Subhash Medical Stores Vs Commissioner of Income Tax

Bhatnagar, J.@mdashIn compliance with the directions of this court in D.B. Civil Misc. Income Tax Reference No. 117 of 1972, the Income Tax Appellate Tribunal, Jaipur Bench (hereinafter to be referred to as " the Tribunal "), filed a statement of the case and referred the following question u/s 256(2) of the I.T. Act, 1961:

"Whether, in the facts and in the circumstances found by the Tribunal there was material to come to the conclusion that the partnership firm constituted by the deed dated July 1, 1959, was not genuine ?"

2. The facts of the case, relevant for answering the question under reference, are as under :

Ramesh Chandra Moondra, in his individual capacity, was running a business known as Subhash Medical Stores, Bhilwara, since November, 1955. He executed a sale deed on July 1, 1959, for a consideration of Rs. 4,500. for the goodwill, in the name of his wife, Smt. Chandra Kanta Moondra, and his brother''s wife, Smt. Shanta N. Maheshwari. On the same date the two ladies entered into a partnership by executing a partnership deed and the partnership business came to be known as M/s. Subhash Medical Stores, Bhilwara. The firm was got registered with the Registrar of Firms and a bank account was also opened in the name of the firm mentioning the two ladies as its partners. "However, the business continued to be carried on by Ramesh Chandra Moondra, as an employee of the registered firm on a remuneration of Rs. 250 p.m. It was he who operated the bank account on behalf of the partners. The information regarding the individual business converted into partnership firm was sent to the Sales Tax Department also. An application was filed on behalf of the firm u/s 184 of the I.T. Act, 1961 (hereinafter to be referred to as "the Act"), for registration of the firm under s. 185 of the Act. The prayer was rejected by the ITO on the ground that the two ladies had no knowledge about the business and Ramesh Chandra Moondra was really in control of the business. In the opinion of the Income Tax Officer (for short " the ITO ") the firm in the partnership of the two ladies was not genuine and -was rather a device to evade tax. An appeal against the order of the ITO rejecting the application for registration was filed before the AAC of Income Tax (for short " the AAC ") but with the same result. The Appellate Tribunal also rejected the appeal filed by M/s. Subhash Medical Stores, Bhilwara, in grievance to the refusal of registration of the firm under the I.T. Act.

3. The question before the authorities concerned related to the assessment for the years 1961-62 to 1963-64. Three reference applications were, therefore, filed u/s 256(1) of the Act for making reference to the High Court regarding the question as to whether the partnership created by the partnership deed dated July 1, 1959, was genuine or not and whether the Income Tax authorities were justified in rejecting the prayer of the partners to register the firm u/s 185 of the Act. The Tribunal was of the opinion that the transaction between Ramesh Chandra Moondra and the alleged partners of the firm, viz., Smt. Chandra Kanta Moondra and Smt. Shanta N. Maheshwari, was a benami transaction and did not involve any liability. The Tribunal considered it to be a pure question of fact which could not be made the subject of reference. For the reasons given in the order, annexure-7, dated January 17, 1972, the Tribunal rejected the reference applications. M/s. Subhash Medical Stores, Bhilwara, then filed an application u/s 256(2) of the Act, in this court with the prayer that the Tribunal be directed to refer the question of law arising in the matter. The Division Bench examined the assessment orders of the ITO and the appellate orders of the AAC and the Tribunal and arrived at a conclusion that a question of law did arise for examination by this court. The Division Bench, therefore, required the Tribunal to state a case bearing on the question and refer it to this court u/s 256(2) of the I.T. Act, 1961. It is in compliance with that direction that the Tribunal has filed a statement of case and referred the question to this court.

4. There is no dispute on the point that since November, 1955, the business under the name and style of Subhash Medical Stores, Bhilwara, was carried on by Ramesh Chandra Moondra in his individual capacity. It is also-not in dispute that on July 1,1959, a sale deed, annexure-1, was executed by Ramesh Chandra Moondra in favour of his wife, Smt. Chandra Kanta Moondra, and Smt. Shanta N. Maheshwari, who happens to be the wife of Shri Naresh Chandra Moondra, the real brother of Ramesh Chandra Moondra. It was on the same date that the two ladies, viz., Smt. Chandra Kanta Moondra and Smt. Shanta N. Maheshwari, entered into a partnership and executed the partnership deed dated July 1, 1959, annexure-3.

