Commissioner Of Income-Tax, Ahmedabad vs A. Abdul Rahim and Co., Baroda

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

Court: supreme-court

Case Number: Civil Appeal No. 982 of 1963

Decision Date: 04/11/1964

Coram: J.C. Shah, S.M. Sikri, Subba Rao

In this appeal the Commissioner of Income‑Tax of Ahmedabad challenged a decision of the Income‑Tax Officer dated 4 November 1964 relating to the registration of a partnership firm known as A Abdul Rahim & Co., Baroda. The matter was placed before a Bench of the Supreme Court consisting of Justice Subbarao, Justice Shah and Justice Sikri. The judgment was recorded on 4 November 1964 and is reported in 1965 AIR 1703 as well as in the 1965 Supreme Court Reports (2) 13. The case is also cited in various subsequent reports, including R 1965 SC 1708, MV 1966 SC 1490, F 1967 SC 383, RF 1969 SC 493, RF 1970 SC 1343, R 1971 SC 383, and D 1986 SC 1152. The statutory provision at issue was Section 26A of the Income‑Tax Act, 1922, which governs the registration of partnerships having more than two partners and requires that the instrument of partnership specify the individual shares of each partner.

The factual background revealed that an existing partnership consisting of three partners was reconstituted to admit a fourth partner who was the nephew of one of the existing partners. The existing partner transferred a portion of his own share to the nephew, thereby creating a new partnership arrangement. The newly formed partnership applied for registration under Section 26A of the Income‑Tax Act. The Income‑Tax Officer refused to register the firm on the ground that the newly admitted partner was a benamidar—a person holding legal title only on behalf of another—and consequently the officer concluded that the partnership was not a genuine commercial entity. The officer’s refusal was based on the belief that the presence of a benamidar rendered the partnership a sham.

The refusal was subsequently appealed before the Appellate Assistant Commissioner, who upheld the original decision of the Income‑Tax Officer. The appellant then approached the Appellate Tribunal, which reversed the earlier findings and held that the partnership agreement was valid under the law and that the existence of a benamidar did not, by itself, justify denial of registration. On further appeal, the High Court affirmed the Tribunal’s view, emphasizing that the partnership instrument accurately reflected the shares of the partners and that the benamidar status of one partner did not affect the legality or genuineness of the partnership. Both the Tribunal and the High Court therefore concluded that the registration should be granted.

The revenue, representing the Commissioner of Income‑Tax, argued that the fourth partner was a dummy or benamidar and that this fact made the partnership non‑genuine. In addition, the revenue contended that the share of the original partner as disclosed in the partnership agreement was inaccurate because it failed to incorporate the portion that effectively belonged to the benamidar. According to the revenue, this alleged mis‑specification meant that the instrument of partnership did not correctly state the individual shares as required by Section 26A, thereby providing a valid basis for the officer’s refusal to register the partnership.

Having considered the submissions and the statutory provisions, the Court dismissed the appeal. The Court held that an Income‑Tax Officer may refuse registration under Section 26A only when he is convinced that the partnership is not genuine or that the partnership instrument does not correctly specify the individual shares of the partners. Once the officer is satisfied that the partnership is genuine and the instrument correctly records each partner’s share, the mere fact that one partner is a benamidar of another cannot be a ground for refusal. The Court explained that where the partnership is genuine, the share allotted to the benamidar is a proper specification of his individual share in the partnership. While the benamidar’s beneficial interest may be relevant for tax assessment purposes, it is irrelevant to the question of registration under Section 26A. Consequently, the Court upheld the decisions of the Tribunal and the High Court and ordered that the registration of the partnership be allowed.

