Case Law Details
Mulberry Textiles LLP Vs ITO (ITAT Bangalore)
LLP receiving share of profit from other partnership firm is eligible for exemption under Income Tax
The ITAT, Bangalore in M/s Mulberry Textiles LLP v. ITO [ITA No. 757/Bang/2022 dated January 3, 2023] has held that, Limited Liability Partnership (“LLP”) is to be treated as a firm under the Income Tax Act, 1961 (“the IT Act”) and a firm can be a partner in other partnership firms therefore, the assessee being a LLP is eligible to exemption under Section 10(2A) of the IT Act from the share of profit received from other partnership firms.
Facts:
M/s Mulberry Textiles LLP (“the Appellant”) filed an income tax return on October 17, 2020 declaring a total income of INR 3,75,710/- which was processed under Section 143(1) of the IT Act and the exemption under Section 10(2A) of the IT Act was denied by the Revenue Department (“the Respondent”). Thereafter, the Appellant filed a rectification application under Section 154 of the IT Act, which was also rejected.
Being aggrieved this appeal has been filed.
It is contended that the Appellant is a LLP, which is a firm as per Section 2(23) of the IT Act and further that, there is an exemption provided under Section 10(2A) of the IT Act stating that the share of profit received by the partner of firm is not included in the total income, for which the Appellant is eligible.
Further, the Respondent submitted that the Appellant is not eligible to claim exemption under Section 10(2A) of the IT Act because it will amount to double deduction.
Issue:
Whether the Appellant is eligible to exemption under Section 10(2A) of the IT Act?
Held:
The ITAT, Bangalore in ITA No. 757/Bang/2022 held as under:
- Observed that, the Appellant is a LLP and the IT Act is very clear that the LLP is to be treated as a firm and a firm can be a partner is other partnership firms.
- Relied upon the judgement of the Hon’ble Gauhati High Court in Radha Krishna Jalan v. CIT [[2007] 294 ITR 28 (Gauhati)] wherein, it was stated that there is no scope of double taxation of an income by a partner of a firm which is separately assessed to tax and therefore, when an income is already assessed in the hands of the firm is obviously not exigible to tax in the hands of the partner.
- Held that, the Appellant is eligible for exemption under Section 10(2A) of the IT Act from the share of profit received from the partnership firm.
Relevant Provisions:
Section 10(2A) of the IT Act:
“In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included-
(2A) in the case of a person being a partner of a firm which is separately assessed as such, his share in the total income of the firm.
Explanation-For the purposes of this clause, the share of a partner in the total income of a firm separately assessed as such shall, notwithstanding anything contained in any other law, be an amount which bears to the total income of the firm the same proportion as the amount of his share in the profits of the firm in accordance with the partnership deed bears to such profits.”
FULL TEXT OF THE ORDER OF ITAT BANGALORE
The sole substantive issue raised by the assessee in this appeal of the assessee is eligible for exemption u/s 10(2A) of the Act, which has been denied by the CIT(A) vide his order dated 26.6.2022 for the assessment year 2020-21.
2. The appeal has been filed with a delay of 13 days, which has been duly explained vide his application dated 29.8.2022 and affidavit dated 3.10.2022, which are placed on record. Considering the explanations given above, I condone the delay for filing the appeal of the assessee belatedly.
3. The brief facts of the case are that the assessee filed return of income on 17.10.2020 declaring a total income of Rs.3,75,710/-. The case was processed u/s 143(1) of the Act on 25.11.2021, wherein the exemption claimed u/s 10(2A) of the Act of Rs.20,71,600/- was denied. The assessee has filed rectification application u/s 154 of the Act, which has also been rejected. The assessee (LLP) is deriving income from business in the form of running of plant and machineries and share of profit from partnership firm, namely M/s. M.S. Enterprises. The ld. CIT(A) has also dismissed the appeal of the assessee by relying on the judgement of Hon’ble Supreme Court in the case of Dulichand Laxminarayan Vs. CIT by observing as under:
“4.2.1 I have carefully gone through the submission of the Appellant. I have also gone through the records and facts of the case. The appellant has claimed that income received as partner in a partnership firm shall be exempt u/s 10(2A) of the Income Tax Act. Though it is correct that a partner’s income from partnership firm is exempt u/s 10(2A), however the fact remains that a firm cannot be partner in another firm. A firm is not the person having a legal existence and therefore cannot as such become a partner in another partnership firm. This was held in the case of Dulichand Laxminarayan vs. CIT (Supreme Court wherein the Apex Court held that firm is not an entity or “person” in law but is merely an association of individuals and a firm name is only a collective name of those individuals who constitute the firm and only one partner of such firm signing on behalf of the firm is not proper compliance. Accordingly, I find that AO was correct in not allowing the income as exempt and hence the ground of appeal is decided against the appellant.”
Aggrieved from the above order, the assessee has filed appeal before us.
