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Civil Reference No. 85 of 1964, decided on 22nd June 196'1.
(a) Income‑tax Act (XI of 1922)
, S. 26‑A read with S. 23(S)(a) Assessee, partner of two firms, under an instrument of partnership entering into arrangement to part with 8 annas share in principal firm in favour of his two sons on consideration of their attending to partnership business on his behalf‑Arrangement a valid and roper sub‑partnership‑ Registration of such partnership, held, could not be refused‑"Real income" of assessee to be calculated after separating share of two sons in terms of sub partnership‑[P. A. Raju Chettiar and Brothers v. Commissioner of Income‑tax, Madras (1947) 17 I T R 51 and Mahaliram Santhalia v. Commissioner of Income‑tax (Central) Calcutta (1958) 33 I T R 261 dissented from].
1960 P T D Trib.) 168 ; Bianco v. Demarco A I R 1932 P C 63 ; 1961 P T D (Trib.) 14 ; Commissioner of Income‑tax Punjab v. Laxmi Trading Company (1953) 24 I T R 173; Commissioner of Income‑tax v. Agardih Colliery Co. (1955) 27 I T R 540 ; Ratilal B Daftari v. Commissioner of Income‑tax, Bombay (1959) 36 I T R 18 ; Bagyalakshmi & Co. v. Commissioner of Income‑tax, Madras (1961) 421 T R 727 ; Commissioner of Income‑tax v. Sivakasi Match Exporting Co. (1964) 53 1 T R 204 ; Pondicherry Railway Co. Ltd. v. Commis sioner of Income‑tax, Madras 1931 P C 165 and Lindley's Law of Partnership, 11th Edn., pp. 67, 69 ref.
Commissioner of Income‑tax v. Amin Match Works P L I) 1964 S C 377 rel.
P. A. Raju Chettiar & Brothers v. Commissioner of Income-tax, Madras (1947) 17 I T R 51 and Mahaliram Santhalia v: Commissioner of Income‑tax (Central) Calcutta (1958) 33 I T R 261 dissented from.
(b) Income‑tax Act (XI of 1922)
, S. 23(J)(a)‑Partner of registered "firm ‑Individual assessment ‑ "Real income", and not income allocated to his share, to be taken into consideration--- "Real income" would mean income remaining after deducting amount diverted.
In the Case of a partner in a registered firm when the question arises as to his individual assessment it is not the income allocated to his share under section 23(5)(x) that has to be taken into consideration but his real income. Otherwise if this principle is not followed what would be assessed would not be his real income but an artificial income said to be earned by him. There can in law be no manner of doubt that his real income would be what remains after deducting the amount diverted which never constitutes income and both in law and equity it shall have to be excluded in order to determine his real income.
Bejoy Singh Dudhuria v. Commissioner of Income‑tax, Calcutta A I‑R 1933 P C 145 ref.
Dlngornal for Appellant.
S.A. Nusrat for Respondent.
Dates of hearing : 13th, 14th and 18th April 1967.
WAHIDUDDIN, J.
‑This reference has been made at the instance of Messrs Merwan K. Irani and Messrs Merwan & Sons and arises out of the consolidated order dated 24th May 1962, in respect of the assessment years 1954‑55 and 1955‑56. During the two years in question Mr. M. K. Irani was a partner in two firms known as Messrs Asiatic Wine Merchants and Messrs Ritz Refreshment and Wine Stores having 4 annas share in the former firm and 1/3rd share in the latter. On 13th January 1954, Mr. M. K. Irani and his two sons K. M. Irani and A. M. Irani applied for registration of a firm composed of the said three partners for the charge year 1954‑55 on the basis of a partnership deed dated 2nd April 1953, and operating from 1st. April 1953, in the name of Merwan & Sons. Under the terms of this partnership it was agreed that the two sons would work in the two principal firms in which their father was a partner on his behalf. In consideration of this it was agreed that the share of profit of the father would be divided half and half, the father would tare 8 annas out of the profits earned by him in the said firms and each son would get four annas share. The genuineness of this transaction has not been doubted by the Income‑tax Appellate Tribunal and it is not disputed that the object of this new firm was that the sons were to assist the father in his work in the first two named firms. A renewal application for the firm of the father and sons was also filed in the charge year 1955‑56. Both these applications were rejected by the income‑tax Officer on the ground that the new firm had no business to carry on, the sons had not contributed any capital and although the father was to get Rs. 3,000 for managing the affairs of Asiatic Wine Merchants he allowed Rs. 29,600.to his two sons out of his share from the profits of the principal firms. After rejecting the applications by order dated 14th February 1958 for registration and renewal of registration the assessing officer included Mr. Merwan K. Irani's share of income from the two principal firms as a partner in his total income and assessed it accordingly.
