1. These references have been made at the instance of the Commissioner of Income-tax, Madras, in the case of a firm known as M/s. S.S.A.M. Shanmugha Nadar Financing Corporation, Tuticorin, and another firm called M/s. S.S.A.M. Shanmugha Nadar. The assessment years under reference are 1972-73 and 1973-74. In T.C. No. 249 of 1975, the question referred is :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee-firm was entitled to the grant of registration for the assessment year 1972-73 ?'
2. In T.C. No. 485 of 1978, in relation to the assessment year 1973-74, the questions referred are as follows :
'1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that there is no material to treat the transaction as a collusive transaction
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the new firm, constituted by the wives of the eight partners of the assessee-firm with another partner of the assessee-firm, is a genuine firm ?'
3. The other two references, viz., T.C. Nos. 809 of 1977 and 484 of 1978, relate to the allowability of the interest paid to what may be conveniently called hereafter as the Financing Corporation. In T.C. No. 809 of 1977, the question referred is :
'Whether on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 42,027 was paid to the genuine firm, and, therefore, not liable to be added in the assessment of the assessee for the year 1972-73 ?'
4. In T.C. No. 484 of 1978, the following questions are referred :
'(1) Whether, on the facts and in the circumstances of the case, it has been rightly held by the Tribunal that the assessee was entitled to registration under Section 185 of the Income-tax Act, 1961
(2) Whether the Appellate Tribunal's finding that there was a genuine firm in existence during the accounting year relevant for the assessment year 1973-74, is based on relevant and valid materials and is a reasonable view to take on the facts of the case ?'
5. If the firm of Financing Corporation is held to be a genuine entity entitled to registration, then the interest will have to be allowed as deduction. If the firm is not a genuine entity, the interest payment would not be allowable as deduction because it would not have been paid to any genuine entity or in other words not paid at all. Therefore, the question of the genuineness of the firm referred to as the Financing Corporation which has claimed registration for the two years is the first question to be decided and the answers to the rest of the questions depend on it.
6. There was a firm by name S.S.A.M. Shanmugha Nadar consisting of nine individual male partners of whom Mr. S.S.A.M.S. Muthurajan is one. On 8th February, 1971, an instrument of partnership was executed with eight ladies and this S.S.A.M.S. Muthurajan as partners. The ladies are all the respective wives of the eight other partners of the firm, S.S.A.M. Shanmugha Nadar.
7. The nine partners of the firm of Shanmugha Nadar had credit balances to their personal accounts and they were getting interest at the rate of 9% per annum on such credit balances. The eight ladies, who werethe wives of the eight partners of the firm, S.S.A.M. Shanmugha Nadar had also credit balances in the same firm and they were being paid interest at the rate of 9% per annum. On 8th February, 1971, when the Financing Corporation is said to have come into existence, the eight ladies are shown to have withdrawn a sum of Rs. 1,16,309 which was to their credit from the firm of Shanmugha Nadar. The other person, Muthurajan, is also shown as having withdrawn a sum of Rs. 5,000 from the credit balance in his favour. Thus, a sum of Rs. 1,21,309 was shown as withdrawn by the nine partners of the Financing Corporation from the firm of Shanmugha Nadar and introduced it as their capital in the firm which came into existence on 8th February, 1971, in the manner mentioned above. On the same day, i.e., on 8th February, 1971, this sum of Rs. 1,21,309 along with a very small additional sum to make up Rs. 1,21,900 was shown as having been advanced to M/s. S.S.A.M. Shanmugha Nadar at the annual rate of interest of 12%. Again, on February 8, 1971, the partners of S.S.A.M. Shanmugha Nadar are shown as having withdrawn a sum of Rs. 2,70,000 and advanced it to the Financing Corporation. The Financing Corporation in its turn made entries of having advanced the said sum of Rs. 2,70,000 to M/s. S.S.A.M. Shanmugha Nadar. No cash actually passed in these transactions which were made only by book adjustments. On 27th August, 1971, a further sum of Rs. 2,10,000 was shown to have been advanced by the partners of S.S.A.M. Shanmugha Nadar to the Financing Corporation at the annual rate of interest at 9%. This amount was again shown as having been advanced on the same day to M/s. S.S.A.M. Shanmugha Nadar at the annual rate of interest at 12%.
8. The ITO had before him the application for registration of the Financing Corporation. He considered that no genuine firm had come into existence and that the whole arrangement was a sham creation to avoid payment of tax by M/s. S.S.A.M. Shanmugha Nadar. In the view of the ITO, the firm of M/s. S.S.A.M. Shanmugha Nadar, instead of paying the interest on the credit balances standing in the accounts of its own partners, has made entries as if interest was paid to the Financing Corporation. If the interest had been paid to the partners of M/s. S.S.A.M. Shanmugha Nadar then the said interest would have been disallowed and considered as part of the income of S.S.A.M. Shanmugha Nadar, so that the tax leviable on the firm of M/s. S.S.A.M. Shanmugha Nadar would have been higher. By adopting the present arrangement, the tax payable by the firm of S.S.A.M. Shanmugha Nadar was reduced. He, therefore, refused registration to the firm for these two years.
