Commissioner Of Income-Tax, Hyderabad vs Sri Rajareddy Mallaram

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 290 of 1963

Decision Date: 20 November 1963

Coram: J.C. Shah, A.K. Sarkar, M. Hidayatullah

In this case the Supreme Court examined a dispute between the Commissioner of Income‑Tax, Hyderabad and Sri Rajareddy Mallaram concerning the assessment of tax on a dissolved business association. The association consisted of three persons who had been carrying on a liquor business, and it had been formally dissolved. No tax return had been filed either by the dissolved association or by any of the individual members. The Income‑Tax Officer issued a notice under section 34 of the Income‑Tax Act requiring Baba Gowd, one of the members, to file a return of the association’s income, but Baba Gowd failed to do so. Consequently, the Officer assessed the taxable income of the dissolved association under section 23(4) of the Act and calculated the tax payable. Efforts to recover the tax from Baba Gowd were unsuccessful, after which the Officer issued a notice of demand to another member of the dissolved association, the respondent, Sri Rajareddy Mallaram. The respondent applied for cancellation of the assessment under section 27, but the Income‑Tax Officer rejected the application. The Appellate Assistant Commissioner then ordered the cancellation of the assessment and directed that a fresh assessment be made after giving the respondent an opportunity to file a return and to produce supporting evidence.

The Income‑Tax Appellate Tribunal held that a valid assessment order had already been made and that there was no basis for issuing a fresh notice of assessment or for conducting a new assessment. At the respondent’s request, the Tribunal referred two questions to the High Court: whether the assessment order dated 30 September 1953, made under section 23(4), was legally defective, and whether the respondent was liable for the tax determined in that order pursuant to section 44 of the Income‑Tax Act. The High Court concluded that the assessment order was invalid in law and that the respondent was not liable for the tax. On appeal, the Supreme Court held that the assessment order made under section 23(4) on 30 September 1953 was not bad in law and that the respondent was indeed liable for the amount of tax determined by that order. The Court explained that under Chapter IV of the Income‑Tax Act an association of persons may be assessed as a single unit or each member may be assessed separately in respect of his share of the income. The Act contains no mechanism for assessing the income of an association collectively in the hands of its members after dissolution, and therefore the “tax payable” referred to in section 44 must be understood as tax that the association, but for its dissolution, would have been required to pay.

In this matter the Court explained that an association of persons may be taxed either as a single unit or, alternatively, each individual member may be taxed on his own share of the income. The Act does not provide any mechanism for assessing the income that an association receives as a whole and then distributing that assessment among its members collectively. Consequently, the proper unit of assessment for the income earned by an association is either the association itself or each member taken separately in respect of his proportionate share. This rule applies while the association continues to exist and it remains applicable after the association has been dissolved. The Court emphasized that a partial assessment of an association’s income, limited only to the portion belonging to a member who has been served with a notice of assessment, is not permissible. The notion that only those members who actually receive a notice of assessment become bound by the assessment was rejected as untenable. The Court further interpreted the phrase “tax payable” in section 44 to mean the tax that the association would have been liable to pay if it had not been dissolved or if its business had not been discontinued. By virtue of section 44, the legal personality of the association is deemed to continue for the purpose of assessment. What may be assessed, therefore, is the income that the association earned before its dissolution, and the members of the dissolved association are jointly and severally liable for that tax in their capacity as members. For such assessment the procedure applicable to a continuing association is to be followed as if the association had never ceased to exist. Accordingly, a notice issued to the appropriate person under section 63(2) suffices to empower the tax authority to levy tax on the association. The argument that the respondent could not be liable because he had not personally received a notice of assessment was rejected as unfounded. The Court referred to the earlier decision in C.A. Abraham, Uppoottil, Kottayam v. Income‑tax Officer, Kottayam, [1961] 2 S.C.R. 765. The judgment recorded that the appeal, identified as Civil Appeal No. 290 of 1963, arose from a judgment and order dated 19 January 1960 of the Andhra Pradesh High Court in case referred No. 7 of 1958. Counsel for the appellant and counsel for the respondent were listed, and the judgment was delivered on 20 November 1963 by Justice Shah. The factual background disclosed that Baba Gowd, P.V. Rajareddy and Rajareddy Mallaram had formed an association of persons known as “Nizamabad Group Liquor Shops”, hereinafter referred to as the Group, for the purpose of conducting liquor contracts for the former State of Hyderabad during the Fasli year 1358 (1 October 1948 to 30 September 1949). When that fiscal year ended, the contracts expired, the business ceased, and the Group was dissolved. The Group failed to file an income return as required by the general notice under section 22(1) of the Income‑tax Act. Subsequently, the Income‑tax Officer of Nizamabad Circle issued a notice under section 34 of the Act directing Baba Gowd, a member of the Group, to file the required return.

