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General Auto Parts Co. v. Commissioner Of Income-Tax, Delhi (Central)
Structured Summary of the Opinion — Reference under s.256(1) of the Income-tax Act, 1961
Factual and Procedural Background
The Income-tax Appellate Tribunal, Delhi Bench 'B referred three questions to the Court under section 256(1) of the Income-tax Act, 1961 relating to the tax treatment of payments made on the retirement of two partners of a firm.
The assessee firm, M/s General Auto Parts, carried on business in automobile parts. Originally there were four partners: Ram Gopal, Kashmiri Lal, Kanwal Kishore and Krishan Kishore. Kanwal Kishore and Krishan Kishore retired with effect from 30 September 1963. A deed of dissolution dated 8 October 1963 recorded the retirement and the terms of settlement.
Clause 1 of the deed recorded amounts standing to the credit of the retiring partners in their capital accounts: Rs. 37,323.10 for Kanwal Kishore and Rs. 75,200.41 for Krishan Kishore. Clause 2 recorded that the retiring partners relinquished any rights in favour of the continuing partners in respect of quota licences, contracts, goods in transit and stock, goodwill, lease rights, cars, a scooter and telephones, and that this relinquishment was made in consideration of a mutually agreed valuation of Rs. 1,00,000 (Rs. 50,000 each). Clause 3 recited the totals due to each retiring partner including the above.
Clause 5 addressed the manner of payment and provided that, on payment, retiring partners would claim no further rights. In the firm’s cash book the Rs. 1,00,000 payment was split into two components: Rs. 48,076.15 shown as goodwill and Rs. 51,923.85 shown as appreciation in value of stocks and licences (the latter calculated by applying profit margins of 25–27% supported by trading accounts).
The Assessing Officer (ITO), the Appellate Assistant Commissioner (AAC) and the Appellate Tribunal disallowed the assessee’s claim to treat Rs. 51,923.85 as deductible revenue expenditure. The Tribunal referred three questions to the Court, and this opinion answers those questions.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the payment of Rs. one lakh to the retiring partners did not include revenue expenditure deductible from the income of the assessee?
- If the reply to question No. 1 is in the affirmative, whether there was any legal difficulty in allowing the revenue expense as deduction from the income of the assessee?
- Whether the claim of the assessee deducting Rs. 51,924 from his income has been disallowed correctly?
Arguments of the Parties
Assessee's Arguments (Mr. G.C. Sharma)
- The Tribunal erred in presuming that any payment to a former partner is necessarily capital in nature.
- On retirement the retiring partners were entitled to amounts standing to their credit in capital accounts (Rs. 37,323.10 and Rs. 75,200.41) and the Rs. 1,00,000 represented an additional payment over and above those capital-account amounts.
- The Rs. 1,00,000 (and specifically the Rs. 51,923.85 component) was paid for the use of certain assets (import and quota licences, cars, telephone) by the continuing partners and/or represented profit on stocks — i.e., payments incidental to carrying on the business or to preserve business assets — and thus deductible as revenue expenditure.
- Reliance was placed on Madras High Court decisions: V. N. V. Devarajulu Chetty & Co. v. CIT (1950) 18 ITR 357 and M. S. Kandappa Mudaliar v. CIT (1957) 32 ITR 313, and on Supreme Court decisions including Devidas Vithaldas & Co. v. CIT (1972) 84 ITR 277 and two Travancore Sugars and Chemicals Ltd. decisions (1966) 62 ITR 566 and (1973) 88 ITR 1.
Revenue's Arguments (Mr. Verma)
- A partner of a firm, while the firm exists, has no specific proprietary right in any particular partnership asset; he only has a right to share profits and, on retirement, his share in the surplus of assets over liabilities.
- The Rs. 1,00,000 was paid on dissolution/retirement as consideration for the retiring partners' interest in the partnership assets as a whole and was therefore capital in nature.
- The Tribunal correctly held that the bifurcation in the cash book did not correspond to the deed and the attempt to treat part of the payment as revenue in nature was not made before the Tribunal (i.e., it was a new argument).
