*THE HON’BLE SRI JUSTICE V.V.S.RAO AND * THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN + I.T.T.A. Nos. 613, 614, 616, 617, 618, 636, 637, 719, 356, 357, 360, 367, 382, 383, 385, 389, 391, 392, 393, 394, 395, 397, 398, 400, 427, 429, 485, 486, 487, 557, 558, 576, 577, 579, 580, 635, 707, 708, 723 AND 737 of 2006 AND 114 AND 201 OF 2007 AND 45, 96, 98, 101, 115, 118, 137, 138, 139, 140, 141, 231 AND 244 OF 2008 I.T.T.A. No.613 of 2006: % Dated 09-09-2010 # Commissioner of Income Tax, Vijayawada …. Appellant Vs. $ M/s. Swarna Bar & Restaurant …. Respondent ! Counsel for the Appellant: Mr. J.V. Prasad, Standing Counsel for Income Tax ^ Counsel for the Respondent: - <GIST: > HEAD NOTE: ? Cases referred [1] Vol. 217 (1996) ITR 746 2 Vol. 234 (1987) ITR 472 3 Vol. 229 ITR 534 4 Vol. 234 (1998) ITR 628 (APHC DB) 5 (Judgment in Civil Appeal Nos.1317-1319 of 2001 dated 4.12.2002) 6 (Halsbury’s Laws of England (Statutes Vol. 44(1), fourth reissue para 1474 pp 9806- 07)) THE HON'BLE SRI JUSTICE V.V.S.RAO AND THE HON'BLE SRI JUSTICE RAMESH RANGANATHAN I.T.T.A. Nos. 613, 614, 616, 617, 618, 636, 637, 719, 356, 357, 360, 367, 382, 383, 385, 389, 391, 392, 393, 394, 395, 397, 398, 400, 427, 429, 485, 486, 487, 557, 558, 576, 577, 579, 580, 635, 707, 708, 723 AND 737 of 2006 AND 114 AND 201 OF 2007 AND 45, 96, 98, 101, 115, 118, 137, 138, 139, 140, 141, 231 AND 244 OF 2008 COMMON ORDER: (Per Hon’ble Sri Justice Ramesh Ranganathan) These ITTAs are preferred by the Revenue against the orders of the Income Tax Appellate Tribunal whereby the respondent-assesses were held entitled to be assessed as partnership firms, and for consequential benefits of payment of salaries, interest on the capital of partners, etc. It would suffice for the disposal of these appeals if the facts in I.T.T.A. No.323 of 2006 are noted. I.T.T.A. No.323 of 2006 is filed against the order of the Income Tax Appellate Tribunal, Visakhapatnam in I.T.A. No.455/Viz/2004. For the assessment year 1999-2000 the assessee firm was carrying on business in trading of Indian made Foreign Liquor having obtained a license from the Andhra Pradesh Excise Department in the name of one of the partners, in his individual status. A return was filed on 31.12.1999, in the status of a partnership firm, admitting to an income of Rs.10.130/-. An order of assessment, under Section 143(1) of the Income Tax Act, was passed on 19.01.2000. Thereafter the Income tax Officer, relying on Rule 39 of the A.P. Indian and Foreign Liquor Rules, 1970 and following the judgment of the Supreme Court, in Bihari Lal Jaiswal v. CIT[1], reopened the assessment on the ground that there was escapement of income in the form of remuneration to partners and interest on partner’s capital. He held that, as the assessee had not obtained permission from the Excise department before entering into the partnership, such a partnership was prohibited under the A.P. Excise Act and, therefore, the status of the assessee could not be treated as a firm. As a result, the remuneration paid to the partners for Rs.48,000/-, and interest on capital of Rs.1,44,000/-, was added and the total income of the assessee was assessed at Rs.2,02,130/-. Aggrieved thereby, the assessee preferred an appeal to the Commissioner of Income Tax (Appeals). In his order the Commissioner, after referring to the judgments of the Supreme Court in Bihari Lal Jaiswal1, CIT v. Motilal Chunnilal[2] and Maddi Venkataraman & Co. (P) Ltd. v. CIT[3], observed that the assessing authority had rightly treated the assessee as an association of persons. The Commissioner rejected the contention, urged on behalf of the assessee, that there was a change in law for the assessment year 1993-1994, and the judgments relating to the assessment years prior thereto could not be applied. He held that, since the provisions of the A.P. State Excise Act had been violated by the assessee, and the written permission of the licensing authority had not been obtained, the assessee was not entitled to be treated as a partnership firm; and the decision of the Supreme Court in Bihari Lal Jaiswal1 related to violation of public policy and not to any procedural aspects under the Income Tax Act. Aggrieved thereby, the assessee preferred an appeal to the Income Tax Appellate Tribunal, Visakhapatnam. The Tribunal held that the point for consideration arose after the year 1992 when Finance Act 18 of 1992 amended Sections 184 and 185 of the Income Tax Act; after the amendment, the CBDT had issued Circular No.636 dated 31.08.1992; the judgment of the Supreme Court, in Bihari Lal Jaiswal1, had considered the provisions of Sections 184 and 185 of the Income Tax Act prior to their amendment by Finance