HIGH COURT OF GAUHATI

Radha Krishna Jalan

v.

Commissioner of Income-tax

Section 10(2A) of the Income-tax Act, 1961 - Firm - Share of profits to partner of firm - Assessment years 1996-97 and 1997-98 - Whether a sub-partnership which is in receipt of share of profit of a partner in main partnership, has to be deemed to be a partner in main partnership for limited purpose of section 10(2A) - Held, yes

Interpretation of statutes : Rule of literal interpretation

Facts

‘J’ and two others were partners in a firm which was engaged in business of supply and export of rock, stone boulders and other goods including the business of export and import of different commodities. ‘ J’ had a share of 45 per cent in the profit and loss of that firm. Later ‘J’ along with four others constituted a sub-partnership firm (the assessee). The agreement provided that the partners would supplement the funds required to be invested by ‘J’ in the partnership business of parent firm. The holding of ‘J’ was at 60 per cent while the remaining four were at 10 per cent each. For the assessment years 1996-97 and 1997-98, the assessee filed a nil return and claimed exemption under section 10(2A) treating itself as a partner of parent firm inasmuch as it was in receipt of share income of a partner in main firm. The Assessing Officer, however, rejected claim of the assessee for exemption under section 10(2A). The Commissioner (Appeals) allowed the appeal permitting exemption under section 10(2A). The Tribunal, however, rejected the claim of the assessee on the ground that it was not and could not be a partner in parent partnership and, therefore, income received by the superior title was not exempt under section 10(2A).

Held

The scheme of the Indian Income-tax Act, 1922, prior to its amendment by the Finance Act, 1956 recognized two kinds of firms—unregistered and registered firms. In the case of an unregistered firm, the tax payable by the firm was assessed as in the case of any other distinct entity and tax was levied on the firm and the partners were not required to pay tax again on their share of income out of the profit of the partnership business. In the case of registered firm, the firm was not required to pay tax and the income of the firm was not assessed to tax. The share of profits of each partner in the income of the firm was added to his other incomes. The levy was on the partners severally and not on the firm. The total income of the partner comprises of his other income and his share of income from the firm. It is, therefore, clear that under the provisions of the 1922 Act, neither the unregistered firm nor the registered firm was subjected to double taxation. After the amendment in 1956, till 31-3-1993, the unregistered firm continued to be assessed to tax as a distinct entity as before and the tax was levied on it. The partners though not liable to pay tax on their income had to include their income from the partnership in computing their total income for the purpose of determining the rate of tax to be applied in determining their tax liability on their other income. In the case of income of registered firm, there was double taxation. Firstly, tax on a nominal rate had to be paid by the registered firm and the partners thereof were also taxed in their individual assessments as before in respect of their share of income from the firm. This position continued till 31-3-1993. The Finance Act, 1992, introduced vide changes in respect of assessment of income of the firms with effect from 1-4-1993. The changed position applicable to the assessment years 1996-97 and 1997-98 recognizes two kinds of firms, i.e., firm assessed as a firm under section 184 and firm assessed as an association of persons under section 185. [Para 13]

In the instant case, the admitted position was that parent firm and the assessee were firms assessed as firms under section 184. In the case of firms which are assessed as firms, payment of interest, salary, bonus, commission or remuneration paid to the partners have been allowed to be deducted in the hands of the firm requiring the firm to pay tax on its total income as a distinct entity as provided in section 167A. The share of income of an individual partner is not to be included in computing his total income, but the interest, salary, bonus, commission or remuneration received by a partner from the firm is assessable in his hands as income from business or profession. It is, therefore, clear that with effect from 1-4-1993, there is no scope for double taxation in the case of a firm assessed as firm under section 184. On the other hand, as provided in section 185, in force with effect from 1-4-1993 to 31-3-2004, a firm is required to be assessed as an association of persons and the provisions of sections 67A, 167B and 86 are applicable to such firm. The share of income of an individual partner is not required to be included in his total income is further crystallized in the provisions of sub-section (2A) of section 10. [Para 14]