The Court referred to several earlier decisions that dealt with the question of registration of partnerships under section 26‑A of the Indian Income‑Tax Act, 1922. The authorities cited included the cases of Sons v. Commissioner of Income‑Tax, Calcutta, reported in the 1959 Supplement to the Supreme Court Reports at page 641; the Commissioner of Income‑Tax, Madras v. Sivakasi Match Exporting Co., appearing in the 1964 volume of the Income‑Tax Reports at page 204; and the earlier decision of Sir Sunder Singh Majithia v. Commissioner of Income‑Tax, Central Provinces and Berar, reported in the 1942 volume of the Income‑Tax Reports at page 457. The judgment also mentioned the Central Talkies Circuit case from Matunga, reported in the 1941 volume of the Income‑Tax Reports at page 44, and the case of Hiranand Ramsukh v. Commissioner of Income‑Tax, Hyderabad, reported in the 1963 volume of the Income‑Tax Reports at page 598. The Court distinguished the case of P. A. Raju Chettiar v. Commissioner of Income‑Tax, Madras, reported in the 1949 volume of the Income‑Tax Reports at page 51. The Court further explained that a benamidar functions merely as a trustee for the real owner and does not possess any beneficial interest in the property or the business of that owner. In the same way that a trustee can lawfully enter into a partnership with another individual, the benamidar’s accountability for his share of the profits to a third party, or his right to be indemnified for any losses by a partner, does not alter his legal character. The Court relied on earlier authorities such as Gur Narayan v. Sheo Lal Singh (1918) reported in the Indian Appeals at page 1, and the case of Aruna Group of Estates, Bodinayakanur v. State of Madras reported in the 1962 volume of the Madras Law Journal at page 264, to support this reasoning.

The appeal before the Court was Civil Appeal No. 982 of 1963, filed against the judgment and order dated 4 April and 5 April 1961 of the Gujarat High Court in Income‑Tax Reference No. 8 of 1960. The appellant was represented by counsel, while the respondent was also represented by counsel. The judgment was delivered by Justice Subba Rao. The appeal, which was taken by way of a certificate, raised the question of whether an Income‑Tax Officer could lawfully refuse to register a genuine partnership consisting of more than two persons on the basis that one of the partners was merely a benamidar for another partner. The factual background was that three individuals—Abdul Rahim Valibhai, Abdulla Rehman, and Abdul Rahim Malanghbhai—had formed a partnership with respective shares of nine annas, five annas and two annas, and were engaged in the business of dealing in goat and sheep skins. During the Samvat year 2012, which corresponds to the period from 15 November 1955 to 2 November 1956, the composition of the firm changed when a fourth partner, Abdul Rehman Kalubhai, who was a nephew of Abdul Rahim Valibhai, was admitted to the partnership. His share of two annas was taken out of Abdul Rahim Valibhai’s original nine‑anna share. On 6 March 1956 the four partners executed a partnership deed that allocated the shares as follows: Abdul Rahim Valibhai held seven annas, Abdulla Rehman held five annas, Abdul Rahim Malanghbhai held two annas, and Abdul Rehman Kalubhai held two annas. On 8 May 1956 the partnership applied to the Income‑Tax Officer for registration under section 26‑A of the Act. The Officer concluded that the partnership was a fictitious arrangement and therefore refused registration. The assessee appealed this refusal to the Appellate Assistant Commissioner, who held that the partnership deed was valid in law and that the presence of a benamidar partner was not a ground for denial of registration, although it might permit the Officer to consider the benamidar’s share as part of the real owner’s assessable income. The Revenue then preferred an appeal to the Appellate Tribunal, Bombay Bench, which also upheld the view that the partnership was genuine and that the transfer of a small portion of a partner’s share to his nephew did not disqualify the firm from registration under section 26‑A. The Revenue subsequently raised before the High Court the specific question whether a partnership in which one partner is a benamidar of another could be registered under the said provision of the Income‑Tax Act.

The Appellate Assistant Commissioner held that the partnership deed was valid under the law and that the mere fact that one partner was merely a benamidar, or nominal holder, of another partner’s share did not constitute a reason to refuse registration of the firm. The Commissioner observed, however, that this circumstance could permit the Income‑tax Officer to treat the income attributable to the benamidar’s share as part of the real owner’s income when assessing tax liability. Dissatisfied with this finding, the Income‑tax Officer filed an appeal before the Appellate Tribunal, Bombay Bench. The Tribunal examined the matter and reached the same conclusion, stating that the partnership was genuine and that the act of one partner transferring a small portion of his share to his nephew did not disqualify the partnership from being registered under section 26A of the Indian Income‑tax Act. On the revenue’s request, the question was referred to the High Court for determination. The initial question presented to the High Court was whether a partnership in which one partner is the benamidar of another partner could be registered under section 26A of the Act. The learned judges of the High Court found that this formulation did not capture the real dispute between the parties. Consequently, they restated the issue as follows: whether, on the facts and circumstances of the case, the partnership created by the instrument dated 6 March 1956 could be registered under section 26A of the Indian Income‑tax Act. After considering the evidence, the High Court answered affirmatively. It held that because the partnership was genuine, the fact that one partner held a share only nominally, due to an internal arrangement with another partner, did not deprive the firm of the right to register under the statute. The revenue consequently filed an appeal against this judgment.

