1998 P T D 1628

[224 I T R 244]

[Rajasthan High Court (India)]

Before V.K. Singhal and M.A.A. Khan, JJ.

ADDITIONAL COMMISSIONER OF INCOME-TAX

versus

HASSAN CHAND & SONS

D.B. Civil Income-tax Reference No.l of 1975, decided on 22/04/1996.

(a) Income-tax---

----Firm---Registration---Law applicable---Application for registration submitted on 31-12-1959 and return submitted in September, 1962-- Registrtaion of firm to be regarded as part of process of assessment---Act of 1961 applies---Indian Income-tax Act, 1922, S.26-A---Indian Income Tax Act, 1961, Ss. 184, 185 & 297---Indian Income-tax (Removal of Difficulties, Order, 1962, Arts.2 & 3.

(b) Income-tax-

----Firm---Registration---Genuineness of firm---Firm having three partners-- Death of one of the partners---Surviving partners carrying on business and subsequently forming partnership and agreeing to pay share of profits to estate of deceased--Partnership was genuine---Indian Income Tax Act, 1961, S.185---Indian Partnership Act, 1932, S.37.

(c) Income-tax---

----Business expenditure---Firm---Share of profits paid to legal representative of deceased partner---Expenditure incurred wholly and exclusively for purposes of business---Deductible---Indian Income Tax Act, 1961, S.37.

(d) Income-tax---

----Appeal to Appellate Assistant Commissioner---Firm---Registration order passed by I.T.O. after considering whether firm was genuine---Order under S.185---Appeal to A.A.C. from such an order was competent---Indian Income Tax Act, 1961, Ss. 184, 185 & 246.

On a reading of Articles 2 and 3 of the Income-tax (Removal of Difficulties) Order, 1962, alongwith section 297(2) of the Income Tax Act, 1961, it becomes quite clear that the matter of registration of a firm is to be regarded as part of the process of assessment and in that sense of the matter has to be dealt with in accordance with the provisions of sections 185 and 187 to 189 of the Income Tax Act, 1961.

Section 184 does not contemplate an order to be passed by the Income-tax Officer in respect of granting or refusing to grant registration to a firm. It is section 185 which empowers the Income-tax Officer to pass an order in that respect. The order passed by an Income-tax Officer under section 185 of the Act is unquestionably an appealable order under the provisions of section 2460).

Section 37 of the Indian Partnership Act, 1932, can apply provided the following three conditions are fulfilled:

(1) Any member of the partnership-firm has died or otherwise ceased to be a partner.

(2) The surviving or continuing partners continue to carry on the business of the firm with the property of the firm, and

(3) There has been no final settlement of accounts as between the out-going partner or his estate and the surviving or continuing partners.

Once the provisions of section 37 of the Partnership Act, 1932, are found applicable to a case, the right of the estate of the deceased or outgoing partner or his legal representatives to receive interest on the amount of deceased or outgoing partner or his legal representatives in the property of the firm or to claim a share in the profits made by the partnership and which is attributable to the use of the share of the deceased or outgoing partner in the property of the firm would be a charge on the assets or profits of the firm and as such a deductible expenditure in the computation of the income of the firm for the reason that such . an expenditure was incurred wholly and exclusively for the purposes of the assessee's business. Such a charge does not make the guardian of the estate of the deceased a partner or his legal representative a partner in the firm nor does it affect the character of the partnership as a genuine entity.

The assessee-firm was engaged in the business of exhibition of films. Originally the firm was constituted of three partners, M; A and H. The accounting year of the firm ended on 31st December of each year. In March 1953, M, one of the three partners, died. The remaining two partners continued to carry on the same business under the same business name, but they did not enter into any new partnership nor did they file a registration application with the Income-tax Department. This position continued up to the assessment year 1959-60 and for all these years the assessee-firm was assessed in the status of an unregistered firm. M had a 1 /3rd share in the partnership business. M had left a will wherein he had appointed A, one of the partners, as executor of the will and administrator of his estate. On January 1, 1959, an instrument of partnership was executed between A and H, i.e., the remaining two partners. In the preamble to this partnership deed it was mentioned that it had been decided and agreed upon between the two continuing living partners to continue the business in the same name and style. They had further decided and agreed to keep the share capital of the deceased partner in the business and to pay to the guardian of his estate an equal share in the profits of the new firm in accordance with the provisions contained in section 37 of the Indian Partnership Act, 1932. The guardian was not to bear the losses which were to be shared equally by the two remaining partners who were to carry on the business. A in his capacity as the guardian of the estate of the deceased M had accepted the terms by appending his signature to the partnership deed. On December 31, 1959, the assessee-firm applied for registration for the assessment year 1960-61 under section 26-A of the Indian Income-tax Act, 1922. The return of income for this year was filed in September, 1962. The Income-tax Officer, however, refused to grant registration to the firm on the ground of limitation and non -genuine character of the firm. According to the Income-tax Officer according to the provisions of section 26-A of the Act of 1922, the application for registration of the firm should have been made within a period of six months of the constitution of the firm, whereas the same was made on the last day of the accounting period. Regarding the genuine character of the assessee-firm, the Income-tax Officer held that the firm was in fact constituted by three partners, the third partner being the legal heirs of M. Since M was having a debit balance of Rs.46,332 as on December 31, 1958, no profits were attributable to the use of his share in the properties of the firm so as to attract the provisions of section 37 of the Indian Partnership Act, 1932. The Income-tax Officer described the order passed by him as an order under the proviso to section 184(4) of the Income Tax Act, 1961, read with the proviso to rule 2(c) of the Indian Income-tax Rules, 1922. The Tribunal held that the partnership was genuine and that the application for registration was within time. It also held that the Income-tax Officer's order was in fact under section 185 and the appeal from it was competent and that the payment made to the guardian of the estate of the deceased partner was deductible. On a reference:

