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Commissioner of Income-tax Vs. G.D. Kothari - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Case NumberIncome-tax Reference No. 88 of 1968
Judge
Reported in[1977]110ITR691(Cal)
ActsIncome Tax Act, 1922 - Sections 10, 16(1) and 23(5)
AppellantCommissioner of Income-tax
RespondentG.D. Kothari
Cases ReferredArvind N. Mafatlat v. Income
Excerpt:
- r.n. pyne, j.1. this reference, at the instance of the revenue under section 66(1) of the indian income-tax act, 1922, relates to the assessment year 1958-59, the relevant previous year for which having ended on march 31, 1958. the facts mentioned in the statement of case prepared by the tribunal are these. the assessee is a partner in two registered firms known as kothari and co. and kothari trading co. in making the assessment on the assessee the income-tax officer took the following amounts as the share income from the said firms and allocated them as follows :name of the firmshare of business loss under section 10share of dividend income under section 12 rs.rs.kothari & co.5,31,38961,150kothari trading co. 41,33031,9712. it may be noted that if the dividend was not taken separately,.....
Judgment:

R.N. Pyne, J.

1. This reference, at the instance of the revenue under Section 66(1) of the Indian Income-tax Act, 1922, relates to the assessment year 1958-59, the relevant previous year for which having ended on March 31, 1958. The facts mentioned in the statement of case prepared by the Tribunal are these. The assessee is a partner in two registered firms known as Kothari and Co. and Kothari Trading Co. In making the assessment on the assessee the Income-tax Officer took the following amounts as the share income from the said firms and allocated them as follows :

Name of the firmShare of business loss under section 10Share of dividend income under section 12

Rs.Rs.Kothari & Co.5,31,38961,150Kothari Trading Co. 41,33031,971

2. It may be noted that if the dividend was not taken separately, then the share income taken as a unit would have been a loss in each of these cases. By the share income being taken separately in respect of business loss and dividend income the assessee stood to lose because the dividend income was treated as unearned income and a higher surcharge was payable. The assessee contested the computation made by the Income-tax Officer in the appeal preferred against the order of the Income-tax Officer before the Appellate Assistant Commissioner. It was submitted that as the assessee had received income as a share of profit from the partnership concera it should be treated as his income from business. The Appellate Assistant Commissioner, however, did not accept this contention of the assessee and was of the view that the Income-tax Officer had correctly treated the income as from other sources under the head ' Dividend '. The Appellate Assistant Commissioner, therefore, dismissed the assessee's appeal.

3. Against the order of the Appellate Assistant Commissioner the assessee preferred a second appeal to the Tribunal. It was contended on behalf of the assessee that the Income-tax Officer should not have treated the sum of Rs. 61,150 and Rs. 31,971 as income from other sources and that the share income was a unit by itself coming under Section 10 and that disintegration was unwarranted. On behalf of the department it was urged that the share income was not a single unit, that the computation made in the hands of the firm in the assessment was transposed in the hands of the partner under respective heads, that the several heads did not lose their identity in the process of transposition and that the action of the Income-tax Officer was proper. On behalf of the department reference was also made to Section 67(2) of the 1961 Act as clarifying what was previously done in the assessment of the partners prior to the 1961 Act.

4. Considering the provisions of Section 16(1)(b) and Section 23(5)(a) of the Indian Income-tax Act, 1922, the Tribunal held that in none of these provisions was there any clear indication that the share income was to be disintegrated into its components as assessed in the instant case. Relying on the decision in the case of Arvind N. Mafatlal v. Income-tax Officer : [1957]32ITR350(Bom) , the Tribunal further held that the amounts of Rs. 61,150 and Rs. 31,971 dealt with as dividend income and assessed in the hands of the firm under the head 'other sources' should have been treated as business income and it is share of profits of a firm which (share) was assessable under the law in force under the head 'Business, profession or vacation'. In the aforesaid view of the matter the Tribunal allowed the appeal.

