Citation Codes

Equivalent Citations

citation codes

Case Number

D.B Income-tax Reference No. 18 of 1980

Judges

Mrs. Mohini Kapoor

Acts

SECTION 185 INCOME TAX ACT 1961
sub-section (2) of section 143,the Income-tax
section 185(1)(b) and under section 185(5).
SECTION 144 INCOME TAX ACT 1961
sub-section (2A) of that section, or(c)
section 185(1)(b) and section 185(5)
provision (under section 185(5)),
sub-section (2) of section 139
sub-section (1) of section 185,
section 23(4) of the old Act.
section 144, the Income-tax
year.6. Section 184
section 185(1)(b)

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Smart Summary

Court Opinion Summary (Judgment delivered by S.K. Mal Lodha, J.)

Factual and Procedural Background

The matter arose from an application for registration submitted in Form No. 11 by the assessee-firm M/s Faiz Mohd., Hasim Ali, Taj Mohd., Noor Mohd., Nagaur for the previous year relevant to assessment year 1973–74. The Income-tax Officer (ITO) refused registration by order dated 11 February 1976 under section 185 of the Income-tax Act, 1961, treating the firm as unregistered. The reason recorded by the ITO was that assessment had been completed under section 144 (an ex parte "best judgment" assessment) and there was no proof that profits were divided according to the partnership deed.

The assessee appealed. The Appellate Assistant Commissioner on 8 November 1978 set aside the ITO's order and directed the ITO to decide the registration application on merits, observing that material filed with the return might permit verification of profit division. The ITO appealed that order to the Income-tax Appellate Tribunal (Tribunal), which agreed with the Appellate Assistant Commissioner and referred two questions of law to this Court under section 256(1). The two referred questions concern (1) whether the Tribunal was justified in holding that the ITO should have recorded certain findings about the firm's genuineness or compliance with the partnership deed when he refused registration under section 185(5) after assessing under section 144, and (2) whether the Tribunal was justified in confirming the Appellate Assistant Commissioner's direction that the ITO decide the registration application on merits.

Legal Issues Presented

Whether, given that the ITO had assessed the assessee under section 144 and rejected its application for registration under section 185(5), the ITO should have given a finding that (i) no genuine firm existed, or (ii) no valid firm existed, or (iii) the firm did not work in accordance with the partnership deed.
Whether the Tribunal was justified in confirming the Appellate Assistant Commissioner's order which set aside the ITO's order and directed him to decide the assessee-firm's application for registration on merits.

Arguments of the Parties

Assessee's Arguments

The assessee contended that material filed with the return would have enabled the ITO to determine whether profits and losses had been divided in accordance with the partnership deed and that therefore the firm was genuine.
Based on that contention, the Appellate Assistant Commissioner directed the ITO to consider and decide the application on merits.