Held, (i) that the application filed by the assessee-firm on December 31, 1959, for grant of registration for the assessment year 1961 was well within time under the provisions of the Act of 1922 and the rules made thereunder. However, in view of section 297(2) of the Act of 1961, the assessment was to be made in accordance with the provisions of the Act of 1961 and the matter of registration was also to be dealt with in accordance with the provisions of sections 185 and 187 to 189 of the Act of 1961. The Tribunal was, therefore, justified in directing the Income-tax Officer to allow the assessee an opportunity to file an application for registration under the provisions of the Act of 1961. The application filed by the assessee-firm on December 31, 1959, for grant of registration to it for the assessment year 1960-61 was within time;

(ii) that the Tribunal was justified in holding that the Income-tax Officer's order passed under section 184(4) was in fact an order under section 185(5) and was appealable;

(iii) that section 37 of the Partnership Act does not apply to sham transactions. The arrangement made by the instrument of partnership, dated January 1, 1959, read in the light of the will of the deceased M was not found to be of a bogus nature. The Tribunal was right in holding that the partnership was valid;

(iv) that the Tribunal was right in holding that the payment made to A in his capacity as guardian of the estate of the deceased partner M was a charge on the profits of the firm for the assessment year 1961-62.

Udhavji Anandji Ladha v. Bapudas Ramdas Darbar AIR 1950 Bom. 94 ref.

G. S. Bapna for the Commissioner

J.K. Singhi for the Assessee.

JUDGMENT

M.A.A. KHAN, J. ---This joint reference under section 256(1) of the Income Tax Act, 1961 (for short, the Act of 1961") has been made by the Income-tax Appellate Tribunal, Jaipur Bench, Jaipur (hereinafter referred to as "the Tribunal"), for the assessment years 1960-61 and 1961-62. The Tribunal has referred to this Court for its opinion of the following questions:

Assessment year 1960-61:

"(i)Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the Income-tax Officer's order passed under section 184(4) was in fact an order under section 185(5) and was appealable?

(ii)Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the application for registration filed on December 31, 1959 for the assessment year 1960-61 was filed within the time allowed?

(iii)Whether, on the facts and in the circumstances of the cast;, theTribunal was right in holding that the partnership was valid?" ,

Assessment year 1961-62:

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the payment made to Shri Abdul Razaq was a charge on the profits of the firm?"

The facts relevant to the questions referred for the aforesaid two years and sufficient to dispose of this joint reference are these:

During the accounting period relevant to the two assessment years, the assessee-firm was engaged in the business of exhibition of films in Ram Prakash Theatre, Jaipur. Originally, the firm was constituted of three partners, namely, Sarva Shri Noor Muhammad, Abdul Razaq, and Hamid Hussain. The accounting year of the firm was 31st December ending of each year. In March, 1953, Shri Muhammad, one of the three partners, died. The remaining two partners continued to carry on the same business under the same business name, but they did not enter into any new partnership nor did they file a registration application with the Income-tax Department. This position continued up to the assessment year 1959-60 and for all these years the assessee-firm was assessed in the status of an unregistered firm.

Shri Noor Muhammad, the deceased partner, is stated to have left a will whereby he had, inter alia, bequeathed that:

"(i)After my death out of the share of the movable and immovable properties belonging to me 1/3rd will be owned by Abdul Razaq, who will have full ownership right.

(ii)After Abdul Razaq inherits 1/3rd share in my movable and immovable properties, the rest of 2/3rd share will be managed by Abdul Razaq. He will have the right to manage the properties according to the income. In case the income from the properties dwindles down and the sale or mortgage is needed then Abdul Razaq will have the right to sell the properties.