In the present appeal, counsel for the Revenue raised two principal points. First, it was submitted that Abdul Rehman Kalubhai was merely a dummy partner, and therefore the partnership could not be regarded as genuine. Second, counsel argued that even if Abdul Rehman Kalubhai was a benamidar for Abdul Rahim Valibhai concerning the two‑annas share, the real owner, Abdul Rahim Valibhai, effectively possessed nine annas of the partnership. The partnership deed, however, recorded his share as only seven annas, which, according to counsel, meant that there was no correct specification of his individual share as required by section 26A of the Act. Consequently, counsel maintained that the Income‑tax Officer was justified in rejecting the firm’s application for registration. Counsel for the respondent, in contrast, contended that the issue of whether the partnership was genuine was a question of fact, one which the Tribunal had already examined and therefore should not be reopened before this Court. He further argued that, assuming the partnership was genuine, the internal arrangement whereby one partner acted as a benamidar for another did not affect the partnership’s validity or its eligibility for registration under the Act.

The Court held that the circumstance of one partner being a benamidar of another does not diminish the partnership’s validity nor render it unregistrable under the Act. In order to understand the parties’ arguments, the Court first set out the relevant statutory provisions of Section 26A of the Act and the accompanying rules. Section 26A provides that (1) an application may be submitted to the Income‑tax Officer on behalf of any firm that is constituted under an instrument of partnership which specifies each partner’s individual share, for registration under this Act and any other law then in force relating to income‑tax or super‑tax; and (2) the application must be made by the persons required, at the times prescribed, and must contain the particulars, form, and verification method prescribed, with the Income‑tax Officer handling the application in the manner also prescribed. The rules made under Section 59 of the Act, namely Rules 2 to 6B, govern the registration of firms. Rule 2 states that any firm formed under an instrument of partnership that specifies the partners’ individual shares may, under Section 26A of the Indian Income Act, 1922 (referred to in the rules as “the Act”), apply to the Income‑tax Officer to register the particulars contained in that instrument, and that such an application must be signed personally by all the partners. Rule 4 provides that when the Income‑tax Officer receives the application referred to in Rule 3 and is satisfied that a firm, as shown in the instrument of partnership, existed or exists and that the application has been properly made, the Officer shall enter, in writing at the foot of the instrument or its certified copy, a certificate in the prescribed form. Rule 6B authorises the Income‑tax Officer, if he is satisfied that the certificate granted under Rule 4 or Rule 6A was obtained without a genuine firm being in existence, to cancel that certificate. The Court then considered these provisions, among others, and referred to its earlier decision in R. C. Mitter & Sons v. Commissioner of Income‑tax, Calcutta, where Justice Sinha explained that for a firm to be eligible for registration under Section 26A, five essential conditions must be fulfilled: (i) the firm must be constituted under an instrument of partnership that specifies each partner’s individual share; (ii) an application on behalf of, and signed by, all the partners, containing all particulars required by the Rules, must be made; (iii) the application must be filed before the firm’s assessment under Section 23 for that year; (iv) any profits or losses of the business for the accounting year must have been divided or credited in accordance with the terms of the instrument; and (v) the partnership must be genuine and actually exist in conformity with the instrument’s terms during the accounting year.

In discussing the requirements for a partnership to be registered under section 26A of the Income‑Tax Act, the Court reiterated that the partnership must be genuine and must have actually existed in conformity with the terms and conditions set out in the instrument of partnership for the relevant accounting year. The Court also referred to its earlier decision in Commissioner of Income‑tax, Madras v. Sivakasi Match Exporting Co., where it held that the jurisdiction of the Income‑tax Officer is limited to determining two matters: first, whether the application for registration complies with the rules made under the Act; and second, whether the firm presented in the registration document is fictitious or lacks legal existence. Consequently, settled law dictates that when a partnership is genuine and valid, the Income‑tax Officer lacks authority to refuse registration provided that all other requirements of section 26A and the applicable rules are satisfied. In the case before the Court, the partnership was found to be genuine. All procedural formalities required by the rules had been fulfilled, and the individual shares of the partners specified in the instrument of partnership were accurately reflected in the registration application. Accordingly, unless a legal impediment exists that prevents a benamidar of one of the partners from being a partner of the firm, the Income‑tax Officer would exceed his jurisdiction by rejecting the registration application.

