HIGH COURT OF KARNATAKA

W.P. No. 18813 of 2013 (T-IT)

MRS. B.V. NAGARATHNA, J.

Venkataraman, A. Shankar and M. Lava for the Petitioner.
E.R. Indra Kumar, E.I. Sanmathi, K.V. Aravind and N. Padmabhushan for the Respondent.

ORDER

The petitioner, a private limited company incorporated under the provisions of the Companies Act, has assailed the Assessment Order dated 28/03/2013 passed by the fourth respondent under sub-section (3) Section 143 of the Income-tax Act, 1961 (hereinafter referred to as "the Act") for the Assessment Year 2010-11 (Annexure-A) as well as the notice of demand for the payment of Rs.21,84,85,240/- (Annexure-B). The explanation to sub-section (2A) of Section 10 of the Act is also challenged on the ground that it is discriminatory and in violation of Articles 14 and 265 of the Constitution insofar it relates to a partnership firm and a further declaration is sought by the petitioner that it is entitled to claim exemption under sub-section (2A) of Section 10 of the Act on its share of profit as partner of the firm income inclusive of the income, which is exempted from tax under sub-section (34) of Sections 10 and sub-section (35) of Section 10 of the Act. In substance, a declaration is sought to the effect that the total income referred in sub-section (2A) of Section 10 of the Act does not include income of the partnership firm which is exempted from tax. Having regard to the aforesaid prayers, the petitioner has filed this writ petition under Articles 226 and 227 of the Constitution.

FACTS:

3. Statement of objection has been filed on behalf of the fourth respondent Assessing Officer contending that sub-section (2A) of Section 10 of the Act clearly and unambiguously provided exemption of only such income which suffered taxation in the hands of the firm. The same cannot be treated as total income as is referred to in the said Section. That sub-section (2A) of Section 10 refers to total income, which means taxable income of the partnership firm and does not include exempted income in the hands of the firm. Defending the validity of the explanation to sub-section (2A) of Section 10 of the Act, it is averred that the explanation only clarifies what is stated in sub-section (2A) of Section 10 of the Act. That the share of a partner in a firm has to be computed by dividing the taxable profits of the firm in the same proportion as the profit sharing ratio mentioned in the partnership firm. According to the Revenue, the income of the partner is exempted from tax only to the extent that the same is subjected to tax in the hands of the partnership firm. But the exempted income in the hands of the firm is not exempted from tax in the hands of the partner. It is contended that the challenge made to the constitutional validity of the explanation to sub-section (2A) of Section 10 of the Act is misplaced. The language of the section speaks of the share in the total income and therefore, the exemption has been accorded to the extent of the share in the total income of the firm as against the share claimed in the book profits. That there is no discrimination or violation of Article 14 of the Constitution. That the 1993 amendment seeks to recognize a partner as a distinct entity from the firm so as to provide a benefit of exemption to the extent of the income that falls within the ambit of the term total income in the hands of the firm. Defending the Assessment Order passed by the fourth respondent in the petitioner's case, it is contended that each of the submissions of the petitioner has been considered and answered and that there is no legitimate reason to invoke the writ jurisdiction of this Court by assailing explanation to sub-section (2A) of Section 10 of the Act. It is stated that as against the impugned Assessment Order and demand notice, petitioner has a remedy by way of an appeal. That there is no jurisdictional issue which has been raised by the petitioner in the matter of the Assessment Order and therefore, filing of the writ petition is wholly unwarranted.

4. That M/s.Prazim Trading & Investment Co. Pvt. Ltd., has disclosed the share of its profit in the partnership firm, in its books of account. But the petitioner, while computing the taxable income, has claimed deduction for the entire amount received as its share of profit invoking sub-section (2A) of Section 10 of the Act as exempted income. The Assessing Authority, therefore, considered as to whether the exemption in terms of sub-section (2A) of Section 10 of the Act is in respect of the share of profit released to the partner on the basis of the book profit of the partners or on the basis of taxable profit computed. That the explanation to sub-section (2A) of Section 10 categorically clarifies that the share of a profit of a partner has to be computed by dividing the taxable profit of the firm in such profit sharing ratio as mentioned in the partnership deed. This would entitle a partner to claim deduction under sub-section (2A) of Section 10 of the Act only on the amount received by the partner out of the taxable profits of the firm on such profit sharing ratio as stipulated in the partnership deed. While contending that there is no ambiguity whatsoever in sub-section (2A) of Section 10 as well as its explanation, it is contended that the object of the said Section is to afford exemption in the hands of the partner only to the extent of income, which suffered tax in the hands of the firm. As a logical corollary, that Section would not allow deduction in respect of income of the firm in the hands of the partner, which has not suffered tax in the hands of the firm.

