Steel Brothers And Co. Ltd. vs Commissioner Of Income-Tax

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 17 May, 1957

Coram: J.L. Kapur, Bhagwati, J.

In the matter titled Steel Brothers And Co. Ltd. versus Commissioner Of Income‑Tax, decided on 17 May 1957, the Supreme Court of India issued a judgment authored by Justice J. L. Kapur, with Justice Bhagwati also named in the judgment.

This appeal, granted special leave, was filed against a judgment and order rendered by the High Court of Judicature at Calcutta. The High Court decision arose from a reference made by the Income‑Tax Appellate Tribunal, Calcutta Bench, pursuant to section 66(1) of the Indian Income‑Tax Act (XI of 1922), hereinafter referred to as “the Act.” The High Court had answered the question referred to it in the negative.

The factual background relevant to this appeal may be summarized as follows. Before 29 November 1928, Steel Bros. & Co. Ltd., referred to in the proceedings as “Steels,” and Ellerman’s Arracan Rice and Trading Co. Ltd., referred to as “Ellermans,” were engaged in the trade of Burmese rice and its by‑products both in Burma and in London, as well as through other channels such as the Burma and London Bullenger Rice Pool and the New General Rice Co. Ltd. In addition to selling rice, each of these companies owned rice‑milling machinery and processed paddy into rice. A third entity, Burma Co. Ltd., referred to simply as “Burma,” also operated a few rice mills but never purchased paddy or sold rice. All of the shares of Burma were held by Steels, which also acted as the managing agents of that company.

On or about 29 November 1928, Steels, Burma and Ellermans entered into a written agreement to amalgamate the Burmese rice business of all three companies under the management of Steels. The combined enterprise created by this agreement was designated “the Combination.” The agreement expressly excluded from its scope the stocks of Burmese rice and by‑products that were in possession on 30 November 1928; those stocks remained the property of the individual owners, who could dispose of them at their discretion. From 1 December 1928 onward, the entire Burma‑based business previously conducted by Ellermans was to be taken over and managed by Steels. This management was to be exercised from Steels’ offices located in London, Rangoon and other Burmese branches, and it was to be conducted solely in the name of Steels, but in conjunction with the whole rice business of Steels and Burma. Steels were authorized to conduct this business in any manner they considered appropriate in their absolute discretion.

The agreement specified that the profit or loss arising from the operations of the Combination at the locations listed would be divided between Steels and Ellermans according to the following percentages: in Rangoon, Bassein and Akyab, Steels and Burma would each receive sixty‑eight percent and Ellermans would each receive thirty‑two percent; in Moulmein, Steels and Burma would receive seventy‑two percent and Ellermans would receive twenty‑eight percent. Additionally, the rice mills owned by Burma — namely the Burma Upper Kanungtoe Mill in Rangoon, the Burma Mill in Bassein and Burma’s Martaban Mill in Moulmein — were to be operated by Steels for the purpose of the Combination, as stipulated in clause 4a of the agreement. The agreement was to

The agreement was stipulated to take effect from the first day of December 1928. It provided that the arrangement could be brought to an end on the thirtieth day of November 1930, or on any later thirtieth day of November thereafter, provided that any party wishing to terminate the contract gave notice of such termination to the other parties no later than the first day of August preceding the intended termination date, as stated in clause twelve. The document was executed with the common seals of both Steels and Ellermans affixed to it, and it also bore the signature of James Kilgour Michie, who signed on behalf of Burma, indicating Burma’s participation in the agreement.

