1963 PLP 898 (PTD)

Application for registration Profits of firm not divided or credited in the separate accounts of partners but taken to reserve fund Whether ground for rejecting registration Income tax Act (XI of 1922), S. 26 A Income tax Rules, 1922, r.

6. The partners of a firm resolved that the profits of the firm as disclosed in the profit and loss account need not be divided and credited in the accounts of the partners, but should be credited to a reserve account in which the share of each partner therein should be stated and the profits were accordingly taken to the reserve account. An application for registration of the firm was rejected on the ground that the firm had not complied with the requirement of rule 6 of the Income tax Rules, 1922 that the profits of the previous year should be divided or credited : Held, that the absence of entries in the separate accounts of each partner was not fatal ; the requirement of rule 6 was met when the profit was taken into a reserve fund showing the partners' shares therein and indicating what was the contribution of each partner to the reserve, fund and the application for registration was not liable to be rejected on the ground that rule 6 had not been complied with. Chhotalal Devchand v. Commissioner of Income tax (1958) 34 I T R 351 fol. STATEMENT OF CASE By this application under section 66 (1), the assessee requires the Appellate Tribunal to refer a certain question of law said to arise out of the Tribunal's order in I. T. A. No. 9846 of 1958 59, dated August 18, 1959, to the High Court of Kerala at Ernakulam. Inasmuch as, in our opinion, a question of law does arise out of the Tribunal's order, we accordingly state a case agreed to by both the parties, and refer it to the High Court.

2. The assessee is a firm consisting of the following partners sharing profits and losses as shown below : Partners : shares

1. Thomas Chandy 2

2. C. K. Kesavan 2

3. O. Oduppan 2

4. S. Unittan 2

5. K. Raghavan 2

6. P. T. Kuriakose 1

7. Pothen Chacko 1

8. Pothen Abraham 1 13 The firm was constituted by an instrument of partnership dated September 10, 1953, copy whereof is annexed herewith as Annexure "A" and forms part of the case.

3. The profits of the aforesaid firm for the first two years are as follows : Rs. Year ended 31-3-1956 ... ... 10,137 do. 31 3 1957 ... ... 49,129

4. The profit of the year ended March 31, 1956, was duly divided and credited to the individual accounts of the various partners in their profit sharing ratios as set out above by entries in the books made on March 31, 1956, itself.

5. The profits of the next year ended March 31, 1957, aforesaid, however, were credited to the reserve account under, date April 10, 1957, narrating the share of each partner therein which corresponded with their profit sharing ratios as aforesaid. This transfer is in pursuance of a resolution of the partners dated April 10, 1957, in the following terms : "Due to the delay in getting the amount due from the customers it is found that financially the business suffers and as such the profits of the period as disclosed in the profit and loss account need not be divided and credited in the accounts of the partners and the same be kept as a reserve."

6. The credit to the reserve on April 10, 1957, aforesaid was eventually transferred to the various partners' individual accounts on March 31, 1958.

7. The aforesaid firm was registered under section 26 A for the assessment year 1956

57. For the year ended March 31, 1957, the "previous year" for the assessment year 1957 58, the assessee applied for renewal of the registration on the basis of the application dated July 20, 1957, a copy whereof is annexed hereunto as Annexure "B" and forms part of the case. The Income tax Officer refused registration, inter alia, on the ground that the profit of the "previous year" in question had not been divided among the partners.

8. The assessee appealed to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner upheld the refusal for the reasons stated in paragraph 5 of his order reproduced below : "Coming to the next point made by the Income tax Officer that profits have not been divided, a resolution of the partners has been put up before me dated April 10, 1957, to the effect that in view of the outstanding collections, the partners have decided not to divide or credit the profits of the year in the partners' accounts and the profit would be carried on as a .reserve. Sri Srikrishnan pointed out a judgment of the Lahore High Court in the case of Maula Dad Mohammad v. Commissioner of Income tax wherein it is stated that the division or crediting of profits is not a necessary prerequisite for registration of the firm. This is a decision of the Pakistan High Court and not of any Indian High Court. Moreover after 1953, the rules for registration have completely been changed in the Income tax Act. In these circumstances, the decision quoted by Sri Srikrishnan will not be of much use to him. There is of course a decision by one of the Indian High Courts to the effect that if individual shares of partners are specified in the instrument of partnership, registration cannot be refused merely because the partners allow the profits to accumulate in business and credit each partner with his share instead of actual distribution and withdrawing the profits every year Kikabhai v. Commissioner of Income-tax (1929) 4 I T C 178 and Khemji Walji & Co. v. Commissioner of Income tax (1945) 13 I T R

