- Bookmark
- Share
- CaseIQ
A. Subbiah Nadar v. Commissioner Of Income-Tax.
Judgment Summary — V. Ramaswami, J.
Factual and Procedural Background
The assessee operated four lorries until 31 March 1961. From 1 April 1961 a partnership firm was formed comprising the assessee, his two sons and a divided brother, Kanniappan; that partnership took over the four lorries. In the income‑tax return for the assessment year 1962–63 the assessee filed as an individual and claimed no profit on the transaction by which the partnership took over the lorries. Both the assessee's and the firm’s accounts showed the lorries at original book value. During assessment the assessee filed an affidavit stating that, through mistake and ignorance, the value standing in his books had been transferred as purchase price to the firm's books and that the actual market value had not been taken into account.
The Income‑tax Officer treated the transaction as a sale by the assessee to the partnership and, applying section 41(2) of the Income‑tax Act, calculated profits with reference to market value as at 1 April 1961 (market value taken at Rs. 45,000; profits assessed at Rs. 29,185). On appeal the Appellate Assistant Commissioner (AAC) disagreed with the ITO's method and recomputed profits on the basis of the difference between cost price (Rs. 61,000) and written down value (Rs. 15,815). The assessee further appealed to the Tribunal, raising two additional grounds: (a) the lorries belonged to the joint family and continued to do so after the partnership took them up; and (b) the partnership took over the business as a going concern so that section 41(2) did not apply.
The Tribunal allowed the assessee to raise the additional grounds, directed evidence to be taken on ownership, and received a report from the AAC that the lorries belonged to the joint family. The Tribunal nevertheless held that when the partnership took over the lorries, ownership passed from the joint family to the partnership (a distinct entity for the purposes of the transaction) and that section 41(2) was therefore attracted; it rejected the going‑concern argument because the lorries were separately valued and consideration shown item by item. The Tribunal dismissed the assessee's appeal.
The assessee secured a reference of three questions to this Court, challenging the Tribunal's conclusion and seeking to establish that section 41(2) did not apply.
Legal Issues Presented
- Did the formation of the partnership between the assessee's sons (as representing the joint family of the assessee) and A. Kanniappan and the taking over of the business carried on by the partners amount to a sale of the assets previously held by the family to the firm attracting section 41(2) of the Income‑tax Act?
- Whether the transaction was a slump transaction (a going‑concern acquisition) and therefore not liable to be treated as a sale of individual assets?
- Whether, on the facts and in the circumstances, the Tribunal's order that the assessee is liable to be taxed under section 41(2) on Rs. 45,185 or any part thereof is lawful?
Arguments of the Parties
Assessee's Arguments
- When the partnership took over the lorries there was no transfer from the joint family to the partnership or from any individual member to the partnership.
- Because a partnership is not a separate legal entity and the members of the Hindu undivided family (HUF) were themselves partners (together with a third party), the lorries continued to be owned by the joint family even though the partnership could be considered an owner in some respects; consequently section 41(2) does not apply.
- The partnership took over the transport business as a going concern, which, the assessee argued before the Tribunal, would preclude treating the transaction as a sale of individual assets under section 41(2).
Revenue's Arguments
- A Hindu undivided family, as such, cannot be a partner in a partnership firm; therefore the HUF cannot be treated as a partner.
- Because the HUF itself cannot be a partner, the lorries that were once HUF properties became the assets of a partnership in which the HUF was not a partner—thus the transaction should be deemed a sale from the HUF to the partnership and attract section 41(2).
