Umacharan Shaw and Bros. vs Commissioner Of Income-Tax, West

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 15 May 1959

Coram: M. Hidayatullah

In this case, the Court noted that the matter involved two appeals that had been granted special leave to be heard before the Supreme Court. The first appeal challenged an order dated 1 June 1956 issued by the High Court of Judicature at Calcutta in Income‑tax Reference No 10 of 1956. The second appeal contested an order dated 22 March 1955 rendered by the Income‑tax Appellate Tribunal, Calcutta Bench, in I.T.A. No 5037 of 1954‑55, which concerned the assessment year 1948‑49. The Tribunal had dismissed the appellant firm’s attempt to set aside an order of the Appellate Assistant Commissioner of Income‑tax that confirmed a prior order refusing to register the appellant firm under section 26A of the Indian Income‑tax Act. The High Court, on the other hand, had summarily rejected an application by the appellant firm that was filed under section 66(2) of the same Act. The appellant firm argued that the denial of registration under section 26A was erroneous and that its application under section 66(2) should have been entertained. The Court further observed that the present judgment was required to dispose of both the Tribunal’s dismissal and the High Court’s summary rejection, and to address the legal and factual issues raised in each appeal.

The Court then recorded the factual background of the dispute. The deceased Bhuban Mohan Shaw had died in 1908 leaving three surviving sons—Uma Charan Shaw, Aboy Charan Shaw and Panchukali Shaw—and a widow named Mst. Surabala Dassi. Prior to his death, Bhuban Mohan Shaw had held an excise licence in his own name for the retail sale of foreign liquor from a shop located at No. 1, Dharamtala Street in Calcutta. After his death, the three brothers formed a Hindu joint family, with Uma Charan acting as the Karta, and the family continued the liquor‑selling business. The joint family was governed by Dayabhaga law, which vested managerial authority in the Karta. The excise licences required for the ongoing business were subsequently taken in the names of Uma Charan and Panchukali. Over the ensuing years the family expanded its commercial operations by opening additional premises. In addition to the original retail shop on Dharamtala Street, the family operated an excise shop at Nos. 201 and 202, Chandney Chawk Sheet, Calcutta, for wholesale of foreign liquor, and a store known as Shaw Brothers Stores at No. 12/13, Bertram Street, Calcutta, which dealt in oil goods and other merchandise. The licences for these establishments were held in the names of individual family members rather than in the name of the Hindu joint family. Moreover, the family purchased immovable property in Calcutta, including shop premises and possibly residential buildings, which were also held in the names of the individual members. The Court emphasized that the family’s business and property arrangements had evolved over time while remaining under the overall management of the Karta.

Finally, the Court described how the family formalised its commercial arrangement through a deed of partnership. According to the appellant’s allegation, the family experienced a disruption in 1938, and on 7 April 1939 the three brothers executed a deed of partnership that was subsequently registered with the Registrar of Firms, Bengal. By virtue of that deed, the brothers agreed to carry on the joint‑family business in the form of a partnership, and they opened a separate set of books of account that they called “Bati Khata”. Those books were intended to reflect each partner’s capital contribution, record the partnership’s accounts, and allocate profits among the partners in accordance with their respective shares. The deed of partnership also stipulated that the income derived from the immovable property would be collected jointly and divided equally among the three brothers. The appellant firm further claimed that even before the partnership was formally created the brothers had begun to live in separate houses, maintain separate messes, food arrangements and places of worship. The Court noted that the partnership agreement, the registration of the deed, and the maintenance of the “Bati Khata” books were evidence of the brothers’ intention to operate the business as a partnership and to share equally the income from the immovable property. During the earlier years, the joint family had been assessed by the tax authorities as a Hindu undivided family under the name “Uma Charan Shaw and Brothers”, with Uma Charan Shaw acting as the Karta for both the business and the immovable property. The Court indicated that the present judgment would consider the effect of the partnership deed and the related arrangements on the tax treatment of the family’s income.