4. The ld. AR. Submitted that the assessee is a LLP (Limited Liability of Partnership), which is a firm as per section 2(23) of the Act. He further submitted that the Act has provided exemption clause as per section 10(2A) of the Act. The Act is very clear and there is no any double deduction claimed by the assessee. He submitted that the LLP is eligible for exemption as per section 10(2A) of the Act and in support of his arguments, he relied on the judgement of Hon’ble KERALA High Court at Ernakulam in WP No.25741 of 2020 dated 8.4.2021 in the case of Jayamma Xavier Vs. Registrar of Firms, Thiruvananthapuram. The relevant part of the judgement is as under;-
3. Petitioner claims that a partnership along with an LLP is not prohibited under the Partnership Act and that LLP is a legal entity, as defined under the LLP Act and it is separate from its partners. It has perpetual succession and is having a common seal. Under Section 14 it is capable of suing and being sued, on its registration. It is also capable of acquiring, developing or disposing of movable or immovable properties. Therefore, petitioner claims that the LLP is liable to be treated as a person and there cannot be any objection for registering a partnership with an LLP which is a person. It is stated that the said LLP has been given Ext.P4 Certificate of Incorporation.
4. The respondent has filed a statement reiterating his stand in the impugned order. It is stated that some of the provisions of the Limited Liability Partnership Act 2008 are inconsistent with that of the Indian Partnership Act, 1932, pertaining to the liability. According to the respondent, Section 25, 26 and 49 of the Indian Partnership Act, 1932 makes the partners to be jointly and severally liable with all the other partners and also severally liable for the acts of the firm, of which such person is a partner. At the same time it is stated that under Section 28 of the LLP Act, 2008 the provisions regarding the liability of the partnership firm is restricted to the contents to the LLP agreement ie. under the LLP Act, the liability of the partner is restricted only to the extent provided in the agreement; such a provision runs contrary to Section 25 and 49 of the Indian Partnership Act. It is also pointed out that under LLP foreign investment is permissible whereas it is not permissible under the Partnership Act.
5. The learned Counsel for the petitioner relied on the judgment of this Court in M.M. Pulimood vs. Registrar of Firm: 1984 KLT 420 in support of his contention that the rejection in Ext.P2 is illegal and without understanding the provisions contained in the LLP Act.
6. Relying on the judgment of the apex court in Dulichand Laxminarayanan vs. Commissioner of Income Tax, Nagpur : AIR 1956 SC 354 the learned Government Pleader argued that a firm cannot enter into a partnership with LLP. It is their case that though LLP is a kind of partnership having the nature of company the provisions inthe LLP are completely frustrating the purport of Section 25 and 49 of the Indian Partnership Act.
7. Heard Adv.Mohammed Al Rafi, learned counsel for the petitioner and Smt.Princy Xavier, learned Government Pleader.
8. The question to be considered is whether LLP can be treated as a person which can be permitted to form a partnership with an individual. In the judgment in M.M.Pulimood’s case (supra) relied on by the petitioner, a learned Single Judge of this Court was considering a case where a partnership deed was executed with a Private Limited Company, incorporated by the Registrar of Companies, as one of the partners. After analyzing the provisions contained in Section 4 of the Partnership Act as well as the definition of person in Section 3 (42) of the General Clauses Act, this Court found that there was no impediment in executing a partnership with a Private Limited Company incorporated under the Companies Act which comes under the definition of Person.
9. At the same time in the judgment in Duli Chand Laxmi Narayanan ‘s case (supra) relied on by the learned Government Pleader the Honourable Apex Court after analyzing the provisions contained in Section 26A of the Income Tax Act as well as the provisions contained in the Partnership Act and the definition of ‘person’ in Section 3(42) of the General Clauses Act arrived at a conclusion that a partnership cannot be formed between 3 firms, a Hindu Undivided Family and an individual. It was found that a firm is not a legal entity.
10. When the judgment in Duli Chand Laxmi Narayanan’s case (supra) was rendered or when this Court rendered the judgment in Pulimood’s case the Limited Liability Partnership Act had not come into force and hence there was no occasion to consider whether LLP can be a partner in a firm. Therefore, in order to examine the contentions raised by the learned Government Pleader it is necessary to have a look at the relevant provisions contained in the Indian Partnership Act, 1942 as well as in the LLP Act. Section 4 of Indian Partnership Act defines “partnership”, “partner”, “firm” and “firm name” which reads as follows:
4. Definition of “partnership”, “partner”, “firm” and “firm name”.—”Partnership” is the relation between persons who have agreed to share the profit of a business carried on by all or any of them acting for all.
Persons who have entered into partnership with one another are called individually “partners” and collectively “a firm” and the name under which their business is carried on is called the “firm name”.
11. It is therefore necessary to find out the definition of ‘person’. ‘Person’ is not defined either in the Partnership Act or in the LLP Act. Section 3(42) of the General Clauses Act, 1897 reads as follows:
3. Definitions.—In this Act, and in all General Acts and Regulations made after the commencement of this Act, unless there is anything repugnant in the subject or context,—
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(42) “person” shall include any company or association or body of individuals, whether incorporated or not;
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12. A partnership can be entered into between two persons. Such persons can be an incorporated body of individuals. LLP is a body corporate. It can be said to be a person, as defined in Section 3(42) of the General Clauses Act, 1897 in case there is no repugnancy in the subject or context. In order to examine the same it is necessary to have a look at some more provisions in both the Acts viz Partnership Act and LLP Act.
