Case: Commissioner of Income Tax, Madras Vs. R.M. Chidambaram Pillai Etc

Two tea estates were owned by two firms with several partners, two of whom were the respondents, in the two sets of appeals, C.As. 17 to 19 and C. As. 20 & 21 of 1972. The tea sold yielded income composite in character, being largely agricultural and partly non-agricultural. The complex situation of apportionment between the two heads for purposes of income-tax has been taken care of by rule 24 of the Income-tax Rules, both the firms having been registered under the Act3. The respondents-partners were, in addition to their share in profits, entitled to salaries for services under the firms. The sole controversy turns on whether the sums so drawn as salaries were wholly liable to income-tax or only to the extent of 40% thereof which fell within the non-agricultural sector. Until the assessment year ending with M arch 31, 1959, the income-tax was so assessed that the whole of the agricultural income i.e., 60% of the total income, was out of bounds for income-tax (which included 60% of the salaries of the respondent partners). But, for the years 1959/60 and 1960/61, the two assessment years involved in these appeals, a different course was followed. The mechanics is simple but the bone of contention between the Revenue and the assessees is as to whether any portion of the salaries so drawn for services rendered are at all agricultural income to be non-exigible to income-tax.Departing from the previous practice and in the prescient light of the law later laid down in Mathew Abraham(51 I.T.R. 467.), the whole salary was subjected by the Income-tax Officer to income-tax as income from other sources in terms of s. 10 [The Income-tax Officer had almost anticipated Mathew Abraham (51 I.T.R. 467.)]. This computation was contested successfully before the Appellate Assistant Commissioner but that decision suffered a reversal before the Appellate Tribunal since, by then, Mathew Abraham (supra) had be en decided in favour of the Revenue. The case escalated to the High Court where a full Bench upset the earlier view and upheld the exclusionary argument of the assessees.

Court's reasoning:
There is plausibility in both approaches but, after some reflection on the scheme as expressed in the statutory text, we are disposed to affirm the decision under appeal. If the intendment of a legislation misfires in court, competency being granted, the answer is amendment, not more litigation.Here the first thing that we must grasp is that a firm is not a legal person even though it has some attributes of personality. Partnership is a certain relation between persons, the product of agreement to share the profits of a business. Firm  is a collective noun. a compendious expression to designate an entity, not a person. in income-tax law a firm is a unit of assessment, by special provisions, but is not a full person; which leads to the next step that since a contract of employment requires two distinct persons, viz., the employer and the employee, there cannot be a contract of service, in strict law, between a firm and one of its partners. So that any agreement for remuneration of a partner for taking part in the conduct of the business must be regarded as portion of the profits being made over as a reward for the human capital brought in. Section 13 of the Partnership Ac t brings into focus this basis of partnership business.This legal ideology expresses itself in the Income-tax Act in s. 10 (4) (b) and s. 16 (1) (b). A firm, partner and partnership, according to s. 2(6B) of the Act bear the same sense as in the Partnership Act. The taxable income of a firm has to be its business profits, as provided in s. 10(1), 10(2)and 10(4).On principle, payment of salary to a partner represents a special share of the profits and is therefore part of the profits and taxable as such. And s. 10(4) (b) stipulates accordingly.The anatomy of the provision is obvious, even if the explanation or motivation for it may be more than one. It is implicit that the share income of the partner takes in his salary. The telling test-is that where a firm suffers loss the salaried partners share in it goes to depress his share of income. Surely, therefore, salary is a different label for profits, in the context of a partners remuneration.Maybe, we may usefully read here s. 10(1) and 10(4) to the extent relevant5. Salaries are profits known by a different name and must be treated as such for taxation purposes. The portion of profits from tea sales, by a grower, which is agricultural, is insulated from incidence and exaction by the Constitution worked out through r. 24. Which means that by that modus operandi we set aside 60% of the total income as representing the agricultural sector, and the salary to partners paid out of it, being only profits , enjoys the same invulnerability to exigibility that r. 24 admittedly confers on the agrarian portion.Shri Ahuja has an attractive counter-theory which merits disturbing attention. It is a variant version of th e ratio in Mathew Abraham (supra). He took us along a different street with plausible