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Nauhar Chand Chanan Ram, v. The Commissioner Of Income Tax, .
Judgment Summary — Question Referred on Partnership Registration (Section 26A)
Factual and Procedural Background
The matter arises from a deed of partnership dated 20 April 1957 for a firm described in the record as carrying on "the business of running the cotton ginning and pressing factory at Mansa" (Clause (3) of the deed). There were ten partners drawn from two families (Nauharchand Chananram and Bishanmal Reluram). The dispute relates to assessment year 1960-61 and to the assessees' application for renewal of registration of the firm under Section 26A of the Income-tax Act.
Historically the factory (established 1935) had been leased out from about 1951. In the relevant previous year (1959–60) the factory was leased to a 13-person lessee-partnership; six persons were common to both the owner-firm and the lessee-partnership. Some original family members did not join the lessee partnership and there were internal family partitions and disputes.
Procedural history: The Income-tax Officer refused renewal of registration on the ground that no partnership in fact carried on business existed. The assessees appealed to the Appellate Assistant Commissioner, who reversed the ITO and held the requirements for registration were met despite the factory being let out. The Income-tax Officer appealed to the Income-tax Appellate Tribunal, which reversed the Appellate Assistant Commissioner and found that the owners acted as rentiers (the factory being let out as a whole and not operated by them) and therefore no carrying on of business existed; consequently, the firm was not entitled to registration. Under Section 66(1) the Tribunal referred a question of law to the High Court for opinion.
Legal Issues Presented
- Whether the Tribunal misdirected themselves in law in coming to the finding that no business was carried on and therefore there was no partnership in law entitled to registration under Section 26 of the Income-tax Act (as framed in the reference).
- Whether, in relation to registration under Section 26A, the classification of income as rental (assessable under Section 12) or as business income (assessable under Section 10) stands in the way of registration of a partnership formed for leasing a commercial asset (i.e., whether Sections 10 or 12 affect entitlement to registration).
Arguments of the Parties
Assessees' Arguments
- The owners of a joint property may validly constitute a partnership for the purpose of leasing the partnership property and earning income from that leasing; there is no legal impediment to such a partnership.
- All that is necessary for registration under Section 26A is that a valid partnership be constituted under the Partnership Act; there is no provision in the Partnership Act that renders such a partnership illegal.
- Whether the income of the partnership is assessable under Section 10 or Section 12 is a separate question and does not determine entitlement to registration under Section 26A.
Department's Arguments
- The primary contention advanced by the department was that the earning of rental income from the factory is not income from "business" (i.e., the owners were rentiers rather than carrying on business).
- Reliance was placed on certain authorities (as cited in the opinion) to support the proposition that leasing/rental income is not business income under relevant statutes or on the peculiar definition of "business" in certain enactments.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| New Savan Sugar and Gur Refining Co. Ltd. v. Commissioner of Income-tax, [1969] 74 I.T.R. 7 (S.C.) | Cited for the proposition that income of a partnership which is merely rental may be assessable under Section 12 rather than under Section 10 of the Income-tax Act. | The court observed that this question of whether income is assessable under Section 12 or Section 10 is irrelevant to the separate question of whether a partnership is validly constituted and entitled to registration under Section 26A. The precedent was noted but not treated as determinative of registration entitlement. |
| Tripurasundari Cotton Press Co. Ltd. v. Commissioner of Income-tax, [1966] 62 I.T.R. 193 (A.P.) | Relied upon in argument (context: treatment of income from leasing or related issues). | The court stated this case "has no bearing so far as the present controversy is concerned" and described it as more in line with the Supreme Court decision already referred to; it was not applied to deny registration. |
| Narain Swadeshi Weaving Mills v. Commissioner Of Excess Profits Tax, [1954] 26 I.T.R. 765; [1955] 1 S.C.R. 952 (S.C.) | Relied upon as an authority concerning the meaning of "business" under Section 2(5) of the Excess Profits Tax Act (peculiar statutory definition). | The court held this decision rests on a peculiar statutory definition of "business" under that Act and was not relevant to the present question; it therefore had no bearing on entitlement to registration under Section 26A. |
| Dal Chand and Sons v. Commissioner of Income-tax, [1968] 69 I.T.R. 247 (Punjab) | Held that income derived from the lease of a factory can be income from business (assessable under Section 10) because exploiting a commercial asset for profit—whether by owner or lessee—can amount to carrying on a business. | The court regarded this decision as nearer in point and quoted it. It used the principle from Dal Chand to support the conclusion that a partnership carrying on the business of leasing a commercial asset can, in law, be a partnership carrying on business and therefore may be entitled to registration. |
Court's Reasoning and Analysis
The court proceeded from the facts found by the Tribunal and the parties' submissions and analysed two interlinked questions: (a) whether a valid partnership existed for the purpose of registration under Section 26A, and (b) whether the fact that the asset was let out converted the owners into mere rentiers so as to preclude a finding of "carrying on business".
