Andhra Pradesh H.C : Whether a genuine partnership, “Ravi Constructions, Visakhapatanam “, had come into existence and whether it is entitled to registration under the IT Act ?

Counsel Appeared

M.S.N. Murthy for the revenue: P. Ramachandra Reddy, M.V. Nageshshaiah & Manga Venkata Rao, for the

Assessee

JEEVAN REDDY, J.:

An identical question is referred for the opinion of this Court under s. 256(1) of the IT Act, 1961, in both these referred cases. The assessee in R. C. No. 50 of 1981, is ” Ravi Constructions, Visakhapatnam “, while ” Uma Constructions, Visakhapatnam “,is the assessee in R. C. No. 51 of 1981. The assessment year concerned is 1973- 74. The question referred in both the referred cases is ” Whether, on the facts and in the circumstances of the case, the assessee was entitled to registration ? ” For the sake of convenience, we shall refer to the facts in R.C. No. 50 of 1981 (Ravi Constructions, Visakhapatnam), since all the relevant facts are identical in both the cases.

2. A partnership firm, ” Y. Seetayya and P. R. Rao “, constituted on October 1, 1971, had obtained and was engaged in executing certain contracts for the construction of port- monoliths for the dry dock and for the supply of building material at Visakhapatnam. The partnership consisted of two partners, namely, Sri Y. Seetayya and P. R. Rao, each having a 50 per cent share. After the contracts were executed in part, Sri P. R. Rao got himself released from the partnership with the result that only Y. Seetayya remained in charge and responsible for the contracts. A new partnership, called ” Ravi Constructions, Visakhapatnam ” was constituted on May 2, 1972. This partnership, according to the partnership deed, consisted of 9 partners. The names of the partners and their shares in profits and losses are mentioned in cl. 8. Indeed, for a proper appreciation of the question at issue, it is necessary to set out cls. 7 and 8 in full, and refer to some other clauses of the partnership. Clauses 7 and 8 read as follows : ” 7. The first partner, Sri Y. Seetayya, shall act and function as consultant and shall be paid 1per cent (one per cent.) of the payments received from the Department or persons awarding the contracts for his advice and guidance and the said 1per cent shall be deposited in the bank account of Sri Y. Seetayya and he shall not be liable for any losses of this firm and partners Nos. 2 to 9 shall jointly and severally indemnify the 1st partner, Sri Y. Seetayya, in the event of any loss arising to him by reason of the Department or any person proceeding against him to enforce any liability or action or claim or whatsoever relating to this firm including any liability or action or claim that might have accrued or arisen or may accrue or arise in the execution of the works for which this partnership is formed.

8. The accrued profits or losses shall be shared by the second, third, fourth, fifth, sixth, seventh, eighth and ninth partners in the following ratio : Profit Loss Partner I Y. Seetayya nil nil Partner 2 A. Shankar Rao 5per cent 5per cent Partner 3 A. Yesodha 5per cent 5per cent Partner 4 K. Srinivasa Rao 15per cent 15per cent Partner 5 K. S. Shanti 15per cent 15per cent Partner 6 K. S. Yamuna Devi 15per cent 15per cent Partner 7 K. S. Prabhakar Rao 15per cent 15per cent Partner 8 P. Jayaratnam 15per cent 15per cent Partner 9 Dr. M. R. Gandhi 15per cent 15per cent Clause 9 provided that Sri Y. Seetayya (first partner) should continue to remain in the firm till the work of the subsisting contracts was completed; thereafter, he had no concern with or claim upon the firm. Clause 10 provided that apart from the Mercantile Bank and the Bank of India, which were the bankers of the firm, any other bank may be chosen by the partners. Clause 12 stipulated that no partner shall be entitled to alienate his or her interest in the firm so as to make the transferee a partner. Clause 17 provided that the partners, by majority, may take in a new partner on such terms as they thought fit. Clause 18 contemplated the firm being converted into a private limited company, if the majority of the partners so decided. The accounting year of the firm was to be the financial year.

