Commissioner of Income Tax, Tamil Nadu-II vs Mariappa Muthiriyar and Sons

Ratnam, J.—The assessee in this case applied for registration of the firm consisting of a father and two adult sons and carrying on business in

plantains. Prior to the coming into existence of the partnership on April 1, 1973, on the strength of which registration was claimed, the father, Sri

Mariappa Muthiriyar, was carrying on business in plantains, such business having been conducted on behalf of the HUF consisting of himself and

his two adult sons. The assessee claimed that in the partnership business, one of the sons, Sri M. Natarajan, had contributed a sum of Rs. 5,000 as

his share of the capital, which amount was partly received from his father-in-law and partly earned by him and the other son, Sri Kandaswami, had

contributed a sum of Rs. 5,000, which amount was stated to have been received by him from his maternal grandfather. The father, Mariyappa

Muthiriyar, claimed that he had contributed as capital a sum of Rs. 37,000 from out of the funds of the HUF. Considering the application of the

assessee for registration of the firm, the ITO passed an order under s. 185(1)(b) of the I.T. Act, 1961 (hereinafter referred to as ""the Act""),

refusing registration on the ground that no partition had taken place in the family, that the action of the two adult members in becoming partners

was detrimental to the interest of the joint family, that the family contribution towards capital was Rs. 37,000, while the capital brought in by the

adult sons was negligible and further that the formation of the partnership was against the principles of Hindu law. On appeal, the AAC agreed with

the ITO and held that the partnership was invalid according to Hindu law and dismissed the appeal. On further appeal by the assessee to the

Tribunal, the Tribunal found that one of the sons, M. Natarajan, contributed a sum of Rs. 5,000 towards capital for the business, which was made

up of a sum of Rs. 2,500 earned by him and a gift of Rs. 2,500 received from his father-in-law. The other son, M. Kandaswami, was found to

have contributed to the partnership a sum of Rs. 5,000 received by him by way of a gift from his maternal grandfather. The capital contribution to

the partnership from the HUF in a sum of Rs. 37,000 was also found. On these factual finding, the Tribunal took the view that though it might be

that the karta of the HUF contributed a larger share of the capital and the junior coparceners made smaller contributions, yet that will not make the

partnership an invalid one in law and inasmuch as the capital was contributed from their individual and separate movies by the junior members, it

cannot be said that they had acted against the interest of the joint family or to its detriments and, therefore, no invalidity will attach to the

partnership. In this view, the appeal filed by the assessee was allowed and the ITO was directed to grant registration to the assessee-firm for the

assessment year 1974-75. Aggrieved by this, the Revenue has come up with this reference before this court under s. 256(1) of the Act and the

question referred for our opinion is as follows :

Whether, on the facts and in the circumstances of the case, and having regard to the fact that there was no partition in the joint family, the

Appellate Tribunal was correct in law in holding that the partnership consisting of karta, Sri. V. Mariappa Muthiriyar, and has two undivided sons

as partners, has been validly constituted and accordingly in granting registration for the assessment year 1974-75 ?

The learned counsel for the Revenue submitted that a partnership as in this case between the karta of the undivided Hindu family and two of is

adult coparceners, would cut at the very vitals of the notion of a joint undivided family, as they cannot, at the same time, be both coparceners and

partners with reference to the partnership and its members and that such a partnership would be invalid in law. Before emparking upon a

consideration of that submission, it is necessary to recapitulate the factual findings recorded by the Tribunal in this case. The capital contribution of

Rs. 5,000 by Natarajan had been found to have been made from out of the his salary earnings in the previous assessment year and a sum of Rs.

2,500 gifted to him by his father-in-law. Similarly, the Tribunal found that Kandaswami, who had also contributed a sum of Rs. 5,000, had

obtained this amount by way of a gift from his maternal grandfather. The karta of the HUF contributed a sum of Rs. 37,000 from out of the funds

of the HUF. The capital contribution to the partnership by the junior coparceners had thus been found by the Tribunal to have been made out of

their own earnings or with the amounts received by them by way of a gift. In either event, such amounts would partake the character of the

separate and individual earnings or funds of the members and, therefore, the question that has to be considered is whether a valid partnership can

be constituted among the members of the undivided a Hindu family with the capital contribution out of the separate earnings of two adult members

and also with the contribution karta from out of the funds of the HUF.

Section 5 of the Partnership Act, 1932, states that partnership is the result of a contract and not status and that members of a HUF carrying on

a family business as such are not partners in such a business. Though the business of a HUF is the property of the family and a divisible asset as

well and the rights and obligations of a members therein are those on a coparcener, yet there is no legal bar on, or impediment to, the members of

the HUF constituting a partnership, even with the karta, by an agreement amongst themselves, without detriment to their joint status. It may be, as

found in this case, that a members of a HUF may get a gift of money from his father-in-law or maternal grandfather or some other relation. It may

even be the receipt of bonus from the employers or an unexpected windfall. There is no legal impediment, however, preventing the members of a

HUF from starting a partnership business with the karta with their own resources while maintaining the family and its properties intact and

undisrupted. If such a partnership constituted between the karta of a HUF and one or more of its coparceners in their individual capacity while the

family still remains joint and the coparcener contributed to the partnership his separate property held in his individual capacity and unconnected

with the family funds is a valid one, then, we do not see how there would be any difference in principle to the validity of a partnership entered into

in respect of an existing joint family business, as in this case.