In relation to the income‑tax assessments for the fiscal years 1943‑44 and 1944‑45, the Combination—referred to in the proceeding as “the assessee”—submitted applications to the Income‑Tax Officer under section twenty‑six A of the Act, seeking registration of a partnership it claimed to consist of Steels and Ellermans. These applications were signed solely by representatives of Steels and Ellermans and were accompanied by a copy of the agreement dated twenty‑nine November 1928, which the assessee relied upon as the instrument of the partnership for which registration was requested. The Income‑Tax Officer of District V, Calcutta, issued two separate orders, dated nineteen March 1948 and thirty‑first March 1949 respectively, rejecting the registration. The officer’s refusal was based on two grounds: first, that the partnership was not limited to Steels and Ellermans but also included a third entity, Burma, and that the deed failed to specify the respective shares of these three partners; second, that the loss incurred in the preceding year had not been proportionately apportioned among the three partners, noting that the entire loss attributable to the shares of Steels and Burma had been borne solely by Steels. The assessee then appealed to the Second Additional Appellate Assistant Commissioner of Income‑Tax, “A” Range, Calcutta, who affirmed the officer’s orders, emphasizing that the registration application had been signed by only two partners while the deed indicated a three‑partner arrangement and did not delineate the individual shares of Steels and Burma. Subsequently, the assessee appealed to the Income‑Tax Appellate Tribunal, Calcutta Bench, and by its order dated twentieth February 1951, the Tribunal held that although the agreement of twenty‑nine November 1928 demonstrated that the three companies would jointly conduct the entire Burma rice business upon amalgamation, a detailed examination revealed that the actual partners forming the partnership were Steels and Ellermans, with Burma—being a wholly owned subsidiary of Steels—playing a negligible role in the Combination. The Tribunal observed: “In order to determine whether there was a partnership we have to look into the surrounding circumstances also under section six of the Partnership Act and reading the document as a whole and considering the fact that it was drawn up in 1928, and also taking into account the profit and loss account of the Burma Co., for the years ending November, 1941, November, 1942, and November, 1943, we”.

The Tribunal, after hearing the Commissioner of Income‑tax, West Bengal, formulated a question of law and referred it to the High Court under section 66(1) of the Act. The question asked was whether, when the deed of agreement dated 29 November 1928 was properly construed and the relevant facts and circumstances were considered, the Tribunal was correct in holding that the partnership existed only between Steels and Ellermans and therefore registration should have been allowed under section 26A of the Indian Income‑tax Act. The High Court heard the reference and answered the question in the negative. In its view, a true construction of the deed – especially the recital and the provisions contained in clauses 1, 3(a), 12 and 14 – indicated that the partnership comprised all three companies. Because the applications for registration had not been made by the three companies and because the deed of partnership did not specify the individual shares of each company, the High Court concluded that the refusal to register the partnership was justified. Subsequently, the assessee sought a certificate of fitness under section 66A(2) of the Act, but the High Court refused that request as well. Following the refusal, the assessee obtained special leave to appeal from this Court under article 136 of the Constitution.

The sole issue for determination in the present appeal was whether, on a proper construction of the agreement dated 29 November 1928 and having regard to the facts and circumstances of the case, the Income‑tax Officer was correct in refusing the assessee’s applications for registration of the partnership that named only Steels and Ellermans as partners, set out their specific shares, and were signed solely by them. Section 26A of the Act provided that an application for registration could be made to the Income‑tax Officer on behalf of any firm constituted under a partnership instrument that specified the individual shares of the partners. The application had to be made by the appropriate persons, at the prescribed time, contain the prescribed particulars, be in the prescribed form, and be verified in the manner prescribed, after which the Income‑tax Officer would deal with it as prescribed. Rule 2 of the Indian Income‑tax Rules, 1922, further required that any firm constituted under a partnership instrument specifying the individual shares of the partners could, under the provisions of section 26A, apply for registration. Such an application needed to be signed by all partners who were not minors, or in the case of a dissolved firm, by all former partners and the legal representatives of any deceased partners. Accordingly, for the Income‑tax Officer to entertain an application for registration and to register the partnership for the purposes of the Act, the application had to be signed by all partners of the firm and had to specify each partner’s individual share. If these conditions were not satisfied, the Officer was not authorised to entertain the application, nor was registration obligatory. The question, therefore, was whether, under the 29 November 1928 agreement, Steels and Ellermans – who were the signatories to the registration applications – could lawfully be considered the only partners for the purposes of the registration provision.

