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A. Abdul Rahim, Travancore Confectionery Works v. Commissioner Of Income-Tax, Kerala.
Structured Summary of the Opinion delivered by Govindan Nair, C.J.
Factual and Procedural Background
The Income-tax Appellate Tribunal, Cochin Bench, referred a question to the High Court whether the Tribunal was right in holding that the withdrawal of the development rebate under section 155(5) of the Income-tax Act, 1961 (amounting to specified sums for the assessment years 1962-63, 1963-64, 1964-65, 1965-66 and 1967-68) by the Income-tax Officer was justified.
The assessee in respect of the years in question was Abdul Rahim, who carried on a confectionery manufacturing and selling business in the name of M/s Travancore Confectionery Works, Quilon. The accounting year was the Malayalam year ending 16 August. On 1 January 1967 Abdul Rahim formed a partnership with his son (partnership deed executed 31 December 1966), under which Abdul Rahim had a 60% share and his son 40%. The firm took over the assets and liabilities of Abdul Rahim's business with effect from 1 January 1967 and continued the business under the same trade name.
Abdul Rahim had earlier been allowed development rebate for the years 1962-63 to 1965-66 and 1967-68. The Income-tax Officer, purporting to act under section 34(3)(b) read with section 155(5), reopened the assessments for those years, recomputed the tax and withdrew the development rebate on the view that a "transfer" as defined in section 2(47) of the Act had taken place when the assets were brought into the newly formed firm.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the withdrawal of the development rebate under section 155(5) of the Income-tax Act, 1961 (in the respective sums stated) by the Income-tax Officer was justified — i.e., whether there was a "transfer" within the meaning of section 2(47) of the Act when the assessee brought his exclusive property into the firm on formation of the partnership, thereby attracting section 34(3)(b) read with section 155(5).
Arguments of the Parties
Assessee's Arguments (as recorded)
- The firm is not a legal entity and therefore cannot hold property or have an interest in property; this is so notwithstanding that the Income-tax Act (section 2(31)) treats "a firm" as a person for certain purposes.
- When the partnership was formed by the assessee bringing in his assets and liabilities, there was no transfer, no relinquishment and no extinguishment of any rights in the assets which had been exclusively his before formation of the firm.
- Because the essential element of a "transfer" (as defined in section 2(47)) is absent, neither section 34(3)(b) nor section 155(5) can be invoked to justify withdrawal of the development rebate.
Revenue's Arguments (as recorded)
- It was not contended that there was a sale or that there was a transfer, exchange or relinquishment in the ordinary senses; the contention was that there was an extinguishment of some of the rights of the assessee in the assets which he brought into the business of the firm.
- All other conditions required by section 34(3)(b) and section 155(5) were not disputed.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income-tax v. Nataraj Motor Service, [1972] 86 ITR 109 (Ker) | Considered whether distribution of firm assets on dissolution amounted to a "transfer" within section 2(47) — Mathew J. held extinguishment of firm's rights on distribution was a transfer; Krishnamoorthy Iyer J. disagreed. | The Court discussed the conflicting views in that case to distinguish it from the present facts (formation of partnership rather than dissolution) and to explain earlier approaches to "transfer" in partnership contexts. |
| Commissioner Of Income Tax, Madhya Pradesh v. Dewas Cine Corporation, [1968] 68 ITR 240 (SC) | Supreme Court ruling relied on in Nataraj Motor Service on the effect of distribution of assets of a firm and whether it constitutes a "transfer". | The Nataraj Motor Service decision had relied on this Supreme Court ruling; the present Court referred to that chain of reliance when examining prior authorities. |
| Commissioner Of Income-Tax, Kerala v. C.M. Kunhammed, [1974] 94 ITR 179 (Ker) | Addressed whether bringing assets into a firm on formation of partnership amounted to a "transfer" under section 2(47). | The Court noted that in that case Isaac J. (and one member of the present Bench earlier) concluded there was no transfer because section 2(47) was not applicable to the alleged transfer; the present Court considered that view as part of the prior jurisprudence. |
| CIT, U.P. v. Sh. Bankey Lal Vaidya (Dead) By Lawyers, [1971] 79 ITR 594 (SC) | Supreme Court authority relied upon in earlier decisions concerning transfers involving partnership property. | The Court cited this decision as part of the line of Supreme Court authorities considered in resolving whether a transfer occurs on partnership formation or dissolution. |
| I.T.Rs Nos. 115 to 118 of 1970 (bench decisions referred to in text) | Those decisions held that distribution of assets on dissolution involved a transfer; mentioned as representing a contrary view in the line of authorities. | The present Court expressly disagreed with the view taken in those decisions (that a firm could be treated as having interests in partnership property leading to relinquishment/extinguishment by the firm) for reasons explained in its reasoning. |
| Addanki Narayanappa v. Bhaskara Krishnappa, AIR 1966 SC 1300 | Principles about partnership property: property brought in by partners becomes partnership property; partners have interest in partnership property (share of profits and on dissolution a share in money representing the value of the property); partner cannot exercise exclusive rights over partnership property during subsistence of partnership. | The Court relied on the Supreme Court's principles in this case to conclude that when an individual brings exclusive property into a partnership, his exclusive right is extinguished to the extent necessary to create the co-partners' interests — thereby supporting the view that an "extinguishment of any rights therein" under section 2(47) can occur on formation of a firm. |
Court's Reasoning and Analysis
The Court confined the dispute to the sole legal question whether there was a "transfer" within the meaning of section 2(47) of the Income-tax Act when Abdul Rahim brought his exclusively held business assets into the newly formed partnership.
