Karnataka High Court
Mushtaque & Co. vs Commissioner Of Income-Tax, Mysore on 4 August, 1970
Equivalent citations: [1972]84ITR561(KAR), [1972]84ITR561(KARN)
JUDGMENT 1. The assessee in this case, M/s. Mushtaque and Company. Davangere, had been refused registration under section 185(1)(b) of the Income-tax Act, 1961, on the ground that the element of agency which is an essential ingredient to constitute a valid partnership was absent in this case. The assessment year involved is 1962-62. The corresponding accounting period was the year ended March 31, 1962. The instrument of partnership produced before the authorities was dated March 30, 1962, and the partnership was deemed to have come into operation with effect from April 1, 1961. The consitution of the partnership in terms of the aforesaid deed was as under : 1. Sri C. R. Sayyad Hafeez Saheb, managing partner 1/2 share. 2. Sri Abdul Warris Saheb, 1/6th share from 1-4-61 to 10-6-61; 1/4 share from 11-6-61 to 31-1-62; 1/6th share from 1-2-62. 3. Sri Sayyad Abdulla Saheb, 1/6th share from 1-4-61 to 10-6-61; 1/4th share from 11-6-61 to 31-1-62; 1/6th share from 1-2-62. 4. Smt. Fatimbhai (died on 10-6-61) From 1-4-61 to 10-6-61 1/6th share. 5. Sri Sayyad Yousuff Saheb With effect from 1-2-62 1/6th share. 2. An application for registration of the firm under section 26A of the Income-tax Act, 1922, was made to the Income-tax Officer on March 30, 1962, followed by a fresh application for registration made on September 29, 1962, under the form prescribed as contemplated under section 184 of the Income-tax Act, 1961. The Income-tax Officer held that the assessee was not entitled to registration for two reasons : firstly, on the ground that the partnership deed was weighted overwhelmingly in favour of the managing partner, Shri Sayyad Hafeex Saheb, who had the power to dismiss the other partners, and, secondly, on the ground that the distribution of profits had not been made in accordance with what had been stated in the partnership deed. In support of his case, the Income-tax Officer had relied on clause 5 of the partnership deed which read as under : "5. That the first party shall be the managing partner, the second the financing partner and the third and fourth are admitted as working partners, respectively. The managing partner shall have full rights of either admitting new partners, raising additional funds and loans, etc., for the business and in case it is found that the activities of the working partners are found detrimental to the interest of the firm, he has powers expel them or to restrict their powers in the interest of the fiirm. In all important matters the working partners shall have to seek advice from the managing partner and act accordingly." 3. The Income-tax Officer, accordingly, made an order on August 12, 1963, under section 185(1)(b) of the Income-tax Act, 1961, refusing registration to the assessee. A copy of the Income-tax Act, 1961, refusing registration to the assessee. A copy of the Income-tax Officers order dated August 12, 1963, under section 185(1)(b) of the Income-tax Act, 1961, is annexed herewith, marked "A", anbd forms part of the statement of the case. A copy of the instrument of partnership dated March 30, 1962, is annexed herewith, marked "B", and forms part of the statmement of the case. 4. The Appellate Assistant Commissioner held that clause 5 of the partnership deed was destructive of the element of agency which was an essential ingredient to constitute valid partnership. He observed that the managing partner, Sayyad Hafeez Shaeb, could not merely expel the working partners in the event of their conduct being found detrimental to the interest of the firm, but he could even in the normal course of business restrict their powers in the interest of the firm. Such a position was not consistent with the principle of agency in the relationship among the partners. The Appellate Assistant Commissioner disposed of the matter on this ground and observed that there was no need to consider the additional ground mentioned by the Income-tax Officer. A copy of the Appellate Assistant Commissioner's order dated November 28, 1964, is annexed herewith, marked "C", and forms part of the statement of the case. 5. On second appeal, the Tribunal took the view that this case was covered by the ratio of the decision of the Mysore High Court in the case of K.D. Kamath & Co. In the present case, the agreement stipulated that the managing partner shall have full rights to admit new partners and raising additional funds and loans for the business, and in case it was found that the activities of the working partners were detrimental to the interest of the firm, the managing partner has power to expel ot restrict their powers. Moreover, in all important matters the working partners had to seek advice from the mnanaging partner and act accordingly. The Tribunal, accordingly, observed on a true reading of the document that