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| V. N. V. Devarajulu Chetty & Co. v. CIT, [1950] 18 ITR 357 (Madras H.C.) | Relied on by the assessee to support that payments could be deductible where they were for use of quota rights or similar business-incidental payments. | The Court held this decision to be not relevant to the present case because here the payment was for acquisition of retiring partners' rights in partnership assets, not merely payment for the use of particular rights. |
| M. S. Kandappa Mudaliar v. CIT, [1957] 32 ITR 313 (Madras H.C.) | Relied on by the assessee for the proposition that certain payments in the context of reorganisation may be deductible as revenue expenditure. | The Court found this precedent inapplicable for the same reasons stated as to Devarajulu Chetty & Co.; the present payment was for transfer of retiring partners' rights, i.e., capital in nature. |
| Devidas Vithaldas & Co. v. CIT, [1972] 84 ITR 277 (Supreme Court) | Concerned with whether payments were for acquisition of goodwill or only for a limited right to use goodwill for a term; cited by the assessee. | The Court held the decision not relevant because the present case involved acquisition of retiring partners' entire right, title and interest in the firm's assets, not a limited right to use goodwill. |
| Travancore Sugars and Chemicals Ltd. cases, [1966] 62 ITR 566 and [1973] 88 ITR 1 (Supreme Court) | Addressed whether payments by reference to profits formed part of a purchase price of a business or were independent payments; invoked by the assessee. | The Court considered these authorities irrelevant in the present factual matrix because the payments here were for acquiring retiring partners' interests in the partnership, not the specific legal questions decided in those Travancore Sugars cases. |
Court's Reasoning and Analysis
The Court proceeded by reading the deed of dissolution as a whole and applying partnership principles described in the opinion. The analysis unfolded as follows:
- Foundational principle: as long as a firm exists, no partner can claim a specific proprietary share in particular partnership assets; the partner's rights are to share profits and, on retirement or dissolution, to his share of the surplus of assets over liabilities.
- Interpreted the deed harmoniously: clause 1 recorded amounts standing to the credit of retiring partners, but clause 2 — read in its context — showed a broader relinquishment of rights in various assets in consideration of Rs. 1,00,000. Thus the Rs. 1,00,000 represented consideration for the retiring partners' relinquishment of their rights in the partnership as a whole.
- Rejected the contention that the clause‑2 payment was payment merely for use of specific assets (quota rights, cars, telephones, etc.). The mention of specific assets in clause 2 served to emphasise the scope of rights relinquished, not to indicate separate payments for use.
- Evaluated the firm’s books and the cash-book bifurcation: the Court noted that the split in the cash book into goodwill and appreciation did not correlate with the clauses of the deed and was not supported as a commercial justification sufficient to treat part of the payment as revenue expenditure.
- Noted procedural point: the attempt to dissect the payment and claim deduction on that basis was not advanced before the Tribunal and thus represented a new case being pressed at this stage.
- Observed that the retiring partners themselves treated the whole receipt as a capital receipt in their hands, which, though not conclusive, supported the conclusion that the payment was capital in nature.
- Considered authorities cited by the assessee and concluded they were not applicable because they addressed different factual and legal questions (payments for use of rights; limited licences; or differing questions about purchase-price composition), whereas the present payment was plainly for acquisition of the outgoing partners' rights in the partnership assets.
- Concluded that the payment was not incidental to the carrying on of the business but was incidental to reconstitution of the firm — i.e., a capital expenditure from the continuing partners' perspective and not deductible as revenue expenditure.
Holding and Implications
Holding: The Court answered the reference in the negative and against the assessee: the payment (including the Rs. 51,923.85 component) was of a capital nature and not deductible as revenue expenditure.
Implications:
- The disallowance of the assessee's claim to deduct Rs. 51,923.85 (rounded in the reference as Rs. 51,924) is upheld; that sum is treated as capital and not allowable as a revenue deduction for the firm.
- The Court agreed with the Tribunal and lower authorities that the Rs. 1,00,000 was paid for the retiring partners' rights, title and interest in partnership assets rather than for the use of particular assets; consequently no deduction was permissible in favour of the continuing firm on that account.
- The Commissioner was awarded costs in the reference.
- No broader precedent was laid down beyond the application of established partnership principles to the facts; the opinion does not purport to create a new legal principle beyond its factual conclusion.
End of summary based exclusively on the provided opinion.
