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City Tobacco Mart v. Commissioner Of Income-Tax, Mysore
Analytical Summary of the Opinion
Factual and Procedural Background
For the assessment years 1952-53 and 1953-54 the concern called the City Tobacco Mart claimed to be a partnership entitled to registration under section 26A of the Indian Income-tax Act, 1922. A written partnership instrument dated March 12, 1951 purported to constitute a firm of five partners:
- H. Mohamed Khan (first partner)
- Mohurunnisa Begum (second partner; wife of the first)
- N. Mohamed Khan (third partner; son of the first)
- H. Gaffar Khan (fourth partner; employee of the first)
- Mirza Habibulla Baig (fifth partner; employee of the first)
The deed provided that capital would be contributed only by the first two partners: Rs. 6,00,000 by the first partner and Rs. 55,500 by the second partner (the wife). The Income-tax Officer refused registration and, in the personal assessment of H. Mohamed Khan, held that the Rs. 55,500 shown as the wife's contribution was in fact contributed by the husband.
On appeal the Appellate Assistant Commissioner accepted that the wife's shown capital was the husband's money, but — after taking statements and considering circumstances — concluded that the other members (partners nos. 3–5) had in fact been admitted as partners. He therefore granted registration in respect of a partnership consisting of partners nos. 1 and 3–5 (omitting the wife).
Both the assessee and the department appealed to the Appellate Tribunal. The Tribunal held that there was no genuine partnership deserving of registration under section 26A. The Tribunal declined to refer any question of law to the High Court under sub-section (1) of section 66. The assessee applied under sub-section (2) of section 66 for a direction to the Tribunal to refer a question of law; this Court directed the Tribunal to refer the following question:
“Whether, on the facts and in the circumstances of the case, the Tribunal was right on the material before it in holding that the firm constituted under the partnership deed dated March 12, 1951, is not a genuine firm?”
The present opinion is the result of that reference and the Court's consideration of the material placed before the Tribunal.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Tribunal was right on the material before it in holding that the firm constituted under the partnership deed dated March 12, 1951, is not a genuine firm?
- Whether the exclusive proprietorship rights reserved to the first two partners in the business assets (clause 2 of the deed) have the effect of depriving the other partners of the status of partners?
- Whether the special right given to the first two partners to introduce new partners and to change the profit shares of the working partners (clause 2 of the deed) has the effect of destroying the partnership character?
Arguments of the Parties
Respondent / Department
- The assessing authority and the department contended that registration should be refused because the Rs. 55,500 shown as capital contributed by the wife was actually contributed by the husband; this was relied upon to argue that the wife did not acquire the status of a partner.
- The department (and the Tribunal, adopting its reasoning) also relied upon certain clauses of the partnership deed — notably clauses (2) and (4) — contending that the overriding powers retained by the first two partners were such as to destroy the character of partnership.
Appellant / Assessee
- The assessee sought registration under section 26A and, after the Tribunal held there was no genuine firm and declined to refer a question of law, contended that a question of law did arise and consequently sought the Court's direction under section 66(2) for a reference. The Court accepted that a question of law arose and framed the reference accordingly.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income-tax v. A. Abdul Rahim & Co., [1965] 55 I.T.R. 651 S.C. | The principle that one partner being a benamidar (nominee) of another does not, by itself, deprive the benamidar of the status of a partner in relation to other partners; the factual relationship between two persons (e.g., benamidar and real owner) need not change their contractual relationship with other partners. | The Court held that the Tribunal's first reason (that the wife being a benamidar of the husband meant she did not acquire partner status) could not be relied upon, in view of this Supreme Court authority; consequently the first reason for rejecting genuineness of the firm failed. |
Court's Reasoning and Analysis
The Court summarized the Tribunal's two principal reasons for holding that the firm was not genuine:
- The finding that the wife's capital contribution was in truth the husband's money (leading to the conclusion she did not acquire partner status).
