Holding

A partnership deed, if reasonably construed, can imply the loss‑sharing ratio and the assessing officer cannot reject registration merely because the shares are not expressly specified.

Summary

Progressive Financers, a partnership of five persons including a minor admitted to the benefits of the firm, applied for registration under Section 184 of the Income Tax Act, 1961 for AY 1967-68 and for renewal for AY 1969-70 and 1970-71. The Income Tax Officer rejected the application, treating the firm as an Association of Persons, on the ground that the partnership deed did not expressly state how losses would be shared. The appellant appealed through the Appellate Assistant Commissioner, the ITAT and the Madras High Court, which held that registration could not be granted because the deed failed to specify loss sharing. The Supreme Court held that, when the deed is read as a whole, the proportion of loss sharing can be inferred from the capital contribution and the profit‑sharing clause, and that the assessing officer cannot reject a registration application merely because the shares are not expressly mentioned. Consequently, the Court allowed the appeal, set aside the High Court judgment and ordered that the firm was entitled to registration for AY 1968-69 and renewal for the subsequent years.

Issues considered

Whether Section 184/185 of the Income Tax Act, 1961 requires the partnership deed to expressly specify the partners' shares in loss for registration.
Whether the assessing officer can reject a registration application on the ground of non‑specification of loss sharing.
Whether the appellant partnership is entitled to registration and renewal for the assessment years in question.

Legislation cited

Income Tax Act, 1961s. 184, s. 185
Indian Partnership Act, 1932s. 13(b)

Subjects

Income Tax registrationSection 184Section 185Partnership deed interpretationMinor partnerLoss sharingAssessing officer discretionConstructive loss allocation

Judgment

A MIS PROGRESSIVE FINANCERS
v.
THE COMMISSIONER OF INCOME TAX, MADRAS

FEBRUARY 20, 1997

B [S.C. AGRAWAL AND G.T. NANAVATI, JJ.)

Income Tax Act 1961-S. 184-Partnership-Minor partner admitted to
benefits-Application for registration-ITO to construe the instrument of
partnership as a whole to ascertain the share of partners--lTO cannot reject
C application for registration merely 011 the ground that the deed does not specify
the respective shares of the partners.

The Appellant, a partnership firm consisting of five partners one of
whom was a minor, applied far registratian with the Income Tax officer
under Section 184 of the Income Tax Act 1961, for the assessment year
D 1967-68 and for renewal for the assessment years 1969-70 and 1970-71. The
application was rejected by the ITO and assessment orders treating the
appellant as an Association of Persons was passed for 1968-69 and sub-
sequent years, holding interalia, that, though in the opening para of the
partnership deed it was mentioned that a minor was admitted to the
E benefits of partnership, the clauses indicated that she was taken as a full
partner since she had contributed the maximum capital and her mother
as guardian had signed on her behalf. Other flaws in the partnership deed
were also pointed out. -
Aggrieved by the order of the ITO, the appellants preferred an
F appeal to the Appellate Assistant Commissioner. Relying on the AP High
Court dedsion in Addepally Nageswara Rao & Brothers v. Commissioner of
Income Tax, 79 ITR 306, the Appellate Assistant Commissioner dismissed
the order of the ITO holding that the instrument of partnership has to be
construed harmoniously and that, since the minor was only admitted to
G the benefits, she will not be liable for losses and therefore the firm was
entitled to be registered.

From the order of the Appellate Assistant Commissioner, the
Revenue appealed to the Income Tax Appellate Tribunal. The Tribunal
upheld the decision of the Appellate Assistant Commissioner relying on
H the decisions in Commissioner of Income Tax, Mysore v. Shah Mohandas
280
PROGRESSIVE FINANCER v. C.l.T., MADRAS 281

Sadhuram., 51 ITR 415 and Commissioner of Income Tax, Mysore v. Shah A
Jethaji Phulchand, 51 ITR 588 and of the decision of AP High Court in
Addepally Nageswara Rao. Since the Revenue wanted a reference to the
High Court, the Tribunal referred the question as to whether the appellant
was entitled to the benefit of registration under S. 185 of the Income Tax
Act 1961, on the facts and circumstances of the case.
B
The High Court allowed the appeal of the Revenue relying on the
decisions of Gujarat High Court in Thacker & Co. v. CIT, 61 ITR 540,
Kerala High Court in Ithappri & George, 88 ITR 332 and AP High Court
in Mandyala Govindu & Co. v. Commissioner of Income Tax AP, 102 ITR
1 for the proposition that the partnership deed should specifically provide C
for the sharing of the losses and should not be left for inference.

