Commissioner of Income Tax, Visakhapatnam vs Circar Enterprises

Motilal B. Naik, J.—This is a reference u/s 256(2) of the Income Tax Act by the Revenue seeking the opinion of this Court on the following questions of law formulated by it, viz.,

(1) Whether on the facts and in the circumstances of the case and in law the appellate Tribunal was justified in holding that the assessee firm is entitled to the benefits of Registration?

(2) Whether on the facts and in the circumstances of the case and in law, the finding of the appellate Tribunal that there was no contravention of Rules 38 and 39 of the Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970, was correct?

(3) Whether on the facts and in the circumstances of the case and in law, the appellate Tribunal was justified in relying on the decision in the case of Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, wherein Rule 19(1) and 19(2) of the Andhra Pradesh Excise (Arrack and Toddy Licences General ConditionsX Rules, 1969, was applicable?

Facts in brief are as under:

Originally Sri M.B.R. Prasada Reddy was carrying on business in liquors, wine and beer after obtaining FL 16 licence from the State Excise Authorities. The licence was, however, exploited by a firm of four partners formed under deed dated 5-10-1978 with effect from 17-5-1978. Sri M.B.R. Prasada Reddy was the Managing Partner of the said firm. He applied to the Licensing Authorities for inclusion of three partners under the deed dated 5-10-1978 in the licence granted according permission to sell liquors, wines and beer on wholesale as well as on retail basis at Vijayawada. The names of other three partners i.e., M. Madan Mohan Reddy, M. Appi Reddy and T. Padmavathi were included in the licence granted by the Excise Authorities by their order dated 3-12-1979 in the proceedings of the Superintendent of Excise, Krishna in D.Dis.No.3116 of 79.

Subsequently, three more persons were added viz., Smt.T. Nagubhai, Smt.T. Ramanamma and Smt. P. Varahalamma, as partners making the total number of partners at seven. However, the firm of seven partners did not obtain permission for the inclusion of the three new partners from the licensing authority in order to enable the department to include their names also in the licence granted in Form FL-16. The Income Tax Officer, however for the Assessment year 1980-81 granted registration to the firm of seven partners u/s 185(1)(a) of the Income Tax Act by his order dated 27-5-1982 and assessed the said firm u/s 143 of the Income Tax Act while accepting the total income returned at Rs.49,210/- and determined the divisible income among partners at Rs.46,521/-. He also made the division of share of the income as well as interest income among the partners as per the table giveruinder his assessment order dated 27-5-1982.

However, the Commissioner of Income Tax, Visakhapatnam was of the view that granting registration to the firm of seven partners was erroneous and prejudicial to fhe interests of revenue, and therefore, took up the matter while exercising powers u/s 263 of the Income Tax Act and revised the order. The CIT, Visakhapatnam felt that the firm contravened Rules 38 and 39 of the Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970. Tne CIT,Visakhapatnam was of the further view that as per Rule 39 of the above Rules, either inclusion or exclusion of any person as a partner to a firm is prohibited, unless prior approval of the licensing authority is obtained. He was further of the view that the addition of three more partners pursuant to deed dated 2-4-1980 making it to seven partners was never intimated to the Superintendent of Excise, Krishna District and no approval of new Constitution was obtained and as such the firm so constituted cannot be legally held to be a valid, form and registration to it under the Income Tax Act cannot be granted. The CIT further found that the contravention of the provisions of the Rules mentioned above, are punishable under Sections 36 and 41 of the Andhra Pradesh Excise Act. The CIT, Visakhapatnam further held that the partnership deed dated 2-4-1980 is void ab initio as it contravened the Rules 38 and 39 of the Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970 (for short ''the Rules").

The CIT, Visakhapatnam issued notices to the assessee-firm before passing his revisionary orders. On behalf of the assessee, written arguments were submitted. It was contended before the CIT that the induction of three more partners to the existing firm of four partners (total number of partners to seven) was duly intimated to the concerned authorities on 29-8-1981. Though such intimation was sent, neither the licencing authority cancelled the licence nor the assessee firm was penalised for any contravention of any provision of law, for not obtaining prior permission for inclusion of more partners and therefore, the partnership deed dated 2-4-1980 is not void ab initio. It is also urged before the CIT on behalf of the assessee that the excise authorities have renewed the licence for the year 1982-83 even after induction of three new partners without any objection and it was contended that there was no illegality in the constitution of the partnership firm. On behalf of the assessee, several decisions were cited before the CIT, including the decision in Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, .