2. The assessees challenged this order in appeal before the Appellate Assistant Commissioner who by order dated 12th November 1959, reversed the finding of the Income‑tax Officer. He held that Mr. Merwan K. Irani's share of income from the above two firms shall be excluded from his personal assessment and only so much therefrom shall be included in his personal assessment as falls to his share out of the said share of income after appropriating the same to the firm. He directed that the new firm shall be assessed as a registered firm and held that the new firm is a sub‑partnership which should be registered and directed that the registration should be renewed for the subsequent year. The Department challenged this order in appeal before the Income‑tax Appellate Tribunal who by order dated 24th May 1962, restored the order of the Income‑tax Officer and upheld his finding that the income of Merwan K. Irani in the above two principal firms be included in his personal income, refused assessment of the new firm as a registered firm and refused registration of the new firm and renewal of registration of that firm. The reasoning of the Tribunal, in income to this conclusion was that because the father alone was a partner in the first two firms and the alleged partnership which he formed with his two sons had no affinity whatsoever with these two firms, it was therefore he and he alone whose income could be assessed under section 23 (5) (a) of the Income‑tax Act., On the question of the registration of the new firm and its nil assessment the Tribunal held that it had no business to carry on and no contribution was made towards the capital by the sons and as such it could not claim registration and consequently there could be no assessment of such a firm. Thereupon the assessees moved these reference applications, two at the instance of Merwan K. Irani and four by Merwan & Sons for referring the point in dispute between the parties to this Court under section 66 (1) of the Income‑tax Act. It is in these circumstances that the Income‑tax Appellate Tribunal by its order dated 10th April 1963, has referred the following questions of law arising out of its order referred to above to this Court for its consideration:
"(1) Whether on the facts and in the circumstances of the case, the entire shares of profits from the two registered firms of Ritz Refreshment Bar and Wine Stores and Asiatic Merchants could be included in the individual assessment of M. K. Irani in view of the provisions of section 23 (5) (a) of the Income -tax Act, 1922.
(2) Whether having regard to the provisions of section 26‑A and the agreement of partnership deed dated 2nd April 1953, of the firm Merwan & Sons, it was right in law to hold that the status of the firm was nil and to refuse registration to it."
