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Punjab Fruit Co. v. Commissioner Of Income-Tax, New Delhi.
Judgment Summary — Wadhwa, J.
Factual and Procedural Background
(Narrative limited strictly to facts and procedure set out in the provided opinion.)
M/s. Punjab Fruits Co. was a partnership constituted by a deed dated 12 June 1968 and it commenced business with effect from 6 June 1968. The firm had six partners whose profit‑sharing percentages were recorded in the partnership deed as:
- Shri Brij Lal – 10%
- Shri Chhajju Mal S/o Sh. Munshi Lal – 20%
- Shri Om Prakash S/o Sh. Desh Raj – 25%
- Shri Suresh Kumar S/o Sh. Chhajju Mal – 10%
- Shri Prem Kumar – 20%
- Shri Om Prakash S/o Sh. Hari Chand – 15%
For the assessment year 1970‑71 (relevant previous year: 6 June 1968 to 30 June 1969) the firm earned profits and, in its books, divided those profits among all six partners according to the partnership deed. In the following year the firm suffered heavy losses; this led to a suit for dissolution and rendition of accounts filed on 5 June 1970 by Chhajju Mal. That suit was compromised by a compromise deed dated 30 July 1970, by which Chhajju Mal and his son Suresh Kumar retired from the partnership effective on that date.
The firm applied for registration under s.184 of the Income‑tax Act, 1961 (the Act) and the application came before the Income‑tax Officer (ITO) under s.185. The ITO, by order dated 8 February 1973, declined registration and assessed the firm as unregistered for AY 1970‑71, but made an allocation of share amounts (for rate purposes) among the six persons in specific rupee figures set out in the record.
On appeal the Appellate Assistant Commissioner (AAC) set aside the ITO's order and held that the firm was entitled to registration because, as he found, profits had been divided among all six partners for the relevant period and the relevant credit balances as on 30 June 1969 had been acted upon. On further appeal by the ITO the Tribunal reversed the AAC and restored the ITO's order; the Tribunal accepted the Department's contention that the compromise deed of 30 July 1970 purportedly amended the partnership deed retrospectively (back to 6 June 1968) reducing partners from six to four and relied on clause 5(a) of the compromise.
The question (reproduced below) was referred to the court under s.256(1) of the Act:
“Whether, on the facts and in the circumstances of the case the Tribunal was right in holding that the firm was not entitled to the claim of registration?”
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the firm was not entitled to the claim of registration?
Arguments of the Parties
Revenue / ITO (and Department) — as represented in the opinion
- The compromise deed dated 30 July 1970, particularly clause 5(a), purported to amend the partnership deed retrospectively with effect from 6 June 1968 and thereby reduce the number of partners from six to four.
- On that basis the firm was not a genuine six‑partner firm for the earlier period and registration could be refused.
- Reference was made to prior decisions (not named in the opinion) where registration or renewal was refused where profits had not been divided among partners as per the partnership deed or where undistributed/black‑market profits were involved.
- The Tribunal relied also on the power under s.186 of the Act to cancel registration subsequently, using that to support the conclusion that the effect of the compromise deed could justify treating registration as unavailable.
Firm / Assessee (and AAC findings) — as represented in the opinion
- The relevant position for registration was the factual position during the relevant previous year (ending 30 June 1969): the firm had earned profits and those profits were divided in the books among all six partners as per the partnership deed.
- The AAC found that on 30 June 1969 the outgoing partners had credit balances (specific figures recorded in the record) and that these balances had been acted upon (withdrawals or later losses), demonstrating genuine operation during the relevant period.
- The compromise deed recorded retirement effective 30 July 1970 and included clauses (3) and (4) acknowledging payment/receipts of amounts standing to the credit of the outgoing partners as on that retirement date — i.e., the compromise settled the retirement, but did not change the historical fact that the firm had been constituted and operated with six partners during the relevant year.
- The firm contended (and the AAC adopted) that retrospective or declaratory language in the compromise deed could not render a genuinely constituted firm for the earlier period into a non‑genuine concern for the purposes of registration.
Table of Precedents Cited
No precedents were cited in the provided opinion.