(iii)Out of the remaining income of the 2/3rds share of the property Rs.50 per month will be paid to my wife, Musmmat Gulab, Rs.10G to my elder son, Wali Muhammad, for the maintenance of himself and his family, which will be managed by Abdul Razaq. My younger son, Abdul Haq. will also be entitled to get Rs.100 per month but since he is a vagabond he will get Rs.30 per month and Rs.70 will be paid to his wife and children."

On January 1, 1959, Shri Abdul Razaq and Shri Hamid Hussain, the remaining two partners of the 'assessee-firm, executed a new partnership deed. The salient features of this partnership are as follows:

"This deed of partnership is made on the first day of January, 1959, between Abdul Razaq, son of Hassan, aged 55 years, resident of Jaipur of the first part and Hamid Hussain, son of Chand, aged 56 years, resident of Jaipur, of the second part.

Whereas Shri Abdul Razaq, Hamid Hussain and Noor Muhammad have for some time past been carrying on the business of film exhibition in partnership together at Jaipur under the name and style of Messrs. Hasan Chand & Sons, Jaipur, duly registered with the Registrar of Firms.

And whereas on the death of the partner Noor Muhammad, Abdul Razaq was appointed as guardian of his share under a will to hold the same on behalf of and for the heirs of the said Noor Muhammad.

And whereas now it has been decided and agreed upon between the two continuing living partners to continue the business in the same name and style on terms hereinafter contained.

And whereas the property of the old partnership has been decided to be transferred as the assets of the partnership hereby constituted.

And whereas the share capital of the deceased partner has been decided to be kept in the business, it has been decided to pay to the guardian of his property equal share in the profits of the new firm in accordance with section 37 of the Indian Partnership Act, 1932, to which the guardian has agreed by appending his signatures to this deed "

By clauses (4) and (5) of the partnership deed, the division of profits and losses of the business was agreed to be made in the following manner:

"The capital coming to the share of Shri Abdul Razaq as the guardian and representative of Noor Muhammad (deceased partner) shall continue to be in this firm and the guardian shall be entitled to 1/3rd share in profits in this account and shall not bear any losses.

The profits and losses of the new partnership shall be divided and borne as under:

(a)Out of total profits 1 /3rd shall be paid to the guardian of Shri Noor Muhammad (deceased).

(b)The remainder thereafter shall be divided between Shri Abdul Razaqand Hamid Hussain equally."

On December 31, 1959, the assessee-firm applied for registration for the assessment year 1960-61 as per section 26-A of the Indian Income-tax Act, 1922 (for short, "the Act of 1922"), read with rule 2 of the Rules made thereunder. This application was duly accompanied by the instrument of partnership and copy thereof as well as the copy of the account showing the division of profit and loss of the firm between the partners. The return of income for this year was filed in September, 1962. The Income-tax Officer, however, refused to grant registration to the firm on the ground of limitation and non-genuine character of the firm. According to the Income-tax Officer, as per the provisions of section 26-A of the Act of 1922, the application for registration of the firm should have been made within a period of six months of the constitution of the firm whereas the same was made on the last day of the accounting period.

Regarding the genuine character of the assessee-firm, the Income-tax Officer held that the firm was in fact constituted of three partners, the third partner being the legal heirs of Shri Noor Muhammad. Since Shri Noor Muhammad was having a debit balance of Rs.46,332 as on December 31, 1958, no profits were attributable to the use of his share in the properties of the firm so as to attract the provisions of section 37 of the Indian Partnership Act, 1932, to the facts of the present case. The Income-tax Officer, therefore, held that neither the application was signed by all the partners nor were the profits and losses distributed amongst the partners according to the shares specified in the instrument of partnership. The Income-tax Officer described the order passed by him as an order under the proviso to section 184(4) of the Income Tax Act, 1961, read with the proviso to the rule 2(c) of the Indian Income Tax Rules, 1922.

It appears that the Income-tax Officer had made assessment for this year ex parte under section 144 of the Act of 1961. On appeal, the said ex parte assessment was set aside by the learned Appellate Assistant Commissioner. The order purported to have been made by the Income-tax officer under section 184(4), as aforesaid, was also set aside by the learned Appellate Assistant Commissioner with a direction to redo the same after allowing an opportunity to the assessee-firm to rectify the mistake, if any, in the application submitted under the old Act of 1922 and allowing him to submit such an application under the provisions of the new Act also. The Income-tax Officer, however, held that in his opinion, the question of giving an opportunity to the assessee-firm as per the direction of the learned Appellate Assistant Commissioner would arise only if the order was to be made under section 185 of the Act of 1961, but since he was making an order under section 184(4) no question of giving such opportunity arose and the Income-tax (Removal of Difficulties) Order, 1962, does not cover the issue. In the order made by the Income-tax Officer in the second round, the same ground for refusal of registration, which had found favour with him in his earlier order, were reiterated. The assessee-firm again approached the first appellate authority who dismissed its appeal as being not maintainable, vide his order, dated September 1, 1970, in Appeal No. 16 of 1970-71.