For the asst. yr. 1973-74, the assessee-firm, Ravi Constructions, filed Form No. 11 along with the partnership deed, requesting grant of registration for the said assessment year. In Form No. 11, in column No. 5, against the name of Sri Y. Seetayya, it was first mentioned that 1per cent of payment received in lieu of profit thereof was his share. This was, however, struck off and, by placing an asterisk mark at the bottom, it was stated that his share was 1 per cent of the payments received from the Department. When this was pointed out by the ITO to the authorised representative of the assessee, the auditor of the assessee-firm filed a letter dated April 22, 1976, explaining that the striking off of the words in column No. 5 should be treated as a mistake and that the entry originally made should be treated as the correct entry.

The ITO refused registration to the firm and treated it as an unregistered firm for the following reasons: (i) In this case there is no agreement to share the profits of the business which is an essential condition of the partnership. A perusal of the deposition of Sri Y. Seetayya recorded on January 27, 1975, clearly proves that he was getting only commission and not profit ; that he was not at ill concerned with the business of the firm, notwithstanding the statement in cl. 7; and that Sri Y. Seetayya was shown as a partner in the partnership deed only for the sake of continuity. Inasmuch as the transfer or assignment of the contract was likely to entail its termination, Sri Y. Seetayya was shown as a partner; thus the inclusion of his name in the partnership deed was only a ” make-believe ” and the 1per cent of the gross receipts paid to him is nothing but a nominal fee for lending his name in the continuation of the contracts in the hands of the assessee; and (ii) the facts mentioned in point No. 1 also go to show that Sri Y. Seetayya was not at all responsible for carrying on the business, nor was the business carried on by all or any one of them acting for all. Thus, the second essential ingredient of partnership is also missing in this case.

Before proceeding further, it would be appropriate to set out the relevant part of the deposition of Sri Y. Seetayya relied upon by the ITO, since the said deposition constitutes an important piece of evidence in this case, and has been relied upon by all the authorities. The relevant portion of the deposition, as found extracted in the assessment order, reads thus: ” Q. Have you disclosed in your returns of income filed for 1973-74 and 1974-75 assessment years that you have received some commission from the above two firms and whether the commission amounts were actually received by you are set off against any amount due by you to the above firm or partners ? A. I have received the commission income by means of drafts. The entire commission due to me is paid. Q. What is the nature of understanding between the old firm of Sri Y. Seetayya & P. R. Rao & Co. (Port Work) and Y. Seetayya & P. R. Rao & Co. (MES Works) on the date they were dissolved? A. The understanding is to receive commission from M/s Ravi Constructions and Uma Constructions at the rate of 1 per cent and 1/4 per cent, respectively, on the gross bills received from the Departments to myself since the dissolution of the above two firms. Q. Except for the commission, are you responsible for any profit or loss of the said two firms? A. No. 1 am not responsible for any profit or loss of the said firms. Q. Are you taking any interest whatsoever in the actual business of the above firms ? A. No… ” Against the refusal of the ITO to grant registration, the assessee-firm filed an appeal before the AAC. The AAC allowed the appeal on the following reasoning:

6. The two elements necessary to constitute a genuine partnership, viz., an agreement entered into by all persons concerned and mutual agency among them are present in this case. The partnership deed itself describes Y. Seetayya as a partner and thus the first requirement is satisfied. So far as the second requirement is concerned, it is necessary to remember that the very existence of the firm’s business (the execution of certain subsisting contracts) owed its origin to the presence of Sri Y. Seetayya as a partner in the firm. But for him, there was no such business. Moreover, he had also acted and functioned as a consultant as shown in cl. 7 of the partnership deed. The deposition of Sri Y. Seetayya does not negative this fact. The several clauses in the partnership deed also go to show that there was mutual agency among all the 9 partners.

7. So far as the manner of giving the share to Sri Y. Seetayya is concerned, it was only a mode of describing his share in the profits. True it is that in the previous partnership firm, Y. Seetayya’s share was 50 per cent, but nothing prevents him from reducing his share in the reconstituted firm; he did not contribute any capital except his services as a consultant in this new firm. He was insured against losses, so he would have decided that the 1 per cent payment was a good bargain. Be that as it may, the said payment can be treated as representing his share in the profits. Aggrieved by the decision of the AAC, the Department filed an appeal before the Tribunal. The Tribunal confirmed the reasoning and conclusion of the AAC and dismissed the appeal.