13. The definition of body corporate, LLP and LLP agreement are given under clause (d), (n) and (o) of Section 2 of the LLP Act as follows:
2. Definitions.—(1) In this Act, unless the context otherwise requires,—
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(d) “body corporate” means a company as defined in Section 3 of the Companies Act, 1956 (1 of 1956) and includes—
(i) a limited liability partnership registered under this Act;
(ii) a limited liability partnership incorporated outside India; and
(iii) a company incorporated outside India, but does not include—
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(n) “limited liability partnership” means a partnership formed and registered under this Act;
(o) “limited liability partnership agreement” means any written agreement between the partners of the limited liability partnership or between the limited liability partnership and its partners which determines the mutual rights and duties of the partners and their rights and duties in relation to that limited liability partnership;
14. A Limited liability partnership shall be a body corporate, as per Section 3 which reads as follows.
3. Limited liability partnership to be body corporate.— (1) A limited liability partnership is a body corporate formed and incorporated under this Act and is a legal entity separate from that of its partners.
(2) A limited liability partnership shall have perpetual succession.
(3) Any change in the partners of a limited liability partnership shall not affect the existence, rights or liabilities of the limited liability partnership.
The provisions of the Indian Partnership Act, 1932 (9 of1932) shall not apply to a limited liability partnership.
But as per Section 4 of the Partnership Act, partnership is 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.
15. In the present case an individual agreed with an LLP to share the profits of the business. LLP is a body corporate, independent legal entity having a common seal and perpetual succession, capable of suing and of being sued. Once a partnership is formed the LLP, which is a partner would have to abide by the partnership Act. The respondent’s objection is based on the liability of the partners of LLP, stating that the same is confined to the terms in the agreement. The extent of liability of limited liability partnership given in Section 27 reads as follows:
27. Extent of liability of limited liability partnership.—(1) A limited liability partnership is not bound by anything done by a partner in dealing with a person if—
(a) the partner in fact has no authority to act for the limited liability partnership in doing a particular act; and
(b) the person knows that he has no authority or does not know or believe him to be a partner of the limited liability partnership.
(2) The limited liability partnership is liable if a partner of a limited liability partnership is liable to any person as a result of a wrongful act or omission on his part in the course of the business of the limited liability partnership or with its authority.
(3) An obligation of the limited liability partnership whether arising in contract or otherwise, shall be solely the obligation of the limited liability partnership.
(4) The liabilities of the limited liability partnership shall be met out of the property of the limited liability partnership.
16. Extent of liability of a partner in an LLP is given under Section 28 as follows:
28. Extent of liability of partner.—(1) A partner is not personally liable, directly or indirectly for an obligation referred to in sub-section (3) of Section 27 solely by reason of being a partner of the limited liability partnership.
(2) The provisions of sub-section (3) of Section 27 and sub-section (1) of this section shall not affect the personal liability of a partner for his own wrongful act or omission, but a partner shall not be personally liable for the wrongful act or omission of any other partner of the limited liability partnership.
17. Now it is necessary to have a look at the provisions contained in Section 25, 26 and 45 of the Partnership Act which read as follows:
25. Liability of a partner for acts of the firm.— Every partner is liable, jointly with all the other partners and also severally, for all acts of the firm done while he is a partner.
26. Liability of the firm for wrongful acts of a partner.— Where, by the wrongful act or omission of a partner acting in the ordinary course of the business of a firm, or with the authority of his partners, loss or injury is caused to any third party, or any penalty is incurred, the firm is liable therefor to the same extent as the partner.
45. Liability for acts of partner done after dissolution.—(1) Notwithstanding the dissolution of a firm, the partners continue to be liable as such to third parties for any act done by any of them which would have been an act of the firm if done before the dissolution, until public notice is given of the dissolution:
Provided that the estate of a partner who dies, or who is adjudicated an insolvent, or of a partner who not having been known to the person dealing with the firm to be a partner, retires from the firm, is not liable under this section for acts done after the date on which he ceases to be a partner.
(2) Notices under sub-section (1) may be given by any partner.
18. The liability of partners of LLP and liability of the LLP as a partner under the Partnership Act would be different. The liability of partners in an LLP cannot have any relevance when the LLP itself becomes a partner, when it would be bound by the provisions in the Partnership Act. The liability of the LLP would be as in the case a company which joins a firm after entering into a partnership.
19. In the judgment in Dhuli Chand’s case, the Apex Court was considering a case where the Income Tax Officer rejected an application submitted under Section 26A of the Income Tax Act on the ground that the deed of partnership consisted of three firms, one Hindu undivided family business and one individual. Apex Court found that a firm cannot be treated as a person which can enter into a partnership with other firms or individuals or Hindu Undivided Family. It was held as follows:
“In our opinion, the word “persons” in Section 4 of the Indian Partnership Act, which has replaced Section 239 of the Indian Contract Act, contemplates only natural or artificial i.e. legal persons and for the reasons stated above, a firm is not a “person” and as such is not entitled to enter into a partnership with another firm or Hindu undivided family or individual. In this view of the matter there can arise no question of registration of a partnership purporting to be one between three firms, a Hindu undivided family business and an individual as a firm under Section 26-A of the Act.