5. It is also averred that there is no double taxation in relation to income from dividend received from domestic company, mutual funds and income arising from transfer of long term capital asset pertaining to Sections 115-O, 115-R and sub-section (38) of Section 10 of the Act. That the aforesaid provisions provide for relief in the hands of the recipient i.e., the partnership firm in the instant case. But when that amount is transferred to the hands of the partner such as the petitioner herein, it is a share in the profit which is taxable. The partnership firm has not been taxed on the aforesaid sources of income on the principle that the company paying dividend or company dealing with units of mutual fund would have paid taxes or in the case of long term capital gains, the security transaction tax would have been paid. But when that income is distributed to the partners of the firm, the exemption cannot be claimed by the partner. Contending that the assessments are in order and that there is no discrimination as against the petitioner, which has received income as a partner in a firm vis-à-vis an individual who would have received similar income namely, dividend income, income from mutual funds and profits of share transfer, the fourth respondent has sought for disposal of the writ petition.

6. Rejoinder to the statement of objections has been filed by the petitioner by reiterating the petition averments and it is contended that dividend income, income from units of mutual funds and income received on long term capital gains on sale of shares would not be taxable in the hands of the firm as these sources of income namely, dividend income would have been liable to tax under Section 115-O read with sub-section (34) of Section 10 of the Act; in respect of income from units of mutual funds, Section 115-R read with sub-section (35) of Section 10 of the Act and with regard to profits from transfer of shares under sub-section (38) of Section 10 of the Act, the tax is exempted in the hands of the partnership firm. When that amount is distributed to the partners in proportion to their share of profits in the partnership firm, having regard to sub-section (2A) of Section 10 of the Act, no tax is liable to be paid on receipt of such income in the hands of the partner.

CONTENTIONS:
7. I have heard learned Senior Counsel, Sri.Venkataraman alongwith Sri A.Shankar, learned counsel for the petitioner and the learned Senior Counsel, Sri.E.R.Indrakumar and other counsel for the respondents.

8. Pointing out various errors in the interpretation placed by the Assessing Officer in the impugned Assessment Order, it is contended by the learned senior counsel for the petitioner that the Assessment Order is not concluded in terms of the object of sub-section (2A) of Section 10 of the Act. That the benefit of exemption on the aforesaid three sources of income are to be given in the hands of the partner under sub-section (2A) of Section 10 of the Act. That the Assessing Officer has failed to appreciate that income, which is exempted in the hands of the firm also stands exempted in the hands of the partner as profits of the firm after taxation is distributed to the partners of the firm in proportion to their share in the profits of the firm. Referring to various provisions of the Partnership Act, 1932, it was contended that partners are not different from a partnership firm and that a firm is a conglomerate of partners. That a firm is not a separate entity independent of its partners. It is so only for making separate assessments under the Act. Referring to the methodology of assessment prior to 01/04/1993 and subsequent to that date and the changes brought about in the Finance Act, 1992, petitioner's counsel explained as to how sub-section (2A) of Section 10 of the Act would now have to be interpreted, by referring to the expression "total income" appearing in sub-section (2A) of Section 10 of the Act and the definition of total income in sub-section (45) of Section 2 of the Act. On the aforesaid premise, the petitioner sought interpretation of sub-section (2A) of Section 10 of the Act, particularly, the explanation thereto and has also sought for striking down the explanation.

9. Countering the aforesaid arguments, learned Senior Counsel for the respondents with reference to the statement of objections, contended that there is no ambiguity in sub-section (2A) of Section 10 or the Explanation thereto and that the challenge made to the Explanation in this writ petition is wholly unwarranted. That the Explanation only clarifies what is stated in subsection (2A) of Section 10 of the Act. That the share of a partner in a firm has to be computed by dividing the taxable profits of the firm in the same proportion as the profit sharing ratio mentioned in the partnership deed. The income of the partner is exempted from tax only to the extent that the same is subjected to tax in the hands of the partnership firm but the income exempted in the hands of the firm is not exempted in the hands of the partner. Defending the assessment order passed by the fourth respondent it was contended that the submission of the petitioner has been considered and answered by the Assessing Officer. That the partner can claim a deduction under sub-section (2A) of Section 10 only to the amount received by the partner out of the taxable profits of the firm in the profit ratio as stipulated in the partnership deed. No doubt, the dividend income received from a domestic company, mutual funds and income arising from transfer of long term capital asset are not taxable in the hands of the partnership firm but when that amount is transferred as profit to the hands of the partner, it is a share in the profit of the firm, which is taxable. In fact, the firm has not been taxed on the aforesaid sources of income as the party paying that income would have paid the tax and when that income is distributed between the partners of the firm, the exemption cannot be claimed by the partner. He therefore, contended that there is no merit in this writ petition and that the petitioner may be directed to approach the appellate authority.

