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Income‑tax Reference No. 46 of 1960, decided on 4th July 1962.
Assessment of partners' shares of profit in their individual Assessments‑Assessment on firm whether permis sible -‑ Reservation in order that income taken provisionally-- Effect‑Income‑tax Act (XI of 1922), Ss. 3, 23(5) & 35(5).
Although an unregistered firm and its partners are distinct assessable entities for the purposes of the Indian Income‑tax Act, 1922, under section 3 of the Act, income‑tax in respect of the income of the firm is chargeable in the hands of either the firm or the partners of the firm, and not in the hands of both. The section gives an option to the Department to choose: it may choose to tax the income in the hands of the firm or it may choose to tax it in the hands of its partners in accordance with their respective shares. But once the choice is made to tax either the firm or the partners, it is no more open to the Department to go behind it and claim to assess the other. Neither section 23(5) nor section 35(5) confers a right on the Department to tax the income of the firm in the hands of the firm after it has been brought to tax in the hands of the partners of the firm.
Where the respective shares of the income of an unregistered firm were included in the assessment of the partners and there was the following note at the end of the assessment order, "joint venture income . . . taken provisionally subject to a rectification after the assessment of the joint venture"
Held, that the right to tax the income of the firm in the hands of the firm was not reserved by the Department. The effect of the note in the assessment order was that the Department had only reserved to themselves the right to ascertain the extent and true income of the firm and make the necessary rectification in the assessment order of the partners.
J. C. Thakkar v. Commissioner of Income‑tax (1955) 27 I T R 658 rel.
[Case‑Law referred]
By this application the Commissioner of Income‑tax requires the Appellate Tribunal to state a case to the High Court on certain questions of law which are said to arise out of the Tribunal's order in I. T. A. No. 11634 of 1958‑59. Inasmuch has, in our opinion, a question of law does arise out of the aforesaid order of the Tribunal, we hereby draw up a statement of the case and refer it to the High Court of Judicature at Bombay under section 66(1) of the Indian Income‑tax Act, 1922.
2. One Murlidhar Jhawar carried on business in the purchase and sale of groundnuts in association with two partners of the registered firm of Purna Ginning and Pressing Factory. In accord ance with the arrangement, Murlidhar carried on the business and made purchases and sales in his own name. All the transactions relating to this joint venture business were recorded in the books of Murlidhar. This venture was carried on only for a few months in the year of account. The assessment year is 1954‑55, the accounting year being the year ended November 6, 1953. This venture resulted in a profit of Rs. 51,280. The respective shares in this income from this venture were assessed in the hands of Murlidhar and the two partners of the Purna Ginning & Pressing Factory. The said regular assessments were completed on March 9, 1967. The respective shares of income were included in the assessments of Murlidhar and the other partners and brought to tax. The share income was not included merely for rate purposes. In the assessment order it was mentioned that this assessment was subject to rectification after the assessment on the firm was completed.
3. At the instance of the Income‑tax Officer, Murlidhar volun tarily submitted, in November, 1957, a return of income of the joint venture firm: But on the 18th December 1957, Murlidhar withdraw the return by his letter of the said date. The Income‑tax Officer completed the assessment under section 23(3). He took the status as that of an unregistered firm as there was no deed of partnership governing the conduct of the affairs, of this joint venture business. He assessed this joint venture on an income of Rs. 80,925. The assessee, respondent herein, objected to the, assessment on the ground that as the partners of the joint venture had already been assessed on their shares of income in their individual assessments and as the Income‑tax Officer had already exercised his option to assess the partners individually, the said proposed assessment on the unregistered firm was unsustainable. It was also contended that as Murlidhar was carrying on the entire business and other persons never acted as his agent or partners of that firm, the said joint venture could not be treated as a firm and brought to tax on that footing. The Income‑tax Officer rejected both these intentions by his order dated December 28, 1957. He held:
The assessee's contentions does not, however, seem to have much force in them as (i) the Department had apparently assessed the partners in respect of the share incomes from the joint venture only provisionally ; (ii) it is not necessary that in a firm all the partners should take part in the account of the business and (iii) Messrs Purna Ginning & Pressing Factory being a registered firm its partners automatically become partners in the joint venture."
