SRINIVASAN J. - The assessee is a firm of four partners constituted under an instrument of partnership of the year 1954. Its application for registration for the prior years were granted. But in respect of its application for renewal of the registration for the assessment year 1958-59, the Income-tax Officer found that the correct profits of the year had not been ascertained and that no profits had been divided and credited to the partners account. The assessee had only estimated its gross profits at five per cent. on the turnover and after debiting all the charges returned a net income of Rs. 4,264. Along with the form of application submitted by the assessee, the assessee enclosed a copy of the profit and loss statement, the relevant part of which is extracted below :
(Statement of profit and loss account for Samvat 2013-2nd November, 1956, to 22nd October, 1957)
Total turnover on sales during the year net Rs. 15,38,807.42 - by profits worked out at 5 per cent. on the turnover
Less : expenses claimed
By total profit for the firm
By profit for each partner
The Income-tax Officer declined to grant the renewal of registration for the reason that the assessees estimate of the profit was not real, and, further, that the profits had not been distributed among the partners or credited in the accounts of the partners. Against this order of the Income-tax Officer, an appeal was taken to the Appellate Assistant Commissioner. The appellate authority confirmed the order of the Income-tax Officer, as it was found and it was not denied, that even the estimated profit had not been divided among the partners or credited in the partners accounts. The only claim put forward by the assessee was that in the profit and loss account that was prepared, such division of the profits had been shown, but this, in the view of the Appellate Assistant Commissioner, did not conform to the requirement of the rule, which called for either division or credit in the partners accounts in the books of account. In the further appeal to the Tribunal, the same contention was put forward. But the Tribunal took the view that the assessee had not maintained proper books of accounts at all and that the accounts maintained recorded only the years transactions without bringing into account the opening balances. These nominal accounts had not also been properly closed and profit of the year had not been ascertained. There was therefore no ascertainment of the real profit of the business and only an estimate of the profits had been made; and this estimated profit was not also distributed among the partners by actual division, nor were the shares of the partners in such estimated profits credited to their accounts. The argument advanced on behalf of the assessee that the profit and loss account showed a division of the profits was not accepted as amounting to a factual division and in that view the Tribunal dismissed the appeal.
On the application of the assessee, the following question stands referred for the determination of this court :
'Whether the division of the estimated profits among the various partners in the profit and loss account prepared on estimates constitute proper division of the profits to entitle the assessee firm to registration under section 26A and the rules made thereunder ?'
To restate the facts, it is admitted that the accounts of the firm were not completed to the close of the accounting year and the true profits of the business were not ascertained. It is also admitted that there was no credit of the shares in the profits of each of the partners in the respective accounts; nor was there proof that the profits were actually distributed among the partners; but in the profit and loss statement that was prepared on the basis of a five per cent. estimate of the profit, the net result was shown as a profit of Rs. 4,264 and it was indicated that each partner was to have a fourth share therein. The question we have now to determine on this set of facts is whether this is insufficient compliance with the requirements of section 26A and the relevant rules governing the renewal of registration.
Mr. Swaminathan, learned counsel for the assessee, has referred to a decision in St. Josephs Provision Stores v. Commissioner of Income-tax. In that case, the partners passed a resolution that the profits of the firm as disclosed in the profit and loss account need not be divided or credited in the accounts of the partners but should be credited to a reserve account in which the share of such partners should be stated, and the profits were accordingly taken to such reserve account. An application for registration was rejected on the ground that the profits had not been divided or credited. The learned judges of the Kerala High Court took the view that the absence of entries in the separate accounts of each partner was not fatal. The requirement of the rule was that there should be an entry in favour of the partner in the accounts specifying such credit in his favour, and if that was done, the rule was in substance conformed to. It will be noticed in this case that there was in fact a credit in the name of each of the partner, though it was not in the general account, but in a special reserve account, which was opened by the partners in accordance with the resolution passed by them. The rule was in fact complied with, though the credit was not in the particular ledger account of the partner.