The Court noted that all other statutory conditions in section 34(3)(b) and section 155(5) were not disputed, so resolution turned on the meaning and applicability of "transfer" / "extinguishment of any rights therein" in the partnership formation context.
The assessee's argument (accepted by the Tribunal below was contested) rested on the traditional principle that a partnership (firm) has no legal existence separate from the partners; therefore, when a person brings his assets into a partnership, he neither transfers nor relinquishes nor extinguishes any rights in the sense required by section 2(47).
The Court reviewed earlier authorities dealing with similar questions. It discussed the split in Nataraj Motor Service where one judge held extinguishment of the firm's rights on dissolution to be a transfer, while another judge held the contrary. The Court also reviewed subsequent Kerala High Court decisions (including C.M. Kunhammed) and bench decisions that had come to differing conclusions.
To resolve the present question (formation of a partnership by one partner contributing exclusive property), the Court relied primarily on the Supreme Court's exposition in Addanki Narayanappa v. Bhaskara Krishnappa. That authority (as stated in its headnote and quoted in the opinion) establishes:
- Whatever is brought in by a partner for the partnership becomes partnership property;
- Each partner has an interest in partnership property (a right to profits and, on dissolution, a share in the value of the property);
- During the partnership no partner can deal with any portion of the partnership property as his own exclusive property.
The Court reasoned that if a person who brings exclusive property into a partnership loses the ability to claim or exercise exclusive rights over that property (because it becomes partnership property and other partners acquire interests), such loss must entail an extinguishment of some of the contributor's prior exclusive rights. That extinguishment is the type of "extinguishment of any rights therein" referred to in section 2(47). The Court emphasized that the interest acquired by other partners is substantial (a "right to property" in the limited sense of a movable interest as described by the Supreme Court) and not illusory.
The Court observed that it was not argued that the machinery brought in by Abdul Rahim was not a "capital asset." Given that the contributor's exclusive rights were thereby diminished (extinguished to the extent required to create the partners' interests), the bringing-in constituted a "transfer" of a capital asset within section 2(47), attracting sections 34(3)(b) and 155(5).
Holding and Implications
Holding: The Court answered the referred question in the affirmative — it held that there was a "transfer" within the meaning of section 2(47) when Abdul Rahim brought his exclusive capital assets into the newly formed firm, and consequently the Income-tax Officer's withdrawal of the development rebate under section 155(5) read with section 34(3)(b) was justified.
Implications and direct effects:
- The decision supports the Revenue's position in this case and is adverse to the assessee (Abdul Rahim).
- The Income-tax Officer's action in reopening and recomputing the assessments under the cited provisions was upheld on the stated legal ground.
- The Court directed the parties to bear their respective costs, noting that this was a question of law on which there had been no authoritative ruling of the High Court prior to this decision.
- The Court directed that a copy of the judgment be sent under the seal of the High Court to the Income-tax Appellate Tribunal, Cochin Bench.
The opinion does not purport to set out any broader legislative amendment or to catalogue binding precedent beyond answering the referred question; it confines its effect to resolving the referred question in favour of the department and against the assessee and ordering costs and transmission of the judgment to the Tribunal.
The Judgment of the Court was delivered by
Govindan Nair, C.J:— The Income-tax Appellate Tribunal, Cochin Bench, has referred the following question to the High Court for its opinion:
“Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the withdrawal of the development rebate, under section 155(5) of the Income-tax Act, 1961, amounting to Rs. 424, Rs. 1,696, Rs. 4,223, Rs. 440 and Rs. 11,674 for the assessment years 1962-63, 1963-64, 1964-65, 1965-66 and 1967-68, respectively, by the Income-tax Officer was justified?”