The application for grant of registration/renewal of registration for the assessment year 1961-62 was also rejected by the Income-tax Officer for almost the same reasons. An appeal against the refusal of grant of registration/renewal of registration was also filed and the learned Appellate Assistant Commissioner agreed with the Income-tax Officer that the firm was in fact constituted of three partners as against two shown in the registration application and the application for renewal of registration. In the opinion of the learned Appellate Assistant Commissioner, the applications did neither depict the real constitution of the firm nor the same had been signed by all the three partners. He held the view that the guardian of the heirs of the deceased partner constituted the third partner in the firm and, therefore, the provisions of section 37 of the Indian Partnership Act, 1932, did not apply to the case.

Having lost its case before the Income-tax Officer and the Appellate Assistant Commissioner for both the years, the assessee-firm approached the Tribunal in second appeal. The two Members of the Tribunal constituting the Bench differed in their views on the issues involved in the appeals. The case was, therefore, referred to the Third Member under section 255(4) of the Act of 1961. The learned Third Member held that the Appellate Assistant Commissioner was not justified in rejecting the appeals of the assessee-firm with regard to the registration. He was of the view that registration being essentially a part of assessment, the provisions of the new Act would app15 to the assessment proceedings as also to the proceedings pertaining to the registration of the assessee-firm. He held that the application filed by the assessee-firm on December 31, 1959. was required to be filed under the Act of 1961. He, accordingly, directed that the Income-tax Officer should give the assessee an opportunity to file an application in accordance with the requirements of the new rules under the Act of 1961.

For the assessment year 1961-62, the learned Third Member opined that the continuation of the registration will have to be considered under section 184(7) of the Act of 1961 after the registration for the assessment year 1960-61 had been considered after giving the assessee-firm an opportunity to furnish a fresh application.

With regard to the character of the assessee-firm as a genuine firm, the learned Third Member held that the partnership did not cease to be genuine merely because the partnership deed stated that it was decided to pay to the guardian an equal share in the profits of the new firm in accordance with section 37 of the Partnership Act. The learned Third Member pointed out that in order to safeguard die interest of the deceased Shri Noor Muhammad, there was nothing to stop the continuing partners from making a commitment which they considered to be reasonable and in conformity with requirements of section 37. In the opinion of the learned Third Member, the arrangements made by the two partners of the assessee-firm did not become unreal or artificial or invalid merely because the continuing partners and the guardian of the heirs of the deceased Noor Muhammad, made efforts to give effect to the provisions of section 37 of the Indian Partnership Act.

Regarding the question as to whether payments made to the guardian of the heirs of the deceased Shri Noor Muhammad were deductible as a charge in arriving at the total income of the firm, the learned Third Member held that the guardian of the heirs did not become a partner in the firm and the payments made to him were in fact payments made to a person who was not a partner in the firm. The learned Third Member further pointed out that the deceased had a considerable share in the goodwill of the assessee-firm and that full accounts were never settled between the present two partners of the assessee-firm and the heirs of the deceased partner, Shri Noor Muhammad. However, he directed an enquiry into this aspect of the case and observed that if on enquiry it was found that accounts had been finally settled and the deceased had no positive interest in the assets of the firm, the payment claimed to have been made by the firm to the guardian would not be justified on commercial grounds. The learned Third Member, therefore, proposed to set aside the assessment for the assessment year 1961-62 with a direction to the Income-tax Officer to redo the same after considering the question of allowance of the payment after holding an enquiry.

On receipt of the opinion of the learned Third Member, the Tribunal finally passed its order in the following manner:

"(i) The partnership could not be held to be not genuine merely because a charge on the profit has been provided for the estate of the late Noor Muhammad. The application for registration filed for the assessment year 1960-61 is also within time. The assessee should, however, be given an opportunity of filing a fresh application a. prescribed under the Income Tax Act, 1961, and the rules framed thereunder. In order to dispose of the matter in accordance with law the order of the learned Appellate Assistant Commissioner dismissing the assessee's appeal, in limine, is set aside and the matter is restored to his file. Appeal No.3025 of 1970-71 is treated as allowed.