5. Thereafter, on the department's application under Section 66(1) of the Indian Income-tax Act, 1922, the question of law stated hereinafter has been referred to this court:

' Whether, on the facts and in the circumstances of the case the sums of Rs. 61,150 and Rs. 31,971 being the dividend income earned and assessed in the hands of the respective firms under the head 'other sources' were income from ' business, profession or vocation ' in the hands of the assessee-partner or income from ' other sources ' for the assessment year 1958-59 '

6. Counsel for the revenue has submitted that while assessing the individual partners of a firm, the nature of their share income is not changed but the nature of such income remains the same as it was in the hands of the firm. He has further submitted that for the purpose of the Income-tax Act in order to assess the total income of the partners of a firm the Income-tax Officer is only to see the different sources of income of the firm. Inasmuch as the charge is on the different sources and the computation is also made on different sources of income, in assessing the share income of a partner the Income-tax Officer will take into account the different sources of the firm's income in the hands of the partner according to his share in the partnership though according to partnership law a partner is only to get his share of profit. It is his submission that the nature and character of the income of the firm do not change in the hands of the partner though that is of no moment under the partnership law. Counsel has further submitted that the expression ' his share of its income, profits and gains ' in Section 23(5)(a) really means the partner's share in the firm's income under appropriate heads and not that the entire share of income is to be treated as business income of the partner and the proviso becomes applicable whenever facts warrant its application. According to counsel Section 67(2) of the Income-tax Act, 1961, has not brought about any change in the law but it has really recognised the existing practice followed by the revenue prior to the enactment of the 1961 Act and in effect it has codified the prevailing law on the subject. Learned counsel further submitted that under Section 12(1A) ' dividend ' is to be taxed as income from other sources and, therefore, assuming that partners are carrying on business, still, because of the said section, the dividend income cannot be said to be income from business. It is the further contention of the counsel that if the dividend income of the firm is treated in the case of partners as their income from business then at the time of individual assessments of the partners who would get the benefit of the tax deducted at the source under the relevant section of the Act Learned counsel submitted that if the partners want to get the benefit of the tax deducted at the source then such income must be treated as dividend income in his hands. In support of his above submission learned counsel has relied upon various cases to which we shall refer hereinafter.

7. Learned counsel for the assessee, on the other hand, has submitted that the share income of a partner is a unit by itself coming under Section 10 of the Act and disintegration of it, as done by the Income-tax Officer in this case, is unwarranted. Referring to the relevant provisions of the Income-tax Act, 1922, and the Indian Partnership Act, 1932, learned counsel has submitted that a partner's share in the income of the firm is really his share of profit in carrying on partnership and, as such, it is assessable under Section 10 of the Act under the head ' Profits, and gains of business, profession or vocation'. Learned counsel in support of Ms contention has also referred to the return form prescribed for the partners of a firm, viz., Form A in Part HI of the Income-tax Rules, 1922. He has also referred to Rule 2(a) of the 1922 Rules. Learned counsel has submitted that while assessing a partner his share income from the firm will have to be looked at as a composite whole and the Income-tax Officer is not to recompute the same. He has also referred to Section 67(2) of the Income-tax Act, 1961, which provides that the share of a partner in the income or loss of the firm, as computed under Sub-section (1), shall, for the purpose of assessment, be apportioued tinder various heads of income in the same manner in which the income or loss of firm has been determined under each head of income and has submitted that this new provision has been introduced in the 1961 Act for the first time and in this respect the new Act has really brought in a change in the prevailing law.

8. Before we proceed further, it would be convenient to deal with various cases cited at the Bar.

9. In the case of P.M. Muthuraman Chettiar v. Commissioner of Income-tax [1957] 31 ITR 61 , the Madras High Court held that where a person was an ordinary resident in the taxable territories and was also a partner in a firm carrying on business outside the taxable territories, he was entitled to have the loss incurred by him as a partner of that firm deducted from his income under the head 'business' in the taxable territories in computing his total income under the head ' business ' even though the firm was a non-resident and the income of the firm as such is not liable to be assessed to income-tax under the Indian Income-tax Act, 1922. It was further held that the share income of a partner of a firm falls under the head ' profits and gains of business' referred to in Section 10 of the Act and is not 'income from other sources ' falling under Section 12, and a loss incurred by an assessee as a partner in a firm must, therefore, be deducted in computing his total income tinder the head ' business ' under Section 10(2) of the Act, The court observed (page 70):