The order of the Income‑tax Officer is Annexure "A" and' forms part of the case.
4. The assessee preferred an appeal to the Appellate Assistant Commissioner and raised the same contentions. It also relied upon the decision of the Bombay High Court in J. C. Thakkar v. Commissioner of Income‑tax ((1955) 27 I T R 658). The Appellate Assistant Commissioner agreed with the Income‑tax Officer in treating the assessee as an unregistered firm. As regards the other contention he distinguished the case cited and held:
"6. The second ground, relating to the validity of the assess ment on the firm, is based on the Bombay High Court judg ment in the case of J. C. Thakkar. At page 667 of the judg ment, the following passage occurs, viz.
In our opinion, the Income‑tax Act advisedly and clearly gives an option to the income‑tax authorities either to assess the unregistered firm and then proceed to assess each individual partner of that firm or not to assess the unregistered firm at all but to assess each individual partner and his share of the profits in the firm for his assessment.'
It is on this passage, in particular, that the appellant's represen tatives rely. In the first place, these observations are by way of obiter, since the question for determination before their Lord ships was the restricted question whether a partner of an un registered firm could be assessed on his share of the firm's profits without the firm being first assessed as such. Secondly, it is clear that the Income‑tax Officer in the present case, while including the share of the joint venture profit in the partners' assessments' had exercised the option of assessing the joint venture (firm). This is clear from the manner in which the joint venture profit has been included in the assessment of Shri Murlidhar Jhawar. The relevant wording of the order is reproduced below:
Add: Joint venture income with Messrs Purna Ginning and Pressing Factory taken provisionally subject to rectification after the assessment of the joint venture.'
The challenge to the validity of the assessment on the appel lant firm thus fails."
The order of the Appellate Assistant Commissioner is Annex ure "B" and forms parts of the case.
5. Thereupon an appeal was preferred to the Tribunal and it was contended that the Department erred in taking the view that in their respective assessment orders the Income‑tax Officer asses sing the partners of this joint venture had reckoned there only provisionally and that the partners having been separately assessed, the assessment on the unregistered firm is bad in law. It was also contended that the Appellate Assistant Commissioner erred in his finding that the question of agreement and agency is not an essential requirement of a partnership. The assessment was also challenged as regards quantum. There was also another conten tion regarding the addition of Rs. 7,071 representing loss in hedging transactions. The Tribunal by its order dated 4th Novem ber, 1959, accepted the contention of the appellant, in that the Department having assessed the individual partners and included his share of profits in the firm in his assessment could not again assess the unregistered firm. The Tribunal relied on two decisions (i) of the Bombay High Court in J. C. Thakkar v. Commissioner of Income‑tax ((1955) 27 I T R 658) and (ii) of the Allahabad High Court in Joti Prasad Agarwal v. Income‑tax Officer, B‑Ward, Mathura ((1959) 37 I T R107). At the hearing of the appeal by the tribunal, it was pointed out by the Departmental Representative that the original assessments oil the partners had been rectified after the present assessment on tire unregistered firm had been made.
Mr. Palkhivala, the learned counsel appearing for the appellant, categorically stated that his clients agreed to have those two assessments re‑rectified so as to restore the status quo ante. In view of the decisions cited and relied on by the Tribunal and in view of the express agreement of Mr. Palkhivala to have the two assessments of Murlidhar and the Purna Ginning and Pressing Factory re‑rectified, the Tribunal allowed the appeal. In view of this Mr. Palkhivala did not press the other points raised in this appeal. The order of the Tribunal dated 4th November 1959, is Annexure "C" and forms part of the case.
