Commissioner Of Income-Tax, Madras vs Bagyalakshmi and Co., Udamalpet

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 1099-1101 of 1963

Decision Date: 4 November, 1964

Coram: J.C. Shah, S.M. Sikri, K. Subbarao

The case concerned an application for registration of a partnership firm under section 26A of the Indian Income‑Tax Act of 1922. The petitioner was the Commissioner of Income‑Tax for Madras, and the respondent was Bagyalakshmi & Co., a firm located at Udamalpet. The judgment was delivered on 4 November 1964 by a Bench of the Supreme Court of India comprising Justice J. C. Shah, Justice S. M. Sikri and Justice K. Subbarao. The matter was reported in 1965 AIR 1708 and in the Supreme Court Cases, volume 2, page 22, with subsequent citations in later reports.

G, a member of a Hindu undivided family, and his son V acted as representatives of that family and were partners in the assessee‑firm. Through them the family held an undivided interest of ten annas in the firm. On 24 August 1950 the family underwent a partition, and the partition deed allotted the ten‑anna family interest among seven members. Under that deed G’s share became two annas and V’s share became one anna and four pies. Subsequently, on 30 November 1950 the partners of the firm prepared a new partnership deed in which G and V were respectively assigned shares of seven and a half annas and two and a half annas, a distribution that differed from that set out in the partition deed.

The firm then applied for registration under section 26A for the assessment years 1952‑53, 1953‑54 and 1954‑55, relying on the new partnership deed. The Income‑Tax authorities accepted the registration and assessed G and V on the basis of the shares specified in the partnership deed. G and V contended that for the first two assessment years they should be liable for tax only on the shares shown in the partition deed, that is two annas and one anna four pies respectively. The Income‑Tax Appellate Tribunal accepted that contention and allowed the assessment on the lower shares.

Acting under section 33B of the same Act, the Commissioner of Income‑Tax cancelled the registration of the partnership for the three years, holding that the partnership deed did not reflect the correct shares of the partners. The Tribunal, on appeal by the Commissioner, affirmed the Commissioner’s order. The matter was then referred to the High Court of Judicature at Allahabad, where two questions were posed: whether the Commissioner’s action under section 33B was lawful, and whether the firm could be registered under section 26A for the assessment years in dispute. The High Court answered both questions in favour of the assessee, concluding that the firm was properly registerable and that the Commissioner’s cancellation was not justified.

Unsatisfied with the High Court’s decision, the Commissioner appealed to the Supreme Court. The Revenue argued that because the partnership deed failed to specify the correct shares of G and V as determined by the partition deed—showing them as holding seven and a half annas and two and a half annas respectively, rather than the two annas and one anna four pies to which they were entitled—the Tribunal had correctly held that the partnership could not be registered under section 26A. The Supreme Court was therefore called upon to examine whether the partnership deed’s discrepancy affected the firm’s eligibility for registration and whether the Commissioner’s cancellation under section 33B was proper.