Court's Reasoning and Analysis
The court examined the documentary record (the partnership deed and the compromise deed dated 30 July 1970) and the sequence of events. It noted that:
- The compromise deed recorded the retirement of two partners effective 30 July 1970 and contained specific clauses: clause 3 setting out the amounts standing to the credit of the two outgoing partners as on that retirement date; clause 4 recording that the outgoing partners received those amounts in cash or promissory notes and gave receipts; and clause 5 containing broader language excluding the outgoing partners from future rights or liabilities and stating they were not entitled to profits "so far".
- The court referred to s.32 of the Partnership Act in the context that, in a partnership at will, partners may retire and that the compromise recorded the terms of retirement.
- The Tribunal's view — that the compromise deed had retrospectively amended the partnership deed back to 6 June 1968 and thereby changed the firm's constitution for the earlier year — was treated critically by the court. The court emphasised that, as the AAC had found, the firm did operate during the relevant period and distributed profits among all six partners in accordance with the deed; credit balances standing to the outgoing partners as on 30 June 1969 had been acted upon subsequently.
- The court reasoned that a subsequent settlement altering the position prospectively or recording a settlement of retirement could not, by that unilateral or mutual recording, alter the historical fact that a genuine firm had existed and carried on business in the relevant period. In other words, the compromise deed could not retroactively make the firm a sham for the earlier period.
- While the court held that the ITO was wrong to refuse registration on the basis of the compromise deed (cl.5), it expressly qualified that this did not mean an ITO could never look into subsequent events occurring after the close of the relevant year if the registration application remained pending. The court did not lay down an absolute bar on considering subsequent events; it only held that in the present facts the ITO's ground for refusing registration was unsound.
Holding and Implications
Answer to the referred question: In the negative — the Tribunal was not right in holding that the firm was not entitled to registration; the firm was entitled to claim registration.
Direct consequences for the parties
- The court answered the referred question in favour of the assessee (the firm).
- The court held that the ITO was wrong to refuse registration on the basis of the compromise deed dated 30 July 1970 (clause 5), because the firm was genuinely constituted and had complied with the requirements for registration for the relevant period.
- The Commissioner (Revenue) was ordered to pay costs to the assessee.
Broader implications noted by the court
The opinion cautioned that the decision should not be read as laying down that the ITO could not consider subsequent events after the relevant year where an application for registration remained pending; such later events may be examined in appropriate circumstances. Beyond that qualification, the court did not assert any novel or sweeping legal principle — its determination was based on the application of statutory registration requirements (ss.184–186 of the Income‑tax Act and rule 22 of the Income‑tax Rules) to the facts of the case.
End of summary. This summary is strictly confined to information appearing in the provided opinion and does not add or infer facts or authorities not present in the text.
Wadhwa, J.:— The question of law which has been referred for decision is as follows:
“Whether, on the facts and in the circumstances of the case the Tribunal was right in holding that the firm was not entitled to the claim of registration?”