HISTORICAL PERSPECTIVE:

10. Before considering the rival contentions of the parties, it would be useful to give a historical perspective to the issue raised in this writ petition.

11. Prior to 1-4-1993, Section 182 of the Act dealt with Assessment of registered firms. It prescribed that after assessing income of the firm; (i) the income tax payable by the firm itself would be determined and (ii) the share of each partner in the income of the firm would be included in his total income and assessed to tax accordingly. Under Section 158 of the Act, an order had to be passed determining total income of the firm as well as an apportionment of the income between the partners. Section 67 of the Act prescribed the methodology of partners sharing profits of the firm by stating that the income tax payable by the registered firm had to be deducted from its total income and the balance ascertained and apportioned among the partners while computing the total income of each partner of the firm. Further the total income of the partner included his share in the profits of the firm in addition to interest, salary, commission or other remuneration or payments made to the partner of the firm, other than in the nature of share profit which were deducted in the hands of the firm. In substance, income was taxed at two stages. One in the hands of the firm at a specified rate and the second, after its allocation in the hands of the partners of the firm. Therefore, the income received by the partnership firm was subject to tax in the hands of the firm and subsequently in the hands of the partner on its allocation. But in case of interest, salary, commission or other remuneration paid to the partners of the firm, the same were allowed as deductions in the hands of the firm. But in the hands of the partners it suffered single tax.

12. In the "Budget Speech of Minister of Finance for 1992-93" held on 29-2-1992, reference has been made to Chelliah Committee Report, which stressed that double taxation of the partnership firms as well as the partners should be avoided. It was stated that the partners would not be taxed on their share in the income of the firm though they will be liable to pay tax on salary and interest income derived from the firm. Salary and interest payments made to the partners by the firm would be treated as deduction in the income of the firm. The object was to have simplification from the point of view of tax payers as well as tax administration as the proposed scheme was to do away for complexities, associated with the procedure relating to registration of firms, rectification of partners' assessments when firms' assessments are revised, etc.

Thus, while restructuring the taxation of firms, it was stated that tax payable by the firm is allowed by deduction before the apportionment of profits, and in order to avoid double taxation of the same income in the assessment of the firms and partners. The salient features of the proposed scheme was that the firm was to be taxed as a separate entity. There was to be no distinction between registered and unregistered firms. Also, the share of the partner in the income of the firm was not to be included in computing his total income. Any salary, bonus, commission or remuneration, by whatever name called, which was due to or received by a partner was to be allowed by deduction subject to certain restrictions in the firms total income. The amendment came into effect from 01/04/1993 for the assessment year 1993-94 and subsequent assessment years thereafter.

13. The Finance Act, 1992, thus, brought about a radical change in the assessment of the partnership firm and its partners. The practice of taxation at two stages was done away with. A firm was to be taxed as a separate unit and there was no distinction between a registered firm and an unregistered firm. After deducting the payments made to the partners, the balance income of the firm was taxed in the hands of the firm. Partners were not liable to be taxed in respect of the share of the income of the firm. However, payments made by the firm to the partners such as remuneration, commission, interest etc., were chargeable to income tax in the hands of the respective partners. Thus, the share of the partner in the income of the firm was to be exempted from tax by virtue of insertion of sub-section (2A) of Section 10 of the Act. However, payments made to the partner by the partnership firm such as interest, salary, bonus, commission or other remuneration were liable to be taxed as business income in the hands of the partner having regard to clause (ve) of sub-section (24) of Section 2 and clause (v) of Section 28 of the Act. sub-section (2A) and explanation were also inserted to the Act. The controversy in this writ petition surrounds the explanation to sub-section (2A) of Section 10 of the Act.

Partnership Firm and status of partners in a Firm:
14. Partnership is a relationship resulting from a contract expressed or implied, the partners commercially and legally or collectively referred to as an entity, distinct from its members and with independent rights and obligations. Consequently, where money is due to or from a partner he will be normally shown as a creditor or debtor of the firm and not as a creditor or debtor of his copartner. But legally speaking, the firm is generally not recognized as an entity distinct from the partners comprising it. Also central to an understanding of the law of partnership is the dual capacity in which a partner acts, i.e., both as a principal and an agent.

Referring to Addanki Narayanappa v. Bhaskara Krishnappa AIR 1966 SC 1300, it was held that a partnership firm as only a collective of separate persons and not a legal person in itself, leads 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 firm's profits, no person being his own servant in law since a contract of service postulates two different persons.