- The presence of overriding powers in clauses (2) and (4) of the deed, which the Tribunal considered destructive of partnership character.
The Court examined and rejected the first reason by reference to the Supreme Court decision in Commissioner of Income-tax v. A. Abdul Rahim & Co. That decision establishes that a partner's being a benamidar of another partner does not, by itself, deprive the benamidar of partner status vis-à-vis other partners. The Court applied that principle and concluded the Tribunal could not rely on the benamidar finding to deny partner status.
The Court then considered the clauses relied on by the Tribunal. It reproduced the relevant clauses:
- Clause (2): Business assets to belong exclusively to the first and second partners in proportion to capital investments; working partners to have rights only to unpaid credit of their share of profit; first and second partners may take in more partners and change the share of profit of the working partners as agreed.
- Clause (4): Management of the business to be by the working partner H. Gaffar Khan (fourth), assisted by working partners third and fifth, under supervision of the first and second partners; in his absence by the third partner.
As to clause (4), the Court noted the Tribunal itself acknowledged that partners are free to define their mutual rights and obligations and that section 20 of the Partnership Act allows partners by contract to extend or restrict the implied authority of any partner. Thus clause (4) was not necessarily destructive of partnership character.
The Court framed two precise points in relation to clause (2):
- Whether exclusive proprietorship reserved to the first two partners in the business assets deprived other partners of partner status.
- Whether the special right of the first two partners to introduce new partners and change the shares of the working partners similarly destroyed partnership character.
On the first point the Court observed that the deed admittedly contemplated capital only from the first two partners. The department argued that because the wife's contribution was held to be the husband's, effectively there was only one capitalist partner and therefore the rights claimed by the "first two" were in reality those of a single partner. The Court treated that as equivalent to the argument rejected in the Abdul Rahim case and therefore insufficient. The Court further reasoned that it is not unusual to provide contractually special protection to a financing or capitalist partner; such protection does not, by itself, negate partnership status whether there is one financier or more.
On the second point concerning the power to introduce new partners and to alter profit shares, the Court explained the power should be seen in the light of protecting the financing partners' proprietary interests. The real issue is not the positive power but the implied deprivation of the same power in the working partners. The Court noted that absent an express provision, introduction of new partners requires consent of all partners and that section 31 (as mentioned in the opinion) recognizes that the ban on introducing partners without consent is subject to contract between the partners. Thus the express contractual provision in the deed was consistent with statutory law and can be understood as necessary to protect the financing partners' interests.
The Court also observed that the power to change profit shares was consequential on the introduction of a new partner and necessary if a new partner were admitted because the deed's profit shares were exhaustive (the noted fractions/annas exhaust the entire profit allocation).
The Court concluded that the Tribunal had not adequately analysed clause (2) in the way the Court did and had not identified any other material facts that would justify finding the partnership not genuine. Indeed, the Court held that the material before the Tribunal pointed towards the partnership being genuine rather than otherwise.
Holding and Implications
Holding: The Court answered the referred question in favour of the assessee. It held that the Tribunal was not right, on the material before it, in holding that the firm constituted under the partnership deed dated March 12, 1951, is not a genuine firm; on the contrary, it should have held that the firm was a genuine one.
Consequences and immediate effects:
- The assessee obtains a favorable answer to the question of law referred to the Court; the Tribunal's conclusion that the firm was not genuine is set aside to the extent inconsistent with this answer.
- The Court awarded costs to the assessee for the reference and fixed the advocate's fee at Rs. 250.
Broader implications:
- The decision applies the Supreme Court's authority (Commissioner of Income-tax v. A. Abdul Rahim & Co.) to reject the proposition that a benamidar relationship automatically negates partner status; the Court emphasised that contractual arrangements protecting financing partners do not necessarily destroy partnership character.
- The opinion does not purport to establish a new legal precedent beyond applying and explaining existing principles; it resolves the reference by finding that the Tribunal's reasons were insufficient on the material before it.
Disposition: Question answered in favour of the assessee; costs to the assessee and advocate's fee Rs. 250.
