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PETITIONER: M/S. RASHIK LAL & CO.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX, ORISSA

DATE OF JUDGMENT:       09/12/1997

BENCH: SUHAS C. SEN, S. SAGHIR AHMAD

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T SEN, J.      The following  question of  law  was  referred  by  the Tribunal to  the Orissa  High Court  under Section 256(1) of the Income Tax Act, 1961;      "Whether on  the facts  and in  the      circumstances  of   the  case,  the      commission paid  by  the  assessee-      firm to  Sri  Rashiklal  P.  Rathor      (individual)  is   allowable  under      section 40(b)  of  the  Income  Tax      Act,  1961  as  a  deduction  while      computing the  business  income  of      the assesses."      The assesses is a partnership firm carrying on a number of  businesses   including  sale  and  purchase  of  various commodities as  well as  mining.   The partners  of the firm were:      (1) Popatlal Devram      (2) Jayantilal Jagmal      (3) Pragji Devram      (4) Ratilal Odhavji      (5) Rashiklal P Rathor      Popatlal is  Rashiklal’s father. On 1.4.1976, there was on oral  partition of  the share  of Popatlal  in  the  firm amongst Popatlal,  his  wife  and  his  two  sons  including Rashiklal.  The assets of Rashiklal continued to be invested in the  partnership firm.  Rashkilal was  Karta of a smaller HUF. On 17.10.1978, there was an agreement between Rashiklal and the  firm Rashiklal  and  Company  that  Rashiklal  will receive 37  paise per  tone of  mineral sold by the firm. In the assessment  year 1980-81 Rashiklal received a sum of Rs. 28579/- as  commission. The  firm claimed  deduction of this amount from  its income.  The claim  was  negatived  by  the Income Tax  Officer. The  Appellate  Assistant  Commissioner allowed the  appeal holding  that the commission was paid to Rashiklal in his individual capacity and not as Karta of the smaller HUF  which is  the partner  of the  firm. Since  the payment was  not made  to the  partner, Section  (b) of  the Income Tax  Act was  not attracted. The amount of commission

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paid to Rashiklal could not be included in the income of the firm. On  further appeal  by the  Revenue, the Tribunal held that Section  40(b) of the Income Tax Act clearly applied in this case.  Payment  to  Rashiklal  will  be  payment  to  a partner. The  partnership firm could not claim any deduction for  this  payment  from  its  income.  The  High  Court  on reference held  that there was clear material that Rashiklal had invested  his joint  family  funds  to  enter  into  the partnership. Payment  was made  to  Rashiklal  who  was    a partner. Accordingly,  the tribunal was correct in coming to the conclusion that Section 40(b) will be applicable in this case. The  firm was  not entitled  to claim any deduction on account of payment of commission to one of its partners.      The firm  has come up in appeal against the judgment of the High  Court. Section 40(b) of the Income Tax Act, at the material time, stood as under:      "40.  Notwithstanding  anything  to      the contrary  in sections 30 to 39,      the following  amounts shall not be      deducted in  computing  the  income      chargeable under  the head "profits      and   gains    of    business    or      profession".      (a)   X     X      X        X      (b) In  the case  of any  firm, any      payment of interest, salary, bonus,      commission or  remuneration made by      the firm  to  any  partner  of  the      firm.      In our  view, the answer to the question raised in this case is  self-evident. There is no dispute the Rashiklal was a partner  of the  assessee-firm. For assessment of the firm under the  head profits and gains of business and profession any payment  of commission by the firm to any partner of the firm will  not be  allowed as deduction. The firm has paid a commission of  Rs. 28579/- to Rashiklal and has claimed that amount as  deduction. Such  deduction is  not permissible in clear terms of Section 40(b).      The language of the Section is simple and clear. But to complicate the matter an argument was sought to be made that Rashiklal had  not joined  the firm as an individual but was really representing an HUF. The payment to Rashiklal did not amount to  payment of  commission to  the HUF  which was the real partner.  Therefore, the  amount of  commission paid by the firm  to a  non-partner or  a partner who had joined the firm in  a representative capacity, will not fall within the mischief of Section 40(b).      We are unable to uphold this contention for a number of reasons. A  firm is  a compendious  way  of  describing  the individuals  constituting  the  firm.  An  HUF  directly  or indirectly cannot  become a  partner of  a firm  because the firm is an association of individuals.      In the  case of  Dalichand Laxminarayan v. Commissioner of Income  Tax ITR  535, it  was held  by a  Branch of three Judges f  this Court  that a  firm is  not a "person" and as such was  not entitled  to enter  into  a  partnership  with another firm  or an  HUF or  an individual. In that case, an individual, a  joint family  and three  firms  purported  to enter into  a partnership.  The agreement of partnership was signed by  the individual  partner, the  Karta of  the joint family and  one partner  each of  the three  firms. The firm applied for registration under Section 26A of the Income Tax Act. The  application  was  signed  by  the  aforesaid  five individuals. This Court held that there could no question of granting registration  to a partnership purporting to be one

