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Conpro Corporation v. Commissioner Of Income-Tax, Karnataka

Karnataka High Court

Jun 11, 1984

Judgment

Subsequent
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Structured Summary of the Opinion (Jagannatha Shetty, J.)

Factual and Procedural Background

The question referred under s. 256(2) of the Income-tax Act, 1961 was whether, on the facts and circumstances of the case, the assessee-firm was not entitled to continuance of registration under the Income-tax Act, 1961.

The assessee was a partnership firm formed by a deed dated 21 June 1971. The deed named two major partners, S.N. Gundu Rao and S.C. Madhukar, as the parties to the deed, and expressly provided that Master Santosh Kadam (a minor) was "admitted to the benefits of partnership." Clause 8 of the deed allocated net profits and losses in the following proportions: S.N. Gundu Rao 20%, S.C. Madhukar 40%, Master Santosh Kadam 40%. Clause 13 stated that the minor shall have no rights over the goodwill of the firm. Clause 12 dealt with dissolution and specifically stated the minor is not liable for loss on account-taking upon dissolution.

For the assessment year 1972-73, the Income-tax Officer (ITO) granted registration to the firm under s. 185 by order dated 29 January 1975 and continued registration for 1973-74. The Commissioner, exercising powers under s. 263, held that the minor was in effect a full partner (not merely admitted to benefits) and that the registration was erroneous and prejudicial to the interests of the Revenue; accordingly, the Commissioner cancelled the registration.

The firm appealed to the Tribunal. The Tribunal confirmed the Commissioner's order on grounds including that the deed did not specify how the minor's 40% share of loss would be apportioned between the major partners and placed reliance on the Supreme Court decision in Mandyala Govindu & Co. v. CIT (1976) 102 ITR 1. The Tribunal also held that the Andhra Pradesh High Court decision in CIT v. Hyderabad Stone Depot (1977) 109 ITR 686 (FB) was no longer good law in view of Mandyala Govindu.

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the assessee-firm was not entitled to continuance of registration under the Income-tax Act, 1961?
Whether the presence of a clause specifying profit and loss ratios that include a minor (40%) means the minor was a full partner (liable for losses) rather than merely admitted to the benefits of partnership?
Whether the Tribunal was correct in treating the Andhra Pradesh Full Bench decision in CIT v. Hyderabad Stone Depot as overruled or no longer good law in view of the Supreme Court decision in Mandyala Govindu & Co. v. CIT?

Arguments of the Parties

Revenue's (Commissioner / Department) Arguments

The Commissioner found that, in substance, the minor was made a full-fledged partner and not merely admitted to the benefits of the partnership; therefore, the registration granted by the ITO was erroneous and prejudicial to the Revenue's interests and should be cancelled.
Sri Raghavendra Rao, learned counsel for the Department, argued that clause 8 of the partnership deed (which allocates 20% / 40% / 40% shares) destroys the effect of the preamble and other protective clauses and does not provide a means to ascertain how the minor's 40% share of loss should be apportioned between the two major partners. In consequence, the deed fails the specification requirement and the firm cannot be registered. He relied upon the Supreme Court decision in Mandyala Govindu & Co. v. CIT (1976) 102 ITR 1.

