1959 (4) TMI 45 - SC - Income Tax

Partnership Registration Hinges on Written Instrument Validity and Procedural Compliance Under Section 26A Income-tax Act

R.C. Mitter & Sons Versus Commissioner of Income Tax, Calcutta. D.C. Auddy and Ors.

The SC analyzed the interpretation of 'constituted under an instrument of partnership' in section 26A of the Income-tax Act, 1922. The Court held that ... - 1. ISSUES PRESENTED and CONSIDEREDThe central legal question considered by the Court in these appeals was the interpretation and effect of the phrase 'constituted under an instrument of partnership' as used in section 26A of the Indian Income-tax Act, 1922. Specifically, the Court examined whether a firm that initially came into existence by an oral or verbal agreement but subsequently executed a written instrument of partnership could be registered under section 26A for assessment years prior to the execution of the written instrument. The issues included:Whether the phrase 'constituted under an instrument of partnership' means that the partnership must have been originally created or set up by a written instrument, or whether it also includes partnerships initially formed orally but later formalized by a written instrument.Whether the instrument of partnership must be in existence and operative during the relevant accounting year for which registration is sought.The interpretation of the procedural requirements under section 26A and the related Income-tax Rules, including the timing of the application for registration and the nature of the instrument required.The scope and effect of the relevant Income-tax Rules and Forms, particularly Rules 2 to 6B, and their interplay with the statutory provisions.The consequences of non-registration under section 26A and the importance of registration for enforcement of income distribution and penalty provisions under section 28(2).2. ISSUE-WISE DETAILED ANALYSISIssue 1: Meaning of 'constituted under an instrument of partnership'Relevant legal framework and precedents: Section 26A of the Income-tax Act permits registration of a firm 'constituted under an instrument of partnership' specifying the individual shares of partners. The Bombay High Court in Dwarkadas Khetan & Co. v. Commissioner of Income-tax held that the section does not require the firm to have been created by the instrument itself, allowing registration even if the firm existed earlier orally but was subsequently documented in writing. Contrastingly, the Calcutta High Court and Punjab High Court decisions interpreted 'constituted under' as meaning 'created by' or 'set up by' an instrument of partnership, requiring the firm to have originated from a written deed operative during the relevant accounting year.Court's interpretation and reasoning: The Court undertook a detailed linguistic and contextual analysis of the phrase 'constituted under an instrument of partnership.' It rejected the narrow interpretation equating 'constituted' solely with 'created.' The Court recognized that 'constituted' may also mean 'to give legal or official form or shape' to an existing arrangement. The Oxford English Dictionary definitions were cited to support this broader meaning, including both establishing and legally formalizing a partnership.The Court criticized the Calcutta High Court's substitution of the word 'by' for 'under,' noting that such reconstruction of statutory language was inappropriate without legislative amendment. Instead, the Court emphasized harmonious construction of the statute and rules, giving effect to all words.Key findings and application of law to facts: The Court concluded that section 26A contemplates both firms originally created by a written instrument and those initially formed orally but subsequently 'constituted under' a written instrument by reducing their terms and conditions to writing. This interpretation aligns with commercial practice and the legislative purpose of ensuring that the true constitution, partners' names, and profit shares are formally documented for tax assessment and enforcement.Treatment of competing arguments: The Court rejected the Revenue's argument that only firms created by a written instrument could be registered. It also disagreed with the Calcutta High Court's narrow construction and its attempt to amend statutory language. However, it acknowledged the necessity of strict compliance with registration requirements to prevent abuse and to facilitate proper tax administration.Conclusion: The phrase 'constituted under an instrument of partnership' includes partnerships initially formed orally but subsequently clothed in legal form by a written instrument operative during the relevant accounting year.Issue 2: Requirement that the instrument of partnership be in existence and operative during the relevant accounting yearRelevant legal framework and precedents: The Income-tax Rules require that the application for registration be made before the assessment of income under section 23 of the Act for the relevant year and that the instrument of partnership accompany the application. The Rules specify that registration is for a particular assessment year. The Punjab High Court and Patna High Court had held that the instrument must be operative during the accounting year to qualify for registration for the subsequent assessment year.Court's interpretation and reasoning: The Court agreed that the instrument of partnership must be operative during the accounting year for which registration is sought. This is because the certificate of registration has effect only for the assessment year specified, and the partnership must have existed in conformity with the terms of the instrument during the relevant accounting period. The Court emphasized that the Rules contemplate a document operative during the accounting year, though it did not decide whether the instrument must exist at the very start of the accounting year or merely before the assessment is completed.Key evidence and findings: In both appeals, the firms had been formed orally earlier but executed partnership deeds after the relevant accounting years. The Income-tax Appellate Tribunal and High Court had refused registration on the ground that the instrument was not operative during the accounting year. The Court upheld these findings.Treatment of competing arguments: While one judge expressed some doubt whether the instrument must exist during the accounting year, the majority accepted this as an implied condition from the statutory scheme and Rules. The Court noted that the Board of Revenue's instructions permitted registration even if the instrument was executed after the accounting year, provided the firm was genuine, but the Court declined to follow such administrative leniency over statutory interpretation.Conclusion: Registration under section 26A requires that the partnership deed be in existence and operative during the relevant accounting year to govern the distribution of profits or losses for that year.Issue 3: Procedural requirements for registration under section 26A and related RulesRelevant legal framework: Section 26A(1) allows application for registration of a firm constituted under an instrument of partnership specifying partners' shares. Section 26A(2) and Rules 2 to 6B prescribe the application procedure, including that the application must be signed by all partners, be made before assessment under section 23, be accompanied by the original instrument of partnership, and specify the assessment year.Court's interpretation and reasoning: The Court highlighted that registration is year-specific and must be renewed annually. The application must disclose the true constitution of the partnership and partners' shares as per the instrument operative in the accounting year. This enables the Income-tax Officer to verify genuineness and proper profit distribution. The Court stressed the importance of strict compliance to prevent concealment and to enable imposition of penalties under section 28(2) if profits are distributed otherwise than according to the registered instrument.Application of law to facts: In both cases, the firms failed to produce an instrument operative during the accounting year for which registration was sought. The applications were thus properly rejected.Conclusion: The procedural requirements under section 26A and the Rules must be strictly complied with; registration is for a specific assessment year and requires an operative instrument of partnership for the relevant accounting year.Issue 4: Effect of non-registration and enforcement of penalty provisionsRelevant legal framework: Section 28(2) imposes penalties if profits are distributed otherwise than according to the registered instrument of partnership. Registration thus serves as the basis for enforcing correct profit sharing and tax liability.Court's reasoning: The Court observed that unless the instrument is registered in respect of the accounting year and before assessment, the penalty provisions cannot be enforced. This reinforces the legislative intent that firms should formalize their partnership terms in writing timely and register them to enable proper tax administration.Conclusion: Registration under section 26A is essential for the Revenue to enforce compliance and penalties related to profit distribution among partners.3. SIGNIFICANT HOLDINGS'If by the expression constituted under an instrument of partnership is meant a firm which originated in a verbal agreement but with respect to which a formal deed was subsequently executed, there would be no room in the section for partnerships, actually created by an instrument and such partnerships, although most obviously entitled to registration, would be excluded from the purview of the section.''The word 'constituted' does not necessarily mean 'created' or 'set up', though it may mean that also. It also includes the idea of clothing the agreement in a legal form.''It is more in consonance with the terms of the relevant provisions of the Act ... to hold that the words 'constituted under an instrument of partnership' include not only firms which have been created by an instrument of partnership but also those which may have been created by word of mouth but have been subsequently clothed in legal form by reducing the terms and conditions of the partnership to writing.''The certificate of registration has reference to a particular assessment year, and has effect for the assessment to be made for that particular year. In other words, the terms of the partnership should appear in instrument of partnership in respect of the relevant accounting year.''Unless the partnership business was carried on in accordance with the terms of an instrument of partnership which was operative during the accounting year, it cannot be registered in respect of the following assessment year.''It is essential, in the interest of proper administration and enforcement of the relevant provisions relating to the registration of firms, that the firms should strictly comply with the requirement of the law, and it is incumbent upon the Income-tax authorities to insist upon full compliance with the requirement of the law.'Final determinations:The phrase 'constituted under an instrument of partnership' in section 26A includes partnerships initially created orally but subsequently formalized in writing.The instrument of partnership must be in existence and operative during the relevant accounting year for registration to be valid for the corresponding assessment year.Registration under section 26A is year-specific and requires strict compliance with procedural requirements, including submission of the operative instrument and application signed by all partners before assessment.Non-registration precludes enforcement of penalties under section 28(2) for improper profit distribution.In the facts of the present appeals, registration was rightly refused because the partnership deeds were executed after the relevant accounting years.