5. The question emerging in the matter is as to whether the execution of sale deed by Ramesh Chandra Moondra in favour of his wife and sister-in-law for a petty amount of Rs. 4,500 and the creation of the partnership can be said to be genuine or it was a sham transaction to avoid tax liability, in the individual capacity.

6. Mr. H. M. Parekh, learned counsel for the firm, strenuously contended that the partnership deed speaks of all the necessary ingredients for creating a partnership firm. That it was duly registered under the Partnership Act and, as such, merely on the ground of the ladies having no knowledge of the business and they being closely related to Ramesh Chandra Moondra, there would be no justification to hold that the transaction was not genuine.

7. Mr. J. P. Joshi, on the other hand, emphasized the fact that Ramesh Chandra -Moondra could not have sold such a nourishing business for a petty amount of Rs. 4,500 and thereafter would have got employed in the same firm for the remuneration of Rs. 250 only. According to Mr. Joshi, the very fact of Ramesh Chandra Moondra continuing to control the business and operating the bank account on behalf of the partners indicates that the sale deed was a benami transaction and creation of the partnership a farce.

8. It has also been stressed by Mr. Joshi that from the statement of the two ladies, it cannot be believed that the source of money they alleged to have invested in the business, really existed.

9. Cases are not rare in which some near relatives form a partnership for a particular business and one of them holds a domineering position or controls the business while others remain- inactive. What is required for a partnership u/s 4 of the Partnership Act is that the partners have specified shares in the business and all of them or any one of them controls and manages the business. Similarly, there are a number-of cases where the partners possess no knowledge about the business and authorise some other person to act on their behalf. In other words, the employees or the agents look after the business. But, that would not mean that the legal requirement of a partnership are lacking. With regard to the argument that the genuineness of the partnership firm is established by the fact that it has been registered under the Partnership Act, suffice it to say that merely because a firm is registered under the Partnership Act, it is not obligatory upon the Income Tax authorities to register it u/s 185 of the Act. The reason is that the Income Tax authorities are expected to probe into the matter from the point of view as to whether the partnership is genuine or a mere device to evade tax or to seek some relief in that respect.

10. In order to appreciate the position in the present case, it is necessary to examine the factors that influenced the Income Tax authorities to refuse the registration of the firm considering the sale deed to be a sham transaction and the creation of the partnership to be a farce. The Income Tax authorities, including the Tribunal, were influenced by the facts that (i) a flourishing business was sold for a petty amount of Rs. 4,500 ; (ii) the business of the firm was operated by Ramesh Chandra Moondra for a petty remuneration of Rs. 250 p.m.; (iii) the two ladies were close relatives of Ramesh Chandra Moondra ; (iv) the two ladies had no knowledge whatsoever of the working of the business; (v) their limited education, i.e., one educated up to 5th standard and the other up to 7th standard with a Vidya Vinodini Diploma gave an impression that they could not have understood the business of the firm.

11. Regarding the investment, the statement of Smt. Chandra Kanta was that she sold her gold and silver ornaments and invested the money. Smt. Shanta N. Maheshwari has stated that she received Rs. 7,000 from the father-in-law in " Munha Dikhai " and she invested that amount in the partnership business. The learned members of the Tribunal were of the opinion that as the specification of the ornaments said to be sold has not been given by Smt. Chandra Kanta and the father-in-law of Smt. Shanta Maheshwari could not explain the source of Rs. 7,000 stated to have been given to her, there was no material to establish that any amount was invested by the ladies. The conclusion was, therefore, drawn that the business continued as it was prior to the execution of the sale deed and the formation of the partnership by the two ladies.

12. In order to determine the real nature of the partnership, it would be profitable to refer to the principles enunciated in the various authorities cited by the learned counsel for the parties dealing with similar questions.