2. For the years mentioned in the question formulated by the Tribunal, the assessee was one Abdul Rahim. He carried on a business in manufacture and sale of confectionery items in the name of M/s. Travancore Confectionery Works, Quilon. The accounting period for each of the years was the Malayalam year ending on the 16th of August of each year. On January 1, 1967, the assessee formed a partnership with his son as his partner. There was a deed of partnership executed on December 31, 1966, under which Abdul Rahim was entitled to a 60% share in the profits and his son to the balance 40%. The firm took over the assets and liabilities of the assessee's confectionery business with effect from January 1, 1967, and carried on the same business under the same trade name. As can be seen from the question itself, Abdul Rahim had been allowed development rebate to the extent of the sums mentioned in the question for the years 1962-63 to 1965-66 and 1967-68.
3. section 34(3)(b) of the Income-tax Act, 1961, for short “the Act”, provides that:
“If any ship, machinery or plant is sold or otherwise transferred by the assessee to any person at any time before the expiry of eight years from the end of the previous year in which it was acquired or installed, any allowance made under section 33 or under the corresponding provisions of the Indian Income-tax Act, 1922, in respect of that ship, machinery or plant shall be deemed to have been wrongly made for the purposes of this Act, and the provisions of sub-section (5) of section 155 shall apply accordingly…”.
4. We are not concerned in this case with the proviso to clause (b) of subsection (3) of section 34. Now, turning to sub-section (5) of section 155 of the Act, we find the following provision:
“Where an allowance by way of development rebate has been made wholly or partly to an assessee in respect of a ship, machinery or plant installed after the 31st day of December, 1957, in any assessment year under section 33 or under the corresponding provisions of the Indian Income-tax Act, 1922, and subsequently—
(i) at any time before the expiry of eight years from the end of the previous year in which the ship was acquired or the machinery or plant was installed, the ship, machinery or plant is sold or otherwise transferred by the assessee to any person other than the Government, a local authority, a corporation established by a Central, State or Provincial Act or a Government company as defined in section 617 of the Companies Act, 1956, or in connection with any amalgamation or succession referred to in subsection (3) or sub-section (4) of section 33; or
(ii) at any time before the expiry of the eight years referred to in sub-section (3) of section 34, the assessee utilises the amount credited to the reserve account under clause (a) of that sub-section—
(a) for distribution by way of dividends or profits; or
(b) for remittance outside India as profits or for the creation of any asset outside India; or
(c) for any other purpose which is not a purpose of the business of the undertaking;
the development rebate originally allowed shall be deemed to have been wrongly allowed, and the Income-tax Officer may, notwithstanding anything contained in this Act, recompute the total income of the assessee for the relevant previous year and make the necessary amendment; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the previous year in which the sale or transfer took place or the money was so utilised.”
5. Purporting to act under section 34(3)(b) read with section 155(5), the Income-tax Officer reopened the assessments for the years 1962-63 to 1965-66 and 1967-68, and recomputed the tax for those years. According to him there was a transfer as defined in section 2(47) of the Act, to which sub-section we shall now turn:
“2. In this Act, unless the context otherwise requires,……………
(47) ‘transfer’, in relation to a capital asset, includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law.”
6. The only question arising for consideration in this case is whether there has been a transfer as defined in section 2(47) of the Act. It is not disputed before us that all the other conditions in section 34(3)(b) and in section 155(5) have been satisfied. Counsel for the assessee would have it that there has been no transfer. His argument was the well-known argument that the firm is not a legal entity; that this is so, notwithstanding the definition in section 2(31) of the Act, of a “person” in which expression, according to the definition, “a firm” is included; that the firm cannot hold property nor can it have any interest in property, for, it has no legal existence; and that, therefore, on the formation of a partnership and the creation of a firm by a person by bringing in his assets and liabilities for the business of the firm, he does not transfer any right in the property which was his to the firm nor is there any relinquishment of any of his rights in the asset, or even of any extinguishment of such rights. The essential element of a transfer being necessary, and that being absent in this case, neither section 34(3)(b) or section 155(5) of the Act can be pressed into service and the order of the Income-tax Officer cannot be sustained. This argument, which was raised before the Tribunal, was not accepted. The Tribunal held that there was a transfer.