It was observed that the partnership deed did not state the correct shares of the partners identified as G and V. According to the partition deed, G was entitled only to a share of two annas and V to a share of one anna and four pies, but the partnership deed recorded G as holding seven and one‑half annas and V as holding two and one‑half annas. On that basis the Tribunal held that the partnership could not be registered under section 26A of the Act, a conclusion that the Court accepted as correct. The Court then set out the principle that a contract of partnership governs only the rights and liabilities among the partners themselves and does not create any obligation of the partners to persons outside the partnership as to how the profit is divided. A partner may simultaneously hold other positions such as the karta of a joint Hindu family, a trustee, a sub‑partner, a representative of a group of persons, or a benamidar for another individual. In each of those situations the partner occupies a dual role: in relation to the partnership the partner acts in his personal capacity, while in relation to third parties the partner acts as a representative. Consequently, third parties that a partner represents cannot enforce any right directly against the other partners, nor can the other partners enforce rights directly against those third parties. The only entitlement of such third parties is to receive, in accordance with law or the terms of an agreement, the share of profits that accrues to their partner‑representative. The Court noted that the law governing partnerships and the Hindu law operate in separate spheres. Members who have been divided from a joint family may, under an arrangement among themselves, form a partnership with external parties. Their respective shares in the partnership are determined by the terms of the partnership deed, whereas their interests in the partnership as representatives of the divided family are determined by the provisions of the partition deed. In this case the High Court had answered the questions correctly. Because the partnership deed was genuine, the shares assigned to G and V under that deed were proper according to the terms of the deed itself. The Court referred to the authorities Commissioner of Income‑tax, Ahmedabad v. M/s. A. Abdul Rahim and Co., (1965) 2 S.C.R. 12, and Charandas Haridas v. Commissioner of Income‑tax, Bombay, (1960) 3 S.C.R. 296, which were relied upon in reaching its conclusion. The matter arose as civil appeals numbered 1099 to 1101 of 1963, taken on special leave from a judgment dated 24 January 1961 of the Madras High Court in RC No. 143 of 1956. Counsel for the appellant and counsel for the respondent argued before the Court, and the judgment was delivered by Justice Subba Rao. These appeals presented a question similar to that decided earlier in Commissioner of Income‑tax, Ahmedabad v. M/s. A. Abdul Rahim and Co., where the assessee‑firm had acted as Managing Agents of

In this case, the firm Palani Andavar Mills Ltd., Udamalpet, had been originally constituted by a deed of partnership dated June 1 1934. The partnership named six persons as partners, allocating to each the following shares: G Venkataswami Naidu – two annas; G T Narayanaswamy Naidu – two annas; G T Krishnaswamy Naidu – two annas; M A Palaniappa Chettiar – five annas; R Guruswamy Naidu – two and a half annas; and K Venkatasubba Naidu – two annas. Subsequent transactions altered this original shareholding. The share belonging to G Venkataswami Naidu was transferred to his son Vidyasagar, and the share belonging to M A Palaniappa Chettiar was purchased by R Guruswamy Naidu. As a result, the partner identified as the fifth partner, R Guruswamy Naidu, held a total of seven and a half annas instead of the earlier two and a half annas. Both Guruswamy Naidu and Venkatasubba Naidu were members of a Hindu undivided family, and the beneficial interest in their partnership shares belonged to that family; indeed, in earlier years the joint family had been assessed on the income attributable to those shares.

On August 24 1950 the Hindu undivided family was divided by execution of a partition deed among its members. Under the deed the ten annas share that had previously belonged to the family was allocated as follows: R Guruswamy Naidu – two annas; Venkataramana – three annas; Subba Naidu – two annas; Venkatasubba Naidu – one and a quarter annas; Rudrappa Naidu – one and a quarter annas; and Jagannatha Naidu – one and a quarter annas. After the partition, a new partnership deed was executed on November 30 1950 among the partners of the assessee‑firm. The new deed allotted the shares in this manner: R Guruswamy Naidu – seven and one third annas; R Venkatasubba Naidu – two and one third annas; G T Narayanaswamy Naidu – two annas; G T Krishnaswamy Naidu – two annas; and Vidyasagar – two annas.

The point to be noted is that the beneficial interest in the original ten annas share belonged to the Hindu undivided family of which Guruswamy Naidu and Venkatasubba Naidu were members. Both individuals remained partners of the firm before and after the family partition. Prior to the partition the beneficial interest in the ten annas share rested in the undivided family; after the partition the beneficial interest passed to the divided members of the family, including the two partners themselves. The assessee‑firm presented the November 30 1950 partnership deed to the Income‑tax Officer for registration for the assessment years 1952‑53, 1953‑54 and 1954‑55, and the deed was duly registered under section 26A of the Indian Income‑tax Act, 1922. Subsequently, Guruswamy Naidu and Venkatasubba Naidu were assessed as partners of the assessee‑firm on the basis of the shares shown in the partnership deed. However, the Income‑tax Appellate Tribunal, with respect to two of those assessments, accepted the partners’ contention and held that they were liable only to pay tax in respect of the shares shown in