' In our opinion, therefore, the question really turns on whether or not under the scheme of the Income-tax Act the share income of a partner in a firm is brought to charge under the head ' business ' falling within Section 10. If the answer is in the affirmative, the income derived by the assessee under the head ' business ' would be the profits or gains, less the losses incurred in the business carried on by the assessee in the several places. Realising the importance of this approach, Mr. Rama Rao Sahib contended that the share income which a partner derived from a business was not ' income from business' within Section 10 but was 'profit' from ' other sources ' falling within Section 12. On this basis he urged that the share income fell under head (v) of Section 6, while the income derived by the unit and by, its sole exertion in the way of business fell under head (iv), and that consequently unless the case fell within Section 24 there could not be a set-off. We are clearly of the opinion that learned counsel for the assessee is well-founded in his argument, that the share income of a partner is income from business within Section 10.'

10. In the case of Arvind N. Mafatlal v. Income-tax Officer : [1957]32ITR350(Bom) , which was relied on by the Tribunal in its decision in the instant case, the question that arose was as to how the dividend deemed to be distributed under Section 23A in respect of shares standing in the name of a partner but on behalf of the firm was to be taxed. The Income-tax Officer taxed the firm on such dividends and the assessee's share thereof came to Rs. 8,528. In the assessment made on the assessee, the Income-tax Officer took this amount and levied tax. Later, he realised that he should have grossed up the dividend under Section 16(2) as it was then in force. The Income-tax Officer gave notice under Section 35 for rectification of the mistake. By the dividend being grossed up the assessee would have to pay large super-tax as his assessable income was about Rs. 19 lakhs. He, therefore, filed a writ petition in the Bombay High Court challenging the proceedings under Section 35 on various grounds. One of the contentions was that the dividends should not be grossed up, as, in so far as the partner's assessment was concerned, there was no dividend income as such. In that case it was held that dividend received by a nominal holder of shares and paid to the real owner could not be regarded as dividend income of the latter within the meaning of Section 16(2) of the Act and as such income was not liable to be processed in terms of Sections 16(2) and 18(5) of the Act. It was also held that where the assessee, who was a partner in a firm, held share in a company, and the Income-tax Officer did not assess the assessee as a shareholder but distributed the dividend income among the partners on the ground that he was a nominee for the firm, on such distribution the amount deemed to have been received by the assessee as a partner of the firm could not be regarded as dividend income in his hands, but could only be his share of profits in the firm. It was observed in that case that (page 357):

' On the distribution of the dividend income so made, the amount deemed to have been received by the assessee in that income as partner of the firm could not be regarded as dividend income in his hands. In the hands of the firm it was evidently dividend income, but in the hands of the assessee it could only be his share of profits of the firm. Not being the dividend income in the hands of the assessee Section 16(2) of the Income-tax Act had ho application, arid the income which had to be taken into account was 5/16th share in the net income received by the firm of Mafatlal Gagalbhai and Sons.'

11. The Tribunal in its order in the instant case has relied on the said observation. Before us counsel for the assessee also strongly relied on the observation of the Bombay High Court quoted above: The Supreme Court in its; decision in Income-tax Officer v. Arvind N. Mafatlal : [1962]45ITR271(SC) , affirmed the said decision of the Bombay High Court on the question of Section 35 but did not express any. view with regard to the observation of the Bombay High Court referred to above.

12. In the case of R.M. Chidambaram Pittai v. Commissioner of Income-tax : [1970]77ITR494(Mad) , the facts were that the assessees were partners in two firms--Kavukal Estate and Tuttapallam Estates--Which ownedtea 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 year ended March 31, 1959, the total income of each firm was compute^ with reference to Section 10(4)(b) which was apportioned between agricultural and business incomes 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 the 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% 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 assessees to the firm. The Tribunal, following the decision of the Madras High Court in the case of Mathew Abraham v. Commissioner of Income-tax : [1964]51ITR467(Mad) , allowed the appeals observing that the partners had nothing to do with the agricultural operations, but drew the salaries for services rendered by them to the firms, and, therefore, Rule 24 had no application to them; In that case it was held that the salary received by a partner of a firm for services rendered by him to it was only a mode of adjustment in his share of the firm's income and continued to bear, for purposes of charge at his hands, the same character as part of the total income of the firm which had to be shared between its partners. The consequences of applying Rule 24 of the Income-tax Rules, 1922, to the total income of the firm computed in accordance with Section 10(4) was necessarily that only 40 per cent. of the salary as referable to agricultural income could be taken as salary in computing the total income of a partner of a firm in terms of Section 16(1)(b). A Full Bench of the Madras High Court observed that : [1970]77ITR494(Mad) :

