COMMISSIONER OF INCOME TAX Vs. BHAGWAN DAS GOPAL PRASAD
LAWS(PAT)-1979-11-27
HIGH COURT OF PATNA
Decided on November 08,1979

COMMISSIONER OF INCOME-TAX Appellant
VERSUS
BHAGWAN DAS GOPAL PRASAD Respondents




JUDGEMENT

- (1.)THIS is a reference made under Section 256(1) of the I.T. Act, 1961, by the Patna Bench of the Income-tax Appellate Tribunal. The questions which have been referred for opinion of this court are :
" 1. Whether, on the facts and in the circumstances of this case, the Tribunal were right in law in holding that the profits of the business for the full year arose only on the last date of accounting year ?

2. If the answer to the above question is in the affirmative, whether, on the facts 'and in the circumstances of this case, the Tribunal were right in law in holding that the distribution of the profit was to be made among the partners who constituted the firm on the last date of the accounting year and in the profit sharing ratio obtaining on that date, even though there was a change in the constitution of the firm both in regard to persons and profit sharing ratio in the middle of the accounting year ?

3. If the answer to the second question is in the affirmative could registration under Section 185 of the Income-tax Act, 1961, be granted to the firm, even though the terms of the instrument of partnership operative for part of the year were completely ignored ? "

The facts relevant for the questions, as stated in the statement of case, are that the assessee is a firm comprising of four partners. The relevant accounting year for the assessment year 1971-72 is the diwali year 2026-27.

(2.)THIS firm had been in existence previously also, and had had the benefit of registration under Section 184 of the I.T. Act. At that time, the constitution of the firm was as under :
(1) Shri Bhagwan Das,

(2) Shri Arjun Prasad,

(3) Shri Mahendra Prasad and

(4) Shri Gopal Prasad.

The last mentioned partner was a minor, who had been admitted to the benefit of the partnership. The profit sharing ratio between the said four partners in case of profit was 30%, 40%, 15% and 15%, respectively. In case of loss, however, the loss had to be distributed in equal proportion between the major partners. THIS partnership continued till June 29, 1970, on which date the said minor, Gopal Prasad, attained majority. A fresh deed of partnership was now executed on June 30, 1970. Under the new partnership deed, all the four partners continued as partners, but with this change that the sharing ratio was now equal between all the four partners, that is to say, each partner was to share 25% in the profit and loss of the business.

In terms of the I.T. Rules, an application for registration was filed in Form XI-A, duly filling in the particulars prescribed under the said form. The ITO, however, refused to grant registration to the firm for the said assessment year 1971-72 on the grounds :

(1) that the books of accounts were not closed on June 29, 1970, when in place of the erstwhile firm the new firm came into existence ; and

(2) that the sharing ratio of the profit between the partners was as per the new partnership deed. The ITO held that " since the profit was not distributed as per the partnership deed registration of the firm is not allowed ",

On appeal, the AAC allowed registration to the firm, observing that the right to share the profit arising in the firm arose to the partners only at the end of the relevant previous year ; and necessarily, therefore, the profit sharing ratio between the partners, must be the one as was prevailing at that relevant time.

The Department, being aggrieved, then moved the Income-tax Appellate Tribunal. The Tribunal confirmed the AAC's order, rejecting the Department's contention that the profit earned by the firm up to June 29, 1970, should have been distributed in accordance with the earlier deed dated September 8, 1969, which was effective till that date. The Tribunal accepted the assessee's plea that the right to receive the share of profit by the partners accrued to them only on the closing of the accounts on the last day of the previous year, i.e., on October 28, 1970. Such profit had to be divided in accordance with the agreement which was operative on that day. The Tribunal having confirmed the AAC's order, this reference has been made at the instance of the Commissioner of Income-tax, Bihar, on the questions as stated earlier.

Mr. Rajgarhia, appearing for the Department, vehemently urged that profit arose with each transaction and although it may be calculated and accounted for, for the sake of convenience, at the end of the accounting year, it did not mean that that profit did not arise at any earlier point of time during the accounting year. He, therefore, submitted that the Tribunal had erred in holding that no profit could be distributed during the interim period of the accounting year. He further submitted that it was one of the essential requirements for the grant of registration to a firm, that the profit arising to it must be divided between the partners in accordance with the terms of the partnership deed specifying their share in the profit or loss of the firm. Such division, it was submitted, had not been made. The Tribunal had, therefore, erred in accepting the claim of the firm, for its registration under Section 185 of the Act.