From the above discussion, it would appear that there is no scope for double taxation of an income by a partner of a firm, which is separately assessed to tax. Keeping this in mind, one has to interpret the provisions of the Act relating to exemption or deduction or benefit to be given to certain kinds of income. [Para 15]

The various decisions of the Supreme Court support the view that the legislative intent cannot be frustrated by attributing literal interpretation of the provisions of the statute. An income which is already taxed in the hands of the firm is obviously not exigible to tax in the hands of the partner. This provision available in section 10(2A) is obviously incorporated to obviate double taxation. On this background, one has to discuss the principles of diversion of share of a partner by superior or overriding title to a sub-partnership comprising the partner and strangers to the main partnership. Sub-partnerships have been recognized in India and registration accorded under the Indian Income-tax Act, 1922, though sub-partnership has not been defined either in the Indian Partnership Act, 1932 or in the Income-tax Act, 1961. [Para 18]

From the decision of the Supreme Court in CIT v. Sunil J. Kinariwala [2003] 259 ITR 10/126 Taxman 161 following principles relating to diversion of share of income of a partner at source by overriding title have emerged :

(1) A sub-partnership is a partnership within a partnership in respect of the share of a partner in the main partnership. Formation of a sub-partnership does not affect the position of the partner in the main partnership though its character changes vis-a-vis the sub-partnership and the income-tax authorities.

(2) The superior title of the sub-partnership diverts at source the share income of the concerned partner in the main partnership before it becomes the income of the partners.

(3) Assessment of a share of income of a partnership in the hands of a partner has to be apportioned as per the provisions of the Act and, thereafter, the income-tax authorities are required to determine whether it would be assessed in the hands of that partner or in the hands of the sub-partnership.

(4) The diversion of the income of a partner in the main partnership at source to the sub-partnership by overriding obligation created by the sub-partnership converts the income of a partner into the income of the sub-partnership, thus, vesting an enforceable right upon the sub-partnership to claim a share in the profits accrued to or received by the partner.

(5) The right to receive profits and pay losses become the asset of the sub-partnership. [Para 21]

It would appear from the above principles that diversion of income by overriding title to sub-partnership confers upon it the attributes of a partner insofar as it relates to such income for the purpose of the Income-tax Act, 1961, irrespective of the provisions of the Indian Partnership Act, 1932. A sub-partnership has been recognized in India and registered as a partnership firm under the Income-tax Act though the term has not been defined in the Indian Partnership Act, 1932. A partnership firm cannot become a partner in another partnership firm for the purpose of the Indian Partnership Act, 1932 since a firm is not a person under this Act and is, therefore, not eligible to enter into an agreement. But the position is otherwise insofar the Income-tax Act, 1961, is concerned. In the Income-tax Act, 1961, a ‘person’ has been defined in sub-section (31) of section 2 which, amongst, others includes a firm also. In the instant case, there was no dispute that the share of income receivable by the ‘J’ from main firm stood diverted by a superior title to the sub-partnership of the ‘J’ before the partner in the assessee could lay hand on it. [Para 22]

The Tribunal relying upon a decision of the Supreme Court in Dulichand Laxminarayan v. CIT [1956] 29 ITR 535 took the view that the provisions of section 10(2A) are not applicable in the case of income diverted to the assessee-firm. The Tribunal was of the view that section 10(2A) is applicable only in case of a partner of the firm and the assessee-firm not being a partner of main firm could not get the exemption under section 10(2A). But the Tribunal failed to notice that the judgment in Dulilchand Laxminarayan’s case (supra) was rendered in the context of rule 2 of the Indian Income-tax Rules, 1922, which required that all the partners of a firm must sign the application for registration. Since a firm is not a partner under the Indian Partnership Act, 1932, the Tribunal held that going by the definition of ‘partnership’ in the Partnership Act, the sub-partnership in the instant case could not enter into any partnership for the reason that one partner of such firm signing on behalf of the firm would not meet the requirement short of compliance with rule 2.

