Ekambaranathan Chettiar vs Commissioner of Income Tax

N.V. Balasubramanian J.

The common question of law arising out of the orders of assessment of income of the assessee for the assessment years 1978-79 to 1980-81,

referred to us for our consideration reads as under:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the appellant firm was not entitled to registration

and continuance of registration for the assessment years 1978-79 to 1980-81 ?

The assessee is a firm constituted by a deed of partnership dated July 26, 1977, consisting of E. Vishalakshmi Ammal, K. Thulasiram and K.

Gnanapandian. Clause 6 of the deed of partnership provides for the profit-sharing ratio amongst the partners and according to that, all the three

partners are entitled to share the profits equally at the rate of one third each. The Income Tax Officer found from the books of account of the firm

that the profit of the firm was shared among the partners at variance with Clause 6 of the partnership deed. He found from the accounts that the

profit of the firm was shared at the rate of 50 : 25 : 25 as against l/3rd share as found in the deed of partnership. The Income Tax Officer held that

the firm was not a genuine firm and invoked the provisions of Section 186(1) of the Income Tax Act, 1961 (hereinafter to be referred to as ""the

Act""), and cancelled the registration granted to the firm.

The Commissioner of Income Tax (Appeals) upheld the order of the Income Tax Officer. The Appellate Tribunal on further appeal by the

assessee, dismissed the appeal preferred by the assessee on the view that there was no genuine firm in existence as registered and the assessee had

not made any attempt to rectify the error already occurred. The Tribunal held that on a plain reading of Section 186 of the Act, there was no

genuine firm in existence and the firm was not constituted in accordance with the partnership deed dated July 26, 1977. The assessee has

challenged the order of the Appellate Tribunal.

Mr. R. Janakiraman, learned counsel for the assessee, submitted that under the provisions of Section 184 of the Act, the Income Tax Officer is

required to consider only two matters : (i) whether the firm is a genuine one ; and (ii) whether the firm was constituted in accordance with the terms

of the partnership deed. According* to learned counsel for the assessee, the Income Tax Officer has granted registration after satisfying himself

that the firm was a genuine one and the firm was constituted under the terms of the partnership deed. He submitted that the expression, ""genuine

ness of the firm"" in Section 186 of the Act should be given the same meaning as found in Section 184 of the Act, and it is not open to the Income

Tax Officer to travel beyond the scope of Section 184 of the Act and cancel the registration because the profits of the firm were distributed in the

accounts of the firm not in accordance with the terms of the partnership deed. Learned counsel referred to Section 271(4) of the Act and

submitted that if the firm had distributed the profits among the partners not in accordance with the terms of the partnership deed, the only course

available to the Income Tax Officer would be to levy penalty u/s 271 of the Act and it is not open to him to cancel the registration. Learned

counsel for the assessee also submitted that the Income Tax Officer should have given an opportunity to the assessee to rectify the defects in the

form of application for registration and, therefore, the cancellation of registration of the firm was not valid in law.

Learned counsel for the Revenue, on the other hand, submitted that the expression, ""genuineness of the firm"" would comprehend not only the

two aspects advanced by learned counsel for the assessee, but would include all other matters which relate to the distribution of profits among the

partners and when the firm has not distributed the profits in accordance with the terms of the partnership deed, the firm is not entitled to the benefit

of registration and is not entitled to continuation of registration.

Section 184 of the Act deals with the registration of a firm and it provides that for registration of a firm, the partnership is to be evidenced by an

instrument and the individual shares of the partners are to be specified in the instrument. Sub-section (1) of Section 184 of the Act deals with the

application for registration and Section 184(6) of the Act provides that the application should be in the prescribed form and shall contain the

prescribed particulars. Rule 22(2)(i) of the Income Tax Rules, 1962, provides that the application shall be made in the prescribed form and the

prescribed form is Form No. 11. Under Clause (4) of Form No. 11, the partners should specify that the profits of the firm relevant for the previous

year were/will be divided or credited as shown in the Schedule and there is also a requirement that the information given in the Schedule should be

verified to be correct, and in the Schedule to Form No. 11, the partners are required to state the mode of sharing the balance of the profits or loss

and specify the percentage of the share of the profit or loss of the sharer. Section 185 of the Act prescribes the procedure to be followed on

receipt of the application for registration and u/s 185 of the Act, the Income Tax Officer is required to inquire into the genuineness of the firm and

its constitution as specified in the instrument of partnership and if he is satisfied that there is or was during the previous year in existence, a genuine

firm with the constitution so specified, he shall pass an order in writing registering the firm for the particular assessment year. Section 186 of the

Act, empowers the Income Tax Officer to cancel the registration of the firm, if he is satisfied that there was during the previous year no genuine

firm in existence as registered, after giving a reasonable opportunity to the assessee and after getting approval of the Inspecting Assistant

Commissioner.

