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PETITIONER: M/S PROGRESSIVE FINANCERS, MADRAS

       Vs.

RESPONDENT: THE ADDITIONAL COMMISSIONER OF INCOME TAX,MADRAS-1, MADRAS,

DATE OF JUDGMENT:       20/02/1997

BENCH: S.C. AGRAWAL, G.T. NANAVATI

ACT:

HEADNOTE:

JUDGMENT:                             WITH              CIVIL APPEAL NOS. 2439-39A OF 1981                       J U D G M E N T NANAVATI, J.      The  appellant   in  these   three  appeals   is   M/s. Progressive Financers,  a partnership  firm.  It  came  into existence with execution of a partnership deed on 1.7.67. It consisted of  five partners.  Out of them Sunitha Pratap was minor and,  therefore,  she  was  admitted  to  benefits  of partnership. The  capital of  the partnership  was fixed  at Rs.5 lacs and each partner had to contribute as follows 1.   M.R. Rajakrishna         ...  Rs. 1,25,000/- 2.   Minor Sunitha Pratap     ...  Rs. 1,87,500/- 3.   W.S. Parthasarathy       ...  Rs.   62,500/- 4.   W.S. Sethunarayan Babu   ...  Rs.   62,500/- 5.   M.S. Rajeswari           ...  Rs.   62,500/-      For  the   assessment  year   1967-68  it  applied  for registration to the Income Tax Officer (for short the ’ITO’) under Section 184 of the Income Tax Act, 1961 (for short the ’Act’) on  31.3.68. For  the assessment  years  1969-70  and 1970-71 it  applied for  renewal of  registration.  The  ITO rejected the application for registration on 30.6.71. On the same day,  he passed  an assessment order for the assessment year  1968-69  treating  the  status  of  the  appellant  as Association  of   Persons.  Applications   for  renewal   of registration for  the assessment  years 1969-70  and 1970-71 were rejected on 13.3.72 and the assessment orders for those years  were   again  passed   treating  the   appellant   as Association of Persons.      The  appellant’s   application  for   registration  was rejected by  the ITO  on the  ground  that  through  in  the opening paragraph  of the  partnership deed it was mentioned that Sunitha  Partap, a  minor, was admitted to the benefits of partnership, the relevant clauses in the partnership deed indicated  that  she  was  taken  as  a  full  partner  and, therefore, the  contract of  partnership was void ab-initio. The ITO  arrived at  this conclusion  as he noticed that the partnership deed  was signed  by Mrs.  Sridevi  Pratap,  the guardian  of   minor  Sunitha   Pratap;  that   Sunitha  had contributed the  maximum capital;  that it was not stated in