In this matter the income‑tax officer issued a notice under section 34 of the Income‑Tax Act requiring Baba Gowd, who was a member of the dissolved Group, to file a return of the Group’s income, but Baba Gowd failed to file the return by the statutory due date. Consequently the officer proceeded to make an assessment of the Group’s taxable income under section 23(4), fixing the assessable amount at Rs 51,000 and fixing the tax liability at Rs 8,826‑14‑0. Subsequent attempts by the Income‑Tax Department to recover the tax from Baba Gowd were unsuccessful, and on 13 March 1954 the officer issued a separate notice of demand addressed to another member of the Group, Rajareddy Mallaram. Rajareddy Mallaram then filed an application under section 27 of the Income‑Tax Act seeking cancellation of the assessment, but the officer rejected the application. Rajareddy Mallaram appealed the rejection to the Appellate Assistant Commissioner, who set aside the officer’s order and directed the officer to cancel the assessment made under section 23(4) and to make a fresh assessment, provided that Rajareddy Mallaram be given an opportunity to file a return and to produce the books of account of the dissolved Group. The Income‑Tax Appellate Tribunal, Hyderabad Branch, subsequently modified the order of the Appellate Assistant Commissioner. The Tribunal held that a valid assessment under section 23(4) had already been made and therefore there was no basis for issuing a fresh notice to Rajareddy Mallaram or for making a fresh assessment. However, the Tribunal also directed the Appellate Assistant Commissioner to consider whether Rajareddy Mallaram had been prevented by sufficient cause from filing the return.

At the instance of Rajareddy Mallaram, the Tribunal referred two questions to the Andhra Pradesh High Court for determination. The first question asked whether, on the facts and circumstances of the case, the assessment order dated 30 September 1953 made by the income‑tax officer under section 23(4) was bad in law. The second question asked, assuming the first answer to be negative, whether the applicant was liable for the tax amount determined in that assessment by virtue of section 44 of the Income‑Tax Act. The High Court answered the first question in the affirmative, holding that the assessment order was indeed void, and it declined to answer the second question. In reaching its conclusion the Court recorded several findings: (i) the assessment was void because the officer had assessed the association as a whole rather than the individual members who were members at the time of dissolution, and because no notice under section 22(4) had been served on the petitioner, the assessment could not bind the petitioner; (ii) consequently the petitioner was not liable for the tax amount specified in the assessment dated 30 September 1953.

The Court noted that the sole question before the assessing authorities was whether the assessment order dated 30‑9‑1953 could be enforced against members of the Group who had not been served with notice, since the assessment had been made after the Group’s dissolution and only one member had received a notice. The Court then set out the material portion of section 44 of the Income‑tax Act, as it existed before its amendment by section 11 of the Finance Act XI of 1958, which read: “Where any business, profession or vocation carried on by an association of persons has been discontinued, or where an association of persons is dissolved, every person who was at the time of such discontinuance or dissolution a member of such association shall, in respect of the income, profits and gains of the … association, be jointly and severally liable to assessment under Chapter IV and for the amount of tax payable and all the provisions of Chapter IV shall, so far as may be, apply to any such assessment.” The Court explained that this provision expressly imposed joint and several liability on each member of a discontinued or dissolved association for the association’s income, profits, gains and the tax due thereon. The Group in the present case had indeed discontinued its business at the end of Fasli year 1358 and had also been dissolved; consequently, every person who was a member at that time was, by the clear terms of section 44, liable to be assessed jointly and severally for the Group’s income, profits, gains and the tax payable. In examining the scheme of section 44 as it stood before the 1958 amendment, the Court referred to the decision in C.A. Abraham, Uppoottil, Kottayam Y. The Income‑tax Officer, Kottayam and another, observing that the legislature had enacted section 44 so that assessment proceedings could continue against a firm whose business had been discontinued as if discontinuance had not occurred, described the provision as a “fiction” whereby the firm was deemed to continue for the purpose of assessment under Chapter IV. In that case the Court addressed the assessment of a firm whose business was discontinued because of dissolution caused by the death of a partner, and it pointed out that section 44, as amended by Act 7 of 1939, applied to discontinuance of the business of associations of persons as well as to firms, citing the report at (1)[1961] 2 S.C.R. 765 at p. 770.

In this case, the Court observed that the question directly presented for determination was whether a penalty imposed for either concealing the particulars of income or for deliberately furnishing inaccurate particulars of income in a return could be lawfully levied after the business of the firm had been discontinued. The Court noted that, although the validity of the order that assessed the firm had not been expressly challenged, the assessment order had been issued at a time when the firm was already dissolved and its business was discontinued. Nevertheless, the Court held that it could not decide the validity of the penalty order without first deciding whether a valid assessment existed, because an order imposing a penalty presupposes a valid assessment. Accordingly, the Court indicated that any determination on the penalty required a prior determination on the existence and validity of the underlying assessment against the dissolved entity.