Act 18 of 1992; the statutory provisions and the Circular of the CBDT (Circular No.636 dated 31.08.1992) made it clear that, prior to the amendment, Section 185 empowered the assessing officer to enquire into the genuineness of the firm and its constitution; consequent to the amendment, the distinction between a registered firm and an unregistered firm had been removed, and a firm would be assessed as a firm if it was evidenced by an instrument of partnership, wherein the individual shares of partners was specified, and the said instrument was enclosed to the return filed by the firm; there was no enabling provision empowering the assessing authority to examine the genuineness of the partnership and its constitution; it was not the case of the department that the assessee had not filed the instrument of partnership specifying the individual share of the partners; reliance placed on the judgments of the Supreme Court, wherein the provisions of the unamended Sections 184 and 185 were considered, was misplaced; reopening of the assessment was, therefore, erroneous; and the assessees were entitled to be assessed as firms, and for the benefits of allowances and salaries as well interest paid to partners of the firm on their capital. Aggrieved thereby, the present appeals before this Court by the Revenue. Both Sri S.R. Ashok, Learned Senior Counsel and Sri J.V. Prasad, Learned Standing Counsel appearing on behalf of the Income Tax department would submit that a firm, contravening the provisions of the A.P. Excise Act and the IMFL Rules, would be acting contrary to public policy, and would not be a legal and valid partnership for the purposes of the Income Tax Act; this position remained unchanged even after Sections 184 and 185 were amended by Finance Act 18 of 1992; while the enquiry regarding the genuineness of the firm, under the pre-amended Sections 184 and 185, was to confer certain benefits on a registered partnership firm, the distinction between a registered and an unregistered firm was done away with post amendment; the power of the Income Tax Officer, to ascertain whether there was a valid partnership in law, was not taken away pursuant to the amendment of Sections 184 and 185 of the Income Tax Act; an entity claiming certain benefits should comply with the law; an illegal firm, opposed to public policy, could not be permitted to claim benefits under the Income Tax Act; in the absence of prior permission being obtained, from the Commissioner of Prohibition and Excise, there was no legally constituted partnership entitled to carry on business of trading in liquor; and, therefore, the partners of the so called firm were required to be assessed only as an association of persons. On the other hand, Sri A.V. Krishna Koundanya, Sri Y. Subrahmanyam and Smt. K. Neeraja, appearing for the respondent- assessees, would submit that the CBDT Circular No.636 dated 31.08.1992 was binding on the Revenue under Section 119 of the Income Tax Act; the decision of the Supreme Court, prior to the amendment of Sections 184 and 185 of the Income-Tax Act by Finance Act 18 of 1992, had no relevance as the requirement of an enquiry into the genuineness of the firm, under Section 184 and 185 of the Income-Tax Act, had been done away with after their amendment; under the amended Section 185, irrespective of status of the firm whether it was registered or not, a firm had to be assessed as such; after amendment of Sections 184 and 185 of the Income Tax Act, a partnership firm did not require registration under the Income Tax Act; on a true construction of Section 184, if a partnership firm was evidenced by an instrument, it was required to be assessed as such; in some of these appeals a partnership deed had been executed and the partnership firm constituted even prior to a license being obtained under the A.P. I.M.F.L. Rules; the partnership deed authorized any one of the partners to obtain such a license to be used by the firm for carrying on business of trading in Indian made foreign liquor; after the license was obtained there was no sub-letting, leasing or transfer of the license by the firm; the assessee had not violated the provisions of the A.P. Excise Act, the Rules made thereunder or Section 23 of the Indian Contract Act; Rule 39 of A.P. I.M.F.L. Rules is not applicable as there was no similar condition in their license; the partnership firm is a partnership at will and is valid even without registration; the Revenue was not empowered to look into the validity of the partnership firm in the light of the amended Sections 184 and 185, more so when the partnership firm was constituted even prior to the licence being obtained; the amended Sections 184 