20. Section 4 of the Partnership Act permits Constitution of a firm or partnership between one or more persons. In this case the partnership deed was executed between an individual and an LLP which is a body corporate having a legal entity and coming within the definition of “person”. The individual liability of the partners of LLP would not be relevant when the LLP itself would have liability independent of the liability of the partners. Therefore, the difference in the provisions under the Partnership Act relating to liability of the firm or the individual partners would not stand in the way of constitution of a partnership with an LLP. Hence I find that LLP cannot have a disqualification from entering into a partnership with an individual or other persons. The judgment in Pulimood’s case (supra) where the Private Company was held entitled to be a partner would apply in the present case though the LLP is not a private company but isa legal entity.
21. Therefore, Ext.P2 order is set aside. There shall be a direction to the respondent to reconsider the request of petitioner for registration and to take appropriate action on the same within a period of one month from the date of receipt of a copy of the judgment.
The Writ Petition is accordingly allowed.”
4.1 He further submitted that the judgement relied by the ld. CIT (A) is not applicable in the present facts of the case and the Hon’ble High Court of Kerala has considered the decision of Dulichand Laxminarayan as relied by the ld. CIT(A).
5. The ld DR relied on the order of lower authorities and he submitted that the assessee is not eligible to claim exemption u/s 10(2A) of the Act because it will amount to double deduction, first in the hands of the assessee as well as in the hands of the assessee’s partners. He strongly relied on the judgment of coordinate bench of the Tribunal of Guwahati bench in the case of M/s Hotel Centre Point, Shillong vs. ITO in ITA No. 348-350/ Gau/2018, M.P. No. 3 to 5/Gau/2016 order dated 13.09.2019.
6. On the rejoinder the ld. AR submitted that there is no double deduction claimed by the assessee and case law relied by the ld. DR. is not applicable in the present facts of the case.
7. Considering the rival submissions and facts of the case, I notice that the assessee (LLP) is a partner in M/s. M.S. Enterprises and assessee has claimed exemption u/s 10(2A) of the Act on the share of profit received from M/s. M.S. Enterprises. The section 10(2A) of the Act grants exemption to a person being a partner of firm which is separately assessed as such, his share in the total income of the firm. The firm has been defined in section 2(23) of the Act, which includes LLP also. The Act is very clear that the LLP is to be treated as a firm. A firm can be a partner in other partnership firms. There is no restriction in the income tax Act for becoming partner by firm in other partnership firms. The assessee is a LLP and has received share of profit from other partnership firm which has been claimed as exempt income. A similar issue has been decided by the Hon’ble High Court of Guwahati in the case of Radha Krishna Jalan Vs. CIT reported in (2007) 165 Taxman 538 (Gauhati). The relevant parts of the judgment are as under:-
12. We have considered the decision in Sun Engg. Works (P.) Ltd.’s case (supra). The Supreme Court provided that it is neither desirable nor permissible to pick out a word or a sentence from the judgment, divorced from the context of the issues under consideration and treat it to be the complete law declared by the Supreme Court. The Hon’ble Supreme Court held that while applying the decision of the Court to a later case, the Courts must carefully try to ascertain the true principle enunciated to support their reasoning. It is in this context, we would now like to examine the proposition canvassed by Shri Agarwalla which are summarised below :
(i) Whether for the limited purpose of assessment by income-tax authorities in the case of income diverted by overriding title to the sub-partnership of a person, such person is to be deemed to be a partner in the main partnership or not?
(ii) Whether for the purpose of the Income-tax Act, 1961, the income diverted by overriding title ceased to be the income of the partner as intended under section 10(2A)?
14. To appreciate the above contention, we may refer to the scheme of the Indian Income-tax Act, 1922, prior to its amendment by the Finance Act, 1956. The scheme recognizes two kinds of firms—unregistered and registered firms. In the case of an unregistered firm, the tax payable by the firm was assessed as in the case of any other distinct entity and tax was levied on the firm and the partners were not required to pay tax again on their share of income out of the profit of the partnership business. In the case of registered firm, the firm was not required to pay tax and the income of the firm was not assessed to tax. The share of profits of each partner in the income of the firm was added to his other incomes. The levy was on the partners severally and not on the firm. The total income of the partner comprises of his other income and his share of income from the firm. It is, therefore, clear that under the provisions of the 1922 Act, neither the unregistered firm nor the registered firm was subjected to double taxation. After the amendment in 1956, till 31-31993, the unregistered firm continued to be assessed to tax as distinct entity as before and tax was levied on it. The partners though not liable to pay tax to their income had to include his income from the partnership in computing his total income for the purpose of determining the rate of tax to be applied in determining his tax liability on his other income. In the case of income of registered firm, there was double taxation. Firstly, tax on a nominal rate had to be paid by the registered firm and the Partners thereof were also taxed in their individual assessments as before in respect of their share of income from the firm. This position continued till 31-3-1993. The Finance Act, 1992, introduced wide changes in respect of assessment of income of the firms with effect from 1-4-1993. The changed position applicable to the assessment years 1996-97 and 1997-98 recognizes two kinds of firms, i.e., firm, assessed as firm under section 184 and firm assessed as association of persons under section 185.