The essential conditions for the grant of registration of a firm under the provisions of Section 26A of the Indian Income Tax Act, 1922, were

considered by the Supreme Court in R. C. Miter and Sons v. CIT , and the Supreme Court held that the following conditions should be satisfied

for the grant of registration to the firm (page 198) :

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

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 ;

That the application has been made before the assessment of the income of the firm, made u/s 23 of the Act (omitting the words not necessary

for our present purpose) for that particular year ;

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,

That the partnership must have been genuine, and must actually have existed in conformity with the terms and conditions of the instrument.

The position of law stated in the above decision of the Supreme Court was reiterated by the Supreme Court in another case in Ratanchand

Darbarilal Vs. Commissioner of Income Tax, M.P., . The apex court has laid down that one of the conditions to be satisfied for the grant of

registration is that the profit or loss, if any, of the business relating to the accounting year should have been divided or credited, as the case may be,

in accordance with the terms of the instrument of partnership and only on fulfilment of all the conditions, there is an obligation cast upon the Income

Tax Officer to grant the benefit of registration and allow the firm to have benefit of registration.

The Supreme Court in Sri Ramamohan Motor Service Vs. Commissioner of Income Tax, Hyderabad, , has taken the view that before the firm

can claim the benefit of registration, the firm must strictly comply with all the requirements of the section concerned and the substantial compliance

with the rules would not be sufficient for the grant of registration.

It is in the light of the decisions of the Supreme Court, that the question whether the assessee is entitled to the registration of the firm has to be

considered. The Allahabad High Court in Setha Ram Dhanvir Singh Vs. Commissioner of Income Tax, , on a more or less similar factual situation

held that if the Income Tax Officer finds that factually the division of profit or loss was at variance with the shares specified in the instrument of

partnership, it would he open to the Income Tax Officer to cancel the registration of the firm. The reasoning'' of the court was that the expression,

genuineness of the firm"" in Section 186 of the Act would indicate that the firm applying for registration must be really in existence and the partners

are collectively carrying on the business and the conditions like the specified constitution of the firm, the identity of the partners and their shares in

the profit or loss of the firm''s business should be satisfied. The Allahabad High Court held that if it was found that the partners after indicating one

mode of division of profit or loss in the deed of partnership, have divided the profit or loss by adopting some other share ratio voluntarily and

knowingly, the firm cannot be regarded as a genuine firm with the specified constitution. We are in agreement with the view expressed by the

Allahabad High Court. We have seen that it is the requirement of law that the identity of the partners must be disclosed and their share in the profit

or loss must be specified in the instrument of partnership and the partners are all required to divide the profits in accordance with the shares

specified in the instrument of partnership and the division of profits by the partners must be in accordance with the terms contained in the instrument

of partnership and it is on the fulfilment of all the conditions that it can be said that the firm registered is a genuine firm as constituted and can be

registered under the provisions of the Act. In our view, the expression, ""genuineness of the firm"", in the context of Sections 184 to 186 of the Act is

not limited or confined to the mode of business carried on by the firm, but it would encompass within itself other essential requirements for the

g''rant of registration of the firm and one of the essential requirements for the grant of registration is the division of profits by the partners in

accordance with the shares specified in the instrument of partnership.

Coming to the facts of the case, the assessee at the time of filing"" the application for registration in the prescribed statutory form has given an

undertaking"" that the profits of the firm would be distributed in accordance with the Schedule to Form No. 11, but ultimately, it was found that the

profits were not distributed in accordance with the instrument of partnership. Therefore it must be held that there is a breach of the statutory

undertaking by all the partners and the breach of the statutory undertaking will have the effect of denial of the benefit of grant of registration to the

firm.