The respondent’s counsel argued that even if the assessment made after the dissolution of the group were to be regarded as valid, the assessment would bind only those persons who had been served with the notice calling for a return. To support this contention, counsel relied upon the statutory clause that provides that “every person who‑was at the time of such dissolution, a member of such association shall in respect of the income of the association be jointly and severally liable to assessment.” Counsel urged that the expression “every person” in section 44 was intended to mean all persons, and that the use of the words “jointly and severally” indicated that, after the association is dissolved, only the members who were members at the date of dissolution could be assessed with respect to the income of the association. As a further corollary to this line of argument, counsel submitted that all members who are sought to be assessed must be individually served with a notice of assessment, and that any member who does not receive such a notice would not be bound by the assessment. The Court noted that this line of reasoning was plainly inconsistent with the observations made in Abraham’s case.

The Court explained that if, by virtue of section 44, the continuity of the firm or association is ensured for the purpose of assessment, then no question of assessing the individual members of the association can arise. The Court referred to the authority in Abraham’s case, citing [1961] 2 S.C.R. 766 at p. 770, to underline that under Chapter IV of the Income‑Tax Act an association of persons may be assessed either as a unit of assessment or by assessing the individual members separately in respect of their respective shares of income, but the Act contains no mechanism for assessing the income received by an association in the collective hands of its members. Accordingly, the unit of assessment for the income earned by the association is either the association itself or each individual member in respect of his share of the income. This principle applies both while the association is existing and after it has been dissolved. The Court therefore held that there can be no partial assessment of the association’s income limited to the share of the member who was served with a notice of assessment. For the purpose of assessment, the Income‑Tax Act invests the association with a personality distinct from that of its members, and if that personality is continued for the purposes of Chapter IV, the theory of assessment cannot be confined only to members who were served with notice; it binds the association as a whole.

In this case the Court observed that an assessment served on a person who has not been given proper notice cannot be considered valid. The Court supported this observation by referring to the expression “tax payable” found in section 44 of the Income‑Tax Act. The Court explained that, in the context of that provision, the phrase can only denote the tax that would have been assessed against the association if the association had not been dissolved or had not discontinued its business. The Court further noted that the main purpose of section 44 is to bring the income of an association within the tax net after the association has been dissolved or its business has ceased, and that the provision does not contemplate assessing only a fractional share of that income. According to the Court, the effect of section 44 is simply to ensure that the assessment machinery set out in Chapter IV of the Act continues to operate and that tax liability can still be imposed even though the association’s business has been discontinued or the association has been dissolved. By operation of section 44, the legal personality of the association is deemed to survive for assessment purposes, and Chapter IV therefore continues to apply to it. The Court stated that what may be assessed is the income earned by the association before its dissolution, and that the members of the association are jointly and severally liable for that income in their capacity as members. For such assessment the Court said that the procedure applicable to the income of an association that had continued to exist is to be followed. Consequently, a notice issued to the appropriate person under section 63(2) is sufficient to authorize the tax authority to assess tax on the association. The Court rejected the argument that the respondent could escape liability because he had not been personally served with a notice of assessment. The Court also recorded that counsel for the respondent argued that the original assessment made under section 23(4) was invalid because the notice of assessment had not been served on the Group in the manner required by section 63(2) of the Income‑Tax Act, contending that Baba Gowd, who had received the notice, was not the principal officer authorized to receive such notice on behalf of the Group. The Court observed that this contention had never been raised before the Tribunal, that it did not arise from the Tribunal’s order, and that the question referred by the Tribunal to the High Court did not justify consideration of that plea. The Court held that the respondent could not be permitted to raise a question that did not originate from the Tribunal’s order and had not been referred. Accordingly, the case had to be decided on the basis that the notice of assessment was properly served on Baba Gowd and that the assessment was correctly made by the Income‑Tax Officer under section 23(4). The Court concluded that the answer to the first question was negative; if the assessment order is valid, the respondent’s application to set aside the assessment on the ground of non‑service of notice must fail. The Court then answered the second question by holding that the applicant was liable for the amount of tax payable under the assessment order.

The Court observed that the assessment order required the respondent to pay the tax amount that had been determined under that order. Consequently, the Court concluded that the appeal raised by the petitioner was maintainable and warranted a favorable judgment. Accordingly, the Court formally allowed the appeal, thereby setting aside the previous adverse decision of the lower tribunal. In the order, the Court directed that the respondent bear all costs incurred in pursuing this appeal before this Court. The same cost liability was also imposed for the expenses that the respondent will have to meet in the subsequent proceedings before the High Court. Thus, the respondent has been ordered to pay the costs of this appeal both in this Court and in the High Court. The judgment concludes with a clear statement that the appeal is allowed, confirming the relief sought by the petitioner. The Court’s decision thereby confirms that the tax liability under the assessment order remains enforceable against the respondent until satisfied. It further emphasizes that the respondent's failure to comply with the assessment will not absolve him from the responsibility to discharge the assessed tax. Accordingly, the respondent must ensure prompt payment of both the tax dues and the cost orders to avoid further enforcement actions.