insights. Ordinarily, salary for services to an employer is salary all the same and there is no agricultural salary as such. Therefore, the item is taxable as salary income under s. 10. The mere fact that its ultimate source was agricultural will not make its current complexion agricultural income, because the payment was receive d not as part of his profit from agricultural property but as remuneration due to him for work done as employee. The source does not leave an indelible stamp on the stream or its tributaries. The nature of the income being salary, taxability is inevitable. Section 10(4)(b) is a special provision; so also s. 16(1)(b). The Parliament has power to provide for possible leakages and safeguard against loss of revenue. Oftentimes partners siphon off substantial profits in the guise of salaries and so arrange such distribution of income via salaries that tax evasion becomes legally protected. To pre-empt such possibility the law has gone out o f its way to exclude manipulation by including salaries as profits. This special provision cannot alter the nature of salaries as is obvious in commercial calculations, . striking of balance sheets, in suing for unpaid salaries and the like. Moreover, Indian law does recognise a firm as a person for many purposes and the contrary tenor of English law has no tenability in our country. The very need for s. 10(4)(b) and 16(1)( b) stresses that otherwise salary will retain its true character and not be regarded as profits. The other categories in both these sections also bring home the purpose to be to prevent evasion, not to inject jurisprudential changes. Both sides are armed cap a pie with rulings for their respective positions. The weaponry in forensic battle is precedentry; also their profusion is fraught with confusion for the laity in the law. We will deal with citations presently but going by basics we feel that albeit the forceful plea of Shri Ahuja, the Revenue is in the wrong.Plainly, only 40% of the income from tea sales is treat- ed as taxable. The balance viz. , 60% is regarded as agricultural and exempt. 60% of the salaries to partners comes out of his exempted gross sum and shares the benefit. (Of course, this may be exigible, by the same token, to agricultural income-tax, if there be any). The core of the logic and failure to grasp this has faulted the reasoning in Mathew Abraham((1964) 51 I.T.R. 467.) is that the true character of the salary (Le., . the impugned 60%) is the same as that of the profits. Both are agricultural and thus it is clear that the amount does not escape tax if the State has and now it has a levy on agricultural income but the title of the State to tax this sum is valid, not of the Union.The whole project of taxation of tea plantations is disclosed in r. 24, Chidambaram Pillai([1970] 77 I T R. 494, 503) explains it and we unfold it by reading here a relevant portion:Income derived from the sale of tea grown and manufactured by the seller in the taxable territories shall be computed as if it were income derived from business, and 40 per cent of such income shall be deemed to be income, profits and gains liable to tax.Under s. 3 of the Partnership Act it is not a person, but a relationship among persons.The Indian law of partnership is substantially the same and the reference in counsels submissions to the Scottish view of a firm being a legal entity is neither here nor there. Primarily our study must zero on the Indian Partner- ship Act and not borrow courage from foreign systems.e life of the Indian law of partnership depends on its own terms although habitually courts, as a hangover of the past, have been referring to the English law on the point. The matter is concluded by the further observations of this Court:t is clear from the foregoing discussion that the law, English as well as Indian, has, for some specific purposes, some of which are referred to above, relaxed its rigid notions and extended a limited personality to a firm. Nevertheless, the general concept of a partnership, firmly established in both systems of law, still is that a 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. In other words, a firm name is merely an expression, only a compendious mode of designating the persons who have agreed to carry on business in partnership. According to the principles of English jurisprudence, which we have adopted, for the purposes of determining legal rights there is no such thing as a firm known to the law as was said by James L.J., in Ex parte Corbett: In re Shand (1880) 14 Ch. D. 122, 1.26). In these circumstances to import the definition of the word person occurring in section 3(42) ofthe General Clauses Act,, into section 4 of the Indian Partnership Act will, ac cording to lawyers, English or Indian, be totally repugnant to the subject of partnership law as they know and understand it to be.In Narayanappa(A./.R. 1966 S.C. 1300, 1303.) the view taken by this Court accords with the position above stated6. The necessary inference from the premise that a partner- ship is only a collective of separate-persons and not a legal person in itself lends to the further conclusion