Legal concept of association of persons

Written by HP Ranina | Updated: Oct 12 2008, 07:24am hrs
Section 4 is the charging section under the Income Tax Act, 1961, and it imposes a tax on the income earned by a person in the previous year. Person has been defined in section 2(31) of the Act to include an association of persons or a body of individuals, whether incorporated or not.

For the purpose of this clause, an association of persons, or a body of individuals or a local authority, or an artificial juridical person, shall be deemed to be a person whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, or profits, or gains.

As legislative history bears, there has been an amendment in section 2(31); inasmuch as prior to 1939, the phrase used in the 1922 Act was association of individuals. The amendment seems to have been made to remove any doubt as to the assessibility as a taxable unit of an association of which the members might not, strictly speaking, be called individuals. The phrase association of persons is of very comprehensive import. Under section 3(42) of the General Clauses Act, person includes any company or association or body of individuals, whether incorporated or not.

Therefore, an association of persons (AOP) may have as its members, companies, firms, joint families and associations (MMIpoh vCIT (67 ITR 106)). Evidently, the companies entering into a joint venture can also be an assessable unit as an AOP, as held in Ganga Metal Refining CoPte Ltd vCIT (67 ITR 771). In various judicial pronouncements, the courts have enunciated the essential ingredients, which constitute an AOP. In fact, the words association of persons have not been used in any technical sense but have to be construed in their plain ordinary meaning.

Analysing its plain ordinary meaning, the Supreme Court observed in the case of CIT vIndiraBalkrishna (39 ITR 546) that the word 'associate' means according to the 'Oxford Dictionary', to join in common purpose, or to join in an action'. Therefore, an 'association of persons', must be one in which two or more persons join in a common purpose or common action, and as the words occur in a section, which imposes a tax on income, the association must be one the object of which is to produce income, profits or gains.

The Andhra Pradesh High Court, after considering previous decisions has, in the case of Deccan Wine and General Stores vCIT (106 ITR 111), laid down the principles governing an AOP by stating that it is clear that an association of persons does not mean any and every combination of persons; it is only when they associate themselves in income-producing activity that they become an association of persons.

They must combine to engage in such an activity, the engagement must be pursuant to the combined will of the persons constituting the association. There must be a meeting of the minds, so to speak. In a nutshell, there must be a common design to produce income, if there is no common design, there is no association. Common interest is not enough. Production of income is not enough.

The explanation inserted in clause (31) to section 2 of the Act with effect from April 1, 2002, provides that an association of persons will be deemed to be a person whether or not it is formed with the object of deriving income. In other words, it is not essential that an AOP should necessarily produce income.

The crystallised judicial view is that the following essentials of an association of persons must exist:

(i) Two or more persons;

(ii) Voluntary combinations;

(iii) A common purpose or common action with object to produce profit or gains. However, the object to produce profit or gains is no longer a sine qua non with the explanation as discussed above;

(iv) Combination in joint enterprise; and

(v) Some kind of scheme for common management.

The term association of persons is not a term of art (vide GMurugesanand Bros vCIT [1973] 88 ITR 432 (SC). It has to be understood in its ordinary sense. The Supreme Court referred to the apt observations of Costello J in his separate but concurrent opinion in BN Elias. In re (3 ITR 408). The Supreme Court remarked that Costello J put the test in more forceful language. The Court stated that, although these four persons did not constitute a body which was the same as partnership, it was in many respects similar to a partnership and was approximate to a partnership and if may well be that the intention of the legislature was to hit combinations of individuals who were engaged together in some joint enterprise but did not in law constitute partnerships. The following passage from the decision of the Supreme Court inNV Shanmugham and Co v CIT (81 ITR 310) is also apposite:

The control and management of business, which was in the hands of the receivers was a unified one. The receivers had joined in a common purpose and they acted jointly. The profits were earned on behalf of the persons who had a common interest created by the order of the court and were on that account an association of persons. The existence of specific defined interest in the profits did not make the earning any the less of an 'association of persons. Liability to tax depends upon the earning of profits by a unit and not upon the ultimate division of the profits.

The dicta in the case of Deccan Wine and General Stores vCIT (106 ITR 111) are very instructive. Chinnappa Reddy J, speaking for the Andhra Pradesh High Court, brought forth the distinction between an AOP and a body of individuals by stating that an association of persons does not mean any and every combination of persons.

It is only when they associate themselves in an income-producing activity that they become an association of persons. They must combine to engage in such an activity; the engagement must be pursuant to the combined will of the persons constituting the association; there must be a meeting of the minds, so to speak. In a nutshell, there must be a common design to produce income. If there is no common design, there is no association. Common interest is not enough. Production of income is not enough. When the word 'association' is replaced by the word 'body', it must follow that the feature of common design or combined will, so peculiar or distinctive to an association of persons, is not a characteristic of a body of individuals.

The author is advocate, Supreme Court