3. The most important question for consideration in this reference is whether in the case of a partner in a registered firm when the machinery provided under section 23(5)(a) is complied with, it is open to him to urge that only his real income from the partnership business should be taxed on the ground that a part of that income or profits has been diverted to some other person as a sub‑partner by a legally binding agreement. The point that requires consideration is whether in such cases his real income would be the share allocated to him under section 23(5Xa) or the amount that would remain with him after the profits apportioned to him are shared by him with a sub‑partner. In support of the reference Mr. Dingomal, the learned counsel for the assessees, has contended that the plea of the assessee that the real income would be the amount that would remain after sharing profit with a sub‑partner has been accepted as sound contention by the Income‑tax Tribunal in a number of reported cases decided by it. In this connection he has referred us to one of their decision in 1960 P T D (Trib.) 168. In that case the appellant's alleged share income from an unregistered firm styled "Messrs R Sukkur" was included in the supplementary assessment, on the reasoning that since the said person had no independent capital or source of income he should be taken to have represented the Association of Persons when he entered into the contract of partnership. In other words, the finding was that although R is shown to be a partner, the real partner was the Association of Persons known as "K. A.". It was assumed in that case that the capital contributed by R came out of the funds of the Association of Persons but it was held this only amounted to an arrangement between R on the one hand and the Association of Persons on the other; and R could not affect the constitution of the firm styled "R". The Tribunal further held that there was some sort of arrangement between R and the Association of Persons to share the profits of the unregistered firm in whole or in part by way of return. But this aspect of the matter was irrelevant because the arrangement may amount to a sub‑partnership. For this reasoning reliance was placed on the decision of the Judicial Committee of the Privy Council in the case of Bianco v. Demarco (A I R 1932 P C 63) in which their Lordships observed:
"Where there is no partnership deed and a person advances, money to a partner in an adventure or partnership, for the purposes of the adventure he thereby becomes a co. adventurer with that partner and is responsible as such to that partner to the extent of his contribution."
The learned Tribunal also referred to the commentary of Lindley on Partnership at page 69 where the same principle was enunciated and on the above consideration reached the conclusion that the share income from the unregistered firm was wrongly included in the total income of the assessee.
4. Learned counsel further referred us to another decision of the Income‑tax Tribunal in 1961 P T D (Trib.) 14. In that case the Tribunal held that the share of profit received by common partner was assessable in his hands according to his share in sub‑partnership between him and partners of an old firm. While coming to this conclusion they further observed:
"A sub‑partnership is as if it were a partnership within a partnership : it pre‑supposes the existence of a partnership to which it is itself subordinate. If several persons are partners and one of them agrees to share the profits derived by him with a stranger, this agreement does not make the stranger a partner in the original firm. The result of such an agreement is to constitute what it called a sub‑partnership, that is to say, it makes the parties to it partners inter se."
In view of the above decisions Mr. Dingomal pressed before us that the view of the Income‑tax Appellate Tribunal in the present case that "in order that a sub‑partnership may claim the share income of one of its partners from another firm it has got to show some affinity with that other firm and the share income it claims has not already been assessed elsewhere. In the instant case, no affinity of the new firm with the principal firms has been established, and Mr. Merwan K. Irani's income from the principal firms had already been included in his total income at the tithe the income of these firms was assessed." "How any arrangement would be acceptable if it is opposed to a clear provision of law, namely, S. 23 (5) (a) of the income‑tax Act which in unmistakable terms lays the procedure" is erroneous and should not be accepted as correct enunciation of the proposition of law referred to this Court. To further strengthen his argument the learned counsel referred us to a series of decisions in the Indian jurisdiction on the points under consideration. In Commissioner of Income‑tax Punjab v. Laxmi Trading Company ((1953) 24 I T R 173); a decision of the East Punjab High Court one Sri Ram Pershad, a wholesale dealer in cloth was a partner in the Wholesale Cloth Association, Ludhiana in his individual capacity. His brother‑in‑law Shri Gopal Das was incharge of his affairs in the Association and was an employee on a monthly salary of Rs. 200. On 1st April 1947, a deed of partnership was drawn up by which Shri Gopal Dass became a partner in the share held by Shri Ram Pershad in the Association and this firm was "Laxmi Trading Company": There was no change in the constitution of the Wholesale Cloth Association by the introduction of Shri Gopal Dass. Registration was sought of the firm Laxmi Trading Company for the assessment year 1948‑49 under section 26‑A of the Income‑tax Act. The registration was refused by the Income‑tax Authorities, but on appeal to the Appellate Tribunal the firm was directed to be registered under S. 26‑A and on the application of the Commissioner of Income‑tax, the matter was referred to the High Court under section 66 (1). It was urged before the High Court that such a relationship as is created by the deed of the alleged partnership between Ram Pershad and Gopal Das is not a partnership within the meaning of S. 4 of the Partnership Act as Gopal Das cannot act for Ram Pershad which is essential for the purpose of S. 4 of the Partnership Act. This contention was repelled by the High Court on the ground that there could in law be a partnership between a partner in a head‑firm and another individual in respect of the partner's share in the head -firm so as to entitle the partners in the sub‑firm to apply for registration thereof under S. 26‑A of the Income‑tax Act, 1922. If several persons are partners and one of them agrees to share the Profits derived by him with a stranger, this agreement does not make the stranger a partner in the original firm. The result of such an agreement is to constitute what is called a sub‑partnership, that is to say, it makes the parties to it partners inter se but it in no way affects the other members of the principal firm. On this view the High Court held that the Income‑tax Appellate Tribunal rightly directed the registration of the firm under section 26‑A.
