- Bookmark
- Share
- CaseIQ
Commissioner Of Income-Tax, Kerala v. Pathrose Rice And Oil Mills, Irinjalkuda, Assessee
Judgment Summary — Reference under S.66(1), Income-tax Act, 1922
Factual and Procedural Background
This opinion arises from a reference made by the Income-tax Appellate Tribunal, Madras A Bench, under S.66(1) of the Indian Income-tax Act, 1922. The Tribunal posed the following question to the court: "There being no other defects in the application, whether the firm is a valid partnership in law and accordingly registrable under S.26A for all the aforesaid 4 years of assessment 1952-53 to 1955-56?"
Counsel appearing are recorded as G. Rama Iyer for the Department and C.T. Peter, C.T. Joseph and T.C. Karunakaran for the assessee. A translation of the partnership instrument was placed before the court; the instrument names three parties — Pathrose, Kochu Deyassy and Devassy — and contains clauses (notably clause 4, clause 7 and clause 8) that were central to the dispute.
The Appellate Tribunal had earlier directed that registration be granted, and the Tribunal's reasoning and the Department's objections were set out in the reference to this court. The court sent a copy of its judgment to the Appellate Tribunal pursuant to S.66(5) of the Act.
Legal Issues Presented
- Whether, assuming no other defects in the application, the firm constituted by the instrument is a valid partnership in law and therefore registrable under S.26A of the Indian Income-tax Act, 1922, for the assessment years 1952-53 to 1955-56?
Arguments of the Parties
Department's Arguments
- The Department relied on clauses 7 and 8 of the partnership instrument to contend that the arrangement did not create a partnership in law — specifically, that those clauses undermine the "principle of agency" required for a partnership.
- It was argued that clause 7 (which gives Partner No.1 an absolute right to exclude or discharge the other partners) and clause 8 (which vests sole discretion for conducting the business in Partner No.1) were inconsistent with the statutory concept of partnership.
- The Department also suggested clause 7 might be contrary to S.33(1) of the Indian Partnership Act, 1932 (which restricts expulsion by a majority and requires exercise in good faith of powers conferred by contract), implying that an expulsion power vested solely in one partner is not in accordance with the law.
Assessee's Position (as reflected in the opinion)
- The assessee did not dispute the genuineness of the arrangement; the instrument provided that "the annual profits in the business after deducting all expenses have to be divided equally among the three partners" (clause 4), and it was not contended that the instrument suffered from the profit-sharing infirmity identified by Chagla, C.J. in the cited case.
- The Appellate Tribunal (representing the assessee's successful position at that stage) maintained that the clauses complained of merely prescribe how the business is to be conducted and do not warrant rejection of the registration application when the deed is considered as a whole.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Umarbhai Chandbhai v. Commissioner of Income-tax, (1952) 22 ITR 27 | Chagla, C.J.'s statement that for a partnership to exist there must be (a) agreement to share profits and (b) the business must be carried on by all or any of them acting for all — i.e., both profit-sharing and the principle of agency are essential. | The court noted the two essential conditions identified in that case but found the present instrument did not suffer from the second infirmity (sharing of profits was expressly provided equally under clause 4). The court distinguished the present facts from Umarbhai Chandbhai on that basis. |
| Bhimji Naik v. Commissioner of Income-tax, Bombay, AIR 1945 Bom 271 | Holds that an instrument conferring wide powers on a senior partner (including dismissal rights and control) may still create the relationship of partners rather than that of employer and employees; profits and losses borne in stated proportions support a partnership characterization. | The court relied on the decision to support the proposition that clause 7 (a power to exclude or dismiss vested in one partner) does not necessarily negate the existence of a partnership. |
Court's Reasoning and Analysis
The court proceeded by reference to the relevant statutory provisions and the governing authorities stated in the record. It set out S.26A of the Income-tax Act (which permits firms constituted under an instrument of partnership to apply for registration) and summarised the essentials from the rules (as collected in the cited text) that an application must satisfy. It observed that the parties agreed there were no defects in the application itself.
The court distilled the limited grounds on which registration could be refused where an application is otherwise in order: (1) when there is no partnership in law; or (2) when a partnership in law exists but is not genuine. Since the genuineness of the arrangement was not disputed, the single live issue was whether the relationship amounted to a partnership in law.
Applying the statutory definition of "partnership" in S.4 of the Indian Partnership Act, 1932 (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), the court examined the instrument. Clause 4 expressly provided for equal division of profits among the three partners; consequently, the instrument did not lack the profit-sharing requirement identified in Umarbhai Chandbhai.
The court addressed the Department's contention that clauses 7 and 8 undermined the "principle of agency." Clause 8 was interpreted as an agreement that Pathrose would conduct the business at his sole discretion — an arrangement analogous to a management or dormant-partner structure that earlier authorities had accepted as compatible with partnership. Clause 7's provision for exclusion by Pathrose alone was considered and found not to be determinative: the court drew on Bhimji Naik to show that instruments conferring wide powers on a senior partner nonetheless have been held to create partnerships. Regarding the S.33(1) argument (that expulsion by a sole partner may be impermissible), the court observed that even if an expulsion by Pathrose might be void, that would not show that the relationship created by the document was not a partnership.
