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Addl. Commissioner Of Income Tax, Jaipur v. M/S. Rahmat Khan Faizu Khan, Bikaner (98)
Structured Summary of the Opinion
Factual and Procedural Background
Shri Rahmat Khan held a 12½% share in profits and losses of M/s New Friends & Co., Jaipur, for the accounting year corresponding to assessment year 1968-69 (April 1, 1967 to March 31, 1968). He entered into an agreement with Shri Faizu Khan in respect of that 12½% share. A formal partnership deed between Rahmat Khan and Faizu Khan was executed on January 27, 1968. The preamble to that deed recited that the parties had "on and from April 1, 1967, agreed to be partners" for the said share.
The partnership deed included clauses providing that (i) the partnership business duration was at the discretion of the first party with liberty to retain or refuse the second party as partner; (ii) the second party (Faizu Khan) gave Rs. 10,000 to the first party (Rahmat Khan) to be invested in the firm and would not receive interest; and (iii) the second party would be actively engaged in the conduct of the business on behalf of the first party.
Faizu Khan advanced Rs. 10,000 which was invested in M/s New Friends & Co., Faizu Khan looked after the business, and profits were shared in accordance with the deed. The firm M/s Rahmat Khan Faizu Khan (the assessee-respondent) applied to the ITO for registration under Section 185 of the Income-tax Act, 1961 for assessment year 1968-69, relying on the partnership deed dated January 27, 1968.
The ITO refused registration by order dated February 25, 1972, holding the firm not genuine. The AAC confirmed the refusal on September 30, 1972. On appeal, the Income-tax Appellate Tribunal (Jaipur Bench) by order dated April 22, 1974, reversed the refusal and directed registration, holding the firm genuine. The Commissioner of Income-tax filed an application under Section 256(1) seeking a reference of questions of law to the High Court, and the Tribunal referred two specific questions of law for decision.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, and on a correct interpretation of the partnership deed, the Tribunal was justified in holding that the partnership existed orally with effect from April 1, 1967, and not only from January 27, 1968?
- If the answer to the first question is negative, whether the Tribunal was justified in holding that the firm was entitled to registration under the Income-tax Act, 1961, for the assessment year 1968-69?
Arguments of the Parties
Revenue's Arguments
- The partnership did not exist, orally or otherwise, prior to January 27, 1968; it came into existence only on the date the formal partnership deed was executed (January 27, 1968).
- The partnership deed could not create the relationship of partners with retrospective effect so as to make the partnership effective from April 1, 1967.
- Implied (by context): the ITO's refusal to register the firm as not genuine should stand.
Respondent (Assessee) / Tribunal's Position
- There was an agreement to form a partnership "on and from April 1, 1967" as recited in the preamble of the partnership deed and the parties had acted in accordance with that agreement.
- Faizu Khan paid Rs. 10,000, was actively engaged in management of the business, profits were divided as per the deed, and amounts due to Faizu Khan were received by him and not appropriated by Rahmat Khan — facts which indicate genuineness of the partnership from April 1, 1967.