and 185 do not admit of any comparison between the Income Tax Act on the one hand and the A.P. Excise Act and the Indian Contract Act on the other; and the orders of the Tribunal do not necessitate interference in these appeals. The Andhra Pradesh Excise Act, 1948, (A.P. Act) is a consolidating law, inter alia, relating to production, manufacture, possession, transport, purchase and sale of intoxicating liquor and drugs, and to provide for matters connected therewith. Section 15 of the A.P. Act prohibits any person from selling or buying intoxicants except under the authority, and in accordance with the terms and conditions, of a license granted in their favour. Chapter VI deals with licenses and permits. Sections 28 and 31(1)(a) and (b) of A.P. Act are relevant, and read thus:- 28. Form and conditions of licence etc:- (1) Every permit issued or licence granted under this Act shall be issued or granted on payment of such fees, for such period, subject to such restrictions and conditions, and shall be in such form and shall contain such particulars, as may be prescribed. (2) The conditions prescribed under sub-section (1) may include provisions of accommodation by the licensee to Prohibition & excise officers at the licensed premises on the payment of rent or other charges for such accommodation at or near the licensed premises and the payment of the costs, charges and expenses (including the salaries and allowances of the Prohibition and Excise Officers) which the Government may incur in connection with the supervision to ensure compliance with the provisions of this Act, the rules made thereunder and the licence. 31. Power to cancel or suspend licence, etc:- (1) Subject to such restrictions as may be prescribed, the authority granting any licence or permit under this Act may cancel or suspend it irrespective of the period to which the licence or permit relates. (a) if any duty or fee payable by the holder thereof is not duly paid; or (b) in the event of any breach by the holder thereof or by any of his servants or by any one acting on his behalf with his express or implied permission, of any of the terms and conditions thereof; or (c) to (e) omitted A bare perusal of these Sections would show that a person or a firm or a company cannot carry on business in intoxicants without obtaining a licence, and without complying with the conditions of such licence. In exercise of its powers under Section 72 read with Sections 9, 11 to 15 and 28 of the A.P. Act, the Government of Andhra Pradesh made the Andhra Pradesh Indian Liquor and Foreign Liquor Rules, 1970 (IMFL Rules), which apply for import, export, transport and sale of Indian Liquor and Foreign Liquor (IMFL). Rule 23 of the IMFL Rules enumerates different categories of licenses. The licence in Form-IL 24 is issued for retail liquor shops. Rules 23 (iii) and (xiii) of the IMFL Rules require the holder of such a license to be permitted to sell IMFL in sealed or capsuled bottles not exceeding the specified quantity of liquor. The license in Form-IL 24 contains eleven special conditions in addition to the general conditions applicable to all IMFL and Beer licenses subject to which a licensee can carry on retail business. Condition No.8 thereof is to the effect that a licence is not transferable. Rule 39 of the IMFL Rules requires a licensee not to declare any person to be or not to be his partner. It is evident from Section 15 of the A.P. Act that except under the authority, and in accordance with the terms and conditions, of a licence granted in their favour, no one can carry on business in trading in liquor in the State of Andhra Pradesh. In addition, a person who has been granted a licence has to ensure compliance with the terms and conditions prescribed therein. As the business of trading in intoxicating liquor is res extra commercium, a high degree of control is exercised by law to ensure that the business of trading in liquor is carried on strictly in accordance with the provisions of the A.P. Excise Act, the rules made thereunder, and the terms and conditions of the licence granted in favour of the licensee. Violation of any of the conditions would entail suspension/cancellation of licence under Section 31 of the A.P. Act. In cases where a licence is granted in favour of an individual it is only he, and no other, who is entitled to carry on business of trading in intoxicating liquor. By his act of entering into a partnership, a licensee would have permitted the other partners also to carry on business of trading in intoxicating liquor. Such a partnership agreement would not only fall foul of, and defeat, the provisions of the A.P. Excise Act but would, under Section 23 of the Indian