The court also reviewed the Appellate Tribunal's reasoning (which had addressed the Department's points about exclusion rights, sole conduct of the business and possession of cash and books by one partner) and agreed with the Tribunal's conclusion that these features, when the deed is taken as a whole, were only conditions prescribing how the business was to be conducted and did not justify rejection of registration.
Holding and Implications
Holding: The court answered the referred question in the affirmative: the firm constituted by the instrument is a valid partnership in law and is registrable under S.26A for the assessment years 1952-53 to 1955-56.
Implications:
- The court directed (via the affirmation of the Tribunal's conclusion) that the Income-tax Officer grant registration to the firm under S.26A.
- The court expressly declined to make any order as to costs in the circumstances of the case.
- The opinion treats the contested clauses (7 and 8) as not fatal to partnership status when the instrument is read as a whole; it affirms the Tribunal's application of existing authority rather than announcing a novel legal principle.
Administrative note in the opinion: A copy of the judgment, under the seal of the Court and signature of the Registrar, was to be sent to the Appellate Tribunal as provided by S.66(5) of the Income-tax Act, 1922.
G. Rama Iyer, for Department; C.T. Peter, C.T. Joseph and T.C. Karunakaran, for Assessee.
Judgement
This is a reference by the Income-tax Appellate Tribunal, Madras A Bench, under S. 66(1) of the Indian Income-tax Act 1922. The question referred is :
"There being no other defects in the application, whether the firm is a valid partnership in law and accordingly registrable under S. 26A for all the aforesaid 4 years of assessment 1952-53 to 1955-56 ?"
2. Section 26A of the Indian Income-tax Act, 1922, reads as follows :
"(1) Application may be made to the Income-tax Officer on behalf of any firm, constituted under an instrument of partnership specifying the individual shares of the partners, for registration for the purposes of this Act and of any other enactment for the time being in force relating to income-tax or supertax.
(2) The application shall be made by such person or persons, and at such times and shall contain such particulars and shall be in such form, and be verified in such manner, as may be prescribed; and it shall be dealt with by the Income-tax Officer in such manner as may be prescribed."
Rules 2 to 6B of the Indian Income-tax Rules, 1922, deal with the registration of firms. Kaghavachariar summarises as follows the essentials to be satisfied under those rules before an application for registration can be allowed by the Income-tax Officer :
"1. The application should be made on behalf of the firm.
2. The firm should be constituted under an instrument of partnership.
3. The instrument of partnership should specify the individual shares of the partners.
4. The application should be made only for the purpose of this Act and any other enactment relating to income-tax and supertax.
5. The application should be presented by such person or persons and at such time and shall contain such particulars and shall be in such form and verified in such manner as may be prescribed." (The Indian Income-tax Act, Vol. I, page 821)
3. It is common ground that there are no defects in the application for registration and the question referred is worded on that assumption. In such a case registration can be refused only
(1) when there is no partnership in law; or
(2) when there is a partnership in law but it cannot be considered a genuine partnership.
The genuineness of the arrangement is not disputed. The only contention before us is that the relationship created does not constitute a partnership in law.
4. According to S. 4 of the Indian Partnership Act, 1932 :
" 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."
As pointed out by Lindley in his Treatise on the Law of Partnership when a statutory definition is provided by the legislature that definition taken in connection with the other sections of the Act
"must for the future be the ultimate test applicable to the determination of the question whether in any particular case a partnership does or does not exist."(11th Edition, page 28)
5. A translation of the instrument concerned forms part of the paper book. There are three parties thereto, one Pathrose, and his brother and son, Kochu Deyassy and Devassy, respectively. The clauses on which reliance is placed by counsel for the Department for the contention that the instrument does not create a partnership are clauses 7 and 8. They read as follows :
"7. If at any time partners Nos. 2 and 3 want to withdraw from the partnership cither jointly or severally or if at any time partner No. (1) wishes to send out partners Nos. 2 and 3 jointly or severally, Partner No. 1 has independent and absolute right and power to immediately exclude or discharge them. All amounts due to or from the outgoing partners should be paid in cash, the expenses incidental to such withdrawals being met by the outgoing partners.
8. All activities connected with the business etc., are to be conducted at the sole discretion of partner No. 1 and all his actions are binding on all the three partners equally".