Revenue's (ITO's) Arguments

The ITO (and the Revenue on appeal) contended that because the assessee failed to comply with statutory notices leading to an assessment under section 144, the ITO was within his rights under section 185(5) to refuse registration.
The Revenue argued implicitly that the ITO's reliance on the ex parte assessment and absence of proof of profit distribution justified refusal without the specific findings the Tribunal thought necessary.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
CIT v. Jekisondas Bhukandas, [1967] 66 ITR 515 (Guj)	Cited as authority that the ITO has power to refuse registration under the relevant provisions; used in discussion of the scope of refusal powers.	Relied upon in demonstrating that refusal under different limbs of section 185 can be distinct and that authority supports the ITO's refusal powers.
The Commissioner Of Income-Tax, Madras v. Krishnamma & Co., Gudur, [1955] 28 ITR 273 (AP)	Earlier authority interpreting registration/refusal powers under the predecessor provisions; used to show how refusal under registration provisions has been treated.	Used in the Court's comparison of section 185(1)(b) and section 185(5) and to support the proposition that refusal powers can be exercised under different conditions.
Meerasahib Tharaganar v. CIT, [1963] 48 ITR 950 (Mad)	Another earlier authority addressing registration/refusal issues under predecessor law.	Referenced as part of the body of authority on the scope of the ITO's power to refuse registration.
Askaran Kissenlal v. Commissioner Of Income-Tax, West Bengal, [1969] 73 ITR 522 (Cal)	Established that, for refusing registration under the predecessor provisions, the proper considerations were (1) whether the default contemplated in the provision occurred and (2) whether the default was of such a nature as to merit denial of registration; whether the firm was otherwise entitled to registration was not decisive for the test.	The Court expressly followed and relied on this decision as controlling the proper approach when exercising discretion under section 185(5): the ITO must examine whether defaults under section 144 occurred and whether they justify refusal.
Durga Prasad Chandi Prasad v. CIT, [1971] 79 ITR 553 (Pat)	Held that the basis of refusing renewal/registration is the default and its nature — not necessarily that the firm is fictitious; the registered firm could be genuine yet lose registration by default.	The Court followed this Patna High Court view and relied on it to conclude that section 185(5) does not require a finding of non-genuineness before refusing registration.
Narayana Chetty (Y.) v. ITO, [1959] 35 ITR 388 (SC)	Referenced among authorities considered when interpreting predecessor provisions governing registration/refusal.	Used as part of the set of decisions considered in understanding the scope of refusal powers and how defaults operate as a basis for cancellation/refusal.
J.M. Sheth v. Commissioner Of Income-Tax, Madras, [1965] 56 ITR 293 (Mad)	Addressed the interpretation of predecessor provisions concerning registration/refusal.	Referenced in the chain of decisions considered by the Patna High Court and relied upon to appreciate the correct approach to refusals under the statutory scheme.
Trivandrum Tobacco Combines v. CIT, [1967] 63 ITR 813 (Ker)	Another precedent dealing with registration/refusal under predecessor statutes.	Included among authorities informing the Court's understanding that denial of registration may follow from defaults even where a firm is otherwise genuine.

Court's Reasoning and Analysis

The Court analyzed the statutory scheme, focusing on sections 144 and 185 of the Income-tax Act, 1961. The key analytical steps were:

Statutory comparison: The Court contrasted section 185(1)(b) (which authorizes refusal when the ITO forms the opinion the applicant is not a genuine firm or the application is not in accordance with law) with section 185(5) (which permits refusal where there are defaults of the kind specified in section 144). It concluded these are distinct, independent powers with different scopes and conditions for exercise.
Nature of discretion under section 185(5): The Court emphasized that section 185(5) uses permissive language ("may refuse") and thus does not mandate automatic refusal where a section 144 assessment exists. Instead, a judicial discretion is conferred on the ITO which must be exercised lawfully, on relevant material, and not arbitrarily.
What section 185(5) requires: The Court held that section 185(5) does not require the ITO to record a finding that the firm is not genuine (that requirement belongs to section 185(1)(b)). Under section 185(5) the relevant inquiry is whether defaults contemplated under section 144 occurred and whether those defaults are of such a nature as to merit the penalty of denial of registration.
Precedential support: The Court followed the Calcutta and Patna High Courts (notably Askaran Kissenlal and Durga Prasad) for the proposition that the proper test for refusal under the predecessor provisions focused on default and the nature of default, rather than an inquiry into the firm's genuineness.
Application to facts before the Court: Applying the statutory test and precedents, the Court examined the ITO's order of 11 February 1976. It found the ITO had simply noted that the assessment was ex parte under section 144 and there was "no proof" about profit division, but he had not specifically applied his mind to whether defaults under section 144 existed in the required sense or whether those defaults warranted denial of registration. In short, the ITO had not judicially applied the requisite discretion under section 185(5).
Appellate review of discretion: The Court reiterated that an appellate authority (and the Tribunal) can examine the circumstances under which the ITO exercised his discretion and substitute or set aside the exercise of that discretion in appropriate cases.

On that basis, the Court concluded that although section 185(5) does not require a finding of non-genuineness, the ITO's refusal in this case was not justified because he failed to record reasons showing that defaults under section 144 had occurred and were of such a character as to warrant refusal.