2. M/s. Punjab Fruits Co., the firm, was a partnership firm and was constituted by a deed of partnership dated June 12, 1968. The firm, however, commenced its business with effect from June 6, 1968. It had 6 partners. Their names and shares in the profit and loss of the business were as under
1. Shri Brij Lal 10% 2. Shri Chhajju Mai S/o Sh. Munshi Lal 20% 3. Shri Om Prakash S/o Sh. Desh Raj 25% 4. Shri Suresh Kumar S/o Sh. Chhajju Mal 10% 5. Shri Prem Kumar 20% 6. Shri Om Prakash S/o Sh. Hari Chand 15%
3. For the assessment year 1970-71 (the year under consideration) of which the previous year was June 6, 1968, to June 30, 1969, the firm earned profit and in its books divided the same as per the terms of the partnership deed among all the 6 partners. In the second year, the firm sustained heavy losses. This led, it appears, Chhajju Mal to file a suit on June 5, 1970, for dissolution of the partnership and rendition of accounts. The suit was, however, compromised in terms of a compromise deed dated July 30, 1970, by which Chhajju Mal and his son, Suresh Kumar, retired from the partnership as on that date. The application of the firm under s. 184 of the I.T Act, 1961 (for short ‘the Act’), for registration came up for consideration before the ITO concerned as required under s. 185 of the Act. The ITO by his order dated February 8, 1973, declined to grant registration to the firm and assessed the firm as unregistered for the assessment year in question, being 1970-71. He, however, made share allocation for rate purposes as under:
Rs. 1. Shri Brij Lal 6,928 2. Shri Chhajju Mal S/o Sh. Munshi Lal 13,856 3. Shri Om Prakash S/o Sh. Desh Raj 17,320 4. Shri Suresh Kumar 6,928 5. Shri Prem Kumar 13,856 6. Shri Om Parkash S/o Sh. Hari Chand 10,392
4. Referring to paragraph 5(a) of the compromise deed between the parties, the ITO was of the view that the retiring partners, Chhajju Mal and Suresh Kumar, had not been given any profit earned by the firm since the date of its formation, and thus, according to him, the profits for the assessment year 1970-71 had not been distributed among the partners as per the terms of the partnership deed. On appeal, the AAC set aside the order of the ITO. He held that the firm was entitled to claim registration. He was of the view that the ITO only took into consideration the fact of dispute among the partners as existed on the date of compromise, i.e, July 30, 1970, rather than the fact as existed on June 30, 1969, when the profits of the firm were duly divided among all the partners whereby Chhajju Mal and Suresh Kumar got Rs. 6,277 and Rs. 3,139 respectively. The AAC found that the credit balances in the accounts of these two partners on June 30, 1969, were Rs. 43,778 and Rs. 49,540 respectively. On the date of the compromise, however, balances in these two accounts came down to Rs. 22,801 and Rs. 45,200, which showed that the earlier credit balances had been acted upon by the two partners either by withdrawing the amounts from their accounts in the later period or by the loss having been debited to their accounts after June 30, 1969. He held that the firm was genuinely constituted of 6 partners and other formalities had been duly completed by the partners of the firm which entitled it to the claim for registration under s. 185 of the Act.
5. On further appeal by the ITO, the Tribunal, however, set aside the order of the AAC and restored that of the ITO. The Tribunal appears to have accepted the contention of the Department that the compromise deed dated, July 30, 1970, purported to amend the partnership deed with effect from June 6, 1968, so as to reduce the number of partners from 6 to 4. Reliance was also placed by the Tribunal on cl. 5(a) of the compromise deed. Dealing with the contention of the AAC that the position as on June 30, 1969, was relevant for the purpose of granting registration, reference was made to the provisions of s. 186 of the Act which empower the ITO to cancel registration subsequently. According to the Tribunal, first the granting of registration under s. 185 on the basis of the facts as on June 30, 1969 and later cancelling the same under s. 186 of the Act “in view of retrospective amendment of the terms of the instrument of partnership” was only a futile and unnecessary exercise.
6. At the instance of the firm, the question set out in the beginning of this judgment was referred to this court under s. 256(1) of the Act.
7. The above narration would show that but for cl. 5(a) of the compromise deed, the firm would have been granted registration. Otherwise, thus, it is not disputed that the requirements of s. 184 were met. At this stage, it will, therefore, be appropriate to refer to the deed of compromise dated July 30, 1970. Paragraph 2 of this deed recited that Chhajju Mal and Suresh Kumar retired from the partnership with effect from July 30, 1970, leaving the reconstituted firm comprising of the remaining 4 partners to continue the business of the partnership. Clause 3 stated that the amount invested by these two outgoing partners in the business of the partnership as on July 30, 1970, was Chhajju Mal Rs. 22,801; and Suresh Kumar Rs. 45,200. As per clause 4 both of these outgoing partners received either cash or promissory notes covering the above two amounts and granted receipts for having received these payments. Clause 5 was as follows:
“5(a) That the plaintiff and defendant No. 5 will henceforth have no right of any kind to the goodwill, the outstanding assets of every description, and the business premises of the firm. Similarly, the plaintiff and defendant No. 5 will neither be entitled to any profit earned by the partnership so far nor will they be liable for any loss incurred by the partnership. The profit and loss of business will belong to and be the liability of the re-constituted firm without the plaintiff and defendant No. 5 being in any manner entitled to profits or liable for losses.