15. In the instant case, the admitted position is that M/s. Rock International and M/s. Radha Krishna Jalan are firms assessed as firms under section 184. It may be mentioned here that in the case of firms which are assessed as firms, payment of interest, salary, bonus, commission or remuneration paid to the partners have been allowed to be deducted in the hands of the firm requiring the firm to pay tax on its total income as a distinct entity as provided in section 167A. The share of income of an individual partner is not to be included in computing his total income, but the interest, salary, bonus, commission or remuneration received by a partner from the firm is assessable in his hands as income from business or profession. It is, therefore, clear that with effect from April 1, 1993, there is no scope for double taxation in the case of a firm assessed as firm under section 184. On the other hand, as provided in section 185, in force with effect from 1-4-1993, to 31-3-2004, a firm is required to be assessed as an association of persons and the provisions of sections 67A, 167B and 86 are applicable to such firm. That a share of income of an individual partner is not required to be included in his total income is further crystallized in the provisions of sub-section (2A) of section 10.
15. From above discussion, it would appear that there is no scope for double taxation of an income by a partner of a firm which is separately assessed to tax. Keeping this in mind, we are called upon to interpret the provisions of the Act relating to exemption or deduction or benefit to be given to certain kinds of income. In this connection, we may refer to the observation of the Apex Court in CIT v. Canara Workshops (P.) Ltd. [1986] 161 ITR 3201. It was held :
“…It seems to us that the object in enacting section 80E is properly served only by confining the application of the provisions of that section to the profits and gains of a single industry. The deduction of 8 per cent is intended to be an index of recognition, that a priority industry has been set up and is functioning efficiently. It was never intended that the merit earned by such industry should be lost or diminished because of a loss suffered by some other industry. It makes no difference that the other industry is also a priority industry. The co-existence of two industries in common ownership was not intended by Parliament to result in the misfortune of one being visited on the other. The legislative intention was to give to the meritorious its full reward….” (p. 324)
16. Again in Bajaj Tempo Ltd. v. CIT [1992] 196 ITR 1882 the Supreme Court held as follows :
“…A provision in a taxing statute granting incentives for promoting growth and development should be construed liberally. In Broach District Cooperative Cotton Sales, Ginning & Pressing Society Ltd. v. CIT [1989] 177 ITR 418 (SC), the assessee, a co-operative society, claimed that the receipts from ginning and pressing activities was exempt under section 81 of the Income-tax Act. The question for interpretation was whether the co-operative society which carried on the business of ginning and pressing was a society engaged in ‘marketing’ of the agricultural produce of its members. The court held that the object of section 81(1) was to encourage and promote growth of co-operative societies and consequently, a liberal construction must be given to the operation of that provision. And since ginning and pressing was incidental or ancillary to the activities mentioned in section 81(1), the assessee was entitled to exemption and the proviso did not stand in his way.
In CIT v. Strawboard Manufacturing Co. Ltd. [1989] 177 ITR 431 (SC), it was held that the law providing for concession for tax purposes to encourage industrial activity should be liberally construed. The question before the court was whether strawboard could be said to fall within the expression ‘paper and pulp’ mentioned in the Schedule relevant to the respective assessment years. The court held that since the words ‘paper and pulp’ were mentioned in the Schedule, the intention was to refer to the paper and pulp industry and since the strawboard industry could be described as forming part of the paper and pulp industry, it was entitled to the benefit.” (p. 193)
17. In CIT v. Podar Cement (P.) Ltd. [1997] 226 ITR 6253, the Hon’ble Supreme Court held as follows :
“We are conscious of the settled position that under the common law, ‘owner’ means a person who has got valid title legally conveyed to him after complying with the requirement of law such as the Transfer of Property Act, Registration Act, etc. But, in the context of section 22 of the Income-tax Act, having regard to the ground realities and further having regard to the object of the Income-tax Act, namely, ‘to tax the income’, we are of the view, ‘owner’ is a person who is entitled to receive income from the property in his own right.” (p. 653)
18. The decisions above support the view that the legislative intent cannot be frustrated by attributing literal interpretation of the provisions of the statute. An income which is already taxed in the hands of the firm is obviously not exigible to tax in the hands of the partner. This provision available in section 10(2A) is obviously incorporated to obviate double taxation. On this background, we may now proceed to discuss the principles of diversion of share of a partner by superior or overriding title to a sub-partnership comprising the partner and strangers to the main partnership. Sub-partnerships have been recognized in India and registration accorded under the Indian Income-tax Act, 1922, though sub-partnership has not been defined either in the Indian Partnership Act, 1932 or in the Income-tax Act, 1961. In support of this proposition, we may refer to the decision of the Apex Court in various cases.
19. In Murlidhar Himatsingka’s case (supra), the Supreme Court held as follows :
“A sub-partnership is, as it were, a partnership within a partnership ; it presupposes the existence of a partnership to which it is itself subordinate. An agreement to share profits only constitutes a partnership between the parties to the agreement. If, therefore, several persons are partners and one of them agrees to share the profits derived by him with a stranger, this agreement does not make the stranger a partner in the original firm. The result of such an agreement is to constitute what is called a sub-partnership, that is to say, it makes the parties to it partners inter se ; but it in no way affects the other members of the principal firm.