Basing on this decision, it was contended on behalf of the assessee, before the CIT that as held by the Division Bench of this Court in the said decision that as long as there is no prohibition to induct new partners to the firm, inducting three more partners to the firm, cannot be held to be against Rule 39 of the Rules and the assessing authority has rightly granted registration to the firm for the assessment year 1981-82.

The Commissioner of Income Tax, Visakhapatnam however, repelled the contentions of the assessee and held that since there was no permission obtained from the licensing authorities by the assessee as required under Rule 39 of the Rules, the newly constituted firm is not entitled to registration under the Income Tax Act. The CIT further held that contravention of Rules 38 and 39 are punishable under Sections 36 and 41 of the A.P. Excise Act, 1968, the partnership firm so constituted in contravention of the provisions is illegal and the business earned on by such firm is opposed to public policy.

The CIT also held that granting registration to the firm and assessing the firm in the capacity of registered firm by the assessing authority is not correct. While holding so, the CIT revised the order of the Income Tax Officer and directed him to take the status of the assessce as an ''Association of Persons" and collect taxes accordingly, through his order dated 16-5-1984.

The order dated 16-5-1984 passed by the Commissioner of Income Tax, Visakhapatnam was carried in appeal by the assesses in 1TA No.716 of Hyd of 84 before the Income Tax Appellate Tribunal ''A'' Bench. The ''A'' Bench of the Tribunal, by its order dated 13-3-1985 allowed the appeal filed by the assessee by holding that in view of the decision of the Andhra Pradesh High Court in Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, the order dated 16-5-1984 passed by the CIT, Visakhapatnam, cannot be justified and set aside the same. As a result of setting aside the order of the CIT, dated 16-5-1984 and restoring the order of the ITO by the Tribunal, the Revenue required the Tribunal to state the case and refer the above questions of law as formulated by it for the opinion of this Court, by filing RA No. 123 of Hyd of 85. However, the Tribunal rejected RA No.123/Hyd/85 by its order 26-11-1985. Thereupon, the Revenue preferred ITC No-36 of 1986 before this Court. This Court, by an order dated 26-11-1986, disposed of the said ITC No.36 of 1986 and directed the Tribunal to state the case and refer the abovestated questions of law formulated by the Revenue for the opinion of this Court u/s 256(2) of the Income Tax Act and thus the present reference has fallen for consideration before us.

Though the Revenue has formulated the abovementioned three questions separately, but they centre around Rule 39 of the Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970 and the decision cited Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, and as such they are being answered jointly.

We have heard Sri J. V. Prasad, learned Standing Counsel for the Income Tax Department and Sri Chalapathi, learned Counsel for the Assessee.

Rule 39 of the Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970 provides that no licensee shall, except with the prior permission of the licensing authority get any other person included as a partner of his business or get an existing partner excluded, provided that there was dissolution of partnership, it shall be notified to the Commissioner. A plain reading of the said Rule makes it clear that whenever there is an attempt either to induct or reduce the number of partners to a partnership firm, the licensee shall do so with the prior permission of the licencing authority. In other words, if there is any change in the constitution of the firm, such change has to be necessarily effected only after obtaining prior permission from the licensing authority.

In this case, originally, Sri M.B.R. Prasada Reddy was the licensee exploiting the licence in his individual capacity and was carrying on business in liquor. However, three more partners were inducted making the partnership firm of four partners under deed dated 5-10-1978 with effect from 17-5-1978, under the name and style of M/s. Circar Enterprises. The Excise authorities, by order dated 3-12-1979 have also granted licence to the firm including the names of the three partners in the licence. However, during the year 1980, through a partnership deed dated 2-4-1980 three more persons were sought to be inducted as partners to the said firm. The Income Tax Officer granted registration to the firm of seven partners u/s 185(1)(a) of the Income Tax Act by his order dated 27-5-1982 and assessed the firm in the capacity of registered firm. However, the Commissioner of Income Tax, Visakhapatnam was of the view that in terms of Rule 39 of the Rules, permission of the licensing authority has not been obtained by the licensee before inducting three more partners into the firm and therefore he held that Constitution of the assessee-firm with seven partners is not legally authorised and as such the firm cannot be registered u/s 185 of the Income Tax Act. However, the Income Tax Appellate Tribunal, Hyderabad ''A'' Bench, on an appeal filed by the assessee in ITA No.716 of Hyd of 84 has held that in view of the ratio laid down by the Division Bench of this Court in the decision cited Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, , even though permission from the licensing authority has not been obtained, since there is no prohibition to include or exclude any members from the existing partnership, the assessee-finn is entitled to registration under the Income Tax Act without regard to Rule 39 of the Rules.

