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Excel Productions v. Commissioner Of Income-Tax
Factual and Procedural Background
The assessee is a registered partnership firm originally registered on 20 October 1952 with five partners. The managing partner held one-third of the partnership; the remaining four original partners held equal shares in the remaining two-thirds. On 29 May 1962 the constitution of the firm was changed by admitting four minors as partners. Under the reconstitution, the five original partners each took 14% shares and the remaining 30% was distributed equally among the four minors. The reconstitution was to take effect from 1 June 1962, but the firm's accounts as originally constituted continued until 30 June 1962. Consequently, the first half-year was treated as the firm as originally constituted and the second half-year as the reconstituted firm.
The Income-tax Officer (ITO) initially assessed the two periods separately. The Commissioner of Income-tax considered separate assessments erroneous and prejudicial to the Revenue and directed the ITO to re-do the assessment for the whole year as a single assessment. The ITO complied and the Appellate Tribunal confirmed that action on appeal. At the instance of the assessee, the following question was referred to this Court:
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that only a single assessment could be made on the firm of Excel Productions, for the assessment year 1963–1964, in regard to its income of the whole period 1-1-1962 to 31-12-1962, when there was a change in the constitution of the firm during the said period.”
Legal Issues Presented
- Whether, where there is a change in the constitution of a firm during an accounting year, only a single assessment can be made on the firm for the whole year (i.e., assessment on the firm as constituted at the time of making the assessment), rather than separate assessments for the periods before and after the change.
Arguments of the Parties
Appellant (Assessee)'s Arguments
- The assessee relied on an observation of Hegde J. in Commr. of Income-tax, Mysore v. Bharat Engineering and Construction Co. (report cited in the opinion) that "for the purpose of assessment, every change in the constitution of a firm brings into existence a new firm." From this, the assessee argued that the reconstituted firm should be treated as a new firm for assessment and that separate assessments should therefore be made for the first and second half-years (i.e., under the approach reflected in Section 188).
Respondent (Revenue)'s Arguments
- The Revenue's counsel suggested that the quoted observation of Hegde J. might be erroneous and perhaps not essential to the Mysore High Court's decision. Implicitly, the Revenue supported the position that the assessment should be made as a single assessment under the statutory scheme applicable (i.e., under the provisions of the Income-tax Act, 1961, as interpreted by the court).
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commr. of Income-tax, Mysore v. Bharat Engineering and Construction Co., (reported at ITR 273 (Mys)) | Observation (by Hegde J.) that "for the purpose of assessment, every change in the constitution of a firm brings into existence a new firm." | The Court noted the observation and that the assessee relied on it, but treated the observation as not determinative here. The Court distinguished the statutory language of the earlier Act (1922) considered in that case from the relevant provisions of the Income-tax Act, 1961, and indicated that it was unnecessary to determine whether the Mysore observation was essential to that decision. Ultimately the Court did not follow the observation to permit separate assessments under Section 188 for this case. |
Court's Reasoning and Analysis
The Court framed the issue as whether the case fell under Section 187 of the Income-tax Act, 1961 (change in the constitution of a firm) or under Section 188 (succession of one firm by another), because Section 188 provides for separate assessments only when the case is not covered by Section 187.
The Court examined differences in statutory language between the earlier Act of 1922 and the Income-tax Act, 1961. It noted that Section 26(1) of the 1922 Act expressly included the phrase "or that a firm has been newly constituted," which is not present in Section 187(1) of the 1961 Act. Similarly, subsection (2) of Section 26 of the old Act lacked a qualifier similar to the phrase "and the case is not one covered by Section 187" found in Section 188 of the 1961 Act. The Court stated it would not resolve whether the Mysore High Court's observation was essential to that earlier decision, because such resolution was unnecessary for deciding the present reference.
The Court accepted (as admitted) that the present case involves a change in the constitution of the firm and not a succession of one firm by another. It then analysed Section 187(1), which provides that where, at the time of making an assessment, a change in the constitution is found, "the assessment shall be made on the firm as constituted at the time of making the assessment." The Court pointed to subsection (2) of Section 187 to explain what constitutes a change in constitution. Clause (a) of subsection (2) covers the situation where one or more new partners are admitted and one or more of the persons who were partners before the change continue as partners after the change — precisely the facts of this case (original five partners continued; four minors admitted; shares altered).
The Court then considered Section 188, which deals with succession of one firm by another and prescribes separate assessments for predecessor and successor firms only when the case is not covered by Section 187. The Court reasoned that even if every change in constitution theoretically creates a new firm for some purposes, if the case falls within Section 187, then the separate-assessment mechanism in Section 188 is excluded. Thus the dispositive question is whether the present facts fall within Section 187.
