The Income Tax Officer vs Arvind N. Mafatlal

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

Court: supreme-court

Case Number: Not extracted

Decision Date: 27 February 1962

Coram: M. Hidayatullah, N. Rajagopala Ayyangar, Bhuvneshwar P. Sinha, P.B. Gajendragadkar, J.R. Mudholkar

The case was decided on 27 February 1962 by the Supreme Court of India. The bench that heard the matter comprised M. Hidayatullah, N. Rajagopala Ayyangar, Bhuvneshwar P. Sinha, P. B. Gajendragadkar and J. R. Mudholkar. The petitioner was the Income Tax Officer and the respondent was Arvind N. Mafatlal. The judgment is reported in 1963 AIR 493 and 1962 SCR Supl. (3) 455, and it has been cited in later cases such as RF 1966 SC1583 (7). The provisions of the Income‑Tax Act, 1922 (Eleventh Amendment) that were discussed include sections 16(2), 18(5) and 35.

The respondents were the four partners of a firm called “M”, which was registered under the Indian Income‑Tax Act. Among the four partners, three of them together held forty shares in a private limited company that was incorporated in the former Phaltan State. For the accounting year ended 30‑September‑1943 the Phaltan Company reported a net profit but did not declare any dividend out of those profits; instead it paid income‑tax and super‑tax on the profits. After the merger of Phaltan State into the Indian Union, the Income‑Tax Officer issued a notice to the Phaltan Company under section 34 of the Act and, acting under the provisions of section 23A, directed that the undistributed assessable income of the company should be deemed to have been distributed as dividend among the shareholders. Before the date of this order the assessment of the firm “M” and the individual assessments of its four partners had already been completed. In order to bring to tax the deemed undistributed dividend, notices were issued to the four partners under section 34 of the Income‑Tax Act. The partners appeared before the Officer and contended that the forty shares held by the three partners were, in fact, the property of the registered firm “M”. The Income‑Tax Officer accepted this contention and consequently treated the dividend attributable to the total of the forty shares as dividend income of the firm. He then apportioned that income among the four partners in proportion to the shares each held in the firm and added this amount to the income that had already been assessed. However, in recomputing the total income of each of the four assessors, the Officer included only the net dividend “deemed to be received” by each partner, but at the same time allowed a deduction for the tax paid by the company attributable to such dividend. This error was later discovered and the Income‑Tax Officer issued a notice pointing out the mistake in including in the income the net dividend without grossing it up, while at the

The Income‑Tax Officer had, at the same time, allowed a credit for the tax that was deemed to have been paid on the dividend and asserted that the inclusion of the net dividend without grossing it up was a mistake apparent on the record. He proposed to correct that mistake under section 35 of the Income‑Tax Act. The Court held that, in view of the decision in M/s Howrah Trading Co. v. Commissioner of Income‑Tax, only persons who are registered shareholders are entitled to the benefit of the credit for tax paid by the company under section 18(5) and also to the corresponding gross‑up required by section 16(2). Accordingly, the only persons who could be treated as shareholders for the purposes of sections 16(2) and 18(5) of the Act were the three partners in whose names the forty shares were registered. The Court further observed that the Income‑Tax Officer possesses jurisdiction under section 36 to rectify genuine errors but does not have the power to make a mere readjustment that merely avoids an illogical error which is otherwise permitted to continue. Moreover, the Court held that the original error could not be corrected in the present proceedings because the notice issued under section 35, which forms the foundation of the power to rectify, was not intended to correct the error but rather to perpetuate it in a form that was less objectionable from the revenue’s point of view.

The Court applied the precedent set in Messrs Howrah Trading Co., Ltd. v. Commissioner of Income‑Tax, Calcutta [1959] Supp. 2 S.C.R. 448. The judgment concerned civil appellate jurisdiction under the case numbers 502 to 505 of 1960, arising from appeals against the judgment and orders dated 14 January 1957 of the Bombay High Court in Special Civil Applications Nos. 1848 to 1851 of 1956. Counsel for the appellant and respondents were noted, and the judgment was delivered on 27 February 1962 by Justice Ayyangar. These four appeals were brought forward on certificates granted by the High Court of Bombay under Article 133(1)(c) of the Constitution and raised identical questions for determination. The respondents were each of the four partners in the firm Mafatlal Gagalbhai & Sons, namely Navinchandra Mafatlal, Arvind N. Mafatlal, Yoginder N. Mafatlal and Homant Mafatlal, who held share fractions of 5⁄16, 3⁄16, 3⁄16 and 5⁄16 respectively in the firm. Although Navinchandra died after the High Court decision and his legal representatives were later brought on record in Civil Appeal No. 502 of 1959, that circumstance was held to be irrelevant for the purposes of these appeals. The firm was registered under the Indian Income‑Tax Act. Additionally, there existed a private limited company named Mafatlal Apte and Kantilal Limited, registered under the Phaltan State Companies Act, in which ten shares were held in the name of Navin Chandra, ten in the name of Arvind and twenty in the name of Homant for the relevant account year.

The company’s accounts for the financial year that ended on 30 September 1945 showed a net profit of Rs 1,09,165/‑. Although the company paid the income tax and super‑tax that were payable on that profit, it did not declare any dividend out of the earnings. After the Phaltan State merged with the Indian Union and the provisions of the Indian Income‑Tax Act were extended to the territory, the Income‑Tax Officer having jurisdiction over the company issued a notice under section 34 of the Act. Acting under section 23A, the Officer directed that the undistributed assessable income of the company, which amounted to Rs 68,228/‑, should be deemed to have been distributed as dividend to the shareholders as of the date of the company’s General Body Meeting, namely 11 March 1946.