5. In Commissioner of Income‑tax v. Agardih Colliery Co. ((1955) 27 I T R 540) the assessee was a partnership firm constituted under a deed of partnership dated 15th September 1944. The partners were Renu Bala Devi and Ratilal Manishankar Dave, each having eight annas share, and were carrying on business of coal mining and to deal in coal and coke. Later on the 23rd November 1945, there was another deed of partnership executed as between Ratilal Manishankar Dave and five other persons. By this document it was agreed that 8 annas share in the profits of the first partnership would be divided between the six partners who are mentioned in the second partnership deed. The partners of the first partnership applied for registration of the partnership under section 26‑A of the Income‑tax Act, but it was rejected on the ground that the real partners were 7 other partners not disclosed in the second partnership deed and it did not correctly represent who were the partners of the firm. It was not a genuine partnership and therefore registration was refused. The correctness of this decision was referred to the Patna High Court. Their Lordships held that:
"If several persons are partners and one of them agrees to share the profits derived by him with a stranger, this agreement does not make the stranger a partner in the original firm. The result of such an agreement is to constitute what is called a sub‑partnership ; it makes the parties to it partners inter se; but it in no way affects the other members of the principal firm."
It was further held :‑---
(i) that as A was not a party to the second partnership there was no privity of contract between the seven persons and therefore the first partnership was not affected in any manner by the constitution of the second partnership ;
(ii) that the five persons who entered into the second partnership with B could not be held to be partners of the first partnership ; and
(iii) that, therefore, the firm of A and B constituted by the original deed was registerable under section 26‑A of the Income‑tax Act.
6. In Ratilal B. Daftari v. Commissioner of Income‑tax, Bombay ((1959) 36 I T R 18) the dispute was in respect of a registered partnership consisting of 16 partners who were to share the profit or loss in proportion to the capital contributed by each partner, the share of the assessee, who was a partner and had contributed Rs. 25,000 out of the capital of the partnership of Rs. 3,45,000 was determined at Rs. 14,661 in accordance with the provisions of S. 23 (5) (a) of the Income‑tax Act. The assessee contended that the whole of the above amount did not belong to him but only two‑fifths viz. Rs. 5,864 and relied upon an agreement between himself and four others entered into on the same date on which the deed of the registered partnership was executed. The agreement provided that the five parties who had contributed diverse sums amounting to Rs. 25,000 were to share the profits or losses in proportion to their individual contribution and also mentioned that the terms and conditions mentioned in the registered partnership were to be applicable to and binding on them. On these facts the Bombay High Court held "that even in the case of the assessment of a partner of a registered firm what was to be considered was not the income allocated to his share by employing the machinery of section 23 (5) (a) but his real income ; and that real income was what remained after deducting the amounts which might be said to have been diverted and never constituted his real income and such amounts would have to be excluded to ascertain his real income ; for ultimately it was his real income which alone could be taxed and not any artificial or notional income that he maybe said to have earned ; and that, therefore, in this case only two‑fifths of the sum of Rs. 14,661 viz. Rs. 5,864 could be assessed in the hands of the assessee as his share in the profits of the registered firm and not the entire sum of Rs. 14,661".