The next case that has been referred to is that of the Andhra Pradesh High Court in Grand Hotel v. Commissioner of Income-tax. In that case, a particular method of accounting had been followed by the assessee and the assessee after striking the balance of receipts over expenditure at the end of each month carried it in his accounts and at the end of the year the surplus was distributed according to the shares of the partners. The department objected to the accounts on the ground that these accounts did not form an acceptable record to show the net annual cash surplus and the division thereof. But the learned judges held that a system of accounting had been regularly employed by the assessee and that the mere fact that that system did not commend itself to the departmental authorities could not be taken to mean that the profits had not been determined and divided according to the shares of the partners. In this case also it will be noticed that there was a factual division or credit of the shares to the partners. If the view of the department was that the accounts could not be accepted as portraying a correct ascertainment of the profits, the remedy lay elsewhere and not in the rejection of the application for registration.
The case of Commissioner of Income-tax v. Sat Ram Gian Chand comes closer to the learned counsels arguments. In that case, the firm had estimated the divisible profits and apportioned amongst the partners the divisible sums so determined. The Tribunal thought that it was for the partners to determine what the divisible profits were going to be and the fact that for the purposes of assessment to income-tax certain additions were made by the department and a different figure had been arrived at was irrelevant and accordingly granted the application for registration. When the matter was taken to the High Court, the High Court held that the division of profits being a matter relating to the internal affairs of the partnership had no bearing upon the genuineness of the firm. But here again the point to note is that there had been an actual division and crediting of the amounts to the accounts of the respective partners.
The learned counsel contends next that a profit and loss statement prepared by the partnership is no less an account of the business and it is urged on behalf of the assessee that in so far as the division has been displayed in the profit and loss statement, it must be taken to be in sufficient compliance with the rules. In this regard, the case reported in Bombay Mutual Life Assurance Society Ltd. v. Commissioner of Income-tax has been referred to. That was a case where the assessability of the profits arising from an increased valuation of certain securities came into question. It was contended on behalf of the assessee, the insurance company, that since the profits had not been taken into the revenue account, but only formed part of the balance-sheet, it would not be profits within the meaning of the relevant rule under Income-tax Act. The High Court held that in so far as the business of insurance was concerned, the special rules governed it; and the only point to take note of was whether there was a surplus existed; and whether this surplus was indicated in the reserve account or in the balance-sheet, it did not make any difference. The point in respect of which reliance has been placed upon this decision in that a profit and loss statement should be regarded as a proper account. A profit and loss statement may no doubt be a part of the regular accounts of the firm; that is not the question here; what we have to decide is whether the entry in the profit and loss account as extracted earlier is sufficient to operate as proof of division of the profits among the partners or of credit to the partners accounts.
The registration of a firm under the Income-tax Act is not as general right. It is a privilege given to the firm in order that the individual partners may get the benefit of the lower rates of assessment. In general, the deed of partnership sets out the share to which each partner is entitled. But the department is entitled to enquire whether, though the partnership may be genuine, the profit-sharing ratio specified in the deed is in fact adhered to. The profit actually distributed to the partner determines the rate at which he is to be assessed. It may happen that while a certain ratio of division is specified in the deed, the partners may actually divide the profits in some other ratio; thus a partner may in fact receive a larger share of the profit while, on the basis of the ratio fixed in the deed, he may improperly obtain the benefit of a lower rate of assessment. The rule, therefore, requires that the actual division of the profit should also be in conformity with the provision in the deed. In order to secure this end, the rule demands that there should be a division of the profits or a credit in the accounts of the partners. A credit has clearly the same effect as an actual distribution, for such an entry in the regular books of the firm confers a right on the partner to be paid that amount in due course and a corresponding liability on the firm to make that payment. This ensures that the mode of division contemplated in the document is real and not merely intended to secure the benefit of the lower rate (see also Surajmalls v. Commissioner of Income-tax.
In the present case, it cannot be denied that except for displaying the profits of the firm and making an entry in the profit and loss account to the effect 'By profit for each partner Rs. 1,066.07' it cannot be said that there has been either a distribution of the profits to the partner or the making of a particular entry in the accounts such as would cast a liability on the firm to pay that share to the partner or create a right in the partner to demand the amount from the firm. There has accordingly been neither a division nor a credit as required by the rules.
It follows that the question has to be answered in the negative and against the assessee. The assessee will pay the costs of the department. Counsels fee Rs. 250.
Question answered in the negative.