Appealing to this Court, from the order of the High Conrt, the
appellant submitted that the High Court was wrong; that the Kerala High·
Court decision relied upon has since been overruled by a Full Bench in
Kera/a Publicity Bureau v. Commissioner of Income Tax, 200 ITR 366, and D
that the instrument of partnership did indicate how profits were to be
shared by the partners. It was the case of the Revenue that since S. 184 ·
confers a benefit which is not othern'ise available, its provisions have to be
strictly complied with; and that the shares of the partners in profit or loss
should be specified.
E
Allowing the appeal, this Court
.....
I
HELD : 1. Ir the partnership deed is construed reasonably it did by
necessary implication provide for the proportion in which the losses of the
firm were to be shared by the major partners. The application for registra- F
tion made by the appellant fulfilled the conditions laid down by section 184
of the Act and, therefore, the ITO ought to have granted registration and
T\ made assessment of the appellant for the relevant years on that basis. 1be
High Court was wrong in taking the contrary view. Therefore the judgment
and order passed by the High Court is set aside and answer the questimn
referred to the High Court by holding that for th_e assessment year 1968-6!1 G
the appellant was entitled to registration and for assessment years 1969-70
and 1970-71 it was entitled to renewal/continuation of registration.
[290-8-C]
2. The correct legal position is that the assessing officer cannot reject
an application.for registration merely because in the deed of partnership H
282 SUPREME COURT REPORTS [1997) 2~.C.R.

A shares of the partners are not expressly specified. The assessing officer will
have to construe the instrument of partnership as a whole and if reasonably
the shares of the partners in profits and losses can be ascertained, then to
accept it as genuine for the purpose of registration. [286-H, 287-A]

Kylasa Sarabhaiah v. CIT, 56 ITR 219; Rao Bahadur Ravulu Subba
B Rao, v. CIT, 30 ITR 163 and Patel (N.T.) and Co. v. CIT, 42 ITR 224,
referred to.

3. In the instant case, High Court, without carefully examining the
facts and circumstances of the case, applied the decision of this Court in
C Mandyala Govindu & Co. In the partnership deed the proportion in which
the five partn"ers including the minor had to contribute the capital was
clearly stated. It was also clearly stated that net profits were to be divided
between the partners in proportion to their shares in the capital. The
application made by the partners for registration of the firm contained the
D statements required to be made therein according to the pl.!scribed form •
. The prescribed schedule was also attached with that application. As the
minor was admitted to the benefits of partnership it is obvious that she
had not to share any loss. The losses were to be distributed among the
major partners only. Since they were to share the profits in the proportion'
E in which they had contributed capital it was implied that they were to share
the losses in the same ratio. This was the reasonable manner in which the
instrument of paknership was required to be construed. Moreove~ the
application made by the appellant in the prescribed form clearly disclosed .
as to how the losses of the firm were to be distributed among the major
F partners. The way they had worked out their share in the loss, if any, in
the schedule attached to the application was quite consistent with the
provisions· made in the instrument of partnership and the legal principles
applicable in that behalf. Accordingly R who was required to contribute
25% as share capital had to bear 40% of the loss and the other three major
partners who had individually contributed 12.5% of the capital had to bear
G the loss in the 'ratio of 20% each. The ITO had not considered these
relevant circumstances as he was of the view that the contract of partner·
ship itself was void. The Appellate Assistant Commissioner and the
Tribunal did not refer to the applicittion and construing the partnership
deed alone held that it was possible to ascerfain how the losses of the firm
H were to be distributed among the major partners. (288-E, 289-E-H] .
PROGRESSIVE FINANCER v. C.I.T., MADRAS [NANAVATI, J.) 283

Mandyala Govindu & Co. v. Commissioner of Income Tax, AP, 102 A
ITR 1 and Parekh Wadilal Jivanbhai v. CIT, 63 ITR 485, relied on.

