P L D 1967 Karachi 363 (PLP)

ABDUL KADIR SHAIKH, J.-In this reference under section 66(1) of the Income-tax Act the following question of law has been forwarded to this Court at the instance of the Commissioner of Income-tax; "Whether in the circumstances of the case the assessee was entitled to the set off of the loss of Rs. 34,024 in the assessment for 1954-55?" The facts of the case briefly narrated are that the respondent is a firm carrying on business in textile goods and Karyana at Karachi and Chittagong. For the assessment year 1954-55, corresponding to the accounting period ending on 31st of Decem ber, 1953, the Income-tax Officer assessed profits of the firm at Rs. 1,24,

270. The status of the firm in the relevant year was that of a registered firm composed of three partners: In the preceding assessment year 1953-54, the status of the firm, however, was that of an unregistered firm. The firm had sustained loss of Rs. 24,024 in the year 1953-54 and it sought 'to set off this loss against the profits in the following year, under the provisions of subsection (2) of section 24 of the Act. The Income-tax Officer refused this benefit to the firm on the ground that its legal entity in the two respective years was not the same. The assessee appealed to the Income-tax Appellate Tribunal who disagreed with the view taken by the Income-tax Officer and held that the firm was clearly entitled to the relief under subsection (2) of section 24 of the Act, as it remained the same and, had continued to be the same unit of assessment, notwithstanding the change in its status during the two assessment years. The opinion of the Appellate Tribunal was influenced by two decisions, one of the Supreme Court of India in the case of Y. Narayana Chetty and another v. Income-tax Officer, Nellor, and others ((1959) 35 I T R 388) and the other of the Privy Council, in the case of Seth Badridas Bada and another v. Commissioner of Income-tax, Central and United Provinces ((1949) 17 I T R 209). The relevant observations made by the Supreme Court of India in the first case are: "The effect of the relevant provisions of section 23, therefore, is that for the assessment of the total taxable income it is the affairs of the assessee firm that are investigated and examined and when the total income of the firm is ascertained, it is allocated to its individual partners in proportion to their respective shares. The result of such allocation undoubtedly is to make the partners liable to pay tax in respect of their taxable income thus allocated; but that cannot justify the inference that the firm is not an assessee in the relevant proceed ings." The Privy Council in the second case observed as under: "It will be convenient to begin with section 23, which deals with assessment, some confusion arises from the fact that in the Act the words `assessment' and `assessee' are used in different places with different meaning. Section 2(2) defines 'assessee' as 'a person by whom income-tax is payable', but the context in section 23 makes it clear that down at least to the middle of subsection (5)(a) 'assessee' and 'assessment' refer primarily to the computation of the amount of income and assessee' means primarily a person the amount of whose income is being computed. The Section requires the Income-tax officer to do two things; first to compute or 'assess' a person's total income and then to determine the sum payable as tax. Sub sections (1) to (4) set out alternative methods of computation or 'assessment'. In the normal case the person whose income is being computed is the person who pays the tax and for that case these subsections also provide for the Income-tax Officer taking the second step and determining the sum payable as tax. But the case of a firm is specially dealt with by subsection (5). This subsection only comes into operation after the total income of the firm has been computed or 'assessed' under one of the earlier subsections. It draws a distinction between registered and unregistered firms. In the case of registered firm the firm does not itself pay income-tax and therefore the sub section directs that the sum payable by the firm shall not be determined, but that each partner's share of the firm's income shall be included in the assessment or computation of the total income of that partner . . . . ."

2. On the success of the appeal of the assessee, the Depart ment moved the Appellate Tribunal under section 66(I) of the Income-tax with the result that the above-mentioned question of law has been referred to this Court.