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the partnership deed how i.e. the manner in which, the loss, if any,  was to  be  apportioned;  that  all  partners  were entitled to  operate bank  accounts individually;  that  all matters of  importance were  to be  decided by  majority  of partners holding  more than  75% of  capital; and,  that  on dissolution, all  the assets  of the firm including goodwill were to  be converted into money and distributed amongst the partners in proportion to their shares in the capital.      Against this  order of  the ITO the appellant preferred an appeal to the Appellate Assistant Commissioner. Following the decision  of the  Andhra Pradesh High Court in Addepally Nageswara Rao  & Brothers vs. Commissioner of Income Tax, 79 ITR 306,  the Appellant Assistant Commissioner held that the instrument of  partnership  was  required  to  be  construed harmoniously and  as the  minor was  admitted  only  to  the benefits of partnership there was admitted only of her being made liable  for the  losses.  He,  therefore,  allowed  the appeal holding  that the  firm was entitled to registration. The Revenue  went in  appeal to  the  Income  Tax  Appellate Tribunal.      Construing the  partnership deed  in the  light of  the decisions of  this  court  in  Commissioner  of  Income-Tax, Mysore  vs.   Shah  Mohandas   Sadhuram  57   ITR  415   and Commissioner  of   Income-Tax,  Mysore   vs.  Shah   Jethaji Phulchand 57  ITR 588 and the decision of the Andhra pradesh high Court  in Addepally  Nageswara Rao (supra) the Tribunal held that minor Sunitha was admitted  merely to the benefits to partnership  and it  was not  correct to say that she was made a full-fledged partner. The Tribunal also held that the minor was not to be burdened with losses and they were to be borne by the other partners. It further held that though the instrument of  partnership did  not specifically provide how the losses were to be borne by the partners the rule that in such cases losses are to be shared in the same proportion as profits became applicable and since the partnership deed was capable of  being construed  in that  manner, the  firm  was entitled  to  registration.  It,  therefore,  dismissed  the appeal.      The Revenue  sought a  reference to  the High Court and the Tribunal  thought it fit to refer the following question to the High Court for its decision:-      "Whether, on  the facts  and in the      circumstances of  the  case  and  a      true construction  of the  terms of      the partnership  deed, the assessee      is  entitled   to  the  benefit  of      registration under  Section 185  of      the Income-tax  Act, 1961,  for the      assessment year 1968-69"      Against the  orders passed  by the ITO refusing renewal or continuation  of registration  for the  assessment  years 1969-70 and 1970-71 the appellant had preferred two separate appeals to  the Appellate  Assistant Commissioner.  the were allowed. The  appeals filed  by the Revenue against the said appellate orders  were dismissed  by the  Tribunal.  At  the instance of  the Revenue,  for the said two assessment years the following question was referred to the High Court:-      "Whether on  the facts  and in  the      circumstances of  the case and on a      true construction  of the  terms of      the partnership  deed the  assesses      is entitled  to the continuation of      registration  for   the  assessment      year 1969-70 and 1970-71."      The High  Court referred to the decision of the Gujarat

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High Court  in Thacker  & Co.  vs. CIT  61 ITR  540 and  two decisions of the Kerala High Court in C.I.T. vs. Ithappiri & George 88 ITR 332 and United Hardwares vs. C.I.T. 96 ITR 348 wherein it  has been held that in view of the clear language of Section  184 it  is necessary  that sharing of the losses also has to be specifically provided in the partnership deed and there  is no scope for applying any principle or rule of law for discerning the proportion in which the losses are to be shared.  It then  held that the decision of this Court in Mandyala Govindu  & Co. vs. Commissioner of Income-Tax. A.P. 102 ITR  1 squarely  applied to  the  facts  of  this  case. Following that  case it  held that  it was  not possible  to determine on  any principle  of inference, from the document itself, how  the remaining  two partners  were to  share the losses  and,   therefore,  the  firm  was  not  entitled  to registration. The  reference was  answered  accordingly,  in favour of the Revenue and against the assessee.      Following that  decision in  Tax Case  No. 336  of 1974 (Reference No.  149 of  1974) the  High Court  answered  the other two  references (Tax  Case Nos.  707 of  1976) also in favour of the Revenue and against the assessee. The assessee has,  therefore,  filed  these  three  appeals  against  the judgment and  orders passed by the High Court in those three cases.      The learned  counsel for  the appellant  submitted that the view taken by the High Court is wrong. The two decisions of the  Kerala High  Court which are relied upon by the High Court have  since been  overruled by  the Full  Bench of the Kerala  High   Court  in   Kerala   Publicity   Bureau   vs. Commissioner of  Income Tax  200 ITR  366. he also submitted that the instrument of partnership, if reasonable construed, did indicate  the method by which profits and losses were to be shared  by the  partners.  On  the  other  hand,  it  was contended by  the learned  counsel for  the Revenue  that as Section 184  of  the  Act  confers  a  benefit  which  would otherwise laid  down therein  are  strictly  complied  with. Therefore, the  said benefit  can be  claimed only if in the instrument of  partnership itself  shares of the partners in profits and losses are specifically stated.      This Court  in Rao  Bahadur Ravulu Subba Rao vs. CIT 30 ITR 163  and Patel  (N.T.) and  Co.  vs.  CIT  42  ITR  224, interpreting Section 26-A of the earlier 1922 Act, held that registration under  that Section  conferred a benefit on the partners which  the partners  were not  entitled to  but for that Section  and, therefore,  that right  could  have  been claimed any  in accordance  with the  statute and  those who claimed it had to bring their case strictly within the terms of that  Section. This view was reiterated subsequently by a 5-  Judge  Bench  of  this  court  in  the  case  of  Kylasa Sarabhaiah vs.  CIT 56 ITR 219. At the same time, this Court disapproved mechanical application of the provision and held that  "in   ascertaining  whether   the  application  is  in conformity with  the Rules,  the deed of partnership must be reasonably construed.".  It was  also  held  that  the  word "specify" as  used in  that Section  and the  relevant  rule meant ’mentioning,  describing or defining in detail’ and it did not  mean ’expressly  setting out  in factional or other shares’. In view of this decision the correct legal position is that  the assessing  officer cannot reject an application for registration  merely because  in the deed of partnership shares of  the partners  are not  expressly  specified.  The assessing officer  will have  to construe  the instrument of partnership as  a whole  and if reasonably the shares of the partners in  profits and  losses can be ascertained, then to accept it as genuine for the purpose of registration.