Reliance was also placed on CIT v. Ramniklal Kothari [1969] 74 ITR 57 (SC), to hold that business of the firm was business of the partners, that profits of the firm were profits of the partners and that expenditure incurred by partners in earning such share was admissible for deduction in arriving at the total income. In that case, Hon'ble Supreme Court ruled that salary paid to a partner by a firm represents a specific share of the profits and retains the same character of the income of the firm.

Partnership taxation under English Law:
15. In the development of partnership taxation under English law also it is well settled that a partnership generally has no legal status or existence independently of the individual partners of which it is composed. The rights and liabilities of a partnership are nothing more than the aggregate of the rights and liabilities of the individual partners. Therefore, in theory, it is possible to dissect the partnership accounts and make an apportionment of overall expenses and gross receipts amongst the individual partners in order to determine their respective net incomes. But under the Income Tax Act, 1918, it was provided that where a trade was carried on by two or more persons jointly, the tax was to be computed and stated jointly and in one sum and was to be treated as separate and distinct from any other tax chargeable on those persons. These provisions were re-enacted and altered in Section 111 of the Income and Corporation Taxes Act, 1988. But with the introduction of the Finance Act, 1994, the individual assessment of each partner of the firm has been by reference to his share of the partnership profits. Under sub-section (3) of Section 111 of that Act, a person's share or profits or gains or losses of the partnership had to be determined according to the interests of the partners during that period. The approach adopted by the new Section 111 was to treat the partnership as a separate person, but only for the purposes of computing the partnership profits. Once the computation was complete and the share of each partner was determined, he had to be taxed thereon as if that share was derived from a separate trade, profession or business carried on by him. Thus, the income tax law in U.K. also recognizes that partnership is a relationship which subsists between persons carrying on business in common with a view of profit. [Source: Lindley on Banks on Partnership-7th Edition.]

Legal Frame Work:
16. Before considering the respective contentions of the parties, it would be useful to refer to the following relevant provisions of the Act:
'Section 2: Definitions.— In this Act, unless the context otherwise requires,-

(23)(i) "firm" shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include a limited liability partnership as defined in the Limited Liability Partnership Act, 2008 (6 if 2009);

(ii) "partner" shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include:—

(iii) "partnership" shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include a limited liability partnership as defined in the Limited Liability Partnership Act, 2008 (6 of 2009).

Section 2 (24):- "income" includes—

(ve) any sum chargeable to income-tax under clause (v) of section 28;

Section 4: Charge of income-tax— (1) Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with and subject to the provisions (including provisions for the levy of additional income-tax) of, this Act in respect of the total income of the previous year of every person:

Provided that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly.

(2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act.

Section 5: Scope of total income— (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which—

Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section(6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India.

(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which—

Explanation 1.—Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India.

Explanation 2.— For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India.

Chapter III
Section 10 : Incomes not included in total income: — In computing the total income of a previous year of any person, any income falling within any of the following clause shall not be included-

Section 10 (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.

Section 10(34):— any income by way of dividends referred to in section 115-O;
Explanation:— For the removal of doubts, it is hereby declared that the dividend referred to in section 115-O shall not be included in the total income of the assessee, being a Developer or entrepreneur;

Section 10(35):- any income by way of —

Provided that this clause shall not apply to any income arising from transfer of units of the Administrator of the specified undertaking or of the specified company or of a mutual fund, as the case may be.
Explanation— For the purposes of this clause,—

Section 10(38):- any income arising from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund where—

Provided that the income by way of long-term capital gain of a company shall be taken into account in computing the book profit and income- tax payable under section 115JB.
Explanation- For the purposes of this clause, "equity oriented fund" means a fund-

Provided that the percentage of equity shareholding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures.

Section 14:- Save as otherwise provided by this Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following heads of income:-

Section 28:- The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession",—

Section 28(v) any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm:

Provided that where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under clause (b) of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted.'

17. While considering judicial approach to construction of a statute, there are three modern methods namely; (i) the Literal; (ii) by employing the Golden Rule; and (iii) by considering the mischief that the statute was designed to obviate or prevent.

18. While construing a statute in the literal sense, the rule generally followed is that general statutes use words in their popular sense. If they are used in connection with some particular business or trade, they will be presumed to be used in a sense appropriate to or usual in such business or trade. At the same time, it is presumed that words in statutes are used precisely and exactly and not loosely or inexactly. Where the words are plain, their literal and simple meaning is to be adopted. If more than one meaning can fairly be attributed to them, then considerations of policy or even convenience may be admitted. At the same time, the same words may often receive a different interpretation in different parts of the same Act for "words used with reference to one set of circumstances may convey an intention quite different from what the same set of words used with reference to any set of circumstance would or might be produced".