9. The assessee appealed to the AAC. He found that a regular partnership deed had been executed and the profits had been divided according to the deed. In his view, there was no violation of any clause in the partner-ship deed as pointed out by the ITO and he, therefore, held that there was no justification for refusing registration.
10. The department appealed to the Tribunal against this decision of the AAC for each of the years 1972-73 and 1973-74. The Tribunal, after considering the respective submissions of the Department and the assessee, came to the conclusion that the assessee-firm was a genuine entity and that they had carried on business and had also complied with all the formalities required under the I.T. Act for obtaining the benefit of registration. The order of the AAC was, therefore, confirmed by it. The Commissioner has obtained reference of the two questions mentioned already for the two years 1972-73 and 1973-74, challenging the grant of registration to the Financing Corporation.
11. The sole question to be examined in the present case is whether the firm is a genuine entity. While in T.C. No. 249 of 1975, the question referred is whether the assessee-firm was entitled to the registration, in T.C. No. 485 of 1978, the question referred is whether the Tribunal's finding that there was a firm in existence was based on relevant and valid materials. The form of the question makes no difference. Thus for both the years, the question to be considered is whether there are valid materials to support the conclusion of the Tribunal that there was a genuine firm in existence. Mr. V. Ramachandran, learned counsel for the assessee (Financing Corporation), submitted that though in the second year, viz., 1973-74, the existence of materials to support the conclusion of the Tribunal had been brought out, for the assessment year 1972-73, the question has not been specifically so framed, and, therefore, as far as that year is concerned, we cannot go into the existence of any material to support the conclusion of the Tribunal. We are unable to accept this submission. In the reference application for the assessment year 1972-73, the question in the form in which it was asked for the assessment year 1973-74, also found a place. The Tribunal has not given any reason why it did not refer the second question. The Tribunal has also not stated that it was rejecting the application for reference with reference to the second question. We have, therefore, to draw the inference that the Tribunal considered the question referred as comprehending the existence of materials. Further, for the registration of a firm, the firm should be a genuine one. When a question is asked whether the firm is entitled to registration, implicit in the question is the point whether the firm is genuine. In order to arrive at the conclusion that the firm is a genuine one; there must be some materials to support it. Therefore, the question of the existence of the materials to support the conclusion of the Tribunal is relevant for both the years.
12. We have already referred to the fact that the Financing Corporation came into existence on 8th February, 1971, under the deed of the same day. The firm started with a capital of Rs. 1,21,309 which was immediately made over to M/s. Shanmugha Nadar. On the same day, the partners of M/s. Shanmugha Nadar are said to have advanced to the Financing Corporation a sum of Rs. 2,70,000 at the rate of interest of 9% per annum. This amount was again advanced back to M/s. Shanmugha Nadar with interest, at 12% p.a. Thus on the same day a sum of Rs. 3,91,900 is shown to have been advanced by the Financing Corporation to M/s. Shanmugha Nadar. With reference to this aspect we have to find out whether there are cash balances in the books of M/s. Shanmugha Nadar so that these amounts could have been withdrawn, deposited and re-advanced. The AAC has observed in para. 2 of his order that the cash balance on February 8, 1971, in the hands of M/s. Shanmugha Nadar amounted to Rs. 1,54,956. He has found that the sum of Rs. 1,21,309 could have been withdrawn by the eight ladies as well as by Muthurajan. We shall proceed on the basis that all these persons had withdrawn in cash the sum of Rs. 1,21,309 and paid it back to the firm of M/s. Shanmugha Nadar on the same day. This would have left a balance of about Rs. 33,000 in the hands of the firm of M/s. Shanmugha Nadar. However, there are entries showing that a sum of Rs. 2,70,000 was withdrawn by the partner, Shanmugha Nadar, and again advanced to the Financing Corporation which again came back from the Financing Corporation to the firm, M/s. Shanmugha Nadar. Thus the entries are posted in such a manner that there is a triangle and ultimately the amounts reach the same point. As far as the sum of Rs. 2,70,000 is concerned, as there was no cash balance to that extent, the whole of it could not have been withdrawn by the partners of M/s. Shanmugha Nadar and paid over to the Financing Corporation so as to be lent back to the firm of M/s. Shanmugha Nadar. On that day, the cash balance in the hands of the firm of M/s. Shanmugha Nadar was only Rs. 52,498. The sum of Rs. 2,70,000 could not also have been withdrawn by the partners on 27th August, 1971, as there was no cash balance to that extent. Thus, apart from making only entries with reference to the part of the advances said to have been made by the Financing Corporation in favour of the firm, M/s. Shanmugha Nadar, there is actually no passing of any cash and the artificiality of the transactions are thus writ large on them.