The Tribunal had found as a matter of fact that:
- The factory had been leased out as a whole from 1951 onwards and the owners never operated it themselves thereafter;
- Some partners did not join the lessee partnership and did not wish to carry on the business;
- Consequently the asset ceased to be a commercial asset in their hands and became merely a capital investment producing rental income; and
- On that basis, the Tribunal concluded that "leasing of the factory" in the circumstances was not an activity in the nature of business and hence the firm was not carrying on business and could not be registered as a partnership.
The High Court examined these factual findings against the legal question of registration. The court emphasised:
- Registration under Section 26A depends on whether a valid partnership is constituted under the Partnership Act; nothing in Sections 10 or 12 of the Income-tax Act by itself prevents a valid partnership from being registered. Thus the tax-characterisation of income (rental vs. business) is legally distinct from the question whether a partnership exists and can be registered.
- The Partnership Act contains no provision shown to the court that would render a partnership formed for the purpose of leasing a commercial asset illegal.
- Certain precedents relied upon by the department either rested on different statutory definitions (Narain Swadeshi) or were not on point (Tripurasundari), and therefore did not establish that a partnership for leasing cannot be a business partnership entitled to registration.
- The decision in Dal Chand and Sons was treated as directly pertinent: it recognised that exploiting a commercial asset through leasing can amount to carrying on business and that income from lease of a factory can be income from business (assessable under Section 10). Accepting that principle, the court concluded that there can be a partnership to carry on the business of leasing property or commercial assets.
On this analytical basis the court concluded that the Tribunal's legal conclusion — that no business was carried on and therefore the firm could not be registered — was a misdirection in law. The court therefore answered the referred question in the affirmative (i.e., the Tribunal misdirected itself).
Holding and Implications
Holding: The court answered the referred question in the affirmative — the Tribunal misdirected itself in law in concluding that no business was carried on and therefore that there was no partnership in law entitled to registration under Section 26A of the Income-tax Act. The assessees were awarded costs of Rs. 200.
Implications:
- Direct effect on the parties: The High Court's opinion indicates that a partnership constituted for the purpose of leasing a commercial asset may, in law, be a partnership carrying on "business" for purposes of registration under Section 26A; the Tribunal's conclusion to the contrary was a legal error. Costs of Rs. 200 were awarded to the assessees.
- Limitations of the decision: The court expressly declined to decide the separate question whether the income of such a partnership is assessable under Section 10 or Section 12 of the Income-tax Act — that is a factual and tax-classification issue to be determined separately and was not the issue in the reference. The opinion does not purport to set out comprehensive rules on tax assessment of leasing income; it confines itself to the registration question under Section 26A and the validity of a partnership formed to lease a commercial asset.
Note: This summary is based exclusively on the terms and content of the provided opinion and contains no material not present in that opinion.
1. The Income-tax Appellate Tribunal, Delhi Bench "A", has referred the following quetsion of law for our opinion : "Whether the Tribunal misdirected themselves in law in coming to the finding that no business was carried on and therefore there was no partnership in law entitled to registration under Section 26 of the Income-tax Act ?"
2. The assessee entered into a deed of partnership on the 20th day of April, 1957. In all there were 10 partners. These ten partners emanated from two families known as Nauharchand Chananram and Bishanmal Reluram. The dispute relates to the assessment year 1960-61 and arose on the application of the assessees for the renewal of the registration of the firm under Section 26A of the Income-tax Act, hereinafter referred to as the Act In the deed of partnership, in Clause (3), it is clearly stated :
"That the business of the firm is and shall be that of running the cotton ginning and pressing factory at Mansa, either by himself or by giving on lease and other allied trades and on such other lines as the partners may desire to take up from time to time."
3. The deed also contained the usual partnership Clause and it is not necessary to refer to them. The shares of the partners were specified in the deed. The Income-tax Officer, B-Ward, Bhatinda, rejected the application on the ground that there was no partnership under the agreement dated the 20th April, 1957, and none ever came into existence. The assessees preferred an appeal to the Appellate Assistant Commissioner against the decision of the Income-tax Ocffier. The Appellate Assistant Commissioner revessed the decision of the Income-tax Officer and held that:
"It cannot be said that the factory in question is not a commercial asset. Further the fact that it has been let out to others and not used by the appellant itself does not mean that no business activity for the purposes of profit is being carried on by the appellant. Furthermore, there is no bar in the Partnership Act to the constitution of the firm in such cases .... All the other requirements of law for the purpose of registration of the firm under Section 26A have been duly complied with. There is no bar, legal or otherwise, to grant of registration."