that the salary stipulated to be paid to a partner from the firm is in reality a mode of division of the firms profits, no person being his own Servant in law since a contract of service postulates two different persons.In an early Madras case Commissioner of Income-tax v. B. S. Mines((1922) 1 I.T.C. 176, i77 (F.B.).) the Madras High Court had held, with reference to the 1918 Income-tax Act: We have no hesitation in answering that the drawings of the partners, by whatever name they are described, are part of the profits and therefore taxable, the question raised being one with reference to the character of salaries paid to partnersOther cases from other High Courts have , been brought to our notice but strong reliance was placed on Ramniklal Kothari((1969) 74 I.T.R-57 (S.C.).) of this Court for reaching the conclusion that the business of a firm was business of the partners , that the profits of the firm were profits of the partners and that the expenditure incurred by partners in earning such share was admissible for deduction in arriving at the total income under s. 10(1).7. Contrary views are not wanting in some rulings, but a catalogue of cases on the other side may be productive Of confusion and not resolution of conflict. We abstain from that enterprise and confine ourselves to the statement of the law that although, for, purposes of the Income-tax Act, a firm has certain attributes simulative of personality, we have to take it that a partnership is not a person but a plurality of persons.Coming to basics over again, this Court, in Karimtharuvi Tea Estates([1963] Supp. I, S.C.R. 823.) and in Anglo-American Direct Tea Trading Co.((1968) 69 I.T.R. 667, 672.) has set out the nature of and manner of assessment of composite income-tax derived by the sale of tea:In Karimtharuvi Tea Estates Ltd. v. State of Kerala this Court held that Explanation 2 to section 5 of the Kerala Agricultural Income-tax Act added in 1961 disallowing certain deductions in the computation of agricultural income did not apply to computation of agricultural income derived from tea plantations. The reasons for this conclusion may be summarised thus: The definition of agricultural income in the Constitution and the Indian Income-tax Act, 1922, is bound up with rule 24 of the Income Tax Rules, 1922. Income derived from the sale of tea grown and manufactured by the seller is to be computed under rule 24 a s if it were income derived from business in accordance with the provisions of section 10 of the Indian Income-tax Act. The Explanation to section 2(a)(2) of the Kerala Act adopts this rule of computation. Of the income so computed, 40 per coat, is to be treated as income liable to income-tax and the other 60 per cent only is deemed to be agricultural income within the meaning of that expression in the Income-tax Act. The power of the Stat e legislature to make a law in respect of taxes on agricultural income arising from tea plantations is limited to legislating with respect to agricultural income so determined. The legislature cannot add to the amount of the agricultural income so determined by disallowing any item of deductions allowable under rule 24 read with section 10(2) (xv) of the Indian Income-tax Act. Explanation 2 to section 5 of the Kerala Act if applied to income from tea plantations would create an agricultural income which is not contemplated by the Income-tax Act and the Constitution and would be void, and it should therefore be construed not to apply to the computation of income from tea plantations.n Tea Estate India((1976) 103 I.T.R. 785, 795.) this Court summarised the scope and implications of r. 24:Income which is realised by sale of tea by a tea company which grows tea on its land and thereafter subjects it to manufacturing process in its factory is an integrated income. Such income consists of two elements or components. One element or component consists of the agricultural income which is yielded in the form of green leaves purely by t he land over which tea plants are grown. The second element or component consists of non- agricultural income which is the result of subjecting green leaves which are plucked from the tea plants grown on the land to a particular manufacturing process in the factory of the tea company. Rule 24 prescribes the formula which should b e adopted for apportioning the income realised as a result of the sale of tea after it is grown and subjected to the manufacturing process in the factory. Sixty per cent is taken to be agricultural income and the same consists of the first element or component, while 40 per cent represents non-agricultural income and the same comprises the second element or component.We are fortified in the above conclusion by two decisions of this Court in the cases of Karimtharuvi Tea Estate Ltd. v. State of Kerala (supra) and Anglo-American Direct Tea Trading Co. Ltd. v. Commissioner of Agricultural Income tax (supra). In the case of Karimtharuvi Tea Estates Ltd. (supra) it was observed while dealing with the income derived from the sale of tea grown and manufactured by the seller in the context of rule 24:Of the income