Commissioner Of Income-Tax v. P.H Patel.

Y.V Anjaneyulu, J.:— Pursuant to the directions of this court under section 256(2) of the Income-tax Act, 1961 (hereinafter referred to as “the Act”), the Tribunal referred four questions of law for the consideration of this court. They are as under:

“(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that there was dissolution of the firm on the date when the assessee retired?

(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the description given as on account of revaluation of assets was wrong and that the receipt of Rs. 90,000 was on account of goodwill?

(3) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is justified in holding that the amount of Rs. 90,000 should not be related to the share of future profits receivable by the assessee?

(4) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that an amount of Rs. 90,000 was not liable for capital gains tax?”

2. The assessee was a partner of the partnership firm known as M/s. Patel Desai and Company. Apart from the assessee, there were two other partners. On January 19, 1973, the assessee gave notice to the other partners indicating his intention to retire from the partnership. Accordingly, the assessee retired from the partnership. At the time of his retirement, his account in the partnership books showed a debit balance of Rs. 1,04,940.49. Obviously, the assessee had overdrawn his account. It may be mentioned that the aforesaid debit balance was arrived at after crediting to his account his share of profits till the date of retirement on January 19, 1973. It appears, the share of profit was ascertained as Rs. 14,879 and credited to his account. On January 22, 1973, an indenture was drawn, described as a deed of dissolution. The deed was executed by the assessee described as the retiring partner on the one hand, and the remaining two partners described as the continuing partners on the other. The deed sets out that the assessee expressed his desire to retire from the partnership business and the continuing partners expressed their willingness to the retirement of the assessee from the partnership. The deed also records that one Mrs. Tarulatha Modi of Secunderabad agreed to join the partnership firm as partner. It proceeded to state that a sum of Rs. 90,000 was agreed to be credited to the account of the assessee towards his share in the goodwill of the partnership firm. On these facts, the questions that arose for consideration are: (i) whether there was a dissolution of the partnership firm on January 19, 1973, as was specified in the deed of dissolution dated January 22, 1973; (ii) whether the sum of Rs. 90,000 credited to the assessee's account by way of his share in goodwill is liable to be taxed as income; and (iii) whether the sum of Rs. 90,000 is, in any event, liable to be taxed in the hands of the assessee as capital gain.

3. The Income-tax Officer did not find any difficulty in coming to the conclusion that the sum of Rs. 90,000 credited to the account of the assessee was not liable to be assessed as income. He was, however, of the opinion that the capital gain arising from the credit of Rs. 90,000 was liable to be taxed. He accordingly determined the capital gain liable for assessment at Rs. 42,500 after giving appropriate deductions under section 80T of the Act.

4. The assessee filed an appeal against the aforesaid assessment before the Appellate Assistant Commissioner of Income-tax. The Appellate Assistant Commissioner held that the receipt of Rs. 90,000 by the assessee in fact represented the future profits which the assessee would, in the normal course, have received had he continued to be a partner in respect of the outstanding contracts and also the profits realisable on the sale of closing stock. In that view of the matter, the Appellate Assistant Commissioner held that the amount of Rs. 90,000 was taxable in the assessee's hands as future profits receivable. Alternatively, the Appellate Assistant Commissioner also held that the said amount of Rs. 90,000 could be considered as the sale price of the assessee's interest in the partnership firm. In that view, the amount was liable to be considered for purposes of tax as capital gain in the assessee's hands.

5. The assessee filed an appeal before the Income-tax Appellate Tribunal against the abovementioned decision of the Appellate Assistant Commissioner and contended that the sum in question was not liable to be taxed as income and cannot also be considered for the purpose of ascertaining any capital gain allegedly involved in the transaction. The Income-tax Appellate Tribunal accepted both the contentions of the assessee and held that the Appellate Assistant Commissioner erred in coming to the conclusion that the sum of Rs. 90,000 represents future profits taxable in the assessee's hands as income. The Tribunal also held that there was no transfer of the assessee's interest according to law and consesequently no capital gain was liable to be assessed in the assessee's hands.

6. The Commissioner of Income-tax applied under section 256(1) for a reference to this court and sought reference of the four questions of law set out above in paragraph 1. On the Tribunal declining to refer the questions to this court, the Commissioner moved this court under section 256(2) of the Act and a direction was then given to the Tribunal to refer the said questions. That is how the present reference is before us.

