Seth Jamnadas Daga And Others vs Commissioner Of Income-Tax, South Bombay

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

Court: supreme-court

Case Number: Civil Appeal No. 516 of 1959

Decision Date: 12 December 1960

Coram: M. Hidayatullah, S.K. Das, J.C. Shah

In the matter titled Seth Jamnadas Daga and Others versus Commissioner of Income‑Tax, South Bombay, the Supreme Court delivered its judgment on 12 December 1960. The case was reported in 1961 AIR 1139 and in the Supreme Court Reporter at 1961 SCR (3) 174. The bench hearing the appeal comprised Justice M Hidayatullah, Justice S K Das and Justice J C Shah. The petitioners were the partners of two firms that were duly registered under the Income‑Tax Act, 1922, and a third firm that had not been registered. For the assessment year 1948‑49 the registered firms together incurred a loss of Rs 11,902 and Rs 1,265 respectively, amounting to a total loss of Rs 13,167. The unregistered firm generated a profit of Rs 26,110, and the partners also reported other income amounting to Rs 262. The unregistered firm’s profit was taxed in the name of the firm. When the Income‑Tax Officer assessed the Rs 262 of other income, he first calculated each partner’s total income by setting off the partner’s share of the profit from the unregistered firm against the partner’s share of the loss from the registered firms.

The petitioners challenged this assessment before the Appellate Assistant Commissioner, but their appeal was dismissed. They then appealed to the Tribunal, which, relying on the precedent set in Commissioner of Income‑Tax v. Ratanshi Bhavanji, held that just as a loss incurred in an unregistered firm could not be set off against profit from a registered firm, profit earned in an unregistered firm could not be set off against loss from a registered firm. On further appeal, the High Court of Bombay reversed the Tribunal’s view. The High Court held that the profit from the unregistered firm could be set off against the loss from the registered firms for the purpose of determining the tax rate applicable to the Rs 262 of other income, and that the loss of the registered firms could not be carried forward to the next year because it was deemed to have been absorbed by the profit of the unregistered firm. The matter then reached the Supreme Court on a certificate from the High Court. The Supreme Court affirmed the High Court’s interpretation that, under sections 14(2) and 16(1)(a) of the Income‑Tax Act, profit and loss must be set off against each other to compute total income, and that although a partner’s share of profit from an unregistered firm is exempt from tax, it must be included in total income for rate‑determination purposes. However, the Supreme Court corrected the High Court’s error in concluding that the losses of the registered firms could not be carried forward, holding that the losses were not absorbed by the unregistered firm’s profit and therefore could be carried forward in accordance with the provisions of the Act.

The appeal, numbered 516 of 1959, originated from a judgment and order dated September 3, 1957, of the Bombay High Court in Income‑tax Reference No. 49 of 1957. The matter was heard on December 12, 1960, and the judgment was delivered by Justice Hidayatullah. Counsel for the appellants and counsel for the respondent were present. The three appellants challenged the High Court’s decision on the specific question whether the share of income that the assessee partners derived from an unregistered firm—taxed separately and amounting to Rs 26,110—could be set off against their share of loss from the registered firms, which amounted to Rs 13,167. The factual background is that two of the appellants are brothers, and the third appellant is the widow of a third brother who died during the pendency of the appeal after the High Court had granted a certificate. The three brothers were partners in two registered firms and in one unregistered firm. The assessment years in issue are 1948‑49 and 1949‑50. For the year 1948‑49 each brother’s income consisted of losses from the two registered firms, Rs 11,902 and Rs 1,265 respectively, totalling a loss of Rs 13,167, a profit of Rs 26,110 from the unregistered firm, and other income of Rs 262. The unregistered firm was taxed in its own name under clause (b) of sub‑section (5) of section 23, and not in the hands of the partners. In computing the Rs 262 other income, the Income‑tax Officer first determined the total income of each appellant by setting off their respective share of the profit of the unregistered firm against their share of the loss of the registered firms. The appellants argued that because tax had already been assessed on the unregistered firm, such a set‑off could not be permitted, and that the loss in the registered firms meant no tax was payable on the Rs 262. They further contended that they were entitled to carry forward the loss of Rs 12,905 to the following year under section 24(2) of the Income‑tax Act. The Income‑tax Officer rejected these contentions; his order is not reproduced in detail. The assessment for the year 1949‑50 was made on the same basis. The appellants appealed to the Appellate Assistant Commissioner, whose decision was also adverse. Consequently, each appellant filed three separate appeals before the Tribunal—one for each assessment year—making a total of six appeals. The Tribunal disposed of all six appeals by a single order. Relying on the second proviso to section 24(1), the Tribunal held that, just as a loss incurred in an unregistered firm could not be set off against profit from a registered firm, the profit earned by an unregistered firm could not be set off against loss from a registered firm.

