JUDGMENT
D.K. Kapur, J.
1. The assessed, M. S. Chanderbhan Harichand & Co., Sabzi Mandi, Delhi, was a partnership firm with four partners holding equal shares. It was registered under the I.T. Act for the assessment years 1962-63 and 1963-64. The statement of case referred by the Income-tax Appellate Tribunal relates to the assessment of the firm for the year 1964-65. For this year, the return was filed on May 18, 1965, according to the statement of case and there was an application in Form No. 11A, instead of under Form No. 12. This particular form is filed only when there is a change in the constitution of the firm of the relevant accounting year, but the change actually took place after the end of the accounting year. The ITO pointed out the error to the assessed which led to the filing of a declaration in Form No. 12, duly signed by he partners. The ITO passed an order under ss. 184/185 of the Act whereby he rejected the application for registration. He held that none of the conditions mentioned in s. 184(7) of the Act were fulfillled, and, therefore, the assessed was not entitled to registration or continuation of registration. The firm was treated as an unregistered firm.
2. On appeal to the AAC, it was held that the ITO had not acted properly. It was held that the ITO had to inform the party concerned of the defect in the application under the provisions of s. 185(2) of the Act and a period of one month was available to rectify the defect. As the assessed had rectified the defect within a fortnight, the application could not be rejected on the ground that the form was wrong. The other ground, namely, the non-existence of the conditions under s. 184(7) was also differed from. It was held by the AAC that the finding of the ITO that some profits had been secretly distributed among some of the partners could not justify the conclusion that there was change in the constitution of the firm or in the profit sharing ratio of the partners.
3. On appeal to the Tribunal, it was held that the application for registration under s. 185(1) and the declaration under s. 184(7) of the Act were on the same footing and it was further held that merely because there were some concealed profits which were divided in a manner different from the partnership deed did not mean that there was change in the constitution of the firm. The existence of secret profits made by some of the partners to the detriment of the other partners did not mean that there was an agreement between the partners to share the secret profits in a manner different from the profit sharing ratio in the partnership deed.It was further held that a change in the constitution of the firm could be brought about only by volition of all the partners and could not be made unilaterally by some of the partners to the exclusion of the other partners. Without a mutual agreement, there was no change in the constitution of the firm.
4. The above facts are a summary of the statement of the case and on these facts, the following questions have been referred to us for our opinion :
“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding (a) that the Income-tax Officer had the authority to condone the delay in the filing of declaration under section 184(7) of the Income-tax Act, 1961, read with section 185(2) of the Income-tax Act, 1961 ?
2. Whether it was necessary for all the partners in a firm to agree to bring about a change in the constitution of the firm within the meaning of section 187 of the Income-tax Act, 1961 ?
3. Whether, on the facts and in the circumstances of the case, the firm was entitled to the continuation of registration under section 184(7) of the Income-tax Act, 1961 ?”
5. Mr. M. L. Verma, learned counsel for the department, has really pressed us for a decision on questions No. 2 and 3 above and has not seriously doubted the decision of the Tribunal on the first question.
6. In order to understand the scope of the second and the third questions, it is necessary to emphasise the facts in somewhat greater detail than have been given in the statement of the case referred to us. There were four partners in the firm, namely, Chander Bhan, Hari Chand, Prem Chand and Hakimuddin. The relevant accounting year was April 1, 1963, to March 31, 1964. The firm changed its constitution with effect from October 25, 1964, when Prem Chand retired and Shakoor Ahmed stepped into his shoes. This fact is stated in the ITO’s order. In dealing with the question of assessment of the firm, certain statements were recorded by the ITO. Shri Prem Chand, the ex-partner made a statement on January 24, 1969, that there were certain extra profits being cash credits amounting to Rs. 35,000, benami trading in potatoes yielding Rs. 20,000 to Rs. 30,000 and profits in the account of Lala Ram group amounting to Rs. 35,000. According to the ITO, this was a concealed income which was shared between Chander Bhan, Hari Chand And Prem Chand in equal shares, but in actual fact only Chander Bhan and Hari Chand made the division. Hakimuddin made a similar statement on February 21, 1969, in which he claimed that the business of the firm was arhat. he did not know of the sale and purchase of potatoes. he claimed that there were secret profits shared between Prem Chand, Hari Chand and Chander Bhan.
