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PETITIONER: KHANJAN LAL SEWAK RAM

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX, U.P.

DATE OF JUDGMENT31/08/1971

BENCH: HEGDE, K.S. BENCH: HEGDE, K.S. GROVER, A.N.

CITATION:  1972 AIR   61            1972 SCR  (1) 502  1971 SCC  (3) 662  CITATOR INFO :  F          1973 SC1445  (15)  R          1973 SC2401  (4)

ACT: Income  Tax Act (11 of 1922), s. 26A and rr. 6(3) and 6A  of the  Rules-Application  for  renewal  of   registration-Book Profits   distributed   but   black   market   profits   not distributed-If firm entitled to renewal of registration.

HEADNOTE: The assessee was a registered firm.  The partners applied to the Income-tax Officer for renewal of registration.  To that application they appended a certificate that the profits  of the previous year were divided or credited as shown.   While the  application was pending, the partners fell out and  the Income-tax   Officer  found,  that  the  firm   had   earned considerable  black  market  profits  which  had  not   been credited  in the account books and had not been  distributed among  the  partners in accordance with  the  instrument  of partnership.   The Department, Tribunal and the High  Court, on  reference,  held  that  the firm  was  not  entitled  to renewal. Dismissing the appeal to this Court, HELD : Under s. 26A of the Income-tax Act, 1922, one of  the conditions   for  registration  and  renewal  is  that   the application   should   contain  such  particulars   as   are prescribed  in the Rules under the Act.. Rule 6(3)  provides that  the  partners  should  append  a  certificate  to  the application for renewal that the profits (or loss if any) of the  previous year or period up to the date  of  dissolution were divided or credited as shown.  So long as the divisible profits had in fact been divided or had been credited to the accounts of the partners, the requirements of the  provision must   be  held  to  have  been  complied  with.   But   the certificate  is not a mere formality because,  a  registered firm is not taxable, but only the partner and, if a  portion of  the profits earned by the firm was not actually  divided amongst the partners or credited to their accounts, to  that extent the assessee firm had evaded tax.  In such a case the only  course  open  to  the Income-tax  Officer  is  not  to register the firm but to tax the partners of the firm as  an association of persons. [506 B, G; 507 C-G]

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Since,  in the present case, the application for renewal  of registration did not comply with the prescribed  conditions, under  r.  6A,  the  Income-tax  Officer  was  justified  in refusing renewal of registration. [507 F-G] Agarwal  & Co. v. C. 1. T., U. P., 77 I. T. R.  110  (S.C.), followed.

JUDGMENT: CIVIL  APPELLATE  JURISDICTION : Civil Appeal  No.  1947  of 1968. Appeal  from the judgment and decree dated January 21,  1964 of  the Allahabad High Court in Misc.  Income-tax  Reference No. 383 of 1958. T.   A.   Ramachandran  and  A.  G.  Ratnaparkhi,  for   the appellant. B.   Sen, J. Ramamurthy, R. N. Sachthey and B. D. Sharma, for the respondent. 503 The Judgment of the Court was delivered by Hegde, J. This is an appeal by certificate.  It arises from. a  decision of the Allahabad High Court.  The  appellant  is the assessee and the concerned assessment year is 1948-49. The  assessee is a firm constituted under an Instrument,  of partnership  dated  April  30,  1947.   The  shares  of  the partners  in, the profit and loss’ of the firm as  mentioned in that deed are as follows : 1.   L. Khanjan Lal--/4/- 2.   L. Lalloo Ram- -/2/ 3.   L. Dwarka Prasad- -/2/- 4.   L. Ram Lal- -/2/- 5.   L. Sewak Ram- -/4/- 6.   Smt.  Jagrani Devi- -/2/- Lallu  Ram, Dwarka Prasad and Ram Lal are the  children  of- Khanjan  Lad.   Sewak Ram is the son of Jagrani  Devi.   The first group has -/ 10/- share in the profit and loss of  the firm and the second group has -/6/- share. The  assesesee firm was registered for the  assessment  year 1947-48.  On July 12, 1949, the partners of the firm applied to  the Income-tax Officer for renewal of  the  registration for  the  assessment  year 1948-49.   That  application  was signed  by  all  the partners.   To  that  application  they appended  a certificate to the. effect that "profits of  the previous year were divided or credited as shown below. . . " On November 5, 1949, the partner-ship was dissolved under  a deed of distribution dated November 9, 1949  One   of    the clauses in that deed provides :               "But if an amount which was not entered in the               books at the time of settlement is found  then               only  that person will be accountable  for  it               through  whom the money was received or  paid.               None of the parties will have any objection to               it." On  October  5,  1950,  the  first  four  partners  made   a disclosure statement to the Income-tax Officer to the effect that  the  firm had’ earned Rs. 15,000/- by way  of  profits outside  the  books.   In that  disclosure  statement,  they further  stated that those profits had been divided  between the  partners.  On December 9, 1950, Sewak Ram, one  of  the partners  stated on oath before the Income-tax Officer  that he  and his mother Jagrani Devi were not given full’  share of the profits of the business earned by the firm in Sam  v. year 2005.  He further stated that the entire profits earned in  that business carried on in the previous year  were  not