The Court observed that, pursuant to section 26A of the Indian Income‑tax Act of 1922, an application for registration of a firm had to be executed by every partner who was not a minor, or, in the case of a dissolved firm, by all persons who had been partners immediately before dissolution together with the legal representative of any deceased partner. In addition, the Court noted that, for an Income‑tax Officer to consider such an application and to register the partnership, the application must bear the signatures of all the partners and must disclose each partner’s individual share in the firm. If these requirements were not fulfilled, the Officer was not empowered to entertain the application nor was he obligated to register the firm under the Act. Consequently, the matter before the Court was whether, under the agreement dated 29 November 1928, the two signatories to the registration applications—Steels and Ellermans—were the sole partners of the combination or whether a third party, Burma, who also signed the agreement but whose profit or loss share was not specified, should be regarded as a partner.

The Court recorded that counsel for the appellant had conceded that, if the agreement of 29 November 1928 was interpreted in a manner that recognized Burma as a partner alongside Steels and Ellermans, then the registration applications signed only by Steels and Ellermans, and containing the share ratios set out in clause 3(a) of the agreement, failed to comply with the requirements of section 26A and rule 2 of the Indian Income‑tax Rules, 1922. The non‑signature of Burma and the absence of any individual share for Burma in clause 3(a) rendered the applications non‑conformant with the statutory provisions.

The determination of the appeal, therefore, hinged on the proper construction of the 29 November 1928 agreement, taking into account the relevant facts and circumstances of the case. The Court referred to section 6 of the Indian Partnership Act, 1932, which provides that, in deciding whether a group of persons constitutes a firm or whether an individual is a partner, the real relationship between the parties must be ascertained by examining all relevant facts collectively. The appellant sought to rely on several factual circumstances: (i) that all of Burma’s shares were owned by Steels; (ii) that the Tribunal had found Burma never purchased paddy or sold rice; (iii) that Burma had never received any share of the profits or losses of the combination; and (iv) that Burma’s only earnings under the agreement consisted of milling hire paid by Steels. The Court indicated that these facts would be examined at the appropriate stage to determine their impact on the question of whether Burma should be considered a partner for the purposes of registration under the Income‑tax Act.

The appellant relied on several facts and circumstances to support its case. First, it asserted that all of the shares belonging to Burma were owned by Steels. Second, it pointed out that the Tribunal’s findings showed that Burma had never purchased paddy or sold rice. Third, it claimed that Burma had never received any share of the profits generated by the Combination, nor had it ever paid any such share. Fourth, it contended that, under the terms of the agreement, the only income that Burma derived was a milling hire paid by Steels. The Court indicated that it would examine how each of these factual assertions bears upon the issue that required determination.

Turning to the agreement dated 29 November 1928, the Court observed that the document was a tripartite contract entered into by Steels, Burma and Ellermans. The purpose of the agreement was to create an amalgamated operation for the rice business conducted in Burma and in London, with Steels assuming management of the combined enterprise. Under the agreement, the entire rice business that had previously been carried on by Ellermans in Burma was to be taken over by Steels effective 1 December 1928. The business was to be conducted from Steels’ offices in London, Rangoon and other Burma branches, and the operation was to be carried out solely in the name of Steels, but in conjunction with the entire rice business of Steels and Burma. The contract specified that Steels could conduct the business in any manner it deemed appropriate at its absolute discretion. The combined operation of Steels, Burma and Ellermans was designated as “the Combination” in clause 1.

Clause 3a of the agreement set out the method for sharing profit or loss at the end of each accounting year. The profit or loss of the Combination’s activities at the mentioned locations—Rangoon, Bassein, Akyab and Moulmein—was to be divided between Steels (together with Burma) and Ellermans in the following proportions: for Rangoon, Bassein and Akyab, Steels and Burma were each to receive sixty‑eight per cent while Ellermans would receive thirty‑two per cent; for Moulmein, Steels and Burma were to receive seventy‑two per cent and Ellermans twenty‑eight per cent. According to clause 3d, once the accounts for each year were signed in the manner prescribed, those accounts were to be regarded as final, conclusive and binding upon Steels and Ellermans. Moreover, a profit‑and‑loss account prepared in London from the yearly accounts was to be final, conclusive and binding on all three parties—Steels, Burma and Ellermans.