Holding and Implications

Holding:

The Court answered the referred questions as follows:

Question No. 1: Answered in the negative — the Tribunal was not correct in holding that the ITO, when refusing registration under section 185(5) after assessing under section 144, should have recorded findings that no genuine firm existed or that the firm did not conform to the partnership deed. In other words, the statute does not require a finding of non-genuineness under section 185(5); refusal may be based on defaults under section 144 and a lawful exercise of discretion.
Question No. 2: Answered in the affirmative — the Tribunal was justified in confirming the Appellate Assistant Commissioner's order setting aside the ITO's decision and directing the ITO to decide the registration application on merits, because the ITO had not applied his mind judicially to the conditions for refusal under section 185(5).

Direct consequences and practical implications:

The Court ordered that Question No. 1 be returned answered in favour of the Revenue and against the assessee; Question No. 2 be answered in favour of the assessee and against the Revenue.
The parties were directed to bear their own costs of the reference.
The Court directed that the answers be returned to the Tribunal in accordance with section 260(1) of the Act.

The Court did not set any new broad precedent overturning prior authorities; rather, it followed and applied earlier High Court decisions (notably Askaran Kissenlal and Durga Prasad) to clarify that section 185(5) refusal is grounded on defaults under section 144 and the discretion to refuse registration must be exercised judicially and for reasons. Where an ITO fails to apply his mind, appellate authorities may require reconsideration on merits.

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Commissioner Of Income-Tax v. Faiz Mohd., Hasim Ali, Taj Mohd., Noor Mohd.

The Judgment of the Court was delivered by

S.K Mal Lodha, J.:— The Income-tax Appellate Tribunal, Jaipur Bench, Jaipur (for short “the Tribunal” hereinafter), has referred the following two questions for the opinion of this court which are said to arise out of its order dated February 23, 1979, passed in I.T.A No. 75.JP/1979:

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the Income-tax Officer having assessed the assessee-firm under section 144 of the Act, for default attracting the provisions thereof, and while rejecting its application for registration under section 185(5) of the Act for the said default, should have given a finding (i) that no genuine firm was in existence, or (ii) that no valid firm was in existence, or (iii) that the firm did not work in accordance with the partnership deed?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in confirming the order of the Appellate Assistant Commissioner through which he set aside the order of the Income-tax Officer and directed him to decide the assessee-firm's application for registration on merits?”

2. The assessee, M/s. Faiz Mohd., Hasim Ali, Taj Mohd., Noor Mohd., Nagaur, submitted an application in Form No. 11 for grant of registration to it. The application was in order. The assessment year involved is 1973–74. The application in Form No. 11 was submitted for the previous year relevant to the assessment year under consideration. The Income-tax Officer by his order dated February 11, 1976, passed under section 185 of the Income-tax Act, 1961 (No. XLIII of 1961) (“the Act” herein), refused to grant registration to the firm and took its status as that of an unregistered firm. The reason given by the Income-tax Officer in the aforesaid order was that the assessment has been completed under section 144 of the Act and there is no proof whether the profits have been divided in the ratio specified in the deed. The assessee went in appeal. It was, inter alia, contended that on the basis of the material that was filed by the assessee, the Income-tax Officer could have ascertained as to whether the profits of the firm were divided or not according to the profit-sharing ratio as specified in the partnership deed and that the firm is genuine and the Income-tax Officer was not justified in refusing to grant registration. The Appellate Assistant Commissioner taking the aforesaid facts into consideration, opined that it was not a proper case for refusal to grant registration for the same reason that an ex parte order has been made. He, therefore, by his order dated November 8, 1978, directed the Income-tax Officer to consider the application and to decide the matter in accordance with law. The consequence of this was that the status of the assessee as found by the Income-tax Officer, namely, unregistered firm, was set aside. Being dissatisfied, the Income-tax Officer, “B” Ward, Hanumangarh, went in appeal. The order of the Appellate Assistant Commissioner was, inter alia, assailed on the ground that as the assessee failed to comply with the notice, the Income-tax Officer was within his rights to reject the application for registration under section 185(5) of the Act. The Tribunal, while agreeing with the order of the Appellate Assistant Commissioner, observed as under:

