Commissioner Of Income-Tax, Madras,... vs S.V. Angidi Chettiar

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 18 January, 1962

Coram: B.P. Sinha, J.C. Shah, J.L. Kapur, J.R. Mudholkar, M. Hidayatullah

The matter before the Supreme Court involved three appeals, each carrying a certificate of fitness issued by the High Court of Madras, challenging orders that had been passed in petitions for writs of certiorari. The writs sought to set aside penalties that had been imposed on the partnership firm Messrs S V Veerappan Chettiar & Co. by the Income‑Tax Officer in accordance with section 28(i)(c) of the Indian Income‑Tax Act. The bench hearing the case comprised Justices B P Sinha, J C Shah, J L Kapur, J R Mudholkar and M Hidayatullah, and the judgment was delivered by Justice Shah.

The partnership consisted of four individuals who carried on a cloth‑trading business at Virudhunagar under the name S V Veerappan Chettiar & Co., hereinafter referred to as “the firm”. The firm had been registered under section 26A of the Income‑Tax Act, 1922 for the assessment years 1947‑48, 1949‑50 and 1950‑51. During the assessment proceedings the firm allegedly concealed certain particulars of its income when filing its returns. Consequently, the Income‑Tax Officer of Virudhunagar, acting within the assessment process, directed by an order dated 20 May 1954 that penalties of Rs 20,000 for the year 1947‑48, Rs 10,000 for the year 1949‑50 and Rs 5,000 for the year 1950‑51 be paid. One of the partners contested these penalty orders by filing a revision application before the Commissioner of Income‑Tax, Madras, but the Commissioner dismissed the revision. Following that, two partners of the firm instituted petitions under article 226 of the Constitution in the Madras High Court, seeking writs of certiorari or other appropriate writs. The petitions asked the court to direct the production of the records relating to the May 1954 orders of the Income‑Tax Officer and to overturn the penalty orders. The petitioners argued that an agreement among the partners had dissolved the firm on 13 April 1951, that notice of this dissolution had been given to the Income‑Tax Officer, and that, irrespective of the earlier agreement, the firm had definitively ceased to exist on 5 May 1953 when one partner died. They contended that, under section 28(1), the Income‑Tax Officer could not validly impose a penalty after the firm’s dissolution.

The High Court accepted the petitioners’ contentions and consequently set aside the Income‑Tax Officer’s orders dated 20 May 1954 as well as the Commissioner’s subsequent refusal to revise those orders in each of the two petitions. Dissatisfied with the High Court’s decision, the Commissioner of Income‑Tax appealed to the Supreme Court. In arriving at its conclusion, the Supreme Court referred to its recent decision in Abraham v. Income‑Tax Officer, Kottayam, where it had held that the Income‑Tax Officer possesses authority under section 28 of the Income‑Tax Act to impose a penalty during the assessment of a firm even if, at the time the order is made, the firm has been dissolved because of a partner’s death.

In reaching its decision, the Court noted that section 44 of the Income‑tax Act establishes a procedure for assessing the tax liability of a firm that has discontinued its business, and that the term “assessment” used in the various provisions of Chapter IV is not confined solely to the calculation of income. Accordingly, when section 44 declares that the partners or members of a firm shall be jointly and severally liable to assessment, the provision is referring both to the liability to compute income under section 23 and to the application of the procedures for declaring, imposing and enforcing tax liability. The Court then turned to the argument presented by counsel for the respondents, who contended that the precedent set in Abraham v. Income‑tax Officer involved an unregistered firm and therefore could not be applied to a registered firm. The Court rejected this contention, explaining that section 44 incorporates the provisions of Chapter IV, insofar as they are applicable, for assessment whenever any business, profession or vocation carried on by a firm has been discontinued, and that the section expressly declares liability of all discontinued firms, not merely of unregistered firms. There is nothing in the wording of section 44 or in its contextual setting that limits its operation to unregistered firms. Moreover, the Court pointed out that in Abraham’s case it had approved the decision of the Andhra Pradesh High Court in Mareddy Krishna Reddy v. Income‑tax Officer, Tenali, a case involving a registered firm that had been dissolved before a penalty was imposed. Counsel further argued that, irrespective of the foregoing, no penalty under section 28 can be imposed on a registered firm either before or after dissolution, even where the defaults specified in clauses (a), (b) or (c) are established. Counsel relied on the scheme of the Act under section 23(5) concerning the assessment of tax liability of a registered firm. The Court observed that this argument was not raised in the original petition, was absent from the High Court’s judgment, and did not appear in the statement of the case filed before this Court; consequently, the plea must be rejected on that basis alone. Even if the appellate authority were to permit the contention, the Court found no supporting authority in its own judgments. The Court then quoted the relevant portion of section 28(i) of the Act, which provides: “If the Income‑tax Officer… in the cores of any proceeding under this Act is satisfied that any person – (a) has without reasonable cause failed to urnish the return of his total income which he was required to urnish by notice given under sub‑section (1) or sub‑section (2) of section 22 or section 34 or has reasonable cause failed to furnish it within the time allowed and in the manner required by such notice, or (b) has without reasonable cause failed to furnish the return of his total income which he was required to furnish”. The Court further noted that the definition of “person” in section 2(a) includes “a Hindu undivided family and a local authority”, but that this definition is not exhaustive, allowing recourse to the General Clauses Act where necessary.