The Tribunal affirmed that profits earned by an unregistered firm could not be set off against losses incurred by a registered firm. In arriving at this conclusion, the Tribunal relied upon the decision of the Madras High Court in Commissioner of Income‑tax v. Ratanshi Bhavanji (1). The Tribunal indicated that it chose to follow that decision rather than the earlier ruling of the Punjab High Court in Banka Mal Niranjandas v. Commissioner of Income‑tax (2). The same line of reasoning was applied to the assessment year 1949‑50, and consequently all six appeals relating to that year were allowed. The Tribunal’s order, besides addressing the foregoing issue, also identified several additional questions that the assessee parties requested to be referred to the High Court for determination under section 66(1) of the Act. The Commissioner likewise sought a reference concerning the matter already summarised above. Accordingly, the Tribunal referred two questions on behalf of the assessee parties and one question, previously quoted, on behalf of the Commissioner. When the matter reached the High Court, the assessee parties withdrew the two questions they had raised, and the High Court issued its opinion in the appealed judgment and order on the sole remaining question. The High Court departed from the Tribunal’s view, holding that the profit of the unregistered firm could be set off against the losses of the registered firms for the purpose of ascertaining the tax rate applicable to the amount of Rs. 262, which constituted other income of the assessee parties. The High Court further held that the assessee parties could not carry forward the loss of the registered firms to the next year, on the ground that such loss ought to be treated as having been absorbed by the profit of the unregistered firm. Nevertheless, the High Court certified that the case was suitable for appeal to this Court, and the present appeal was consequently filed.

The Court observed that the High Court correctly answered the specific question that had been referred to it, but erred in concluding that the losses of the registered firms could not be carried forward because they were deemed to have been absorbed in the profit of the unregistered firm. While the Court agreed substantially with the High Court on the first part of the dispute, it found it unnecessary to scrutinise in detail the reasoning that underpinned the High Court’s decision. The Court considered the matter to be straightforward and capable of being expressed within a narrow scope. It noted that under section 3 of the Income‑tax Act, income‑tax is chargeable for an assessment year at the rate or rates prescribed by the annual Finance Act on the total income of the preceding year. Prior to its amendment in 1956, section 14(2)(a) stipulated that tax was not payable by an assessee who was a partner in an unregistered firm, insofar as any portion of his share in the firm’s profits and gains—calculated in accordance with clause (b) of subsection (1) of section 16—had already been taxed at the firm level. Consequently, that provision granted immunity from tax on such a share.

In this case, the Court explained that the exemption under section 14(2)(a) applied only to the share of the assessee as a partner in an unregistered firm with respect to the profit share that he received from that firm and on which the unregistered firm had already paid tax. Section 16(1)(a), however, required that when the total income of an assessee was computed, any amount that was exempted under sub‑section (2) of section 14 had to be included. The combined effect of these two provisions, as expressed by the High Court, was that “although the share of a partner in the profits of an unregistered firm is exempt from tax, it is included in his total income for the purpose of rate only.” The Court affirmed that this interpretation was correct. The Tribunal, on the other hand, relied on the second proviso to section 24(1), which states: “Provided further that where the assessee is an unregistered firm which has not been assessed under the provisions of clause (b) of sub‑section (5) of section 23 … any such loss shall be set off only against the income, profits and gains of the firm and not against the income, profits and gains of any of the partners of the said firm; and where the assessee is a registered firm, any loss which cannot be set off against other income, profits and gains of the firm shall be apportioned between the partners of the firm and they alone shall be entitled to have the amount of the loss set off under this section.” The Tribunal concluded that “…just as a partner in an unregistered firm which has suffered loss will not be allowed to set off his share loss in the unregistered firm against his income from any other source, so it stands to reason that his loss from other sources cannot also be set off against his share income from an unregistered firm.” This conclusion was not grounded in any specific provision of the Income‑Tax Act; rather, the Tribunal applied a parity of reasoning, treating a provision that dealt with loss in one direction as if it operated in the opposite direction as well. The High Court correctly observed that section 14, sub‑section (2), merely saved the profits of an unregistered firm from tax liability in the hands of the partners and did not affect the computation of total income for determining the rate applicable under section 3, especially in view of section 16(1)(a). Section 16(1)(a) explicitly required that any sum exempt under section 14(2) be included in the total income of an assessee, and because of this specific provision, the converse of the second proviso to section 24(1) that the Tribunal had quoted could hardly be applied. Accordingly, the Court held that the Tribunal’s order was incorrect. The High Court had pointed out this error, and the question raised was properly decided. The Court found no reason to depart from the High Court’s view on this aspect of the case.

In this case, a question arose before the High Court as to whether, in view of the earlier decision, the assessees were entitled to carry forward the loss incurred by the registered firms to the subsequent year or years. The High Court reached the conclusion that such loss could not be carried forward. Earlier, the Tribunal had stated that if the profits of the unregistered firm were set off against the losses of the registered firms, those losses would not be carried forward to the following year, and that such a result would be contrary to section 24 of the Act. The High Court rejected that argument when it considered the issue of the rate applicable to the other income, and correctly observed that, under sections 14(2) and 16(1)(a), profits and losses must be set off against each other in order to determine the total income of the assessee. However, the High Court also held that once the losses were set off against the profits, they were thereby absorbed and nothing remained to be carried forward. That conclusion does not follow from the statute. Section 24 provides for a distinct situation; it authorises the carrying forward of a loss in a business to the subsequent year or years until such loss is absorbed in profits or until it cannot be carried forward any further. This provision has little to do with the manner in which the total income of an assessee is computed for the purpose of fixing the tax rate applicable to his income taxable in the year of assessment. To read sections 14(2) and 16(1)(a) in an extended manner that would preclude the operation of section 24 would, in effect, nullify section 24 in certain cases, which is neither expressed nor can be implied as legislative intent. Accordingly, while the High Court was correct on the principal issue and on one aspect of the question placed before it, it was in error in deciding that the losses of the registered firms could not be carried forward because they had been absorbed by the profits of the unregistered firm. The judgment and order of the High Court are therefore modified to the extent of this error. Subject to that modification, the appeal is dismissed. In the circumstances of the case, no order as to costs is made. The appeal is dismissed with modification.