“It is correct that if an assessment order is made under section 144 of the Act, the learned Income-tax Officer is empowered to refuse the application for registration. The application for registration can be rejected provided the learned Income-tax Officer on the basis of the evidence on record comes to the conclusion that no genuine firm was in existence. In the/present case, the learned Income-tax Officer did not give a finding in clear words that no genuine firm is in existence. The Appellate Assistant Commissioner pointed out that the assessee filed material along with the return from which it could be ascertained whether the profits and losses were divided or not according to the specified ratio detailed in the partnership deed. The Appellate Assistant Commissioner only directed the Income-tax Officer to decide the matter on merits and in accordance with law. Looking to the provisions of section 185 of the Act, the evidence on record and the order of the learned Appellate Assistant Commissioner, it is correct that the Income-tax Officer did not decide the matter properly. The directions given by the learned Appellate Assistant Commissioner are quite justified.”

3. According to the Tribunal, from the material that was filed before the Income-tax Officer, he could very well determine whether the profits were divided in accordance with the profit-sharing ratio as specified in the deed or not and that the Income-tax Officer did not record the finding that no valid firm was in existence. On an application under section 256(1) of the Act, the Tribunal has referred the aforesaid two questions as, according to it, they are questions of law arising out of its order. We have heard Mr. B.R Arora, learned counsel for the Revenue, as well as Mr. D.K Parihar, learned counsel for the assessee.

4. We propose to answer the questions ad seriatim.

5. Question No. 1.—It was not in dispute before the Tribunal as appears from its order as well as from the statement of the case and question No. 1 formulated for opinion that the application for registration of the firm was rejected by the Income-tax Officer under section 185(5) of the Act as the Income-tax Officer had assessed the assessee under section 144 of the Act. It will be relevant here to read sections 144 and 185(5) of the Act:

“144. If any person—

(a) fails to make the return required by any notice given under sub-section (2) of section 139 and has not made a return or a revised return under sub-section (4) or sub-section (5) of that section, or

(b) fails to comply with all the terms of a notice issued under subsection (1) of section 142 or fails to comply with a direction issued under sub-section (2A) of that section, or

the Income-tax Officer, after taking into account all relevant material which the Income-tax Officer has gathered, shall make the assessment of the total income or loss to the best of his judgment and determine, the sum payable by the assessee or refundable to the assessee on the basis of such assessment.

185. (5) Notwithstanding anything contained in this section, where, in respect of any assessment year, there is, on the part of a firm, any such failure as is mentioned in section 144, the Income-tax Officer may refuse to register the firm for the assessment year.”

6. Section 184 provides for application for registration and the procedure on receipt of application has been provided in section 185. The material part of section 185 for the present purpose is as quoted above.

7. In order to appreciate the contention raised by the learned counsel for the Revenue, it may be stated that under section 185(1), after the receipt of the application for registration, the Income-tax Officer has to hold an enquiry regarding the genuineness of the firm and its constitution as specified in the instrument of partnership and if he feels satisfied that there was during the previous year a genuine firm with the constitution so specified, was in existence, he may order registration of the firm for that assessment year. If he is not so satisfied as specified in sub-section (1) of section 185, he may refuse registration of the firm.

8. A perusal of section 185(1)(b) and section 185(5) shows that the Income-tax Officer has full powers to refuse registration of the firm. These two powers are distinct and independent. The scope of the two powers is also different and different conditions govern the exercise of the two powers. Under section 185(1)(b) of the Act, the Income-tax Officer has been empowered to refuse registration to a firm if he forms an opinion that the application for registration has not been made in accordance with the provisions of law or that the applicant-firm is not a genuine firm. However, refusal under section 185(5) follows only when there is one or more of the defaults specified in section 144. Though the Income-tax Officer has power to refuse registration either under section 185(1)(b) or under section 185(5), he can refuse registration under section 185(1)(b) or in the exercise of discretion under section 185(5) or simultaneously under section 185(1)(b) and under section 185(5). Reference in this connection may be made to CIT v. Jekisondas Bhukandas, [1967] 66 ITR 515 (Guj), The Commissioner Of Income-Tax Madras…Applicant; v. Krishnamma & Co., Gudur…., [1955] 28 ITR 273 (AP) and Meerasahib Tharaganar v. CIT, [1963] 48 ITR 950 (Mad).