3. Before we proceed to answer the question, we may reproduce the relevant provisions to which reference will have to be made. These are subsection (5) of section 23 and subsection (2) of section 24 of the Income-tax Act: Section 23 (5). Notwithstanding anything contained in the foregoing subsection, when the assessee is a firm and the total income of the firm has been assessed under subsection (1), subsection (3) or subsection (4), as the case may be. (a) In the case of a registered firm super-tax (but not income-tax) payable by the firm itself shall be determined and the total income of each partner of the firm, including therein his share of its income, profits and gains of the previous year shall be assessed and the sum payable by him on the basis of such assessment shall also be determined: Provided that if such share of any partner is a loss it shall be set off against his other income or carried forward and set off in accordance with the provisions of section 24: Provided further that when any of such partners is a person not resident in Pakistan his share of the income, profits and gains of the firm shall be assessed on the firm at the rates which would be applicable if it were assessed on trim personally, and the sum so determined as payable shall be paid by the firm: (b) in the case of an unregistered firm, the Income-tax Officer, . . . . . . proceed in the manner laid down in clause (a) as applicable to a registered firm, if, in his opinion, the aggregate amount of the tax including super-tax, if any payable . . . . . under such procedure would be greater than the aggregate amount which would be payable by the firm and the partners individually if the firm were assessed as an unregistered firm." The relevant portions of subsection (2) of section 24 of the Act reads as under: "(2) Where any assessee sustains a loss or profits or gains in any year, being a previous year not earlier than the previous year for the assessment for the year ending on the 31st day of March, 1940, under the head 'Profits and gains of business, profession or vocation', and the loss cannot be wholly set off under subsection (1), so much of the loss as is not so set off, or the whole of the loss where the assessee has no income under any other head, shall be carried forward to the following year, and ..... Provided that . . . . (c) nothing herein contained shall entitle any assessee being a registered firm, to have carried forward and set off any loss which has been apportioned between the partners, under the proviso to subsection (1), or entitle any assessee, being a partner in an unregistered firm which has not been assessed under, the provisions of clause (b) of subsection (5) of section 23 in the manner applicable to a registered firm, to have carried forward and set off against his own income any loss sustained by the firm.; (d) where an unregistered firm is assessed as a registered firm under clause (b) of subsection (5) of section 23 during any year, its losses shall also be carried forward and set off under this section as if it were a registered firm;".

4. In support of the reference Mr. S. A. Nusrat, the learned counsel appearing for the Department, contended that subsection (5) of section 23 provides for different modes of assessments of firms accordingly as they are registered or unregistered. If the firm is registered, the tax payable by the firm is not to be deter mined but the total income is to be carried to the assessment of the partners in accordance with their shares and the profits or losses, as the case may be, are to be assessed as part of their other income. In the case of an unregistered firm however, the assessment is of the firm, unless the Income-tax Officer finds that by assessing the unregistered firm as a registered firm more tax is likely to result. The assessment otherwise being that of the firm and not that of individual partners. They themselves cannot carry forward their losses from their unregistered firm to the following year for the purposes of set-off from the income earned individually or in partnership firm registered or unregis tered. In other words the contention is that a partner of an unregistered firm who is not allowed the benefit of section 24 cannot claim benefit of that section simply because he gets his firm registered in the following year. In support of his conten tions, the learned counsel cited decision of this Court in the case of "Seth Ismail Jamal Budhani v. Commissioner of Income-tax, Karachi (1963 P T D 413)" and the case of "Commissioner of Income-tax, Bombay City v. Jadavji Narsidas & Co. ((1963) 48 I T R 41)," decided by the Supreme Court of India.

5. The learned counsel has put forward the argument rather attractively, but if reference is made to the clear language o section 24, it would be found that the argument is without substance. This provision of law does not place any embargo on an unregistered firm, as an assessee under the Act, from claiming the benefit given under it, if other conditions of that section are complied with by it. It would be seen that the benefit given by this section is to an "assessee", and it is unquestionable that a firm is an assessee under section 2(2) of the: Act, whether or not it is registered under section 26-A of the Act. Under section 3, a firm, is a unit of assessment and the income earned by it is computed in its hands as that of entity, irrespective of whether the firm is registered or unregistered. The only distinction between a registered and unregistered firm is in regard to the assessment proceedings. These proceedings consist of three distinct steps (i) computation of the taxable income, (if) determination of tax payable, and (iii) demand for the tax so found. As for the first step is concerned, registration of a firm 14 under section 26-A makes no difference whatever. The factor of registration of the firm is to be taken into account only after the total income has been computed or assessed. In other words, the total income of a registered or an unregistered firm is assessee or computed in the like manner. The registration of a firm does, however, make a difference for the purposes of the second and the third steps of assessment proceedings, as the procedure for levying the tax is different in the two cases. It is at this stage that subsection (5) of section 23 comes into operation where the firm is unregistered, the tax payable by the firm itself is to be determined in the same manner as in the case of any other distinct entity and the demand or levy is also made on the firm itself. On the other hand when the firm is registered, the firm does not itself pay the tax and therefore the tax payable by the firm is not determined, but each partner's share of the firm's profits is included in his total income and taxed in his hands.