Since the decision of the House of Lords in Cox v. Hickman [1860] 8 HL Cas 268, a sub-partner could not before the Partnership Act, 1890, be held liable to the creditors of the principal firm by reason only of his participation in the profits thereof, and there is nothing in that Act to alter the law in this respect.” (p. 329)
20. The above judgment of the Apex Court lends support to the contention of Shri R.P. Agarwalla that sub-partnership has been recognized in India and registration has been accorded to them under the Indian Income-tax Act, 1922. It has also been held that sub-partnership creates a superior title and diverts the income before it becomes the income of the partner. The partner in the main firm receives the income not only on his behalf but on behalf of the partners in the sub-partnership. This view is crystallised in the judgment of the Hon’ble Supreme Court in Murlidhar Himatsingka’s case (supra), the Apex Court held that in the case of a sub-partnership, the sub-partnership creates a superior title and diverts the income before it becomes the income of the partners. This otherwise means that the partner in the main firm receives the income not only in his behalf but on behalf of the partners in the sub-partnership. In Sunil J. Kinariwala’s case (supra), the Supreme Court held that when a third person becomes entitled to receive the amount under obligation of an assessee even before he could lay a claim to receive the income, there would be a diversion of income by overriding title. Referring to the decision of P.C. Mullick v. CIT [1938] 6 ITR 206 (PC), the Supreme Court had observed in Sunil J. Kinariwala’s case (supra) as follows :
“In Murlidhar Himatsingka’s case [1966] 62 ITR 323 (SC). . . . It was held there was overriding obligation which converted the income of the partner in the main firm into the income of the sub-partnership and, therefore, the income attributable to the share of the partner had to be included in the assessment of the sub-partnership. That was on the principle that a partner in the sub-partnership had a definite enforceable right to claim a share in the profits accrued to or received by the other partner in the main partnership, as on entering into a sub-partnership, such a partner changes his character vis-a-vis the sub-partners and the income-tax authorities. Further, a sub-partnership creates a superior title and results in diversion of the income from the main firm to the sub-partnership before the same becomes the income of the concerned partner. In such a case, even if the partner receives the income from the main partnership, he does so not on his behalf but on behalf of the sub-partnership. . .
It is apt to notice that there is a clear distinction between a case where a partner of a firm assigns his share in favour of a third person and a case where a partner constitutes a sub-partnership with his share in the main partnership. Whereas in the former case, in view of section 29(1) of the Indian Partnership Act, the assignee gets no right or interest in the main partnership, except, of course, to receive that part the profits of the firm referable to the assignment and to the assets in the event of dissolution of the firm in the latter case, the sub-partnership, acquires a special interest in the main partnership. The case on hand cannot be treated as one of a sub-partnership, though in view of section 29(1) of the Indian Partnership Act, the trust as an assignee, becomes entitled to receive the assigned share in the profits from the firm not as a sub-partner because no sub-partnership came into existence but as an assignee of the share of income of the assignor-partner.” (p. 17)
21. From the decisions referred to above, we may cull out the following principles relating to diversion of share of income of a partner at source by overriding title :
(1) A sub-partnership is a partnership within a partnership in respect of the share of a partner in the main partnership. Formation of a sub-partnership does not affect the position of the partner in the main partnership though its character changes vis-a-vis the sub-partnership and the income-tax authorities.
(2) The superior title of the sub-partnership diverts at source the share income of the concerned partner in the main partnership before it becomes the income of the partners.
(3) Assessment of a share of income of a partnership in the hands of a partner has to be apportioned as per the provisions of the Income-tax Act and, thereafter, the income-tax authorities are required to determine whether it would be assessed in the hands of that partner or in the hands of the sub-partnership.
(4) The diversion of the income of a partner in the main partnership at source to the sub-partnership by overriding obligation created by the sub-partnership converts the income of a partner into the income of the sub-partnership, thus, vesting an enforceable right upon the sub-partnership to claim a share in the profits accrued to or received by the partner.
(5) The right to receive profits and pay losses become the asset of the sub-partnership.
22. It would appear from the above principles that diversion of income by overriding title to sub-partnership confers upon it the attributes of a partner insofar as it relates to such income for the purpose of the Income-tax Act, 1961, irrespective of the provisions of the Indian Partnership Act, 1932. As stated hereinbefore, a sub-partnership has been recognized in India and registered as a partnership firm under the Income-tax Act though the term has not been defined in the Indian Partnership Act, 1932. A partnership firm cannot become a partner in another partnership firm for the purpose of the Indian Partnership Act, 1932 since a firm is not a person under this Act and is, therefore, not eligible to enter into an agreement. But the position is otherwise insofar the Income-tax Act, 1961, is concerned. In the Income-tax Act, 1961, a “person” has been defined in sub-section (31) of section 2 which, amongst, others include a firm also. In the instant case, there is no dispute that the share of income receivable by Shri Radha Krishna Jalan from M/s. Rock International stood diverted by a superior title to the sub-partnership of M/s. Radha Krishna Jalan, the appellant before the partner in Shri Radha Krishna Jalan could lay hand on it.