19. If the language of a statute is clear, it must be enforced though the result may seem unfair and inconvenient. The Court cannot cut down the plain words so as to limit the application of the statute in accordance with public policy which prevailed before the statute was passed. At the same time, statutes have to be construed as far as possible to avoid absurdity. This is called the provision against absurdity. The presumption against absurdity is part of the larger principle that statute has to be construed in a manner to give it validity rather than invalidity - ut res magis valeat quam pereat. In the case of possible alternative meanings, one which would lead to an absurdity and one which would avoid it, the rule is that the Court is entitled to look at the results of adopting each of the alternatives respectively, in its quest for the true intention of the Parliament. But when there is no alternative, the Court is bound to construe the words in their natural sense whatever the consequences; the danger of adopting any other course would make that Court into legislators instead of interpreters.

20. The second method of judicial approach to the construction of a statute namely, Golden Rule, states that all statutes must be construed in their grammatical and ordinary sense of the words, unless that would lead to some absurdity or inconsistency with the rest of the instrument, in which case the grammatical and ordinary sense of the words may be modified so as to avoid that absurdity and inconsistency, but no further. This Golden Rule is a corollary to the literal Rule.

21. When, to a judicial mind, words are not plain, then the object and scope of the Act has to be considered. This is popularly known as the Mischief Rule evolved in Heydon's case. Four things have to be considered under this Rule as stated in Heydon's case:- "(1) what was the common law before passing of the Act. (2) what was the mischief and defect for which the common law did not provide. (3) what mischief the Parliament has resolved and appointed to cure the disease of the commonwealth. (4) The true reason of the remedy. The idea is to suppress the mischief and advance the remedy."

22. The aforesaid test implies that a statute is not passed in a vacuum, but in a framework of circumstances, so as to give a remedy for a known state of affairs. In order to arrive at its true meaning, one should know the circumstance with reference to which the words are used and what was the object appearing from those circumstances which Parliament had in view. In carrying out this exercise, Courts have to take judicial notice of the previous state of law and other matters generally known to well informed people. This is done in order to give a construction to statute which is in harmony with an intention. [Source - Odgers' Construction of Deeds and Statutes - Fifth Edition]

23. An explanation is appended to a section to bring out the true meaning of the words contained in the section. It is a part and parcel of the enactment. While construing an explanation, one has to see whether it is in line with the main section, so as to promote the object of that section. Some times, an explanation is added to include something within or to exclude something from the ambit of the main enactment or the connotation of some word occurring in it. An explanation, normally, should be read so as to harmonise with and clear up any ambiguity in the main section and should not be so construed as to widen the ambit of the section. It is also possible that an explanation may have been added in a declaratory form to retrospectively clarify a doubtful point in law and by way of abundant caution.

24. While applying the aforesaid principles, to taxation statutes, it has been observed as under in various decisions of the Hon'ble Supreme Court:-

In R.M. Chindmbaram Pillai (supra) His Lordship Krishna Iyer J., has said that first principles plus the bare text of the statute furnish the best guidelight to understanding the message and meaning of the provisions of law. Thereafter, the sophisticated exercises in precedents and booklore. This should be the approach in the instant case.

25. Sub-Section (45) of Section 2 defines the expression "Total Income" to mean the total amount of income referred to in Section 5 computed in the manner laid down in the Act. Chapter III of the Act deals with incomes which do not form part of total income. The expression "total income" in Section 2(45) has to be examined in the context of the expression "total income" in Chapter III. In Chapter III, incomes which do not form part of total income are enumerated. But in sub-section (45) of Section 2, ' total income' means, the total amount of income referred to in Section 5. Section 5 deals with the scope of total income. Total income has to be computed in the manner laid down in the Act. Chapter IV onwards deals with computation of total income commencing with Section 14. Therefore, Chapter III pertains to such of those incomes, which are outside the scope of computation of total income. Thus, while computing the total income in the context of sub-section (45) of Section 2 such of those incomes stated in Chapter III have to be excluded. In other words, Chapter III pertains to such of those incomes, which are exempt from computation of total income as defined in sub-section (45) of Section 2 of the Act. All these expressions have already been considered in several decisions of this Court as well as by the Hon'ble Supreme Court.