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1568
(NT) OF 1981.

From the Judgment and Order dated 16.1.78 of the Madras High B
Court in T.C. No. 336n4 (Reference No. 149 of 1974)

A.T.M. Sampath for the Appellant.

K.N. Shukla, T.C. Sharma and B.K. Prasad for the Respondent.
c
The Judgment of the Court was delivered by

NANAVATI, J. The appellant in these three appeals is M/s. Progres-
sive Financers, a partnership firm. It came into existence with execution of
a partnership deed on 1.7.67. It consisted of five partners: Out of them
Sunitha Pratap was a minor and, therefore, she was admitted to benefit~._ D
of partnership. The capital of the partnership was fixed at Rs. 5 lacs and
each partner had to contribute as follows:

1. M.R. Rajakrishna Rs.1,25,000

2. Minor Sunitha Pratap Rs.1,87,500 E
3. W.S. Parthasarathy Rs. 62,500

4. W.S. Sethunarayan Babu Rs. 62,500

5. M.S. Rajeswari Rs. 62,500 F
For the assessment year 1967=68 it applied for registration to the
Income Tax Officer (for short the 'ITO') under Section 184 of the Income
Tax Act, 1961 (for short the 'Act') on 31.3.68. For the assessment years
1969-70 and 1970-71 it applied for renewal of registration. The ITO
rejected the application for registration on 30.6.71. On the same day, he . G
passed an assessment order for the assessment year 1968-69 treating the
status· of the appellant as Association of Persons. Applications for renewal
of registration for the assessment years 1969-70 and 1970-71 were rejected
on 13.3.72 and the assessment orders for those years were again passed
treating the appellant as Association of Persons. H
284 SUPREME COURT REPORTS [1997) 2 S.C.R.

A The appellant's application for registration was rejected by the ITO
on the ground that though in the opening paragraph of the partnership
deed it was ~entioned that Sunitha Pratap, a minor, was admitted to the
benefits of partnership, the relevant clauses in the partnership deed indi-
cated that she was taken as a full partner and, therefore, the contract of
B partnership was void ab-initio. The ITO arrived at this conclusion as he
noticed that the partnership deed was signed by Mrs. Sridevi Pratap, the
guardian of minor Sunitha Pratap; that Sunitha had contributed the maxi-
mum capital; that it was not stated in the partnership deed how i.e. the
manner in which, the Joss, if any, was to be apportioned; that all partners
were entitled to operate bank accounts individually; that all matters of
C importance were to be decided by majority of partners holding more than
75% of capital; and, that on dissolution, all the assets of the firm including
goodwill were to be converted into money and distributed amongst the
partners in proportion to their shares in the capital.

D Against this order of the ITO the appellant preferred an appeal to
the Appellate Assistant Commissioner. Following the decision of the
Andhra Pradesh High Court in Addepally Nageswara Rao & Broih_ers v.
Commissioner of Income Tax, 79 ITR 306, the Appellant Assistant Com-
missioner held that the instrument of partnership was required to be
construed harmoniously and as the minor was admitted only to the benefits
E of partnership there was no question of her being made liable for the
losses. He, therefore, allowed the appeal holding that the firm was entitled
to registration. The Revenue went in appeal to the Income Tax Appellate
Tribunal.