8. The question for our consideration is whether the Tribunal was right in coming to the conclusion it did in the facts and circumstances of the case. In other words, the question is whether a genuine partnership, “Ravi Constructions, Visakhapatanam “, had come into existence and whether it is entitled to registration under the IT Act ?

9. Section 4 of the Partnership Act defines the expression ” partnership ” as ” the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all “. Sec. 6, which is relevant in this behalf, deals with the ” mode of determining existence of partnership “. It says: ” In determining whether a group of persons is or is not a firm, or whether a person is or is not a partner in a firm, regard shall be had to the real relation between the parties, as shown by all relevant facts taken together.” The two Explanations, appended to s. 6, are equally relevant and may be reproduced: “Explanation 1.—The sharing of profits or of gross returns arising from property by persons holding a joint or common interest in that property does not of itself make such persons partners. Explanation 2.—The receipt by a person of a share of the profits of a business, or of a payment contingent upon the earning of profits or varying with the profits earned by a business, does not of itself make him a partner with the persons carrying on the business; and, in particular, the receipt of such share or payment: (a) by a lender of money to persons engaged or about to engage in any business, (b) by a servant or agent as remuneration, (c) by the widow or child of a deceased partner, as annuity, or (d) by a previous owner or part owner of the business, as consideration for the sale of the goodwill or share thereof, does not of itself make the receiver a partner with the persons carrying on the business. “

10. Sec. 9 provides that partners are bound to carry on the business of the firm to the greatest common advantage, to be just and faithful to each other, and to render true accounts and full information of all things affecting the firm to any partner or his legal representative. Sec. 11 provides that subject to the provisions of the said Act, the mutual rights and duties of the partners of a firm may be determined by contract between the partners, and that such contract may be expressed or may be implied by a course of dealing. Secs. 12 and 13 make it clear that the conduct of the business of the firm and mutual rights and liabilities of the partners is a matter of contract between the parties ; but subject to any such contract, each partner has a right to participate in the conduct of the business and is bound to attend diligently to his duties in the conduct of the business; he has also a right to have access to, and to inspect and take copies of the books of the firm. A partner is not entitled to receive any remuneration for taking part in the conduct of the business.

From the above provisions of law, it is evident that the following are the three essential elements of a partnership, viz. : (i) there must be an agreement entered into by all the persons concerned; (ii) the agreement must be to share the profits of the business; and (iii) the business must be carried on by all or any of the partners concerned acting for all.

11. Section 6 says that, in determining whether a firm exists or not, or whether a person is a partner of the firm or not, ” regard shall be had to the real relation between the parties as shown by all relevant facts taken together “. Explanation 1 to s. 6 illustrates the said rule by saying that mere sharing of profits or gross returns arising from property by persons holding a joint or common interest in that property does not by itself make such persons partners. Explanation 2 in particular says that the receipt by a person of a share of the profits of a business does not by itself make him a partner, and that, in particular, the receipt of such share by or payment to a previous owner or part owner of a business, as consideration for the sale of the goodwill or share thereof, does not of itself make the receiver a partner with the persons carrying on the business. We are of the opinion that the test prescribed by s. 6 was unfortunately not kept in mind by both the appellate authorities in deciding the question at issue. They have approached the issue in a hyper-technical manner; they took each aspect separately into consideration and held that it by itself does not militate against the existence of a genuine partnership; but they failed to consider the cumulative effect of all the facts and circumstances taken together; nor did they make any attempt to find out what was the real nature of relationship between Y. Seetayya on the one hand and the other partners on the other. Now, let us set out all the facts and circumstances relevant upon the said question and then determine the real nature of the relationship between Y. Seetayya and others. We may note that, according to the contention of learned standing counsel for the Revenue, this was a case of a mere assignment of the business relating to contracts by Y. Seetayya in favour of the eight other persons, for which the consideration was determined at 1 per cent of the payments received from the Department and that Sri Y. Seetayya had no concern with the business thereafter or with its profits or losses whatsoever. On the other hand, the contention of learned counsel for the assessee is that it was a valid and genuine partnership and that the stipulation to pay 1 per cent of the payments received from the Department towards Y. Seetayya’s share was only one mode of describing his share in the profits. It is emphasised that, according to cl. 7, Sri Y. Seetayya was to provide advice and guidance to the other partners in the conduct of the firm’s business.

