Commissioner of Income Tax vs Sujankhan Laloo Khan

B.R. Arora, J.—The Tribunal, Jaipur Bench, Jaipur, has referred the following question of law for the opinion of this court :

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the assessee is entitled to registration?"

Theka Sharab, Ajmeri Gate, Jaipur, consisting of two partners, was granted a liquor contract for Jaipur district. Sujankhan, one of the partners in Theka Sharab, Ajmeri Gate, Jaipur, constituted a sub-partnership firm, Sujankhan Laloo Khan, consisting of Sujankhan Laloo Khan, Razaq Khan and Badroo Khan. This partnership was constituted with effect from April 1, 1974, by a deed which was drawn up on February 26, 1975. The names and shares in the profit and loss of the sub-partnership business are stated to be as under :

(1) Sujan Khan, S/o Khaju Khan 30 per cent. (2) Laloo Khan, S/o Khaju Khan 40 per cent. (3) Razaq Khan, S/o Khaju Khan 15 per cent. (4) Badroo Khan, S/o Karne Khan 15 per cent.

The main purpose of constituting this sub-partnership-firm was to distribute the share income of Sujankhan derived from or losses incurred to him in the business of Theka Sharab, Ajmeri Gate, Jaipur, amongst the partners of sub-partnership-firm. According to this sub-partnership deed, Sujan Khan became a partner in the original firm on behalf of the assessee-firm. The assessee, Sujankhan Laloo Khan, applied for registration along with Form No. 11 before the Income Tax Officer. The Income Tax Officer, by his order dated March 13, 1978, refused to grant registration to the assessee on the grounds that: (1) no business was carried on by the assessee-firm during the accounting year relating to the assessment year 1975-76, and (2) the agreement contravenes the provisions of the Rajasthan Excise Act. After the refusal of the registration, the assessee preferred an appeal before the Appellate Assistant Commissioner, Jaipur, who, by his order dated May 9, 1979, upheld the order of the Income Tax Officer and dismissed the appeal filed by the assessee by holding that the deed of partnership and the application did not bring into existence any genuine firm. In coming to this conclusion, the learned Appellate Assistant Commissioner took into account the facts that : (i) all the partners are close relatives; (ii) no capital was contributed by Laloo Khan and Razaq Khan though they were given 40 per cent. and 15 per cent. share; (iii) no interest was paid to Jan Mohammed on an advance of Rs. 40,000 while interest was paid to Shri Sujan Khan and Badroo Khan on the capital invested by them; and (iv) these partners never assisted in carrying on the business of the main partnership business.

Aggrieved by the order passed by the Appellate Assistant Commissioner refusing to grant registration to the firm, Sujankhan Laloo Khan preferred an appeal before the Tribunal, Jaipur, and the Tribunal, by its order dated October 30, 1980, allowed the appeal filed by the assessee and held that the assessee-firm, as a matter of fact, is a validly constituted partnership firm, and, therefore, the firm is entitled to registration. The Tribunal, therefore, directed the Income Tax Officer to allow registration to the assessee-firm. Dissatisfied with the order passed by the Tribunal, the Revenue moved an application u/s 256 of the Income Tax Act, 1961 ("the Act"), requesting the Tribunal to refer the question of law mentioned in the application for the opinion of the High Court. The Tribunal, by its order, dated March 25, 1981, referred the question of law, mentioned in paragraph No. 1 above, for the opinion of this court.

We have heard learned counsel for the Revenue as well as learned counsel for the assessee.

It has been contended by learned counsel for the Revenue that the sub-partnership in the present case is illegal and void and is not genuine as it is not carrying on any business except distributing the income of Sujankhan in the main partnership firm which firm is deriving profits from the business in liquor which cannot be done without written permission of the competent excise authority. As Sujankhan is the licensee of the liquor business and the other three persons in the partnership are admittedly non-licensees and when they cannot be included in the main partnership firm, they cannot be permitted to share the profits of the firm by forming a sub-partnership. The sub-partnership, therefore, is in contravention of the provisions of the Rajasthan Excise Act and, therefore, void and non est in law. In support of his argument, learned counsel for the Revenue has placed reliance over the Full Bench decision of this court rendered in the case of Motilal Chunnilal v. CIT [1987] 168 ITR 650.