The aforesaid view of this Court is consistent with the decision of the Hon'ble Supreme Court, in CIT v. Williamson Financial Services [2008] 297 ITR 17/[2007] 165 Taxman 638 (SC), while considering the definition of the term ' total income', the Hon'ble Supreme Court held that it involves two ingredients: firstly, the income must consist of the total amount of income referred to in Section 5; and, secondly, it must be computed in the manner laid down in the Income-tax Act. Therefore, the manner of computation laid down in the Income-tax Act forms an integral part of the definition of total income. The correct method of approach is to treat nothing as being charged to tax until by the process laid down by the Act, the status of income, profits and gains emerges. The tax is on income and not on gross receipts. It was further held that agricultural income is not only exempt from tax under the Income-tax Act but the scheme of the Act it is also to be excluded from computation of the total income. Income covered by Sections 10 and 11, which is not chargeable to tax, does not fall under Section 14 and under the various computation sections, Section 15 to Section 59. Exempted income is tax-free income. On the other hand, deduction under Chapter VI-A is for income which forms part of total income but is free of tax.

26. Thus, what emerges from the aforesaid rulings is that, the expression "total income" as defined in sub-section (25) of Section 2 of the Act is distinct from the expression total income used in Section 10 of the Act. Sub-section (45) of Section 2 defines total income in the context of Section 5 and as is computed in the manner laid down in the Act. Once the total income is determined, the tax would have to be paid in accordance with the rate envisaged. But what Section 10 states is that certain incomes do not form part of total income. In fact, the heading of Chapter-III itself states "incomes which do not form part of total income". Thus, the concept of total income has to be interpreted as income which is not includable for the purpose of computation of tax.

27. Keeping in mind the rules of interpretation elaborated above while considering sub-section (2A) of Section 10, along with the decisions discussed above, what surfaces is the fact that the Act intended that certain incomes cannot be included in the gross total income of a person while computing the tax payable thereunder.

28. A perusal of Section 10 of the Income-tax Act would make it clear that the Parliament intended that certain incomes should not be included in the total income of a person i.e., gross total income. Examples are, agricultural income; any sum received by an individual as a member of a Hindu undivided family, where such sum has been paid out of the income of the family and in the case of a person being a partner of a firm, which is separately assessed as share in the total income of the firm. While the expression "total income" in the beginning of Section 10, would refer to total income of a person as computed from Chapter-IV onwards, the expression total income in the heading of the Chapter is quite different. The intention of the Parliament is to exclude income such as agricultural income, income of a coparcener from a Hindu undivided family or income of a partner of a firm from their gross income while computing the persons' total income for the purpose of taxation. In other words, after taking into consideration, the income of a person from all sources to arrive at the gross total income, incomes such as, agricultural income; income received as a individual by an individual as a member of the Hindu undivided family etc., have to be excluded in the same way after considering the total gross income of a partner of the firm from various sources including his share in the profits of the firm and his share in the profits of the firm has to be excluded from the gross total income and from the remaining amount, computation has to be made in accordance with the Act, in order to arrive at the total income of the partner for the purpose of taxation. Thus, the share of a partner of a firm in the total income of the firm is not includable in the gross income of the partner of a firm i.e., whatever amount the partner of a firm receives from the firm as his share of profits would have to be kept aside and not be taken into consideration for the purpose of computing the total income for the purpose of taxation under the Act. The explanation to sub-section (2A) of Section 10 only highlights this aspect. It states that 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 which bears to such profits. It provides that the share of the partner in the total income of the firm would not mean the share of the partner in the taxable income of the firm. The share of the partner in the profits of the firm which is after taxation of the firm, would also include that portion of the income on which the firm would not have paid any tax on account of the firm also having the benefit of certain provisions of Chapter-III but which would nevertheless be part of the profits of the firm. The provision and the explanation under consideration can be better understood if they are related to the facts of the present case.

29. Annexure "E", is the return of income filed by the partnership firm M/s.Prazim Traders. On a perusal of the same, it is noted that income received by way of dividend, income received from mutual funds and profits earned from sale of long term capital assets are excluded from the computation of income of the firm. This is because, while applying Chapter-III to the computation of the income of partnership firm, the firm has the benefit of exemption of income earned by way of dividends referred to Section 115-O, under sub-section (34) of Section 10 of the Act; income arising from transfer of long-term capital asset, being an eligible equity share in a company under sub-section (36) of Section 10 of the Act as well as income arising from the transfer of a long term capital asset being an equitable share in a company or a unit on equity oriented fund referred to in Section 115–R (Mutual Funds) under sub-section (36) of Section 10 of the Act. Therefore, the aforesaid three sources of income which are the subject-matter of the controversy in this case have to be excluded while computing the total income of the firm for the purpose of taxation under the Act. The total income of the firm is Rs.3,73,40,610/- on which tax has been paid by the firm. But the profits of the firm would definitely become income received by way of dividends or from mutual funds or by sale of long term capital assets of shares, on which the firm need not pay tax as it is paid on these heads at source. Therefore, while dividing the profits of the firm between the partners of the firm, the income which is excluded from total income of the firm for the purpose of taxation of the firm would also have to be divided. In the instant case, as the dividends paid by the company, or income derived from mutual funds or from transfer of equity shares are not includable in the income of the firm for the purpose of taxation, but are reflected in the return of income filed by the firm, the firm would not have paid any tax on those amounts but they are nevertheless part of the profits of the firm. While dividing the profits of the firm between the partners, those incomes which are not includable in the income to be considered for the purpose of taxation or exempted incomes, would have to be also divided as profits of the firm. Thus, as discussed earlier, when profits of the firm are divided amongst the partners of the firm, under sub-section (2A) of Section 10 of the Act, such income would not be includable in the total income of the partners of the firm in view of the amendments to the Act and this is with the object of avoiding double taxation.