Narayana Pai, J.:— In respect of the assessment for the two years 1952-53 and 1953-54, the claim was made by the concern called the City Tobacco Mart, that it was a partnership entitled to registration under section 26A of the Indian Income-tax Act, 1922. According to the case, the partnership which was constituted by a written instrument was to consist of five partners, namely:
(1) H. Mohamed Khan,
(2) Mohurunnisa Begum,
(3) N. Mohamed Khan,
(4) H. Gaffar Khan,
(5) Mirza Habibulla Baig.
2. Out of these, number 2 is the wife of number one, and number 3, the son of number one. Numbers 4 and 5 were employees under number one. The capital was to be contributed only by the first two in the sum of Rs. 6,00,000 by the former and R. 55,500 by the latter. The assessing authority, the Income-tax Officer, refused registration. In the personal assessment of H. Mohamed Khan, he also held that the sum of Rs. 55,500 shown as capital contribution by the wife was in fact not her money, but a contribution by the husband himself.
3. Upon Appeal, the Appellate Assistant Commissioner accepted the finding that the capital contribution shown as having been made by the wife was, in truth, contribution by the husband himself. But upon further investigation into the attendant circumstances and relevant facts and after recording sworn statements of the parties concerned, he felt satisfied that the other members of the partnership had in fact been admitted as partners, although till the date of the constitution of the firm some of them had been working only as employees of the first partner. He, therefore, thought that it was a case in which registration under section 26A could be granted in respect of the partnership composed of partners Nos. 1 and 3 to 5, omitting No. 2.
4. Both the assessee and the department were dissatisfied with this order and both of them went on appeal to the Appellate Tribunal, before which the department succeeded. The Tribunal came to the conclusion that there was no genuine partnership at all deserving of registration or capable of being registered under section 26A of the Act.
5. The Tribunal having refused to refer any question of law to the High Court on an application made to it by the assessee under sub-section (1) of section 66, the assessee moved this court for a direction to the Tribunal under sub-section (2) of the said section. This court, accepting the contention of the assessee that a question of law did arise out of the order of the Appellate Tribunal, directed the Tribunal to refer to this court, together with a statement of the case, the following question of law:
“Whether, on the facts and in the circumstances of the case, the Tribunal was right on the material before it in holding that the firm constituted under the partnership deed dated March 12, 1951, is not a genuine firm?”
6. The present reference is one made pursuant to that direction.
7. The Tribunal gave two principal reasons in support of its conclusion: (i) that the finding accepted by the first two authorities that what appeared to be capital contributed by the wife was really the contribution by the husband, was sufficient to make out that the wife did not acquire the status of a partner; (ii) that the overriding powers given to the first two partners in clauses (2) and (4) of the deed of partnership were such as to destroy the character of partnership.
8. The first reason is no longer available in view of the decision of the Supreme Court in Commissioner of Income-tax v. A. Abdul Rahim & Co. [1965] 55 I.T.R 651 S.C. Their Lordships distinctly state that the fact that one of the partners may be a benamidar of another partner is by itself insufficient to deprive the benamidar of the status of a partner in relation to other partners. Just as a person may be a partner in a firm on behalf of the joint family or as manager of a joint family, and his capacity as manager of the joint family is a capacity limited to the ascertainment of rights as between him and the members of his family and not to any extent bringing about a change in the ordinary contractual relationship of partner between him and other partners, so also the fact that as between two persons one is a benamidar and the other the real owner need not have any bearing on the relationship of either or both of them with the other persons constituting the firm.
9. This clarification of the principle by the Supreme Court makes it impossible to rely upon the first reason to hold against the genuineness of the firm.
10. The clauses of the partnership deed depended upon by the Tribunal read as follows:
“(2). The business assets shall belong exclusively to the first and second partners in the proportion of the capital investments and the working partners shall have a right in the assets only to the extent of any unpaid credit of their share of profit in the accounts. It is open to the first and second partners to take in more partners and to change the share of the profit of the working partners as agreed to herein….