Learned counsel for the respondent, on the other hand, contended that the business of the main firm is different from the sub-partnership and the three partners of the sub-partnership firm have nothing to do with the main firm and its business and the business of the sub-partnership is only to finance one of the partners of the main firm who is doing business in liquor along with the other partner(s) at Jaipur in the name and style of "Theka Sharab, Ajmeri Gate, Jaipur", and , therefore, the provisions of the Rajasthan Excise Act have nothing to do with the distribution of the profits of the excise business after allotment of the same to the share of a partner and the sub-partnership is neither illegal nor void and the sub-partnership firm is, therefore, entitled to registration. Learned counsel for the respondent has tried to distinguish the Full Bench decision of this court on the above lines. He has further submitted that the partner(s) of the main registered firm can enjoy the entire income of the firm himself, or, in the alternative, can divert his income or loss to other persons, may be relatives or strangers, provided they agree to be sub-partners by constituting a sub-partnership firm. In support of his case, learned counsel for the respondent has placed reliance on P.R. Chowdhary and S. Gangoli Vs. The State of U.P., Commissioner of Income Tax, Madras Vs. Sivakasi Match Export Company, Fatehchand Murlidhar and Another Vs. Commissioner of Income Tax, Calcutta, Commissioner of Income Tax Vs. R.B. Jodha Mal Kuthiala and Co., and Additional Commissioner of Income Tax Vs. Degaon Gangareddy G. Ramkishan and Co. and Others, .

In order to appreciate the scope of the respective contentions of counsel for the parties, it is necessary to briefly refer to the law relating to the concept and/contents of the partnership and sub-partnership and the principles that govern the registration of a firm under the Act.

Lindley on Partnership, Twelfth edition, page 99, deals with sub-partnerships as follows :

"A sub-partnership is, as it were, a partnership within a partnership; it presupposes the existence of a partnership to which it is itself subordinate. An agreement to share profits only constitutes a partnership between the parties to the agreement. If, therefore, several persons are partners and one of them agrees to share the profits derived by him with a stranger, this agreement does not make the stranger a partner in the original firm. The result of such an agreement is to constitute what is called a sub-partnership, that is to say, it makes the parties to it partners inter se; but it in no way affects the other members of the principal firm."

The Supreme Court in P.R. Chowdhary and S. Gangoli Vs. The State of U.P., had to consider the question whether a firm is entitled to registration. The Supreme Court, in this case, after considering the various provisions of the Indian Income Tax Act, 1922 ("the 1922 Act"), and the various judgments on the point, came to the conclusion that, if any firm fulfils the following five essential conditions, then that firm is held to be entitled to registration. The five essential conditions laid down by the Supreme Court as necessary for registration of a firm are as under (at page 198):

"(1) That the firm should be constituted under an instrument of partnership, specifying the individual shares of the partners;

(2) That an application on behalf of, and signed by, all the partners, containing all the particulars as set out in the Rules, has been made;

(3) That the application has been made before the assessment of the income of the firm, made u/s 23 of the Act for that particular year;

(4) That the profits (or loss, if any) of the business relating to the previous year that is to say, the relevant accounting year, should have been divided or credited, as the case may be, in accordance with the terms of the instrument; and lastly

(5) That the partnership must have been genuine, and must actually have existed in conformity with the terms and conditions of the instrument:"

The apex court further held that, if these five conditions are satisfied, then the authorities under the Act are bound to grant registration to the firm.

In Commissioner of Income Tax, Madras Vs. Sivakasi Match Export Company, there were five match factories run by five different concerns of which four were firms and the fifth was a sole proprietorship. One partner from each of those four firms and the proprietor of the fifth concern, in his individual capacity, constituted a firm and executed a deed of partnership to carry on the business of banking and commission agency and also of marketing the products of the match factories. Under Clause 16 of the deed, the firm was to collect the commission on the entire production of the five match factories, irrespective of whether the sales were effected through the assessee-firm or not, and a further commission on the sales effected through the assessee-firm. There were other works which were to be carried on by the assessee-firm. This firm was refused registration and, therefore, in those circumstances, the Supreme Court held that the firm was entitled to registration which was wrongly refused to the asses-see u/s 26A of the 1922 Act.

