Rajagopala Ayyangar, J.:— This reference arises out of proceedings under the Excess Profits Tax Act in respect of the assessment to tax levied on two firms R.O Rangaswami Chetti and Brothers, Salem, and R.C Sundarakrishna Chetti and Brothers, Salem, and the question referred for our decision under S. 66(2) is:

“Whether on the facts and in the circumstances of the case the application of the provisions of Section 10-A of the Excess Profits Tax Act and the aggregation of the income of the two firms R.C Rangaswami Chetti and Bros, and R.C Sundarakrishna Chetti and Bros. was wrong in law?”

2. The following facts are necessary to understand the point arising in the reference. One Chennappa Chettiar had seven sons, three by his first wife and four by his second. The first wife's sons were R.C Rangaswami, R.C Ramaswami, and R.C Lakshmanan; while his sons by the second wife were R.C Sundarishnan, Govindarajulu, Jagannadhan and Krishnaswami. This undivided Hindu family carried on two businesses, one in the name of Chennappa Chettiar and Rangaswami Chettiar dealing in cloth and money lending, and the other in the name and style of Chennappa Chettiar and Sons, the business of this concern being the dyeing of yarn and the sale thereof. On the 5th December, 1935, there was a partition in the family and under this partition the father was allotted a sum of Rs. 3500 for his share out of the family assets. The two businesses referred to above were thereafter carried on in partnership between the sons. This firm, of seven partners, in which each of the sons had a seventh share, was dissolved on the 18th of January 1943, and two new firms called R.C Rangaswami Chetti and Bros, and R.C Sundarakrishna Chetti and Bros, came into being on that day.

3. The first firm had for its partner the three sons by the first wife and the second was comprised of the four sons by the second wife who also between themselves had been divided. These two firms were recognised by the Income-tax authorities as distinct entities, and their partnerships were registered under S. 26-A of the Act.

4. The chargeable accounting periods for the purpose of the excess profits tax in respect of these businesses were those ended 20th January, 1944, 18th January, 1945, 24th January, 1946, and 31st March, 1946, the last one being the period since when the excess profits tax ceased to be levied. The Excess Profits tax officer issued a notice on 28th October, 1947, under Section 10-A of the Excess Profits Tax Act to these firms stating that he proposed to club the income of the two firms for the purpose of excess profits tax. In this notice he stated:

“I find that with effect from 18th January, 1943, the firm of R.C Rangaswami Chetti and Bros, carrying on business in cloth, money lending and manufacture and sale of dyed yarn was converted into two new firms of Messrs, R.C Rangaswami Chetti and Bros. and R.C Sundarakrishna Chetti and Bros. Till today there has been no formal dissolution of the old firm and all the seven partners are continuing together for distributing properties and other assets of the firm upto 28th July, 1947 even.

There has been no fresh capital for the two new firms. The discontinuance and separation of the older firm was alleged to be due to misunderstandings which could not be substantiated. Lastly it is significant to note that the separation and constitution of the old firm into the new firms take place precisely at the point when (sic) the chargeable accounting period ending 18th January, 1943.

In the circumstances stated above I cannot but conclude that whatever be the alleged cause the main purpose for discontinuance and splitting up of the old firm's business into two new firms was only for the avoidance of excess profits tax liability.”

5. The assessees, Rangaswami Chetti and Bros, filed their objections on 15th November, 1947. They repudiated the statement, that the main purpose of the dissolution was the avoidance of excess profits tax. They put forward their positive case, setting out the reasons for the division. They stated “there were serious disputes between the step-brothers and their sons of the three brothers, only Ramaswami Chettiar and Sons, and Lakshmanan Chettiar and Sons were attending to the factory. Quarrels arose, (the quarrels were set out) and this led to the well-wishers of the family advising them to stop the common business.” A similar reply was sent by Sundarakrishna Chetti and Bros. The Excess Profits tax Officer, however, passed an order on the 30th November, 1947, clubbing the income of the two firms for purpose of excess profits tax.

6. Before this officer, the assessees filed an affidavit signed by four merchants of Salem, dated 20th November, 1947, in which the deponents affirmed that there were misunderstandings which they settled and that in pursuance of that settlement the original partnership was stopped and the two new firms were started. The Excess Profits tax Officer passed an order, re-stating the matters which had been set out by him in his original notice and recorded that as the books of account of the firms did not show that the separation had been effected through the aid of arbitrators, the affidavit by the merchants should be rejected. He finally stated.