Indeed, the decided cases to which we shall presently refer highlight the aforesaid aspects. The decision of the Privy Council in Sir Sundar Singh

Majithia v. CIT [1942] 10 ITR 457 laid down that there was nothing in the I.T. Act to prohibit the members of a HUF from dividing some

properties while electing to retain their joint status and carrying on business as partners in respect of those properties treating them as capital of the

partnership. This case establishes that there is nothing in law to prohibit the members of a HUF from entering into partnership with a portion of the

joint family property divided amongst themselves as an asset of the partnership without any change or disruption in the status of the family. In the

oft-quoted decision of the Privy Council in Lachhman Das v. CIT [1948] 16 ITR 35, it was pointed out that an individual coparcener, while the

remaining joint, can possess, enjoy and utilise in any way he likes, property which is his individual property not acquired with the aid of or with any

detriment to the joint family property and that order to so utilise the property, the individual coparcener must be accorded the freedom to enter into

contractual relations with other including his family, so long as the family represented by the manager, in which case, the individual coparcener

retains his share and interest in the property of the family while he simultaneously enjoys the benefit of his separate property and the fruits of its

investments, for which purpose it is not necessary that the individual coparcener should separate himself from the family. It was also further pointed

out that if a stranger can enter into a partnership with reference to his own property with a HUF through its karta, there is no sound reasoning to

withhold from a coparcener that benefit in respect of has separate and individual property. The following observations of the Privy Council in

Lachhman Das v. CIT [1948] 16 ITR 35 , are instructive in this connection :

After careful consideration, their Lordships cannot accept this view and on general principles they cannot find any sound reason to distinguish the

case of a stranger from that of a coparcener who puts into the partnership, what is admittedly his separate property, held in his individual capacity

and unconnected with the family funds. Whatever the view of a Hindu joint family and its property might have been at the early stage of its

development, their Lordships think that it is not firmly established that an individual coparcener, while remaining joint, can possess, enjoy and

utilise, in any way he likes, property which was his individual property, not acquired with the aid of or with any detriment to the joint family

property. It follows from this that to be able to utilise this property at his will, he must be accorded the freedom to enter into contractual relations

with others, including his family, so long as it is represented in such transactions by a definite personality like its manager. In such a case he retains

his share and interest in the property of the family, while he simultaneously enjoys the benefit of his separate property and the fruits of its

investment. To be able to do this, it is not necessary for him to separate himself from his family. This must be dependent on other considerations,

and the result of a separate act evincing a clear intention to break away from the family. The error of the Income Tax Officer lay in his view that,

before such a contractual relationship can validly come into existence, the ''natural family relationship must be brought to an end''. This erroneous

view appears to have coloured his and the subsequent decisions of the Income Tax authorities.

In this view of the Hindu law, it is clear that if a stranger can enter into partnership, with reference to this own property, with a joint Hindu family

through its karta, there is no sound reason in their Lordships'' view to withhold such opportunity from a coparcener in respect of his separate and

individual property.

The observations of the Privy Council referred to above clearly lay down that without separating himself from his family, an individual

coparcener can, like any other individual in the exercise of his freedom of contract, enter into contractual relations with the karta of the HUF in

respect of his separate and individual property. Therefore, a valid partnership can be entered into by a coparcener with a karta, provided the

coparcener invests in the partnership his separate property held in his individual capacity and not in any manner in connected with the family finds

and to be able to do this, there need be no separation from the family. In Firm of Bhagat Ram Mohanlal Vs. The Commissioner of Excess Profits

Tax, Madhya Pradesh, Nagpur and Another, , the Supreme Court had to consider the question whether there was a change in the person carrying

on business within the meaning of s. 8(1) of the Excess Profits Tax Act, 1940, in the following factual backdrop. In a firm of the name of Bhagat

Ram Mohanlal consisting of three partners, one of the partners holding an eight annas share was the HUF of Bhagat Ram Mohanlal of which

Mohanlal was the karta and two of his brothers were the other members. For the accounting years 1943 and 1944, the firm was assessed to

excess profit tax, but a during of the year ending 1945, it sustained a loss and the ITO acting under s. 7 of the Excess Profits Tax Act, proceeded

to set off the profits of the firm for the years 1943 and 1944, against the loss during the year ending 1945. Accounting to s. 8 of the Act, such relief

could not be granted, if there was a change in the persons carrying on the business and in fact, there was such a change, as there was a

reconstitution under the agreement dated December 17, 1944, consequent upon the disruption of the joint family consisting of Mohanlal and his

brothers. Under the agreement, Mohanlal and his two brothers were introduced as partners of the firm along with two other original partners and

there was also a change in the shares of the partners. Purporting to exercise the powers of rectification, the Commissioner of Excess Profits Tax

set aside the orders granting relief under s. 7 of the Excess Profits Tax Act and the matter was carried in appeal to the Supreme Court. Before the