7. Taking up the first question, the controversy appears to be whether there is a dissolution of the partnership on January 19, 1973, or there was merely a change in the constitution of the partnership by the assessee retiring from the partnership. As far as we can see, the controversy on this question does not have any reflection on the question of assessability of the sum of Rs. 90,000 in the assessee's hands. Even so, since the question has been referred to us, we have considered the facts and looked into the document dated January 22, 1973. In the first place, it was clear that the assessee did not give any notice conveying his intention to dissolve the partnership under section 43 of the Partnership Act, as was inadvertently mentioned by the Tribunal in its order. The notice given was to the effect that the assessee would like to retire from the partnership. Thus, the notice given by the assessee did not seek to bring about any dissolution of the partnership firm. Although the document executed on January 22, 1973, describes it as a deed of dissolution, we may mention that the recitals in the document do not support the description of the document. The description of a document, in any particular manner, is not decisive of the real character of that document. The true and real character of a document will have to be determined on the basis of the contents of the document itself. It is not, therefore, necessary to be misled by the description given to the document as one of a deed of dissolution. The recitals in the document clearly indicate that the assessee desired to retire from the partnership, gave a notice to that effect, the remaining partners agreed to the assessee's retirement, and a change in the constitution was accordingly brought about. Thus, what happened on January 19, 1973, was only a change in the constitution of the firm and no dissolution had taken place. The Tribunal's view that there was dissolution of the partnership firm is not supportable either on facts or on law. We accordingly hold that there was no dissolution of the partnership firm when the assessee retired from the partnership and the decision to the contrary by the Appellate Tribunal was erroneous. The first question is accordingly answered in the negative.

8. Questions Nos. (2), (3) and (4) can be considered together. Learned standing counsel for the Revenue, Sri M. Suryanarayana Murthy, endeavoured to persuade us that the sum of Rs. 90,000 was liable to be taxed in the assessee's hands as income attributable to the future profits. Learned standing counsel adopted the reasoning of the Appellate Assistant Commissioner for this purpose. We may mention that it was not the Income-tax Officer's case when the assessment was made that the sum of Rs. 90,000 represented future profits to which the assessee would have been entitled had he continued to remain a partner. That view was taken only for the first time by the Appellate Assistant Commissioner referring to certain outstanding contracts of the partnership firm at the time of retirement of the assessee and to the possibility of profit being derived on the sale of closing stock. The Tribunal dealt with this question at considerable length and demonstrated that there was no possibility of the sum of Rs. 90,000 representing the assessee's share of future profits. Indeed, neither the entries made in the account books nor the recitals in the documents would support any such conclusion. The Tribunal pointed out, in our opinion rightly, that there can be no assumption of profit being realised in the course of transactions at a future date. A business may conceivably result in suffering losses also. This apart, the Tribunal had referred to the particulars of outstanding contracts, etc., at the time of the assessee's retirement and demonstrated that there was no possibility of describing the sum of Rs. 90,000 as the assessee's share in the future profits realisable by the partnership firm in respect of the contracts outstanding at the time of the assessee's retirement and on the sale of the closing stock. Having gone through the factual basis furnished by the Tribunal in the order, we have no hesitation in upholding the view of the Tribunal in this regard and in rejecting the Revenue's contention that the sum of Rs. 90,000 could represent the assessee's share of future profits.

9. That leaves us with the question whether any liability to capital gain exists in so far as the sum of Rs. 90,000 credited to the assessee's account is concerned. Learned standing counsel invited our attention to the so-called deed of dissolution and pointed out that the real effect of the averments contained in the document is that the assessee had transferred his partnership interest, in favour of the continuing partners and such a transfer gave rise to capital gain. We need not deal with this argument of learned standing counsel in detail as, in our opinion, the matter is concluded by the highest authority. We may refer to the decision of the Gujarat High Court in CIT v. Mohanbhai Pamabhai, [1973] 91 ITR 393 (Guj). In the aforesaid decision, the Gujarat High Court held that when a partner retires from a partnership firm taking his share of partnership interest, no element of transfer of interest in the partnership assets by the retiring partner to the continuing partner was involved. This view was upheld by the Supreme Court while disposing of the appeal filed by the Department.