The agreement also imposed a restriction, set out in clause 4a, prohibiting Steels, Burma and Ellermans from hiring out any of their owned properties or the use thereof by any other party without obtaining prior consent from Steels. Clause 6 provided that the existing Rangoon fleet belonging to Steels and Burma, which included rice cargo boats, motor barges and towing launches, together with any of Ellermans’ towing launches deemed necessary for the Combination, were to be employed for the Combination’s purposes while remaining the property of their respective owners. Finally, clause 7 required that all bonuses paid to any staff member for passing language examinations, as well as the cost of furlough passages to and from Europe for all staff of Steels, Burma and Ellermans employed for the Combination whose leave was due and taken, were to be charged to the Combination.

During the term of the agreement, the expenses incurred for medical attendance that the staff of Steels, Burma and Ellermans, who were employed for the purpose of the Combination, were entitled to receive under their own separate contracts were to be charged to the Combination, as stipulated in clause 7. All Bullenger settlements were required to be accounted for by the Combination and to be incorporated in the Combination’s profit‑and‑loss account for the purpose of distribution according to the ratios specified in clause 3 of the agreement, in accordance with clause 10. The agreement was to become effective on 1 December 1928 and it was provided that it could be terminated on 30 November 1930, or on any later 30 November, by any of the parties giving notice of termination to the others not later than the 1 August prior to the intended termination date, as set out in clause 12. The parties further agreed that any dispute arising out of or in connection with the agreement, other than a dispute that was expressly provided for in a particular provision of the agreement, would be referred to arbitration in accordance with the provisions of the Arbitration Act, 1889, as required by clause 13.

The Court observed that the parties declared that, by entering into the agreement and making the arrangements contemplated therein, they intended to conduct their respective businesses jointly, to give each other mutual assistance, and to achieve greater economy in their operations, which was captured in clause 14. The agreement bore the signatures of Steels and Ellermans and also the signature of James Kilgour Michie, who executed it on behalf of Burma. The Court noted that, if read in isolation, the clauses of the agreement would describe a partnership between Steels, Burma and Ellermans. Accordingly, the relationship that had been created among the three parties was a partnership relationship in which the parties had agreed to share the profits of a business carried on by all of them, acting for the benefit of all, within the meaning of the definition of partnership contained in section 4 of the Indian Partnership Act, 1932. Even when the earlier definition of partnership in section 239 of the Indian Contract Act (IX of 1872) was considered, the Court held that the relationship satisfied the description of partners who combined their property, labour and skill in the business of the Combination and who shared the resulting profits. Nevertheless, the appellant pointed out that several clauses in the agreement conferred rights on Ellermans that were not granted to Burma; these included the right to be fully informed of the progress of the business and to have their suggestions considered (clause 1), and the right to have the accounts for the year ending 30 November 1930 and for subsequent years prepared in Burma, audited by a chartered‑accountants firm designated by Steels upon receipt of a written request (clause 3).