'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 edition, volume 3, at page 3092. It is there stated :

' The decision of the High Court in Rose v. Federal Commissioner of Taxation [1951] 84 CLR 118 ; 5 AITR 197, established that there is nothing in the relevant income-tax legislation to warrant treating a partnership as a distinct legal entity. A partner cannot, thereore, 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 part of the partnership income [Ellis' case [1905] 1 KB 324 ], per Mathews L.J., at page 329 and see Federal Commissioner of Taxation v. Seville [1953] 5 ITR 458 ; 3 CTBR (NS) 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 no 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 a 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 partners' salary is the service and not the share in the profits of the firm cannot, therefore, be accepted......

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 Indian 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]51ITR467(Mad) was not correctly decided.'

13. In the case of Commissioner of Income-tax v. Ramniklal Kothari : [1969]74ITR57(SC) the Supreme Court held that the respondent, who was a partner in four firms but did not carry on any independent business, was entitled to deduct from his share of the profits from the firms amounts paid as salary and bonus to staff, expenses for maintenance and depreciation of motor cars and travelling expenses expended by him in earning the income from the firms. In that case it was observed that business carried on by a firm is business carried on by the partners. Profits of the firm are profits earned by all the partners in carrying on the business. The share of the partner is business income in his hands for the purpose of Section 10(1) of the Indian Income-tax Act, 1922, and, being business income, expenditure necessary for the purpose of earning that income and appropriate allowances are deductible therefrom in determining the taxable income of the partner. The Supreme Court further observed (pages 59, 60):

'Where a person carries on business by himself or in partnership with others, profits and gains earned by him are income liable to be taxed under Section 10 of the Indian Income-tax Act, 1922. Share in the profits of a partnership received by a partner is ' profits and gains of business ' carried on by him and is on that account liable to be computed under Section 10, and it is a matter of no moment that the total profits of the partnership were computed in the manner provided by Section 10 of the Income-tax Act and allowances admissible to the partnership in the computation of the profits and gains were taken into account...........The receipt by the partner is business income for the purpose of Section 10(1), and being business income, expenditure necessary for the purpose of earning that income and appropriate allowances are deductible therefrom in determining the taxable income of the partner.'

14. In the case of Saraf Mull Rairoo Mutt v. Commissioner of Income-tax : AIR1968Delhi18 the facts were : The assessee, a partnership firm, had income from interest on securities, general merchandise business, motor parts business and commission agency. The assessee maintained one profit and loss account in respect of all its business activities. The assessee used to deposit some moneys in call deposit accounts with banks and earned interest thereon. The assessee had one consolidated interest account with respect to interest on call deposits and that earned from other parties. The total interest received by the assessee amounted to Rs. 15,497.07 while the interest paid by it was Rs. 11,816.47, leaving a profit of Rs. 3,680.60. The Income-tax Officer determined a sum of Rs. 3,489 as the interest realized on call deposits. He assessed this amount under the head 'other sources' rejecting the contention of the assessee that it ought to have been taxed under the head ' business '. The Appellate Assistant Commissioner also upheld the decision of the Income-tax Officer. The appeal preferred by the assessee to the Tribunal against the order of the Appellate Assistant' Commissioner was also decided against the assessee. In the reference to the Delhi High Court from the Tribunal's order it was held that the interest received by the assessee could not be said to be income which arose out of its business taxable under Section 10 and that it was rightly taxed under Section 12 as income from other sources. The High Court observed that (page 21):

' In the Income-tax Act, 1961, Section 67(2) has been introduced for the first time. This sub-section provides that the share of a partner in the income or loss of a firm should in making the assessment on the partner be apportioned in the various heads in the same manner in which the firm's income had been determined. The introduction of this provision, however, does not, to my mind, introduce any change in law so far as the aspect under consideration is concerned. Of course, even under the 1922 Act, if the income of a registered firm was assessed under the head 'business' that income would be assessable in the hands of the partners as business income. That would be so because common interest, mutual agency and division of profits are the essential conditions for the. existence of a partnership and consequently the partners really carry on business in the name of the firm. If, on the other hand, the income of the firm consists of income from property it cannot be suggested that such income in the hands of the partners should be treated as business income.'