Note: The opinion contains no detailed, separate statement of the assessee-firm's formal submissions beyond the factual description of the deed and the firm's appeal to the Tribunal. The court's analysis, however, sets out the factual and interpretive position that supports the assessee.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Mandyala Govindu & Co. v. CIT, [1976] 102 ITR 1 (SC)	Authority relied upon by the Tribunal and Revenue to contend that certain partnership deed formulations may not meet statutory specification requirements for partner shares.	The court observed that Mandyala Govindu was relied on by the Tribunal/Revenue but held that Mandyala Govindu is distinguishable on facts and did not automatically invalidate the Andhra Pradesh Full Bench decision in Hyderabad Stone Depot in the circumstances of the present deed.
CIT v. Hyderabad Stone Depot, [1977] 109 ITR 686 (AP) (Full Bench)	Held that specification of shares need not be in conventional units (e.g., 100 paise) and partners may adopt any digit/unit so long as shares can be worked out; a minor may be admitted to benefits despite unusual notation.	The court treated the reasoning in Hyderabad Stone Depot as valid and distinguishable from Mandyala Govindu; it endorsed that a deed which permits computation of shares by a chosen unit can satisfy s.184(2).
Commissioner Of Income Tax, Bombay v. Dwarkadas Khetan & Co., [1961] 41 ITR 528 (SC)	Principle that if a minor is admitted as a full partner with rights and liabilities of an adult partner, the partnership deed would not be valid.	The court relied on this authority to underscore that a deed that makes a minor a full partner (liable for losses) would be invalid, thereby reinforcing the need to ascertain whether the present deed made the minor a full partner or merely admitted him to benefits.
CIT v. Shah Mohandas Sadhuram, [1965] 57 ITR 415 (SC)	Explains the incidents and true nature of "benefits of partnership," and the powers of a guardian to accept benefits and to sever connection on behalf of a minor (including references to sub-sections of s.30 of the Partnership Act).	The court quoted and relied on this decision to interpret the concept of admission to benefits and the guardian's ability to accept conditions on behalf of a minor; used as a foundation for construing the deed in favour of the assessee when the deed indicated admission to benefits.
Commissioner Of Income-Tax, A.P. v. Krishna Mining Co., [1980] 122 ITR 362 (AP) (Full Bench)	Reiterated and upheld the view in Hyderabad Stone Depot that specification of shares need not be in conventional fractional notation and that partners can adopt any digit/unit to express shares; considered the effect of Mandyala Govindu on Hyderabad Stone Depot.	The court cited this Full Bench decision as confirming that Hyderabad Stone Depot was not overruled by Mandyala Govindu and that the manner of specification in a deed could be acceptable. The present court relied on Krishna Mining to reject the Tribunal's conclusion that Hyderabad Stone Depot was no longer good law.
Kylasa Sarabhaiah v. CIT, Hyderabad, [1965] 56 ITR 219 (SC)	Explained the meaning of the word "specify" under the relevant statutory provision: it means mentioning, describing or defining in detail and does not require expressly setting out fractional or other shares.	The court relied on this explanation to support the proposition that the statutory requirement that individual shares be "specified" does not mandate a particular numeric form; a general mention of ratios can meet the requirement.

Court's Reasoning and Analysis

The court's reasoning proceeded in a sequence grounded in the statutory scheme and authoritative precedents:

The court set out the statutory framework: Sections 184 and 185 of the Income-tax Act prescribe registration requirements for firms. Section 184(2) requires that the partnership be evidenced by an instrument and that the individual shares of partners be specified in that instrument. Section 185 prescribes the ITO's procedure on receiving an application and provides for rectification of defects.
The court explained the purpose of the specification requirement under s.184(2): to enable income-tax authorities to make proper assessments and to allow partners to be assessed at concessional rates where appropriate. It emphasized that the requirement is intended to benefit genuine firms and facilitate assessment, not to defeat legitimate entitlements by hyper-technicality.
The court then considered the Partnership Act, s.30 and its sub-sections, noting the statute's rule that a minor may be admitted to the benefits of partnership but is not liable for losses, and that a guardian may accept or refuse such admission on behalf of the minor. The court relied on the Supreme Court's discussion in Shah Mohandas Sadhuram of the incidents of admission to benefits and the guardian's powers.
The court advised that a partnership deed presented for registration should receive a reasonable and fair construction; recitals should be reconciled, parties' intentions effectuated, and bad drafting should not be allowed to defeat legitimately intended statutory benefits.
Applying these principles to the deed before it, the court observed:
- The deed was executed by two major partners only; the preamble expressly stated the minor was admitted only to the benefits of partnership.
- Other clauses (including clause 12 concerning dissolution and clause 13 excluding the minor from rights over goodwill) supported the conclusion that the minor was not intended to bear liability for losses.
- Clause 8 referred to profits and losses but, read harmoniously with the preamble and other clauses, did not demonstrate an intent to saddle the minor with loss liability.
The court rejected the Revenue's contention (and the Tribunal's reliance on Mandyala Govindu) that clause 8 rendered it impossible to ascertain how the minor's 40% loss-share would be apportioned between the major partners. The court held that the partners had effectively specified profit-sharing ratios and that the minor, being admitted only to benefits, should not be liable for losses; therefore losses must be borne by the two major partners consistent with the instrument as a whole.
The court endorsed the reasoning of Andhra Pradesh Full Bench decisions (Hyderabad Stone Depot and Krishna Mining) that specification of shares need not appear in a conventional fractional notation and that parties are free to take any digit or unit so long as shares can be worked out. The court concluded that clause 8 could reasonably be construed as using different units for dividing profits (100) and losses (60), thereby excluding the minor from loss liability while still specifying shares sufficiently for statutory purposes.
Finally, the court held that the Tribunal was not justified in declaring Hyderabad Stone Depot no longer good law in view of Mandyala Govindu. The court observed both that the Supreme Court in Mandyala Govindu had not considered Hyderabad Stone Depot and that the Andhra Pradesh larger Bench in Krishna Mining had considered and upheld Hyderabad Stone Depot after considering Mandyala Govindu.