The agreement gave Ellermans a number of distinct rights that were not granted to Burma. First, clause 1 allowed Ellermans to be fully informed of the business’s progress from time to time and required that any suggestions or observations made by them be given due consideration. Second, clause 3d entitled Ellermans to have the accounts for the year ending 30 November 1930, and for any subsequent year, prepared in Burma, audited by a firm of chartered accountants designated by Steels, and to receive these accounts before the first of November immediately preceding the period covered; it also gave them a right to inspect all accounts and to obtain a copy of them. Third, clause 4c provided that the superintending engineers of Ellermans, together with those of Steels, could inspect any mills or other articles taken over by Steels from any party to the combination in order to verify that the items were in efficient working order and to decide whether any expenditure should be classified as repairs or renewals. Fourth, clause 4e gave a similar right to the Ellermans’ superintending engineers to determine the mills and stores likely to be required for the combination and to fix their current market values. Fifth, clause 4f required that Ellermans receive assurance that the mills owned by them would obtain a fair share of all paddy landed and that any mills taken over for the combination would be operated, as far as possible, at full capacity. Sixth, clause 5 allowed matters covered by sub‑clauses (c) and (e) of clause 4 to be referred to arbitration. Seventh, clause 6 gave the superintending engineers of Ellermans, together with those of Steels, the authority to verify that all cargo boats, motor barges and towing launches employed by any party for the combination were in efficient working order. Eighth, clause 11a gave Ellermans the right to utilize the finance they provided. Ninth, clause 11b permitted them to use their bankers in connection with bills and drafts. Tenth, clause 11c allowed Ellermans to draw upon their London office for a fair share of clean drafts. Finally, clause 14 contained a specific provision designed to protect Ellermans’ interests.

These eleven provisions were expressly made in favour of Ellermans and none of them applied to Burma. Consequently, it was argued that Burma could not be considered a partner alongside Steels and Ellermans in the combination. However, the record showed that Burma was a wholly owned subsidiary of Steels, with Steels holding all of Burma’s shares and acting as its managing agent. Although legal separation existed between the parent company and its subsidiary, in practice they functioned as a single economic entity. There was no conflict of interest between Steels and Burma, and Steels, as the managing members of the combination, were expected to protect not only their own interests but also those of Burma. By contrast, the Ellermans were independent parties who joined the partnership with Steels and Burma; therefore, they required explicit rights to safeguard their position against the other two parties. Providing such special rights to Burma would have been unnecessary because any protection needed for Burma would automatically be exercised by Steels in its capacity as managing agent. Hence, the absence of the eleven rights for Burma did not imply that Burma was not a partner in the combination, and the specific clause 3a of the agreement could be understood in this light.

In the circumstances, the fact that Burma was not granted any special rights of the kind given to the Ellermans cannot be taken to mean that Burma was not a partner together with Steels and Ellermans in the Combination. Providing such special rights to Burma would have been unnecessary because any rights so granted would have been exercised only by Steels, which acted as Burma’s managing agent. If Steels were in fact the managing members of the Combination, they would have performed all tasks required to protect not only their own interests but also the interests of Burma. Consequently there was no reason to create a separate set of rights for Burma that were similar to those granted to the Ellermans.

When this position is kept in mind, the wording of clause 3a of the agreement becomes clear. For the purpose of the partnership, the agreement placed Steels and Burma together in a single bracket and allotted to that bracket a joint share of the profit or loss of the Combination’s business. The remaining share was allotted to the Ellermans. The ratios specified in the clause therefore amounted to roughly two parts for the Steels‑Burma bracket and one part for the Ellermans, who were the third partner. Between Steels and Burma it was not considered necessary to further subdivide the profits, because any amount that passed to Burma would ultimately be received by Steels, which owned all of Burma’s one‑hundred‑percent share.

Thus, clause 3a expressly reserved the joint share for Steels and Burma together and separately reserved the share for the Ellermans. However, clause 3 of the agreement went on to state that the profit or loss of the Combination would be shared and divided between Steels and the Ellermans. Under this provision the Steels were to receive the entirety of the amount that belonged to the joint Steels‑Burma share, and whatever the Steels did with that amount thereafter was a matter between the Steels and Burma. The clause 3a agreement also required Burma to acknowledge that it had a joint share in the profit or loss together with Steels, and that whatever amount accrued to that joint share would be taken by the Steels. That is why clause 3a provided for the actual division of profit or loss between the Steels and the Ellermans.

The absence of any separate provision that Burma would directly receive a share of the profit or loss belonging to the joint Steels‑Burma share does not imply that Burma lacked any share in the Combination. There is no ambiguity on this point, and no suggestion of any mistake in the drafting of clause 3a.