it was clear that no relation of partnership was created by the document in question since the working p[artners could not represent the firm on their own. The decision of the Mysore High Court in the case of City Tobacco Mart cited by the learned representative for the assessee was also considered by the Tribunal. The Tribunal observed that the present case went a step further, inasmuch as powers were given to the managing partner to expel the other working partners by restricting their sphere of activities and in all important matters the working were required to seek advice from the managing partner and act accordingly. These restrictions, according to the Tribunal, struck at the root of the partnership by taking away the element of agency which was an essential ingredient of a partnership. The assessee's representative also relied on the decision of the Madras High Court in the case of Subbu and Company and A.M. Palaniappa Chettiar. The Tribunal found that the facts in the present case were quite different from the facts in the above cases and observed that the analogy drawn by the representative for the assessee was not appropriate. Having regard to these considerations, the Tribunal took the view that the assessee's case fell squarely within the ratio of the Mysore High Court's decision in the case of K.D.Kamath & Co. The Tribunal accordingly held that no valid partnership was constituted by the document dated March 30, 1962, and the authorities below were, therefore, right in refusing to grant the benefit of registration to the assessee. The Tribunal dismissed the assessee's appeal accordingly. A copy of the Tribunal's order dated October 6, 1967, in I.T.A. No. 1696 of 1965-66 is annexed herewith, marked "D", and forms part of the statement of the case. 6. On these facts, the question of law that arises is : "Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was not entitled to the benefit of registration for the assessment year 1962-63 ?" JUDGMENT The judgment of the Court was delivered by Govinda Bhat, J.
7. The question of law referred under section 256(1) of the Income-tax Act, 1961, for our opinion is :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was not entitled to the benefit of registration for the assessment year 1962-63 ?"
8. The reference relates to the assessment year 1962-63, the corresponding accounting period being the financial year April 1, 1961, to March 31, 1962. The instrument of partnership is dated March 30, 1962. The partnership consisted of four partners of whom No. 1, Sayyad Hafeez Saheb, was the managing partner; No. 2, Abdul Warris Saheb, was the financing partner and Nos. 3 and 4 were the working partners. The deed of partnership provided for the sharing of profits and losses in accordance with the shares of the partners as defined under the deed. The Income-tax Officer refused registration of the firm on the ground that, in view of the provisions of clause 5 of the deed of partnership, the element of agency required to constitute a partnership was lacking. That view of the Income-tax Officer was upheld by the Appellate Assistant Commissioner of Income-tax and Tribunal. The question is whether, in view of the provisions of clause 5 of the deed of partnership, the element of agency can be said to be lacking.
9. Clause 5 of the deed of partnership reads :
"That the first party shall be the managing partner, the second the financing partner and the third and fourth are admitted as working partners, respectively. The managing partner shall have full rights of either admitting new partners, raising additional funds and loans, etc., for the business and in case it is found that the activities of the working partners are found detrimental to the interest of the firm, he has powers to expel them or the restrict their powers in the interest of the firm. In all important matters the working partners shall have to seek advice from the managing partner and act accordingly."
10. Whether the relationship of partnership exists in a given case must be determined on the facts of each case, bearing in mind the fact that two essential ingredients of the partnership are that there should be an agreement to share the profits and losses of the business and each of the partners should be acting as the agent of all. It is not the case of the department that the partnership in question is not a genuine one. Their contention is that, in view of the provisions of the clause 5 aforesaid, no valid partnership came into existence. Under the said clause, the managing partner has been conferred with the power to admit new partners, raising additional funds and loans, etc., for the business and the power to expel any of the working partners if it is found that their continuance in the firm is detrimental to the interest of the firm and further that the working partners have to seek advice from the managing partner and act accordingly in all important matters.