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between three  firms, an HUF and an individual. In coming to this conclusion,  this Court  relied on  the  provisions  of Indian Partnership  Act wherein,  ’Partnership’,  ’partner’, ’firm’ and ’firm name’ were defined in the following manner:      "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"."      S. R. Das, C.J. Speaking for the Court observed:      "This Section  clearly requires the      presence of three elements, namely,      (1) that there must be an agreement      entered  into   by  two   or   more      persons;  (2)  that  the  agreement      must be  to share  the  profits  of      business; and (3) that the business      must be carried on by all or any of      those  persons   acting  for   all.      According   to    this   definition      "persons"  who  have  entered  into      partnership with  one  another  are      collectively called  a  "firm"  and      the name under which their business      is carried  on is  called the "firm      name".  The   first  question  that      arises is  as to  whether a firm as      such can  enter into  an  agreement      with another  firm  or  individual.      The answer  to the  question  would      depend on  whether a  firm  can  be      called a "person".      Das, C.J., thereafter, went on to examen the meaning of the word  "person" in  the Partnership  Act. It  noted  that "persons" had  not been  defined  in  the  Partnership  Act. However, the General Clauses Act, 1897, had defined ’Person’ in Section 3(42) as under:      "Person" shall  include any company      or   association    or   body    of      individuals whether incorporated or      not."      After referring  to the  definition of  ’person’ in the General Clauses  Act, Das,  C. J. observed that the firm was not a  company but  was certainly  an association or body of individuals.      The Court,  however, after  examining the scheme of the Partnership Act  and the  corresponding  provisions  of  the English Law  on the  subject, held that the definition given to "person" by the General Clauses Act could not be extended to  the   Partnership  Act  having  regard  to  the  various provisions of that Act. The Court concluded:      " It  is clear  from the  foregoing      discussion that the law, English as      well  a   Indian,  has,   for  some      specific purposes,  some  of  which      are referred  to above, relaxed its

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    rigid  notions   and   extended   a      limited  personality   to  a  firm.      Nevertheless, the  general  concept      of partnership,  firmly established      in booth  systems of  law, still is      that a  firm is  not an  entity  or      "person" in  law but  is merely  an      association of  individuals  and  a      firm name is only a collective name      of those individuals who constitute      the firm."      The view  of this  Court was that when Section 4 of the Partnership Act  spoke of  "persons" who  had  entered  into partnership with one another it could only be individual and not a  body of  person. A  body of persons like a firm could not enter into partnership with other individuals.      An HUF  cannot be  in a  better position than a firm in the scheme of the partnership Act. The reasons that led this Court to  hold that  a firm  cannot join  a partnership with another "individual"  will apply with equal force to an HUF. In law, an HUF can never be a partner of a partnership firm. Even if  a person  nominated by the HUF joins a partnership, the partnership will be between the nominated person and the other partners  of the firm. Having regard to the definition of "partnership" and "Partners" and in view of the principle laid down in Dulichand’s Case (supra), it is not possible to hold that  an HUF  being a  fluctuating body of individuals, can enter into a partnership with other individual partners. It cannot  do indirectly  what it  cannot do  directly. If a Karta or any other member of the HUF joins a partnership, he can do  so only as an individual. His rights and obligations vis-a-vis other  partners are  determined by the partnership Act and  not by  Hindu Law. Whatever may be the relationship between an  HUF and  its nominee  partner, in a partnership, neither the  HUF nor any member of the HUF can claim to be a partner or connected with the partnership through a nominee. Where  the  Karta  of  an  HUF  enters  into  a  partnership agreement with a stranger, the Karta alone in the eye of law is the  partner. If  any payment by the firm to a partner is prohibited by law, the Karta cannot be heard to say that the payment was  received by  him not  as a  partner but in some other capacity.  Within the  partnership,  the  Karta  is  a partner like any other partner with whom he has entered into a partnership  agreement individually.  It is  essential  to have  an   agreement  between   the  partners   to  form   a partnership. An  HUF not  being a "person" cannot enter into an agreement  of partnership.  If the Karta of an HUF enters into partnership  with a  stranger, upon  the death  of  the Karta, the  partnership will stand dissolved. In the absence of a  contract to the contrary, another member of the family cannot step  into the  shoes of  the Karta claiming that the Karta was  merely representing  the HUF and the real partner was the HUF.      A Karta  who enters into a contract of partnership with a stranger  may be  accountable to  the other members of the HUF for  the profits received from the partnership business. But that  is something  between the  Karta and  the HUF. But that is  something between the Karta and the HUF. But so far as the partnership firm is concerned, the Karta is a partner like any other partner. if a commission is paid to a partner who happens to be a nominee of an Huf, the commission is not paid to  the HUF.  It is  paid by  the firm  to one  of  its individual partners. The partner may have to account for the monies received  from the  firm to another person or another firm or  an association  of persons or an HUF. But that will

