Commissioner of Income Tax vs Jayalakshmi Oil Firm

B.S. Raikote, J.—In obedience to the direction of this court dated September 25, 1986, in I.T.C. No. 313 of 1985, the Income Tax Appellate Tribunal, Hyderabad, Bench B, has stated the case and referred the following questions for the consideration of this court :

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the firm would be entitled to registration notwithstanding that there is no evidence that the secret profits have been divided in accordance with the profit sharing ratios in the deed of partnership ?

(2) Whether, on the facts and in the circumstances of the case, the decision of the Appellate Tribunal that the firm would be entitled to registration on the ground that the finding of the benami nature of Sri B. Narayana''s partnership in the firm is based on surmises and doubts and not on facts, is based on facts and is rational, reasonable and free from perversity ?

(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the assessee-firm is entitled to registration ?"

In order to consider these questions it is necessary to note a few facts of this case. The assessee, Jayalakshmi Oil Firm, Khammam, sought registration of its firm for the assessment year 1976-77. The Income Tax Officer disallowed the claim of the assessee on three grounds. (1) The partnership deed and Form No. 11 were not signed by a partner, Sri P. Srirangaraja Bhattar; (2) the profits of the secret business were not apportioned among the partners of the assessee-firm, and (3) Sri Bajjuri Narayana, who is shown to have seven and half per cent. share, was a benamidar of another partner, Sri Palavarapu Satyanarayana, who held five per cent. interest in the firm. In an appeal filed by the assessee before the Appellate Assistant Commissioner, the said appellate authority held that it was not necessary for every partner to sign the instrument of partnership. Regarding the absence of the signature of one of the partners in Form No. 11, the said appellate authority held that the Income Tax Officer should have given an opportunity to the assessee to rectify the said defect as per sub-section (2) of section 185 of the Income Tax Act. So far as the non-division of secret profits was concerned, the appellate authority confirmed the order of the Income Tax Officer in view of the conflicting versions given by the partners regarding such division of shares. Regarding the third objection that Sri Bajjuri Narayana was a benamidar of Sri Palavarapu Satyanarayana, he confirmed the findings of the assessing authority and accordingly held that the firm was not entitled to be registered. On a further appeal filed by the assessee before the Income Tax Appellate Tribunal, the Tribunal allowed the appeal and held that the firm was entitled to be registered. Before the Tribunal, the learned Departmental representative had confined his argument to the second and third objections only. With regard to non-sharing of secret profits, the Tribunal held that on discovery by the Department a revised return was filed by Sri Palavarapu Satyanarayana and as per the judgment of this court in VARIETY HALL AND RAMAKRISHNA TEXTILES Vs. COMMISSIONER OF Income Tax, A. P., , the failure to disclose certain income and to divide the same amongst partners in accordance with the terms of the partnership deed does not by itself disentitle the firm to be registered as long as the partnership is evidenced by an instrument of partnership and as such there was no reason to doubt the genuineness of the partnership. Accordingly, the Tribunal overruled the second objection. This finding of the Tribunal has not been seriously contested before us and it is rightly so in view of the judgment of this court referred to by the Tribunal. Therefore, learned counsel on both sides focussed their arguments on the third objection regarding the benami nature of the transaction pertaining to Sri Bajjuri Narayana. According to his own statement, Sri Bajjuri Narayana was working as a manager in Sriram Rice and Oil Mills which was the proprietary concern of Sri Palavarapu Satyanarayana. When secret profit was discovered by the Department it was Sri Palavarapu Satyanarana who filed a revised return disclosing an additional income of Rs. 14,000 being the rent for the oil mill, received from the appellant''s firm from its secret books. These secret books were found in the business-cum-residential premises of Sri C. Krishna Murthy, the managing partner of the assessee-firm. On the basis of this evidence, the Income Tax Officer and the Appellate Assistant Commissioner held that Sri Palavarapu Satyanarayana was closely associated with the assessee-firm. They also took note of the other fact that Sri C. Krishna Murthy, the managing partner of the assessee-firm transferred the loss account standing during the preceding year to the account of Sri Bajjuri Narayana