(4) The business of the partnership shall be managed by H. Gaffar Khan, the working partner of the fourth part, with the assistance of the working partners of the third and fifth parts, and in his absence by N. Mohamed Khan, the working partner of the third part, under the supervision of the first and second partners.
11. Regarding the fourth clause, the Tribunal itself does not seem to think that it would necessarily make any difference to the situation, because immediately after quoting the clause they state, “we do not intend to say that persons agreeing to enter into a partnership are not at liberty to define their mutual rights and obligations in the way they like.” That is exactly what the law itself states in section 20 of the Partnership Act, according to which it is open to partners by contract between themselves either to extend or restrict the implied authority of any partner.
12. The two points for consideration in relation to clause No. (2) are:
“(1) Whether the exclusive rights of proprietorship reserved to the firstb two partners in the business assets of the firm have any effect on the rights of other partners as partners so as to deprive them of the status of a partner?
(2) Whether the special right given to the first two partners to introduce new partners and change the share of profits of the working partners has a similar effect?”
13. Obviously, the first provision need not have any such effect as stated above. Admittedly, the capital was contributed only by the first two partners according to the deed. The only argument on behalf of the department in that regard was that in the light of the finding that the wife's contribution also was made by the husband, we have only one capitalist-partner in this case and that, therefore, what is really said to be a right appertaining to the first two partners is in actual event a right belonging only to one partner. This is, in our opinion, a restatement of the argument rejected by the Supreme Court in the case cited above. Even otherwise, if there is nothing out of the way—and it is in fact not uncommon—to provide for special considerations in favour of a capitalist or a financing partner in protection of his financial or proprietary interest, it should make no difference whether there is only one such partner or more partners than one in a partnership.
14. The power given to the financing partners to introduce new partners may also, in one sense, be related to the same idea of protecting their financial and proprietary interests. What is of real importance is not the positive power given to the first two partners to introduce new partners, but the implied deprivation of a similar right in the other three partners. In the absence of such a provision, it would have been impossible to introduce new partners except on a common agreement of all the five partners; and because the majority in number is that of the working partners, there could always have been a possibility of a person not enjoying the confidence of the financing partners entering the partnership to the real or at least apprehended prejudice of the financing partners. Section 31 itself says that the ban against the introduction of partners without the consent of all is subject to a contract between the partners. Obviously, it is in the light of this provision of law that express contract of the type mentioned above was considered necessary or desirable. The power to change the shares of the profit of working partners as stipulated in the deed is not, in our opinion, to be regarded as a power to be exercised independently of the introduction of a new partner; it is really consequential upon the introduction of a new partner and quite necessary in such an event, because, according to the deed, the shares were:
First partner — four annas, Second partner — two annas, Third partner — four annas, Fourth partner — four annas, Fifth partner — two annas,
thus exhaustive of all the profits.
15. If the Tribunal had analysed the position in the manner we have done above, we do not think that it would have entertained the opinion that there is anything in the second clause which is destructive of the character of partnership. It also does not appear to us that any circumstance other than what is stated above was taken into account by the Tribunal to come to the conclusion that the partnership was not a genuine one. All that the Tribunal says is that “taking into consideration all the relevant facts and the manner in which the rights and obligations of the persons inter se are defined…”, it was unable to say that the working partners were really partners.
16. In the light of the foregoing discussion, it becomes clear that not only was there no material in support of the conclusion of the Tribunal but that such material as there is points to the partnership being a genuine one rather than otherwise. We, therefore, answer the question referred to us in favour of the assessee as follows:
On the facts and in the circumstances of the case, the Tribunal was not right, on the material placed before it, in holding that the firm constituted under the partnership deed dated March 12, 1951, is not a genuine firm; on the contrary, it should have held that the firm was a genuine one.
17. The assessee will have the Costs of this reference. Advocate's fee Rs. 250.
18. Question answered in favour of the assessee.
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