1. The Income-tax Appellate Tribunal, Delhi Bench ‘B has referred the following questions for our decision under s. 256(1) of the I.T Act, 1961)
“1. Whether, on the facts and in the circumstances of the case, the payment of Rs. one lakh to the retiring partners did not include revenue expenditure deductible from the income of assessee?
2. If the reply to question No. 1 is in the affirmative, whether there was any legal difficulty in allowing the revenue expense as deduction from the income of the assessee?
3. Whether the claim of the assessee deducting Rs. 51,924 from his income has been disallowed correctly?”.
2. The above questions arise in the following circumstances:
The assessee, M/s. General Auto Parts, is a registered firm doing business in automobile parts. The business was previously carried on by four partners, namely, Ram Gopal, Kashmiri Lal, Kanwal Kishore and Krishan Kishore. Kanwal Kishore and Krishan Kishore agreed to retire from the firm with effect from September 30, 1963. On October 8, 1963, a deed of dissolution was drawn up between the retiring partners on the one hand and the continuing partners on the other. Clauses 1, 2 and 3 of this deed of dissolution are relevant and may be set out here:
“1. That the parties to this deed have thoroughly and satisfactorily checked, scrutinised and gone through the entire existing stock-in-trade at the above-mentioned premises, the accounts which stand rightly, regularly and correctly posted in the books of account of partnership, the recoveries and outstandings due to the partnership, the liabilities of the partnership, the bank accounts of the partnership. That as per books of account of the partnership Rs. 37,323.10 (Rupees thirty-seven thousand three hundred and twenty-three and paise ten only) stands entered as the capital investments of Shri Kanwal Kishore Khanna, member of the party of the 1st part, and Rs. 75,200.41 (Rupees seventy-five thousand two hundred and paise forty-one only) stands entered as the capital of Shri Krishan Kishore Khanna who, was the other member of the party of 1st part, which sums are refundable and payable to them by the members of the party of the second part.
2. That the members of the party of the first part in their disposing mind and without any duress having been brought to bear on them agreed to relinquish their respective rights, if any, in favour of the members of the party of the second part in the quota licence standing at present granted to or ‘to be granted in the name of the partnership, various contracts pending on the basis of existing import licences, various goods under transit, under clearance and in bank godowns and in stock, in goodwill, the lease rights of the above mentioned premises in the assets, quota rights of import and export, the two cars Nos. DLF; 2742 and NEW 544 and scooter; No. MAX-479 and two telephone Nos. 226019 and 227158 at Delhi and the members of the party of 2nd part agreed to this relinquishment in their favour in consideration of payment of Rupees one lakh only (Rs. 1,00,000) to them by the members of the party of the second part as per the valuation mutually and consentingly agreed to by all the parties to their entire satisfaction. This valuation mutually agreed to a sum’ of Rs. 1,00,000 (Rupees one lakh only) is due to the members of the party of the first part in equal shares, i.e, Rs. 50,000 (Rupees fifty thousand only) each to Shri Kanwal Kishore Khanna and Shri Krishan Kishore Khanna, from the members of the party of the second part.
3. That thus Rs. 87,323.10 (Rupees eighty-seven thousand three hundred and twenty-three and paise ten only) and Rs. 1,25,200.41 (Rupees one lakh twenty-five thousand two hundred and paise forty-one only) are found due and payable to Shri Kanwal Kishore Khanna and Shri Krishan Kishore Khanna, the retiring partners, respectively, which the parties admit and acknowledge to be correct.”
3. Clause 5 set out the manner of payment of the amounts due to the retiring partners and stated that in view of the payment in the above manner the retiring partners shall have left and shall claim no right, title, interest, demands or claims of any nature whatsoever from or against the continuing partners. Clause (ii) of the deed of dissolution provided that the continuing partners will have absolute rights and would be entitled to all the assets, goodwill, quota rights of imports and exports and licences previously held by the dissolved partnership and all other rights whatsoever and whosoever relating to the same without any let or hindrance and that the retiring partners shall have no right, title or interest in the same. In pursuance of the above agreement a sum of Rs. 1 lakh was paid to the two retiring partners. In the cash book of the firm as on September 28/30, 1963, which was signed by all the four partners, however, the payment of Rs. 1 lakh was split up into two component parts. A sum of Rs. 48,076.15 was stated to be the amount of goodwill paid to the retiring partners and the balance of Rs. 51,923.85 was stated to represent the amount of appreciation in value of stocks and licence paid to retiring partners. It was stated that, this sum of Rs. 51,923.85 had been determined by taking the profits on the stocks held by the assessee at various offices at certain rates ranging between 25% and 27%. It was, however, stated that this profit rate was determined on the basis of the normal profit margin obtained by the firm and this was sought to be supported by reference to the copies of the trading account of the firm for the years ending on December 31, 1963, to December 31, 1966.