The following situations better clarify the position :

(1) A Hindu Undivided Family cannot be partner per se in a firm under the Partnership Act, though a ‘karta’ representing it can be a partner therein. For the purpose of the Partnership Act, his position in the firm is that of a partner and his share is not assessed in his hands, but in the hands of the Hindu Undivided Family.

(2) A trust cannot be partner in a firm, whereas a trustee may be. The share of income pertaining to such trustee is assessed in the hands of the trust. [Para 23]

As regards the anomalous situation that would emerge in case a sub-partnership is not deemed to be a partner in respect of assessment of its income diverted from a partner in the main partnership by overriding title with effect from 1-4-1993, the income of a partnership is subject to tax in the hands of the firm. The share of an individual partner has been exempted under sub-section (2A) of section 10. If the benefit of section 10(2A) is denied in case of diversion, it would completely nullify the basic scheme of the Act since the income of the partner once taxed in the hands of the partnership would be again eligible to tax in the hands of sub-partnership. This would be contrary to the legislative scheme in force with effect from 1-4-1993, relating to assessment of partnership firm. The Tribunal negated the contention of the assessee-firm relying upon a decision of the Rajasthan High Court in CIT v. Alisher Contractors [1986] 159 ITR 534. But in that case, the assessment year in question was 1973-74, i.e., prior to 1-4-1993, when the scheme of the Act was different and the burden of tax was on the partner and not the partnership firm. The provision for exemption under section 10(2A) came into force with effect from 1-4-1993, and, therefore, the said decision could not be relied upon by the Tribunal in deciding the case at hand. [Para 26]

The Act provides for levy of tax on the total income of an assessee after computation of income from all sources, setting off the losses and deducting the allowable deduction. In the instant case, the total income of main firm had been computed at Rs. 39,426 for the assessment year 1996-97 and Rs. 42,750 for the assessment year 1997-98. ‘J’ was entitled to 45 per cent of the aforesaid income of the main partnership for the two assessment years. His personal income as partner of the main partnership would roughly be Rs. 17,742 and Rs. 19,234, respectively. The said amount stood diverted to the assessee-firm by overriding title. But the income-tax authorities assessed the total income of the assessee-firm at Rs. 1,83,13,993 for the assessment year 1996-97 as against the total taxable income of Rs. 39,426 of main firm though the share of income of ‘J’ diverted at source to the sub-partnership could not be more than Rs. 17,427. Similarly, for the assessment year 1997-98, the total income of the main firm was Rs. 42,750 and the share of ‘J’ was Rs. 19,327. This amount was diverted at source to the sub-partnership. But the total income of sub-partnership had been assessed at Rs. 2,89,09,158. [Para 27]

This anomalous and illogical consequence had arisen because of refusal to consider the assessee-firm as a partner of the main partnership firm for the limited purpose of section 10(2A). This was evidently not only contrary to the facts available on record, but also to the scheme of the Act as well as the principles of diversion of income by overriding title. This refusal had ended in double taxation. The legal fiction created the non-application of the provisions of section 10(2A) on the ground that the assessee-firm was not a partner of the main partnership had ushered in an absurd situation contrary to the facts as well as the provisions of the Act. The note of discord had to be tuned with the legislative intent as reflected in the scheme of the Act. To obviate this absurdity, it was to be held that a sub-partnership which is in receipt of the share of profit of a partner in the main partnership, has to be deemed to be a partner in the main partnership for the limited purpose of section 10(2A). Else, the absurdity will continue. The contention of the revenue that the assessee-firm not being a partner of the main partnership would not be entitled to the benefit of section 10(2A) was not accepted for the reason that it was totally in disharmony with the scheme of the Act. [Para 28]

Consequently, the order passed by the Tribunal was to be set aside.