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    We will  now refer  to the  decision of  this Court  in Mandyala Govindu  & Co.  (102 ITR  Page 1),  which has  been relied upon  by the  High Court and on the basis of which it decided the  question referred  to it against the appellant. That case  arose under  Section  26-A  of  the    1922  Act. Answering the  question  whether  it  was  a  condition  for registration under  Section 26-A  that   the  instrument  of partnership ought  to have  specified respective  shares  of partners in losses it was held that "the Income-Tax Officer, before allowing the application for registration, must be in a position  to ascertain  the shares  of the partners in the losses even if Section 26A did not require the shares in the losses to  the specified  in the instrument of partnership". It referred to the conflict of opinion in the High Courts on the point  but did  not think  if necessary  to decide which view was  correct as  the assessee  was bound to fail on any view. What  is  significant  to  note  is  that  this  Court referred to Rules 2 and 3 of the Rules framed under that Act and also  the form  of application  including  the  Schedule annexed to  Rule 3.  The form and the Scheldule required the partners to state particulars of the apportionment of income and profits  or gains  (or loss)  and also  to state  if any partner, though entitled to share in profits, was not liable to bear  any loss.  Thereafter it was observed that "it does not appear  to have been considered in this case whether the application for  registration made  by the  firm conforms to the prescribed rules". Thus, this Court was of the view that even if  the shares  of  the  partners  were  not  expressly specified in the instrument of partnership but if that could be  ascertained   by  the   Income  Tax   Officer  from  the application and  the required information supplied therewith then the  requirements of Section 26-A could be said to have been satisfied.  It is  also significant  to not e that this court  tacitly   approved  application   of  the   principle contained in  Section 13(b)  of the  Indian Partnership  Act that the  partners are  entitled to  share  equally  to  the losses sustained  by the  firm and also the rule that ’where the shares  in the  profits are  unequal, the losses must be shared in  the same proportion as the profits if there is no agreement as  to how  the losses  are to be apportioned’. On facts, it  was held  in that  case that  even after applying those two  principles, it  was not possible to ascertain how the  losses   pertaining  to   minor’s  share   were  to  be apportioned amongst the adult partners.      In an  earlier decision  in the  case of Parekh Wadilal Jivanbhai vs.  CIT 63  ITR  485  this  Court  construed  the partnership deed  by reading  it as  a  whole  and  "in  the context of  the relevant circumstances of the case" and held that there was specification of the individual shares of the partners in  the profits  within the meaning of Section 26-A of  the   Act  and   the  assessee-fire   was  entitled   to registration. The  relevant circumstances  which were  taken into account were (1) under clause 3 of the partnership deed the capital  allotted to  each partner  was equal  (2) under clause 10  net profit  or loss was to be divided amongst all partners (3)  in the  application the  three  partners  were shown to  share the  profits equally and (4) in the books of accounts the  profits were  apportioned  equally  among  the three partners. Thus, it was laid down by this Court in that case that  the instrument of partnership has to be construed reasonably  by  reading  it  as  a  whole  and  taking  into consideration the  relevant circumstances  disclosed by  the instrument of  partnership and  the account  books  for  the relevant year  and the statements made in that behalf in the application.