After considering the whole law on the point, it was held as under (at page 208) :

"The combined effect of Section 26A of the Act and the rules made thereunder is that if the application made by a firm gives the necessary particulars prescribed by the rules, the Income Tax Officer cannot reject it, if there is a firm in existence as shown in the instrument of partnership. A firm may be said to be not in existence if it is a bogus or not a genuine one, or if in law the constitution of the partnership is void. The jurisdiction of the Income Tax Officer is, therefore, confined to the ascertaining of two facts, namely, (i) whether the application for registration is in conformity with the rules made under the Act, and (ii) whether the firm shown in the document presented for registration is a bogus one or has no legal existence. Further, the discretion conferred on him u/s 26A is a judicial one and he cannot refuse to register a firm on mere speculation, but he shall base his conclusion on relevant evidence."

The case of registration of a firm where one of the partners brought capital from a firm of which he was a partner and paying the share of profit to the firm wherefrom he brought the capital and whether registration could be granted to such firm or not came up for consideration before the Madras High Court in the case of Siddhi Vinayagar and Co. Vs. Commissioner of Income Tax, Madras, and the Madras High Court, after following the judgment of the Supreme Court in Commissioner of Income Tax, Madras Vs. Sivakasi Match Export Company, and Commissioner of Income Tax, Gujarat Vs. A. Abdul Rahim and Co., , came to the following conclusion (headnote);

"If a firm is not a bogus one or one which has no legal existence, the mere fact that one of the partners brought the share capital from the funds of another firm and took back his share of the profits in the firm to the other firm for division between its partners will not disentitle the firm to registration u/s 26A. The source of the share capital contributed by one of the partners and the division of his share of profits in the firm between the partners of another firm in which he happens to be a partner is wholly irrelevant to the question whether a given firm is a real one and has legal existence;"

The matter : Whether a partner in a registered firm can divert his share to the sub-partnership firm, whether it can be treated as the income of the sub-partnership firm and the provisions of Section 23(5)(a) of the 1922 Act apply in that case or not came up for consideration before the Supreme Court in Fatehchand Murlidhar and Another Vs. Commissioner of Income Tax, Calcutta, , and it was held (headnote) :

". . . . There was nothing in Section 23(5)(a) of the Indian Income Tax Act, 1922, which prevented the income from firm A being treated as the income of firm B and Section 23(5)(a) being applied again."

It was further observed (headnote) :

"A sub-partner has definite enforceable rights to claim a share in the profits accrued to or received by the partner in the original partnership. When a sub-partnership is entered into, the partner changes his character, vis-a-vis, the sub-partners and the Income Tax authorities, although other partners in the original partnership are not affected by the changes that may have taken place."

It was further observed by Sikri J., as he then was, speaking for the court, as under (at page 331) :

". . . , When a sub-partnership is entered into, the partner changes his character vis-a-vis the sub-partners and the Income Tax authorities, although other partners in the original partnership are not affected by the changes that may have taken place.''. . . In our view, in the case of a sub-partnership the sub-partnership creates a superior title and diverts the income before it becomes the income of the partner. In other words, the partner in the main firm receives the income not only on his behalf but on behalf of the partners in the sub-partnership. . . .

Under the law of partnership, it is the benamidar who would be entitled to receive the profits from the other partners but, for Income Tax purposes, it does not mean that it is the benamidar alone who can be assessed in respect of the income received by him."

This decision is an authority for the proposition that a valid sub-partnership can be entered into by a partner of the main firm with some strangers to share the income or loss receivable by him from the main partnership and a sub-partner has definite enforceable rights to claim a share in the profits accrued to or received by the partner in the original partnership and such sub-partnership is entitled to registration and it creates a superior title and diverts the income from the main firm before it becomes the income of the partner.

In Commissioner of Income Tax Vs. R.B. Jodha Mal Kuthiala and Co., the matter for consideration before the Punjab High Court was : Whether a sub-partnership firm is entitled to registration ? In that case, R. B. Jodha-mal had a 4 annas and 6 pies share in Hoshiarpur Electric Supply Company. With regard to this share, he constituted a partnership which consisted of himself, his two major grandsons and two other minor grandsons. These sub-partners were held interested in the share income of R.B. Jodhamal derived from Hoshiarpur Electric Supply Company. The Division Bench of the Punjab and Haryana High Court, placing reliance on the judgment of the Supreme Court in Fatehchand Murlidhar and Another Vs. Commissioner of Income Tax, Calcutta, , came to the conclusion that the sub-partnership in the case is entitled to registration u/s 26A of the Indian Income Tax Act, 1922.