5. The only question that arises out of the order of the Tribunal is:
"Whether on the facts and in the circumstances of the case the assessment of the unregistered firm was proper and legal, the two partners of this partnership having been assessed in respect of their shares of income from this partnership business "
6. The Department accepts the statement and has n suggestions to offer. The assessee did not appear at the hearing of the draft statement, though served with notice.
G. N. Joshi and R. J. Joshi for the Commissioner.
N. A. Palkhivala with S. P. Mehta and Y. P. Trivedi for the Assessee.
At the instance of the Commissioner of Income -tax, the Tribunal has referred to us the following question under subsection (1) of section 66 of the Indian Income‑tax Act:
"Whether on the facts and in the circumstances of the case the assessment of the unregistered firm was proper and legal, the two partners of this partnership having been assessed in respect of their shares of income from this partnership business "
The facts giving rise to this reference in brief are : One Murlidhar Jhawar carried on business in the purchase and sale of groundnuts in association with the two partners of the firm called Purna Ginning and Pressing Factory. The business was conducted in accordance with the arrangements between the partners. The conduct of the business was in the hands of Murlidhar. This business venture lasted for a few months in the accounting year ending with 6th November 1953. We are here thus concerned with the assessment year 1954‑45. In the assess ment proceedings of partners the profit of the venture as disclosed amounted to Rs. 51,280. The respective shares in the said income from this venture were assessed and brought to tax in the hands of Murlidhar and the two partners of Purna Ginning and Pressing Factory and the three assessments of these persons were completed on 9th March 1957. At the end of the assess ment order, the Income‑tax Officer made the following note "Joint venture income with Messrs Purna Ginning and Pressing Factory taken provisionally subject to rectification after the assessment of the joint venture." It appears that, at the instance of the Income‑tax Officer, Murlidhar voluntarily submitted in November 1957, a return of the income of the joint venture, but soon on 18th December 1957, he withdrew the return. The Income‑tax Officer, however, proceeded and completed the assess ment of the firm under section 23(3) of the Act in the status of an unregistered firm. He computed the income of the joint venture at Rs. 82,925 and brought it to tax in the hands of the firm. Inter alia, an objection was raised to this assessment by the partners on the ground that the income of the joint venture having been already taxed in their hands, it was not open to the Income‑tax Officer to tax it again in the hands of the firm, but the same was overruled by the Income‑tax Officer. The appeal filed by the firm against the assessment also failed. The firm filed a further appeal before the Tribunal. Before the Tribunal, the firm reiterated its aforesaid contention and further contended that the Department was in error in holding that the assessment of the income of the joint venture in the hands of its partners was not final but provisional. The Tribunal accepted the conten tion of the appellant. It held that the Department, having assessed the individual partners and having included their respective shares of profit in the joint venture in their individual assessment, could not again assess the unregistered firm. In support of its conclusion, the Tribunal placed reliance on a decision of this Court in J. C. Thakkar v. Commissioner of Income‑tax and the decision of the Allahabad High Court in Joti Prasad Agarwal v. Income‑tax Officer, B‑Ward, Mathura ((1959) 37 I T R 107). On an application made by the Commissioner of Income‑tax, the aforesaid question has been referred to us.
Mr. Joshi, learned counsel for the Department, raised two contentions before us‑firstly, that there is nothing in the provisions of the Income‑tax Act that prohibits the income‑tax authorities from assessing the income of an unregistered firm in its hands even after having assessed the respective shares of profit of the different partners in their hands, and, secondly, that, at any rate, on the facts of this case, the assessment of the partners was only a provisional assessment, the Department reserving to itself a right to assess the income in the hands of the firm.