The submission of learned counsel for the assessee was that the assessee should have been given an opportunity by the Income Tax Officer to

rectify the defects noticed by him. The statement with reference to the division of profits is found in the accounts of the firm and when the assessee

consciously admitted that there was a division of profits not in accordance with the instrument of partnership, it is not necessary for the Income Tax

Officer to grant a fresh opportunity to the assessee to rectify the defects as the defects contemplated in Section 185(2) of the Act would not cover

conscious defect committed by the assessee in the division of profits among the partners not in accordance with the terms of the partnership deed.

We are of the view that the question of granting an opportunity would arise had there been some defect in the form filed for the purpose of

registration. We hold that where according to the accounts, the profits of the firm have already been divided, the granting of an opportunity to

rectify the defect in the form would be an empty formality and would serve no purpose as the profits have already been divided among the partners

in a particular manner as exhibited in the accounts and the accounts cannot be rewritten contradicting the actual division of profits among the

partners, particularly in a case where it was found that the error committed was not accidental, but deliberate in the division of profits.

N.S.S. Sokkalingam Chettiar and Co. Vs. Commissioner of Income Tax, Madras, , is a case dealing with registration of a firm and in that case

on the facts it was found that there was no division of profits in accordance with the terms of the partnership deed, and some of the partners were

paid salary in addition to their shares to which they were entitled under the terms of the partnership deed. This court held that the net profits were

arrived at after deducting the salary given to the employees and the fact that some of the partners undertook to do certain extra duties of the firm

and were paid for it would make no difference and the decision is clearly distinguishable and is not applicable to the facts of this case.

Learned counsel for the assessee also relied upon the decision of the Rajasthan High Court in the case of Commissioner of Income Tax Vs.

Narbada Shankar Bhikkabhai, . In that case it was found that the profits were divided in accordance with the terms of the partnership deed and

the only difference was that instead of 100 per cent. 63 per cent, of the profits were divided among the partners, except one of them who had

retired and who had 37 per cent. Therefore, the decision of the Rajasthan High Court is not applicable to the facts of the case.

Learned counsel for the assessee also brought before us the decision of the Supreme Court in the case of Agarwal and Co. Vs. Commissioner

of Income Tax, Uttar Pradesh, , wherein the conditions for registration prescribed in Section 26A of the Indian Income Tax Act, 1922, were

considered. The Supreme Court in the above case reiterated the following conditions (page 17) :

(1) On behalf of the firm, an application should be made to the Income Tax Officer by such person and at such time and containing such

particulars, being in such form and verified in such manner as are prescribed by the rules ;

(2) the firm should be constituted under an instrument of partnership ;

(3) the instrument must specify the individual shares of the partners; and

(4) the partnership must be valid and genuine and must actually exist in the terms specified in the instrument.

Learned counsel for the assessee, therefore, contended that the condition that the profit or loss of the business of the firm should have been

divided or credited in accordance with the terms of the partnership deed is not an essential condition as held by the Supreme Court in considering

the question whether the firm is a genuine one or not. He also relied upon the decision of the Supreme Court in the case of Commissioner of

Income Tax, Madras Vs. Sivakasi Match Export Company, , and submitted that the jurisdiction of the Income Tax Officer to grant registration is

confined to two aspects : (i) whether the application for registration was in conformity with the rules made under the Act ; and (ii) whether the firm

shown in the document presented for registration was a bogus one or had no legal existence. The decisions of the Supreme Court in Commissioner

of Income Tax, Madras Vs. Sivakasi Match Export Company, and in Agarwal and Co. Vs. Commissioner of Income Tax, Uttar Pradesh, , are

not applicable to the facts of the case. In both the cases, the Supreme Court was not dealing with the question whether the firm would be regarded

as a genuine firm though the profits of the firm were not distributed in accordance with the terms of the partnership deed and in the statutory

declaration, a different profit-sharing ratio was indicated. The Supreme Court in Ratanchand Darbarilal Vs. Commissioner of Income Tax, M.P.,

after noticing the decision in Commissioner of Income Tax, Madras Vs. Sivakasi Match Export Company, , held that one of the essential

conditions for the registration of a firm is that the profit or loss of the business should be divided or credited in accordance with the terms of the

partnership deed.