421. The decision, of course, presupposes the crediting of each partner with his share of profit and it was decided that once such credit is made in each partner's accounts, the profits need not be withdrawn or distributed. To my knowledge, it has not been decided anywhere that even if the profits have not been credited to the partners' accounts, registration cannot be refused. For this purpose, I think we will have to go into the section and the rules made thereunder. This is a case of renewal of registration and the renewal application to be made under rule 6 clearly requires a certificate to be signed by the partners that profits of the previous year were divided or credited as shown in the application. The application for renewal registration should be made on or before 30th June of the assessment year in question, and by that time the accounts of the year would have been closed and the profits would have been credited or distributed among the partners. Hence there is no ambiguity as regards the certificate to be given for renewal of registration in that it requires a certificate by the partners to the effect that the profits of the year were divided or credited as shown in the application. It categorically requires the partners to give the certificate that profits were divided or credited as shown. In this particular case the profits have not been credited to the partners' accounts but have been taken to the reserve. Hence the certificate to be given by the partners as per paragraph 3 has not been fulfilled and the application made is not in order. In view of the form of application for renewal prescribed in the rules which have some force as the main section itself, the crediting of profits to each partner's acc3unts is absolutely necessary and if such crediting has not been done, the certificate given by the partners as per paragraph 3 of the renewal application would be wrong. As can be inferred from the case law mentioned above, crediting of the share of profits in each partner's accounts is absolutely necessary though it may not be necessary that the partners should actually distribute the profits among themselves or withdraw the profits but could allow it to get accumulated in the business but the credit should have been made in the partners' accounts. In the absence of division of profits among the partners by crediting the share of profits in each partner's accounts, I have to conclude that the application made by the appellant for renewal is not in order and cannot be accepted. In these circumstances, I feel that the renewal has properly been refused in this case."

9. The assessee thereupon appealed to the Tribunal. The Tribunal also dismissed the appeal holding, in the following words, that the requirements of the rules had not been satisfied. "(3) The learned counsel for the assessee also urges that there is no rule which says that the division of profits must take place in the year of account and that crediting alone is necessary and relies for this position upon the ruling in Kikabhai v. Commissioner of Income tax, (1929) 4 I T C

178. The Departmental Representative has submitted that in the very next entry after April 10, 1957, in which the profits are supposed to have been divided, the profits as on March 31, 1958, have also been divided and that this showed that the profits only remained in the books and there was never a division of this and crediting to the respective partners. Thus, he says, rule 3 is not satisfied and registration must be refused. (4) The contention of the learned counsel is that only division is contemplated and not crediting also, because the word "or" used is very attractive. We do not think that there are two different processes. That apart, how there can be crediting without division, we are unable to understand. Be that as it may, even if all that were sufficient, the assessee, by resolution dated April 10, 1957, has categorically stated that because the business gets into difficulties if the profits are credited, it must be allowed to remain in the business. This positive act rules out the necessity for speculation as to what is necessary for satisfying rule

3. We find as a fact that there has been neither division nor crediting of profits in pursuance of the resolution to that effect passed on April 10, 1957. The profits are very much in the books and have not passed to the partners. Whether they are actually drawing from the profit is another matter but it seems to us that even the right to draw has been restrained. In other words, the conditions necessary for the grant of registration after fulfilling the requirements of all the rules in this behalf have not been satisfied in this case, and registration, in our opinion, has been rightly refused."

10. From out of the aforesaid facts, the question of law that arises is : "Whether the registration of the firm is renewable for the assessment year 1957 58 under section 26 A and the rules made thereunder?" P. Govindan Nair, K. V. R. Shenol, P. K. Kurien, G. Balagangadharan Nair and K. Sukumaran for the Assessee. G. Rama Iyer for the Commissioner.