MULBERRY TEXTLIES LLP,BENGALURU vs. INCOME TAX OFFICER, WARD-7(2)(3), BANGALORE

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. M/s. Mulberry Textiles LLP, Bangalore Page 2 of 19 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:

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.

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:

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.”

The ld DR relied on the order of lower authorities and he submitted that the assessee is not eligible to claim exemption u/s ITA No.757/Bang/2022 M/s. Mulberry Textiles LLP, Bangalore Page 9 of 19 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 co- ordinate bench of the Tribunal of Guwahati bench in the case of M/s Hotel Centre Point, Shillong vs. ITO in Gau/2018, M.P. No. 3 to 5/Gau/2016 order dated 13.09.2019.

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.

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 M/s. Mulberry Textiles LLP, Bangalore Page 10 of 19 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)?

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 31-3- 1993, 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.

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 :

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 Co- operative 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. M/s. Mulberry Textiles LLP, Bangalore Page 12 of 19 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)

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)

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.

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 :

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 M/s. Mulberry Textiles LLP, Bangalore Page 15 of 19 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.

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.

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 M/s. Mulberry Textiles LLP, Bangalore Page 16 of 19 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) M/s. Mulberry Textiles LLP, Bangalore Page 17 of 19 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)

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".

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.

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 M/s. Mulberry Textiles LLP, Bangalore Page 18 of 19 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.

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.

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.

In the result, the appeal of the assessee is allowed.