7. From these facts, the ITO concluded that there were secret profits of Rs. 98,399 which were shared between Chander Bhan and Hari Chand to the exclusion of Prem Chand and Hakimuddin. He also found that as profits were shares among two partners but not by four partners equally, there had been a change in the share ratio of the partners. Accordingly, he held that the conditions of s. 184(7) were not fulfillled.
8. Mr. Verma contends that the question referred is covered by the judgment of the Supreme court in Khanjan Lal Sewak Ram v. CIT [1972] 83 ITR 175.
9. The facts of that case show that there were some secret profits and there was a disclosure statement made on October 5, 1950, about the same. It also appears that Sewak Ram and Shrimati Jagrani Devi claimed that they had not been given full share of the profits and they wanted to withdraw the application for registration. There was also a suit between the parties which was compromised, but before the ITO on March 15, 1952, Sewak Ram and Shrimati Jagrani Devi gave an application stating that they were withdrawing their application for renewal of registration. The ITO acting under rule 6 of the Indian I.T. Rules, 1922, held that the firm was not entitled to registration. This order was upheld by the AAC. In appeal, there was a difference between the members of the Appellate Tribunal which led to a reference to the President of the Tribunal who held that the firm was not entitled to renewal. On a reference to the High Court, the Allahabad High Court held that the firm was not entitled to renewal of registration which was in turn confirmed by the Supreme Court in the judgment in question.
10. It is contended before us that the question referred to us are really covered by the judgment of the Supreme Court.
11. On a close examination of the facts and circumstances, we find that this is not so. There was a considerable changes in the law regarding the registration of partnership firms brought about by the I.T. Act, 1961. No doubt, the position was different under the Indian I.T. Act, 1922.
12. Under the law as it previously stood, i.e., under the Act of 1922, a renewal of registration had to be applied for every year. A certificate was required a under r. 6(3) to be appended to the certificate for renewal of registration certifying that the profit or loss would be divided or credited in the manner shown below. Then, r. 6A provides that the ITO, if satisfied that the application was in order and there is or was a firm in existence, shall grant a certificate signed and dated in the form below. The important words in r. 6A were as below :
“If the Income-tax Officer is not so satisfied, he shall pass an order in writing refusing to renew the registration of the firm.”
13. After analysing the question in some detail, the Supreme Court noted that the apprehension of the learned counsel for the assessed that the decision of the court might be used for refusing registration was not justified. The following observations were made by the court (p. 182 of 83 ITR) :
“The apprehension of Mr. Ramachandran that our decision might be taken advantage of by he department for refusing registration of firms whose return of income or claim for some allowance has not been accepted by the Income-tax Officer for one reason or the other, appears to us to have no basis. Herein, we are merely considering the scope of paragraph 3 of rule 6. So long as the divisible profits had been divided or had been credited to the accounts of the partners, the requirement of that provision was complied with.”
14. It will thus be seen that the legal position under the Act of 1922 was contained in the Rules and not in he Act. The application had to be in a particular form and the ITO had the power to reject the application for renewal.
15. Under the Act of 1961, there has been a considerable change in the legal position which is an follows. Under the Act of 1961, the provisions applicable to firms are contained in ss. 182 to 189 of the Act. A firm may be assessed either as a registered firm or as an unregistered firm. It is obviously more advantageous that the firm should be registered from the point of view of incidence of tax. An application for registration of a firm has to be under s. 184. There has to be an instrument creating the partnership and defining the individual shares of he partners and the application for registration has to be signed by all the partners who are not minors and submitted to the ITO having jurisdiction to assess the firm. The application is to be made before the end of the previous year relating to the assessment year in question. The prescribed form is contained in the I.T. Rules. The important part of s. 184 is sub-s (7) which reads as follows :
“Where registration is granted to any firm for any assessment year, it shall have effect for every subsequent assessment year :
Provided that –
(i) there is no change in the constitution of the firm or the shares of the partners as evidenced by the instrument of partnership on the basis of which the registration was granted; and
(ii) the firm furnished, along with its return of income for the assessment year concerned, a declaration to that effect, in the prescribed form and verified in the prescribed manner.”
16. This sub-section shows that once a firm is registered in any assessment year, the registration is also effective for every subsequent year in certain circumstances. These circumstances are that there is no change in the constitution of the firm or the shares of the partners and the firm furnishes along with its return of income a declaration to that effect. It is noteworthy that it is not necessary to apply for a renewal of registration as was required under the previous law, i.e., the Act of 1922.