Contract Act, also be an agreement opposed to public policy and, hence, unlawful and void. Rule 39 of the IMFL Rules prohibits a licensee, except with the prior permission of the licensing authority, to get any person included as a partner to his business or get an existing person excluded therefrom. It is not in dispute that in none of these appeals, which form part of this batch of ITTAs, has the licensee obtained prior permission of the Commissioner of Prohibition and Excise (Licensing Authority) to get any person included as a partner to his business. In the absence of such prior permission being obtained, the partnership firm, which has been formed to carry on business of trading in intoxicating liquor, would be an illegal partnership both under the Partnership Act, 1932 and the A.P. Excise Act, and the Partnership agreement opposed to public policy. Such a firm cannot be treated as a valid partnership for the purposes of the Income Tax Act. In this context it would be appropriate to refer to the judgments of the Supreme Court and the Division bench of this Court. In Commissioner of Income-tax v. Rangila Ram: 254 ITR 230, the Supreme Court held:- “……..The basic principle, as it seems to us, is that the liquor business is res extra commercium. No one may deal in liquor without express permission. It is only the licensee who is granted such permission. If he enters into a partnership to deal in liquor, all the other partners would, as partners, also be dealing, in liquor and holding the same. This would be contrary to the basic principle and illegal………” (emphasis supplied) In Bihari Lal Jaiswal1 a licence for retail sale of country spirit, under supply system in Form CS No. 3 of the Madhya Pradesh Excise Rules, 1960, was obtained by Biharilal Jaiswal in respect of twenty- two shops in a public auction. He entered into a partnership with ten others to carry on business under the said licence. The partnership was evidenced by a partnership deed. It is in this factual matrix that the Supreme Court held:- “……..In our opinion, the correct position appears to be this (we are confining ourselves to partnerships entered into with respect to a licence/permit granted under the State Excise enactments): these enactments deal with intoxicating liquor, that is to say, the production, manufacture, possession, transport, purchase and sale of intoxicating liquors (Entry 8 of List II of the Seventh Schedule to the Constitution) and other noxious substances besides providing for duties of excise referred to in Entry 51 of the said List. It has been held by this court repeatedly that no person has a fundamental right to deal or trade in intoxicating liquors and that the State is entitled to prohibit and/or closely regulate their production, manufacture, possession, transport, purchase and sale. Take the Madhya Pradesh Act, with which we are concerned herein. Clause VI of the General Licence Conditions - it is not disputed that these conditions are statutory in character - provides expressly that a holder of a licence/privilege shall not enter into a partnership for the working of such privilege in any way or manner without the written permission of the Collector, which permission shall be endorsed on the licence. This condition is binding upon the licensee. If so, he cannot enter into a partnership nor can there be, in law, a partnership with respect to the privilege (business) granted under the licence. No person, and no licensee, can claim any right contrary to the said provision. The object underlying the said clause is self-evident. Since the licence is granted for dealing in intoxicating liquors, the business wherein is res extra commercium - and also because they are supposed to be harmful and injurious to health and morals of the members of the society - close control is envisaged and provided over the business carried on under the licence. This object will be defeated if the licensee is permitted to bring in strangers into the business, which would mean that instead of the licensee carrying on the business, it would be carried on by others - a situation not conducive to effective implementation of the excise law and consequently deleterious to public interest. It is for this very reason that transfer or sub- letting of licence is uniformly prohibited by several State excise enactments. It, therefore, follows that any agreement whereunder the licence is transferred, sub-let or a partnership is entered into with respect to the privilege/business under the said licence, contrary to the prohibition contained in the relevant excise enactment, is an agreement prohibited by law. The object of such an agreement must be held to be of such a nature