The Court then turned to the substantive question of whether a benamidar of a person may be recognised as a partner of a firm. Under section 2(6B) of the Income‑tax Act, the terms “firm”, “partner” and “partnership” bear the same meanings as those in the Indian Partnership Act, 1932, with the clarification that “partner” also includes a minor admitted to the benefits of partnership. Section 4 of the Indian Partnership Act defines “partnership” as the relationship among persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Since the partnership in the present matter was held to be genuine, it follows that the four individuals named in the partnership deed must be deemed to have agreed to share the profits of the business in accordance with the provisions of that deed. The instrument of partnership and the registration application both contain explicit statements confirming that each of the four partners possesses a definite share of the firm’s profits. The Court also cited the judgment of the Judicial Committee in Sir Sundar Singh Majithia v. Commissioner of Income‑tax, C.P. & U.P., where the Board, through Sir George Rankin, observed that when an instrument of partnership is presented under section 26A, a question may arise as to whether the instrument is intended to have real effect in governing the rights and liabilities of the parties, or whether it has been fabricated merely to evade tax liability. This observation framed the further analysis of the benamidar’s eligibility to be a partner.

In this case the Court examined whether a partnership instrument was created with the genuine intention of defining the rights and liabilities of the parties among themselves, or whether it was merely a façade intended to avoid tax liability and lacked any real intention to govern the parties’ inter‑se relationships in the business. The Court explained that to determine that such an instrument is not genuine requires a factual finding. The Tribunal had previously found that the Instrument of Partnership was genuine. Consequently, the Court held that the instrument was not a pretence to escape tax liability; rather, it truly defined the rights and obligations of the parties in relation to each other.

The Court then turned to the question of whether a benamidar, a person in whose name property is held but who has no beneficial interest, can be regarded as a partner under the law. Referring to the judgment of the Judicial Committee in Gur Narayan v. Sheo Lal Singh (1) (1942) 10 I.T.R. 457, 461‑462, the Court quoted the definition that a benamidar “has no beneficial interest in the property or business that stands in his name; he represents, in fact, the real owner, and so far as their relative legal position is concerned he is a mere trustee for him.” The Court observed that most Indian judicial opinion supports the view that in any proceeding involving a benamidar, the beneficial owner is fully bound by the doctrine of res judicata. Citing the decision of the Madras High Court in Aruna Group of Estates, Bodinayakanur v. State of Madras (2) (1962) 2 M.L.J. 294, the Court noted that the benami character does not diminish a benamidar’s capacity to be a partner nor affect his relationship with the other partners. The High Court had explained that if a partner is merely a benamidar for another, this merely means that he must account for the profits earned from the partnership to the real owner. Accordingly, a benamidar is a trustee of the real owner and possesses no beneficial interest in the owner’s property or business. Nevertheless, the Court affirmed that, like a trustee, a benamidar is capable of entering into a partnership with others. The Court then considered whether any legal principle prohibits a benamidar who is a partner from simultaneously being a partner with other individuals. It concluded that, with respect to the other partners, the benamidar has a separate and real existence, is governed by the partnership deed, and his rights and duties are determined by that deed and by the provisions of the Partnership Act. His liability to third parties for partnership acts is equal to that of the other partners, and the other partners have no direct relationship with the real owner, but may look to the benamidar to enforce their rights or satisfy obligations under the partnership agreement.

In the case, the Court observed that the other partners were entitled to seek performance of their rights or to demand fulfillment of their obligations solely from the benamidar, and that such claims had to be made under the terms of the partnership deed. The Court further explained that any private arrangement that might exist between the benamidar and another partner did not fall within the scope of the partnership agreement; such an arrangement operated only on the profits that accrued to the benamidar and therefore remained outside the legal relationship created by the partnership. The Court held that even if a benamidar possessed the legal capacity to become a partner in his own name, the fact that he was required to account for his profits to a third party, or that he possessed a right to be compensated for his losses by either a third party or by another partner, did not remove his capacity to act as a partner. The Court cited two authorities, namely (1) the 1918 case reported in L.R. 46 I.A. 1 at page 9, and (2) the 1962 decision reported in 2 M.L.J. 294, to support this proposition.