7. In Bagyalaksh mi & Co. v. Commissioner of Income‑tax; Madras ((1961) 42 I T R 727) in a case of Hindu joint family at pages 735 and 736 the learned Judges of the Madras High Court considered the effect of a sub‑partnership on the income of a partner of a registered partnership and observed that a sub‑partnership entered into by one of several partners in the main firm would not, affect the registrability of either the firm or the sub‑partnership. To the same effect is the decision of the Supreme Court of India in Commissioner of Income‑tax v. Sivakasi Match Exporting Co. ((1964) 53 I T R 204). In that case there were five match factories in Sivakasi run by five different concerns of which four were firms and the fifth a sole proprietorship. In 1948 a person from each of these five concerns in his representative capacity formed a partnership, that partnership was refused registration under S. 26‑A of the Indian Income‑tax Act, 1922 on the ground that different firms could not constitute a valid partnership. Thereafter one partner from each of the four firms and the proprietor of the fifth concern in their individual capacity constituted the assessee firm and executed a deed of partnership on 1st April 1950, to carry on the business of banking and commission agent and of making the products of the match factories. The Income‑tax Officer refused registration of the assessee firm and on, appeal the Appellate Tribunal held that the partnership was not genuine for the following reasons :‑---
(a) registration of the earlier partnership formed in 1948 had been refused ;
(b) under clause 16 the assessee firm had the right to collect commission on the entire match production of the five concerns whether they effected their sales through it or not ;
(c) capital was contributed to the assessee firm directly by J one of the four firms on behalf of its partner ; and
(d) the other three firms divided amongst their partners the profits derived by their respective partners from the assessee firm.
On a reference made the High Court held that the business was the business of the partners alone and not of the firms and that the circumstances relied upon by the Tribunal were irrelevant in ascertaining whether the partnership was real or not and the registration of the assessee firm under section 26‑A was wrongly refused. In this connection Subha Rao, J. observed as under at page 209:
"It is not disputed that the partnership deed ex facie conforms to the requirements of the law of partnership as well as the Income‑tax Act. Under S. 4 of the Indian Partner ship Act, partnership is the relation between persons who have agreed to share the profits of the business carried on by all or any of them acting for all ; persons who have entered into the partnership with one another are called individually partners and collectively a firm and the name under which the business is carried on is called the firm name. The document certainly conforms to the said definition. There is also no prohibition under the partnership Act against a partner or partners of other firms combining together to form a separate partnership, to carry on a different business. The fact that such a partner or partners entered into a sub‑partnership with others in respect of their share does not detract from the validity of the partnership ; nor the manner in which the said partner deals with the share of his profits is of any relevance to the question of the validity of , the partnership. The document, therefore, embodies a valid partnership entered into in conformity with the law of partnership."
The learned Judges further observed at page 210:
"If the larger firms cannot constitute members of a new partnership, some of the partners of those firms can certainly' enter into a partnership shedding their representative capacity if they can legally do so. If they can do so, the mere fact that one of them borrowed the capital from a parent firm we are using this expression for convenience of reference or some of them surrendered their profits to, the parent first cannot make it any the less a "genuine first."
8. Mr. Dingomal, in the light of the above discussion, argued that the amount paid to the sub‑partners cannot be considered as the real income of the assessee and that as the Tribunal has held the sub‑partnership as a genuine transaction its registration could not be refused. In order to further strengthen his argument the learned counsel referred us to a decision of the Supreme Court of Pakistan in Commissioner of Income‑tax v. Amin Match Works (P L D 1964 S C 377). In that case certain minors were admitted to benefits of partnership. Constitution of the firm and its registration was refused on the ground that such a partnership was not permissible under the law. In this connection their Lordships observed as under:
"It is no doubt correct that a minor cannot create a partnership but it cannot be said that by being merely admitted to the benefits of a partnership he also becomes a partner. In any event, we fail to appreciate why the inclusion of the minors should have rendered the constitution of the firm itself invalid when there were at least two adult partners, besides the minors, who could lawfully have entered into the partnership. Under S. 26‑A of the Income‑tax Act two conditions have only to be satisfied, firstly, that the firm has been constituted under an instrument of partnership, and, secondly, that the instrument has specified the shares of the partners. If these conditions are satisfied, the firm is entitled to registration. Both these conditions were fully satisfied in the present case."