17. Section 185 prescribes the procedure on receipt of the application. If the application is for registration of the firm, the ITO is require to make an enquiry regarding the genuineness of the firm and he may either register the firm or by an order in writing refuse to register the firm. There is no provision in s. 185, as it stood, that the order has to be passed for every assessment year. The provisions of s. 185, as they then stood, in thee relevant assessment year were as follows :
“185, (1) On receipt of an application for the registration of a firm, the Income-tax Officer shall inquire into the genuineness of the firm and its constitution as specified in the instrument of partnership, and –
(a) if he is satisfied that there is or was during the previous year in existence a genuine firm with the constitution so specified, he shall pass an order in writing registering the firm for the assessment year;
(b) if he is not so satisfied, he shall pass an order in writing refusing to register the firm.
(2) The Income-tax Officer shall not reject an application for registration merely on the ground that the application is not in order, but shall intimate the defect to the firm and give it an opportunity to rectify the defect in the application within a period of one month from the date of such intimation.
(3) If the defect is not rectified within such time, the Income-tax Officer may reject the application.
(4) Where a firm is registered for any assessment year, the Income-tax Officer shall record a certificate on the instrument of partnership or on the certified copy submitted in lieu of the original instrument, as the case may be, to the effect that the firm has been registered under this act, for that assessment year; and where a declaration under sub-section (7) of section 184 is furnished by the firm, for the relevant subsequent assessment year.
(5) No withstanding anything contained in this section, where, in respect of any assessment year, there is, on the part of a firm, any such failure as is mentioned in section 144, the Income-tax Officer may refuse to register the firm for the asessment year,”
18. It will be seen from these provisions that the ITO is to record a certificate on the instrument of partnership or the certified copy submitted in lieu of the original instrument to the effect that the firm has been registered and when a declaration is made under sub-s. (7) of s. 184, a similar certificate has to be record for the relevant subsequent asessment year. The noteworthy feature of the section is that the inquiry as to genuineness of the firm is to be made only in the first year, i.e., at the time of registering the firm and not for subsequent years as was the case under the Act of 1922.
19. It has been urged before us by learned counsel for the revenue that the provision of s. 184(7) show that the registration can be effective for subsequent years only if the conditions are satisfied, i.e., there is no change in he constitution of the firm or there is no change in the shares of the partners in the partnership firm and a declaration is furnished along with the return. It is submitted that when it is found that there has been a the return. It is submitted that when it is found that there has been a change in the shares of the partners, then the conditions of s. 184(7) are not satisfied. On the other hand, the provisions of s. 185, reproduced above, do not clearly indicate how the ITO is to act when a declaration under sub-s. (7) of s. 184 has been filed. The proviso to that sub-section seems to indicate that only a declaration is required stating that the constitution of the firm or the shares of the partners as evidenced by the instrument of partnership have not been altered. If such a declaration is furnished, is it sufficient for the ITO to record a certificate under s. 185(4) ? Or should he made an inquiry before such a certificate is recorded ? Normally, it would appear that the furnishing of a declaration should be sufficient because, normally the ITO would treat that as sufficient material for recording the certificate. However, there may be facts known to the ITO or coming to light before the ITO suggesting that the certificate is either wrong or faulty or even false. In such a case, it would stand to reason that the ITO would refuse to record the certificate. The existence of a proviso to s. 184(7) indicates that the ITO is not wholly powerless to refuse a certificate if facts so justify. The conclusion of the Tribunal in the present case was that the declaration furnished was a true one. There is a specific finding that there was no change in the constitution and the certificate given by the partners in the declaration form was a correct certification. This finding of fact would itself be sufficient to dispose of this objection.
20. This brings us to the important question in this case. On the facts, the ITO found that there was secret profits which had been distributed by some of the partners in a manner different from that set out in the partnership deed. Was the effect of such a conclusion sufficient to give the I.T. authority to say that the continuation of the registration had come to an end as the proviso to s. 184(7) was not satisfied ? According to learned counsel for the Commissioner, this conclusion is inevitable because it has been found as a fact that the secret profits were not shared in accordance with the partnership deed.
21. It seems to us that though the contention is attractive, it is not wholly sound. If a firm furnishes a declaration to the effect that there has been no change in the constitution of the firm or the shares of the partners and it is found by the ITO that either the constitution has changed or the shares of the partners are actually different from that mentioned in the instrument of partnership, it would clearly be a ground for refusing the certification under s. 185(4). But the mere fact that some of the partners made a secret profit is not boy itself sufficient to justify such a conclusion. It must also be found that the other partners have assented to such a distribution. In this case, it appears that some of the partners not only made a secret profit, but made the same without the knowledge of the other partners. This cannot be described as a change in the constitution of the firm or a change in the profit sharing ratio of the partners.