Holding and Implications

Holding: The court answered the referred question in the negative and in favour of the assessee. In other words, the assessee-firm was entitled to continuance of registration under the Income-tax Act; the cancellation by the Commissioner (and the Tribunal's confirmation of cancellation) was not sustained.

Implications:

Direct effect on the parties: The decision vindicates the assessee-firm's entitlement to registration under s.184/185 for the relevant period; the firm should not have had its registration cancelled on the basis that the minor was a full partner.
On construction of partnership deeds: The opinion reinforces that partnership instruments must be given a reasonable and harmonious construction; recitals and protective clauses (e.g., preamble admitting a minor only to benefits, clauses excluding liability for loss, and excluding rights over goodwill) must be read together and can sustain registration even if the numerical notation of shares is unconventional.
On precedent: The court rejected the Tribunal's view that the Andhra Pradesh Full Bench decision in Hyderabad Stone Depot was overruled by the Supreme Court in Mandyala Govindu. The opinion records that the larger Bench in Krishna Mining considered both decisions and upheld Hyderabad Stone Depot; thus the present court found no basis to treat Hyderabad Stone Depot as no longer good law in the circumstances presented.
No broad new principle was declared beyond the application of existing statutory interpretation and partnership-law principles; the decision applies those principles to the deed at hand to determine that registration was properly maintainable.

Show all summary ...

Jagannatha Shetty, J.:— The question referred under s. 256(2) of the I.T Act, 1961 (the “Act”), runs as follows:

“Whether, on the facts and in the circumstances of the case, the assessee-firm was not entitled to continuance of registration under the Income-tax Act, 1961?”

2. The assessee is a partnership firm. The firm was established by an indenture dated June 21, 1971. S.N Gu.ndu Rao and S.C Madhukar were partners and also pa’rties to the deed. Besides, Master Santosh Kadam (minor) has been admitted to the benefits of partnership. The relevant portions of the deed of partnership are set out below for immediate reference:

“Whereas the parties have agreed to admit Master Santosh Kadam to the benefits of partnership on the same terms and conditions hereinafter mentioned and described.

Clause-8:

The net profits and losses of the firm for any year shall be divided among partners as follows:

Sri S.N Gundu Rao 20% Sri S.C Madhukar 40% Master Santosh Kadam 40%

Clause-13:

‘The minor member admitted to the benefits of the partnership shall have no rights over the goodwill of the firm’.”

3. For the assessment year 1972-73, the ITO by an order dated January 29, 1975, granted registration to the firm under s. 185 of the Act. By the same order, he continued the registration for the subsequent year 1973-74.

4. But the Commissioner in the exercise of his powers under s. 263 of the Act has found fault with the order granting registration to the firm. According to him, the minor was made a full-fledged partner. He was not admitted only to the benefits of the partnership. The registration was erroneous and prejudicial to the interests of the Revenue. So, he cancelled the registration of the firm.