10. We may invite attention to the decision of the Supreme Court in Addl. CIT v. Mohanbhai Pamabhai, [1987] 165 ITR 166 (SC). The Supreme Court upheld the view taken by the Gujarat High Court as abovementioned, following its earlier decision in Sunil Siddharthbhai v. CIT and Kartikeya V. Sarabhai v. CIT, [1985] 156 ITR 509 (SC). We may also refer to the decision of a Division Bench of this court in CIT v. L. Raghu Kumar, [1983] 141 ITR 674 (AP). In identical circumstances, this court held that when a partner retires from the partnership and receives his interest either in a lump sum or otherwise, there is no element of transfer of interest in the partnership assets by the retiring partner to the continuing partners. It was further held by this court that for the purpose of section 45 of the Act, no distinction can be drawn between an amount received by the partner on the dissolution of the firm and that received on his retirement, since both of them stand on the same footing. In that view, the amount received by a partner from the partnership in excess of the capital and profits standing to his credit in the partnership books at the time of retirement, was held to be not capital gain under section 45 of the Act inasmuch as there is no transfer within the meaning of section 2(47) of the Act and such excess is not exigible to tax on capital gains. These authorities, in our opinion, concluded the question against the Revenue.

11. Learned standing counsel, however, invited our attention to the decision of the Bombay High Court in N.A Mody v. Commissioner Of Income-Tax, [1986] 162 ITR 420. We may point out that the decision of the Bombay High Court relied upon by learned standing counsel follows its earlier view in CIT v. H.R Aslot, [1978] 115 ITR 255 (Bom). That view was expressly dissented from by this court in CIT v. L. Raghu Kumar, [1983] 141 ITR 674 (AP). It is not, therefore, necessary to consider the decision relied upon by learned standing counsel.

12. Learned standing counsel also raised a further plea that the facts and circumstances would clearly show that the assessee's partnership interest was transferred to Mrs. Tarulatha Modi. Inviting our attention to the averments contained in the so called dissolution deed dated January 22, 1973, learned standing counsel pointed out that the sum of Rs. 90,000 credited to the assessee's account was brought into the partnership by Mrs. Tarulatha Modi, and, therefore, it is a case where the assessee's partnership interest was purchased by Mrs. Tarulatha Modi by paying consideration of Rs. 90,000. We do not find any factual basis for this plea raised by learned counsel. There is absolutely no evidence, much less any finding, to indicate that there was any bilateral agreement between Mrs. Modi and the assessee in regard to the alleged sale of the assessee's interest in the partnership firm. It may be true to say that when the assessee retired from the partnership, Mrs. Modi was admitted by the continuing partners as a partner, and pursuant to the agreement between the continuing partners on the one hand and Mrs. Modi on the other, Mrs. Modi might have brought in capital of Rs. 90,000 into the partnership firm. There is no indication anywhere whatsoever that, pursuant to any direct negotiations, Mrs. Modi paid to the assessee the sum of Rs. 90,000 by way of consideration for acquiring the partnership interest. On the contrary, the evidence clearly points to Mrs. Modi bringing in the aforesaid amount of Rs. 90,000 into the partnership firm and in the books of the partnership firm. All that happened was that the assessee's account was credited with the sum of Rs. 90,000 depleting the debit balance to that extent in the assessee's account in the partnership books. On these facts, it is not possible to accept the plea of learned standing counsel for the Revenue that there is any direct sale of partnership interest by the assessee in favour of Mrs. Tarulatha Modi. Learned standing counsel invited our attention to the observations contained in the concluding portion of paragraph 10 of the Tribunal's order which do lend support to that plea. But it seems to us that these observations of the Tribunal are made unguardedly and based on no evidence at all. Indeed, that was not the Revenue's case at any stage of the proceedings. We are, therefore, unable to countenance the plea raised by learned standing counsel as to the above fact at this stage. There is sufficient evidence to show that the sum of Rs. 90,000 credited to the assessee represented his share of goodwill relating to the partnership firm. In fact, the Tribunal furnished statistics in its order in support of the proposition that there is basis for the sum of Rs. 90,000 being arrived at as the assessee's share of goodwill in the partnership firm. If what was credited to the assessee's account represented the consideration for goodwill, it is clear, no liability to capital gains arises, in view of the decision of the Supreme Court in CIT v. B.C Srinivasa Setty, [1981] 128 ITR 294.

13. Having regard to the facts and circumstances, we answer questions Nos. (2); (3) and (4) as indicated above, i.e, in favour of the assessee and against the Revenue. No costs.