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not alter  the fact  that commission was paid by the firm to one of its partners.      The  partnership   Act  contains   various   provisions regulating the  relationship between  partners. The partners are bound  to carry  on the  business of  the  firm  to  the greatest common  advantage, to  be just and faithful to each other and to render true account and true information of all things affecting  the firm  to  any  partner  or  his  legal representative. Every  partner has  a right  to take part in the conduct  of the  business. Every  partner  is  bound  to attend diligently  to his  duties  in  the  conduct  of  the business. Any  differences arising  as to  ordinary  matters connected with  the business  may be  decided by majority of the partners  and every  partner shall  have  the  right  to express his  opinion before the matter is decided. No change can be  made in  the nature  of  the  business  without  the consent of  all the  partners. Every  partner has a right to have access to and to inspect and copy and y of the books of the firm.  All these  provisions will apply to a partner who represents another body the HUF who has a nominee partner in a firm  has neither  any right  nor any obligation under the provisions of  the Partnership Act. Section 13 provides that a partner is not entitled to receive remuneration for taking part in  the conduct  of  the  business.  The  partners  are entitled to  share equally  in the  profits earned and shall contribute equally  to the  losses sustained  by  the  firm. Where a  partner is  entitled   to interest  on the  capital subscribed by  him, such  interest shall be payable only out of profits.  A firm has to indemnify a partner in respect of payments  made  and  liabilities  incurred  by  him  in  the ordinary and  proper conduct  of business  and in doing such act, in  an emergency for the purpose of protecting the firm from any  loss as  would be  done by  a person  of  ordinary prudence under similar circumstances. The partner has also a duty to  indemnify for  any loss  caused to  the firm by his willful neglect in the conduct of the business of the firm.      All these  provisions relating  to  mutual  rights  and liabilities are  only applicable  to the individual partners who are members of the firm. There is no way that an HUF can intrude into  the relationship created by a contract between certain individuals.  The only  right of the HUF is possibly to call  upon its nominee partner to render accounts for the profits  that he has made from the partnership business. But that is something between the nominee and the HUF with which the partnership is not concerned.      The specific provision in Section 13 of the Partnership Act  that   a  partner   is  not  entitled  to  receive  any remuneration for  taking part in the conduct of the business has been  interpreted to mean that every partner is bound to attend diligently to the business of the firm. For doing his duties  he   cannot  charge   his  copartners   any  sum  or remuneration whether  in the  shape of salary, commission or otherwise  on  account  of  the  trouble  taken  by  him  in conducting the  partnership business. There, however, can be a special  contract to  the  contrary  in  which  case,  the provisions of that contract will prevail.      Section 40(b)  of the  Income Tax  Act will  apply even when there  is such  a special contract. Any commission paid by a  firm to its partner will not be permitted as deduction from the  business income of the firm. If a claim is made by a partner  that he  is representing an HUF or any other body of persons  then  the  position  in  law  will  not  be  any different. The  HUF is  not and  cannot be  a partner  in  a partnership firm. The remuneration or the commission that is paid to  the partner  cannot be claimed to be a remuneration