Whether a partner of a registered firm can enter into a sub-partnership with other persons and can form a sub-partnership to share his income derived from the main partnership firm between the partners of the sub-partnership firm, came up for consideration before the Andhra Pradesh High Court in the case of Additional Commissioner of Income Tax Vs. Degaon Gangareddy G. Ramkishan and Co. and Others, . That was a case in which, for the assessment year 1964-65, a partnership by the name "Nizambad Group Sendhi Contractors" was formed under the deed of the partnership with 17 partners and one of the partners was Rampuram Ganga Goud, having 10 per cent. share. This Rampuram Ganga Goud entered into a partnership with 11 others and executed a partnership deed to the effect that Ganga Goud, after becoming a partner in the "Nizambad Group Sendhi Contractors", found it difficult to contribute the required capital towards his share and, therefore, the other eleven partners agreed to provide finance on their being taken as partners in respect of his 10 per cent. share in the main partnership. The main partnership, i.e., Nizambad Group Sendhi Contractors, was the lessee who was dealing in the business of liquor and was granted licence by the excise authority for the year 1962-63. The main partnership firm was registered by the Income Tax Department The partners of the sub-partnership firm filed an application for registration which was rejected by the Income Tax Officer on the ground that no business was conducted by the assessee and the sub-partnership was ab initio void under the Andhra Pradesh Abkari Act, as the members of the sub-partnership except Ganga Goud were not licence-holders under the Andhra Pradesh Abkari Act. After considering the various judgments on the point, the Division Bench of the Andhra Pradesh High Court held as under (headnote) :

". . . . it was open to a partner of a registered firm either to earn income that falls to his share by himself and enjoy the entire income and make himself liable for losses, if any, or, in the alternative, agree to divert a portion of his income or loss to strangers, by constituting another sub-partnership firm, provided they agree to be partners of the sub-partnership. There is no prohibition under the law of partnership or under the provisions of the Income Tax law or the rules made thereunder, prohibiting a partner from entering into such sub-partnership with strangers and sharing the profits and losses in respect of his share in the main firm. In such cases, the second partnership firm is described as a sub-partnership firm, which concept is fairly settled and is recognised in India.

Unless privity of contract is established between the business of the main firm and that of the sub-partnership firm, the members of the sub-partnership firm do not become partners of the main firm, as a sub-partnership firm is a different and distinct entity. In the instant case, the partners of the sub-partnership firm are entitled to share the profits and losses which accrue to the share of ''R'' in the main partnership firm. The business of the sub-partnership firm is described in its partnership deed as financing of the capital of ''R''. In the circumstances, it cannot be said that the sub-partnership firm did not carry on any business. As long as the sub-partnership firm exists and is found to be a genuine one, it is entitled to registration under the Income Tax Act."

The matter regarding the grant or refusal of registration under the Act again came up for consideration before the Supreme Court in the case of Ratanchand Darbarilal Vs. Commissioner of Income Tax, M.P., and the Supreme Court reaffirmed its view taken in the case of P.R. Chowdhary and S. Gangoli Vs. The State of U.P., and further held that once such conditions are satisfied, then it is obligatory on the Income Tax Officer under the Act to extend the benefit of registration and allow the firm to enjoy the benefit provided by the Act.

In CIT v. Uppala Rameshwara Rao [1990] 186 ITR 24, the question regarding the grant of registration to the sub-partnership firm in the abkari matter came up for consideration before the Supreme Court and the Supreme Court dismissed the Department''s SLP against the judgment dated March 31, 1985, of the Andhra Pradesh High Court in C. R. No. 55 of 1978, whereby the High Court answered against the Department the question whether the Income Tax Officer was entitled to refuse registration to a firm engaged in liquor business on the ground that a sub-partnership was formed in order to provide funds to a partner of the firm and the permission for this had not been obtained under the Abkari Act.

The result which thus follows from a consideration of these authorities cited above is that a valid sub-partnership can be entered into by the partners of the main firm with some stranger or relative to share the income or losses receivable by him/them from the main partnership and a sub-partner has definite and enforceable right to claim a share in the profits accrued to or received by the partner in the original partnership firm. It is open to a partner of a registered firm to share his profits earned in the original firm with the other persons by forming a sub-partnership. The Income Tax Act or the Partnership Act does not prohibit the formation of sub-partnerships. Such a sub-partnership firm is, therefore, entitled to registration.