12. The relevant facts are these: (a) the partnership deed described Y. Seetayya as a partner; (b) the contracts in question were initially awarded to a firm, Y. Seetayya & P. R. Rao, consisting of two partners, Y. Seetayya and P. R. Rao, each of whom had a 50per cent share; the said partnership executed the contracts to some extent, whereafter the partnership came to an end with the retirement of Sri P. R. Rao; Sri Y. Seetayya was left alone with the contracts. At that stage, the assessee-partnership ” Ravi Constructions ” was formed on, May 2, 1972, to carry on and complete the said contracts. As soon as the said contracts were over, Sri Y. Seetayya was to cease to be a partner; (c) Sri Y. Seetayya did not contribute any capital in the new partnership; cl. 7 of the partnership deed, no doubt, says that 1per cent of the payments received from the Department shall be paid to him ” for his advice and guidance ” but his own deposition shows that he was not taking any interest in the actual business of the firm ; (d) Sri Y. Seetayya was not liable for any losses, nor was he entitled to profits apart from 1per cent of the payments received. The other eight partners also indemnified him against any loss arising to him by reason of the Department or any person proceeding against him to enforce any liability, action or claim whatsoever relating to the said firm including any liability or action or claim that might have accrued or arisen or may accrue or arise in execution of works for which the said firm was formed. According to cl. 8, profits and losses were divided in certain specified proportions only among the eight other partners ; (e) according to the deposition of Sri Y. Seetayya, he was entitled to receive commission at 1per cent and he was not responsible for any profits or loss of the said firm; and (f) the partnership firm was registered with the Registrar of Firms.

13. Now, the approach should not be to take each of the above factors individually and examine whether it by itself militates against the existence of a partnership or otherwise. Taken in this manner, neither fact is conclusive, but it can be explained. The proper approach is to take all the facts and circumstances together and find out what really was the nature of the relationship between Y. Seetayya and others and whether, indeed, Y. Seetayya can be called a ” partner ” in the firm ” Ravi Constructions “. In other words, one has to determine, on a cumulative consideration of all the facts and circumstances, whether a genuine partnership, consisting of 9 persons, including Y. Seetayya, had come into existence, in which case alone it would be entitled to registration under the IT Act. But, unfortunately, both the appellate authorities had adopted the former approach which has completely vitiated their findings and conclusions. They went merely by form and not by substance. Merely because the partnership deed describes Sri Y. Seetayya as a partner, they were of the opinion that he is a partner. When it was argued that he had no share in the profits, the appellate authorities referred to certain decisions and held that sharing the profits need not necessarily be provided in a direct manner but can be provided in such manner as the partners think fit, and that the provision in this case is ultimately a mode of giving a share in the profits. When it was next argued that Sri Y. Seetayya is not at all responsible for the business of the firm and that the recital in cl. 7 about his tendering aid and advice was a mere ” make-believe ” and, reliance in support of this contention was placed upon his own deposition, the said deposition was explained away in a very unsatisfactory manner. It is this erroneous and compartmentalised approach which has resulted in their coming to the unsustainable conclusion that Sri Y. Seetayya was a partner and that there was a genuine partnership comprising him and eight other partners which is entitled to registration. Taking all the above facts and circumstances together, what, in our opinion, has really happened in this case is this: Y. Seetayya and P. R. Rao had formed a partnership and had obtained certain contracts ; half way through P. R. Rao, retired from the partnership, leaving Y. Seetayya alone with the contracts; Y. Seetayya was himself in no mood or in no position to execute the contracts; the best way he thought was to assign the contracts for certain consideration and thus practically get rid of the contracts; but it was not possible to assign the contracts since such an assignment would have invited termination. Therefore, the device of partnership was resorted to. The real partners in ” Ravi Constructions ” were those shown as partners Nos. 2 to 9; only for the sake of continuity and to avoid cancellation of the contracts, Y. Seetayya was also shown as a partner, but his share in the profits and losses was shown as nil. Y. Seetayya was to take 1 per cent of all the payments received after the dissolution of the earlier partnership and he had nothing to do with the business or its profits and losses. In fact, the partnership deed further provided that if any claim is made against Y. Seetayya or any liability is created against him in respect of the said contracts, or their working by the earlier partnership, he shall be indemnified in full by the other partners. Thus, it was clearly a case of an assignment of contract by Y. Seetayya in favour of eight other partners and not a case of a partnership comprising 9 partners. On this aspect, however, we must elaborate our comment with respect to the manner in which the appellate authorities have explained away the deposition of Sri Y. Seetayya that he was not concerned with the business or its profits or losses. We have already set out the relevant portion of his deposition in full.

