Decided on November 24,1994



R.V. Easwar, Judicial Member - (1.) THE only ground in this appeal by the department is that on the facts and In the circumstances of the case the CIT (A) erred in directing the ITO to allow registration to the assessee-firm under Section 184(7) of the I.T. Act. THE appeal arises this way. THE assessee is a partnership firm consisting of five partners. In respect of the assessment year 1987-88 for which the accounting year ended on 31-3-1987 the ITO while completing the assessment passed an order under Section 186 of the Act along with the assessment order. In this order he stated that the assessee had earned a gain of Rs. 11,68,268 out of which a sum of Rs. 8 lacs was transferred to the general reserve and the balance only was transferred to the partners' capital accounts. THE ITO thus came to the conclusion that the entire profits have not been divided which is a condition for getting registration. He therefore called upon the assessee to show cause as to why registration should not be cancelled. THE assessee responded by objecting to the proposal. It was pointed out that the gain referred to by the ITO was not a commercial profit but was a capital gain assessed as such in the assessment order and therefore there was no need to divide the same between the partners. THE ITO was not convinced with the explanation. He therefore cancelled the registration. On appeal the CIT (A) came to the following conclusion : I have gone through the order passed under Section 186 and have considered the submissions made as above. I find that the order of the A/O is very vague and, as admitted by him during the course of discussion on 26-2-1991, no finding regarding genuineness of the firm has been given and no material in that regard has been brought on record. As rightly argued above, the registration can be cancelled only if it is held no genuine partnership, as evidenced by the deed of partnership, existed or if there was any default of nature contemplated in Section 144 of the Act. THE A/O has not brought any materials on record to indicate such a situation and has not given any such finding. In these circumstances I do not find any reason for cancelling the registration. THErefore, the order of A/O cannot survive. THE same is cancelled and he is directed to allow registration to the firm.
(2.) It is against the aforesaid order of the CIT (A) that the revenue has come in appeal. We have heard the Ld. D.R. as well as Mr. G.N. Singh, the learned counsel for the assessee. Mr. Singh argued the matter elaborately with reference to the paper book containing 35 pages. After hearing the rival contentions we are of the view that the contentions of Mr. Singh have to prevail and the order of the CIT(A) has to be upheld. As rightly pointed out by Mr. Singh there are various infirmities and illegalities in the order passed by the ITO, purporting to be an order under Section 186 of the Act. Firstly, the order is vague and does not incorporate the relevant objections of the assessee. It does not even specify the year for which the registration already granted is cancelled. Under Section 186 of the Act, registration already granted for a particular year can be cancelled subject to certain conditions. In the present case, the assessee-firm has filed an application under Section 184(7) of the Act in Form No. 12 for continuation of registration. A perusal of Form No. 12 shows that a declaration with regard to the division of the profits amongst the partners is not a requirement of the statutory provision. All that has to be declared by the partners is that the firm continues without a change in the constitution or in the shares of the partners and that none of the partners was a benamidar of any other partner. Secondly, registration can be cancelled under Section 186 only if the firm is found to be non-genuine. In the present case there is no finding by the ITO that there was no genuine firm in existence as registered. In fact before the CIT (A) the ITO appears to have admitted that the genuineness of the firm is not in dispute at all. Since a primary requirement for the applicability of Section 186 has not been complied with the order has to be cancelled on that score alone. Thirdly, under the second proviso to Section 186(1) registration cannot be cancelled except with the previous approval of the IAC/DC. There is no indication in the order passed under Section 186 as to whether this condition has been complied with. Fourthly, no reasonable opportunity of being heard against the cancellation of the registration was afforded to the assessee-firm. The letter of the ITO dated 23-2-1990 does not at all indicate the proposal of the ITO to cancel the registration. All that it states is that the entire gains of Rs. 11.68 lacs have not been divided amongst the partners. The assessee was only called upon to explain how the profits were divided. Therefore, the assessee-firm has had no reasonable opportunity as contemplated by the section to object the proposal of the ITO. In fact, there was no proposal to cancel the registration at all thereby denying the assessee an opportunity of effectively meeting the ITO's case. That apart, the registration was first granted to the firm in the assessment year 1980-81. Unless the registration for that year is cancelled there is no question of cancelling the registration for the assessment year 1987-88. It is beyond our imagination as to how the registration for the assessment year 1987-88 can be cancelled without even being granted ! The ITO apparently could not grasp the ingredients of the provisions of Section 186 of the Act. There is also no merit in the ITO's case that the profits of the business have not been divided amongst the partners in accordance with the profit-sharing ratio. The profit and loss account for the year shows the net profit of Rs. 3,35,689 from the business. This profit has been taken "below the line". The assessee has also derived, a profit on exchange of land and building amounting to Rs. 11,68,268. This profit was added to the profits from the business and the total profit was arrived at Rs. 15,03,948 below the line. Out of this aggregate profit, a sum of Rs. 8 lacs was transferred to the general reserve, leaving a balance of Rs. 7,03,948 to be distributed amongst the partners equally as per profit sharing ratio. In fact each of the partners has been credited with his share of the profits which amounted to Rs. 1,40,790. The profit on the exchange of land and building has been assessed in the assessment order under the head 'Capital gains' after giving necessary deduction under Section 80T, etc. This profit is a capital profit and is not business profit. Under the Partnership Act as well as under Section 184 of the Income-tax Act it is the duty of the partners to divide the profits of the business alone amongst themselves and there is no condition that even the capital profits should be divided amongst them. Therefore, by transferring a sum of Rs.8 lacs to the general reserve and dividing only the balance of Rs.7,03,948 amongst themselves the partners did not violate any condition prescribed for securing registration. The business profits as per profit and loss account were only Rs. 3,35,680 which were undoubtedly divided between the partners in the profit-sharing ratio, when they divided the profits of Rs.7,03,948. Even assuming that the profits of the business as computed in the assessment order should be divided between the partners, that condition also is satisfied in the present case, since the profits of the business as per the assessment order are Rs. 4,34,395. In the present case the partners have divided the business profits as well as that part of the capital profits which have not been transferred to the general reserve account; thereby they have not in any manner violated the condition that the profits of the business have to be divided between them in accordance with the profit-sharing ratio. The ITO, as rightly held by the CIT(A), has not appreciated this fact at all while passing the order under Section 186. It is now well-settled that in order to secure registration two conditions have to be satisfied by the firm. The firm should be a genuine firm and it should have complied with all the formalities of registration prescribed by the rules [please see the case of CIT v. Sivakasi Match Exporting Co. [1964] 53 ITR 204 (SC)]. In the present case, the genuineness of the firm is not impeached. It has also complied with all the formalities prescribed by the rules, such as, filing of Form No. 12, seeking continuation of registration already granted. The firm has therefore been rightly held entitled to registration. We wholly agree with the order of the CIT(A). We uphold his order and dismiss the appeal filed by the revenue.;

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