(ii)The question of the continuation of registration for the assessment year 1961-62 should be considered after disposing of the question-of grant of registration for the assessment year 1960-61, as directed in Appeal No. Income Tax Appeal 3025 of 1970-71. The assessee should be given an opportunity of filing the appropriate application, for this purpose, under the provisions of the Income Tax Act, 1961, and the rules framed thereunder. In order to pass an order in accordance with law, on this point, we set a side the orders of the Appellate Assistant Commissioner and restore the matter to his file to be disposed of afresh. Thus, Appeal No. 13033 of 1966-67 is also treated as allowed

(iii)Though the provisions of section 37 of the Partnership Act are not strictly applicable to payments made by the assessee-firm to the estate of the deceased Noor Muhammad, such payments, to the extent to which they are made for the purposes of the business, have to be allowed in computing the total income of the firm. In order to find out the extent of such payments which will be justified, it will be necessary to find out whether Noor Muhammad had any interest in the property of the firm at the time of his death and, if so, the extent of such interest. It has to be seen whether such share of property belonging to Noor Muhammad has been used by the continuing partners in the business of the assessee-firm. It is also necessary to determine the proportion which such property bears to the total property of the firm. Only that proportion of the profits-of the firm will represent the reasonable payment to the estate of the late Noor Muhammad towards utilising its property, for the purpose of the business of the assessee-firm. Such share of profits will represent a charge against the profits of the assessee-firm and the assessee will be entitled to deduct the same in determining its total income for purposes of assessment.

In order to determine the above figures and to arrive at the proper deduction, if any, on that account, it is necessary to set aside the assessment for 1961-62 and to restore it to the file of the Income-tax Officer to be redone, in accordance with law and on the basis of the above directions. Accordingly, that assessment is set aside. Appeal No. 13032 of 1966-67 is also treated as allowed."

It is in the above background that this Court is required to answer the questions referred to it for its opinion for the two years under consideration.

We have heard learned counsel for the parties at length and carefully gone through the material brought on record.

We propose to answer the referred questions in the following manner

(1)Assessment year 1960-61:

For this year, the Tribunal has referred three questions as reproduced above. We find it convenient to consider questions Nos. l and 2 together as the relevant facts are interconnected.

(2)The first question that arises for consideration is whether the application filed by the assessee-firm on December 31, 1959, for grant of registration for this year was in time. At the relevant time, the Act of 1922 was in force and the question of grant or refusal to grant registration to a firm could have been considered under section 23(4) and/or section 26-A of that Act. Section 22 obliged the Income-tax Officer to give a notice on or before the first day of May, in each year, requiring every person whose, total income during the previous year exceeded the maximum amount which is not chargeable to income-tax to furnish, within such period not being less than 60 days as may be specified in the notice, a return of his income during that year. The assessment proceedings were to be conducted as per the provisions of section 23 and in the course of proceedings under subsection (4), the Income-tax Officer was empowered to refuse to register a firm or cancel its registration if the firm was already registered. The procedure laid down in section 23(4) indicates that the question of grant or refusal of registration to firms could have been considered by the income tax Officer in regard to the assessment proceedings. However, section 26-A of the Act of 1922 laid down the procedure for registration of firms. Such application was required to be filed in accordance with rule 2 of the Rules made under section 59 of the Act of 1922. Rule 2 of such rules provided as under:

"2. Any firm constituted under an instrument of partnership specifying the individual shares of the partners may, under the provisions of section 26-A of the Indian Income-tax Act, 1922 (hereinafter in these rules referred to as the Act), register with the Income-tax Officer, the particulars contained in the said instrument on application made in this behalf.

Such application shall be signed by all the partners (not being minors) personally, or in the case of a dissolved firm by all persons (not being minors) who were partners in the firm immediately before dissolution and by the legal representative of any such partner who is deceased, and shall, for any year of assessment up to and including the assessment for the year ending on the 31st day of March, 1953, be made before the 28th February, 1953, and for any year of assessment subsequent thereto, be made---

(a)where the firm is not registered under the Indian Partnership Act, 1932 (IX of 1932), or where the deed of partnership is not registered under the Indian Registration Act, 1908 (XVI of 1908), and the application for registration is being made for the first time under the Act, .

(i)within a period of six months of the constitution of the firm or before the end of the 'previous year' of the firm, whichever is earlier, if the firm was constituted in that previous year,

(ii)before the end of the previous year in any other case;

(b)where the firm is registered under the Indian Partnership Act, 1932 (IX of 1932), or where the deed of partnership is registered under the Indian Registration Act, 1908 (XVI of 1908), before the end of the previous year of the firm, and

(c)where the application is for renewal of registration under rule 6 for any year, before the 30th day of June, of that year:

Provided that the Income-tax Officer may entertain an application made after the expiry of the time-limit specified in this rule, if he is satisfied that the firm was prevented by sufficient cause from making the application within the specified time. "

It may be appreciated that clause (a) of rule 2 provided that where a firm is not registered under the Indian Partnership Act, 1932, or where the deed of partnership is not registered under the Indian Registration Act, 1908, and the application for registration is being made for the first time under the Act, the application required to be filed (1) within a period of six months of the constitution of the firm or before the end of the previous year of the firm whichever was earlier, if the firm was constituted in that previous year, or (2) before the end of the previous year in any other case. It is an undisputed fact that the assessee-firm had been doing its business of exhibition of films since much prior to March, 1953, when Shri Noor Muhammad, partner, had died. As stated by the Tribunal, the remaining two partners had continued to carry on the same business though they had not entered into anew partnership agreement nor had they filed any registration application with the Income-tax Department. That position continued right up to the assessment year 1959-60. It is, thus, clear that the assessee-firm had been in existence prior to the assessment year 1960-61 and, therefore, the provisions of sub-clause (ii) of clause (a) of rule 2 of the Rules, 1922, were applicable to the case of the assessee. The accounting year of the assessee-firm ended on December 31, 1959, and on that day the assessee-firm had filed an application for registration duly accompanied by the instrument of partnership and other relevant papers.