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recorded in 504 the  books and the first four partners had given to him  and his  mother  only their shares of those profits  which  were recorded  in the books.  Therein he sought to  withdraw  the application for registration because all the profits  earned had not been divided according to the shares.  According  to Sewak  Ram,  the  profits ,earned and  not  entered  in  the accounts    amounted   to   Rs.   1,13,571/-.    From    the aforementioned  statements,  it s clear that  the  firm  was trying  to evade tax on a portion of the profits .earned  by it by not bringing the same into their books. On  March 31, 1951, Sewak Ram sued the first  four  partners for  rendition of accounts.  In that suit he  estimated  his share of profits in the amount that had not been entered  in the  account books at Rs. 50,0001.  Ultimately the suit  was compromised  and  Sewak  Ram  withdrew  his  suit.   In  his application  to withdraw the suit, he stated that he  wanted to  withdraw the suit "in view of the circumstances  of  the above case", an expression of utmost ambiguity.  Therein  he stated  that he is not entitled to get any more amount  from the defendants. On  March  15, 1952, Sewak Ram and his mother  Jagrani  Devi gave  an application to the Income-tax Officer stating  that they are withdrawing their signatures on the application for renewal of registration as the profits of the previous  year were  not distributed according to the deed  of  partnership and the certificate of registration required under rule 4(1) of the Income-tax Rules, 1922 (to be hereinafter referred to as "the Rules") framed under the Indian Income-tax Act, 1922 (in  brief ’the Act’) had never been granted as required  by law  on  the  back of the partnership  deed.   Therein  they further stated that as the certificate under rule 6 had  not been  granted  by the assessee in accordance with  law,  the firm  was not entitled for registration under rule 6 of  the Rules. On  the  basis of the material before  him,  the  Income-tax Officer  came  to the conclusion that the  firm  had  earned considerable black market profits, and the same had not been distributed   amongst   the  partners   according   to   the partnership deed and therefore the firm was not entitled for renewal  of  the registration.  He further opined  that  the application  for registration had stood withdrawn.   On  the basis  of  those  conclusions,  he  refused  to  renew   the registration of the firm and taxed the firm in the status of association  of persons.  In appeal the Appellate  Assistant Commissioner, upheld the decision of the Income-tax Officer. The  assessee  took the matter in appeal to  the  Income-tax Appellate  Tribunal.  The two members who heard  the  appeal ,concurred  with  the Income-tax Officer and  the  Appellate Assistant  Commissioner  that a substantial portion  of  the profits  earned  by the firm had not been  entered  in  the books.    They  also  held  that  those  profits  were   not distributed amongst the partners according 505 to  the  Instrument of partnership.  On the basis  of  those findings  the  Judicial member held that the  firm  was  not entitled  to the renewal of registration asked for  but  the Accountant  member opined that inasmuch as the profits  that had  been entered in the books had been  distributed,  there was  compliance with the provisions of the "Act" as well  as the, "Rules".  In view of this difference of opinion between the two members, the matter was referred to the President of the  Tribunal  under  s. 5A(7) of the  Act.   The  President agreed  with the Judicial Member that firm was not  entitled

