. Beyond this. Rule 24 has no effect. Salary paid to a partner being treated as part of the profit of the firm by disallowance of the amount, there is no warrant for the view that after applying Rule 24 to the total composite income the entire salary paid to the partner will enter into the computation under Section 16(1) (b). What is apportioned by application of Rule 24 is the total composite income of the firm inclusive of the salary paid to the partner and it follows, therefore, that such salary is necessarily apportioned and it is only 40 per cent of the salary that can properly be taken for the purpose of computation of the total income under Section 16(1) (b). (1964) 51 ITR 467 (Mad) however, held a contrary view, but, with due respect we are of opinion that it cannot be upheld as correct In that case, the assessee was the managing partner of a firm which carried on the manufacture and sale of tea. The managing partner owned a fifth share in the partnership and was entitled, under the terms of the partnership, to a monthly allowance of Rupees 250 as salary for the services rendered by him to the firm. Jagadisan and Srinivasan, JJ. held that Rule 24 was not applicable to the monthly allowance received by the assessee, even though it was paid out of the profits and the whole of such income was assessable to income-tax, though they were prepared to say at the same time that, under Rule 24 of the Income-tax rules, only 40 per cent of the share income received by the managing partner was assessable to tax. The basis for the view held by the learned Judges was (page 471):--
"Though for purposes of computation of Income his share income of the firm is clubbed along with the allowance and commission, it is obvious that the character of the receipt of the latter amounts, though related to the business, cannot be said to partake of the same character of their receipt by the firm. The assessee who is a managing partner was entitled to receive the amount not by virtue of the relationship between him and the other members of the firm as partners but by virtue of the special agreement between the partners by which his services to the partnership were agreed to be remunerated."
We are wholly unable to accept this reasoning for the reasons we have already given. As we said, the salary received by a partner from the firm cannot be regarded in anywise having a source different from that of his share of the profit of the firm he receives. Having regard to the legal position of a firm vis-a-vis its partners and Section 10(4) (b) and Section 16 (1) (b) of the Income-tax Act 1922, receipt of salary by a partner, if we may reiterate, is but a mode of adjustment in his share of the firm's income. The salary of a partner and his share of the income do not emanate from two different sources, but from one and the same, which is the source of income of the firm. We hold, therefore, that Mathew Abraham v. Commissioner of Income-tax, (1964) 51 ITR 467 (Mad) was not correctly decided.
15. For the Revenue a number of decided cases, particularly, Syed Mohd. Isa v. Commr. of Income-tax, 10 ITR 267 -- (AIR 1942 All 194); Habibulla v. Commr. of Income-tax, 11 ITR 295= (AIR 1943 PC 20); Commr. of Income-tax v. Kamakhaya Narayana Singh, 16 ITR 325 - (AIR 1949 PC 1); Kameshwar Singh v. Commr. of Income-tax, ; Commr. of Income-tax v. Kunwar Trivikram Narain Singh. 57 ITR 29 = (AIR 1965 SC 1386) and K. Simrathmul v. Commr. of Income-tax, (1967) 64 ITR 166 (Mad) have been cited to us to show that the salary received by a partner from his firm had no nexus with the estate and that its immediate source was but his service. We do not think that any useful purpose will be served by examining those cases, as the contention of the Revenue in these references based on those decisions overlooks that a partner cannot be the employee of the firm of which he is a member, that the salary paid to him is but an element of his share of its profits and that Rule 24 of the Income-tax Rules has no relevance to the source but is applied to the entire income of the firm which by disallowance includes also the salary paid to the partner.
16. We accordingly answer the common question in these references in favour of the assessee in each case with costs, counsel's fee in each case Rs. 250/-.