“Above all the points to be remembered is not that the legality or the fact of the dissolution has been questioned; but the case made out is that whatever might have been the background for the alleged dissolution, there is unmistakable evidence from the course of conduct and state of affairs that the discontinuance and splitting up of the old firm's business into two new firms was for the main purpose of reducing the profits of the business as a whole which was within the charge and creating new subjects of charge with a view to reduce the excess profits tax liability.”

7. We are unable to find in this order any specific rejection of the story put forward that the dissolution of the parent firm and the creation of two new firms were due to misunderstandings between the step-brothers. The grounds, however, upon which the motive for the splitting up was said to be the avoidance of liability of excess profits tax were:

(i) absence of formal dissolution of the old firm; (ii) the new businesses carrying on the transactions with the customers of the older firm; and (iii) absence of fresh capital for the new businesses.

8. The assessees filed an appeal to the Tribunal. The findings of fact by the Tribunal are rather vague. They clearly rejected several of the reasons, on the basis of which the Excess profits tax Officer justified the application of S. 10-A. They formally recorded: “We do not think we can agree with the Excess Profits tax officer in holding that there was no dissolution of the old firm.”

9. They did not consider that there was much force in the criticism that no new capital had been introduced into the two new firms. There was no dispute between them, and it was not the case of the department that the firms were not genuine but bogus ones. They characterised the observation of the Excess Profits tax Officer regarding “continuity of the business with the same constituents” as rather obscure; and they went on to add” it was apparently the view of the Excess Profits tax Officer that the original business was continued to be carried on.” and this they thought was irrelevant for the question which they had to decide.

10. They, however, went on to add: “He is, however, on firm ground when he holds that there is no satisfactory evidence of misunderstandings and secondly that there has been no explanation as to why the misunderstandings should have caused the dissolution of the old firm and the bringing into existence of the two new firms just in the year in which for the first time the old firm had become liable to excess profits tax.”

11. So far as regards the reality of the misunderstandings, apart from whether the misunderstandings were of such a nature as should have led at the precise point in January 1943, to a separation, there are other portions of the appellate order which appear to suggest that this was not doubted. Thus in paragraph 4, after referring to the evidence placed before them by the assessees, as regards trade rivalry between the new firms as well as the variations in the shares of the several partners which took place on different occasions in the previous years, the Tribunal said:

“But the point that is not explained is, assuming that there was that misunderstanding in those years, how did it happen that the dissolution of the old firm and the constitution of the two new firms should happen just in the year in which the old firm had for the first time become liable to excess profits tax?” They went on to add: “on the materials placed before us, it has not) been proved that there was in fact misunderstanding between the brothers of any serious nature, and, even if it has to be assumed that there was any misunderstanding between them, that it was the proximate cause of the dissolution of the old firm and the constitution of the two firms.”

12. It will be seen from the above that, though the inclination of their opinion is in favour of the misunderstandings having existed, they considered (a) that the misunderstandings were not so serious as to justify disruption; and (b) there was so explanation as to how this breaking point was reached just in January 1943, when the liability of the parent firm to excess profits tax became clear.

13. Section 10-A of the Excess Profits Tax Act runs thus:

“(1) Where the Excess Profits Tax Officer is of opinion that the main purpose for which any transaction or transactions was or were effected, (whether before or after the passing of the Excess Profits Tax Act (Second Amendment) Act, 1941) was the avoidance or reduction of liability to excess profits tax, he may, with the previous approval of the Inspecting Assistant Commissioner, make such adjustments as respects liability to excess profits tax as he considers appropriate so as to counteract the avoidance or reduction of liability to excess profits tax which would otherwise be effected by the transaction or transactions.”

14. The purport and scope of the phrase “the main purpose of the transaction being the avoidance or reduction of liability to excess profits tax” has been the subject of several decisions and the following points may be taken as clearly established:

(1) The mere fact that a new business was started at a time when by such starting there would be a reduction of liability is not by itself proof, that it was started with the main object of avoiding the excess profits tax liability within the meaning of the S. 10-A. In other words, the point of time when these businesses are started or a transaction takes place does not by itself furnish proof that the transaction was effected with a sinister motive.

(2) The burden is on the department to prove that this was the main purpose with which the transaction was effected.

(3) The relationship between the parties to the transactions is not by itself conclusive to prove that the motive of the actors in the transaction was the avoidance of liability.

(4) It is not sufficient if this was an incidental advantage which might have accrued to an assessee; it must be the main motive to compass which the transaction was brought about.