6. Counsel for the Department also cited Umarbhai Chandbhai v. Commr. of Income-tax, (1952) 22 ITR 27. In that case Chagla, C.J. said :
"Now in this case the partnership is between Mahomed Umer and his two sons, and the question is whether on the terms of the document itself it can be stated that in law there was a partnership. Now there are two essential conditions before it could lie stated that by contract a relationship has been brought about between persons which is the relationship of a partnership; and the two conditions are that the partners must agree to share the profits of the business and the business must be carried on by all or any of them for all of them. Therefore, not only must there be a sharing of profits but there must be also the principle of agency. This particular document seems to offend against both the principles. It is unnecessary to go into the details, but taking the two outstanding points it is clear that whatever contractual relations existed between the father and the sons the result was certainly not a partnership in law. The father has been given the right to exclude either or both the sons from the management of the firm wholly or in part, or to entrust the management to any other person.
Sir Jamshedji relies on cases where there are dormant partners or arrangement is made that a particular partner shall be in the management thereof; but they are all cases where partners agree that a particular partner shall manage and that another person should get a share in the profits without being under an obligation to work for the partnership. But where we have a case where a partner who is willing to work is excluded and where he has no power to work as an agent of the business clearly it is a case where the partner so excluded would not be a partner at all. The other outstanding feature of this case is that even with regard to the sharing of profits it is left to the father to determine what quantum of any profits should be distributed and it is also left to him after such distribution what should be done with the remaining profits. Therefore, under this document there is not even sharing of profits contemplated. It is left to the father whether profits should be shared or not, when they should share them and to what extent. Clearly an arrangement like this cannot be considered in law to be a partnership."
Clause 4 of the instrument before us provides that
"the annual profits in the business after deducting all expenses have to be divided equally among the three partners"and it is not contended that the instrument suffers from the second of the two infirmities dealt with by Chagla, C.J.
7. The only contention is that clauses 7 and 8 militate against "the principle of agency". We cannot agree. By clause 8 all that the partners did was to consent to Pathrose conducting the business at his sole discretion. Such an agreement is of the type relied on by Sir Jamshedji - agreements to the effect that a particular partner shall be in management and that the others shall remain dormant - and accepted by Chagla, C.J., as not militating against the existence of a co-partnery.
8. The contention that the right of exclusion embodied in clause 7 precludes the creation of a partnership is equally unsustainable. In Bhimji Naik v. Commr. of Income-tax, Bombay, AIR 1945 Bom 271, an instrument somewhat similar to the one before us came up for consideration. The Head Note states the relevant details and conclusion as follows :
"R carried on business as a general merchant in South Africa. By a deed of 1937 R admitted his three managers as partners in his business. The managers were not to be disclosed as partners so far as the public was concerned and were to be held out as managers of the business and were to the extent required to be given power of attorney by R. The assets and liabilities of the business were taken over by the new firm and R became the creditor of the Firm for the amount. In the profits and losses of the business R retained an eight annas share whilst the others were the owners of the balance. R was given the right to dismiss any of the partners described as managers for misconduct and R was to be the sole judge of whether misconduct was established. R was to retain full control of the business and the managers were to carry out all instructions given to them from time to time by R.
Held, that the deed though it gave R wider powers than were usually found in a partnership deed as being conferred on a senior partner nevertheless created the relationship of partners and not that of employer and employees, profits and losses being borne by all in the proportion stated."
9. It was suggested by counsel for the Department that clause 7 is not in conformity with S. 33(1) of the Indian Partnership Act, 1932 :
"A partner may not be expelled from a firm by any majority of the partners, save in the exercise in good faith of powers conferred by contract between the partners".
According to him a deed of partnership can only provide for expulsion by a majority of the partners and the provision for expulsion by Pathrose alone embodied in clause 7 is not in accordance with the law. It is unnecessary to evaluate this contention. If it is correct any expulsion by Pathrose may have to be considered as void and of no effect. It does not follow that the relationship created by the document is not a partnership between the parties thereto.
10. The Appellate Tribunal dealt with the contentions of the Department as follows :
"We will now go through the reasons given by the Appellate Assistant Commissioner which prompted him to ignore the order of the Tribunal in regard to the preceding year. One is the competency given to one partner to exclude the other two partners from the firm at any time; the second is the conduct of the business being left in the hands of one of the partners and the possession of the cash balance and the books of accounts in the hands of one of the partners. These the Appellate Assistant Commissioner considers as serious defects which warrant rejection of the assessees claim for registration. We do not see anything wrong in the said clauses of the deed warranting the rejection of the application of the assessee for registration, if we are to take into consideration the deed as a whole. These are only conditions prescribing the manner in which the business has to be conducted. Hence following the aforesaid decisions of the Tribunal, we hold that there is no justifiable reason to reject the application of the assessee for registration. We, therefore, direct the Income-tax Officer to grant registration to the assessee".
11. The conclusion reached by the Tribunal appears to be correct and in the light of what we have stated above the question referred has to be answered in the affirmative. We do so, though in the circumstances of the case without any order as to costs.
12. A copy of this judgment under the seal of the Court and the signature of the Registrar will be sent to the Appellate Tribunal as provided in S. 66(5) of the Indian Income-tax Act, 1932.
Answer in affirmative.
Alert