11. Section 20 of the Partnership Act, 1932, hereinafter called "the Act", provides that the partners in a firm may by contract between them extend or restrict the implied authority of any partner. Section 31 provides that subject to contract between the partners and to the provisions of section 30 no person shall be introduced as a partner into a firm without the consent of all the existing partners.
12. Pollock and Mulla in their Commentary on the Sale of Goods Act and Partnership Act, 3rd edition, by D. N. Pritt, at page 338, state as follows :
"Introduction of partners by agreement. - Express power for a senior or principle member of a firm to introduce one or more new partners, named or not named, under agreed conditions, is in fact constantly given by partnership articles."
13. Section 33 of the Act provides that a partner may not be expelled from a firm by any majority of the partners, save in the exercise, in good faith, of powers conferred by contract between the partners. In other words, the power of expulsion can be conferred by contract between the partners, provided such an action is taken in good faith in exercise of the powers conferred by contract. Section 33 of the Act corresponds to section 25 of the English Partnership Act, 1890 (53 and 54 Vic. c. 39). With reference to the said provision Halsbury's Laws of England, 3rd edition, volume 28, at pages 564 and 565, states :
"Dissolution on expulsion. - No majority of the partners can expel any partner unless a power to do so has been conferred by express agreement between the partners. A power of expulsion conferred by articles of partnership cannot be exercised to determine a partnership at will arising after the expiration of the term. The power must be exercised in the utmost good faith by all the partners whose concurrence may be necessary under the partnership contract."
14. In Carmichael v. Evans, a provision in the articles of partnership conferred power of expelling a junior partner on a senior partner and that power was held to have been validly exercised.
15. In Balubhai Gulabdas Navlakhi v. Commissioner of Income-tax, the instrument of partnership conferred power on a partner to introduce a new partner or to dismiss an existing partner by giving notice. In the said case, it was held that if the two essential conditions which are necessary to found the relation of partnership, viz., (1) that there should be an agreement to share the profits as well as the losses of the business, and (2) that each of the partners should be acting as an agent of all, exist then the other conditions which confer a larger share to one of the partners in the management or the ownership of the assets would not negative the existence of the partnership.
16. In Commissioner of Income-tax v. Pathrose Rice and Oil Mills, clause 7 of the partnership in question provided that if at any time partner No. 1 wished to send out partners Nos. 2 and 3 jointly or severally, he has independent and absolute right and power to immediately exclude or discharge them. Clause 8 provided that all activities connected with the business, etc., were to be conducted at the sole direction of partner No. 1 and all his actions were binding on all the three partners equally. It was held that the said provisions did not render the partnership invalid.
17. In Commissioner of Income-tax v. R. S. Shoe Factory, three persons agreed to form a partnership. The business of the firm was to be carried on by two or three partners and the third partner was to have no right to interfere with the conduct of the business and he was liable to be dismissed by the other partners. Despite such a provision, it was held that the agreement satisfied all the essentials of a valid partnership and as such entitled to registration.
18. In City Tobacco Mart v. Commissioner of Income-tax, this court held that the overriding powers given to the first two partners under clause 2 and 4 of the deed of partnership were not such as to destroy the character of partnership. It was held that under the provisions of the Partnership Act, the partners could contract for the introduction of new partners without the consent of all the original partners.
19. In Commissioner of Income-tax v. K. D. Kamath & Co., relied on by the Tribunal on the facts of the particular case, it was held that the element of agency was lacking. The terms of the deed of partnership in the said cases are not similar to the terms of the deed in the instant case. The said decision is under appeal before the Supreme Court.
20. In the instant case, clause 5 of the deed of partnership is not repugnant to the provisions of the Act and it cannot be said that, in view of the provisions of clause 5, the element of agency is lacking. Therefore, the Tribunal was not right in the view it has taken that no valid partnership has been constituted under the instrument of partnership.
21. For the above reasons, we answer the question referred to us in favour of the assessee as follows :
On the facts and in the circumstances of the case, the Tribunal was not right in law in holding that the assessee was not entitled to the benefit of registration for the assessment year 1962-63.
22. The assessee will be entitled to the costs of this reference. Advocate's fee Rs. 250.