4. The Income-tax Officer then preferred an appeal to the Income-tax Appellate Tribunal and the Tribunal reversed the decision of the Appellate Assistant Commissioner. The reasons which prevailed with the Tribunal must be stated in their own words :
"2. (a) We briefly summarise the facts : Messrs. Nauharchand-Chanan-ram Mansa (hereinafter called 'the assessee') was constituted under a deed of partnership dated 20th April, 1957, There were 10 partners as shown below :
(i) Shri Ramjidas, s/o. L. Nauharchand l/4th share
(ii) Shri Purshotamdas, s/o. do.
l/4th share
(iii) Shri Chananram, s/o. L. Bishanmal l/12th share
(iv) ShriBanarsidas, s/o. do.
l/12th share (V) ShriBaburam, s/o. do.
l/12th share
(vi) Shri Rajaram, s/o. L. Reluram l/20th share
(vii) Shri Ramkarandas, s/o. do.
l/20th share
(viii) Shri Dwarkadas, s/o. do.
l/20th share
(ix) ShriBrij Lal, s/o. do.
l/20th share
(x) Shri Roshanlal, s/o. do.
l/20th share
(b) All the above ten gentlemen belonged to two families. The first family was known as "Nauharchand Chananram" and the second family as "Bishanmal Reluram". The members of both the families have now partitioned among themselves.
(c) These families owned a ginning and pressing factory which was established in 1935. This factory was known as 'Nauharchand Chanan-ram Factory'. During the course of time there were several partitions in the families and on each partition the assessee-firm was reconstituted.
(d) From and after the year 1951 (assessment year 1952-53), the factory was leased out to others. In the previous year (i.e., the year 1959-60), the factory was leased out to another partnership (hereinafter called the "lessee-partnership") of 13 persons as shown below :
(i) Shri Chananratn, s/o. L. Bishanmal 9nP.
share
(ii) ShriBaburam, s/o.
do.
9nP.
,,
(iii) ShriBenarsides, s/o.
do.
9nP.
,,
(iv) Shri Rajaram, s/o. Reluram 15 nP.
,,
(v) Shri Parshotamdas, s/o. L. Nauharchand 7 nP.
,,
(vi) Shri Ramjidas, s/o.
do.
6nP.
,,
(vii) Shri Faqir Chand, s/o. L. Munnalal 9nP.
,,
(viii) Shri Shadiram, s/o. L. Gondamal 6nP.
,,
(ix) Shri Nauharchand Jindal, s/o. Daulatram 6nP.
,,
(x) Shri Ramparshad, s/o, L. Chetumal 6nP.
,,
(xi) Shri Parbhdyal, s/o. L. Ramdittamal 6 nP.
,,
(xii) Shri Madanlal, s/o. L. Nandram 6nP.
,,
(xiii) Shri Suchamal, s/o. L. Bholamal 6nP.
,, The first six partners were common in these two concerns.
(e) It may be noticed that of the five sons of L. Reluram only one, viz., Shri Rajaram, joined the new partnership and the other four did not.
(f) On a question from us the learned counsel for the assessse stated that the assessee did not carry on the business for two reasons:
(i) the partners did not have enough finances and did not want to risk any further; and
(ii) there were disputes among the five sons of L. Reluram and they did not wish to join the new partnership.
(g) In the new partnership, Shri Shadiram, son of L. Gonda Mal, came in as a financing partner and the last six were outsiders who joined as wording partners.
(h) We have also studied the deed of partnership and it lays down that the partners could either carry on business themselves or they could lease out the factory.
3. (a) On the above facts we think that it cannot be said that the assessee carried on any business. It is no doubt true that 'Nauharchand Chananram Factory' was at one time a commercial asset, but it ceased to be so when it was let out because it was leased out as a whole and, thereafter, the owners never worked the factory themselves. Four of the partners did not even join the new lease partnership and, evidently, they did not want to carry on the busings. In our opinion, the asset no longer maintains its character of a commercial asset and it is merely a capital investment from which the owners derive rental income.
(b) Another finding of fact is necessary, viz., was the lease only a temporary phase of business? We find that it was not a temporary phase inasmuch as the partnership never carried on the ginning business. Similarly, we also record the finding that it was not a case when the main business was carried on but a subsidiary portion was let out. The factory was leased out as a, whole as an entity.
