JAGADISAN J. - The Income-tax Officer, Cuddalore, refused registration of a firm called S. P. Doraiswami Chettiar and Sons, carrying on business at Panruti, South Arcot District. The alleged partners of this firm went up on appeal to the Appellate Assistant Commissioner, C. Range, who differed from the Income-tax Officer and held that the firm was registrable. The department preferred an appeal before the Income-tax Appellate Tribunal and succeeded in having the order of the Income-tax Officer restored. On an application made by the alleged firm under section 66(1) of the Income-tax Act, the Tribunal has referred the following question to this court :
'Whether the firm is registrable under section 26A for the assessment year 1957-58 ?'
The simple undisputed facts are as follows : S. P. Doraiswami Chettiar and his sons, Ramaswami, Shanmugham and Arumugham, were members of a Hindu undivided family. The family was carrying on business in arecanuts at Panruti, South Arcot District. The father died in or about February, 1953. The family trade in arecanuts was carried on by the surviving members of the family, namely, the three brothers, Ramaswami, Shanmugham and Arumugham. Arumugham was a minor and the karta of the family was Ramaswami, the eldest adult male member. It appears that the brothers conceived the idea of forming a partnership and obtained registration of the firm, S. P. Doraiswami Chettiar and Sons, with the Registrar of firms on 29th December, 1954. It is obvious that the minor brother, Arumugham, could not enter into any contract of partnership, though the law permits him being admitted to the benefits of the partnership. On 16th April, 1956, a deed of partnership was executed between Ramaswami, the karta of the family, and Shanmugham, his adult brother, constituting the family business into a partnership and admitting their brother, minor Arumugham, to the benefits of the partnership. The minor Arumugham who was aged about sixteen years in 1956 was represented in that document by his mother and guardian, Irusammal. The preamble to this document states that the three brothers agreed to divide the family trade in or about 1954 and to carry on that trade as a partnership concern. It is needless to say that each of the three brothers was allotted one-third share in the business in accordance with their shares as coparceners of the undivided family. In the business accounts of the family separate ledger folios had been allotted in the name of each one of the brothers, and they had the following debits as on 12th April, 1956, corresponding to 30th Panguni, Manmadha : Ramaswami : debit Rs. 13,824; Shanmugham : debit Rs. 929; Arumugham : debit Rs. 1,042. The capital of the family business as on 12th April, 1956, was the sum of Rs. 1,85,996-5-9. Now the partnership deed recites that the excess credit amounts as found in the ledger folio relating to the capital of the family business should be divided in three equal shares and each of the shares could be credited with their respective shares in the partnership accounts. The capital of Rs. 1,85,996-5-9 was split up into three shares and each one of the shares became entitled to the sum of Rs. 61,998-12-7. Notwithstanding the recital in the partnership deed that the share capital thus arrived at by dividing Rs. 1,85,996-5-9 into three shares should be credited to the respective share accounts of the members, in fact the partnership accounts did not contain any entry of distribution of capital contemporaneously with the execution of the partnership instrument. On 12th April, 1957, the last day of the previous year relevant to the assessment year 1957-58, the capital account was divided equally amongst all the three members and an entry to that effect was made in the partnership accounts, stating that it should take effect on and from the 13th April, 1956, the beginning of the accounting year. The firm, which will be referred to as the assessee, applied to the Income-tax Officer on 25th September, 1956, for registration under section 26A of the Act for the assessment year 1957-58. The Income-tax Officer refused registration for the following reasons : (1) There was no division of capital till the end of the accounting year. (2) The customers of the business were not informed of the conversion of the family business into one of partnership. (3) The notices under section 22(2) of the Act sent by the Income-tax Officer to the two partners, Shanmugham and Arumugham, were refused on the ground that only Ramaswami, the karta, was under an obligation to receive such notice. (4) In the application preferred by Ramaswami for the grant of import and export licence the verification certificate attached to the application did not disclose that the members of the family had formed themselves into a partnership.