22. One of the cases cited at the bar was CIT v. Voleti Veerabhadra Rao & Sons , which was a somewhat similar case. The 1961-62 and 1962-63, but in the assessment year 1963-64, although the firm furnished the necessary declaration and fulfillled the requirements of s. 184(7), the ITO on scrutinising the accounts of the assessed found that there was no profit and loss account and no declaration of profits, and was upheld by the AAc, but the Tribunal held, on further appeal by the assessed that even if there was no ascertainment or division of profits, the partnership could not be denied continuation of registration. This view was upheld by the High Court on reference. It was observed that if the conditions of ss. 184 and 185 were satisfied, then the registration had to be continued but the ITO could make an inquiry regarding the existence of the facts contained in the declaration. It was also held that if the inquiry revealed that the facts contained in the declaration were not correct, then the ITO could refuse to record the continuation of registration under s. 185(4). The legal position thus emerges is that normally when a declaration has been furnished under s. 184(7) and, it is to the effect that the partnership continues without change of the deed and without change of the shares of the partners as recorded in the instrument of partnership, the ITO would continue the registration and record a certificate to that effect under s. 185(4). If the finds on inquiry or facts come to light showing that in fact the declaration is not correct factually, then the ITO may refuse to record the necessary certificate under s. 185(4). However, in this case, the Tribunal found as a fact that the declaration made by the partners was correct and not wrong. This conclusion was based on examining the nature of the secret profits which were allegedly made by some of the partners. It was held that the mere fact that some of the partners made a secret profit was not sufficient for refusing the continuation of the registration. It appears that the Tribunal was not wrong in coming to the conclusion it did come to in the circumstances of this case.
23. The reason for this is not difficult to find. The rights of the parties under a partnership deed are governed by the instrument of partnership. No partner is permitted in law to make a secret profits. If he makes a secret profit, he is bound to account for the same to his other partners. Every partner is a trustee of the firm and he is bound to account for any secret profits to his other partners. If there are any secret profits, they have to be distributed according to the partnership deed. The mere fact that some partners dishonestly took away some of the profits does not mean that there is a change in the constitution of the firm or in the profit sharing ratio of the partners. It merely means that one or more partners have acted dishonestly qua their other partners which they are not entitled to do in law. The legal right of the other partners is to recover their share of profits. Therefore, there is no change as such in the constitution of the firm.
24. This view that the there has been actually no change in he constitution of the firm is confirmed in the present case from the circumstances which have been brought to our notice. When the ITO made the substantive assessment, he included the so-called secret profits in the assessment, and divided the shares equally amongst the partners and thus accepted the fact that the share in the profits was equal and in accordance with the partnership deed. If there had been a change in the shares of the partners, then the ITO would have shared the profits amongst the partners in accordance with the changed shares. Therefore, the ITO did not in fact accept that there was a change in the share ratio of the partners, but merely found that some of the partners had wrongly appropriated some of the profits. The Tribunal was right in coming to the conclusion that there was no change in the constitution of the firm as the same required the agreement of the partners and a conscious act by all of them. A unilateral act contrary to the partnership deed did not actually have the effect of altering the partnership deed or the rights of the partners. Therefore, there was in fact no change in the constitution of the firm nor any change in the profit sharing ratio of the partners. This would mean that the conditions of s. 184(7) were satisfied both by reason of the declaration and in accordance with the legal position subsisting between the partners. The mere fact that masse partners acted contrary to the partnership deed and were could to have cheated the other partners did not mean that the partnership deed was altered.
25. It would thus appear that the Tribunal was right in holding that the firm did not change its constitution within the meaning of s. 187 of the I.T. Act, 1961, as there was no such agreement between the partners. It would also follow that the firm would be entitled to the continuation of the registration under s. 184(7) of the I.T. Act, 1961, even if some of the partners made a secret profit.
26. As a result of this discussion, it is not necessary to refer to the other cases cited by learned counsel for the assessed which are cases relating to the renewal of registration under s. 26A of the Act of 1922.
27. We would, accordingly, answer the questions referred to us as follows. We would answer all the questions in the affirmative in favor of the assessed and against the department, but have the parties to bear their own costs.