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to  have the renewal of the registration asked for.   There- after at the instance of the assessee, the Tribual submitted the  following question to the High Court under s. 66(1)  of the Act.               "Whether   the   assessee   firm   which   had               distributed  its  book  profits  amongst   the               partners   according  to  the  Instrument   of               Partnership but which had not distributed  the               profits  earned  by  it in  the  black  market               amongst  the six partners in  accordance  with               the Instrument of Partnership was entitled for               renewal  of  registration for  the  assessment               year 1948-49 ?" The  High  Court  answered that question in  favour  of  the Department.  Hence this appeal by the assessee firm. Before examining the scope of the question submitted to  the High  Court under s. 66(1) of the Act, we may  mention  that the   question  whether  the  application  for  renewal   of registration  stood withdrawn or not is not before  us.   On that question, the Judicial member of the Tribunal took  the view  that  the  said application stood  withdrawn  but  the Accountant  member  did  not  agree  with  that  view.   The President  of  the Tribunal did not express any  opinion  on that point. Now turning to the question referred to the High Court, that question is based on two findings of fact which are no  more open  to question.  Those findings are : (1) that  the  firm had  distributed  its  book  profits  amongst  the  partners according  to the Instrument of partnership, (2) but it  had not distributed the profits earned by it in the black market amongst  the six partners in accordance with the  Instrument of partnership. Mr.  Ramachandran,  the  learned Counsel  for  the  assessee sought  to assail the correctness of those findings  on  the ground  that those findings are not supported  by  evidence, but  we  did  not permit him to go into  the  same  as  that question is not before us.  We are bound by those  findings. Having  said  that much, we shall now turn to  the  relevant provisions in the Act and the Rules.  Section 26 (A) of  the Act reads :               " 1. Application may be made to the Income-tax               Officer  on  behalf of any  firm,  constituted               under an ins-               506               trument   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 super-tax.               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." This  Court  has  ruled in Agarwal  &  Co.  v.  Commissioner of .Income-tax, U.P.(1) that the conditions of  registration prescribed by s. 26-A and the relevant Rules are :               1.    On  behalf of the firm,  an  application               should  be made to the Income-tax  Officer  by               such  person and at such times and  containing               such  particulars,  being  in  such  form  and               verified  in such manner as are prescribed  by               the rules;

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             2.    The firm should be constituted under  an               instrument of partnership;               3.    The   instrument   must   specify    the               individual shares of the  partners and               4.    The  partnership must be valid and  must               actually  exist in the terms specified in  the               instrument. Therein  it was further laid down that if  those  conditions are  fulfilled, the Income-tax Officer is bound to  register the  firm.  The same rule will apply in the case of  renewal of  registration.  In this case we are  primarily  concerned with  the question whether the application made by the  firm is in accordance with the rules prescribed.  The rules  with which we are concerned in this appeal is paragraph 3 of rule 6  and  rule 6-A.  Paragraph 3 of rule 6 provides  that  the partners  should append the following certificate  to  their application for renewal of registration.               "We do hereby further certify that the profits               (or  loss,  if any) of the  previous  year  or               period  upto  the  date  of  dissolution  were               divided ’or credited as shown below........ Rule 6-A provides that " on receipt of an application  under rule  6, the Income-tax Officer may if he is satisfied  that the application is in order and that there is or was a  firm in existence (1)  77 I.T.R,10. 507 constituted as shown in the instrument of partnership, grant to the assessee a certificate signed and dated by him in the following form. . . . . It further provides :               "If the Income-tax Officer is not satisfied he               shall  pass  an order in writing  refusing  to               renew the registration of the firm." Now   the  sole  question  for  decision  is   whether   the application made in this case complied with the requirements of  paragraph  3 of rule 6. If it did not  comply  with  the requirements  of rule 6, the Income-tax Officer  was  within his powers in rejecting it.  As seen earlier, the finding of the Tribunal is that though the profits of the firm  entered in  its  account  books had been  distributed,  the  profits earned but not entered into the account books have not  been divided  or  credit  in the account  books.   From  that  it follows  that the certificate given in the  application  for renewal  of  registration  is not  a  true  certificate  and further that a substantial portion of the profits earned had not been divided. The reason behind rule 6 was that at the relevant time,  the registered firm as such was not taxable.  Only the  partners of  a firm could be taxed.  That being so, if ’a portion  of the  profits earned by the firm was not divided amongst  the partners or credited to their accounts, to that extent,  the profits  earned by the firm escaped  assessment.   Therefore the  certificate  contemplated  by  rule 6  is  not  a  mere formality.  It has a definite purpose.  If a portion of  the profits earned by the firm was not actually divided  amongst the  partners or credited to their accounts, then  the  only course  open to the Income-tax Officer was not  to  register that  firm  and  to  tax the partners  of  the  firm  as  an association of persons.  By giving a false certificate  that the profits earned by the firm had been divided or  credited in  the manner shown in the application, the  assessee  firm was  trying  to  evade tax.  Hence we  must  hold  that  the application for renewal of registration made by the assessee did not comply with conditions prescribed in paragraph 3  of rule 6. Hence the Income-tax Officer was justified to refuse