Applying the statutory definitions, the Court concluded that the addition of four minor partners while the original partners continued, with resultant alteration of shares, falls squarely within clause (a) of subsection (2) of Section 187. Consequently, assessment must be under Section 187 and not under Section 188.
The Court clarified that while the assessment must be made on the firm as constituted at the time of making the assessment (i.e., the reconstituted firm), the computation of individual partners' shares of profit or loss may require separate consideration of the two periods (before and after the reconstitution).
Holding and Implications
Holding: The Court answered the referred question in the affirmative — against the assessee — and upheld the view that only a single assessment could be made on the firm for the whole year (i.e., assessment under Section 187 on the firm as constituted at the time of making the assessment).
Implications:
- The direct effect is that the assessment for the assessment year in question must be made on the firm as it was constituted at the time of making the assessment (the reconstituted firm), not by treating the pre-change and post-change periods as separate firms for the purpose of separate assessments under Section 188.
- When computing the shares of profit or loss attributable to individual partners, the relevant accounting periods (before and after reconstitution) may still need to be separately considered so as to apportion shares correctly.
- The Court distinguished a prior observation in the Mysore High Court decision relied upon by the assessee and declined to treat that observation as dispositive in this matter; the judgment did not adopt the view that every change in constitution automatically mandates separate assessments under Section 188. The decision therefore applies the specific language of Sections 187 and 188 of the Income-tax Act, 1961, to the facts before the Court.
- No order as to costs was made by the Court.
This summary is prepared strictly from the text of the provided opinion. No information has been added beyond what appears in that opinion.
Raghavan, J.:— The question involved in this reference lies within a narrow compass, though the counsel on both sides have told us that there is no precedent on the question.
2. The assessee is a registered partnership firm, originally registered on 20th October, 1952 with five partners. The managing partner had a third share in the partnership and the remaining four partners had equal shares in the remaining two-thirds. On 29th May, 1962, the constitution of the firm was changed by taking four minors also as partners. The five original partners took 14 per cent, each as their shares and the remaining 30 per cent. was distributed equally among the four minors. The reconstitution was to take effect from 1st June, 1962, though the accounts of the firm as constituted originally continued till 30th June. In other words, for the first half year, the firm as constituted originally continued and for the second half year, the firm as reconstituted was treated as another firm. The Income-tax Officer assessed the two periods separately; but the Commissioner of Income-tax felt that such separate assessment for the two periods was erroneous and prejudicial to the Revenue. Therefore, he directed the Income-tax Officer to re-do the assessment for the whole year in one assessment. The Income-tax Officer did so; and the action of the Income-tax Officer was confirmed in appeal by the Appellate Tribunal. Subsequently, at the instance of the assessee, the following question has been referred to this Court:
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that only a single assessment could be made on the firm of Excel Productions, for the assessment year 1963–1964, in regard to its income of the whole period 1-1-1962 to 31-12-1962, when there was a change in the constitution of the firm during the said period.”
3. There is no direct decision covering this question. But, the counsel of the assessee has invited our attention to an observation of Hegde J., in the decision of the Mysore High Court in Commr. of Income-tax, Mysore v. Bharat Engineering and Construction Co. 1968-1967 ITR 273 (Mys)). That was a case under the Income-tax Act of 1922; and the question considered was whether the entire loss of an unregistered firm during a particular year or particular years could be carried over and adjusted towards the profit of the firm in a subsequent year, if, in the meantime some of the partners of the firm had retired. And a Division Bench of the Mysore High Court held that only the share of the loss of the partners who continued in the partnership in the subsequent year could be carried over and adjusted towards the profits the firm made during that year, in other words, the share of the loss of the partners who had retired could not be carried over. This conclusion is of no avail to the assessee in the present case. But, one observation of Hegde J., who spoke for the Division Bench, is relied upon by the counsel of the assessee. The observation appearing at the end of the first paragraph of page 280 of the reports is:
“In other words, if it is found that a change has occurred in the constitution of the firm, assessment will have to be made on the firm as constituted at the time of making the assessment and not on the firm that was in existence earlier. From this it follows, for the purpose of assessment, every change in the constitution of a firm brings into existence a new firm”.