9. As stated above, there is no controversy in the case before us as is borne out from question No. 1 formulated by the Tribunal that registration of the firm may be refused on the application of the assessee under section 185(5) of the Act. The words used in section 185(5) are “may refuse to register From these words, it is abundantly clear that section 185(5) does not prescribe automatic refusal of registration in the event of any such failure as mentioned in section 144 but confers a discretionary power on the Income-tax Officer to refuse registration in such a case. It follows that merely on the ground that the Income-tax Officer has proceeded to make a best judgment assessment, registration cannot be refused. For refusing registration, he has to give reasons for his order. The discretion which has been conferred on the Income-tax Officer under section 185(5) of the Act is a judicial one and in an appeal, the appellate authority can examine the circumstances in which the discretion was exercised and may set aside the order in a proper case. But that discretion is not to be exercised arbitrarily or capriciously but in a lawful manner and on the basis of the material circumstances present in a given case. The Tribunal in its order has stated that the application for registration can be rejected by the Income-tax Officer if he comes to the conclusion that no genuine firm was in existence. Is this the requirement under section 185(5) of the Act? A close reading of section 185(1) and section 185(5) and a comparison of the two provisions show that in the latter provision (under section 185(5)), it is not incumbent on the Income-tax Officer before refusing registration of the firm to come to a conclusion that the firm is not genuine, for that is the requirement under section 185(1)(b) of the Act. Section 23(4) and section 26A of the Indian Income-tax Act, 1922 (“the old Act”), were considered in Askaran Kissenlal v. Commissioner Of Income-Tax, West Bengal, [1969] 73 ITR 522 (Cal). It was held therein that the relevant considerations for deciding whether the action of the Income-tax Officer in refusing registration under section 23(4) was justified were: (1) whether there had been a default on the part of the assessee as contemplated in that section and (2) whether such default was of such a nature as to merit the penalty of denial of registration. It was observed as under (headnote):

“Whether the firm was genuine or not or whether it was otherwise entitled to registration under section 26A would not be germane for testing the propriety of the Income-tax Officer's action in refusing registration under section 23(4)?”

10. It may be stated that sections 184 and 186 were previously sections 26A and 23(4) of the old Act. Section 23(4) of the old Act was also examined by the Patna High Court in Durga Prasad Chandi Prasad v. CIT, [1971] 79 ITR 553 (Pat). After referring to The Commissioner Of Income-Tax Madras…Applicant; v. Krishnamma & Co., Gudur…., [1955] 28 ITR 273 (AP), Narayana Chetty (Y.) v. ITO, [1959] 35 ITR 388 (SC), J.M Sheth v. Commissioner Of Income-Tax, Madras., [1965] 56 ITR 293 (Mad) and Trivandrum Tobacco Combines v. CIT, [1967] 63 ITR 813 (Ker), it was held that the basis of an order for consideration of registration under section 23(4) is not that the firm which had been registered is a fictitious one, but that, though the registered firm was genuine, by its failure to comply with the requirement of law, it had incurred the penalty of having its registration cancelled. In the facts and circumstances of that case, the learned judges came to the conclusion that the Income-tax Officer was justified in refusing the renewal of registration of the firm under section 26A of the old Act while exercising the discretion vested in him under section 23(4) of the old Act.