Before the partnership was formally created, the brothers began to live in separate houses and they also kept separate messes, food arrangements and places of worship. The deed of partnership, which was executed on 7 April 1939, stipulated that the income generated from the family’s immovable property would be collected jointly and would be divided equally among the three brothers. In the years preceding the execution of that deed, the tax authorities had treated the family as a Hindu undivided family and had assessed the income under the name “Uma Charan Shaw and Brothers”, with Uma Charan Shaw acting as the Karta for both the business and the immovable property. In the assessment year 1939‑40, Uma Charan Shaw filed applications under sections 25A and 26A of the Income‑Tax Act, requesting that the authorities recognise that the family had effected a partition and that the partnership formed by the April 1939 deed be registered. The Income‑tax Officer of District II(2), Calcutta rejected both applications and continued to assess the income of the family as that of a Hindu undivided family. Subsequently, on 1 December 1944, the three brothers transferred all of the family’s immovable property to a newly formed limited liability company named Bhuban Mohan Shaw Estate, Ltd. Each brother was allotted ninety‑one shares of Rs 1,000 each. After this conveyance, the income from the properties was assessed in the hands of the company rather than in the hands of the family.

Aboy Charan Shaw died on 14 April 1945. In accordance with the 1939 partnership deed, his son Shashadhar Shaw was admitted as a partner to represent the deceased brother’s share, which was equal to Aboy Charan’s original share. In January 1946, another limited liability company, Shaw Brothers Stores, Ltd., was incorporated, with partners Uma Charan, Panchukali and Shashadhar. This company took over the business conducted at No. 12/13, Bertram Street, Calcutta, and the income from that business was thereafter assessed in the company’s hands. Uma Charan died on 25 January 1947 and his son Radha Raman Shaw was admitted as a partner with a share equal to his father’s. On 10 April 1947, a new deed of partnership was executed by Panchukali, Shashadhar and Radha Raman covering the remaining shops: (i) Messrs Uma Charan Shaw at No. 40, Moti Sil Street, Calcutta; (ii) Messrs Panchukali Shaw and Radha Raman Shaw at No. 1, Dharamtala Street, Calcutta; and (iii) Messrs S. B. Dassi and A. C. Shaw at No. 201/202, Chandney Chawk Street, Calcutta. The partnership deed for these three shops formed the basis of a fresh application under section 25A of the Act, which gave rise to the two appeals before the court. Initially, a tax return was filed claiming the status of a Hindu undivided family; after correction, a second return was filed still as a Hindu undivided family. A third return was then filed in the name of “Uma Charan Shaw and Brothers”, describing the entity as a firm of partners. At the same time, applications were made under sections 25A and 26A of the Act. The Income‑tax Officer, District II(2), Calcutta, considered these submissions in the subsequent proceedings.

By an order dated 31 March 1953, the Income‑Tax Officer rejected the application filed under section 26A. Although the officer did not issue a separate order on the application made under section 25A, he observed that the assessment should continue to be made in the manner of a Hindu undivided family as had been done previously. The usual appeals against that order were filed but were subsequently dismissed. The appellants then approached the Tribunal invoking section 66(1) and later sought a reference from the High Court under section 66(2); both attempts were unsuccessful. Consequently, the appellant firm proceeded to file the two appeals that are the subject of the present proceedings.

In refusing the claim for registration, the Income‑Tax Officer set out several reasons. He noted that the books of business of the appellant did not contain a separate capital account for each of the alleged partners, and that the profit of each partner had not been credited to an individual account in the ledger. The officer further explained that he could not assign any value to the “Bati Khata” because the purpose for maintaining such a book was “not very clear or convincing”. He also observed that the deed of partnership had been executed with retrospective effect, which raised additional doubts about the genuineness of the firm, especially since the excise business appeared to have continued unchanged under different names. Moreover, the officer pointed out that the partnership could have applied for registration at an earlier stage, particularly after the decision in the case of Sic Sunder Singh Majithia in 1942.