F Construing the partnership deed in the light of the decisions of this
Court in Commissioner of Income Tax, Mysore v. Shah Mohandas Sad-
hurom, 57 ITR 415 and Commissioner of Income-Tax, Mysore v. Shah
Jethaji Phulchand, 57 ITR 588 and the decision of the Andhra Pradesh
High Court in Addepally Nageswara Rao (supra) the Tribunal held that
minor Sunitha was admitted merely to the benefits of partnership and it
·G was not correct to say that she was made a full-fledged partner. The
Tribunal also held that the minor was not to be burdened with losses and
they were to be borne by the other partners. It further held that though
the instrument of partnership did not specifically provide how the losses
were to be borne by the partners the rule that in such cases losses are to
H be shared in the same proportion as profits became applicabie and since
PROGRESSIVEFINANCERv. C.l.T.,MADRAS(NANAVATI,J.] 285

the partnership deed was capable of being construed in that manner, the A,
firm was entitled to regiStration. It, therefore, dismissed the appeal.

The Revenue sought a reference to the High Court and the Tribunal
thought it fit to refer the following question to the High Court for its
decision:
B
"Whether, on the facts and in the circumstances of the case and
on a true constrution of the terms of the partnership deed, the
assessee is entitled to the benefit ofregiStration under Section 185
of the Income-true Act, 1961, for the assessment year 1968-69?"

-- c
I''

Against the orders passed by the ITO refusing renewal or continua-
tion of regiStration for the assessment years 1969-70 and 1970-71 the
appellant had preferred two separate appeals to the Appellate Assistant
Co~missioner. They were· allowed. The appeals filed by the Revenue
against the said appellate orders were dismissed by the Tribunal. At the
instance of the Revenue, for the said two assessment years the following D
question was referred to the High Court:

"Whether on the facts and in the circumstances of the case and
on a true con5truction of the terms of the partnership deed the
assessee is entitled to the continuation of regiStration for the
assessment year 1969-70 and 1970-71." E

The High Court referred to the decision of the Gujarat High Court
in Thacker & Co. v. CIT, 61 ITR 540 and two decisions of the Kerala High
Court in C.I. T. v. Ithappiri & George, 88 ITR 332 and United Hardwares v.
C.I. T., 96 ITR 348 wherein it has been held that in view of the clear F
language of Section 184 it is necessary that sharing of the losses also has
to be specifically provided in the partnership deed and there is no scope
for applying any principle or rule of law for discerning the proportion in
which the losses are to be shared. It then held that the decision of this
.,
Court in Mandyala Govindu & Co. v. Commissioner of Income-Tax, A.P.,
102 ITR .1 squarely applied to the facts of this case. Following that case it G
held that it was not possible to determine on any principle of inference,
from the document itself, how the remaining two partners were to share
the losses and, therefore, the firm was not entitled to regiStration. The
reference was answered accordingly, in favour of the Revenue and against
the assessee. H
286 SUPREME COURT REPORTS [1997] 2 S.C.R.

A Following that decision in Tax Case No. 336 of 1974 (Reference
No.149 of 1974) the High Court answered the other two references (Tax
Case Nos.707 of 1976 and 708 cf 1976 I Reference Nos. 575 and 576 of
1976) also in favour of the Revenue and against the assessee. The assessee
has, therefore, filed these three appeals against the judgment and orders
B passed by the High Court in those three cases .

The learned counsel for the appellant submitted that the view taken
by the High Court is wrong. The two decisions of the Kerala High Court
which are; relied upon by the High Court have since been overruled by the
Full Bench of the Kerala High Court in Kera/a Publicity Bureau v. Com-
e missioner of Income Tax, 200 ITR 366. He also submitted that the instru-
ment of partnership, if reasonably construed, did indicate the method by,
which profits· and losses were to be shared by the partners. On the other
hand, it was· contended by the learned counsel for the Revenue that as
Section 184 of the Act confers a benefit which would otherwise be not
D available it is necessary that the conditions laid down therein are strictly
complied with. Therefore, the said benefit caii. be claimed only if in the
iristrument of partnership itself shares of the partners in profits and· losses
are specificaily stated.