4. The question that arises in this reference is whether the sum of Rs. 51,923 is liable to be taxed as revenue expenditure in the hands of the firm consisting of the four partners who carried on the business with effect from October 1, 1963. Apparently there was no dispute that the amount shown as paid by way of share of the goodwill of the retiring partners was a capital expenditure and the controversy related only to a sum of Rs. 51,923. The assessee's claim was rejected by the ITO, the AAC as well as the Appellate Tribunal and hence the present reference.
5. The Tribunal has rejected the assessee's claim on the following grounds:
“We do not find adequate ground for interfering with the conclusion of the Appellate Asst. Commissioner. It was not possible to ignore the context in which the payment of Rs. 1 lakh was made. It was clearly made on the occasion of dissolution of the old firm and the formation of the new one. The amount was, therefore, paid to the outgoing partners as value of their shares in the assets of the partnership firm. The manner in which distribution was made was immaterial in determining the exact nature of the transaction. The crucial fact was that the payment was in lieu of their share in the partnership assets at the time of the dissolution of the firm. Such a payment could not be broken up and correlated to the different assets of the firm. It is a settled law that no partner can claim in respect of any specific item of partnership assets that he has a specific share in those assets. What the outgoing partners got was, therefore, not their share in any specific assets of the firm but their share in the assets of the partnership as a whole. Even otherwise, we are not at all satisfied that the valuation by the assessee was justified on any commercial grounds. Having regard to the various assets of the firm in which the outgoing partners had interest, it was not possible to say with any precision that goodwill was deflated and trading assets had appreciated in value. Moreover, there is no getting away from the fact that the assessee before us is a firm which continued throughout the year and we do not see how such a firm can claim deduction of payments made to outgoing partners on the occasion of their retirement and as a consideration for the retirement. As stated earlier, the manner in which the payment has been made or the formula according to which the payment has been determined is not at all important. What is important is the main object of payment and having regard to that object we have no doubt at all in our minds that the payment in question was payment of a capital nature. It was a payment which was not incidental to the carrying on of the business but to its reconstitution or to the fundamental structural changes in its framework. The disallowance was, therefore, in order and the same is upheld.”
6. Mr. G.C Sharma, learned counsel for the assessee, submitted that the Tribunal had committed an error in assuming that any payment made to a former partner of a firm would necessarily be of capital nature. According to him, on the dissolution of the firm, the interest of the retiring partners was evaluated by reference to the amounts standing to their credit in their capital accounts in the firm. These figures are Rs. 37,323 in the case of Kanwal Kishore and Rs. 75,200.41 in the case of Krishan Kishore. Mr. Sharma contends that this was the only payment made to these two partners in respect of their interest in the firm. The amount of Rs. one lakh paid under the second clause of the deed of dissolution, according to Mr. Sharma, represents a payment over and above the amounts due to the retiring partners in respect of their shares in the firm. Mr. Sharma points out that the firm had certain import licences, certain quota licences and certain other assets like cars and telephone in regard to which the retiring partners were laying a claim. His submission is that the retiring partners were raising some disputes in regard to the continued use of these assets by the continuing partners and that the amount of Rs. one lakh was paid to them for the use of these assets by the continuing partners. In support of the contention that such a payment was deductible, Mr. Sharma relied on the decisions of the Madras High Court in the case of V. N.V Devarajulu Chetty & Co. v. CIT, [1950] 18 ITR 357 and in the case of M.S Kandappa Mudaliar v. CIT, [1957] 32 ITR 313. Mr. Sharma also characterised these items as payments made incidental to the carrying on of the business and as also the amounts paid in order to protect or per-serve the assets of the firm. Reference was also made by the learned counsel to the decisions of the Supreme Court in the case of Devidas Vithaldas & Co. v. CIT, [1972] 84 ITR 277 and the two cases of Travancore Sugars and Chemicals Ltd. reported in [1966] 62 ITR 566 and [1973] 88 ITR 1.