The difficulty that seems to have arisen appears to have ensued from the fact that the return for this year was filed by the assessee in September, 1962. By that time, the Act of 1961 had already come into force with effect from April 1, 1962, and as per the provisions of section 297(2)(b) of the Act of 1961, the assessment was to be completed in accordance with the provisions of the Act of 1961. Section 297, as is relevant for our purpose provided as under:

"297. (2)...Notwithstanding the repeal of the Indian Income-tax Act, 1922 (11 of 1922) (hereinafter referred to as "the repealed Act) ....

(b)where a return of income is filed after the commencement of this Act-otherwise than in pursuance of a notice under section 34 of the repealed Act by any person for the assessment year ending on the 31st day of March, 1962, or any earlier year, the assessment of that person for that year shall be made in accordance with the procedure specified in this Act."

Clause (b) of subsection (2) of section 297 clearly mandates that where a return of income is filed after the commencement of the Act of 1961 otherwise than in pursuance of a notice under section 34 of the repealed Act by any person for the assessment year ending on the 31st day of March, 1962, or earlier year, the assessment of that person for that year shall be made in accordance with the procedure specified in the Act of 1961. The difficulty which appears to have arisen before the Income-tax Officer in the case of the assessee for this year seems to be that whereas an application for registration of the firm was filed as per the provisions contained in section 26-A of the Act of 1922 and rule 2 of the Rules framed under that Act, the return was filed after coming into force of the Act of 1961 and such return was to be processed as per the provisions of the Act of 1961. The Income-tax Officer appears to have completed the assessment as per the provisions of the Act of 1961 but dealt with the registration application as per the provisions of the Act of 1922. That was the permissible in law. It seems to us that the Central Government with a view to remove difficulties being faced by the Income-tax Officers in the matter of registration and refund proceedings and completion of assessments during the transitional period made the Income-tax (Removal of Difficulties) Order, 1962. Article 2 of such order provided that for the purposes of clauses (a) and (b) of subsection (2) of section 297 of the Income Tax Act, 1961, proceedings relating to registration of a firm or a claim for refund of tax shall be regarded as part of the proceedings for the assessment of the person concerned for the relevant assessment year. Article 3 provided that in cases covered by clause (b) of subsection (2) of section 297 of the repealing Act, the assessment shall be made, inter alia, in accordance with the procedure specified in the following sections of the reapealing Act, in so far as they may be relevant for the purpose of sections 131 to 136, 140 to 146, 153 (except subsection (2) and clause (iii) of subsection (3)), sections 156 to 158, 185, 187 to 189, 282 to 284 and 288.

It is, thus, quite evident that the matter of registration of a firm was to be considered as part of the proceedings for the assessment of a person and such matter was to be dealt with as per the provisions of sections 185 and 187 to 189 of the Act of 1961. In this context, it may be useful to refer to Circular No.43(xv)-(ii) of 1954, dated December 17, 1954, and No.34(25)-(9) of 1955, dated August 20, 1955, which, in substance, enjoined upon the Income-tax Officers not to reject an application for renewal of registration without giving an opportunity to the assessee to file an application for renewal of registration within reasonable time. On a reading of Articles 2 and 3 of the Income-tax (Removal of Difficulties) Order, 1962, alongwith section 297(2) of the Act of 1961, it becomes quite clear that the matter of registration of a firm was to be regarded as part of the process of assessment and in that sense of the matter was to be dealt with as per the provisions of sections 185 and 187 to 189 of the said Act. As has been discussed above, the application filed by the assessee-firm on December 31, 1959, for grant of registration for the assessment year 1961 was well within time as per the provisions of the Act of 1922 and the rules was made thereunder. However, in view of section 297(2) of the Act of 1961, the assessment was to be made as per-the provisions of the Act of 1961 and the matter of registration was also to be dealt with in accordance with the provisions of sections 185 and 187 to 189 of the Act of 1961. The Tribunal was, therefore, well-justified in directing the Income-tax Officer to allow the assessee as opportunity to file an application for registration as per the provisions of the Act of 1961.

To sum up, we hold that the applications filed by the assessee-firm on December 31, 1959, for grant of registration to it for the assessment year 1960-61 was well within time. Referred question No.2 is thus required to be answered in the affirmative, i.e., for the assessee and against the Revenue.