23. The Tribunal relying upon a decision in Dulichand Laxminarayan v. CIT [1956] 29 ITR 535 (SC) has taken the view that the provisions of section 10(2A) is not applicable in the case of income diverted to the appellant-firm. The Tribunal was of the view that section 10(2A) is applicable only in case of a partner of the firm and the appellant-firm not being a partner of M/s. Rock International cannot get the exemption under section 10(2A). But the Tribunal failed to notice that the judgment in Dulichand Laxminarayan’s case (supra), was rendered in the context of rule 2 of the Indian Income-tax Rules, 1922, which required that all the partners of a firm must sign the application for registration. Since a firm is not a partner under the Indian Partnership Act, 1932, the Tribunal held that going by the definition of “partnership” in the Partnership Act, the sub-partnership in the instant case could not enter into any partnership for the reason that one partner of such firm signing on behalf of the firm would not meet the requirement short of compliance with rule 2. The following situations better clarify the position :
(1) A Hindu undivided family cannot be partner per se in a firm under the Partnership Act, though a “karta” representing it can be a partner therein. For the purpose of the Partnership Act, his position in the firm is that of a partner and his share is not assessed in his hands but in the hands of the Hindu undivided family.
(2) A trust cannot be a partner in a firm whereas a trustee may be. The share of income pertaining to such trustee is assessed in the hands of the trust.
24. In support of the above proposition, we may refer to the decisions of the Hon’ble Supreme Court in CIT v. Kalu Babu Lal Chand [1959] 37 ITR 123; Charandas Haridas v. CIT [1960] 39 ITR 202 and CIT v. A. Abdul Rahim & Co. [1965] 55 ITR 651. The decisions rendered therein are relevant for the purpose at hand are quoted below :
Kalu Babu Lal Chand’s case (supra) :
“It is now well-settled that a Hindu undivided family cannot as such enter into a contract of partnership with another person or persons. The karta of the Hindu undivided family, however, may and frequently does enter into partnership with outsiders on behalf and for the benefit of his joint family. But when he does so, the other members of the family do not, vis-a-vis the outsiders, become partners in the firm. They cannot interfere in the management of the firm or claim any account of the partnership business or exercise any of the rights of a partner. So far as outsiders are concerned, it is the karta who alone is, and is in law recognized as, the partner. Whether in entering into a partnership with outsiders, the karta acted in his individual capacity and for his own benefit or he did so as representing his joint family and for its benefit is a question of fact. If for the purpose of contribution of his share of the capital in the firm the karta brought in monies out of the till of the Hindu undivided family, then he must be regarded as having entered into the partnership for the benefit of the Hindu undivided family and as between him and other members of his family he would be accountable for all profits received by him as his share out of the partnership profits and such profits would be assessable as income in the hands of the Hindu undivided family. . . .
What are the facts here ? Here was the Hindu undivided family of which B.K. Rohatgi was the karta . . . . . The finding in this case is that the promotion of the company and the taking over of the concern and the financing of it were all done with the help of the joint family funds and the said B.K. Rohatgi did not contribute anything out of his personal funds if any. In the circumstances, we are clearly of the opinion that the managing director’s remuneration received by B.K. Rohatgi was, as between him and the Hindu undivided family, the income of the latter and should be assessed in its hands. . . .” (p. 130)
Charandas Haridas’ case (supra) :
“In our opinion, here there are three different branches of law to notice. There is the law of partnership, which takes no account of a Hindu undivided family. There is also the Hindu law, which permits a partition of the family and also a partial partition binding upon the family. There is then the income-tax law, under which a particular income may be treated as the income of the Hindu undivided family or as the income of the separated members enjoying separate shares by partition. The fact of a partition in the Hindu law may have no effect upon the position of the partner, insofar as the law of partnership is concerned, but it has full effect upon the family insofar as the Hindu law is concerned. Just as the fact of a karta becoming a partner does not introduce the members of the undivided family into the partnership, the division of the family does not change the position of the partner vis-a-vis the other partner or partners. The income-tax law before the partition takes note, factually, of the position of the karta, and assessee not him qua partner but as representing the Hindu undivided family. In doing so, the income-tax law looks not to the provisions of the Partnership Act, but to the provisions of Hindu law. When once the family has disrupted, the position under the partnership continues as before, but the position under the Hindu law changes. There is then no Hindu undivided family as a unit of assessment in point of fact, and the income which accrues cannot be said to be a Hindu undivided family. There is nothing in the Indian income-tax law or the law of partnership which prevents the members of a Hindu joint family from dividing any asset. Such division must, of course, be effective so as to bind the members, but Hindu law does not further require that the property must in every case be partitioned by metes and bounds, if separate enjoyment can otherwise be secured according to the shares of the members. For an asset of this kind there was no other mode of partition open to the parties if they wished to retain the property and yet hold it not jointly but in severally, and the law does not contemplate that a person should do the impossible. Indeed, the results would have been the same, even if the dividing members had said in so many words that they had partitioned the assets, because insofar as the firms were concerned, the step would have been wholly inconsequential.” (p. 208)
A. Abdul Rahim & Co.’s case (supra) :
“. . . If the partnership is genuine and legal, the share given to the benamidar will be the correct specification of his individual share in the partnership. The beneficial interest in the income pertaining to the share of the said benamidar may have relevance to the matter of assessment, but none in regard to the question of registration.” (p. 659)
25.It would appear from the above judgments that the formation of sub-partnership creates a legal fiction whereby the income or loss of a partner becomes the income or loss of the sub-partnership. This situation creates a legal fiction. Mr. Agarwalla, learned senior counsel submitted that such income or loss has to be assessed in the hands of sub-partnership by the income-tax authorities. The effect thereof, according to Shri Agarwalla, is that for the purpose of assessment, the sub-partnership has to be deemed to be a partner of the main partnership. It is because once the sub-partnership becomes the real owner of the income for the purpose of assessment despite the provisions of the Partnership Act, it would be imperative to assume all those facts on which alone the fiction operates. In CIT v. S. Teja Singh [1959] 35 ITR 408 (SC) at page 413, it is held—”It is a rule of interpretation well-settled that in construing the scope of legal fiction it would be proper and even necessary to assume all those facts on which alone the fiction can operate”. Similarly, in Assam Bengal Carriers Ltd. v. CIT [1999] 239 ITR 862, 886 (Gauhati) it is held—”When a legal fiction is created for an obvious purpose full effect of it is to be given—there is no half way house”.