On the first aspect of the question, Mr. Joshi's argument is that the film is a separate and distinct unit of assessment as contradistinguished from its partners. Each unit is liable to pay tax. Subsection (5) of section 23 gives the Department a right to tax the firm and that right is not taken away by any of the provisions of the Act. It is only when the firm is assessed in accordance with the provisions of section 23(5), and the profits of the firm are taxed in the hands of the partners, then the Department would be prohibited from charging the same in the hands of the firm. In the instant case, no assessment under section 23(5) was made on the firm and, therefore, the assessment of the individual partners does not come in the way of the Department from charging to tax the income of the firm in the hands of the firm. Mr. Joshi also says that the provisions of subsection (5) of section 35 recognize the right of the Department to assess a firm even after the completion of the assessment of its partners. He places reliance on the decision in Meka Venkatappaiah v. Additional Income‑tax Officer, Bapatla ((1957) 32 I T R 274) and the following observations in Talipatigala Estate v. Commissioner of Income tax ((1950) 18 I T R 320, 327) : "But it cannot be said that the assessment of an individual partner iii a particular year is a bar to the assessment of the firm for that year." We have no hesitation in accepting the argument of Mr. Joshi that an unregistered firm and its partners are two distinct assessable entities for the purposes of the Income‑tax Act. But we find considerable difficulty in accepting the contention of Mr. Joshi that the Department has a right to assess the income of an unregistered firm in the hands of the firm, when the same had been assessed and brought to tax in the hands of its partners. Section 3 is the charging section, and omitting its unnecessary parts, it reads : "Where any Central Act enacts that income‑tax shall be charged for any year at any rate or rates, tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions of, this Act in respect of the total income of the previous year of every firm and other association of persons or the partners of the firm or the members of the association individually." 'It would be noticed that, under this section, income‑tax in respect of the income of the firm is chargeable in the hands of either of the firm or of the partners of the firm and not in the hands of both. The section, in our view, gives an option to the Department to choose. It may choose to tax the income in the hands of the firm or it may choose to tax it in the hands of its partners in accordance with their respective shares. But it is implicit in the section that, once the choice is made to tax either the firm or the partners, it is no more open to the Department to go behind it and claim to assess the other. Mr. Joshi however contends that the provisions of section 3 are subject to the provisions of the Act. Subsection (5) of section 23 empowers the Department to tax the firm. That right is in no manner taken away by section 3. We are unable to accept this argument. In our opinion, the provision of sub section (5) of section 23 does not confer a right on the Department to bring to tax the income of the firm both in the hands of the partners as well as the firm. On the other hand, in our view, the provisions: of subsection (5) of section 23 come into play when the Department proceeds to assess the income of the firm in the hands of the firm and that section deals with the procedure that has to be followed when the assessee is a firm. The material part of subsection (5) of section 23, as it then stood, reads;
"(5) Notwithstanding anything contained in the foregoing subsection, when the assessee is a firm and the total income of the firm has been assessed under subsection (1), subsection (3) or subsection (4), as the case may be,‑
(a) in the case bf a registered firm, the sum payable by the firm itself shall not be determined but the total income of each partner of the firm, including there in his share of its income, profits and gains of the previous year, shall be assessed and the sum payable by him on the basis of such assessment shall be determined:
(b) in the case of an unregistered firm, the Income‑tax Officer may instead of determining the sum payable by the firm itself proceed in the manner laid down in clause (a) as applicable to a registered firm, if, in his opinion, the aggregate amount of the tax including super‑tax, if any, payable by the partners under such procedure would be greater than the aggregate amount which would be payable by the firm and the partner's individually if the firm were assessed as an unregistered firm.