5. The firm appealed to the Tribunal. The Tribunal confirmed the order of the Commissioner with some more reasons. It held that there is no specification as to distribution of 40% loss of minor's share as between the major partners. So, the minor cannot be held to have been admitted only to the benefits. The case was governed by the decision of the Supreme Court in Mandyala Govindu & Co. v. CIT, [1976] 102 ITR 1. The decision of the High Court of Andhra Pradesh in CIT v. Hyderabad Stone Depot, [1977] 109 ITR 686 [FB], is no longer good law in view of the said decision of the Supreme Court. The Tribunal has also referred to some decisions of other High Courts.

6. Sections 184 and 185 of the Act are special provisions applicable to firms for registration.

7. Section 184 provides for filing application for registration of a firm for the purposes of the Act.

8. Section 184 provides that the partnership should be evidenced by an instrument. The individual shares of the partners must also be specified in that instrument. The firm must be in existence in the accounting year in respect of which the assessment is required to be made.

9. The second requirement mentioned under s. 184(2) is that the individual shares of the partners should be specified in the instrument of partnership. The purpose behind this requirement is to enable the income-tax authorities to make proper assessment. If the firm is registered, the assessment on the income of each partner should be at the concessional rate of tax. If there is no specification of such individual shares, it would be difficult for the income-tax authorities to make proper assessment. There appears to be no other intention in s. 184 in insisting upon that individual shares of the partners should be specified in the instrument.

10. Section 185 prescribes the procedure to be followed by the ITO on receipt of such application. Sub-section (2) thereof requires the ITO to intimate the defect, if any, in the application. If the application is not in order, the ITO must give the firm an opportunity to remove the defect within a period of one month. If the defect is not removed within that period, the ITO shall reject the application. Likewise, the ITO has also to provide an opportunity to rectify the defect, if any, in the declaration furnished by the firm under sub-s. (7) of s. 184.

11. These provisions were indubitably meant to confer benefits of the concessional rate of tax to genuine firms.

12. In this context, it is also necessary to refer to s. 30 of the Partnership Act. It provides that “a person who is a minor according to the law to which he is subject may not be a partner in a firm, but, with the consent of all the partners for the time being, he may be admitted to the benefits of partnership”. Sub-sections (2) and (3) of s. 30 provide that such minor has a right to such share of the property and of the profits of the firm, but not loss. It, therefore, goes without saying that if a minor is admitted as a full partner with the rights and liabilities of an adult partner, then the deed of partnership would not be valid. (See Commissioner Of Income Tax, Bombay v. Dwarkadas Khetan & Co. , [1961] 41 ITR 528 (SC).

13. It is now necessary to examine the true nature and incidents of “benefits of partnership” and the rights of the guardian of a minor in regard to it. In CIT v. Shah Mohandas Sadhuram, [1965] 57 ITR 415 (SC), the Supreme Court observed at page 420 thus:

“…it is necessary to consider what are the incidents and true nature’ of ‘benefits of partnership’ and what is a guardian of a minor competent to do on behalf of a minor to secure the full benefits of partnership to a minor. First, it is clear from sub-section (2) of section 30 of the Partnership Act that a minor cannot be made liable for losses. Secondly, section 30, sub-section (4), enables a minor to sever his connection with the firm and if he does so, the amount of his share has to be determined by evaluation made, as far as possible, in accordance with the rules contained in section 48, which section visualises capital having been contributed by partners. There is no difficulty in holding that this severance may be effected on behalf of a minor by his guardian. Therefore, sub-section (4) contemplates that capital may have been contributed on behalf of a minor and that a guardian may on behalf of a minor sever his connection with the firm. If the guardian is entitled to sever the minor's connection with the firm, he must also be held to be entitled to refuse to accept the benefits of partnership or agree to accept the benefits of partnership for a further period on terms which are in accordance with law. Sub-section (5) proceeds on the basis that the minor may or may not know that he has been admitted to the benefits of partnership. This sub-section enables him to elect, on attaining majority, either to remain a partner of not to become a partner in the firm. Thus it contemplates that a guardian may have accepted the benefits of a partnership on behalf of a minor without his knowledge. If a guardian can accept benefits of partnership on behalf of a minor, he must have the power to scrutinise the terms on which such benefits are received by the minor. He must also have the power to accept the conditions on which the benefits of partnership are being conferred. It appears to us that the guardian can do all that is necessary to effectuate the conferment and receipt of the benefits of partnership.”