The Appellate Assistant Commissioner, who took a view different from that of the Income-tax Officer, held that it was immaterial when the book entries relating to capital came to be made, that so long as the partnership was a genuine partnership, the mere fact that the entry relating to the capital was made at the end of the year rather than at the beginning, will not defeat or negative the existence of the partnership, that the verification certificate relied upon by the Income-tax Officer as not supporting the case of partnership is properly explicable on the ground that till the date of the application, the family had only been assessed as a Hindu undivided family, and that there was evidence to show that the members of the family conducted themselves as partners in carrying on the business during the relevant year.
When the matter went up on appeal to the Appellate Tribunal, it posed the question : 'What was the position on the date when the instrument of partnership was got up between the parties Was the business partitioned among them on the date ?'
The Tribunal answered these question by stating that a division of the capital account of the family is an essential requisite of a partition, that partition should necessarily precede the formation of the partnership and that though the decision of this court and courts have taken the view that a division of capital can be inferred from appropriate entries in books of account, there was no authority in law for the view that an entry made on a particular date would have retrospective effect as and from an earlier date. The Tribunal recorded its finding in these terms : 'We are of opinion that on the crucial date, the business was not partitioned among the members of the Hindu undivided family, who were parties to the instrument of partnership and hence they were not competent to enter into the contract of partnership. In the present case, the members must have divided the business among themselves before agreeing to carry it on in partnership. But this is not the case here, for, on the date of the deed of partnership, the business remained joint. This objection being fatal to the assessees case, we uphold the refusal of registration by the Income-tax Officer.'
The point whether the members of a Hindu undivided family can carry on a business as partners has some bearing in the present case. Section 5 of the Partnership Act states that partnership results from contract, and not from status, and that members of a Hindu undivided family carrying on a family business as such are not partners in such business. A business of a Hindu undivided family is property and is therefore a divisible asset. In respect of the rights and obligations of a member, they are those of a coparcener. But there is no disability on the part of the members of the family to form a partnership by agreement amongst themselves without detriment to their joint status. In a family of two members one may get a gift of money from his father-in-law and the other may get a bonus from his employer, there is no legal impediment preventing them from starting a partnership business, with the resources thus acquired, still maintaining the joint family undisrupted.
In Lachman Das v. Commissioner of Income-tax, the Judicial Committee held that there can be a valid partnership between the karta of a Hindu undivided family as representing the undivided family on the one hand and a member of that undivided family in his individual capacity on the other. In such a such a case the latter who has put his separate property into the partnership retains his share and interests in the property of the family, while he simultaneously enjoys the benefits of his separate property and the fruits of its investments, and to be able to do this, it is not necessary for him to separate himself from the family. It follows as a logical corollary from the proposition that the joint family status is no incapacity to contractual relationship of the members as partners, that a family business can be converted into a partnership business consistently and simultaneously with the subsistence of the corporate character of the family.
Now turning to the Income-tax Act the conditions necessary for obtaining registration of a firm are laid down in section 26A. The essential condition is that there should an instrument of partnership specifying the individual shares of the partners. But it is implicit in section 26A that there must be a genuine or real firm. An instrument of partnership would no doubt be a piece of evidence to support the existence of a firm. But the instrument cannot be treated as conclusive of a firm having come into existence as disclosed by the instrument. The department was entitled to investigate the question whether or not the firm sought to be registered is real as otherwise non-existing firms would obtain the benefit of registration under the cloak of an instrument of partnership. This is now well settled law and needs no elaboration. Even in a case where an existing joint family business is alleged to have been converted into a partnership business between the members of the family, the genuineness of the constitution of the partnership has to be established before the firm can be registered.
In order to enable the members of a Hindu undivided family to bring into existence a partnership arrangement in respect of the erstwhile family business, it is certainly not necessary that they should divide all the joint family assets including the business assets; not is it necessary that there should be a total disruption of their joint status. Section 25A provides for assessment after partition of a Hindu undivided family. Where at the time of making an assessment any member of a Hindu family, claims that a partition has taken place amongst the members of the family, the Income-tax Officer should make an enquiry, and if he is satisfied that the property has been partitioned as claimed, he should record an order to that effect. It is not necessary to refer to the consequences of such decision but what has to be noted is the division contemplated under this provision. Section 25A is a physical division of property. Though the Hindu law takes note of severance in status such severance is not enough for a claim under section 25A. That provision will apply only to the case where the joint family itself has ceased to exist, and where there has been a physical division of property. In cases arising under this provision it has been held that the business asset not being capable of physical division into parts as pieces of land or chattels and moveables, division can be inferred by reason of entries in the books of accounts of the business. That there can be recognition of a partition, having regard to appropriate entries in the books of account, has been laid down in the following cases : Jakka Devayya & Sons v. Commissioners of Income-tax; Meyyappa Chettiar v. Commissioner of Income-tax and In re Ghulam Singh Johri Mal.