Prior to the issuance of this order, the assessment of the firm Mafatlal Gagalbhai & Sons and the individual assessments of its four partners had already been completed. To bring the deemed dividend declared under section 23A within the charge of tax, notices were served on the four partners under section 31 of the Income‑Tax Act. In response to the notices, the partners appeared and submitted that the forty shares held by three of the partners in the company were, in fact, held on behalf of the registered firm and were held benami for the firm. The Income‑Tax Officer accepted this submission and consequently treated the dividend attributable to those forty shares as income of the firm. He then apportioned that dividend income among the four partners in proportion to the shares each partner held in the firm and added the apportioned amounts to the income that had already been assessed for each partner.

In the course of this procedure, the Officer committed an error. While recomputing the total income of each of the four assessee partners, he included only the net dividend that each partner was to receive, but at the same time he allowed a deduction for the tax that the company had paid on that dividend. No appeal was filed against those assessment orders, and they consequently became final. Subsequently, the mistake was discovered. On 13 April 1954 the Income‑Tax Officer issued fresh notices to the four partners pointing out that the earlier addition of the net dividend to their income was erroneous because the dividend had not been grossed up. At the same time, he allowed a credit for the tax that had been deemed to have been paid by the company on that dividend. The Officer characterized the mistake as apparent from the records and stated his intention to rectify it under section 35 of the Income‑Tax Act.

The four assessee partners lodged objections to the proposed rectification. Almost all of the grounds on which they objected concerned the legality of the original assessment, and the partners asserted that any rectification, if it were to be made, should be limited to those items and not extend to matters for which notice had already been served.

By his order dated 12 October 1955 the Income Tax Officer altered the assessment by adding the dividend income that had previously been omitted and then grossed up that amount by the tax that was deemed to have been paid by the company on that dividend. In doing so he kept the original benefit that had been granted under section 18(5) of the Act. The assessees were not satisfied with this rectification and they attempted to obtain relief by making representations to higher authorities, but those attempts were unsuccessful. Consequently, the four partners filed writ petitions before the High Court, invoking the jurisdiction of Articles 226 and 227 of the Constitution, seeking an order that would prevent the tax authorities from proceeding with the enforcement of the assessment dated 12 October 1955. The learned judges of the High Court entertained the petitions and allowed them, thereby staying the operation of the assessment. After the relief was granted, the Income Tax Officer applied to the same High Court for certificates of fitness under article 133(1)(c). Those certificates were issued, and the parties consequently appealed the High Court’s order, bringing the matter before this Court.

The High Court’s basis for granting relief to the respondents was that the assessment had been made on the premise that the firm Mafatlal Gagalbliai and Sons was the registered shareholder that received the dividend income, and that the individual partners of the firm were only liable for their respective shares of the profits that the firm earned. In that view, the distribution made to the individual partners could not be treated as dividend income within the meaning of section 16(2) of the Income Tax Act. The present appeals therefore arise for the purpose of testing whether that construction of section 16(2) was correct. The Court, however, holds that the appeals must be dismissed on a simple ground without examining the correctness of the High Court’s interpretation of section 16(2). The Court refers to the earlier decision in Messrs. Howrah Trading Co., Ltd. v. The Commissioner of Income‑Tax, Calcutta, where it was held that only the registered shareholder is entitled to the credit for tax paid by the company under section 18(5) and to the corresponding gross‑up under section 16(2). Accordingly, only the three partners in whose names the forty shares were registered could be treated as shareholders for the purposes of sections 16(2) and 18(5). The Income Tax Officer had erred by treating the registered firm as the owner of all forty shares. That original error was not the subject of the rectification sought under section 35; rather, the proceeding under section 35 was intended merely to remove an anomaly that remained in the assessment and to give logical effect to the error that had been made in the assessment dated 12 October 1955, which had been passed after invoking the provisions of the Act.

In its deliberation, the Court examined the argument advanced by the counsel for the respondents that the Income Tax Officer possessed authority under section 35 of the Act to correct mistakes, but that this authority did not extend to merely readjusting the assessment in order to eliminate illogical consequences while allowing the original mistake to persist. The Court found this contention to be well‑founded and accepted that the officer’s jurisdiction was limited to genuine rectification of errors, not to superficial adjustments designed to mask the continued existence of a flawed determination. The Court further observed that the present proceedings could not be employed to cure the fundamental error because the notice issued under section 33, which constituted the basis of the officer’s power to effect a rectification, in reality sought not to correct the mistake but to perpetuate it in a form that the Revenue considered less objectionable. In this context, the Court noted that one of the four partners, Yoginder Mafatlal, did not hold any shares in his own name. Nevertheless, under the order of assessment made pursuant to section 34, he was charged with a tax liability proportionate to his three‑sixteenth share in the firm, a liability that had been partially offset by an improperly granted credit under section 18(5) for tax deemed to have been paid by the company on the same income. Having considered these points, the Court concluded that the appeals could not succeed. Accordingly, the Court dismissed the appeals and, given the circumstances of the case, declined to make any order as to costs.