Supreme Court, it was argued that persons who entered into the contract of partnership were not only Mohanlal as the karta of the joint family and

two strangers, but also his brothers, Chhotelal and Bansilal, in their individual capacity and, therefore, they were partners under the ordinary law of

partnership since the inception and, accordingly, there was no change in the constitution of the firm under the new partnership agreement. The

Supreme Court repelled this argument as an after-thought and being contrary to the registration and certificate as well. In that context, the Supreme

Court pointed out as follows (at page 526) :

...... it is difficult to visualise the situation which the appellant contends for, of a Hindu joint family entering into a partnership with strangers though

its karta and the junior members of the family also becoming at the same time its partners in the personal capacity. In Lachhman Das v.

Commissioner of Income Tax [1948] 16 ITR 35, it was held by the Judicial Committee that the karta of the a joint Hindu family could enter into

partnership with an individual members of the coparcenary quoad his separate property. It was also held by the Privy Council in Sundar Singh

Majithia v. Commissioner of Income Tax [1942] 10 ITR 457, that there was nothing in the Income Tax Act to prohibit the members of a joint

Hindu family from dividing some properties, while electing to retain their joint status, and a carrying on business as partners in respect of those

properties treating them as its capital. But in the present case, the basis of the partnership agreement of 1940 is that the family was joint and that

Mohanlal was its karta and that he entered into the partnership as karta of behalf of the joint family. It is difficult to reconcile this position with that

of Chhotelal and Bansilal being also partners in the firm in their individual capacity, which can only be in respect of their separate or divided

property. If members of a coparcenary are to be regarded as having become partners in a firm with strangers, they would also become under the

partnership of law inter se, and it would cut at the very root of the notion of a joint undivided family to hold that with reference to coparcenary

properties the members can at the same time be both coparceners and partners.

It is thus clear that the principle laid won by the Judicial Committee in Lachhman Das. v. CIT [1948] 16 ITR 35, that the karta of a HUF can

enter into a partnership with an individual member of the coparcenary in respect of his separate property was approved by the Supreme Court and

there can, therefore, be no doubt regarding the validity of such a partnership between the karta of a HUF and a coparcener falling within the

principle laid down by the Judicial Committee in Lachhman Das v. CIT [1948] 16 ITR 35. Again while approving the ratio in Lachhman Das v.

CIT [1948] 16 ITR 35 and Sir Sunder Singh Majithia v. CIT [1942] 10 ITR 457, the Supreme Court has also pointed out that by reason of the

fact that the karta of a family has entered into a partnership on behalf of the HUF, the individual members thereof cannot be considered as partners

in the firm in their individual capacity but that can be so only in respect of a partnership entered into with the karta with their separate or divided

property. The Supreme Court has also cautioned that if the individual members of a family, who had entered into a partnership though its karta, are

sold to be regarded as having become partners in a firm with a stranger, that would strike at the very notion of a joint undivided family, as with

reference to the interest of the HUF in the firm, they would at the same time occupy the position of partners as well as coparceners. The

observations of the Supreme Court thus made in the aforesaid context cannot be pressed into service by the Revenue in this case, where, on the

facts, the capital contribution by Natarajan and Kandaswami in the partnership business had been found to be from out of their own separate or

self-acquired earnings. In Shah Purshottamdas Ghelabhai v. CIT [1974] 96 ITR 442 , a similar question regarding the validity of the partnership

formed between the karta of a HUF and the coparceners, who contributed their separate capital, came up for consideration. There, it was held,

applying the ratio in Lachhman Das v. CIT [1948] 16 ITR 35 and Firm of Bhagat Ram Mohanlal Vs. The Commissioner of Excess Profits Tax,

Madhya Pradesh, Nagpur and Another, , that there could be valid partnership between the karta or HUF and one or more of its coparceners in

their individual capacity while still remaining joint if the coparcener contributes to the partnership what is admittedly his separate property held in his

individual capacity and unconnected with the family funds and that such a partnership can be entered into not only for commencing a new business,

but also in respect of an existing joint family business and such a firm would be entitled to registration under s. 26A of the Indian Act, 1922. In

view of the facts found in this faces that the contribution made by Natarajan and Kandaswami towards capital for the partnership proceeded from

their earnings or from out of the amounts which belonged to them separately and exclusively, it has to be held that in the light of the principles laid

down by the Privy Council and the Supreme Court referred to earlier that the partnership, on the facts found in this case, would be perfectly valid

in law. We, therefore, agree with the conclusion of the Tribunal and answer the question referred to us in the affirmative and against the Revenue.

There will be however, however, no order as to costs.