Mr. Jain, appearing for the assessee, has Contended that it all depends upon the agreement between the partners as to the point of time when profit or loss arising to a firm has to be divided between them. In the instant case, by reference to the terms of the partnership deed, a part of which is* quoted in the order of the Income-tax Appellate Tribunal, he submitted that both under the previous deed dated September 8, 1969, and the present deed dated June 30, 1970, the profit was to be divided at the end of the accounting year, on the Diwali day. That being the position, the profit or loss had to be divided between the partners on the last day of the accounting year. In the instant case, it was submitted that that had been done. The further submission which Mr. Jain made was that the ratio in which the profit or loss of the partnership would be divided would depend upon the terms to which the partners had agreed, whether in the ratio as it existed under the deed dated September 8, 1969, or in the ratio as in the present partnership deed dated June 30, 1970. He further submitted that it was not one of the essential requirements for a grant of registration that the profit or the loss must be distributed between the partners. Moreover, the further question, according to learned counsel was, if there were more than one deed of partnership in one accounting year, which deed will govern the distribution of profit of the accounting year, besides being a question of law, would also be a question depending upon the terms of agreement between the partners. According to the learned counsel, it will be implied by the manner in which the division has been made between the partners that the partners had agreed to share the profit or loss of the firm in the ratio as was laid down under the later partnership deed dated June 30, 1970. He, therefore, submitted that the Tribunal was right in holding that on the facts and circumstances of the case, the profit of the business for the full year arose on the last day of the accounting year and further, that the right of the partners to get their shares in the profits arose only on that date. If on that date, the partnership deed which was in vogue was the one dated June 30, 1970, it must be held that the Tribunal had correctly held that the partnership firm was entitled to grant of registration under Section 185 of the Act.

(3.)THE primary question which arises for consideration on the basis of the rival contentions is, whether it would be correct to say that the period of time when a profit is said to arise on a transaction, entered into by a firm, would be determined not by the transaction in question but by the agreement between the parties. Say, as in this case, the partners had agreed that they will work out the profit and loss of the business of their partnership firm at the end of the relevant accounting year ; will it, therefore, mean that a profit arose only on that date and at no earlier point of time ? According to learned counsel for the assessee, it arose only on the last day of the accounting year and on no earlier date. In this connection, he has cited a decision of the Supreme Court in the case of CIT v. Ashok-bhai Chimanbhai [1965] 56 ITR 42. This was a case in which under an agreement of partnership the manager of an HUF, who was one of the partners, was to receive a share in the profits of the firm. THE accounts of the firm were to be adjusted at the end of every calendar year. Now it so happened that before the expiry of the previous year relevant to the assessment year 1955-56, a partition took place in the family and a share of the profits of the firm fell to the lot of the manager. THE ITO, however, wanted to apportion the profit received by the manager between the undivided family and the manager in his individual capacity. In this context, their Lordships held that the right to receive the profit of the firm for the previous year 1955 arose on the settlement of the account of the firm and not before, and, on that date, the manager alone was the owner of the share of the profits and the family had no right thereon and, accordingly, the family was not liable to be assessed in respect of any part of the income arising from the firm.
This decision, in our opinion, is wholly on a different plane. It does not deal with the question as to when and at what stage a profit arises on transactions entered into by a firm. In the case of CIT v. Bangalore Transport Company Ltd. [1967] 66 ITR 373 (SC), a question arose as to whether the undertaking having been taken over by the Government, would be liable to be taxed on the profits which accrued during the period when the undertaking was with the assessee. In that context, their Lordships observed (p. 376):

" The company carried on the business of a transport operator between April 1, 1956, and September 30, 1956, and the audited accounts of the company disclosed that embedded in the gross receipts was a net profit of Rs. 4,01,954 during that period. That profit reduced by outgoings properly allowable in the computation of the total taxable income became subject to a charge to tax"

The important observation now further is--

"The total taxable profits may under the scheme of the Act be determined at the end of the previous year: but it does not fellow therefrom that to profits earned during the year, the charge of tax does not attach."

It is one of the accepted principles of accountancy that profit or loss arises on each single transaction. May be that the net result of all the transactions are worked out at the end of a certain period, but it will be wrong to say that the profit or loss does not arise during the interim period of such accounting year. It is true that the partners of a firm can, by agreement between themselves, lay down a certain date on which they would work out the net result of all the transactions, but that is not the same thing as saying that the profit arose to them on all the transactions on that single day. The agreement is only with a view to work out the total net result of all the transactions and nothing more. The argument made by Mr. Jain, that the date on which profit and loss arose to the partnership business would be the date on which the profit or loss was calculated, to our mind, is not a sound argument. In our opinion, therefore, question No. 1 aforesaid, has to be answered in the negative, that is to say, that the Tribunal was not right in holding that the profit or loss of the firm arises only on the last day of the accounting year.

The question then is with regard to the distribution of the profits of the accounting year, as to who should receive the profits on distribution and in what proportion. According to learned counsel for the Department, since the profit of the business of the firm is to be computed and determined at the end of the relevant previous year for the whole year, the distribution must also be made according to the sharing ratio as evidenced by the two partnership deeds, the one dated September 8, 1969, and the other dated June 30, 1970, which cover the whole year. In other words, the sharing ratio of the profit or loss shall follow the sharing ratio of the two partnership deeds for the period for which they have been in vogue.



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