The case of Umacharan Shaw and Bros. Vs. Commissioner of Income Tax, West Bengal, related to a partnership of three brothers forming a joint Hindu family business of sale of foreign liquor. The claim for registration was rejected by the ITO on the ground that there was no separate capital account of the partners and that the share of profits of each partner was not credited in his account in the ledger. The officer placed no value to the " Bahi Khata " maintained by the partners. The Tribunal affirmed the decision of the ITO that there was no genuine partnership, especially as the existence of the partnership was not disclosed to the bankers or to the excise authorities who issued the licence for the shops and as such the formation of the partnership was in violation of the Bengal Excise Act, 1911, When the matter came before the Supreme Court, in view of the facts and circumstances of the case, it was held that there was no evidence of transgression of the provisions of the Bengal Excise Act, 1911, and there was nothing affecting the validity of the partnership. Their Lordships found no material on which the ITO or the Appellate Tribunal could come to the conclusion that the firm was not genuine ; it was, therefore, opined that there were many surmises and conjectures and the conclusion was the result of suspicion which could not take the place of proof.

13. In the case of Krishna Flour Mills Vs. Commissioner of Income Tax, Bangalore, the question about the genuineness of a partnership firm came up for consideration. A person entered into a partnership with his wife and brother-in-law. The evidence showed that the wife and the brother-in-law had contributed their own share in the capital. There was nothing in the conduct of the parties inter se to indicate that the partnership was not genuine. The Tribunal, however, assuming "that a partnership consisting of the wife and brother-in-law must be necessarily suspect, held that the firm was not genuine. While deciding the point whether the matter involved a question of law, their Lordships of the Supreme Court were pleased to hold that on the material placed on record, the inference of the Tribunal was unreasonable and not justified either by partnership law or common human experience. In the case of P.A.C. Ratnaswamy Nadar and Sons Vs. Commissioner of Income Tax, Madras, the father, after carrying on as a sole proprietor of a business for the manufacture and sale of matches, debited his personal account in the business with a sum of Rs. 27,000 on March 31, 1955, and credited each one of his son with Rs. 4,500. Thereafter a partnership deed was executed between the father and the sons and the minor sons were admitted to the benefits of the partnership. The licence standing in the name of the father was transferred in the name of the partnership. When an application was made for registration of the firm u/s 26A of the Indian I.T. Act, 1922, the ITO refused to register the firm on the ground that there was no deed of gift; the credit entries in favour of the sons could not constitute gift ; the control and the management of the business remained with the father who was originally the sole proprietor ; and of the four sons only one had business experience. The AAC and the Appellate Tribunal confirmed the findings of the ITO. The question before their Lordships of the Madras High Court was whether, in the facts and circumstances of the case, there was material to find that there was no genuine firm which could be registered u/s 26A of the Indian I.T. Act, 1922. Their Lordships while answering the question in favour of the assessee and against the Revenue were pleased to observe as under (headnote):

" Section 26A of the Indian Income Tax Act, 1922, is an enabling provision conferring the privilege of registration on firms to lighten the tax burden. Recourse to obtain benefit of registration has nothing sinister about it. The Department, no doubt, has a duty under the statute to scrutinise every application for registration and satisfy itself that the firm has been genuinely constituted. It is quite true that mere existence of a deed of partnership is not a passport for obtaining registration. But an undue scepticism in the matter and suspicion that every partnership put forward is only a device to escape tax cannot be the basis for the disposal of the application. "

14. The question of registration of a firm in which one of the partners was benami of another came up for consideration before the Supreme Court in the case of Commissioner of Income Tax, Gujarat Vs. A. Abdul Rahim and Co., Distin- guishing a case where a partnership is only between two persons, of whom one is benamidar of the other, and in a case were the benamidar of one partner is taken as a partner with the consent of the other partners, their Lordships were pleased to hold that the registration of the partnership deed u/s 26A of the Indian I.T. Act, 1922, could not be refused on the ground that one of the partners was a benamidar of another.