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or  commission   paid  to   the  HUF.  The  Partner  may  be accountable to  the family  for the  monies received  by him from the partnership. But in the assessment of the firm, the partner cannot  be heard to say that he has not received the commission as  a partner  of the  firm but  in  a  different capacity.      We were referred to two decisions of this Court on this point, Brij  Mohan Das  Laxman Das  V. CIT,  223 ITR 825 and Suwalal Anandilal  Jain v.  Commissioner of  Income Tax, 224 ITR 753.  Both the cases dealt with payment of interest to a partner  who   had  joined  the  firm  in  a  representative capacity. Section  40(b) prohibits  deduction on  account of payment of interest, salary, bonus or remuneration by a firm to any  partner of  the specifically providing that where an individual was  a partner  in a  firm  in  a  representative capacity for and on behalf of any other person, the interest paid by  the firm to such individual shall not be taken into account for the purpose of clause (b) of Section 40.      This Court  held that in view of this Explanation, when a Karta of an HUF had joined a firm representing his HUF and had made  deposits in  the firm  in his individual capacity, the interest  paid to  him could not be disallowed by reason of the  Explanation II  added to Section 40(b) of Income Tax Act, 1961. It was further held that the explanation was only clarificatory.  It   is  difficult   to  agree   with   that proposition  because   the  Explanation  was  added  by  the Taxation  laws   (Amendment  Act,   1984  with  effect  from 1.4.1985, i.e.,  from the assessment year 1985-86. By adding the  Explanation,   the  legislature     altered   the   law prospectively on and from 1.4.1985. If what was contained in the Explanation  was already  the law  in force, then giving effect to  the Explanation  from 1.4.1985  does not make any sense.      However, in  the case before us, no question of payment of any  interest is  involved. A  commission was paid by the firm  for   the  services  rendered  by  the  partner.  Such commission cannot  be paid  because  of  the  provisions  of Section 13  of the  Partnership Act  in  the  absence  of  a special contract. Even if a special contract exists, Section 40(b) of  the Income  Tax Act  prohibits allowance  of  such commission as  deduction from  the business  income  of  the firm.      The  argument   that  Rashiklal  had  joined  the  firm Rashiklal  &   Company  not   as  an  individual  but  in  a representative  capacity   overlooks  the   fact  that   the Partnership Rashiklal  & Company  is a  compendious  way  to describe the  individuals who  are partners of the firm. The other partners  of the  firm have a contractual relationship with Rashiklal  only. Section  40(b) categorically disallows any deduction of payment of commission to a partner .      The position  of a  person belonging  to an HUF who has joined a  firm on behalf of the family has been explained in Mulla’s Hindu Law, Sixteenth Edition, page 265:-      "Not  all   members  of  the  joint      family,  but   only  such   of  its      members as  have, in  fact, entered      into partnership with the stranger,      become partners.  The  manager,  no      doubt,  is   accountable   to   the      family,  but   the  partnership  is      exclusively   one    between    the      contracting members  including  the      manager and  the stranger.  Such  a      partnership would  be  governed  by      the  provisions   of   the   Indian