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income‑Tax, Madras v. Janab N. Hyath Batcha Sahib [1969] 72 ITR 528 (Mad) | Explains that a partnership/firm is normally not a separate legal entity; section 4 of the Indian Partnership Act defines partnership as a relation between persons and partners retain their identity; when a person makes over property to a firm consisting of himself and others it is a delicate question whether a transfer in the sense of a transfer of title has occurred. | The Court relied on this precedent to support the view that a transfer to a firm does not necessarily amount to a divestment of rights by the contributing partner and to show that conversion of property to firm use does not always create a 'sale' within taxation provisions. |
| Commissioner of Income Tax, Madhya Pradesh v. Dewas Cine Corporation (Supreme Court) | Held that when a partnership is formed and a member brings assets into the firm, there need not be a transfer in the sense of a sale; the property becomes that of the firm by the intention of the parties as evinced in the partnership agreement. | The Court invoked this authority to demonstrate that the formation of a partnership and the bringing in of assets can effectuate firm ownership by agreement rather than by a transfer attracting section 41(2). |
| D. Kanniah Pillai v. Commissioner of Income‑Tax, Madras [1976] 104 ITR 520 (Mad) | Confirmed that, even though income‑tax law enables assessment in the name of a firm, that does not make the firm a legal person with all consequences; conversion of a sole proprietorship to a partnership does not amount to a sale within the meaning of the Sale of Goods Act. | The Court followed this precedent and the earlier authorities to treat the present conversion/transfer context similarly and to hold that no sale occurred for purposes of section 41(2) when property held by the HUF members was brought into a partnership composed of those members. |
Court's Reasoning and Analysis
The Court proceeded by examining whether the formation of the partnership and the taking over of the lorries involved a transfer within the meaning of section 41(2) of the Income‑tax Act. The Court reviewed precedents establishing the legal position that a firm is, for most purposes, not a separate legal entity and that goods or property brought into a firm by a partner may, depending on intention and agreement, become firm property without an act of sale in the sense relevant to income‑tax law.
The Court considered the argument that these authorities do not apply to Hindu undivided family property because an HUF, as such, cannot be a partner. It observed that in the present case the HUF consisted only of the father and his two sons, and all three became partners in the new firm along with a third party. Thus, what had been held by them as HUF property was thereafter held by them as partners. The Court analogised this situation to the conversion of individual property into partnership property: in the individual case the person ceases to hold the property as an individual and holds it as a partner; similarly the HUF ceases to hold it as HUF property and the members hold it as partners.
On that basis the Court held that the precedent principles applicable to conversion of individual proprietorship into partnership also apply to this case of HUF property contributed by the members who became partners. Consequently, there was no "transfer" within the meaning of section 41(2). Because the first question was answered in the assessee's favour, the Court found that the second and third questions did not arise for decision and therefore gave no answer to them.
Holding and Implications
Holding: The Court answered the first referred question in the negative and in favour of the assessee: there was no transfer within the meaning of section 41(2) of the Income‑tax Act when the partnership took over the lorries contributed by members of the Hindu undivided family who became partners in the firm.
Implications:
- Direct effect: The Court's ruling favours the assessee on the principal question referred — section 41(2) does not apply to the facts as found. The Court did not address the second and third referred questions because they became unnecessary in view of the answer to the first question.
- Costs: The assessee was awarded costs, specifically counsel's fee of Rs. 250.
- Precedential scope: The Court applied and followed prior authorities about partnerships not being separate legal entities for these purposes and extended the same reasoning to the situation where HUF members contribute HUF property to a partnership of which they are partners. The Court did not purport to lay down a broader rule beyond the facts considered; it limited its conclusion to the case at hand and answered only the first question referred.
All statements in this summary are derived directly from the provided opinion and no additional facts or inferences have been introduced.