15. The question of the genuineness of the partnership of close relatives and the investment being a gift by one to another was the subject-matter for determination in the case of A.M. Abdul Rahman Rowther and Co. Vs. The Commissioner of Income Tax, Madras, The assessee, a Muslim, who was the sole proprietor of a business, purported to make certain gifts to his two married daughters incorporating certain entries in his accounts. He debited his account to the extent of Rs. 50,000 and credited his two daughters with Rs. 25,000 each. Subsequently a partnership was executed and the two daughters were taken as partners. The profits of the business were distributed in accordance with the terms of the partnership. The Income Tax authorities refused registration to the firm on the ground that the gifts were not valid and the partnership was not-genuine. Their Lordships of the Madras High Court answering the question whether the assessee firm was entitled to registration u/s 26A of the Indian I.T. Act, 1922, were pleased to observe that if the validity of the gifts cannot be challenged and the subsequent conduct of the parties does support the formation of a genuine partnership, the circumstances that the two partners were the daughters of the assessee, or that they took no active part in the conduct of the business are irrelevant for the purpose of deciding the question. . In that view of the matter, the Tribunal was not held legally justified in refusing registration to the firm.

16. In the case of Himalaya Engineering Co. Vs. Commissioner of Income Tax, the question was of two sons being admitted as .partners of a firm. Registration u/s 26A of the 1922 Act was refused on the ground that the deed was a sham, as no capital was contributed by the new partners, and the change in the constitution of the firm was not notified to the banks in which the old firm had accounts. Despite these shortcomings, their Lordships of .the Patna High Court were pleased to hold that there was no material before the Income Tax authority to support the conclusion that the firm was not genuine. The firm was, therefore, held entitled to registration.

17. In the case of S.S.A. Gangamirthammal and Co. Vs. Commissioner of Income Tax, four ladies of over 55 years constituted themselves into a partnership and appointed two persons, one . of whom was the son of one of the ladies as agents, to carry on the business of the partnership. The ladies were examined by the ITO, who came to the conclusion that their oral testimony disclosed that it was not a genuine partnership. As such registration was refused. The Tribunal confirmed the finding. When the matter came on a reference before the Madras High Court, their Lordships were pleased to hold that on an overall impassionate scrutiny of the evidence recorded by the officer, there was nothing suspicious about the document and the conditions essential for securing registration under the Act having been observed in the case, it was highly uncharitable for the Revenue to characterise this association as a figment of imagination and hence non-genuine, when all the partners who were examined gave out material particulars regarding the business and its activities and without hesitation mentioned and furnished details on the normal working of the partnership. The firm was held entitled to registration.

18. The above referred decisions throw light on the point that individual circumstances need not lead to the conclusion that a partnership is not genuine, but the cumulative circumstances are to be taken into consideration to lead to the conclusion as to whether a particular firm is entitled to registration under I.T. Act or not. The inter se relations between the partners or the partners admitted to the existing partnership, need not give rise to a suspicion that the whole affair is a farce. Similarly, a partnership being carried on by an agent authorised by the partners need not necessarily lead to the conclusion that the partners had no control over the business.

18. Mr. J. P. Joshi, referred to the case of Manilal Jamnadas Vs. Commissioner of Income Tax, Bombay City I, where the refusal to register the firm under s. 26A of the Indian I.T. Act, 1922, on the ground of the partnership not being genuine was held to be justified. In that case, two brothers M and C, and two sons of each of them were partners in a firm called CJ under a deed dated November 13, 1951. In the year 1957, C purchased a broker''s card on the stock exchange and, as such, he was prohibited from being a partner of a firm which had business in the stock exchange. C accordingly retired from the firm and a new firm called MJ continued the business of the old firm under a partnership deed dated January 8, 1958. The partners in the new firm M J were M, his four major and two minor sons and two sons of C. The shares which C and his two sons together held in the old firm were allotted to the two sons of C in the new firm. Besides that, the bank account of the new firm was opened not in the name of the firm, but the title of the account was M and C Jt. A/c. The explanation that it was so done with a view to obviate the objection raised by the bank that certain credit facilities which were till then available to the earlier partnership would not be available unless C''s name was associated, was not considered to be satisfactory for not opening the account in the name of the new firm. Apart from it, though '' C'' was said to have retired from the erstwhile partnership, his retirement had not caused any loss to the group of partners belonging to C in the matter of percentage of share "in the profit and loss of the firm. In view of such glaring facts, their Lordships of the Bombay High Court on a reference did not consider the order of the Tribunal to be capricious or unreasonable or a finding based on no evidence at all. Registration was, therefore, held to be rightly refused.