by getting it adjusted to the account of Sri Palavarapu Satyanarayana. The managing partner of the assessee-firm has stated before the authorities that has been done with the tacit consent of Sri Palavarapu Satyanarayana. Moreover, Sri Bajjuri Narayana himself earlier claimed as an employee of the assessee-firm denying his interest in the firm and he even claimed gratuity as an employee. But, the fact also remains that the said claim for gratuity filed before the Labour Commissioner was subsequently withdrawn. His statement before the Income Tax Officer is that he was not a partner in the appellant firm and he did not contribute any capital though in his account, in the books of account of the appellant firm for the assessment year 1976-77, an entry debiting the share of loss (for the assessment year) is present, so it is clear that he was acting as a benamidar for Sri Palavarapu Satyanarayana, another partner. In fact, the Appellate Assistant Commissioner referred to these statements and also the letters written by Sri Bajjuri Narayana dated July 12, 1978, addressed to Sri K.V. Subba Rao, an advocate for Sri C. Krishna Murthy, the managing partner of the assessee firm. In the said letter, Sri Bijjuri Narayana had denied the knowledge of the partnership deed dated rune 26, 1975. Yet the partnership deed shows his name as a partner; thus, from the entire evidence placed on record it is clear that he was acting for and on behalf of Sri Palavarapu Satyanarayana. Subsequent filing of the suit by Sri Palavarapu Satyanarayana in O.S. No. 127 of 1979 against the firm for the full amount due to him without adjusting the said loss does not militate against the benami nature of the transactions. The secret profit being discovered by the Department on a search and Sri Palavarapu Satyanarayana subsequently filing the revised return also reinforces the conclusion that Sri Bajjuri Narayana had lent his name in the assessee-firm to Sri Palavarapu Satyanarayana. This part of the evidence and material referred to by both the Income Tax Officer and the Appellate Assistant Commissioner was not considered by the Income Tax Tribunal while recording its findings. In view of the entire assessment of the material on record, we are of the opinion that the findings arrived at by the Income Tax Officer and by the Appellate Assistant Commissioner that the partnership was not genuine appears to be proper and plausible. As per section 185 of the Act as it stood at the relevant year, the authorities could refuse the registration if during the previous year the firm was not a genuine firm. The Explanation to section 185 of the Act further clarifies that for the purposes of section 185 and section 186 "a firm shall not be regarded as a genuine firm if any partner of the firm was, in relation to the whole or any part of his share in the income or property of the firm, at any time during the previous year, a benamidar." Under Explanation (b) to the above section when any person, not being a partner of the firm, and any of the other partners knew or had reason to believe that the first-mentioned partner was such benamidar and such knowledge or belief had not been communicated by such other partner to the Assessing Officer in the prescribed manner, the firm shall be regarded as not being genuine. From the evidence on record, it is further clear that such benami nature of transaction was not even intimated to the authorities in terms of Explanation (b) in the prescribed manner. Therefore, the assessee-firm was not entitled to be registered. Considering a similar question, the High Court of Allahabad in SHUBHAM FABRICS Vs. INSPECTING ASSISTANT COMMISSIONER OF Income Tax AND ANOTHER., held that after the Explanation was added to section 185(1) of the said Act, the earlier decisions in Commissioner of Income Tax, Madras Vs. Bagyalakshmi and Co., Udamalpet, and Commissioner of Income Tax, Madhya Pradesh, Nagpur and Bhandara Vs. Hukumchand Mannalal and Co., would no longer hold good and the Income Tax Officer is entitled to traverse outside the partnership deed in order to find out the benami nature of the partnership firm. In other words, in terms of this Explanation, the partnership firm may be held to be ungenuine if it is having a benamidar (as a partner). This Explanation is added as per the Taxation Laws (Amendment) Act, 1970, with effect from April 1, 1971, and as on the date of the assessment, the Explanation held the field. In this view of the matter, we are of the opinion that in view of the benami nature of the partnership as held by the Income Tax Officer and the Appellate Assistant Commissioner, the assessee-firm was not entitled to be registered. Having regard to these conclusions, we answer all the three questions referred to above in the negative, that is against the assessee and in favour of the Revenue. Accordingly, the reference is answered.