The questions and answers show that questions were put and the answers given in the present tense. No doubt, the deposition was recorded on January 27, 1975, by which date, it is said, the relevant contracts had been completed and come to an end; but that is no reason to hold that Sri Y. Seetayya was referring to the position obtaining on the date of his deposition, i.e., after the conclusion of the contract, and not to the situation obtaining, when the contracts were under execution and the partnership was, in force. It must be remembered that, according to cl. 9 of the partnership deed, Y. Seetayya was to cease to be a partner as soon as the contracts in question came to an end. If, by January 27. 1975, the said contracts had come to an end, it means that he was no longer a partner on that date. If so, there is no question of his saying that he is not taking any interest in the actual business. He was really referring to the situation when the contracts were in progress and when the alleged partnership consisting of himself and eight other persons was existing. The interpretation placed by the appellate authorities is too involved and too strained to be called reasonable. It is not as if he stated anywhere else that he was taking interest in the business of the partnership while the contracts were in progress or when he was a partner in the said firm. We are, therefore, of the opinion that his deposition clearly shows that the recital in cl. 7 that he was to be paid 1 per cent of the payments received from the Department ” for his advice and guidance ” is only ” make-believe “, as rightly held by the ITO.

In the light of what we have said above and in particular the wrong approach adopted by the appellate authorities, we do not think it necessary to examine the decisions relied upon by them in support of their proposition. However, a brief reference would be in order. The first decision relied upon is in Raghunandan vs. Hormasji, AIR 1927 Bom 187. Two solicitors entered into a partnership. Partner A was to be paid Rs. 500 per month in lieu of profits, whether profits were earned or not. The Bombay High Court held that A became a salaried partner and justified the same by saying that with a view to avoid the accounting and computation of profits, the partners agreed that partner A shall take Rs. 500 per month towards his share in the profits.

The next decision is in Raghumull Khandelwal vs. Official Assignee of Calcutta (1925) 28 CWN 34; 81 IC 17. A co- partnership agreement was entered into between four persons, namely, Raghumull, Dorian Evans, H.C. Ghosh, and D. N. Sircar. The deed provided that Dorian Evans shall be in charge of the firm and devote his whole time to the business. He was to get Rs. 50 per month over and above 10 per cent as commission on the net profits of the firm, but he shall have no share in the profits of the firm; the profits of the firm were to be distributed among the three other partners in certain specified shares. The question was whether Dorian Evans was a partner ? It was held he was, having regard to the agreement of partnership as a whole. The discussion shows that while arriving at the said conclusion, all the relevant facts and circumstances were taken into account and the real intention of the partners inferred.