19. Another case on which Mr. Joshi has placed much reliance is Commissioner of Income Tax Vs. Kanhayalal Ram Chand, The ITO declined to register a sub-partnership on the ground that it was not genuine. His finding that the firm was not genuine was based on a number of grounds, viz., that the investment of Rs. 12,000 did not come from Ramchand but from his son, and even that was not properly proved. Ramchand was an old man of 72 years and had retired from service in 1962. His bank pass books were not produced. The share given to Ramchand was disproportionate to his investment. He never drew his share of profits from the firm. Though the firm was said to be dissolved in 1971, the dissolution deed was not produced. The Tribunal held that Ramchand being too old to take any interest in any investment or business, the circumstance that the sum of Rs. 12,000 did not in fact belong to Ramchand and the circumstance that the share of profit of Ramchand was disproportionate to his investment, were not relevant considerations. The Tribunal, therefore, held the firm entitled to registration. On a reference, their Lordships of the Punjab and Haryana High Court were pleased to opine that in considering whether a firm is genuine, the question is not whether each individual circumstance by itself is sufficient to enable the Revenue to conclude that the firm was not genuine, rather it is to be seen whether the circumstances as a whole were sufficient to lead to that conclusion. According to their Lordships, the Tribunal misdirected itself and also failed to take into consideration the relevant facts. The facts taken as a whole showed that the firm was not genuine and as such not entitled to registration.

20. In the case of K.D. Kamath and Co. Vs. Commissioner of Income Tax, Mysore, the question regarding registration of a firm u/s 26A of the Act of 1922 came up for consideration with reference to a firm of which K was the sole proprietor for a long time and thereafter he entered into a partnership by admitting five other partners. Under the deed of partnership, he was the financing and managing partner of the business, the goodwill belonged to him, and the rest were, admitted only as working partners contributing labour. Discussing the various clauses of the partnership agreement, the High Court held that no relationship of partners, as understood in law, had been created as between the parties under the partnership deed and, therefore, the firm was not entitled to registration. The matter went in appeal before the Supreme Court. Their Lordships of the Supreme Court, reversing the decision of the High Court, held that exclusive power and control by agreement of the parties was vested in one partner, and the further circumstance that only one partner could operate the bank accounts or borrow money on behalf of the firm was not destructive of the theory of partnership, provided two essential conditions were satisfied, viz., that there should be an agreement to share profits and losses of the business of the firm and that the business must be carried on by all the partners or any of them acting for all. Their Lordships were also pleased to hold that the second condition was also satisfied, even though vast powers of management and control had been given to K as the business was being carried on by him on behalf of all the partners.

21. The principle enunciated in the decision just referred to above was followed by their Lordships of the Orissa High Court in the case of Jammula Venkataswamy and Sons Vs. Commissioner of Income Tax, The exclusive power of control by agreement of the parties, as found in the partnership deed, was vested in one of the partners and only one partner was to operate the bank account on behalf of the firm. These facts were not considered destructive of the partnership, provided the two essential conditions, viz., that there should be an agreement to share the profits as well as the losses of the business; and that the business must be carried on by all or any of them acting for all, within the meaning of the definition of partnership contained in Section 4 of the Partnership Act were fulfilled. In this view of the matter, the domineering position of the first partner, i.e., the father in the control and management of the business, because he had greater experience in the business and the two sons, though adults, were comparatively young and inexperienced, was not held to be coming in the way of the registration of the firm on the ground that it was not genuine.

22. In order to claim registration under the I.T. Act, what is required to be established is that the legal requirements of a partnership are fulfilled. From the principles enunciated in the above referred cases, it is clear that the inter se relations of the partners and all of them not being concerned with the control and management of the business, are not the circumstances coming in the way of registration of the partnership under the I.T. Act.

23. The distinguishing feature of the present case, however, on which Mr. Joshi has emphasised much, is that here the sole proprietor of the business, Subhash Medical Stores, viz., Ramesh Chandra Moondra, has stepped out of the business and the partnership constituted of two ladies who happened to be his close relations. The criticism is also levelled against the document of sale of the business to the two ladies on the ground of inadequate consideration.