(c) The economic distinction between 'business activities' and 'the activity of a rentier' needs no elaboration. The assessee-firm since its inception has acted like a 'rentier' and it has never carried on any business. We would, therefore, record this finding that the 'leasing of the factory' was not, in the circumstances of the case, an activity in the nature of business.
(d) If this conclusion is arrived at, then it cannot but be held that the partnership is not entitled to registration because the fundamental requirement of a valid partnership, viz.; 'carrying on of business' is not fulfilled."
5. The assessee were dissatisfied with this order and moved the Tribunal under Section 66(1) of the Act. The Tribunal by its order dated the 12th April, 1965, thus, referred the question of law for our opinion.
6. The contention of the learned counsel for the assessees is that there is no legal impediment for the owners of the joint property to enter into a partnership for the purpose of leasing out the partnership property and earning income therefrom. The only argument addressed by the learned counsel for the department was that earning of rental income is not income from business. That may or may not be so. But that is a matter wholly irrelevant for the purpose of determining whether a partnership should or should not be registered under Section 26A of the Act. All that has to be seen is whether there is a validly constituted partnership and for that purpose on has to refer to the provisions of the Partnership Act. The learned counsel for the department was unable to point out any provision in the Partnership Act which would render such a partnership illegal. It was not disputed that if there was legal partnership it was entitled to registration under Section 26A of the Act. Therefore, the controversy merely rested on the short matter as to whether the partnership in question is a legal partnership or not. The learned counsel drew our attention to the decision of the Supreme Court in New Savan Sugar and Gur Refining Co. Ltd. v. Commissioner of Income-tax, [1969] 74 I.T.R. 7 (S.C.) for his contention that the income of such a partnership being merely rental income would only be assessable under Section 12 and not under Section 10 of the Act. That is a matter which has nothing to do with registration of the partnership under Section 26A of the Act, It may be that the income of this partnership may have to be assessed under Section 12, but that is a matter on which we are not called upon to pronounce. All that we have to determine is whether Section 12 or Section 10 of the Act stands in the way of partnership being registered under Section 26A of the Act. In our opinion these provisions have nothing to do with the validity of partnership either under the Partnership Act or its registration under Section 26A of the Income-tax Act. The learned counsel then relied upon Tripurasundari Cotton Press Co. Ltd. v. Commissioner of Income-tax., [1966] 62 I.T.R. 193 (A.P.). This case has no bearing so far as the present controversy is concerned. In fact, that is a case which is more in line with the earlier decision of the Supreme Court already referred to. The next decision which was relied upon by the learned counsel for the department is Narain Swadeshi Weaving Mills v. Commissioner Of Excess Profits Tax, [1954] 26 I.T.R. 765 ; [1955] 1 S.C.R. 952 (S.C.). This was a decision under Section 2(5) of the Excess Profits Tax Act. This decision rests solely on the peculiar definition of "Business" in the Act. The question which we are called upon to determine was not a subject of controversy in this case. It has thus no bearing on the matter before us. The decision which is nearer in point is the one reported as Dal Chand and Sons v. Commissioner of Income-tax, [1968] 69 I.T.R. 247 253 (Punj). The judgment in this case was rendered by Chief Justice Mehar Singh and it was observed by the learned Chief Justice as follows: "A business may be done in a number of ways and one of the ways is to run a commercial asset as such and another way may be that the commercial asset, at a particular time, is found to be more responsive to profit if allowed to be run as such by another lessee. In either case the owner of the factory carries on the business of earning profits and gains from such an asset.... So long as a business asset is exploited as such and profits or gains are earned from it, the same are profits and gains of a business, however the owner of the commercial asset exploits the same. So when it is said whether he carried on the business himself or not that only means whether he carried on a business activity which may have led to his earning profits or making gains. Once profits or gains are made from the use of the commercial asset itself, then the further detail whether the owner ran the commercial asset himself or it had been run by another person as a lessee for him makes not the least difference. He makes profits or gains just the same and he makes the same from and in consequence of running of the business asset. Hence, income derived by an assessee from the lease of a factory becomes income from business and assessable under Section 10 of the Income-tax Act."
7. This decision clearly indicates that there can be a partnership to carry on business of leasing property or commercial assets. As regards rental income, the question whether such income is assessable under Section 10 or Section 12 of the Act is a matter which, as already pointed out, we are not called upon to pronounce and in any case that is a matter which has to be determined on the facts and in the circumstances of each individual case.
8. For the reasons recorded above we return the answer to the question referred for our opinion in the affirmative. The assessees will have their costs which are assessed at Rs. 200.
Bal Raj Tuli, J.
9. I agree.
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