(b) The re-constituted firm will be within its rights to continue the business with the remaining partners or to include more partners in their business if they so desire.
(c) Neither Shri Chhajju Mal nor Shri Suresh Kumar shall be responsible for any existing or future liability of the original firm or the re constituted firm. Similarly, the income-tax levied on the firm up to the date of retirement of Shri Chhajju Mal and Shri Suresh Kumar shall be the responsibility of the firm and neither Shri Chhajju Mal nor Shri Suresh Kumar shall be responsible for payment of the same. The ad-interim injunction order passed by this Hon'ble Court stopping the operation of the accounts in the banks of the partnership, shall be vacated.”
8. One is left in no doubt that the compromise deed recorded the terms of retirement of the two partners from the partnership. A reference in this connection may be made to s. 32 of the Partnership Act. Since, in the instant case, the partnership was at will, a partner had also the option to go in for dissolution of the firm. The partners decided, however, to retire two partners and the deed of compromise recorded the terms of retirement of the two partners as from July 30, 1970. Though cl. 5 loosely used the words that the outgoing partners “will neither be entitled to any profit earned by the partnership so far nor will they be liable for any loss incurred by the partnership”, as per cl. 3 both the outgoing partners accepted the amounts standing to their credit as on July 30, 1970. The Tribunal found that the profits of the firm for the year under consideration had been divided as per the terms of instrument in the books of the firm among all the 6 partners. The firm did carry on the business during that year. If for any reason like the firm suffering heavy losses in a subsequent year the parties decided to retire two partners and settle the terms and conditions even though stating that the outgoing partners would be deemed never to have been the partners, it would not, nevertheless, make the firm a non-genuine firm.
9. The order refusing registration was passed by the ITO on February 8, 1973. He would certainly have granted registration to the firm if he had passed the order before July 30, 1970. No explanation could be found as to how the registration could be cancelled under s. 186 of the Act if it had earlier been granted by the ITO inasmuch as a genuine firm was in existence during the year, it earned profits, it divided profits among the partners as per the terms of instrument, which credit balances were acted upon. Even reversal of an entry would not make the firm a non-genuine once if it is done under the terms of some settlement amicably reached without a winding up. The compromise deed could not affect or alter the past.
10. Counsel for the Department cited certain decisions wherein registration or renewal, of registration of a firm was refused by the ITO where it was found that the profits had not been divided among the partners as per the partnership deed or profits had not been divided at all or the profits earned by the firm in the black market were not distributed among the partners and the like. We do not find these decisions to be relevant, and it is not necessary to refer to them.
11. The requirements of ss. 184 and 185 of the Act and rule 22 of the I.T Rules, which deal with registration of a firm, are quite simple. The application for registration of a new firm is required to be made in Form No. 11 as prescribed by rule 22. It is to be accompanied by the partnership deed which must specify the individual shares of the partners. The application is to be made to the ITO concerned and is required to be signed by all the partners personally. An exception is provided in the case of a partner who is absent from India or is a lunatic or an idiot. The application is required to be made before the end of the previous year unless sufficient cause is shown for not making the application in time. The ITO then goes into the genuineness of the firm and its constitution. He is to grant registration if he is satisfied that a genuine firm with the constitution so specified was in existence during the relevant period. The expression “genuine firm” would mean that a firm is really in existence and the partners carry on the business of the firm in accordance with the terms of the deed or partnership. This is what is ordinarily understood by a genuine firm. It should not be sham or bogus. It would thus be seen that the ITO was wrong in refusing registration to the firm on the basis of the compromise deed dated July 30, 1970, and particularly with reference to cl. 5 of the compromise deed. We should, however, not be understood to lay down that the ITO could not look into the subsequent events, after the close of the relevant year, to decide the application for registration, if pending, whether a genuine firm as evidenced by an instrument of partnership existed during that period.
12. We accordingly answer the question in the negative and in favour of the assessee. The Commissioner will pay costs to the assessee.
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