- The Tribunal concluded these factual elements were germane to genuineness and that registration should be granted; it was not the Department's case that Faizu Khan was a sham or that he did not receive or retain his share of profits.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| CIT v. Sivakasi Match Exporting Co. [1964] 53 ITR 204 (SC) | Interpreting Section 26A of the Indian I.T. Act (1922): ITO's jurisdiction limited to whether application complies with rules and whether the firm is bogus or has no legal existence; ITO cannot refuse registration on mere speculation and must base conclusion on relevant evidence. | The court relied on this principle to note that registration must be refused only on relevant evidence of sham/invalidity and that the ITO's discretion is judicial; applied to conclude that, on the material, refusal was not justified and registration should be granted. |
| Agarwal & Co. v. CIT [1970] 77 ITR 10 (SC) | Reaffirmed conditions essential for registration under Section 26A: if conditions are fulfilled, ITO must register unless there is contravention (here described as contravention of Section 23(4) of the earlier Act). | The court cited the case to underline that where the statutory conditions are met, registration is mandatory — supporting the conclusion that the firm was entitled to registration for assessment year 1968-69. |
| R. C. Mitter & Sons v. CIT [1959] 36 ITR 194 (SC) | Holds that firms created orally and subsequently reduced to writing can be registered under Section 26A of the Indian I.T. Act, 1922. | The precedent was referred to in construing the partnership deed and to support the proposition that an oral partnership, later reduced to writing, is registrable; the court applied this to hold the partnership existed from April 1, 1967. |
| Kalwant Singh Gurdial Singh v. CIT [1962] 45 ITR 569 (P & H) | Held that a partnership formed by an oral agreement and later reduced to writing is validly constituted within Section 26A and entitled to registration. | Used as supporting authority that oral formation subsequently documented does not preclude registration — reinforcing the conclusion that the partnership was effective from April 1, 1967. |
| CIT v. Shah Mohandas Sadkuram [1965] 57 ITR 415 (SC) | Held that partnership deeds must be construed reasonably and reasonably interpreted. | Referred to the guiding principle of reasonable construction of deeds; the court applied a reasonable interpretation to the recital admitting a partnership from April 1, 1967. |
| Ram Laxman Sugar Mills v. CIT [1967] 66 ITR 613 (SC) | When construing partnership agreements, the court first determines intention of the parties from recitals and relevant circumstances; ambiguous expressions construed, where possible, to uphold the deed if parties acted on assumption of validity. | The court invoked this approach to ascertain the dominant intention of the parties and to adopt an interpretation upholding the deed — concluding that the parties intended partnership from April 1, 1967. |
Court's Reasoning and Analysis
The court proceeded by reference to the statutory definitions and tests in the Partnership Act and the Income-tax Act: Section 4 of the Partnership Act defining "partnership" and Section 6's instruction to regard the real relation between parties as shown by all relevant facts taken together when determining if a partnership exists.
The court set out the essential conditions for registration under Section 185 of the Income-tax Act (as summarised in the opinion): (i) application before the end of the accounting year complying with Section 184 and relevant rules; (ii) firm evidenced by an instrument of partnership; (iii) instrument specifying individual shares; and (iv) the partnership being valid, genuine and actually constituted as specified.
Applying those tests and relevant precedents, the court examined the material facts that were undisputed: an agreement to form a partnership existed; Faizu Khan advanced Rs. 10,000 which was invested in M/s New Friends & Co.; Faizu Khan managed the business; profits were shared per the terms and amounts due to Faizu Khan were received by him and not appropriated by Rahmat Khan; and there was no suggestion that Faizu Khan was a sham or non-existent.
The court gave weight to the recital in the preamble "on and from April 1, 1967" and to the parties' real intention, which is an important test under Section 6 of the Partnership Act. It applied authorities (including cases holding that oral partnerships later reduced to writing are registrable and that deeds must be reasonably construed) to determine that the correct interpretation of the deed was that the partnership had been entered into from April 1, 1967, though reduced to writing on January 27, 1968.
The court rejected the Revenue's contention that the partnership could not have retrospective effect and that it only came into existence on January 27, 1968. On the facts and in light of the authorities, the court concluded the Tribunal was right to hold that the partnership existed orally from April 1, 1967, and that the partnership firm was genuine from that date.
Having found that the partnership existed from April 1, 1967 and that the statutory conditions for registration for assessment year 1968-69 were satisfied, the court concluded the respondent was entitled to registration under Section 185 of the Income-tax Act for that assessment year.
Holding and Implications
Holding: The court answered both referred questions in the affirmative in favour of the respondent and against the Revenue. In particular, the court held that the Tribunal was justified in holding that the partnership existed orally with effect from April 1, 1967, and did not come into existence only from January 27, 1968.
Direct Effect and Consequences:
- The respondent (M/s Rahmat Khan Faizu Khan) was entitled to registration under Section 185 of the Income-tax Act, 1961, for the assessment year 1968-69 with effect from April 1, 1967.
- The Tribunal's order directing registration was upheld by this court.
- The parties were ordered to bear their own costs of the reference, and the answers were to be returned to the Tribunal for necessary action under Section 260 of the Act.
Broader Implications: The opinion applied existing precedents and statutory tests to the facts of the case. The court did not purport to lay down a new principle of law beyond applying established authorities; the decision's immediate consequence is the registration of the firm for the specified assessment year and vindication of the Tribunal's factual and legal conclusion.