30. Further, any share of profits derived from a firm by a partner, is not includable in the total income of the partner as it is an exempted income. The underlying reasoning is that the partnership firm would have already reckoned that income for computation of tax under the Act. Therefore, the explanation to sub-section (2A) of Section 10 of the Act must be read in consonance with the above interpretation. The expression total income of a firm in the explanation would not mean taxable income of the firm but gross total income of a firm in which certain incomes would not be assessable to tax or exempted income. But it would nevertheless, form part of the profits of the firm. Therefore, total income of the firm cannot be equated with taxable income of the firm, as contended by the respondents, but, gross total receipts of the firm.

31. The reason as to why the partnership firm would not have paid any tax on the income received by way of dividends or from mutual funds or from sale of equity shares is because the company paying the dividends or income derived from mutual funds or company paying the amounts would have paid the tax on these incomes and the balance amounts are received by the partnership firm. Similarly, when the shares are transferred, tax is paid under the Security Transactions Act [long term capital assets] and the partnership firm in question would not have to pay tax on that amount once again. Thus, when the partnership firm itself would not pay any tax on the aforesaid three sources of income and when that income as profits, is divided between the partners, the partners need not pay tax from their hands. These three sources of income would have already suffered the tax at source. It is because of that reason, the partnership firm in the instant case, when it has received income from those three sources, was not liable to pay any tax on those incomes and when the profits of the firm is divided and paid to the partners, the partners cannot be asked to pay tax on those three sources of income received by the firm. This can be explained further, by an illustration. If a partner in the firm has in his individual capacity and not as a partner invested his funds in companies or mutual funds or transferred shares and earned dividends etc., then also, the partner would not have to pay any tax on the dividends etc., received by him or income derived from mutual funds or profits from long term equity shares. This is because, the income derived from these sources by the partner would have already suffered tax at source.

32. Having regard to the concept of partnership and the status of a partner in a partnership firm which has been explained supra and with the object of avoiding double taxation once at the hands of the firm and subsequently when the profits of the firm are distributed to the partners of the firm, in the hands of the partners, the amendment has been introduced with effect from 01/04/1993 under the Finance Act of 1992. That is why, a partner's share in the income of the firm will not be included in his total income.

33. The Assessing Officer has lost sight of this aspect of the matter and has held that "total income" in the explanation to sub-section (2A) of Section 10 of the Act, is defined in sub-section (45) of Section 2 of the Act, means the total amount of income referred to in Section 5, computed in the manner laid down in the Act. The Assessing Officer was also not right in holding that subsequent to the amendment, there are two distinct entities, one being the firm and the other being the partners of the firm, who are sought to be taxed separately on distinct incomes at different rates with diverse deductions. He is also not right in stating that the whole entity of the firm is delinked from that of a partner while introducing the provisions of sub-section (2A) of Section 10 of the Act.

34. It is reiterated that the object of sub-section (2A) of Section 10 is to avoid double taxation vis-à-vis, the profits of the firm, which is distributed in the hands of the partners. It does not mean that income which is taxed in the hands of the firm is taxable in the hands of the partners and on the same principle, when the income is not taxed in the hands of the firm, it becomes taxable in the hands of the partner. The Assessing Officer is also not right in holding that the incomes which are excluded from the total income of the firm by operation of various clauses of Section 10 and which form part of the share of profits of the firm would have to be taxed in the hands of the partners, as only income which is taxed in the hands of the firm is exempted from tax in the hands of the partner. The Assessing Officer has focused his attention on income that is subjected to tax in the hands of the firm rather than income which is excludable from total income in the hands of the partner but which is a share in the profits of the firm. The Assessing Officer has given a literal interpretation to the explanation to sub-section (2A) of Section 10 of the Act, which is contrary to the object of the amendment made to Section 10 of the Act. However, having regard to the principles of statutory interpretation culled out supra, from precedents, it is abundantly clear that a reasonable construction of a taxing statute ought to be preferred over a literal construction, if the latter defeats the manifest purpose and object of the statute. Such a reasonable construction of the explanation to sub-section (2A) of Section 10 with respect to its placement in Chapter III, does not envisage taxation of the shares of profits of the firm at the hands of the partners.