11. We respectfully follow the view taken by the Calcutta and the Patna High Courts in the aforesaid two decisions and in disagreement with the Tribunal hold that it is not necessary for the Income-tax Officer while taking action under section 185(5) of the Act to record a finding on the application for registration of the firm that it is genuine. If the conditions, namely, that there has been a default on the part of the assessee as contemplated by section 144 of the Act and that the default was of such a nature so as to merit the penalty of denial of registration, are satisfied, then the Income-tax Officer can refuse registration under section 185(5) of the Act and it is not necessary for him to go into the question whether the firm was genuine or it was otherwise entitled to registration under section 185 of the Act. Once defaults as stated in section 144 have occurred, a discretion has been given to the Income-tax Officer to refuse registration by resorting to section 185(5) of the Act.

12. For the reasons mentioned above, we hold that, on the facts and circumstances of this case, the Tribunal was not right in coming to the conclusion that the Income-tax Officer having assessed the assessee under section 144 of the Act for default, attracting the provisions thereof while rejecting its application for registration under section 185(5) of the Act on the ground of defaults under section 184, it should have given a finding (1) that no genuine firm was in existence, or (2) that the firm did not come into existence in accordance with the partnership deed.

13. Question No. 2.—Now, we pass on to question No. 2. The Appellate Assistant Commissioner was impressed by the contention raised on behalf of the assessee that there was material on record for the Income-tax Officer to verify, that the profits have been distributed in accordance with the ratio indicated in the partnership deed and so he should have granted registration. In that view of the matter, he directed the Income-tax Officer to consider the application for registration on merits and to decide the matter in accordance with law. On appeal, the Tribunal concurred with the view taken by the Appellate Assistant Commissioner and held that the Income-tax Officer could very well know that the profits were divided in accordance with the ratio as specified in the deed or not and as the Income-tax Officer had not given a finding that a valid firm had come into existence, the direction given by the Appellate Assistant Commissioner calls for no interference.

14. We have already observed while discussing question No. 1 that merely on the ground that the Income-tax Officer has proceeded to make a best judgment assessment, registration cannot be refused. In the present case, the Income-tax Officer, as is clear from the order dated February 11, 1976, rest contented by saying that the assessment has been completed ex parte under section 144 of the Income-tax Act, 1961, and there is no proof whether the profits have been divided in the ratio specified in the deed. The Income-tax Officer did not specifically consider the condition laid down under section 185(5) of the Act for refusing registration. In other words, he was required to specifically mention whether the defaults as envisaged by section 144 of the Act have been committed by the assessee or not and that defaults were of such a nature that they warranted refusal of registration to the firm and on the fulfilment of those conditions, he could, in the exercise of his discretion, refuse registration. Even at the risk of repetition, it may be stated that it is not necessary for the Income-tax Officer while passing an order under section 185(5) of the Act to record a finding that the firm is genuine or not. It is also well-settled that where the Income-tax Officer has refused registration in exercise of discretion under section 185(5) of the Act, the Tribunal in appropriate cases can substitute its discretion for that of the Income-tax Officer. Here the refusal by the Income-tax Officer was not warranted, as he had not applied his mind judicially while passing an order under section 185(5), particularly keeping in view the principles laid down in Askaran Kissenlal's case, [1969] 73 ITR 522 (Cal), with which we respectfully agree. The Tribunal was right in maintaining the order of the Appellate Assistant Commissioner directing the Income-tax Officer to consider the application on merits and to decide the matter afresh in accordance with law. The result is that question No. 1 is answered in the negative, i.e, in favour of the Revenue and against the assessee and question No. 2 is answered in the affirmative, i.e, in favour of the assessee and against the Revenue. We leave the parties to bear their own costs of this reference.

15. Let the answers be returned to the Tribunal in accordance with the provisions of section 260(1) of the Act.

Commissioner Of Income-Tax v. Faiz Mohd., Hasim Ali, Taj Mohd., Noor Mohd.

Court Opinion Summary (Judgment delivered by S.K. Mal Lodha, J.)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee's Arguments

Revenue's (ITO's) Arguments

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax v. Faiz Mohd., Hasim Ali, Taj Mohd., Noor Mohd.

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