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    In this  case, it  appears that the High Court, without carefully examining the facts and circumstances of the case, applied the decision of this Court in Mandyala Govindu & Co. (supra). In the partnership deed the proportion in which the five partners  including the  minor had  to  contribute  the capital was clearly stated. It was  also clearly stated that net profits  were to  be divided  between  the  partners  in proportion to  their shares  in the capital. The application made by  the partners for registration of the firm contained the statements  required to be made therein according to the prescribed form.  The prescribed  Schedule was also attached with that application. The said Schedule read as under :-                     "S C H E D U L E Name of               Date of     Interest    Salary   Share partner       Address   admittance   on capital  Commi-   in                       to partner-  or loans if ssion    bala                        ship.        any         or       nce of                                            other   profit                                               remune   loss;                                               ration percen                                               from   tage                                               firm -----------------------------------------------------------    (1)       (2)      (3)      (4)    (5)     (6)     (7) ------------------------------------------------------------ 1.Mr. M.R. Rajakrishna Vijaya Raga- vachari Road, Madras-17.      1.7.67    Nil   Nil    25% of Profit                                        40% of loss 2.Miss Sunitha Pratap (Minor) Villa Enchantre, Ranjit Road, Kottur Adyar Madras - 25      1.7.67   Nil   Nil    37.5% of Profit No                                        Share of loss 3.Mr.W.S. Parthasarathy 80, Harris Road, Madras-2        1.7.67    Nil   Nil    12.5% of profit                                        20% of loss 4.Mr.W.S.Sethunaryana Babu, 80,Harris Road, Madras-2       1.7.67     Nil   Nil    12.5% of profit                                        20% of loss 5.W.S. Rajeswari 80, Harris Road, Madras-2.      1.7.67      Nil  Nil   12.5% of profit                                        20% of loss".      As minor  Sunitha  was  admitted  to  the  benefits  of partnership it  is obvious  that she  had not  to share  any loss. The  losses were  to be  distributed among  the  major partners only.  Since they  were to share the profits in the proportion in  which they had contributed the capital it was implied that  they were  to share  the losses  in  the  same ratio.  This   was  the   reasonable  manner  in  which  the instrument of  partnership was  required to  the  construed, applying  the  second  principle  referred  to  above  while dealing with  the case  of mandyala  Govindu &  Co. (supra). Moreover, the  application made  by  the  appellant  in  the prescribed form  clearly disclosed  as to  how the losses of the firm  were to  be distributed  among the major partners. The way they had worked out their share in the loss, if any, in the  Schedule  attached  to  the  application  was  quite consistent with  the provisions  made in  the instrument  of partnership and  the legal  principles  applicable  in  that

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behalf.  Accordingly   Rajakrishna  who   was  required   to contribute 25%  as share capital had to bear 40% of the loss and the  other three  major partners  who  had  individually contributed 12.5% of the capital had to bear the loss in the ratio of 20% each. The ITO had not considered these relevant circumstances as  he was  of the  view that  the contract of partnership  itself   was  void.   The  Appellate  Assistant Commissioner  and   the  Tribunal   did  to   refer  to  the application and  construing the  partnership deed alone held that it was possible to ascertain how the losses of the firm were to be distributed among the major partners.      If the  partnership deed  is construed  reasonably,  as indicated above,  then it  has to  be held  that it  did, by necessary implication,  provide for  the proportion in which the losses  of the  firm were  to be  shared  by  the  major partners. The  application  for  registration  made  by  the appellant fulfilled  the conditions laid down by Section 184 of the  Act and,  therefore, the  ITO ought  to have granted registration and  made assessment  of the  appellant for the relevant years  on that  basis. The  High Court was wrong in taking the contrary view. Therefore, we allow these appeals, set aside  the judgment  and orders passed by the High Court and answer  the question  referred  to  the  High  Court  by holding that  for the  assessment year 1968-69 the appellant was entitled  to registration  and for  the assessment years 1969-70 and  1970-71 it was entitled to renewal/continuation of registration.  In view  of the facts and circumstances of the case, the parties shall bear their own costs.