In so far as referred question No. l for this year is concerned, it may be pointed out that the Income-tax Officer had no doubt purported to pass his order under section 184(4) of the Act of 1961, but, in fact, the order passed by him refusing grant of registration to the assessee-firm was in fact and in reality an order passed under section 185(5).

A bare perusal of the relevant provision contained in section 184 makes things quite clear. Section 184 simply deals with the subject of filing an application for registration. Subsection (4) of section 184 lays down that the application shall be made before the end of the previous year for the assessment year in respect of which registration is sought. The proviso under subsection (4) empowers an Assessing Officer to entertain the application made after the end of the previous year. Subsection (4) of section 184 does not empower the Income-tax Officer either to grant or refuse to grant registration to the firm. It is section 185 which deals with the procedure after receipt of application for registration. Enquiry into the genuineness of the firm and its constitution as specified in the instrument of partnership is to be made under subsection (1) of section 185. The Income-tax Officer, after conducting such enquiry, may grant or may refuse to grant registration to a firm. Subsections (2), (3) and (4) deal with rectification of defects, if any, in the application and empower the Income-tax Officer to pass necessary orders in that behalf. Subsection (5) empowers the Income-tax Officer to refuse to register a firm for an assessment year where there has been failure, as is mentioned in section 144, on the part of a firm. It is thus quite clear that section 184 does not contemplate an order of a firm. It is thus quite clear that section 184 does not contemplate an order to be passed by the Income-tax Officer in respect of granting or refusing to grant registration to a firm. It is section 185 which empowers the Income-tax Officer to pass an order in that respect. The order passed by an Income-tax Officer under section 185 of the Act of 1961 is unquestionably an appealable order as per the provisions of section 2460) of the Act of 1961.

In view of the above discussion, we hold that the Tribunal was justified in holding that the Income-tax Officer's order purported to have been passed under section 184(4) was, in fact, an order under section 185(5) and as such was an appealable order. We, accordingly, answer question No. l in the affirmative, i.e., for the assessee and against the Revenue.

Now, coming to question No.3 in this year we find that the validity of the partnership has been challenged on the ground that the profits of the business were in reality distributed amongst three persons whereas the agreement of partnership was entered into between two persons. The scope of the question referred in the assessment year 1961-62 requires us to examine the nature and character of the payment made to the alleged third person, namely, Shri Abdul Razaq, in his capacity as guardian of the estate of the deceased partner, Shri Noor Muhammad. It would, therefore, be, we think, convenient and proper to deal with question No.3 for the assessment year 1960-61 alongwith the question referred to us for the assessment year 1961-62.

The assessment Year 1961-62:

As pointed out above the deceased partner, Shri Noor Muhammad, had a 1/3rd share in the partnership business. Shri Noor Muhammad died in March, 1953, leaving behind him a will wherein he had appointed Shri Abdul Razaq as executor of the will and administrator of his estate It is an admitted position that the remaining partners, Sarva Shri Abdul Razaq and Hamid Hussain, continued to carry on the said business in the same business name. No new partnership was entered into nor any application for registration of the partnership with the Income-tax Department was ever filed. As stated by the Tribunal, this position continued right up to the assessment year 1959-60. It was on January 1, 1959, that the instrument of partnership which is in question, was executed between Shri Abdul Razaq and Hamid Hussain, i.e., the remaining two partners. In the preamble of this'': partnership deed, it was mentioned that it had been decided and agreed upon "'44 between the two continuing living partners to continue the business in the same name and style. They had further decided and agreed to keep the share capital of the deceased partner in the business and to pay to the guardian of his estate an equal share in the profits of the new firm in accordance with the provisions contained in section 37 of the Indian Partnership Act, 1932. The guardian was not to bear the losses which were to be shared equally by the two remaining partners who were to carry on the business. ShriNoor in his capacity as guardian of the estate of the deceased Shri Noor Muhammad had accepted the terms by appending his signature to the partnership deed. This takes us to examine the scope, effect and applicability of the provisions of section 37 of the Indian Partnership Act, 1932, to the present case:

"37. Right of outgoing partner in certain cases to share subsequent profits---Where any member of a firm has died or otherwise ceased to be a partner, and the surviving or continuing partners carry onthe business of the firm with the property of the firm without any final settlement of accounts as between them and the outgoing partner' or his estate, then, in the absence of a contract to the contrary, the outgoing partner or his estate is entitled at the option of himself or his representatives to such share of the profits made since he ceased to be a partner as may be attributable to the use of his share of the property of the firm or to interest at the rate of six per cent. per annum on the amount of his share in the property of the firm: Provided that where by contract between the partners an option is given to surviving or continuing partners to purchase the interest of a deceased or outgoing partner, and that option is duly exercised, the estate of the deceased partner, or the outgoing partner or his estate, as the case -may be, is not entitled to any further or other share of profits; but if any partner assuming to act in the exercise of the option does not in all material respects comply with the terms thereof, he is liable to account under the foregoing provisions of this section."