1. The Income-tax Appellate Tribunal, Jaipur Bench (hereinafter referred to as "the Tribunal"), has referred the following questions of law which arise out of its order dated April 22, 1974, for our decision :
"1. Whether, on the facts and in the circumstances of the case, and on a correct interpretation of the partnership deed the Tribunal was justified in holding that the partnership existed orally all along with effect from April 1, 1967, and that the partnership had not come into existence only from January 27, 1968, onwards?
2. If the answer to the above question be in the negative, was the Tribunal justified in holding that the firm was entitled to registration under the Income-tax Act, 1961, for the assessment year 1968-69 ?"
2. Shri Rahmat Khan is a partner in M/s. New Friends & Co., Dhamani Market, Jaipur. He had 121/2% share in the profit and loss of that firm, for the accounting period corresponding to the assessment year 1968-69 which began on April 1, 1967, and ended on March 31, 1968. Shri Rahmat Khan entered into an agreement of partnership with one Shri Faizu Khan S/o. Molabux in respect of his share of 121/2% in M/s New Friends & Co. The formal partnership deed was drawn on January 27, 1968, between Shri Rahmat Khan and Shri Faizu Khan. The preamble to the partnership deed dated January 27, 1968, amongst others, contains the following recitals I
......... and whereas the parties hereto have on and from April 1, 1967, agreed to be partners in the profit and loss of 121/2% in the name of the party hereto of the first part in the firm of M/s. New Friends & Co., Jaipur, and whereas to avoid future differences the parties have agreed to execute a deed of partnership.
3. It will also be useful to refer to Clauses 3, 4 and 6 of the partnership deed which are as under :
"3. The partnership business shall be for a period for which the party hereto of the first part may desire and he will be at liberty to keep the party hereto of the second part as partner or to refuse to keep him as partner. The party hereto of the second part shall have no claim whatsoever in this respect.
4. The party hereto of the second part has given Rs. 10,000 to the party hereto of the first part who has to invest the money in the firm of M/s. New Friends & Co. Party hereto of the second part shall not be entitled to any interest on this sum of Rs. 10,000. The amount shall be returned only when the full amount standing to the credit of the party hereto of the first part is received by him from the firm of M/s. New Friends & Co."
"6. The party hereto of the second part shall be actively engaged in the conduct of business of M/s. New Friends & Co., on behalf of the party hereto of the first part."
4. Shri Faizu Khan advanced Rs. 10,000 to Shri Rahmat Khan for investing the aforesaid amount in M/s. New Friends & Co. The profits received from M/s. New Friends & Co. by Shri Rahmat Khan was divided in accordance with the shares specified in the partnership deed between Shri Rahmat Khan and Shri Faizu Khan. The amount which was given to Shri Faizu Khan in accordance with the terms of the partnership deed was received by him. It was not appropriated by him for his own use. It may also be stated that there is no dispute that Shri Faizu Khan and Shri Rahmat Khan are not related in any manner. M/s. Rahmat Khan Faizu Khan, Bikaner (assessee-respondent), submitted an application for registration of the firm for the purpose of the I.T. Act, 1961 (Act No. XLIII of 1961) (for short "the Act" hereinafter), to the ITO concerned for registration of the firm and claimed registration under Section 185 of the Act on the basis of the partnership deed dated January 27, 1968. The ITO by his order dated February 25, 1972, declined to register the firm for the assessment year 1968-69, holding that the firm is not genuine as per reasons given in the assessment order for the assessment year 1968-69. The order of refusal to register the firm passed under Section 185(1)(b) of the Act was assailed by filing an appeal. The AAC of Income-tax, Bikaner Range, Bikaner, by his order dated September 30, 1972, confirmed the order of the ITO, refusing to register the firm. A further appeal was taken to the Tribunal. The only point before the Tribunal was whether the ITO and the AAC were justified in refusing the registration to the firm M/s. Rahmat Khan, Faizu Khan Bikaner, regarding the assessment year 1968-69, The Tribunal by its order dated April 22, 1974, reversed the orders refusing to register the firm and directed that registration should be granted to the firm as per its request as it is a genuine firm as per the material on record.