6. If these requirements of section 23(5) are borne in mind, the applications of various provisos of section 24 to the cases of unregistered firm would have clear meaning. The section provides that any loss incurred by an unregistered firm may be set-off by the firm against its profits of the same year under the same or any other head, and further that any unabsorbed losses may be carried forward by the firm and set-off from its profits in the following year. But no individual partner of the unregistered firm has the right to set-off his share of loss from the firm, against his own income of the same year, under the same head or any other head, nor has ire the right to carry forward his share of the firm's loss. This proviso was necessary in section 24 in order to give effect to the distinction already made in respect of mode of levying the tax in the case of an unregistered firm, under subsection (5) of section

23. The later provision of law does not recognize partners of an unregistered firm individually for the purposes of the tax to be assessed, levied and payable by their firm, unless of course the Income-tax Other proceeds to take action against the unregistered firm as a registered firm under section 23(5)(b). It is for this reason that an embargo has been placed under the provisos of section 24 on an assessee, being a partner of an unregistered firm, from carrying forward and claim ing set-off against his own income, any loss sustained by the unregistered firm. In short the effect of the provisos of section 24 is that in computing the income of registered as well as unregis tered firms, any loss incurred by the firm may be set off against the firm's income of the same year under any head and if there are any unobserved losses, the unregistered firm is entitled to carry forward the same, with only this restriction that its partners cannot carry forward the loss and claim set-off: This being the only restriction imposed by law on the right of an unregis tered firm to carry forward its loss for the purpose to set-off against the income earned by it in the following year, the question is what would happen in this situation, if the firm gets itself registered under section 26(a) in the following year, i.e. during the year in which it claims the benefit of section

24. In other words, would the firm which would have otherwise been entitled to the benefit of section 24, be deprived of the benefit because of the effect of the registration under section 26-A on it. The answer is simple if the discussion detailed above regarding the incidents of registration under section 26-A are borne in mind. As stated above, registration under the Income-tax Act does not affect or bring about any change in the firm, as a unit of assessment. It continues to remain the same `legal entity' or `the assessee' for the purpose of computation of profits earned by it. The registration of the firm has nothing to do with its being a unit of assessment. The firm, whether it is registered or unregistered, is a legal entity in its own status. Undoubtedly therefore, the registration of the firm fin the following, year, in the above situation, would not make any difference for the purpose of it claim to the benefit of section 24, as it remains the same legal entity, the same unit of assessment and the same assessee, in the two respective years. In other words, for the mere fact that the unregistered firm becomes registered in the same or the following year, there is no change in its legal entity, as the assessee, and it entitlement to the benefits under section 24 is not, therefore, taken away. .