It would be seen that the subsection has application when the Department proceeds to assess the firm, i.e. when the assessee is a firm. The procedure is, firstly, the income of the firm, boot registered and unregistered, has to be computed in the case of a registered firm there is no option to the Department, but the respective shares of the partners in the said computed amount of profits have to be taxed in the hands of the respective partners in the case of an unregistered firm, however, there is still an option left open to the Department. It may either choose to tax he income of the firm in the hands of the firm or it may bring to tax the respective shares of the partners in the income in their hands if the requisite conditions are fulfilled. The sub section however is not a condition precedent for bringing the income to tax in the hands of the partners, if the Department otherwise chooses to do so. It is therefore not possible to accept the contention of Mr. Joshi that it is only when the procedure laid down in subsection (5) of section 23 is followed by the Department then alone it would be prohibited from taxing the same income in the hands of the firm: The view taken by us finds support in the decision of this Court in J. C. Thakkar v. Commis sioner of Income‑tax ((1955) 27 I T R 658) on which reliance has been placed by the Tribunal. In that case, the question arose before this Court in exactly the opposite way. The share in the profits of an unregister ed firm was, in the assessment of its partner, included in his total income, and was brought to tax in his hands. The assessee, i.e., the partner, inter alia, contended that the said share of profits could not be included in his total income without assessment being made on the firm. In other words, the contention raised was that, without following the procedure prescribed in subsec tion (5) of section 23, a partner could not be taxed in respect of his share to the profits in the firm. The stand of the Department in that case was exactly opposite to the stand taken here. It was contended on behalf of the Department that it was perfectly open to the Department to include in the total income of a partner his share of profits and bring it to tax in his hands without following the procedure prescribed in subsection (5) of section 23. The contention of the Department was accepted and it was held that the Income‑tax Act advisedly and clearly gives an option to the income‑tax authorities either to assess the unregistered firm and then proceed to assess each individual partners of that firm or not to assess the unregistered firm at all but to assess each individual partner and include his share of the profits in the firm in his assessment and, in this view of the matter, the assessment of the partner was held valid. At page 661 of the report; Chagla, C. J. observed:
"The first section to which we must look naturally is the charging section which is section 3, and unless the Legislature has provided for a partner of an unregistered firm being liable to pay income‑tax, the assessee's contention must be accepted. Now, as has often been pointed out, the assessable entity under the Income‑tax Act is different from a legal, entity. The object of the Income‑tax Act is to spread its net wide and to include in that net every person and, every association of persons however that association may have been constituted. Therefore we find that what is subjected to tax under section 3 is the total income of the previ ous year of every individual, Hindu undivided family, company and local authority, and every firm and other associa tion of persons or the partners of the firm or the members of the association individually. Therefore an individual can be assessed to tax, a partnership in which the individual is a partner can be assessed to tax, and section 3 does not provide that when there is a partnership only the firm can be taxed and not the partners of that firm."
Chagla, C. J. further, at page 667 of the report, observed:
"In our opinion the Income‑tax Act advisedly and clearly gives an option to the income‑tax authorities either to assess the unregistered firm and then proceed to assess each individual partner of that firm or not to assess the unregistered firm at all but to assess each individual partner and his share of the profits in the firm for his assessment."
We are in respectful agreement with the view. The material part of subsection (5) of section 35 is in the following terms:
"(5) Where in respect of any completed assessment of a partner in a firm it is found on the assessment or re‑assessment of the firm .. that the share of the partner in the profit or loss of the firm has not been included in the assessment of the partner or; if included, is not correct, the inclusion of the share in the assessment or the correction thereof, as the case may be, shall be deemed to be a rectification of a mistake from the record within the meaning of this section, and the provisions of sub section (1) shall apply thereto accordingly, the period of four years referred to in that subsection being computed from the date of the final order passed in the case of the firm."