There is no mystery or mistake in the provision contained in clause three a concerning the distribution of profit or loss of the Combination. In fact, clause three a clearly indicates that Burma was a partner together with Steels and Ellermans in the Combination. Upon a proper construction of the agreement dated twenty‑ninth November, nineteen twenty‑eight, the Court concluded that Burma was indeed a partner alongside Steels and Ellermans and that Burma shared jointly with Steels the profit or loss arising from the Combination. The agreement expressly gave Burma the right to terminate the partnership by giving notice to the other partners in accordance with clause twelve. It also conferred upon Burma the right to refer any dispute that might arise between the partners to arbitration as prescribed by the Arbitration Act of eighteen eighty‑nine. The parties shared the profit or loss of the Combination’s business, and an agency relationship existed whereby Steels were authorised to manage and conduct the business on behalf of all the partners of the Combination. Consequently, every essential ingredient of a partnership was present, making any argument that the document was a hybrid or merely a tripartite arrangement concerning the Combination’s business, while being a partnership only between Steels and Ellermans, untenable. There is no doubt whatsoever that Burma was a partner with Steels and Ellermans in the Combination, and that the partnership created under the agreement comprised three partners: Steels, Burma and Ellermans. Having regard to this finding, the Court saw no need to examine any facts or circumstances that might diminish this position or suggest that, despite the apparent three‑party partnership, the Combination in reality consisted only of Steels and Ellermans with Burma serving merely as a confirming party. Nevertheless, the Court considered the specific facts and circumstances on which the appellant relied, because the question framed required such an examination. In reviewing those facts, the Court found nothing that contradicted the earlier conclusion. The fact that all of Burma’s shares were owned by Steels explains why the agreement dated twenty‑ninth November, nineteen twenty‑eight did not grant Burma any distinct rights akin to those given to Ellermans for the protection of its interests. Burma’s interests were fully secured in the hands of Steels, and therefore no separate provision was necessary to safeguard Burma’s interests as such. The fact that Burma

In this case, the fact that Burma never bought paddy nor sold rice was held to be irrelevant. The Court explained that Burma had contributed its property to the Combination, and after Steels took over the management of the Combination’s business, Burma could not independently purchase paddy or sell rice. The Court further noted that no share of the Combination’s profits had ever been paid to or received by Burma, a point already discussed earlier. It was observed that Steels and Burma together held a joint share amounting to roughly two‑thirds of the total profit or loss of the Combination. Although all of Burma’s one‑hundred percent share was owned by Steels, the Court said that even if Steels, by an internal arrangement, appropriated to themselves all the profits that arose from the joint Steels‑Burma share, this circumstance did not demonstrate that Burma was not a partner in the Combination. The Court also rejected the argument that the only earnings of Burma derived from milling hire paid by Steels to Burma, stating that this fact was of no consequence. Regarding the accounts of the Combination, the Court found no evidence of any payment by the Combination to Burma for milling charges. Even if, through a private arrangement, Steels paid Burma a sum out of the joint profits, the Court held that such a payment was merely an internal matter between Steels and Burma and could not affect Burma’s status as a partner, given that the agreement of 29 November 1928 contained no provision to the contrary.

The Court further stated that the foregoing facts and circumstances were of no significance and could not support the appellant’s claim that Burma was merely a party to the combine and not a partner in the Combination. It found no justification for characterising the 29 November 1928 instrument as a composite agreement that could be split into a tripartite pact among the members of the Combination and a separate partnership agreement between Steels and Ellermans, with Burma acting only as a confirming party for the portion of its assets placed in the Combination. In the Court’s view, the language of the 1928 agreement did not create a distinction between a three‑party arrangement and a two‑party partnership, and the contribution of Burma’s assets was intended to make Burma a full participant in the Combination. Accordingly, the Court concluded that the High Court’s negative answer to the reference was correct. Consequently, the appeal was dismissed with costs, and the order of dismissal was affirmed. The dismissal with costs means that the appellant must bear the expenses of the proceedings.