7. In our opinion, the contentions of the learned counsel for the assessee are not tenable. As rightly pointed out by Mr. Verma, learned counsel for the department, no partner of a firm so long as the firm is in existence is entitled to claim that he has any specific share in any of the assets belonging to the firm. His rights comprise only of a right to share the profits so long as the firm is a going concern and to get back his share of the surplus of the assets over the liabilities at the time of his retirement or in the event of dissolution of a firm. In the present case, the two retiring partners decided to retire from the firm and received the value of their interest in the firm. We are unable to accept the contention of Mr. Sharma that the clauses of this agreement should be read in isolation and that cl. 1 should alone be deemed to represent the payment towards the value of the interest of the retiring partners and that the second clause deals with a totally different subject-matter. In our opinion, the entire agreement has to be read harmoniously and as one integral whole. No doubt on the date of the retirement the amounts mentioned in clause 1 were the only amounts standing to the credit of the partners in their capital account. But apparently the parties were of opinion that this did not represent the entirety of the value of their interests. The language of cl. 2, clearly shows that the ‘sum of Rs. one lakh mentioned in that clause has been made by way of consideration for the relinquishment by the retiring partners in favour of the continuing partners of any rights that they may have in respect of various assets of the firm. The fact that some of these assets are mentioned by specific reference does not mean that the payment was intended to be made for the use of these assets. The reference to import licences, quota licences, cars and telephones are only to emphasise that the retiring partners were giving up all their rights, title and interest in the firm in consideration of the payment of the sum of Rs. 1 lakh.
8. In the above view of the matter, we are of the opinion that the decisions of the Madras High Court cited by Mr. Sharma have no relevance in the present case. This is not a case where amounts have been paid by way’ of payment for the use of quota rights or by way of profits in respect of certain contracts which were kept reserved in the contract of dissolution. This is a case where a certain sum of money has been paid by the continuing partners in order to acquire the right, title and interest of the retiring partners in the assets of the former firm. We agree with the conclusion of the Tribunal that the payment made was one which was not incidental to the carrying on of the business but was incidental to a reconstitution of that framework of the business itself. The payment was made in the context of a distribution of the assets of the firm which has been dissolved on the retirement of the two partners therefrom.
9. We are also unable to see any relevance in view of the facts stated above of the decisions of the Supreme Court cited by Mr. Sharma. In the case of Devidas Vithaldas & Co., [1972] 84 ITR 277, the Supreme Court was concerned with the question whether certain payments had been made for the acquisition of goodwill or merely for acquiring the right to use the goodwill for a certain term of years. In the other case of Travancore Sugars and Chemicals Ltd., [1966] 62 ITR 566, a payment was made by reference to the profits and the question was whether it constituted a part of the purchase price of business or whether it was an independent payment which had nothing to do with the acquisition of the concern as such. These cases have no relevance in view of our conclusion that in the present case the two els. 1 and 2 should be read separately and that in form and substance the payments were made by the two continuing partners of the firm to acquire the right, title and interest of the retiring partners. We also agree with Mr. Verma, learned counsel for the department, that the attempt to dissect the amount and claim a deduction by reference to the quota rights, etc., was not made before the Tribunal and that this is a new case that is being now put forward on behalf of the assessee. Further, this bifurcation made in the books has no correlation with the clauses of the dissolution deed. The sum of Rs. 51,923 has not also been calculated in the accounts as payment for the use of the quota and licence rights or the car, telephone or other assets used by the firm. It has been paid to acquire the rights of the retiring partners in these and other assets and is a payment of a capital nature. We may also refer to the fact that even the retiring partners appear to have treated the entire sum as one integral receipt and claimed it as a capital receipt in their hands as a payment received for their right, title and interest in the firm. Though that is not conclusive, that also shows that no separate payments were contemplated as contended for by Mr. Sharma.
10. For the reasons mentioned above, we agree with the view taken by the Tribunal and answer the question referred to us in the negative and against the assessee. The Commissioner will be entitled to his costs in this reference.
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