It is true that this subsection envisages a case where the assessment of the firm gets completed after assessment of its partners. But we are unable to read in the subsection anything which confers a right on the Department to bring to tax the income of the firm in the hands of the firm after its having been brought to tax in the hands of its respective partners. All that is provided in the section is that in such a case, if on the completion of the assessment of the firm it is found that any income of the firm has not been correctly included in the income of its partners, the necessary rectification in that matter be made in the partners' assessment as if it was a mistake apparent from the record. The decisions on which reliance is placed by Mr. Joshi, in our opinion, are also not of any assistance to the revenue and are distinguish able on facts. The question that arose in Meka Venkotappaiah v. Additional Income‑tax Officer, Bapatla was one under section 18‑A (3) of the Act. Section 18‑A relates to advance payment of income‑tax. Subsection (3) provides that "any person who has not hitherto been assessed shall, before the 15th day of March in each financial year, if his total income of the period which would be the previous year for an assessment for the financial five year next following is likely to exceed the maximum amount not chargeable to tax in his case by two thousand five hundred rupees, send to the income‑tax Officer an estimate of the tax payable by him on that part of his income to which the provisions of section 18 do not apply ." Failure to observe the said subsection rendered the person concerned to pay penal interest. A penal interest was levied on the assessee. Before the High Court, it was, inter alia, contended by the assessee that he was not liable to pay penal interest under section 18‑A (3) as until immediately before that assessment year, he was a partner in a firm which was assessed to income‑tax as an unregistered firm and, therefore, it could not be said that, "he had not hitherto been assessed" he had not hitherto been assessed" within the meaning of section 18‑A (3). . This contention was not accepted by the High Court on the ground that the unregistered firm was a distinct assessable entity and was different from the assessee who was a partner of that firm and the assessee was a person "who had not hitherto been assessed" within the meaning of section 18‑A(3) of the Act. This decision is only an authority for the proposition that an unregistered firm and its partners are two distinct entities under the Income‑tax Act. We have already stated that with this proposition we have no quarrel. The other decision is also distinguishable on facts. In that case, in the assessment of only one of the partners of the partnership his share in the profits of an unregistered firm was included in his total income and brought to tax and, thereafter, the Department proceeded to assess the un registered firm as a distinct entity and, to bring its income to tax its hands. On these facts, it has been held that the assessment of a partner who was not a bar to the assessment of the firm. We are here concerned with a case not where one of the partners has been assessed, but where the entire income of the firm had been assessed and brought to tax in the hands of all its partners. The decision, therefore, in our opinion, would have no application to the facts of the present case. Apart from it, we may say that the ratio deducible from the decision in Jot Prasad Agarwal v. Income‑tax Officer, B‑ Ward, Mathura appears to run counter to the view taken in this case. In our judgment, therefore, the first contention of Mr. Joshi should fail.
It is next to be considered whether on the material on record it can be said that the Department had finally exercised its option of assessing the partners. It is the contention of Mr. Joshi that the Department had not exercised its option finally when it assessed the partners. At that time, the Department was not aware whether the firm was a registered firm or an unregis tered firm. It also did not know what the extent of its profits were. The Department, therefore, was not in a position to make an option and the assessments of the partners were made subject to the reservation of the right of the Department to proceed to assess the firm and bring the income of the firm to tax in its hands. It is indeed true that the assessment of the partners was made subject to certain reservations. But, in view of the endorsement of the Income‑tax Officer on the assessment' order, it is difficult to hold that the right to tax the income of the firm in the hands of the firm was reserved by the Department. In our view, on reading the endorsement all that call be said is that the Depart ment had not finally accepted the income, namely, Rs. 51,280 as the income of the firm, when it proceeded to assess the partners in respect of the income of the firm and had reserved to themselves the right to ascertain the extent and the true income of the firm and make the necessary rectification in the assessment orders of the partners. Therefore, all that was open to the Department to do was to compute the income of the firm and make necessary adjustments in accordance with its conclusions. To that the assessee had raised no objection. The second contention raised by Mr. Joshi also, therefore, in our judgment, fails.
Our answer to the question referred to us, therefore, is that, on the facts and in the circumstances of the case, the assessment of the unregistered firm in the sense that the income has been charged to tax in its hands was not proper and legal, the two partners of this partnership having been assessed in respect of their shares of income from this partnership business.
The Department shall pay the costs of the assessee.
Order accordingly.
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