After the Income‑Tax Appellate Tribunal had accepted the partners’ contention and held that they were liable only for the shares shown in the partition deed, the Commissioner of Income‑Tax, exercising the power granted by section 33B of the Act, cancelled the registration of the partnership on the ground that the partnership deed did not disclose the correct shares of the partners. The Appellate Tribunal affirmed the Commissioner’s order with respect to the three assessment years 1952‑53, 1953‑54 and 1954‑55. The firm then asked the Madras High Court to consider two questions of law: first, whether the Commissioner’s order under section 33B cancelling the firm’s registration for those three years was lawful; and second, assuming the answer to the first question was affirmative, whether the firm could nevertheless be registered under section 26A of the Act for the same assessment years.

A Division Bench of the Madras High Court, hearing the reference, concluded that the partnership was a genuine one. It observed that although the partition of the joint Hindu family, which allotted specific shares to the family members, might have affected the partners’ accountability to the other family members, the partners’ relationship to the other partners in the firm remained unchanged. Consequently, the Bench held that the Tribunal had erred in refusing registration of the partnership. Accordingly, the Court answered the first question in the negative, finding the Commissioner’s order unlawful, and answered the second question in the affirmative, holding that the firm was registrable under section 26A for the years in question.

The Attorney‑General, appearing for the Revenue, argued that the partnership deed failed to specify the correct shares of Guruswamy Naidu and Venkatasubba Naidu. According to the partition deed the two partners were entitled only to two annas and one anna four pies respectively, yet the partnership deed recorded their shares as seventy‑one annas and two and a half annas. On this basis, the Revenue contended that the Tribunal was right in deciding that the partnership could not be registered under section 26A.

Counsel for the respondent countered that the partition of the family’s beneficial interest in the partnership’s business was irrelevant to the question of registration. He maintained that the relevant authorities examined only the validity and genuineness of the partnership deed executed by the partners and did not consider the partners’ dealings with third parties concerning their individual shares. Citing the decision in The Commissioner of Income‑Tax, Ahmedabad v. M/s. A. Abdul Rahim and Co., Baroda(1), he noted that an Income‑Tax Officer may refuse registration if the firm is not genuine or valid or if the registration application does not comply with the rules under the Act. He emphasized that the partnership in this case was genuine and could not be said to be invalid; the only objection was the discrepancy between the shares shown in the partition deed and those recorded in the partnership deed.

The Court explained that when the distinction among three separate concepts is kept in mind, much of the apparent confusion in the matter disappears. It observed that a partnership is fundamentally a creature of contract, created solely by the mutual agreement of the persons who become partners. Under Hindu law, a joint family is regarded as a status group, and the right of partition is merely one of the incidents that may arise within that status. The Income‑tax statutes empower the Income‑tax Officer to assess the income of any person in accordance with the procedures and provisions laid down in the Act. Except where a specific provision of the Income‑tax Act expressly overrides any other statutory or personal law, its provisions must be read in the context of the relevant body of law. A partnership contract does not deal with the partners’ obligations to third parties concerning the share of profit that each partner is entitled to receive. Instead, the contract merely regulates the rights and liabilities that exist among the partners themselves. Consequently, a partner may simultaneously hold the position of karta of a joint Hindu family, act as a trustee, enter into a sub‑partnership, or serve as a representative or benamidar for another person. In each of those situations the individual occupies a dual role, acting in a personal capacity for the partnership while acting in a representative capacity toward the third parties. The third parties represented by a partner cannot enforce rights directly against the other partners, nor can the other partners enforce rights against those third parties. The only entitlement of the third parties is a share in the profits that accrue to their representative partner, pursuant either to law or to the terms of any agreement. Applying this principle, the Court held that Guruswamy Naidu could validly become a partner in a genuine partnership and take a ten‑annas share in the business. This was permissible even though his personal share in the family partition was only two annas. He would remain liable to account for the profits attributable to his ten‑annas share to the divided members of the family, without impairing the partnership’s validity. The Attorney‑General conceded this point. The Court noted that the same reasoning would apply if, instead of one family member, two members jointly held a ten‑annas share under an arrangement between them. Since the Revenue’s contention failed when a single member acted as representative, it could not succeed when two members acted together as representatives of the divided family. Because the partnership deed was genuine, the Court concluded that the shares allotted to Guruswamy Naidu and Venkatasubba Naidu were correct according to the terms of that deed. The Court contrasted this conclusion with the opposite view it had examined in Charandas Haridas v. Commissioner of Income‑tax, Bombay (1)[1965] 2 S.C.R. 12, where a different factual scenario was considered.