15. In the case of Commissioner of Income-tax v. Jethalal Zaverchand Patalia : [1966]61ITR357(Guj) it was held that the partner of an unregistered firm is entitled to adjust his share of the loss sustained by the firm against profits from his other business in computing his income under Section 10 of the Act. The second proviso to Section 24(1) could not be construed as an independent enactment but must be read subject to the provisions of the main section and refers only to the set-off of loss under one head against profits from another. Proviso (c) to Section 24(2) did not also apply to set-off of loss from one source against profits from another source under the same head.

16. The only point which falls for determination in this reference is whether under the 1922 Act the share income of a partner for the purpose of his assessment should be apportioned under various heads of income in the same manner in which the income of the firm was determined under each head of income. Shortly put, the question is, what is the true nature of the share income of a partner. Is it the business income of the partners for carrying on partnership business or is it the income of the partners derived from the same source as that of the partnership If the share income of a partner is treated as the income or profits or gains from business carried on by him then it would be assessable under Section 10 of the 1922 Act, even though the partnership may have derived its income from-different sources. On the contrary, if the share income of a partner retails its original character in the hands of the individual partners then it would be assessable in their hands under appropriate heads depending on the sources from which the firm's income was derived. In the instant case the controversy is whether Rs. 61,150 and Rs. 31,971 for the purpose of assessment of the assessee, a partner of the two firms, should be treated as the dividend income of the assessee because it came out of the dividend income of the firm or it should be treated as the business income of the assessee-partner in his assessment. If the said sums have retained their original character then they should be treated as income from other sources and assessed under Section 16 of the 1922 Act.

17. In our opinion, the observation of the Supreme Court in the case of Commissioner of Income-tax v. Ramniklal Kothari : [1969]74ITR57(SC) , noted earlier, decides the point in issue in this reference. According to the Supreme Court the share in the profits of a partnership received by a partner is ' profits and gains of business ' carried on by him and is on that account liable to be computed under Section 10 of the 1922 Act.' In the view taken by the Supreme Court in that case stated above, profits of the firm distributed amongst its partners cannot be said to have retained the original character of the sources from which the partnership derived its income. If the share income of a partner retains the character of the different sources from which the partnership derived its income, then in cases where the partnership has different sources of income such income in the assessment of individual partners cannot be said to be the partner's income from profits and gains of business and liable to be taxed under Section 10 of the Indian Income-tax Act, 1922, as observed by the Supreme Court. In our view, for the purpose of assessing the share income of the partners under various heads from which the partnership derived its income, Section 67(2) of the Act has been introduced in the Income-tax Act, 1961. The fact that the share income of a partner is income from profits and gains of business also finds support from the relevant return form prescribed under the 1922 Act mentioned earlier. The observation of the Supreme Court noted earlier is binding on us and the observations of the Madras High Court in the case of Chidambaram Pilled v. Commissioner of Income-tax : [1970]77ITR494(Mad) and of the Delhi High Court in the case of Saraf Mull Rairoo Mull v. Commissioner of Income-tax : AIR1968Delhi18 , being contrary to the observation of the Supreme Court in Ramniklal's case : [1969]74ITR57(SC) cannot, therefore, prevail. It should also be noticed that the Bombay decision in the case of Arvind N. Mafatlat v. Income-tax Officer : [1957]32ITR350(Bom) was neither cited nor considered by the Madras and Delhi High Courts in the aforesaid cases. Following the said decision, of the Supreme Court we hold that under the Indian Income-tax Act, 1922, the share income of a partner in his assessment should be treated as income derived from 'profits and gains of business', and, accordingly, assessable under Section 10 of the Act. In our view, the Tribunal came to a correct decision and the same should be upheld. In the aforesaid view of the matter we answer the question in favour of the assessee by saying that the sums of Rs. 61,150 and Rs. 31,961 are income from business in the hands of the assessee. In the facts and circumstances of this case we do not propose to make any order as to costs.

Deb, J.

18. I agree.


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