14. When a deed of partnership comes up for consideration with an application for registration of the firm, the income-tax authorities must broadly examine whether the deed generally conforms to the requirements prescribed under s. 184(2). In doing so, the deed like any other document must receive a reasonable and fair construction. There shall be an attempt to effectuate the intention of the parties to the deed and not to highlight the bad drafting, if any. As far as possible, the various recitals should be reconciled with a view to extend the statutory benefits to parties, if they are legitimately entitled to by the tenor of the deed.

15. There is also one other salutary principle to be borne in mind in construing a deed of partnership. The Supreme Court observed in Shah Mohandas Sadhuram's case, [1965] 57 ITR 415 (SC), at page 420, that if the recital of the deed expressly states that it is the major members who had decided to constitute the partnership and admitting the minors to the benefits of the said partnership, then the rest of the clauses must be construed in light of that recital,

(underlining* is ours).

16. With these preliminary observations, let us have a close look at the deed in question.

17. The deed of partnership was between two major partners: (i) Sri S.N Gundu Rao, and (ii) Sri S.G Madhukar. They were the only two parties to the deed. They constituted the firm to do business under the name and style of “Conpro Corporation Preamble to the deed states that the said two persons agreed to admit Master Santosh Kadam to the benefits of partnership. The minor represented by the guardian was not eo nomine party to the deed. The business, as the preamble states, was required to be conducted only by the parties to the deed. The entire capital of the firm was contributed only by the parties to the deed.

18. By clause (9), Sri S.N Gundu Rao was constituted as the managing partner charged with the duty to do the day-to-day business of the firm.

19. Clause (12) provides for dissolution of the partnership and distribution of the assets and liabilities. It states that the outgoings of the firm shall be paid first and out of the balance, the capital contributed by the partners shall be refunded. It also states that the remaining properties of the firm shall be distributed among the parties including the minor in the same proportion in which they are entitled to share the profits. This clause takes care to mention that the minor is not liable for loss, if any, on the accounts being taken upon dissolution of the partnership.

20. Clause (13) provides that the minor member admitted to the benefits of the partnership shall have no rights over the goodwill of the firm.

21. Sri Raghavendra Rao, learned counsel for the Department, urged that the effect of all the above clauses has been destroyed by clause (8). He urged that there is no means to ascertain as to how the 40 per cent, allocated to the minor should be apportioned between the two major partners in the event of the firm incurring loss. Since the deed is silent in regard to that, the firm cannot be registered. In support of the contention, he relied upon the decision of the Supreme Court in Mandyala Govindu & Co.'s case, [1976] 102 ITR 1.

22. We do not think that there is any such difficulty in the distribution of any loss in the instant case. Firstly, clause (8) does not refer to losses only. It refers to profits and losses. Secondly, it should be construed in harmony with the other recitals in the deed. The parties to the deed were only the two major partners. They had agreed to confer some benefits on the minor who is a third party to the deed. They had expressly stated in the preamble that the minor was admitted only to the benefits of partnership. It is, therefore, unreasonable to construe that the major partners who were parties to the deed had intended to impose on the minor, the liability to share the loss. Such a construction, in the first place, would be inconsistent with the preamble and clauses (3), (5), (9), (12) and (13), to which we have earlier referred. Secondly, it cannot be said that it is not possible to apportion the losses as between the two major partners.

23. A clause somewhat similar to clause (8) was considered by a Full Bench of the Andhra Pradesh High Court in CIT v. Hyderabad Stone Depot, [1977] 109 ITR 686. In that case, the firm was reconstituted after including a minor as partner with 7 paise share out of 100 paise and the partners have to share profits and losses according to the ratio prescribed in para. 16 of that deed. The High Court while construing the instrument held that the minor was admitted only to the benefits of the partnership, but to determine the shares of the major partners in the losses, the parties would be free to take any digit or figure as a unit. The court observed at page 692:

“There is no rule which compels the partners to always take 100 paise or 16 annas as a unit and then determine the shares of the partners in the losses. The parties are free to take any digit or* figure as a unit and specify the shares of the major partners in the losses in that unit. As long as the partnership deed specifies the shares of the partners in profit and loss, whatever may be the method by which that is specified, it cannot be argued that the deed does not specify the shares of the partners in profit and loss as required by section 26A of the Act. As long as the shares can be worked out according to the specification made in the deed, the registration cannot be refused on the ground that the deed omits to specify the share in profit or loss.”