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    Partnership  Act,  1932,  with  the      result that  if the  manager  died,      the partnership  would be dissolved      on his death."      Under the  Income Tax  Act, 1961, ’firm’, ’partner’ and ’partnership’ have  been given  the same meaning as assigned to them in the partnership Act. But the expression ’Partner’ has been  extended to include any person who, being a minor, has  been   admitted  to  the  benefits  of  a  partnership. Therefore, there  is no  scope for  any argument  that  even though under  the Indian Partnership Act, an HUF not being a ’person’ cannot ba partner, but the payment of commission to the nominee  partner will  tantamount to  payment to the HUF and  therefore,  such  payment  will  not  come  within  the mischief of  Section 13  of the  Partnership Act  or Section 40(b) of  the income Tax Act. To repeat what has been stated in Mulla’s Hindu Law, only the members who have entered into partnership are to be regarded  as partners.      The position  of the  other members  is no  higher than sub-partnership.      The application  for registration of a firm has to be a made under  Section  184  of  the  Income  Tax  Act.  It  is specifically provided that:      (1)   the   partnership   must   be      evidenced  by   an  instrument   in      writing;      (2)  the   individual   shares   of      partners must  be specified in that      instrument;      (3)     the     application     for      registration shall be signed by all      the partners.      The very  fact that  individual shares  of the partners have to  be specified and that such partners must personally sign the  partnership deed  and  also  the  application  for registration go  to show  that even if a person joins a firm as  a  representative  of  an  HUF  or  any  other  body  or association, within  the firm  his position  is that  of  an individual. He  may have  an agreement with a third party to divide  the   profits  received  from  the  firm,  but  that agreement does  not bind  the firm  nor does  it  alter  the position or  the Income  Tax Act.  This aspect of the matter was explained  by Subba  Rao, J. (as his Lordship, then was) in the  case of Commissioner of Income Tax v. Bagyalakshmi & Co. 55 ITR 660 in the following words:      " A  partnership is  a creature  of      contract. Under  Hindu Law  a joint      family is  one of  status and right      to  partition   is   one   of   its      incidents. The income-tax law gives      the  Income  of  a  person  in  the      manner provided  by the Act. Except      where there is a specific provision      of   the   Income-tax   Act   which      derogates from  any other statutory      law or  personal law, the provision      will have  to be  considered in the      light of  the relevant  branches of      law. A  contract of partnership has      no concern  with the  obligation of      the partners  to others  in respect      of their  shares of  profit in  the      partnership. It  only regulates the      rights  and   liabilities  of   the      partners.  A  partner  may  be  the

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    Karta of  a joint  Hindu family; he      may be a trustee; he may enter into      a sub-partnership  with others;  he      may be  a benamidar for another. In      all such  cases he  occupies a dual      position. Qua  the partnership,  he      functions in his personal capacity;      qua  the   third  parties,  in  his      representative capacity.  The third      parties, whom  one of  the partners      represents,  cannot  enforce  their      rights against  the other  partners      nor the  other partners  can do  so      against the said third parties."      This judgment  given by  a bench of three Judge of this Court is  a complete  answer to  the  argument  advanced  on behalf of  the  assesses.  A  partner  does  not  act  in  a representative capacity  in the partnership. He functions in his personal capacity like any other partner. The provisions of the  Partnership Act  and the  Income Tax Act relating to partners and  partnership firms will apply in fully force in respect of  such a partner. If any remuneration is paid or a commission is  given to  a partner  by a  partnership  firm, Section 40(b)  will apply even if the partner has joined the firm as  a nominee of an HUF . The Hindu Undivided family or its representative  does not  have any special status in the partnership Act.  Although the  partnership firm  is  not  a legal entity,  it has been treated as an independent unit of assessment under  the Income  Tax Act.  The assessment  of a firm will  have to  be made  strictly in accordance with the provisions of  the income  Tax Act. The assessment of a firm will have  to  be  made  strictly  in  accordance  with  the provisions of the Income Tax Act. The law has to be taken as it is.  Section 40(b)  applies to certain payments made by a firm to  its partners. Neither the firm nor its partners can evade the  tax law on the pretext that although in law he is a partner  but in  reality he is not so. He may have to hand over the  money to  somebody else.  That may be his position qua a  third party.  But the firm has nothing to do with it. It has paid the commission to one of its partners. it cannot get any deduction in its assessment for that payment because of  Section  40(b)  of  the  Act  expressly  prohibits  such deduction.      The basic  principle that  a firm is a compendious mode of describing  the persons constituting the firm who are its partners. The  partner may  be under an obligation hand over the monies  received by  him to somebody else by virtue of a sub-contract or  any other arrangement. That will not change the character  of the  payment by the firm to its partner or the status  of the  partner in  the firm  . The  firm is not entitled to  get any  deduction on  account  of  payment  of Commission to  a partner  merely because  the partner has an obligation to  share the money with somebody else. So far as the firm  was concerned,  the commission  was paid to one of the partners in his personal capacity.      The provisions  relating  to  assessment  of  the  firm should not  be construed  in a  way to  defeat  its  object. Section 40(b) forbids deduction of any amount paid by way of commission to a partner. In the instant case, Rashiklal is a partner of  the firm  Rashiklal and  Company. The commission received by  him from the partnership firm cannot be allowed as a deduction from the business income of the partnership .      The appeals, therefore, fails and are dismissed with no order as to costs.

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