It was strongly contended before us that both the conditions laid down by their Lordships in the above‑mentioned case have been fulfilled by the sub‑partnership and therefore the learned Income‑tax Officer wrongly refused its registration.
9. On the other hand, Mr. S. A. Nusrat, the learned counsel for the Department, has contended that registration of firms under the Income‑tax Act is not a general or common law right, but it is a privilege given to the firms in order to get the benefit of the assessment ; and in such cases it is open to the Income‑tax Officer to examine whether the partnership is genuine, whether each of the partners mentioned therein is a real partner, whether the shares are 'specified properly, whether the shares specified are real ones and whether the profits which are to be distributed under the deed, will truly be the profits of those particular individuals. If he finds that there is no genuineness with regard to any one, it is open to him to reject the application on the ground that there was no genuine partnership brought into existence by the deed. In support of his contention the learned counsel placed reliance on the case of P. A. Raju Cheteiar & Brothers v. Commissioner of Income‑tax, Madras ((1947) 17 I T R 51). In our opinion this question is irrelevant for the decision of this case because the finding of the learned Income -tax Tribunal is that the sub‑partnership entered into between the father‑ and two sons in the present case is a genuine transaction. In this connection the learned Tribunal in he order of reference in para. 3 have clearly stated as under:---
"At the time the appeals which give rise to these applica tions were heard the Tribunal found that no original deed of partnership setting up the firm of father and sons was produced at any stage. However, when these applications came up for hearing the Department came out with the original document which obviously necessitated the rectification of the mistake committed in paragraph 9 of the Tribunal's appellate order, and, therefore, we have, by our order under section 35 of the Income‑tax Act, deleted the aforesaid para graph 9: '
Thus it is quite clear that the finding of the Tribunal that it was not a genuine sub‑partnership was rectified and it has been held that the sub‑partnership is a genuine transaction. It is, therefore, unnecessary for us in this case to consider the question of the genuineness of the sub‑partnership.
10. Mr. Nusrat then referred to a decision of the Calcutta High Court in Mahaliram Santhalia v. Commissioner of Income‑tax (Central) Calcutta ((1958) 33 I T R 261) and contended that after a proportionate share of the income of a pander of the firm bad been included in the total income of a partner for the purposes of his personal assessment it could not be further divided between such partner and his sub‑partners. In support of his contention the learned counsel referred us to section 23 (5) (a) of the Income‑tax Act. He further contended that a partner in a firm who has already earned and received his share of profits cannot by a voluntary act in respect of such sum by mere diversion to strangers escape liability in respect of such income. Both the contentions of the learned counsel were at length discussed in the above‑mentioned Calcutta case. In that case the four partners including one M of a firm A, each owning a one fourth share in the firm, made an application for registration of the firm under S. 26‑A of the Income‑tax Act on the basis of a partnership deed dated 24th December 1943. The Income‑tax Officer allowed the application and assessed the firm as a registered firm for four assessment years. In respect of none of these years did M include his share of the income from the firm A on the ground that he was a partner of the firm A not in his individual capacity, but as a representative of another firm B of which bin was a partner with three others, and that the proportionate share of the income in firm A attributable to his share was the income of firm B. In support of his case M produced an agreement dated 3rd April 1944, between the partners of firm 7 which contained a provision to the effect that income from firm A belonged to all the partners of firm B. Firm B did not include M's share of the income in firm A in its own total income. On these facts it was held by the Calcutta High Court that as each of the partners of the firm A, including M, made application under section 26‑A for registration of the firm in his personal capacity on the footing that he was a partner .as an individual and that was the basis upon which the registration was allowed, the consequence of allowing registration on the representation thus made was that laid down, in S. 23 (5) (a) of the Act i.e. 1/4th share of the income of the firm was bound to be included in the total income of each partner in his personal assessment, and it was impossible for a partner's share of the income to be further divided between such partner and other parties. It was further held that apart from the fact that neither the deed of partnership of firm A nor the application for registration gave the slightest indication that firm B had any interest in firm A, firm B, being itself a partnership, could not itself be legally a partner of firm A. The learned Judges further observed that under the second proviso to section 30 (1) M was entitled to raise the question of apportionment of his share of the income in firm A only in an appeal from the assessment of that firm, but was not entitled to raise that question in the proceedings for assessment of his own total income, as his share in the income of a firm A was a matter determined by an order passed in the assessment of firm A. In this connection the learned Judges further observed as under :‑---