The Judgment of the Court was delivered by
V. Ramaswami, J.:— The assessee was plying four lorries up to March 31, 1961. On and from April 1, 1961, a partnership firm consisting of the assessee, his two sons and his divided brother, one Kanniappan, was formed and this partnership firm took over the four lorries. In the return filed by the assessee for the assessment year 1962–63, he claimed his status as an individual and made a claim that he did not make any profit in the transaction by which the partnership firm took over the lorries. In the accounts of both the assessee and the partnership firm, the value of the lorries was shown at the original book value. At the time of assessment, however, the assessee filed an affidavit stating that due to mistake and ignorance, the value standing in the account of the lorries in his individual books was transferred as purchase price to the books of the firm and in doing so the actual market value of the lorries was not taken into account resulting in presenting a wrong picture of the assets. Treating that transaction as a sale by the assessee to the partnership firm, the Income-tax Officer considered that neither the cost price nor the written down value could be taken into account for determining the profits made under section 41(2) of the Income-tax Act and that it will have to be computed only with reference to the market value as on April 1, 1961, when the firm took over the assets. He, accordingly, valued the market value of the four lorries at Rs. 45,000 and determined the profits chargeable to tax under section 41(2) at Rs. 29,185.
2. In the appeal filed by the assessee against this assessment, the Appellate Assistant Commissioner was of the view that the Income-tax Officer went wrong in computing the profits on the basis of the difference between the estimated market value and the written down value and it should have been assessed on the difference between the cost price and the written down value.
3. Accordingly, after issuing a notice to the assessee he redetermined the profits chargeable to tax on the basis of the difference between Rs. 61,000, the cost price, and the written down value of Rs. 15,815.
4. The assessee preferred a further appeal to the Tribunal. Before the Tribunal, the assessee raised two additional grounds on which he contended that the lorries did not belong to the assessee exclusively; but belonged to the joint family of himself and his sons and that these assets continued to belong to the joint family even after they were taken up by the partnership. He also contended that the new partnership took up the transport business as a going concern and, therefore, no question of computation of profit could arise under section 41(2). The Tribunal permitted the assessee to raise these two additional grounds. The Tribunal, therefore, directed the Appellate Assistant Commissioner to receive evidence on the question whether the lorries belonged to the assessee or to the joint family of himself and his sons and submit a finding. The Appellate Assistant Commissioner in his report gave a finding that the lorries belonged to the joint family of the assessee and his sons. The Tribunal was of the view that when the partnership was formed and the lorries were taken over by the partnership, the lorries which were once the assets of the joint family became the assets of the partnership and since the ownership accordingly was tansferred from the joint family to the different entity which is the partnership, section 41(2) was attracted. The Tribunal did not agree with the assessee that the transfer to the partnership firm was as a going concern or amounted to a reorganisation of the business and held that since the lorries had been separately valued and the consideration for each item shown separately, the difference in the sale price and the written down value had to be treated as profit within the meaning of section 41(2). In the result, the Tribunal dismissed the appeal.
5. At the instance of the assessee, the following three questions have been referred:
“1. Did the formation of the partnership between the assessee's sons as representing the joint family of the assessee and A. Kanniappan and the taking over of the business carried on by the partners, amount to a sale of the assets previously held by the family to the firm attracting section 41(2) of the Act?
2. Whether the transaction is a slump transaction and is not liable to be treated as a sale of assets?
3. Whether, on the facts and in the circumstances of the case, the order passed by the Tribunal that the assessee is liable to be taxed under section 41(2) of the Act on Rs. 45,185 or any part thereof is lawful?”
6. The learned counsel for the assessee contended that when the partnership took over the lorries, there was no transfer from the joint family to the partnership or from an individual member of the joint family to the partnership. Since the partnership is not a legal entity and the members constituting the joint family were also members of the partnership with a third party, the lorries still continued to be owned by the joint family as such though the partnership also could be considered as an owner and that, therefore, section 41(2) is not attracted. The learned counsel for the revenue, on the other hand, contended that a Hindu undivided family as such could not be a partner in a partnership concern. Therefore, even though all the members constituting the Hindu undivided family are the members of the partnership, the Hindu undivided family as such could not be treated as a partner in a partnership. The lorries which were once the properties of the Hindu undivided family had become the asset of the partnership in which the Hindu undivided family was not a partner and, therefore, it should be deemed that there was a sale from the Hindu undivided family to the partnership as such.