The Court acknowledged that distinct issues might arise when a partnership consisted of only two persons, one of whom was a benamidar of the other. In such a scenario, the Court explained, the partnership could be considered invalid not because the benamidar lacked authority to join the partnership, but because the law defines a partnership as a relationship between at least two distinct persons, and when the benamidar merely represented the real owner, the legal relationship in fact involved only one person. The Court also observed that if a benamidar were admitted as a partner with the consent of the remaining partners, he might function merely as a “dummy” partner. The Court expressly stated that it would not express a final opinion on these two questions, since they did not arise for consideration in the present appeal.

The Court then referred to a decision of a Division Bench of the Bombay High Court in The Central Talkies Circuit, Matunga, In re (1), which held that there was sufficient evidence for the Income‑tax authorities to conclude that the alleged partnership was not a genuine partnership, and that the authorities were therefore justified in refusing registration of the firm. The Court noted that this finding alone was adequate to dispose of the reference before it. However, the Court also noted that Chief Justice Beaumont, C.J., while delivering the judgment, made certain observations that appeared to support the appellant’s contention. The Chief Justice was quoted as saying, “Speaking for myself, I should say that if it were shown that one of the partners was only a nominee of a share allotted to him or her for another partner, the deed would not then specify correctly the individual shares. I think it must specify correctly the individual and beneficial shares, because that is a matter which is relevant from the point of view of the Income‑tax authorities. If the Assistant Commissioner had any evidence before him to lead to the conclusion that the mother in the case was not really entitled to a beneficial interest of 4 1/2 annas share, I think he was justified in refusing to register the deed.”

With due respect, the Court indicated that it could not agree with the observations of the Chief Justice. The Court reiterated that if a benamidar possessed the character of a trustee and could therefore enter into a partnership in his own name, the share allotted to him in the partnership must be interpreted as correctly specifying his individual share. The discussion concluded with a reference to Kania, J., as he then was.

The Court observed that the earlier judge had not expressed any view on the particular issue under consideration. The Court then referred to a decision of a Division Bench of the Andhra Pradesh High Court in Hiranand Ramsukh v. Commissioner of Income‑tax, Hyderabad, which held that a person who was named as a partner in a partnership deed but who was not a genuine partner rendered the income‑tax officer fully justified in refusing to register the firm. In that case the assessee firm had originally consisted of two partners, Ramprasad and Bhagwandas, who each held an equal share. After the death of Bhagwandas, Ramprasad admitted his aunt, Mrs. Chandrabai, and his minor son as partners. The income‑tax officer examined the arrangement and concluded that both Mrs. Chandrabai and the minor son were not genuine partners; rather, they were merely dummies whose names had been placed in the deed to reduce the tax burden. Because two of the three persons listed as partners were not genuine, the officer held that the partnership itself was not genuine. The Court noted that, although some observations in that judgment were broad, the decision did not control the present matter.

The Court also mentioned a judgment of the Madras High Court in P. A. Raju Chettiar v. Commissioner of Income‑tax, Madras, where the court similarly found that the partnership was not genuine; that decision, too, was considered irrelevant to the case at hand. The Court then set out the applicable legal position. It stated that when a firm files an application for registration under section 26A of the Income‑tax Act, the income‑tax officer may refuse registration if he is satisfied that the partnership is not genuine or that the partnership instrument does not correctly specify each partner’s individual share. However, once the officer is convinced that the partnership is a genuine and valid entity, he cannot refuse registration on the ground that one of the partners is a benamidar (a nominee) of another partner. In a genuine and legal partnership, the share allotted to the benamidar accurately reflects his individual share in the firm. The Court explained that any beneficial interest that the benamidar may have in the income attributable to his share could be relevant for assessing tax liability, but it was not relevant to the question of registration.

On the basis of this reasoning, the Court affirmed that the answer rendered by the High Court was correct. Consequently, the appeal was dismissed, and the party bringing the appeal was ordered to bear the costs of the proceedings. The appeal was therefore dismissed with costs.