26. Let us consider the anomalous situation that would emerge in case a sub-partnership is not deemed to be a partner in respect of assessment of its income diverted from a partner in the main partnership by overriding title. With effect from April 1, 1993, the income of a partnership is subject to tax in the hands of the firm. The share of an individual partner has been exempted under sub-section (2A) of section 10. If the benefit of section 10(2A) is denied in case of diversion, it would completely nullify the basic scheme of the Act since the income of the partner once taxed in the hands of the partnership would be again exigible to tax in the hands of sub-partnership. This would be contrary to the legislative scheme in force with effect from April 1, 1993, relating to assessment of partnership firm. The learned Tribunal negated the contention of the appellant-firm relying upon a decision of the Rajasthan High Court in CIT v. Alisher Contractors [1986] 159 ITR 534. But in that case, the assessment year in question was 1973-74, i.e., prior to April 1, 1993, when the scheme of the Act was different and the burden of tax was on the partner and not the partnership firm. The provision for exemption under section 10(2A) came into force with effect from April 1, 1993, and, therefore, the said decision could not be relied upon by the Tribunal in deciding the case at hand.
27. The Income-tax Act provides for levy of tax on the total income of an assessee after computation of income from all sources, setting off the losses and deducting the allowable deduction. In the instant case, the total income of M/s. Rock International has been computed at Rs. 39,426 for the assessment year 1996-97 and Rs. 42,750 for the assessment year 1997-98. Shri Radha Krishna Jalan was entitled to 45 per cent of the aforesaid income of the main partnership for the two assessment years. His personal income as partner of the main partnership would roughly be Rs. 17,742 and Rs. 19,234 respectively. The said amount stood diverted to the appellant-firm M/s. Radha Krishna Jalan by overriding title. But the income-tax authorities assessed the total income of M/s. Radha Krishna Jalan, the appellant-firm at Rs. 1,83,13,993 for the assessment year 1996-97 as against the total taxable income of Rs. 39,426 of M/s. Rock International, though the share of income of Shri Radha Krishna Jalan diverted at source to the sub-partnership could not be more than Rs. 17,427. Similarly, for the assessment year 1997-98, the total income of the main firm was Rs. 42,750 and the share of Shri Radha Krishna Jalan was Rs. 19,327. This amount was diverted at source to the sub-partnership. But the total income of sub-partnership has been assessed at Rs. 2,89,09,158.
28. This anomalous and illogical consequence has arisen because of refusal to consider M/s. Radha Krishna Jalan, the appellant-firm as a partner of the main partnership firm M/s. Rock International for the limited purpose of section 10(2A) of the Income-tax Act, 1961. This is evidently not only contrary to the facts available on record, but also to the scheme of the Income-tax Act as well as the principles of diversion of income by overriding title. This refusal has ended in double taxation. The legal fiction created for non-application of the provisions of section 10(2A) on the ground that the appellant-firm is not a partner of the main partnership has ushered in an absurd situation contrary to the facts as well as the provisions of the Act. The note of discord has to be tuned with the legislative intent as reflected in the scheme of the Act. To obviate this absurdity, we hold that a sub-partnership which is in receipt of the share of profit of a partner in the main partnership, has to be deemed to be a partner in the main partnership for the limited purpose of section 10(2A). Else, the absurdity will continue. The contention of the revenue that the appellant-firm not being a partner of the main partnership will not be entitled to the benefit of section 10(2A) is not accepted for the reason that it is totally in disharmony with the scheme of the Act.
29. For the reasons above, we answer the questions formulated in both the appeals in favour of the assessee and against the revenue. Consequently, we set aside the order dated 17-9-2003 passed by the Income-tax Appellate Tribunal, Gauhati Bench, Guwahati in ITA Nos. 49(Gau.)/2001 and 33 (Gau.)/2001.
7.1 Respectfully following the above judgment and also the judgment relied by the ld.AR cited supra, I hold that the assessee is eligible for exemption u/s 10(2A) of the Act from the share of profit received from the partnership firm. I do not find much weightage on the case law relied by the ld. DR. Accordingly, I allow the appeal of the assessee.
8. In the result, the appeal of the assessee is allowed.
Order pronounced in the open court on 3rd January, 2023.
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