24. The view taken in the above decision has been accepted by a larger Bench of five judges of the same High Court in Commissioner Of Income-Tax, A.P v. Krishna Mining Co., [1980] 122 ITR 362 (AP) [FB], and at page 373, it was observed:

“…that the specification of the shares need not be expressly set out in fractional or other shares, that there is.no rule which compels the partnership firm always to take 100 paise or 16 annas as a unit, that it is open to the partners to take any digit as a basis and specify the shares in profits and losses…”

25. Section 184(2) which states that the individual shares of the partners should be “specified” in the instrument has not prescribed any particular method of specification. If the shares of the individuals are generally mentioned in the instrument, then it would meet the statutory requirement. In Kylasa Sarabhaiah v. Cit, Hyderabad , [1965] 56 ITR 219, the Supreme Court while explaining the meaning of the word “specify” under s. 26A of the 1922 Act has observed at page 223:

“The word ‘specify’ is used in section 26A and rule 2 as meaning mentioning, describing or defining in detail: It does not mean expressly setting out in fractional or other shares.”

26. Bearing in mind these principles, if the instrument in this case is perused, one will not fail to see that the partners have specified the ratio in which the profits and losses have to be shared. The profits are required to be allocated in the ratio in which it has been set out in clause (8). Since the minor was admitted to the benefits of the partnership, he should not be saddled with any loss of the partnership. The loss must fall to be shared only as between the two major partners.

27. In other words, the intention of the parties to the deed was to take 100 as unit for dividing the profits and 60 as unit for sharing the losses. The minor partner thus stands excluded from the liability to share the losses. It cannot, therefore, be said that there is no means to ascertain as to how the amount of losses is to be allocated among the major partners. The firm, in our opinion, was entitled to registration.

28. What remains to be considered is whether the Tribunal was justified in stating that the decision of the Andhra Pradesh High Court in Hyderabad Stone Depot's case, [1977] 109 ITR 686 (AP) [FB] is no longer good law in view of the decision of the Supreme Court in Mandyala Govindu & Co.'s case, [1976] 102 ITR 1. It seems to us that the Tribunal was not justified in taking that view. The decision in Hyderabad Stone Depot's case, [1977] 109 ITR 686 [FB] was rendered by the Andhra Pradesh High Court on July 14, 1972. The Supreme Court gave the decision in Mandyala Govindu & Co.'s case, [1976] 102 ITR 1 on October 6, 1975. There was no occasion for the Supreme Court to consider the validity of the ratio of that decision of the Andhra Pradesh High Court. But the effect of the decision of the Supreme Court in Mandyala Govindu & Co.'s case, [1976] 102 ITR 1, on the correctness of the decision in Hyderabad Stone Depot's case, [1977] 109 ITR 686 (AP) [FB], came up for consideration before a larger Bench of the Andhra Pradesh High Court in Krishna Mining Company's case, [1980] 122 ITR 362. There, the Andhra Pradesh High Court after considering both the decisions has reiterated the view taken in Hyderabad Stone Depot's case, [1977] 109 ITR 686, by observing thus at page 378:

“We must, therefore, hold that the case of Mandyala Govindu & Co. v. CIT, [1976] 102 ITR 1 (SC), is distinguishable on facts. The decision of the Full Bench of this court in CIT v. Hyderabad Stone Depot[1977] 109 ITR 686 must be upheld as, on a reasonable construction of the instrument of partnership as a whole, it was found that there was specification of the shares of the partners in respect of loss, if any, of the partnership in the same proportion as they distribute the partners' share of profits. We are unable to agree with Sri P. Rama Rao, learned standing counsel for the Revenue, that the Full Bench decision must be deemed to have been over ruled or is no longer good law in view of the decision of the Supreme Court in Mandyala Govindu & Co. v. CIT, [1976] 102 ITR 1”.

29. In the result, we answer the question in the negative and in favour of the assessee.