According to section 28 of the Income‑tax Act, when a notice issued under sub‑section (1) or sub‑section (2) of section 23 has been ignored, or when a notice under sub‑section (1) or sub‑section (2) of section 23 has not been complied with, or when a person has cancelled the particulars of his income or has deliberately furnished inaccurate particulars of such income, the Income‑tax Officer may direct that the person be liable to a penalty. In the situation described in clause (a), the penalty is imposed in addition to any income‑tax and super‑tax, if any, that may be payable by the person, and the amount of the penalty may not exceed one and a half times the tax amount. In the situations described in clauses (b) and (c), the penalty is also imposed in addition to any tax payable by the person, and the penalty amount may not exceed one and a half times the amount of income‑tax and super‑tax, if any, that would have been avoided had the income returned by the person been accepted as the correct income.

The expression “person” is defined in section 2(a) of the Act to include a Hindu undivided family and a local authority. This definition is not exhaustive. Under section 3 of the General Clauses Act, a “person” also includes any company, association, or body of individuals, whether incorporated or not. Because a firm is a body of individuals, it falls within the definition of “person” and therefore can be subject to a penalty order under the circumstances specified in clauses (a), (b) and (c) of section 28. The proviso (d) to section 28 further clarifies that both registered and unregistered firms may be liable to pay a penalty, and it specifies the quantum of penalty that may be imposed on such firms.

The respondent’s counsel argued that, even if a firm is regarded as a “person” within the operative part of section 28 and its proviso, an obvious drafting defect prevents the imposition of a penalty on a registered firm. The counsel relied upon the last clause of the first subsection, which provides that the penalty is imposed “in addition to any tax payable by him”. The argument is that only the person who is liable to pay tax can be ordered to pay a penalty if found guilty of the misconduct described in clauses (a), (b) and (c). By the legislative scheme for imposing tax liability on registered firms under section 23(5), a registered firm never becomes liable to pay tax. Consequently, the counsel contended that the penalty cannot be enforced against a registered firm.

Further, the respondent’s counsel pointed out that when the Legislature, by Act 40 of 1940, introduced clause (d) of the proviso, it merely declared the amount of penal liability that could attach to a registered firm. However, the substantive provision required an enforceable tax obligation before a penalty could be levied. Since section 23(5) had not, at that time, been amended to create such an enforceable tax liability for a registered firm, the penalty, although quantified, remained unenforceable. The argument therefore rested on the view that without an amendment to section 23(5) imposing a tax obligation on a registered firm, the penalty provision could not operate against that firm.

The counsel asserted that Section 28(1), in its original form, suffered from two distinct defects that affected the operation of the provision. The first defect was that a penalty could be imposed only on a person who was liable to pay income tax or super‑tax. The second defect was that the penalty, when imposed, was expressed as a multiple of the income‑tax or super‑tax that would have been avoided if the income returned by that person had been accepted as correct. By inserting clause (d) into the proviso, the legislature eliminated the second defect but left the first defect untouched. To support this argument, counsel relied on the wording of Section 23(5) as it existed before its amendment by Section 14 of the Finance Act, 1956. Section 23(5) provided that where the assessee is a firm and the total income of the firm has been assessed under sub‑section (1), (3) or (4), the sum payable by the firm would not be determined. Instead, the total income of each partner, including his share of the firm's income, profits or gains of the previous year, would be assessed and the tax payable by each partner would be determined on that basis. Under this scheme, the income of a registered firm was computed, but tax was not levied on the firm as a whole. The income was allocated among the partners according to their partnership agreement and each partner was taxed individually on his share. Relying on this method of tax assessment, counsel for the respondent argued that because the registered firm itself was not liable to pay tax, it could nevertheless be made liable to pay a penalty under Section 28(1)(c). Section 28, as originally enacted, was somewhat obscure in its operation because the relationship between the penalty and the tax avoided was not clearly defined. The penalty that could be imposed for the situations described in clauses (b) and (c) was limited to a sum not exceeding one and a half times the amount of tax that would have been avoided if the income returned by the person had been accepted as correct. However, the legislature did not indicate whether the tax avoided referred to the tax that would have been payable by the partners of the firm or the tax that would have been payable by the firm if it were treated as an unregistered entity. Because Section 23(5) made income‑tax payable by the individual partners rather than by the firm, the legislative intention concerning the penalty was not expressed with clarity. To remedy the identified defect, the legislature created an artificial basis for computing the penalty payable by a registered firm. It provided that in the cases covered by clauses (b) and (c), the amount of income‑tax and super‑tax that would have been avoided if the income as returned had been accepted as correct would be taken as the basis for the penalty.