5. An application under Section 256(1) of the Act was filed by the Commissioner of Income-tax to refer the questions stated in the application for the opinion of this court in respect of assessment year 1968-69. The Tribunal, however, has referred the two questions stated hereinabove for our decision.
6. Section 4 of the Indian Partnership Act, 1932 (Act No. IX of 1932) (for the sake of brevity it will be referred to as "the Partnership Act") defines "partnership", "partner" and "firm" as under :
"4. Definition of 'partnership', 'partner', 'firm' and 'firm-name'.--'Partnership' is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.
Persons who have entered into partnership with one another are called individually 'partners' and collectively 'a firm', and the name under which their business is carried on is called the 'firm-name'."
7. Section 6 of the Partnership Act lays down tests for determining the existence of partnership. The material portion of Section 6 for our purpose is as follows :
6. Mode of determining existence o] partnership.--In determining whether a group of persons is or is not a firm, or whether a person is or is not a partner in a firm, regard shall be had to the real relation between the parties, as shown by all relevant facts taken together.
8. Sections 26A and 23(4} of the Indian I.T. Act, 1922, were deleted and in their place Sections 184 and 186 have been incorporated in the new Act. Section 26A of the Indian I.T. Act, 1922, was examined in CIT v. Sivakasi Match Exporting, Co. [1964] 53 ITR 204 (SC). Subba Rao J., as he then was, with whom Sikri J. concurred, observed as under (p. 208).
"A cnnbined effect of Section 26A of the Act and the rules made thereunder is that if the application made by a firm gives the necessary particulars prescribed by the rules, the Income-tax Officer cannot reject it, if there is a firm in existence as shown in the instrument of partnership. A firm may be said to be not in existence if it is a bogus or not a genuine one, or if in law the constitution of the partnership is void. The jurisdiction of the Income-tax Officer is, therefore, confined to the ascertainment of two facts, namely, (i) whether the application for registration is in conformity with the rules made under the Act, and (ii) whether the firm shown in the document presented for registration is a bogus one or has no legal existence. Further, the discretion conferred on him under Section 26A is a judicial one and he cannot refuse to register a firm on mere speculation, but he shall base his conclusion on relevant evidence."
9. Section 26A of the Indian I.T. Act, 1922, and Section 4 of the Partnership Act were again examined in Agarwal & Co. v. CIT [1970] 77 ITR 10 (SC). After reiterating the conditions essential for the registration of a firm as laid down in Sivakasi Match Exporting Co.'s case [1964] 53 ITR 204 (SC), their Lordships held that if the conditions essential for registration of a firm are fulfilled, the ITO is bound to register the firm unless the assessee has contravened Section 23(4) of the Indian I.T. Act, 1922.
10. Sections 184 and 185 deal with registration of firms. It is well settled that the following conditions are essential for the registration of a firm under Section 185 of the Act I
(i) An application on behalf of the firm should be made to the ITO before the end of the accounting year and the application should comply with the requirements of Section 184 and Rules 22 to 24.
(ii) The firm should be evidenced by an instrument of partnership.
(iii) The instrument should specify the individual shares of the partners.
(iv) The partnership should be valid and genuine and should actually be constituted as specified in the instrument.
11. Before the Tribunal, on behalf of the Revenue, a contention was raised on the basis of the portion of the preamble of the partnership deed which has already been excerpted above that there was no partnership, oral or otherwise, existing between Rahmat Khan and Faizu Khan prior to January 27, 1968, that in fact the partnership was entered into between them from the date of the partnership deed, i.e., January 27, 1968, and further that the partnership deed could not bring into existence the relationship of partners with retrospective effect, i.e., from April 1, 1967. Reference was made before the Tribunal to the following clause in the partnership deed :
(i). "The name of the partnership shall be Rahmat Khan Faizu Khan."