Now, we would like to take into consideration the judgment of the Full Bench of the Rajasthan High Court in the case of Motilal Chunnilal [1987] 168 ITR 650. While considering the various provisions of the Rajasthan Excise Act, the Full Bench of this court held as under (headnote):

"Under the Rajasthan excise law and as per licence condition 3 of Form No. C. L. I. E. and C. L. (1) G. prescribed u/s 42E and rules 57, 67/(Jha) and 93, it has been laid down that a licence-holder cannot enter into a partnership without the written permission of the competent excise authority. Section 34(c) of the Rajasthan Excise Act, 1950, renders the licences liable to cancellation on breach of conditions of the licence; and Sections 54 and 58 make it punishable with imprisonment or fine. If a penalty is imposed with the object of protecting the public, then it is a case of prohibition and not a device for earning revenue. The imposition of a condition in the licence and of penalty on transgression of such condition is a prohibition. The object of insistence on permission is that certain unwarranted, unscrupulous and unsocial elements, defaulters or persons of objectionable history should not be allowed to do the liquor business. This is a case of a prohibition based on public policy.

Hence, where a licence-holder under the Rajasthan excise law enters into partnership without the written permission of the competent excise authority, such a partnership would not be valid and would not be entitled to registration under the Income Tax Act, 1961."

This judgment of the Full Bench of the Rajasthan High Court, so far as the present case is concerned, is not applicable because in the case of Motilal Chunnilal [1987] 168 ITR 650, new partners were added in the main partnership itself, which changed the constitution of the main partnership while, in the present case, though the main partnership firm is doing business in liquor, the sub-partnership firm is not carrying on business in liquor. The business in liquor under the Rajasthan Excise Act requires the specific permission of the State Government or the district authorities and the business can only be done by the persons who obtain a specific licence for the same. The requirement of specific licence by the persons or the person who conduct(s) such business is a condition pro cedent as the persons other than the licensees or the permit-holders are specifically prohibited on the ground of public policy from conducting such business. The Full Bench of this court, while considering the provisions of the Rajasthan Excise Act and the conditions of the licence, came to the conclusion that if any breach of the conditions of the licence is made by the licensee, it makes the licence liable to cancellation u/s 34 of the Act. It was further observed that the object of insis tence on permission is that certain unwarranted, unscrupulous and unsocial elements, defaulters or persons of objectionable history should not he allowed to do the liquor business, as the grant of licence under the Excise Act is a case of prohibition and is based on public policy.

Now, we have to see : whether, in the present case, the sub-partnership is entitled to do or, in fact, did any business in liquor, which was the business of the main partnership firm ? The sub-partnership never indulged in business in liquor nor were the sub-partners, in any way, connected with the day-to-day business of the main partnership firm regarding the purchase and sale of liquor in any manner and, therefore, it cannot be said that the sub-partnership, in the present case, was, in any way, illegal and void. The judgment of the Full Bench of this court is, thus, not applicable in the present case.

Now, after taking into consideration the fact that the sub-partnership can be constituted to share the profits or losses of the main partnership firm and regarding the genuineness of the firm, there is a finding of the Tribunal. The Tribunal has specifically opined that the sub-partnership firm in the present case is validly constituted and it fulfils all the necessary requirements of a valid partnership, as laid down by the Supreme Court in Fatehchand Murlidhar and Another Vs. Commissioner of Income Tax, Calcutta, and Commissioner of Income Tax, Madras Vs. Sivakasi Match Export Company, . The finding regarding the genuineness of the firm is a finding of fact which was arrived at by the Tribunal after considering the complete record of the case. This court is not expected to set aside the findings of fact arrived at by the Tribunal and add its own findings. The Tribunal also, while giving the finding regarding the genuineness of the firm, gave the finding that the conditions necessary for registration are also satisfied and the firm is entitled to registration. In this view of the matter, taking the finding of the Tribunal, we are of the opinion that the assessee-firm is entitled to registration.

Consequently, we answer the question in the affirmative, i.e., in favour of the assessee and against the Revenue, by holding that the Tribunal was justified in holding that the assessee is entitled to registration.