that if permitted it would defeat the provisions of the excise law within the meaning of Section 23 of the Contract Act. Such an agreement is declared by Section 23 to be unlawful and void. When the law prohibits the entering into a particular partnership agreement, there can be in law no partnership agreement of that nature. The question of such an agreement being genuine cannot, therefore, arise. Where, of course, the statutory provisions or the conditions of licence do not prohibit the entering into of partnership, it is obvious, such a partnership cannot be held to be illegal, unlawful or void, as held by this court in Jer and Co. But where there is a specific prohibition as in the case before us, any partnership entered into would be unlawful and void agreement within the meaning of Section 23 and no other law, whether State or Central, can recognise such an agreement. The context - that it is an excise enactment - should not be forgotten. The grant of registration under the Income Tax Act, it must be remembered, confers a substantial benefit upon the partnership firm and its members. There is no reason why such a benefit should be extended to persons who have entered into a partnership agreement prohibited by law. One arm of law cannot be utilised to defeat the other arm of law. Doing so would be opposed to public policy and bring the law into ridicule. It would be wrong to think that while acting under the Income Tax Act, the Income Tax Officer need not look to the law governing the partnership which is seeking registration. It would probably have been a different matter if the Income Tax Act had specifically provided that registration can be granted notwithstanding that the partnership is violative of any other law -- but it does not say so. We may clarify that our holding does not mean that such an illegal partnership cannot be taxed. It is certainly bound to be taxed either as an unregistered partnership firm or as an association of persons. ………” (emphasis supplied) I n Commissioner of Income-tax v. Circar Enterprises[4], originally an individual was carrying on business in liquors, wine and beer after obtaining FL 16 licence from the State Excise Authorities. The licence was, however, exploited by a firm of four partners formed under a partnership deed. The Managing Partner of the firm applied to the licensing authorities for inclusion of three partners in the licence and, accordingly, their names were included in the licence granted by the State Excise authorities. Subsequently, three more persons were added as partners thereby increasing the total number of partners to seven. However the firm of seven partners did not obtain permission, for the inclusion of the three new partners, from the licensing authority to enable inclusion of their names also in the licence granted in Form FL-16. It is in this factual background that the Division Bench of this Court held:- “……… In so far as the State of Andhra Pradesh is concerned, the relevant excise enactment is the Andhra Pradesh Excise Act, 1968 and the rules made thereunder which includes Andhra Pradesh (Foreign Liquor and Indian Liquor) Rules, 1970. Rule 39 of the said Rules makes it clear that inclusion of a person as a partner is prohibited, unless prior approval of the licensing authority is obtained………. Rule 39 of the Rules clearly mandates that approval of the licensing authority is required for inclusion of a person as a partner. Though it is contended on behalf of the assessee- firm that the licensing authority has been intimated on 29-8-81 about the induction of three members as partners, mere intimation is not sufficient and approval of the licensing authority has to be obtained. As the licensing authority, admittedly, has not accorded its approval for the induction of three more partners to the existing four member partnership firm, we are inclined to hold that the seven member partnership firm which was constituted in contravention of Rule 39 of the Rules, is an agreement prohibited by law and has no legal sanctity and it cannot be registered under the Income Tax Act………” (emphasis supplied) Reliance is, however, placed by the counsel for the respondents on the judgment of the Supreme Court in Grand Enterprises, Kerala v. The Commissioner of Income Tax, Kerala[5]. In Grand Enterprises5, the Supreme Court observed:- “……The condition of the licence which the High Court found had been violated in the appellant’s case is condition 13 which reads: “13. Licensee shall not lease out, sell or otherwise transfer his licence without the written consent of the Excise Commissioner.” The settled law is that no registration can be granted to a firm under Section 184(1) of the