35. The Assessing Officer has lost sight of the fact that insofar as the three sources of income of the firm under consideration which are not includable in the total income of the firm, as they have already suffered tax at source i.e., before the receipt of income by the partnership firm, they cannot be liable to be taxed once again as profits of the firm distributed to the partners in the hands of the partner. The Assessing Officer is also not right in holding that income which remains exempted in the hands of the firm would become taxable in the hands of the partner in view of sub-section (2A) of Section 10 of the Act. The flaw in the reasoning of the Assessing Officer can be better understood in light of sub-section (v) of Section 28, which says that any interest, salary, bonus, commission or remuneration etc., by whatever name called, due to, or received by, a partner of a firm from such firm shall be income chargeable to Income-tax under the head "Profits and gains of business or Profession". Thus, if a partner of a firm receives any interest, salary, bonus, commission or remuneration etc., from a firm that income in the hands of the partner is chargeable to tax, sub-section (v) of Section 28 does not include the share of a partner in the total income of the firm, which is the profit of the firm. Infact, sub-section (v) to Section 28 of the Act was inserted with effect from 01/04/1993 precisely because of the amendment made to Section 10 of the Act by inserting sub-section (2A) and explanation thereof. Therefore, the Parliament has clearly made a distinction between certain incomes received by a partner from the firm and profits which are received by a partner from the firm. This is because the partners are not distinct from the firm though they may be distinct from the point of view of taxation. But in law, a partnership is a collective name of partners and the firm cannot be recognized as an entity distinct from the partners comprising it.

36. The analogy of a partner to partnership firm is found in a coparcener in relation to Hindu undivided family. Hindu undivided family is separately assessed to tax under the Act. Any sum received by a coparcener by an individual member of a Hindu undivided family where the income is paid out of the income of the family is not to be taxed once again in the hands of the individual member, otherwise, it would amount to double taxation.

37. Therefore, the explanation would not call for any striking down in the hands of this Court. The explanation has to be interpreted in light of the aforesaid discussion. It cannot be given a literal interpretation, so as to defeat the object of the amendment made to the Act. The object of the amendment is to make it clear that the distribution of profits and gains of a firm in the hands of the individual partners shall not be considered to be income of the partners and therefore, not includable while computing the total income of the partner under the Act. Such interpretation is also in line with the decisions of this Court as well as Delhi High Court and the Hon'ble Supreme Court.

38. Therefore, if the aforesaid precedents are to apply, then the share of a partner in the total income of a firm has to be excluded before arriving at the gross total income of the partner. While computing the profits of a partner of the firm, the share of a partner in the total income has to be excluded from the gross total itself and not in the total income of the partner as understood in sub-section (45) of Section 2 of the Act. Hence, the income eligible under sub-section (2A) of Section 10 would not enter into computation as the same is exempted income just as agricultural income or income received by an individual as a member of Hindu undivided family is exempted from computation of total income under sub section (45) of Section 2 of the Act.

39. Learned Senior Counsel for the petitioner has pressed into service Article 14 of the Constitution, to contend that there is discrimination between a partner of a firm and an individual, who receives income from dividends or mutual funds or by sale of equity shares; that the partner of the firm by the interpretation given by the Assessing Officer would be liable to pay tax on these sources of income once again; whereas, an individual who has received such income is not liable to pay tax again. That contention would now not arise in the instant case, having regard to the interpretation given to the explanation to sub-section (2A) of Section 10 of the Act. Therefore, reliance placed on K.T.Moopil Nair v. State of Kerala AIR 1961 SC 552, would not be of any assistance in this regard. Thus, what sub-section (2A) of Section 10 r/w explanation thereof envisages is the amount to be determined as not includable in the total income of the partner. For this, three factors have to be considered:—

In this context, the total income of the firm is not the taxable income of the firm. The total income from business of the firm is Rs.1,63,65,79,390/-. In the instant case, the formula has to be applied to determine the eligible amount, which is as follows:—

Eligible amount = Total income of the firm × Share profit of the firm ÷ profits of the firm, which is:-
Rs.1,63,65,79,390 × 48,39,31,164 ÷ 1,61,31,03,881

and eligible amount is Rs.49,09,73,817, which has to be exempted under sub-section (2A) of Section 10 of the Act. The aforesaid calculation has been submitted by the Revenue in its written submissions as approximate figures.

40. In the result, the appeal is allowed in part in the following terms :—