The Appellate Assistant Commissioner of Income‑Tax endorsed all of the foregoing reasons and added further observations. He highlighted that for the assessment year in question, at least two returns had been filed in the status of a Hindu undivided family before a return was finally filed in the name of a firm, indicating that the change of status was an afterthought. He also referred to the drawings made by the members in the books of the Chandney Chawk and Dharamtala shops, noting that there was no separate capital account maintained at the head office. The commissioner rejected the “Bati Khata” on the ground that it was kept outside the ordinary business accounts without any satisfactory justification. The explanation offered by the appellant—that the separate book was maintained to avoid difficulties with the Excise Department and to keep it away from the knowledge of employees—was not accepted as a sound reason.

The Tribunal summarized all of these reasons and added others, quoting its own findings in these words: “It was admitted on behalf of the assessee that the existence of the partnerships not communicated to any outside authority including the bank in which the assessee has an account. It was represented that even when the partners constituted a Hindu undivided family, they had a bank account in the name of one of the partners and the same is continued even after the partnership was constituted. It was also admitted that the outside world is not aware of the fact that the excise business is being carried on in partnership. A partnership is an artificial legal entity. If the partnership among the three partners is one which could not be disclosed to the very authorities under whom licences are obtained for”.

In this case the Court noted that because the excise shops were being run without informing the licensing authorities that a partnership existed, the assessee could not claim registration under section 26A; this fact led the Court to conclude that no genuine partnership had ever been created. The Court further held that, based on the material before it, there was no compelling reason to disturb the order issued by the income‑tax authorities, since the assessee had failed to demonstrate any division of the capital of the business or to show that the profits were being allocated among the partners in the business accounts. The Court also observed that the so‑called Bati Khata could not be regarded as a valid or recognised account book. Moreover, the Court pointed out that the very formation of the partnership contravened the Excise Rules, and therefore the partnership could not be treated as a valid and genuine entity for the purpose of registration under section 26A. Regarding the Tribunal’s last reason, the Court quoted the Tribunal’s own explanation given in the order relating to the application under section 66(1) of the Act, which stated that the appellate Tribunal had not based its decision on the illegality of the partnership but, after considering the materials placed before it, had arrived at the conclusion that a genuine partnership had not come into existence. The Court then turned to the factual background of the partnership deed, observing that the deed had indeed been executed on 10 April 1947 and subsequently registered with the Registrar of Firms, thereby establishing that the partnership existed from that date. The deed, in clause 4, specified that the co‑partnership would be deemed to have commenced on 25 January 1947, the day on which Uma Charan Shaw died; the appellants contended that his right, title and interest under the earlier 1939 partnership document passed to Radha Raman Shaw, who represented the heirs and successors of Uma Charan Shaw. The recitals in the deed further declared that from that day forward the business of the partnership, styled “Uma Charan Shaw & Bros.”, was to be carried on with Radha Raman as one of the partners. The deed also stated that “the capital of the co‑ partnership shall be the amount as will be found to the credit of the parties thereof” and permitted the partners to draw reasonable sums for personal expenditure, to be adjusted at the time of determining the year’s profit and loss, with the profits and losses to be shared equally between the partners. Finally, the deed provided that “for properly carrying on with this co‑partnership business account/accounts with reputed bank/banks shall be opened in the name of the co‑partnership firm or in any other name/names as may be agreed upon. If agreed upon by and between the partners the parties hereof may continue to operate the existing account/accounts with different bank/banks or close down the same as and when necessary. Such bank account/accounts shall unless otherwise agreed upon be operated jointly and/or severally by the partners.”

In this case, the Court observed that the provisions set out in the partnership deed appeared to have been fashioned primarily to create a superficial appearance of a partnership for the purpose of income‑tax assessment, while in reality the Hindu undivided family continued to operate in the same manner as before the deed was executed. By maintaining the accounts in the same way as the partners had previously done, the parties did not disclose to external parties that the family unit had undergone any disruption. The judgments issued in the earlier proceedings were said to involve a factual finding, and the Department argued that there existed material upon which such a finding could be based.