so computed, 40 per cent is, under rule 24, to be treated as income liable to income-tax and it would follow that the other 60 per cent only will be deemed to be agricultural income within the meaning of that expression in the Income-tax Act.In the case of Anglo-American Direct Tea Trading Co. Ltd. (supra) the Constitution Bench of this court held that income from the sale of tea grown and manufactured by the assessee is derived partly from business and partly from agriculture. This income has to be computed as if it were income from business under the Central Income-tax Act and the Rules made thereunder. Forty per cent of the income so computed is deemed to be income derived from business and assessable to non- agricultural income-tax. The balance of 60 per cent of the income so computed is agricultural income within the meaning of the Central Income-tax Act.t follows that by statutory dichotomy, 60% of the tea income is agricultural in character and central income-tax cannot break into its inviolability. This conceded, the flexible arrangement among partners regarding distribution of this sum may take many forms but the essential agricultural character and consequential legislative immunity cannot be lost because of tags and labels: That which we call a rose, By any other name would smell as sweet. Needless to say, the position is different if the situation.-is of a stranger not a partner drawing a salary.8. With ideological clarity, this legal position has been set forth by a learned author whom we refer(Law of Income-tax by A.C. Sampath Iyengar, 6th Edn., 1973 pp. 10631064 (Vol. II).) to (by no means, rely on) compendious as his summary is:Any interest, salary, bonus, commission or remuneration paid by a firm to any of its partners cannot be deducted by the firm as an expenditure in its profit-computation. The reason is this: The partners in a firm are ultimately entitled to the entire profits of the firm, according to their shares in the business. Therefore, the entirety of such profits should be brought to charge and no portion be exempted by giving the same away to a partner as his salary, bonus, commission, remuneration or interest. A partner is bound to find the necessary finances for the partnership and hence any interest on capital supplied by the partner is not deductible. A partners rendering services to the firm stands on the same footing as his providing capital; only instead of in money, in kind. Further, no remuneration is permissible to a partner for his rendering services to the firm, since the carrying on of the business of the partnership is a primary duty which, all the partners, or some of the partners acting for all, are required to do by the law relating to partnership.The matter may be looked at another way too. In law, a partner cannot be employed by his firm, for a man cannot be his own employer. A contract can only be bilateral and the same person cannot be a party on both sides, particularly in a contract of personal employment. A supposition that a partner is employed by the firm would involve that the employee must be looked upon as occupying the position of one of his own employers, which is legally impossible. Consequently, when an arrangement is made by which a partner works and receives sums as wages for services rendered, the agreement should in truth be regarded as a mode of adjusting the amount that must be taken to have been contributed to the partnerships assets by a partner who has made what is really a contribution in kind, in stead of contribution in money. Hence, all the aforesaid payments are non-deductible.e contrary view favoured by Mathew (supra) proceeds on the following reasoning:h for purposes of computation of income his share income of the firm is clubbed along with the allowance and commission, it is obvious that the character of the receipt of the latter amounts, though related to the business, cannot be said to partake of the same character of their receipt by the firm. The assessee who is a managing partner was entitled to receive the amount not by virtue of the relationship between him and the other members of the firm as partners but by virtue of the special agreement between the partners by which his services to the partnership were agreed to be remunerated. (p. 471)9. We regard this conclusion as unsound, the source of the error being a failure to appreciate that the salary of a partner is but an alias for the return, by way of profits, for the human capital sweat, skill and toil are, in our socialist republic, productive investment he has brought in for common benefit. The immediate reason for payment of salary was service contract but the causa causans is partnership.When this Court, as the apex adjudicator declaring the law for the country and invested with constitutional credentials under Art. 141, clarifies a confused juridical situation, its substantial role is of legal mentor of the nation. Such is the spirit of the ruling in Trustees of Port, Bombay ([1974] 4 S.C.C 710). If parties have been fair, the costs of the litigation must come out of the national exchequer, not out of as partys purse