4. The argument of the counsel of the assessee is that this observation indicates that the firm whose constitution has been changed is a new firm for the purpose of assessment. The counsel of the Revenue has suggested that this observation of Hegde J., might probably be erroneous and might not also be essential for the decision of the question involved in the case before the learned Judges. We do not propose to go into the question whether this observation was necessary for the case before the Mysore High Court, However, we would indicate the difference in language between the relevant section in the Act of 1922, which Hegde J., was considering, and the section in the Act of 1961, which we have to consider. Hegde J., was considering Section 26(1) of the Act of 1922; and the section provided that where, at the time of making an assessment, it was found that a change had occurred in the constitution of a firm or that a firm had been newly constituted, etc. The corresponding section of the new Act, viz., Section 187(1), provides that where, at the time of making an assessment, it is found that a change has occurred in the constitution of a firm, etc. The expression “or that a firm has been newly constituted”, which was found in Section 26(1) of the Act of 1922, is not present in Section 187(1) of the Act of 1961. Again, sub-section (2) of Section 26 of the Act of 1922 provided that where a person carrying on any business, profession or vocation had been succeeded in such capacity by another person, such person and such other persons should each be assessed, etc. The corresponding section of the Act of 1961, we mean Section 188 of the new Act, provides that where a firm carrying on a business or profession is succeeded by another firm and the case is not one covered by Section 187, separate assessments shall be made, etc. An expression similar to “and the case is not one covered by Section 187” found in Section 188 of the new Act is absent in sub-section (2) of Section 26 of the old Act. We do not propose to consider whether this difference in language justified or warranted the observation of Hegde J., extracted by us hereinbefore, because, as will presently appear, such consideration is unnecessary for the decision of the question referred in this case.
5. It is admitted (this was done before the Tribunal too) that this is a case of change in the constitution of the firm and not a case of succession of one firm by another firm. Section 187 deals with change in the constitution of a firm; and sub-section (1) of the section provides that where, at the time of making an assessment, it is found that a change has occurred in the constitution of the firm, the assessment shall be made “on the firm as constituted at the time of making the assessment.” The proviso to this sub-section is not relevant. Sub-section (2) of the section indicates as to what is meant by change in the constitution of the firm for the purpose of the section. Clause (a) provides that, if one or more of the partners cease to be partners or one or more new partners are admitted, in such circumstances that one or more of the persons who were partners of the firm before the change continue as partner or partners after the change, there is a change in the constitution of the firm. Clause (b) states that, where all the partners continue with a change in their respective shares or in the shares of some of them, then also there is a change in the constitution of the firm. (The case before us comes within clause (a) of this sub-section.)
6. Next we come to Section 188, which deals with the succession of a firm by another firm. This section enacts that, where a firm carrying on a business or profession is succeeded by another firm, and the case is not one covered by Section 187, separate assessments shall be made on the predecessor firm and the successor firm.
7. The argument of the counsel of the assessee is that, though the case before us is only one where a change has occurred in the constitution of the firm, the assessment should be in the manner indicated by Section 188, viz., the firm as constituted originally should be assessed for the first half year and the firm as con stituted after the change in the constitution should be assessed for the second half year as another firm. The counsel relies on the observation of Hegde J., that, “for the purpose of assessment, every change in the constitution of a firm brings into existence a new firm.”
8. From the language of Sec. 188, one thing appears: i.e, that there might be a case of one firm succeeding to another which might still fall under Section 187. Succession of one firm by another is not defined in Section 188; the section merely says that, when one firm is succeeded by another, the assessment should be in a particular manner—the predecessor firm and the successor firm should be separately assessed. But the section also says that even in a case where there is a succession of one firm by another, the separate assessment need be done only if the case does not fall under Section 187. Therefore, the question is not whether there is a change in the constitution of a firm or whether there is a succession of one firm by another; the question is whether the particular case falls under Section 187 or not. If it does, even if there is a succession of one firm by another separate assessment as contemplated by Section 188 cannot be had. In other words, even if every change in the constitution of a firm brings into existence a new firm, still, if the case falls under Section 187, separate assessment under Section 188 is ruled out. Only a case which does not fall under Section 187 may fall under Section 188 to claim separate assessment. Therefore, the only question we have to consider in this case is whether this is a case falling under Section 187, and if it falls under that section, the assessment contemplated by Section 188 is excluded.
9. What happened in this firm in 1962 was the addition of four minor partners; all the five original partners continued. And the shares of the original partners in the firm were also altered so as to give shares to the partners newly brought in. Such change in the constitution comes under clause (a) of sub-sec. (2) of Section 187. Then the assessment should be only under that section and not under Section 188. Of course, the assessment has to be on the firm as constituted at the time of making the assessment—the firm as reconstituted; but in working out the shares of the loss or the profit of the several partners, the two periods may have to be separately considered.
10. The result is that our answer to the question referred is in the affirmative —against the assessee. However, we do not pass any order regarding costs. The answer will be communicated to the Tribunal.
11. Answered in the affirmative.
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