The Tribunal had specifically stated that it had not decided the matter on the ground that the partnership was illegal under the Bengal Excise Act of 1911. Nevertheless, the Tribunal referred to that argument in order to support its conclusion that the firm was not genuine. Section 42(1)(a) of the Bengal Excise Act provides that a licence may be cancelled or suspended by the authority that granted it if the licence is transferred or sub‑let without the authority’s permission. The Court noted that no evidence had been produced to show that any of the excise licences had been transferred or sub‑let. It further observed that the three shops concerned were managed separately and that the accounts of each shop were kept distinct from one another. Consequently, there was nothing in the record that directly contradicted the existence of a partnership, and the Court could not say that this circumstance affected the genuineness of the agreement.

Evidence of the partnership’s business records was presented in the form of extracts from the Bati Khata. Those extracts displayed the capital account of the partners, the amounts drawn by each partner from time to time, and the profits allocated to each partner separately. The Court found no indication that the entries in the Bati Khata differed from those recorded in the other account books, and it held that the Bati Khata functioned as an abstract of the entire business of the partnership. The fact that the Bati Khata had not been shown to the excise authorities did not, in the Court’s view, demonstrate that the book was inauthentic. The account had been in existence since the first partnership agreement, and no evidence had been adduced to establish that it had not been regularly maintained in the ordinary course of business.

Similarly, the Court examined the manner in which the bank accounts were maintained. The accounts remained in the names of the licence holders so that the various business undertakings could be kept separate and distinct. The partnership deed expressly provided for this arrangement, and there was nothing in the circumstances that rendered the partnership doubtful. The maintenance of these bank accounts, therefore, could not be said to constitute a mere veneer of partnership while, beneath the surface, the family continued to operate undisturbed.

The Court further noted that, although the family continued as a Hindu undivided family for nearly three decades, there was no legal prohibition against a family that had previously functioned as a joint family from disrupting that arrangement and forming a partnership. The earlier decision was not deemed to be res judicata, and the family was free to enter into a new agreement with new partners at a later date and to seek registration of that agreement. This is precisely what occurred in 1947, when a fresh partnership document was executed following the death of Uma Charan, who had been the eldest member and senior partner of the firm. The Court remarked that the death of the senior partner created a need for further adjustments, and the execution of the new document was a legitimate response to that need.

The Department argued that a striking characteristic of the arrangement was that, although the individual partners’ capital balances varied from time to time because each partner made cash withdrawals, the profit of the firm was nevertheless allocated equally among all partners. The Court acknowledged that this pattern was indeed unusual, but noted that its significance depended upon the manner in which the withdrawals were interpreted by other observers. The deed of partnership itself contained a provision allowing cash drawings, and, when the family circumstances were examined, the amount withdrawn by any partner in a given year could not be described as excessive, because other partners also withdrew substantial sums during the same period. 20. After reviewing the whole factual matrix, the Court was convinced that the Income‑Tax Officer had no substantive basis on which to hold that the partnership was a sham. The Court observed that the assessment relied on many suppositions and conjectures, and that a conclusion drawn merely from suspicion could not replace the requirement of proof in tax matters. 21. It was further submitted that three separate orders existed, namely the assessment order, the order made under section 25A and the order made under section 26A, and that setting aside only the order under section 26A would be of no practical effect because the order under section 25A remained in force. The Court stated that it was not called upon to decide what benefit might accrue to the appellant firm, and therefore rejected that line of argument. 22. Consequently, the Court reversed the decision of the Appellate Tribunal and directed that the firm be registered under section 26A of the Act for the assessment year 1948‑49. The Court also held that the appeal against the High Court’s order need not be entertained, as no further orders were required in that matter. 23. The appellant was awarded costs of the appeal against the Appellate Tribunal’s order, while costs incurred in the companion appeal were to be borne by the respective parties. 24. Accordingly, Civil Appeal No. 41 of 1958 was allowed.