It may be mentioned that earlier there was no corresponding provision like section 37 in the repealed sections 239 to 266 of the Indian Contract Act, 1872, which were replaced by the present Indian Partnership Act, 1932. By giving a place to this section in the present Partnership Act a well-recognised principle of partnership law embodied in analogous section 42 of the (U.K.) Partnership Act, 1890, and which principle is that if, after the dissolution of a partnership firm, a partnership has used assets or the profits which are attributable to the share of a different partner, he must either pay interest or the profits which have resulted by the use of the moneys of the other partner, was given legal recognition in the Indian partnership law. Even prior to the legal recognition having been so given, the Indian Courts applied the equitable principle underlying this section to suits for accounts of partnership (vide Udhavji Anandji Ladha v. Bapudas Ramdas Darbar AIR 1950 Bom. 94 (1313). What section 37 of the Indian Partnership Act, 1932, aims at is to avoid taking of unfair advantage by the surviving partners of the share and interest of the deceased partner in the business and assets of the partnership. The object of this provision is to award compensation, for the excessive use of moneys or other assets belonging to a firm by one or some of the partners, to the partner or his heirs who did not continue to carry on the business. The principle underlying this section is in fact based on and invokes the equitable jurisdiction of the Court to grant relief in a case where the surviving partner has carried on the business of the firm with the property of the firm without any final settlement between him and the outgoing partner. Till the final settlement, the amount due to the retiring partner or the estate of a deceased partner out of the firm's assets not paid over to him or his legal representatives but utilised by surviving partners for continuing the business is treated as a loan by the former to the latter and interest is awarded thereon though, in fact, there was no contract for a loan and payment of interest. The character of the amount of interest due to the retiring partner in the unsettled accounts of the business which is being carried on by the remaining or surviving partners or the profits attributable to the use of his share in the partnership assets being basically of the nature of loan it would be illogical to make the estate of the deceased a partner or his legal representatives share the losses of the business being so continued and carried on by the living partners. That being the nature of such a right the guardian of the estate of the deceased or the legal representative does not become a partner in the firm.

A reading of section 37 tells that this provision can apply provided the following three conditions are fulfilled:

(1)Any member of the partnership firm has died or otherwise ceased tobe a partner,

(2)The surviving or continuing partners continue to carry on thebusiness of the firm with the property of the firm, and

(3)There has been nofinal settlement of accounts as between theoutgoing partner or his estate and the surviving or continuingpartners.

If these three conditions are not satisfied section 37 cannot be brought into play. It may be noted that section 37 does not contemplate the dissolution of a partnership firm by a notice as provided in section 43 of the Indian Partnership Act, 1932. Nor does it apply to clandestine or sham arrangements spelling lack of good faith and honest exigencies of business. The arrangement made in the present case by the instrument of partnership, dated January 1, 1959, read in the light of the will of the deceased Shri Noor Muhammad was not found to be of such a nature. Section 37 in fact lays down, inter alia, the substantive law relating to the liability of the surviving partners in utilising the assets of the firm without settling accounts with the representatives of a deceased partner continuing the business as their own. Since the principle underlying section 37 is based on the equitable jurisdiction of the Court to grant relief in a case, the merits of the given case shall have to be examined for the applicability of this section. Once the provisions of section 37 are found applicable to a case, the right of the estate of the deceased or outgoing partner or his legal representatives to receive interest on the amount of deceased or outgoing partner in the property of the firm or to claim a share in the profits made by the partnership and which is attributable to the use of the share of the deceased or outgoing partner in the property of the firm would be a charge on the assets or profits of the firm and as such a deductible expenditure in the computation of the income of the firm for the reason that such an expenditure was incurred wholly and exclusively for the purposes of the assessee's business. Such a charge does neither make the guardian of the estate of the deceased partner or his legal representative a partner in the firm nor does it affect the character of the partnership as a genuine entity.

In view of the above discussion, we answer the questions, referred to us for the two years, in the following manner:

Assessment year 1960-61

Question No. l:	The Tribunal was justified in holding that the Income-tax Officer's order passed under section 184(4) was in fact an order under section 185(5) and was appealable.
Question No.2:	The Tribunal was right in holding that the application for registration filed on December 31, 1959, for the assessment year 1960-61 was filed within the time allowed.
Question No.3:	The Tribunal was right in holding that the partnership was valid.--

Assessment year 1961-62:

The Tribunal was right in holding that the payment made to Shri Abdul Razaq in his capacity as guardian of the estate of the deceased partner Shri Noor Muhammad, was a charge on the profits of the firm

Let the above answers alongwith the record of the Tribunal, if requisitioned, be communicated -to the Tribunal for further action according to law.

M.B.A./1417/FC Order accordingly.