24. The quantum of amount Ramesh Chandra Moondra had for the sale is not of much importance for the reason that it is the amount only for the goodwill of the business. His amount in the business remained in his name and interest was calculated for that amount. Mr. Joshi has stressed that there could not be any reason for the sale of the business to the ladies. The statements of the two ladies were that they had extra money whereas Ramesh Chandra Moondra did not appear to have any at that time and, therefore, they formed the partnership. Smt. Chandra Kant sold her gold and silver ornaments arid invested money in the business; She was already having a deposit account in the business when it was carried on by her husband. That the father-in-law of Smt. Shanta N. Maheshwari could not give satisfactory explanation for the source of Rs. 7,000 said to have been given by him to his daughter-in-law, is not the subject-matter of consideration in the present case. As the circumstances indicate, such a gift was not unnatural , and the Income Tax authorities have also not suspected the correctness of accounts maintained by the firm.

25. In the case of Chitra Cinema Vs. Commissioner of Income Tax, their Lordships of the Allahabad High Court were pleased to observe that the fact that the reasons given for arriving at a partnership agreement is wrong may be taken into consideration with other circumstances for coming to the conclusion that the agreement was a sham transaction. But a wrong recital of the reason for the agreement would not by itself be evidence of the fact that there was no agreement at all.

26. It is pertinent to note that the firm was duly registered under the Partnership Act. Fresh bank accounts were opened in the name of the firm constituting the two ladies as partners. The information was sent to the Sales Tax Department about the creation of the partnership. The shares of the two partners were specified and proper account of profit and loss was maintained.

27. Mr. Joshi submitted that despite all these factors, as Ramesh Chandra Moondra was carrying on the business, the legal requirement that the business and control of the firm should be in the hands of the partners is not justified.

28. It is correct that Ramesh Chandra Moondra still retained the domineering position in the business. The question will be whether the partnership can be condemned for the purpose of registration on account of the domineering status of the former proprietor of the business. It is important to note that Ramesh Chandra Moondra was being paid Rs. 250 p.m. as an employee to look after the business. Whether he had retained his domineering position without entrusting the business to the two ladies by virtue of the sale deed or had retired from the business and was thereafter authorised to look after the business, being employed by the two partners, will have to be inferred and understood from the contents of the partnership deed, annex.-2.

29. It has been specifically mentioned therein that the parties to the first and second part, meaning thereby the two ladies, had taken over the assets and liabilities as on 30th June, 1959, on the terms and conditions agreed upon by them. It has also been mentioned therein that the parties of the first and second part have agreed to carry on the said business in partnership. Clause 11 of the partnership deed reads as under:

" The partners shall be at liberty to execute general power of attorney in favour of any person or persons giving all or any of the powers vested in partners and it will be sufficient if such power is executed by any of the partners for and on behalf of the firm."

30. Clause 2 of the partnership deed reads as under :

" This partnership business shall be carried on at Bhilwara and/or at such other place or places as the partners may from time to time determine."

31. These clauses clearly disclose that the partners had taken over the business and Ramesh Chandra Moondra was looking after the said business not in his own right but in the capacity of an employee and by virtue of the authority given by the partners, who had the right to take policy decisions.

32. The Tribunal attached much importance to the fact that the two ladies had limited education and they had little or no knowledge about the business carried on by the firm. These factors should not come in the way of the partners claiming registration, because there is nothing illegal in getting the business conducted through some person employed by the partners or by someone authorised by them. The Income Tax authorities should not have misconstrued the provisions of the partnership deed upon irrelevant considerations. Correct it is that mere registration of a firm under the Partnership Act will not entitle the firm, as of right, to be registered u/s 185 of the I.T. Act, 1961, because the question of tax is involved The Income Tax authorities are of course expected to take into consideration the facts and circumstances of a given case to find out whether in the garb of a sham transaction, the assessee was avoiding liability to tax. However, if from the circumstances taken as a whole, it can be deduced that it is not an unlawful attempt to avoid payment of tax and at the most, it may be a legal device to reduce tax liability, there is no justification for rejecting the request for registration under the I.T. Act.

33. In view of the facts and circumstances of the case discussed above and the law applicable on the point, we are of the opinion that the Income Tax authorities were in error in refusing the registration of the assessee firm. There was no satisfactory material before the Tribunal to come to the conclusion that the partnership firm constituted by the deed dated July I, 1959, was not genuine.

34. We, therefore, answer the question under reference in the negative, i.e., in favour of the assessee and against the Revenue. Costs are made easy.