7. This court in Commissioner Of Income-Tax, Madras v. Janab N. Hyath Batcha Sahib.* [1969] 72 ITR 528, 531 Mad. had to consider the applicability of section 10(2)(vii) of the Indian Income-tax Act, 1922, corresponding to section 41(2) of the Income-tax Act, 1961, in a case where a proprietary concern was converted into a partnership concern. This court observed as follows:
“Barring the exceptional cases of limited recognition of a firm of partnership as an entity, the normal position in law of a firm is that it is not a legal entity, unlike an incorporated company. A firm is but a convenient and compendious name given to a contractual relationship in which two or more persons combine their efforts and conjointly apply the same to a commercial or business activity with a view to make profit. Section 4 of the Indian Partnership Act makes this explicit and says that a ‘partnership’ is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. This relationship does not appear to cloud or destroy the identity of the partners whose rights and liabilities vis-a-vis each other are governed by the terms of the partnership and the provisions of the Indian Partnership Act. The members of a firm, from a certain point of view, therefore, remain as co-owners in a limited sense and subject to the terms of the contract of partnership and the principles of law governing such relationship. When, therefore, A makes over his property to a firm consisting of A and B, it will be a nice question—whether the transaction involves a transfer of the property. By such a transfer A clearly does not divest himself completely of his rights or interest in the property, though it is true B, by reason of the transaction, becomes entitled to certain rights which are regulated by the terms of the agreement of partnership, as well as the provisions of the Indian Partnership Act.”
8. The Supreme Court also in Commissioner Of Income Tax, Madhya Pradesh v. Dewas Cine Corporation, with reference to a partnership formed for the first time and one of the members of the partnership bringing into the firm assets held by him, held that there was no transfer and that the property became the property of the firm, not by any transfer, but by the very intention of the parties evinced in the agreement between them to treat such property belonging to one or more of the members of the partnership as that of the firm. In Tax Case No. 260 of 1969 (D. Kanniah Pillai v. Commissioner Of Income-Tax, Madras. [1976] 104 ITR 520 Mad.), we had occasion to deal with this question and following these decisions, we have also held that even though the Income-tax Act enables an assessment to be made in the name of a firm, it does not in terms make it a legal entity with all its consequences and, therefore, there could not be a sale within the meaning of the Sale of Goods Act when one person converts his sole proprietary concern into a partnership of which he is a partner.
9. The learned counsel for the revenue, however, tried to distinguish these cases on the ground that they were all cases of individual persons converting their assets into a partnership property and not cases of properties of Hindu undivided families becoming the properties of a partnership. According to the learned counsel since the Hindu undivided family as such could not be a partner of a partnership firm, that principle could not be applied to such a case. In this case, it is not necessary to consider in general whether the property of a Hindu undivided family could become the property of a partnership firm without a transfer. In this case, the Hindu undivided family consisted of the father and two sons and all the three were partners in the new partnership along with a third party. Therefore, what was originally held by them as a Hindu undivided family is now held by them as partners in a partnership firm. In this respect there is no difference between an individual and a Hindu undivided family. As in the case of an individual, when he converts his individual property to that of a partnership, a Hindu undivided family also when the property of the Hindu undivided family becomes the property of the partnership ceases to hold the property. In the first case, the individual ceases to hold the property as his individual property and in the other case, the Hindu undivided family ceases to hold the property as Hindu undivided family property, but the members of the Hindu undivided family hold the property as partners. We are of the view that the ratio or the principle applicable to the case of a proprietary concern being converted into a partnership must also apply to the instant case. We, accordingly, hold that there was no transfer within the meaning of section 41(2) of the Income-tax Act, 1961. We, accordingly, answer the first question in the negative and in favour of the assessee. In view of our answer to the first question, the other two questions do not arise for consideration. We, accordingly, give no answer to those two questions. The assessee will be entitled to his costs. Counsel's fee Rs. 250.
Alert