The third decision is a Full Bench decision of the Madras High Court in R. M. Chidambaram Pillai vs. CIT (1970) 77 ITR 1977 CTR (SC))71:494(Mad), which has been affirmed by the Supreme Court in CIT vs. R. M. Chidambaram Pillai (1977) 106 ITR 292(SC). The question in this case was whether the salaries paid to the partners by a partnership firm constitute ” profits ” in their hands and whether they are taxable. It was held that, since in law a partnership firm is not a distinct legal person, the concept of ” employer ” and ” employee ” does not exist. It was observed that partners cannot be both employers and employees simultaneously. It was, therefore, held that payment of salary to a partner represents a special share of profits, and that it retains the character of the income of the firm.

As against the above, learned standing counsel brings to our notice the decision of the Calcutta High Court in CIT vs. Janatha Medical Stores (1985) 46 CTR (Cal) 340:(1985) 155 ITR 377(Cal). In this decision, it was held that, in view of the decision of the Supreme Court in K. D. Kamath & Co. vs. CIT (1971) 82 ITR 680(SC), where a partnership deed confers immunity from loss on one of the partners, it detracts from there being a genuine partnership between the executants of the deed and such a firm cannot be granted registration under the Act.

In Raj Construction Company vs. Addl. CIT (1985) 49 CTR (Raj) 348:(1986) 157 ITR 734 (Raj), the Rajasthan High Court was of the opinion, that in order to entitle a firm to registration under the IT Act, the specification of shares of the partners in profits as well as losses is necessary. However, it was held that, even if there is no such specification in the deed, if such specification is found in Form No. 11, that is enough to warrant the grant of registration. A Full Bench of this Court also has taken the same view in CIT vs. Krishna Mining Company (1980) 15 CTR (AP) 203 (FB): (1980) 122 ITR 362(AP)(FB). It was held that, if the specification of shares of the partners is evident from the partnership deed, or where it can be inferred from the other material on record, the firm must be granted registration. It was also observed that, whether there is specification of shares of the partners or not in a given case is a mixed question of fact and law to be determined on the facts and circumstances of each case.

In K. S. Badrinarayana Rao vs. CIT (1984) 42 CTR (Kar) 264:(1985) 152 ITR 159 (Kar), it was held by the Karnataka High Court that, where a fixed sum is paid to one person described as a working partner without a right to share in the profits or assets of the firm on dissolution, such person cannot be treated as a partner and registration cannot be granted to the firm.

The Kerala High Court has held in United Hardwares vs. CIT (1974) 96 ITR 348(Ker), that the specification of shares of the partners in the instrument of partnership is a necessary requirement for granting registration under the IT Act.

In Mandyala Govindu & Co. vs. CIT 1976 CTR (SC) 20:(1976) 102 ITR 1(SC), the Supreme Court held that, before allowing an application for registration, the ITO must be in a position to ascertain the shares of the partners in the losses even if the said aspect is not specified in the instrument of partnership. It was held that, where the shares in the profits were unequal, the losses must be shared in the same proportion as the profits, in the absence of an agreement with respect to the sharing of losses. In the case before us, however, it must be remembered, Seetayya was specifically exonerated and freed from sharing of any losses. While the above review of the decisions discloses the various angles from which the issue was examined, one thing appears clear from the decisions of the Supreme Court and the Full Bench decision of this Court, viz., that either from the partnership deed or other material, it should be possible to ascertain the shares of the partners both in profits as well as losses. In this case, even if it is held that Seetayya’s share in profits is ascertainable, his share in the losses is not. Indeed, he had no share in the losses and this is certainly a strong indication against the assessee’s case. Be that as it may, it is not any single aspect or factor that should be taken as conclusive one way or the other, as observed by us hereinbefore, but all the relevant facts and circumstances should be taken together and the real intention of the parties and the real nature of the relationship between them determined, as directed in s. 6 of the Partnership Act. We have pointed out hereinbefore that the approach of the appellate authorities in this case has been totally different, which has vitiated their findings and conclusion, and that the conclusion arrived at by the Tribunal is unsustainable in law and the facts of this case.

For the above reasons, the questions referred to us are answered in the negative, i.e., in favour of the Revenue and against the assessees. There shall be no order as to costs.

[Citation : 169 ITR 662]