This Court in Rao Bahadur Ravulu Subba Rao v. CIT 30 ITR 163
E and Patel N. T. and Co. v. CIT 42 ITR 224, interpreting Section 26-A of the
earlier 1922 Act held that registration under that Section conferred a
benefit on the partners which the partners were not entitled to but for that
Section and, therefore, that right could have been claimed only in accord-
ance with the statute and those who claimed it had to bring their case
p strictly within the terms of that Section. This view was reiterated sub-
sequently by a 5-Judge Bench of this Court in the case of Kylasa Sarabhaiah
v. CIT, 56 ITR 219. At the same time, this Court disapproved mechanical
application of that provision and held that "in ascertaining whether the
application is in conformity with the Rules, the deed of partnership must
be reasonably construed." It was also held that the word "specify" as used
G in that Section .and the relevant rule meant 'mentioning, describing or
defining in detail' and it did not mean 'expressly setting out in factional or
other shares'. In view of this decision the correct legal position is that the
assessing officer cannot reject an application for registration merely be-
cause in the deed of partnership shares of the partners are not expressly
H specified. The assessing officer will have to construe the instrument of
PROGRESSIVEFINANCERv. C.I.T.,MADRAS[NANAVATI,J.] '2B7.

partnership as· a whole and if reasonably the shares of the partners in A
profits and losses can be ascertained, then to accept it as genuine for the
purpose of registration.

We will now refer to the decision of this Court in Mandyala Govindu
& Co., 102 ITR Page 1, which has been relied upon by the High Court and B
on the basis of which it decided the question referred to it against the
appellant. That case arose under Section 26-A of the 1922 Act. Answering
the question whether it was a condition for registration under Section 26-A
that the instrument of partner~hip ought to have specified respective shares
of partners in losses it was held that "the Income-tax Officer, before
allowing the application for registration, must be in a position to ascertain C
the shares of the partners in the losses even if Section 26A did not require
the shares in the losses to be specified in the instrument of partnership".
It referred to the conflict of opinion in the High Courts on the point but
did not think it necessary to decide which view was correct as the assessee
was bound to fail on any view. What is significant to note is that this Court D
referred to Rules 2 and 3 of the Rules framed under that Act and also the
form of application including the Schedule annexed to Rule 3. The form
and the Schedule required the partners to' state particulars of the appor- ·
tionment of income and profits or gains (or loss) and also to state if any
partner, though entitled to share in profits, was not liable to bear any loss.
Thereafter it was observed that "it does not appear to have been considered E
in this case whether the application for registration made by the firm
conforms to the prescribed rules". Thus, this Court was of the view that
even if the shares of the partners were not expressly specified in the
instrument of partnership but if that could be ascertained by the Income
Tax Officer from the application and the required information supplied p
therewith then the requirements of Section 26-A could be said to have been
satisfied. It is also significant to note that this Court tacitly approved
application of the principle contained in Section 13(b) of the Indian
Partnership Act that the partners are entitled to share equally in the profits
earned and must constribute equally to the losses sustained by the firm and
also the rule that 'where the shares in the profits are unequal, the losses G
must be shared in the same proportion as the profits if there is no
agreement as to how the losses are to be apportioned'. On facts, it was
held in that case that even after applying those two principles, it was not
possible to ascertain how the losses pertaining to minor's share were to be
apportioned amongst the adult partners. H
288 SUPREME COURT REPORTS (1997) 2 S.C.R.

A In an earlier decision in the case of Parekh Wadi/al Jivanbhai v. CIT,
63 ITR 485 this Court construed the partnership deed by reading it as a
whole and "in the context of the relevant circumstances of the case" and
held that there was specification of the individual shares of the partners in
the profits within the meaning of Section 26-A of the Act and the assessee-
B firm was entitled to registration. The relevant circumstances which were
taken into account were (1) under clause 3 of the partnership deed the
capital allotted to each partner was equal (2) under clause 10 net profit or
loss was to be divided amongst all partners {3) in the application the three
partners were shown to share the profits equally and (4) in the books of
accounts the profits were apportioned equally among the three partners.
C Thus, it was laid down by this Court in that case that the instrument of
partnership has to be construed reasonably by reading it as a whole and
taking into consideration the relevant circumstances disclosed by the in-
strument of partnership and the account books for the relevant year and
the statements made in that behalf in the application.
D In this case, ic appears that the High Court, without carefully examin-
ing·. the facts and circumstances of the case, applied the decision of this
Coprt in Mandyala Govindu & Co. (supra). In the partnership deed the
proportion, in which the five partners including the minor had to contribute
the capital was clearly stated. It was also clearly stated that net profits were
E · to be divided between the partners in proportion to their shares in the
c;;pital. The application made by the partners for registration of the firm
contained the statements required to be made therein according to the
· prescribed form. The prescribed Schedule was also attached with that
application. The said Schedule read as under :