In the case before the Court, the father who was a member of a Hindu joint family acted as a partner in six managing‑agency firms, and the share of commission that he received in his capacity as partner was treated by the tax authorities as income of the joint family. Subsequently the family underwent a partial partition in which the father allotted to his daughter one‑quarter share of the commission earned from each of two of the managing agencies. The remaining commission from those two agencies together with the commission from the other four agencies was then divided equally among five persons: the father himself, his wife, and his three minor sons. The memorandum of partition expressly stated that, with effect from 1 January 1946, the commission accrued thereafter would cease to belong to the joint‑family property and that each participant would become the absolute owner of his allotted share. Despite the execution of that partition deed, the Income‑tax authorities nevertheless assessed the total commission income as belonging to the joint family, and the Bombay High Court upheld that assessment. However, this Court examined the genuineness of the partition document and held that, being a genuine instrument, it was fully effective between the family members, thereby removing the divided property from the definition of Hindu joint‑family income.

In delivering its opinion, Justice Hidayatullah, speaking for the Court, set out several observations to explain the effect of a partition under Hindu law on partnership taxation. He observed that a partition may have no bearing on the partner’s status under partnership law, but it does affect the family’s standing under Hindu law. He illustrated this by stating that, just as the appointment of a karta as a partner does not bring the other undivided‑family members into the partnership, the division of the family does not alter the partner’s relation to the other partners. He then quoted the case citation “(1) [1960] 3 S.C.R. 296” to emphasize that the position of the partner vis‑à‑vis the other partners remains unchanged. He further explained that, prior to the partition, the Income‑tax law takes note of the factual position of the karta and assesses him not as a partner but as the representative of the Hindu undivided family. Accordingly, the tax law looks to the provisions of Hindu law rather than to the Partnership Act when determining the assessable entity. He continued that once the family is ruptured, the partnership relationship continues as before, but the Hindu‑law relationship changes, so that no longer does a Hindu undivided family exist as a unit of assessment. Consequently, any income that accrues after the partition cannot be characterized as income of a Hindu joint family. He added that neither the Indian Income‑tax law nor the partnership law contains any bar to members of a Hindu joint family dividing any of their assets. The Court affirmed that these observations support its conclusion that the division of the joint family did not alter the karta’s position as a partner with respect to the other partners in the existing partnership. Therefore, based on the same principle, a member or members of a formerly joint family are free to enter into a partnership with third parties, their shares being determined by the terms of the partnership and the partition deed.

In this case the Court observed that the former members of a Hindu joint family, after the family had been divided, could become parties to a partnership under an arrangement that they themselves made among those members of the divided family. The portion of the partnership that each former family member would own was required to be fixed by the terms of the partnership agreement that they executed. Likewise, the portion of the interest that the members of the divided family would hold through any representative appointed in the partnership was required to be fixed by the terms contained in the partition deed that effected the division of the family property. Because the allocation of shares in the partnership and the allocation of the representative’s interest were both governed respectively by the partnership agreement and by the partition deed, the Court concluded that the High Court had correctly answered the question that had been posed to it. Accordingly the Court held that the appeals filed against the High Court’s decision could not succeed. The appeals were therefore dismissed and the appellants were ordered to pay the costs of the proceedings. In addition, the Court ordered that a single hearing fee be payable. In sum, the appeals were dismissed with costs and the hearing fee imposed.