7. Now the two cases cited by the learned counsel for the department may be discussed. The first case is of no help to him as it is clearly distinguishable. The assessee in that case had ceased to be the partner of the firm which had suffered the loss. It was held that he was not entitled to set-off his share of loss, against his share of profits from another firm composed of different partners, in the following assessment year, as the assessee was not carrying on the same business in the two respective years. In second case the assessee was a registered firm consisting of four partners, which dealt in speculation, in a joint venture with another individual under an agreement. The assessee a registered firm had suffered loss in the joint venture and claimed to set-off that loss against its profits from the business carried on by itself. It was held by the Supreme Court of India that the losses sought to be set off by the assessee firm could not be allowed because they were the losses of an unregistered firm and could only be set off against the income of that unregistered firm. It is thus clear that the assessee was a registered firm consisting of four partners. The unregistered firm consisted of the four partners of the registered firm and a stranger. The partners of the unregistered firm were five individuals and the registered firm was not a partner by itself. The loss suffered in the business of the unregistered firm went to the share of the five individual partners and they were their losses in the partnership business. They could not be regarded as the losses in business suffered by the registered firth because the registered firm by itself was not a partner in the partner ship firm. It was in these set of facts, that the Supreme Court of India held that the share of the losses of the four partners of the registered firm in the unregistered firm could not be availed of by the registered firm, in the computation of its profits and gains from business. This case as pointed out by Mr. S. A. Nusrat was later on considered and distinguished in this manner by the Bombay High Court in the case of "Commissioner of Income- tax v. Jagannath Narsindas ((1965) 55 I T R 128)". This Bombay case is in fact very pertinent. The same question as the one before us arose there. The assessee was an individual carrying on business as Commission Agent in certain commodities. From the business he disclosed the profit of Rs. 14,189 but during the same assessment year he suffered a loss of Rs. 13,831 in a joint venture in 'Kapas' with someone else, under an agreement of partnership. The assessee claimed set-off of the loss sustained by him in the joint venture against his income from the business carried on individually by him. The Income-tax Officer rejected his claim and the Appellate Assistant Commissioner confirmed this action on an appeal by the assessee. But the Income-tax Appellate Tribunal upheld the claim of the assessee and granted him the benefit of section 24 (2) of the Income-tax Act. The matter came up before the High Court, on a reference made under section 66 (1) of the Act, and after considering the case law on the subject in great details, it was held that "in computing the business income of an assessee under section 10 of the Indian Income-tax Act, 1922, the assessee is entitled to adjust his share of loss sustained by an unregistered firm in which he was a partner, against the profits made by him in business carried by him individually." The question referred to the High Court in this case was "whether the assessee is entitled to claim a set-off of Rs. 13,831 that being his share of loss in a business carried on by an unregistered firm against the profits of his personal business?" and the answer given was in the affirmative. The Bombay High Court went a little further and even allowed a partner of an unregistered firm the benefit under section 24 of the Act on the ground that "so long as the adjustment that the assessee seeks is in his income under the same head, namely, business, there is nothing in the proviso to section 16(1)(6) or the second proviso to section 24(1) which would preclude him from seeking that adjustment under section 10 of the Act . . . . . . . . Section 24 has no application where the set-off is not of loss under one head of income against profits under another head but is a case of adjustment and set-off between the profits and losses under the same head. The adjustment of profits and losses under the head of business is to be done not under section 24 but under section 10." For this view reliance was placed on the following observations of the Supreme Court of India in the case of Anglo-French Textile Co. Ltd. v. Commissioner of Income-tax ((1953) 23 I T R 82). " , . . a set-off under section 24(1) can only be claimed when the loss arises under one head and the profit against which it is sought to be set off arises under a different head. When the two arise under the same head, of course, the loss can be deducted but that is done under section 10 and not under section 14(1)." In the same connection reliance was also placed on the following observations made by the Supreme Court of India in the case of Commissioner of Income-tax v. Muthuraman Chetriar ((1962) 44 I T R 710): "Thus the profits of each distinct business may have to be computed separately, the tax is chargeable under section 10, not on the separate income of every distinct business, but on the aggregate of the profits of all the business carried on by the assessee. Therefore, where the assessee carries on several business, he is entitled under section 10, and not under section 24 (1), to set off losses in one business against profits in another. If section 24(1) has no application, the second proviso thereto can also be of no application." The Bombay High Court then observed: "The treatment of the losses under section 24 will only be for the purpose of setting off losses under different heads. Where the partner of an unregistered firm seeks a set off or a carry forward and set-off of his losses under one head against profits under another head, no doubt, he will have to be governed by section 24, and also by the second proviso to that section. In view of the second proviso, his share of the losses in the unregistered partnership will not be capable of being set off against his income from any other head, cut so long as the adjustment that he seeks is in his income under the same head, viz., 'business', there is nothing in the provisions of section 24 which would preclude him from seeking that adjustment under section 10 of the Indian Income-tax Act." Mr. Nusrat frankly conceded that the view taken in this case completely answers the contentions raised by him in this case.

8. For the reasons given above, we are of the opinion that the Appellate Tribunal has correctly held that although the respondent was an unregistered firm during the assessment year 1953-54, yet it remained during the same unit of assessment for the purposes of assessment for the following year, in spite of the fact that it got itself registered under section 26-A of the Income-tax Act, and that it was entitled to the benefit of carrying forward the loss sustained by it, to the following assessment year 1954-55 when it was a registered firm. In these circumstances the assessee was entitled to the set-off of the loss claimed and the question referred to this Court is, accordingly, answered in the affirma tive. The respondent is entitled to the costs of these proceed ings. S. Q. Reference answered in the affirmative.