12. The Tribunal has stated in its order as follows :
"In the present case, it is not the stand of the Department that S/Shri Rahmat Khan and Faizu Khan did not enter into an agreement to form a partnership. It has also not been disputed that in accordance with the said agreement, Shri Faizu Khan contributed Rs. 10,000 and further Shri Faizu Khan looked after the business of M/s New Friends & Co. It is also not the case of the Department that Shri Faizu Khan was a sham person who did not exist or who did not work and that he did not get the profits in accordance with the partnership deed or that he returned the profit to Shri Rahmat Khan. In our opinion, the aforesaid were the facts which were germane for determining the genuineness or otherwise of the firm. As none of them has been assailed, it cannot be disputed, in our opinion, that the partnership firm as stipulated by the above referred partnership deed had come into existence."
13. In R. C. Mitter & Sons v. CIT [1959] 36 ITR 194 (SC), it was ruled that the firms which were created by word of mouth but the constitution of which had subsequently been reduced to writing can also, therefore, be registered under Section 26A of the Indian I.T. Act, 1922.
14. A Division Bench of the Punjab High Court in Kalwant Singk Gurdial Singh v. CIT [1962] 45 ITR 569 (P & H), held that a partnership formed by an oral agreement but on terms and conditions reduced to writing subsequently is validly constituted within the meaning of Section 26A of the Indian I.T. Act, 1922 and is entitled to registration for assessment.
15. R. C. Mitter & Sons' case [1959] 36 ITR 194 (SC) was referred to while construing the partnership deed.
16. In CIT v. Shah Mohandas Sadkuram [1965] 57 ITR 415 (SC), their Lordships observed that the partnership deed must be construed reasonably and that reasonable interpretation should be given to the deed.
17. We are tempted here to quote the following from Ram Laxman Sugar Mills v. CIT [1967] 66 ITR 613 (SC), wherein the agreement of partnership was construed and in that connection it was observed (p. 616) :
In adjudicating upon that plea the court has in the first instance to determine the intention of the parties as disclosed by the recitals in the deed of partnership and other relevant circumstances.......In ascertaining the legal effect of a transaction, the court seeks in the first instance to determine the intention of the parties, and when ambiguous expressions are used, the court may normally adopt that interpretation which upholds the deed, if the parties thereto have acted on the assumption of its validity.,,.(underlining* is our own).
18. Applying the tests laid down in the aforesaid authorities and having regard to the dominant intention of the parties and considering the partnership deed as a whole, it is clear that the parties in the partnership deed had agreed to be partners in the profit and loss on and from April 1, 1967, and the terms were reduced to writing on January 27, 1968, the date when the partnership deed came into existence. This has to be considered in the light of the following facts and circumstances regarding which no dispute has been raised on behalf of the Revenue. There is no dispute that Shri Rahmat Khan and Shri Faizu Khan had entered into an agreement of partnership, that a sum of Rs. 10,000 was paid by Shri Faizu Khan and that since then Shri Faizu Khan had been looking after the business of M/s New 'Friends' &.Co. It was a partnership firm under Section 4 of the Partnership Act. The words "hereto have on and from April 1, 1967" are not without significance. The, intention of the parties was that they had agreed to be partners from April 1, 1967. Real intention of the parties to the partnership is one important test under Section 6 of the Partnership Act. In our opinion, the Tribunal was right in rejecting the interpretation put on behalf of the Revenue on the partnership deed that the partnership had come into existence only from January 27, 1968, i.e., from the date the partnership deed had come into existence. The correct interpretation is that the partnership was entered into from April 1, 1967, and that the partnership firm was genuine from that date. As the conditions essential for the registration of the firm ior the assessment year 1968-69 were satisfied, the respondent was entitled to registration under Section 185 of the Act from April 1, 1967. The Tribunal was right and justified when it held that the partnership existed orally all along with effect from April 1, 1967, and had not come into existence only from January 27, 1968, and onwards.
19. For the reasons aforesaid, our answer to the first question is in the affirmative, i.e., in favour of the respondent and against the Revenue.
20. In view of our answer to the first question in the affirmative, it follows as a necessary consequence that the respondent was entitled to registration under the Act in respect of the assessment year 1968-69. The second question is also answered in the affirmative, in favour of the respondent and against the Revenue.
21. In the circumstances of the case, we leave the parties to bear their own costs of this reference. Let the answers to these questions be returned to the Tribunal for necessary action under Section 260 of the Act.
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