The assessee, in the instant case, had not divided the profits of the firm in accordance with the terms of the partnership deed. Further, the

Supreme Court in Commissioner of Income Tax, Madras Vs. Sivakasi Match Export Company, , held that the Income Tax Officer should not

reject the application for registration, if the assessee furnished necessary particulars prescribed for registration. The decision of the Supreme Court

makes it clear that furnishing of particulars in accordance with the rules is an essential requirement and in the instant case, there is a variation in the

mode of sharing the profits between the form filed for grant of registration and the deed of partnership and, hence, the firm is not liable to be

regarded as a genuine firm. The assessee filed the requisite form on the basis of the accounts maintained by the partnership firm and when the entire

form is liable to be rejected, it cannot be said that there was an application pending before the Income Tax Officer for his consideration for the

grant of registration.

Learned counsel for the Revenue invited our attention to the decision of the Punjab and Haryana High Court in the case of Commissioner of

Income Tax Vs. Ram Saran Inder Singh, , wherein the court held that the assesses is not entitled to registration and continuation thereof as the

corrigendum with regard to the distribution of profits was issued subsequently. The Punjab and Haryana High Court further held that there was no

valid partnership deed in existence for the firm till that date. The Punjab and Haryana High Court proceeded on the basis that where there is a

change in the constitution of the firm and the new constitution was evidenced by the new partnership deed and the distribution of profits was not in

accordance with the new partnership deed, the firm is not entitled to registration. The decision of the Punjab and Haryana High Court, in our view,

supports the case of the Revenue to the extent that profits of the firm should be distributed in accordance with the terms of the partnership deed

and if it was not distributed in accordance with the terms of the partnership deed, then, the conclusion that follows will be that the firm was not

constituted in accordance with the terms of the partnership deed.

Learned counsel for the assessee also referred to the provisions of Section 271(4) of the Act and submitted that if the profits of the registered

firm have not been distributed in accordance with the shares of partners as shown in the instrument of partnership, the partners would be liable to

pay penalty, and he submitted that the Income Tax Officer should have proceeded under the provisions of Section 271(4) of the Act and should

not have cancelled the registration of the firm on the ground that it is not a genuine firm. In other words, according to learned counsel for the asses-

see, the only remedy available for the Income Tax Officer would be to levy penalty u/s 271(4) of the Act and he has no power to cancel the

registration u/s 186 of the Act. We are unable to accept the contention of learned counsel for the assessee. Section 271(4) of the Act provides for

levy of penalty on the partners in a case where the profits of the firm were not distributed in accordance with the terms of the partnership deed,

but, on the other hand, Section 186 is intended to operate against the firm in such contingency, the registration of the firm is liable to be cancelled

u/s 186 of the Act on the ground that the firm is not a genuine one.

It is no doubt true that the Income Tax Officer has the power to levy penalty on the partners u/s 271(4) of the Act. In our view, in the absence

of any provision showing any contrary intention, there is an option left with the Income Tax Officer to invoke any one of the provisions or both the

provisions. Further, the availability of the power to levy penalty against the partners u/s 271(4) of the Act does not in our view, preclude the

Income Tax Officer from exercising his powers u/s 186 of the Act, if the statutory requirements found in Section 186 are satisfied. In our view, the

two powers conferred upon the Income Tax Officer by the Act are distinct and different and the availability of one does not preclude the officer

from exercising another statutory power vested in him.

We find that the explanation offered by the assessee that the division of shares as shown in the accounts was an error and was not intentional

was not accepted by one of the authorities. The assessee-firm has not made any attempt to rectify the error that crept in its accounts and it was

found that the error was not accidental. In our view, since the profits of the firm were divided not in accordance with the terms of the instrument of

partnership, the Tribunal was justified in holding that there was no genuine firm in existence and the order of the Tribunal holding that the firm was

not constituted in accordance with the partnership deed dated July 26, 1977, and hence, not a genuine firm is sustainable in law.

Accordingly, we answer the common question of law referred to us in the affirmative in all the tax cases, against the assessee and in favour of

the Revenue. The Revenue will be entitled to costs of the reference of a sum of Rs. 2,000 one set.