13. The AAC himself has discussed the existence of the cash balances. In the absence of the adequate cash balance, these amounts could not have been withdrawn by the respective persons who had credit so as to advance the amounts to the Financing Corporation which in turn could have advanced it to M/s. Shanmugha Nadar. He and the Tribunal were wrongin proceeding as if there were cash balances which could have been utilised and this triangular process of making entries merely dispensed with the actual passing of cash.
14. There were two other objections to the grant of registration to the firm and one of them was that under Clause 8 of the partnership deed, the appointment of a manager was referred to, but no such manager had been appointed. It has been brought out by the AAC that one of the accountants of the firm of M/s. Shanmugha Nadar had been utilised as a part-time accountant of the firm of the Financing Corporation and, in his view, there was no violation of the terms of the partnership deed in any manner or non-observance of any essential covenants of the partnership deed. In the present case, the absence of a manager, which was considered to be important enough to find a place in Clause 8 of the partnership deed, clearly shows that the firm did not actually do any business in the manner in which it was conceived. The appointment of a manager would have been necessary if there had been any business. In the present case, excepting making certain entries, which a part-time accountant could have done on a single day, there were no other functions for which a manager would be required. Though the non-appointment of a manager covenanted in Clause 8 need not be taken to be such as to disqualify the firm from getting registered, it is a relevant fact to show that the firm had not done any business in the real sense and an entity which did not come into existence for doing business cannot be registered as a firm. The absence of a manager itself is a significant pointer to the non-existence of any business.
15. The other aspect which was brought to our notice was that the firm. Financing Corporation, had transactions only with M/s. Shanmugha Nadar and that this extraordinary feature would not have been there if there was a genuine firm. The AAC merely pointed out that there was nothing which prevented a firm having transactions with only one entity and he left it at that.
16. When the matter came on appeal to the Tribunal, the Tribunal also has not found that there was anything done by the firm of Finance Corporation apart from making those entries in its books and apart from seeking to get the benefit of a difference of 3% interest, which it claimed to have, earned. If the cash balances of the ladies had continued in the firm of M/s. Shanmugha Nadar they could have earned interest at 9% or even at 12% p.a. However, the claim for payment of interest with reference to the other amounts could not have been made by M/s. Shanmugha Nadar without interposing this entity. The ladies did not have any money beyond their credit balance. They did not borrow from any one else to make these large advances. The firm came info existence by mere book entries. It carried on what it called business by making only entriesin books. The genuineness of a firm cannot be taken to be established merely because some entries, three or a few more entries, are posted in the respective books of the assessee, Finance Corporation or M/s. Shanmugha Nadar.
17. It is true that any attempt at an avoidance of taxation by interposing a firm cannot disentitle it from getting registered, provided it was genuinely brought into existence and it actually carried on business. In the present case both the requisites are absent. In the Tribunal's order we looked in vain for any actual piece of evidence or material which would go to show that the firm had actually come into existence and had carried on business. The execution of a partnership deed is not by itself a talisman which can entitle a firm to be registered. Apart from the execution of the partnership deed there must be circumstances and facts to show that it had come into existence and that it had carried on business. On these aspects, the evidence is clearly lacking in the present case.
18. Both the sides referred us to certain decisions but we do not think it necessary to discuss those decisions because no decision can throw any light on the question of fact relating to the genuineness of the firm. The result is that the question referred to in T.C. No. 249 of 1975 and T.C. No. 485 of 1978 are answered in the affirmative and in favour of the Revenue.
19. In the other two references, T.C. No. 484 of 1978 and T.C. No. 809 of 1977, as indicated earlier, the only question is whether the amount paid or in fact only shown to have been paid as interest to the Financing Corporation can be allowed as deduction. In view of the conclusion that the firm is not a genuine entity the question of payment of interest to it does not arise. The firm, M/s. Shanmugha Nadar, therefore, was rightly refused the deduction by the ITO and the conclusion to the contrary by the AAC and the Tribunal is wrong. The questions referred in T.C. Nos. 809 of 1977 and 484 of 1978 are answered in the negative and in favour of the Revenue.
20. We may only point out that question No. 1 in T.C. No. 485 of 1978 is not happily worded ; but the purport is whether there are materials to treat the transaction as a colourable transaction. It is this aspect that we have been asked to consider.
21. One of the points that was sought to be urged by the learned counsel for the assessee was that at any rate, with reference to the amounts that belonged to the ladies and to Muthurajan and which remained to their credit in the firm of Shanmugha Nadar, there could be no disallowance. It is common ground that the entire amount was actually available for withdrawal and could have been withdrawn and reinvested in the firm of Shanmugha Nadar. However, the question referred does not admit ofour going into this aspect but we are sure that the Tribunal would go into it to the extent possible in the appeals, before it. The Revenue will be entitled to the costs of Rs. 500, one set.