"In the second place, it is quite impossible to see how there could conceivably be any question of diversion by an overriding title in the present case, which could be said to prevent the share of Income received by Mahaliram Santhalia from, the Benares‑ Steel Rolling Mills from becoming his income. If, as Mr. Mitra conceded, Mahaliram was rightly taken as a partner of the Benares Steel Rolling Mills m his personal capacity and if a one‑fourth share of the income was rightly allocated to him, any agreement between him and his three partners of the firm of Radhakissen Santhalia, under which the income was to be treated as the income of the whole firm, could only be an agreement by which Mahaliram Santhalia was allowing what was really his income to be treated as the income of the firm or, in other words, an agreement by which he was applying or distributing an income which he had already himself earned and received. Such application or distribution would be voluntary act of Mahaliranp Santhalia in respect of a sum which, it was conceded, had rightly been included in his own total income sad, therefore, was his own income. If the moment the share of income from the Benares Steel Rolling Mills was allocated to Mahaliram Santhalia, it became his income and liable as such to be included in his own total income for the purpose of his personal assessment, an agreement by him with other persons regarding the right to that income could only be a voluntary disposition of his income by him. No question of diversion by superior title could possibly arise."
10. Mr. Nusrat further referred us td a decision of the Privy Council in Pondicherry Railway Co. Ltd. v. Commissioner of Income‑tax, Madras (1931 P C 165) and particularly referred us to the following observations at page 170 of the report:
"A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits. It was persuasively argued that inasmuch as the Pondicherry Company as a condition of making any profits must pay over one half of them to the French authorities and could never itself receive the whole profits the payment so made was pf the nature of a rent payable by the Company or a charge on the undertak ing. But the analogy in their lordships' opinion is imperfect, and the form in which the parties have contracted that the French Government can participate in the success of the undertaking precludes the deduction claimed."
11. These are the two divergent views placed before us by the learned counsel for the parties in support of their respective contentions. After carefully considering their arguments, we have come to the conclusion that the Tribunal has fallen into an error in deciding both the questions referred to this Court against the assessees. In the first place, the Tribunal failed to notice that in law there is no bar for a partner to agree to share the profits derived by him with a stranger. This principle of law is enunciated by Lindley in his treatise on Lindley's Law of Partnership at page 67, 11 th Edition. It was also approved by the Privy Council in A I R 1932 P C 63. This being the legal position the sub‑partnership agreement entered into by Mr. Merwan K. Irani with his two sons was a perfectly valid transaction and it could only be discarded on the ground that it was not a genuine transaction. The finding of the Tribunal in this respect is that it is a genuine transaction. Keeping in view in such circumstances, the decision of our own Supreme Court referred to above it is difficult for us to hold that the Tribunal was justified in refusing the registration of the sub‑partnership. According to their Lordships' observations at page 377, section 26‑A of the Income‑tax Act is only to be satisfied in two respects. Firstly, that the firm has been constituted under an instrument of partnership and, secondly, that the instrument specifies the shares of the partners. If these two conditions are fulfilled the firm is entitled to registration. In the present case it cannot be disputed that both these conditions have been fulfilled. It is not disputed that Mr. Merwan K. Irani is an old person and his two sons are attending to the two partnership business on his behalf and if for this purpose he has parted with his 8 annas share in the above firms in favour of his two sons, it is a perfectly proper and valid arrangement. We are, therefore, of the view that the Tribunal was not justified in setting aside the registration of the sub‑partnership directed by the Appellate Assistant Commissioner.