F Salary
Date Interest
comnus-
of on Share in the
sion or
s. Name of Partner admitt- capital
other
balance of
No. Address ance to or profit or loss
remune-
partner- loans percentage
ration
G ship if any
from firm
(1) (2) (3) (4) (5) (6) I (7)
1. Mr. M.R. Rajakrishna, 1.7.67 Nil Nil 25% of
Vijaya Ragavachari Profit
Road, Madras-17 40% of loss
H
-
PROGRESSIVE FINANCER v. C.l.T., MADRAS [NANAVATI, J.] 289

2. Miss Sunitha Pratap 1.7.67 Nil Nil 37.5% of A
(Minor) Villa ' .Profit
Enchantre, Ranjit No share of
Road, Kottur Adyar, loss
Madras-25
Mr. W.S. 1.7.67 Nil Nil 12.5% of B
3.
Parthasarathy, profit
80, Harris Road, 20% of loss

- 4.
Madras-2
Mr.W.S.
Sethunarayana Babu,
80, Harris Road,
1.7.67 Nil Nil 12.5% of
profit
20% of loss.
c
Madras-2
5. W.S. Rajeswar~ 1.7.67 Nil Nil 12.5% of
80, Harris Road, profit
Madras-2. 20% <>f loss." D
"As minor Sunitha was admitted to the benefits of partnership it is
obvious that she had not to share any loss. The losses were to be distributed
among the major partners only. Since t11ey were to share the profits.in the
proportion in which they had contributed the capital it was implied that
they were to share the losses in the same ratio. This was the reasonable E
manner in which the instrument of partnership was required to be con-
strued, applying the second principle referred to above while dealing with
the case of Mandyala Govindu & Co. (supra). Moreover, the application
made by the appellant in the prescribed form clearly disclosed as to how
the losses of the firm were to be distributed among the major partners. The F
way they had worked out their share in the loss, if any, in the Schedule
attached to the application wa$ quite consistent with the provisions made
in the instrument of partnership and the legal principles applicable in that
behalf. Accordingly Rajakrishna who was required to contribute 25% as
share capital had to bear 40% of the loss and the other three major
parnters who had individually contributed 12.5% of the capital had to bear G
the loss in the ratio of 20% each. The ITO had not considered these
relevant circumstances as he was of the view that the contract of partner-
ship itself was void. The Appellate Assistant Commissioner and the
Tribunal did not refer to the application and construing the partnership
deed alone held that it was possible to ascertain how the losses of the firm H
290 SUPREME COURT REPORTS (1997) 2 S.C.R.

A were to be distributed among the major partners.
If the partnership deed is construed reasonably, as indicated above,
then it has to be held that it did, by necessary implication, provide for the
proportion in which the losses of the firm were to be shared by the major
partners. The application for registration made by the appellant fulfilled
B the conditions laid down by Section 184 of the Act and, therefore, the ITO
ought to have granted registration and made assessment of the appellant
for the relevant years on that basis. The High Court was wrong in taking
the contrary view. Therefore, we allow these appeals, set aside the judg-
ment and orders passed by the High Court and answer the question '
I
C referred to the High Court by holding that for the assessment year 1968-69
the appellant was entitled to registration and for the assessment years J
1969-70 and 1970-71 it was entitled to renewal/continuation of registration.
In view of the facts and circumstances of the case, the parties shall bear
their own costs.

D I.M.A. · Appeal allowed.