15. These propositions were laid down in a decision of this court in Mohamed Ibrahim and Co. v. Commissioner of Excess Profits Tax, 1952-22 ITR 324 : (AIR 1953 Mad 221) (A), following a previous unreported decision of this court in Madalai Nadar v. Commissioner of Excess Profits Tax, R.C No. 64 of 1946 (Mad) (B). The following passage from the judgment of Satyanarayana Rao, J., at page 330 (of ITR): (at P. 223 of AIR), would suffice to illustrate the propositions which we have set out above:

“As has been decided in this court in R.C No. 64 of 1946 (Mad) (B), the burden of establishing that the transaction in question is within the mischief of S. 10-A of the Act is undoubtedly on the department and it is for them to establish by cogent and convincing evidence that there were circumstances which point to the conclusion that the main purpose of the transaction was to avoid or reduce the liability to excess profits tax.

This view is also supported by the decision in Ganga Sahai Umrao Sing v. Commissioner of Excess Profits Tax, 1950-18 ITR 988 : (AIR 1950 All 595) (C) and in Dixon and Gaunt Ltd. and James Hare Ltd. v. Commissioners of Inland Revenue, 1947-29 Tax Cas 289 (D). The Department made no effort to place any circumstance to establish that the main purpose of the transaction was to avoid or reduce the tax. All that is urged and which has also been stressed before up by Mr. Rama Rao Sahib, the learned advocate for the Income-tax Commissioner, was the time factor and the result, meaning thereby that if a transaction was brought into existence after the Excess Profits Tax Act came into force and when it continued to operate and if the result of the transaction was in fact to avoid or reduce the tax, it must be presumed that the transaction was within the mischief of S. 10-A of the Act.

This argument if accepted would practically shift the burden of proof in every case to the assessee, for the section can only apply to transactions which were brought into existence either after the Act came into force or even before the Act came into force when it was fairly well known that the Act would be passed. It would be impossible to conceive of any cause, applying that test, which would not fall within the purview of the section. It is not enough, in our opinion, for the department in order to discharge the onus on them to establish merely that the transaction was one which came into existence after the Act came into force.

There should be additional circumstance or circumstances which would point to the conclusion that the object with which the parties entered into the transaction and the main object was to avoid the tax or to get it reduced………. That there were dissensions was recited in the deed of dissolution of partnership and was also proved by the statement of Chellakanni Rowther. It is difficult to understand what the Tribunal meant when it said this statement of Chellakanni Rowther did not by itself conclude the matter.”

16. It is by applying these principles that the question referred to us has to be answered. If there were misunderstandings between the partners and there was the probability of their having separated, because the two groups consisted of step-brothers, then the only questions are, (1) whether the misunderstandings were so serious as to lead to a disruption, and (2) whether they came to a head in January 1943.

17. If the fact that the separation took place precisely at a time when it would be advantageous to the assessee is dismissed, as it has to be, as an overriding consideration for the determination of the question as to the dominant or main motive of the transaction, we are unable to find anything else in the present case which would furnish us a material for holding that the department has discharged the burden that lay upon it to bring the case within S. 10A of the Act.

18. No doubt the motive of an individual cannot be proved by direct evidence; and it is only the inference from the circumstances that would show what the motive was. But under the law the departmental authorities have to establish that the main motive for effecting the transaction of splitting was the avoidance of liability. That burden is not discharged merely by proof that it took place at a time when it would be an advantage to the assessee, and would, in fact, result in the avoidance or diminution of tax liability.

19. The fact that the assessees have not positively established to the satisfaction of the Tribunal that the misunderstandings came to a head just at that point of time does not, in our opinion, by itself lead to the inference that the department had discharged the onus, or that by itself is proof that the dominant motive with which the transaction was effected was the avoidance of liability to tax.

20. Mr. Rama Rao Sahib, the learned counsel for the department, sought to distinguish the decision relied on by the learned counsel for the assessee on two different grounds. He sought to explain the unreported decision in R.C No. 64 of 1946 (Mad) (B), as a case where the assessee had been able to establish that there was necessity for the splitting up by reason of having to expand the business, and in the second case by the fact that one of the partners had gone out of the business and therefore there was necessity for the reconstitution of the firms.

21. These no doubt were certainly factors which were taken into account by the learned Judges in those two decisions. But, in our opinion, even in the present case, if the misunderstandings were there, as we must take it, having regard to the very dubious manner in which the matter is stated by the tribunal, which would have led to a disruption any moment, the fact that it took place at a time when possibly the excess profits tax liability was feared might not by itself be a ground for holding that the transaction was brought about in order to avoid or diminish the tax liability.

22. We hold, therefore, that on the findings of the tribunal the inference drawn that the transaction of splitting up was with the main motive of avoiding the tax liability is wrong in law. The question is accordingly answered in the affirmative and in favour of the assessee. He will be entitled to the costs of the reference. Counsel's fee Rs. 250.

S.L.L

23. Reference answered in affirmative.