Court quashes tax notice for lack of jurisdiction, prohibits use of firm funds for partners' tax.

The court held that the ITO lacked jurisdiction to issue a notice under section 226(3) of the Income-tax Act, 1961, as no recovery certificate had been issued by the specified date. It was also determined that the ITO improperly used the partnership firm's funds to settle individual partners' tax liabilities, which was deemed impermissible under the law. Consequently, the court allowed the petition, quashed the notice, and directed the respondents to return the funds to the concerned party, while also awarding costs to the petitioners.

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Issues Involved:
1. Jurisdiction of the ITO to issue a notice under section 226(3) of the I.T. Act, 1961.
2. Legality of using partnership firm's funds to settle individual partners' tax liabilities.

Detailed Analysis:

1. Jurisdiction of the ITO to Issue Notice Under Section 226(3) of the I.T. Act, 1961:

The petitioners challenged the validity of the notice issued under section 226(3) on the grounds that no tax demand was in arrears on April 22, 1972, and no recovery certificate had been issued by then. The court examined the provisions of section 226 and section 222 of the Income-tax Act, 1961, which stipulate that the modes of recovery under section 226 can be adopted concurrently with proceedings under section 222, but only after the issuance of a certificate under section 222. The court found that the ITO did not claim any certificate had been issued under section 222 by April 22, 1972, making the notice under section 226(3) void and without jurisdiction.

The court also noted that the firm and its partners were not in arrears for the tax demand for the assessment year 1971-72, as the prescribed 35-day period to pay the demand had not expired by April 22, 1972. Additionally, there was no evidence of any tax demand in arrears from prior periods. The court concluded that the ITO had no jurisdiction to issue the notice under section 226(3) for recovering the tax demand or advance tax from the firm or its partners.

2. Legality of Using Partnership Firm's Funds to Settle Individual Partners' Tax Liabilities:

The court examined whether the ITO could legally use the firm's funds to settle the individual partners' tax liabilities. The court cited the Supreme Court's decision in Narayanappa v. Bhaskara Krishnappa, which clarified that during the subsistence of a partnership, no partner can deal with any portion of the partnership property as his own. The court held that the individual partners do not have any right or interest in the business income earned by the partnership firm, and no part of such income can be deemed to vest in any individual partner.

The court found that the ITO had adjusted a significant portion of the firm's funds towards the personal tax liabilities of the individual partners, which was not permissible under the law. The court emphasized that the jurisdiction to recover tax due from a partner from the assets of the firm arises only when it is found that the tax assessed upon a partner cannot be recovered from him. In this case, there was no evidence that the ITO was satisfied that the tax assessed upon the partners could not be recovered from them.

The court also noted that there was no provision in the Income-tax Act allowing the personal liability of a partner with regard to advance tax to be recovered from the assets or funds of the firm. The court concluded that the ITO's action in resorting to section 226 to realize the demands due from the individual partners by adjusting the firm's funds was invalid.

Conclusion:

The court allowed the petition, quashing the notice dated April 22, 1972, and directed the respondents to return the sum of Rs. 1,91,362 to the Engineer-in-Chief, Northern Railway (Electrification), Allahabad. The petitioners were also entitled to costs. The court held that the ITO had acted without jurisdiction and had improperly used the firm's funds to settle individual partners' tax liabilities.

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