The question now is whether a joint family business can be converted into or changed into a partnership business only by what may be called a physical division of the assets evidenced by the entries in the books of accounts. We do not think that all the conditions imposed by section 25A for a valid partition should also be complied with as necessary in a case where it is claimed by the assessee that an erstwhile joint family business had emerged into a partnership as a result of the agreement between the members of the family. It is true that so far as the business asset its concerned, coparceners should enter into a contract to form a partnership, and such a contract should necessarily be only in respect of an asset in which each one of them acquires absolute and exclusive rights. Therefore, it is clear that there shall be a division between the coparceners qua the joint family business. The division has to be proved like any other question of fact and should not be conclusively presumed from the existence of an instrument of partnership. In this view of the matter, the fact that the entry relating to the capital was made not in the beginning of the year of account, but towards its end may not be a disabling circumstance impeding the right of registration if the parties have otherwise such a right. Though the Tribunal posed the correct question to be answered for a proper decision in the case, it has gone wrong in thinking that unless and until the entries showing the distribution and allocation of the capital are made, there cannot be a partition of the joint family business. As stated already, cases arising under section 25A of the Act stand apart from claims for registration under section 26A. The essential steps that have to be taken for forming a partnership from a coparcenary are that the business assets should shed its character as joint family property and that the members of the family should cease to be coparceners in respect of that item of property. In other words, on the eve of the partnership the accounts of the family business should be so fully cast, ascertained and settled, between the members, that each member must know what his rights and obligations are in the even of the business itself being wound up and a division of that business is effected. A joint family business cannot acquire the character of a partnership by mere declaration to that effect by the parties interested. A separation of the shares and the re-employment of the shares by agreement between the parties for further carrying on the business are the two things that are necessary and indispensable. There need of course be no hiatus between separation and re-employment.
The question still remains whether in fact and in truth the members of the family formed themselves into a partnership during the course of the accounting year. The verification certificate filed by the assessee for obtaining the import and export licence is clear evidence against the formation of partnership in consequence of the instrument of partnership or the year 1957. The certificate is dated 14th November, 1957. Column 4 of the certificate provides that the applicant should state whether he is assessed to income-tax as individual, Hindu undivided family, company, firm or association of persons. The two persons who signed the certificate, namely, Ramaswami and his brother Shanmugham, filed up the columns by inserting the words Hindu undivided family. Column 9 provides that if the applicant is a firm, a list of the partners with their addresses should be provided. No such list was in fact given in the present case. Learned counsel for the assessee however stresses the fact that the application was signed both by Ramaswami and Shanmugham and relies upon it as a circumstance to show that the licence was applied for not on behalf of the family as in such a case only the karta, Ramaswami, would have signed. But column 9(c) provides that if the applicant is a family concern, the names of the adult male members should be given. Perhaps, it is in compliance with this requirement that the two brothers signed. Arumugham, the other brother, being a minor, of course, could not and did not sign. There is also the evidence in the case that the notices under section 22(2) served upon Shanmugham and Arumugham were refused on the ground that the karta alone was entitled to receive it. There is thus material on record which would tend to support the view of the Income-tax Officer that there was in fact no partnership at all during the relevant period. The belated entry relating to capital which was admittedly made only at the end of the year of account can also be taken into account in determining the question as to whether a partnership was in existence prior to 12th April, 1957, the date of the entry. In our opinion, registration was properly refused as it is abundantly clear that despite the ostensible indicia of a partnership, brought about by the execution of the partnership agreement, there was not genuine partnership in the year in question.
The reference is answered against the assessee, who will pay the costs of the department. Counsels fee Rs. 250.