The Division Bench of this Court in the decision cited Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, was of the view that even if a partner is inducted or excluded by a partnership firm without the permission of the licencing authority (sic. prior permission), the partnership firm will still be legal and could be registered. The Supreme Court in a decision reported in Bihari Lal Jaiswal and Others Vs. Commissioner of Income Tax and Others, , has considered similar provisions arising out of Madhya Pradesh Excise Act. While examining the relevant provisions, the Supreme Court has held thus:

"... Since the licence is granted for dealing in intoxicating liquors, the business wherein is res extra commercium and also because they are supposed to be harmful and injurious to the health and morals of the members of the Society close control is envisaged and provided over the business carried on under the licence. This object will be defeated if the licensee is permitted to bring in strangers into the business, which would mean that instead of the licensee carrying on the business, it would be carried on by the others - a situation not conducive to effective implementation of the excise law and consequently deleterious to public interest.

The Supreme Court further held as under:

"It therefore, follows that any agreement whereunder the licence is transferred, sub-let or a partnership is entered into with respect to the privilege/business under the said licence, contrary to the prohibition contained in the relevant excise enactment, it is an agreement prohibited by law''''.

The Supreme Court further considered the question whether such an unlawful or void partnership can be treated as a genuine partnership within the meaning of Section 185(1) and whether registration can be granted to such a partnership under the provisions of the Income Tax Act, and held that when law prohibits the entering into a particular partnership agreement, there can be, in law, no partnership agreement of that nature. The question of such an agreement being genuine cannot, therefore arise.

Though the correctness of the view taken by the Andhra Pradesh High Court in the decision cited Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, did not fall for consideration before the Supreme Court, but however, the Supreme Court disapproved the view of the Andhra Pradesh High Court in the decision cited (supra). The Supreme Court has held that any agreement whereunder the licence is transferred, sublet or a partnership is entered into with respect to the privilege/business under the said licence, contrary to the prohibition contained in the relevant excise enactment, is an agreement prohibited by law.

Insofar as the State of Andhra Pradesh is concerned, the relevant excise enactment is the Andhra Pradesh Excise Act, 1968 and the rules made thereunder which includes Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970. Rule 39 of the said Rules makes it clear that inclusion of a person as a partner is prohibited, unless prior approval of the licensing authority is obtained. Though Sri Chalapathi, learned Counsel for the assessee-firm has contended that the induction of three more persons as partners to the existing firm of four partners was duly intimated to the concerned licensing authority on 29-8-1981 and as such there is no contravention of Rule 39 of the Rules by the assessee-firm, we are unable to accept the said contention. Rule 39 of the Rules clearly mandates that approval of the licensing authority is required for inclusion of a person as a partner. Though it is contended on behalf of the assessee-firm that the licensing authority has been intimated on 29-8-81 about the induction of three members as partners, mere intimation is not sufficient and approval of the licensing authority has to be obtained. As the licensing authority, admittedly, has not accorded its approval for the induction of three more partners to the existing four member partnership firm, we are inclined to hold that the seven member partnership firm which was constituted in contravention of Rule 39 of the Rules, is an agreement prohibited by law and has no legal sanctity and it cannot be registered under the Income Tax Act. Therefore, we hold that the decision of this Court reported in CIT v. Nalli Venkataramana, (cited supra) no longer holds the field and the order of the Tribunal in ITA No.716 of Hyd of 84 dated 13-3-1985 basing on the said decision of this Court Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, cannot be sustained.

Having regard to the above discussion, we answer the questions of law formulated by the Revenue as under:

(a) The appellate Tribunal is not justified in holding that the assessee firm is entitled to the benefits of registration;

(b) The finding of the appellate Tribunal that there was no contravention of Rules 38 and 39 of the Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970 was not correct; and

(c) In view of the decision of the Supreme Court in Bihari Lal Jaiswal and Others Vs. Commissioner of Income Tax and Others, , the Tribunal is not justified in relying on the decision repotted in Commissioner of Income Tax, Andhra Pradesh-IV Vs. Nalli Venkataramana and Others, .

We answer this Referred Case accordingly.