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to renew the registration. In resisting the above conclusion, Mr. Ramachandran  Counsel for  the  assessee relied on certain decisions of  the  High Courts.  The first decision relied on by him is that of  the Bombay  High  Court  in Commissioner of  Income-Tax,  M.  P. Nagpur  and  Bhandaru v. D Costa Brothers(1).   Therein  the Court  held that the Income-tax Officer was not entitled  to reject  the  application  for registration of  the  deed  of partnership  of  the assessee firm on the  ground  that  the house-hold  expenses  of the partners were  debited  to  the profit and loss account of the firm.  Therein there was no (1)  49, I.T.R. 181. 508 contention that all the profits earned were not distributed. The  only question was whether the household expenses  could have  been deducted before dividing the profits.   In  other words the question was whether the household expenses was  a proper  deduction  to be made in the circumstances  of  that case  before dividing the profits.  Hence that decision  has no bearing on the question under consideration. He  next placed reliance on the decision of the Punjab  High Court  in Commissioner of Income-tax, Simla v. Sat Ram  Gian Chand(1).    Therein  the  partners  first   estimated   the divisible profit and divided the same.  The Court held  that the division of profit was a matter relating to the internal affairs  of  the  partnership  and had  no  bearing  on  the genuineness  of the firm and that no question of  law  arose from the order of the Appellate Tribunal.  The ratio of that decision has no relevance for our present purpose. Counsel for the assessee next relied on the decision of  the Madras High Court in N. S. S. Chokkalingam Chettiar- and Co. v.  C.I.T.  Madras ( 2 ). In that case though there  was  no provision  in the deed of partnership for payment of  salary to  any  of the partners, some of the partners were  paid  a salary in addition to the shares to which they were entitled under  the  terms  of the  partnership  and  the  Income-tax Officer refused to register the firm on the ground that  the profits were not divided in accordance with the  partnership deed  as some of the partners took an additional amount  out of the profits in the shape of salary.  The court held that, as  the  partnership was found to be a genuine one  and  the application for registration was also in due form, the  mere fact that some partners took some portion of the profits  as salary  was  not a ground for  refusing  registration.   The question  whether  a partner should be paid salary  for  the services  rendered by him is a matter to be decided  by  the partners of the firm : so long as their payment is bona fide one,  the  same  has to be  deducted  before  the  divisible profits are computed.  Hence the ratio of that decision also does not bear on the facts of the present case. Reliance  was  next  placed on the decision  of  the  Madhya Pradesh   High  Court in C.I.T., M.P. v.  Mandanlal  Chhagan Lal(3).   In  that case the partnership deed  provided  that each partner will be entitled to interest at 6 per cent  per annum on his capita investment and that the profit and  loss will  be divided equally among the partners after  deducting the  interest  payable on the capital advances made  by  the partners.   When  the  partners  made  an  application   for registration under s. 26A of the Act, the Income-tax Officer refused  to  register  it  but  the  Court  held  that   the application was a valid one and the provision for payment of inte- (1) 42, ITR, 543.             (2) 60, ITR, 671. (3)  50, I.T.R. 477. 509

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rest  did  not  in any manner  conflict  with  the  relevant provision.  Here again there is no question of not  dividing any  portion  of,  profits  earned.   That  being  so,  that decision is irrelevant for our present purpose. Lastly  reliance  was placed on the decision of  the  Kerala High  Court  in  St. Joseph’s Provisions  Store  v.  C.I.T., Kerala(1).   Therein  the  partners  of  the  assessee  firm resolved  that the profits of the firm as disclosed  in  the profit and loss account need not be divided and credited  in the profit and loss accounts of the partners, but should  be credited  to a reserve account but each of the  partners  to have  an  equal share in that amount.   An  application  for registration of the firm was rejected on the ground that the firm had not complied with the requirements of rule 6 of the Rules.   The court held that the absence of entries  in  the separate  accounts  of  each  partner  was  not  fatal;  the requirement of rule 6 was met when the profit was taken into a  reserve  fund showing the partners’  shares  therein  and indicating what was the contribution of each partner to  the reserve  fund.  Therefore the application  for  registration was not liable to be rejected on the ground that rule 6  had not  been complied with.  Here again the profits earned  had beep  divided and they were credited to the accounts of  the partners  though the same were credited to a  reserve  fund. Hence the rule laid down in that case is inapplicable to the facts of the present case.  As the above referred  decisions do not bear on the point in issue we have not gone into  the question  whether all or any of them were correctly  decided or not. The apprehension of Mr. Ramachandra that our decision  might be  taken  advantage  of  by  the  Department  for  refusing registration  of firms whose return of income or  claim  for some  allowance  has  not been accepted  by  the  Income-tax Officer  for one reason or the other, appears to us to  have no  basis.   Herein we are merely considering the  scope  of paragraph 3 of rule 6. So long as the divisible profits  had been  divided  or had been credited to the accounts  of  the partners,  the  requirement of that provision  was  complied with. In  the result this appeal fails and the same  is  dismissed with costs. V.P.S.                   Appeal dismissed. (1) 45, I.T.R. 380. --1340SupCI/71 510