12. Secondly, Mr. Nusrat's contention that diversion of profits received by a partner is not permissible in law in view of the provisions of section 23(5)(a) of the Income‑tax Act has not impressed us. In law it is the total and real income of the partner which is subject to assessment. The learned counsel has not drawn our attention to any provision of law showing that the income of a partner in the partnership firm allocated to his share has to be assessed separately from his other income. This provision of law only lays down that such income could be assessed as an individual income and that it will be added to his other income. Otherwise in. order to assess his total income it is open to him to plead that his real income should be taken into consideration; and to achieve that conclusion any amount paid by bite to bit sub‑partners shall We to be deducted and then his real income would be determined after such deduction. In a different context the Privy Council approved this principle in Bejoy Singh Dudhuria v. Commissioner of Income‑tax, Calcutta (A I R 1933 P C 145). Their Lordships observed at page 147:
"When the act by S. 3 subjects to charge "all income" of an individual, it is what reaches the individual as income which it is intended to charge."
Their Lordships later on at page, 148 observed:
"While their Lordships are disinclined to entertain any argument from the one system to the other, they would infer if any inference were permissible, that the omission from the Indian Act of any such provision points rather to an intention to tax, in Lord Davey's phrase, only "the real income" of the tax‑payer, than to an intention to impose, without right of re‑imbursement, a tax on what is charged upon his income."
13. We have, therefore, found much force in the argument of Mr. Dingomal that in the case of a partner in a registered firm when the question arises as to his individual assessment it is not the income allocated to his share under section 23(5)(a) that has to be taken into consideration but his real income. Otherwise if this principle is not followed what would be assessed would not be his real income but an artificial income said to be earned by him. There can in law be no manner of doubt that his real income would be what remains after deducting the amount diverted which never constitute his income and both in law and equity it shall have to be excluded in order to determine his real income.
14. With respect we are unable to share the view of Chakravartti, C. J. expressed in Mahaliram Santhalia v. Commissioner of Income‑tax, Calcutta referred to above. We have already held that no such bar the impossibility of which has been referred to in the above decision‑exists under section 23(5)(a) of the Income‑tax Act. Nor is there any such difficulty as has been pointed out by the learned Judge under section 30(l) of the Income‑tax Act. Under proviso two of this provision of law the assessee has been granted a concession that in such cases he need not file any appeal against the assessment of his total income. Moreover it only shows that though an individual partner may appeal against the assessment of the firm, he cannot in an appeal from an order assessing him personally ask for re‑determination of the question of the assessment of the firm.
15. The upshot of the above discussion is that there being a valid and genuine agreement between the partners of Messrs Merwan & Sons and one of them being a partner in the principal firms referred to above, this arrangement is nothing short than in the nature of an overriding agreement which had the effect of diverting at source the share of profits earned from them which had been allocated to the share of Mr. M. K. Irani. In law there being a valid sub‑partnership his real income would he calculated after separating the share of the two sons under its terms. In that view of the matter the tribunal erred in refusing the registration of the sub‑partnership and further had fallen into an error in treating his share of profits in the two principal firms as his real income.
16. We would, therefore, answer the two questions referred to this Court in the following manner: '
1. In the negative.
2. In the negative.
The reference is accordingly answered. The Department will bear the costs of this reference.
S. Q. Reference answered in tote negative.
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