In this case the Court explained that the amount of penalty to be imposed on a firm that is not registered should be measured as the difference between the tax that would have been due if the firm were unregistered and its total income. Although the rule for computing the penalty for a registered firm was clearly stated, the Court rejected the view that the phrase “any tax” in section 28(1) meant that a tax liability must exist before a penalty could be levied. The Court illustrated the flaw in that view by referring to clause (b), which permits a penalty for failure to obey a notice under subsection (4) of section 22 or subsection (2) of section 23 even when the assessee has no assessable income. Therefore, the liability to pay tax by the person against whom the penalty is sought is not a condition precedent to the imposition of the penalty. The Calcutta High Court, in Khusiram Murarilal v. Commissioner of Income‑tax, had been asked to consider the same submission that was raised in the present matter. The issue before that Court was whether, under section 28(1)(b) of the Income‑Tax Act, a registered firm could lawfully be subjected to a penalty. The assesse, a registered firm, argued that because section 28(1)(b) allows a person to be liable for a penalty in addition to any income‑tax or super‑tax that may be payable, a penalty could not be imposed on a registered firm, since no tax is payable by the firm under the Act. Chief Justice Chakravartti, speaking for the court, observed that even when the language of section 28(1) is read literally, the concluding paragraph does not impose a condition that a person must be liable to pay some income‑tax or super‑tax before a penalty can be imposed. He further explained that clause (b) of the proviso reinforces this interpretation, indicating that a person may be chargeable with a penalty even though he is not chargeable with tax. The Chief Justice also noted that clause (d) of the proviso was not required to expressly state that a registered firm would be liable for a penalty despite the fact that it could not be charged with income‑tax or super‑tax. He rejected the argument of Dr. Sen and Gupta that the concluding paragraph of section 28(1) created a gap which clause (d) attempted to fill but failed; in his view, the only gap was the absence of a provision specifying the quantum of penalty that could be levied on a registered firm, a matter that depended on the amount of income‑tax payable.

Section 28(1) did not contain a rule that fixed the amount of any penalty that could be imposed on a registered firm because the amount of the penalty was dependent on the amount of income‑tax that was payable. The learned Chief Justice was therefore correct in stating the law in those terms. Under section 23(5) of the Indian Income‑Tax Act, as it stood before its amendment in 1956, the tax due by a registered firm was not calculated on the firm itself. Instead, the total income of each partner of the firm, including each partner’s share of the firm’s income, profits and gains of the preceding year, had to be assessed individually and the tax payable by each partner on that assessment was to be determined. This procedure was merely a method for collecting the tax that was due from the firm. Consequently, the penalty provisions contained in section 28 became applicable during the assessment of a registered firm whenever any of the defaults described in clauses (a), (b) or (c) occurred. Moreover, if a registered firm committed any of those defaults by reason of section 44, the assessment proceedings were required to continue against the firm even after the firm had been dissolved, as if the dissolution had not taken place.

Counsel argued that a penalty for the assessment year 1949‑50 could not be imposed on the assessee firm because there was no evidence that the Income‑Tax Officer had been satisfied, during any assessment proceedings under the Income‑Tax Act, that the firm had concealed its income or had deliberately supplied inaccurate income particulars. The authority to impose a penalty under section 28 depended on the officer’s satisfaction during the course of the assessment proceedings; the officer could not exercise that authority unless he was satisfied that the conditions laid down in clauses (a), (b) or (c) were met before the assessment proceedings were concluded. The initiation of penalty proceedings did not have to occur before the completion of the assessment, but the officer’s satisfaction prior to the conclusion of the assessment was the essential condition for exercising the jurisdiction, not the issuance of a notice or any other step. The record did not contain any evidence that the officer was unsatisfied that the firm had concealed its income. In fact, the assessment order dated 10 November 1951 bore an endorsement at its foot by the Income‑Tax Officer stating that action under section 28 had been taken for concealment of income, which clearly demonstrated that the officer had been satisfied during the assessment that the firm had concealed its income. In the Court’s view, the High Court was therefore mistaken in holding otherwise.

The Court observed that the provision of section 28(1)(c) could not be invoked to levy a penalty on the firm Messrs S V Veerappan Chettiar & Co. after the firm had already been dissolved. Consequently, the Court concluded that the appeals filed by the petitioners must succeed. Accordingly, the judgments and orders issued by the High Court were set aside in their entirety. The petitions that had been filed by the respondents were ordered to be dismissed, and the respondents were directed to bear the costs incurred in both this Court and the High Court. In addition, the Court ordered that a single hearing fee be paid for the conduct of these proceedings. Finally, the Court affirmed that the appeals were allowed, thereby confirming the reversal of the earlier orders and the dismissal of the respondents’ petitions.