7. This court has had occasion to answer questions similar to that now raised before us. But all the aspects of the questions did not arise in all the cases. The decision in Commissioner of Income-tax v. Nataraj Motor Service, [1972] 86 ITR 109 (Ker) was concerned with the case of dissolution of partnership and the dissolution took place before the Act came into force. The judgment which resolved the controversy between Mathew J., as he then was, and Krishnamoorthy Iyer J. was rested purely on the ground that the definition in section 2(47) of the Act did not apply. In that judgment reliance was placed on the ruling of the Supreme Court in Commissioner Of Income Tax, Madhya Pradesh v. Dewas Cine Corporation, [1968] 68 ITR 240 (SC) and it was held that there was no transfer on the distribution of the assets of the firm and hence no question of applying the sections permitting the withdrawal of the development rebate arose. Bat Mathew J. and Krishnamoorthy Iyer J. rested their decisions by answering the question whether there was a transfer within the meaning of the definition in section 2(47). Mathew J. said—See [1972] 86 ITR 109, 114 (Ker):
“The assessee in the case, it will be remembered, was the firm; and for the purpose of income-tax law the firm was a person: See section 2(31) of the 1961 Act. That person's right in the partnership property became extinguished by its distribution between the partners. Even if the extinguishment of its rights in the partnership property was simultaneous with its extinction as a person, that would not matter. The question is whether the rights of the firm, the assessee, in the assets of the firm were extinguished by the distribution of the assets between the partners on its dissolution. I think that the extinguishment of the rights of the firm in the partnership property on its distribution between the partners is transfer within the meaning of the words ‘otherwise transferred’ in section 34(3)(b) of the Income-tax Act, 1961.”
8. Krishnamoorthy Iyer J., did not agree with the view that there has been any extinguishment of the rights of the firm so as to constitute a transfer by the firm. The transfer, it may be noted, must be by the assessee and the firm was the assessee in that case. The learned judge expressed himself thus (page 116):
“The decision of their Lordships of the Supreme Court is that the distribution of assets of a firm among its partners as a result of its dissolution by the application of section 48 of the Partnership Act is not a transfer. As a result of the dissolution there is only an extinguishment of the co-ownership rights of the partners in the partnership property and this position is not in any way altered by the change in the wording of section 34(3)(b) of the Income-tax Act, 1961, or the definition of the word ‘person’ therein.”
9. The difference between the two learned judges was only on the question whether there was an extinguishment of any interest of the firm, which was the assessee, on its dissolution and the distribution of assets among the partners. This question as such does not arise before us as is evident from the facts we have stated, this being a case of the formation of a partnership by one of the partners bringing in what was his exclusive property as an asset of the firm for continuing the same business that he was carrying on, as the business of the firm.
10. In I.T.Rs Nos. 54 and 55 of 1968 [Commissioner Of Income-Tax, Kerala v. C.M Kunhammed, [1974] 94 ITR 179 (Ker)], the question did arise as to whether on the formation of the partnership by one of the partners bringing in assets for the purpose of the business of the firm there was a transfer as envisaged by section 2(47) of the Act. Isaac J., relying on the decisions of the Supreme Court in Commissioner Of Income Tax, Madhya Pradesh v. Dewas Cine Corporation, [1968] 68 ITR 240 (SC) and Cit, Up v. Sh. Bankey Lal Vaidya (Dead) By Lawyers† , [1971] 79 ITR 594 (SC), came to the conclusion that there was no such transfer. One of us who was a party to the Bench that heard the case agreed with the conclusion of Isaac J., but only on the ground that there was no transfer involved, section 2(47) of the Act not being applicable to the alleged transfer. Recently, the question again arose in I.T.Rs Nos. 115 to 118 of 1970* and Gopalan Nambiyar and Viswanatha Iyer JJ. came to the conclusion that there was a transfer involved on the distribution of the assets of the firm on its dissolution.
11. It was not contended before us by counsel for the revenue that there has been a sale or that there has been a transfer, exchange or even relinquishment of the asset. The only contention that has been raised was that there was an extinguishment of some of the rights of the assessee in the assets which were brought in by him for the purpose of the business of the firm. To understand this contention we must go back to the facts stated earlier. The assets brought in were of course the assets of the business of an individual, and which belonged to him exclusively. The commercial community and even others ordinarily understood and treated for all practical purposes the “assets of the firm” in the sense of the assets used for the purpose of the business of the firm, as assets belonging to the firm. The legal position, however, is different as can be seen from a passage of Lindley on Partnership, 13th edition, at page 25:
“The firm is not recognised by English lawyers as distinct from the members composing it. In taking partnership accounts and in administering partnership assets, courts have to some extent adopted the mercantile view, and actions may now, speaking generally, be brought by or against partners in the name of their firm; further, tax assessments are made, in the first instance, against the partnership, but speaking generally, the firm as such has no legal recognition (the emphasis is ours). The law, ignoring the firm, looks to the partners composing it; any change amongst them destroys the identity of the firm; what is called the property of the firm is their property, and what are called the debts and liabilities of the firm are their debts and their liabilities. In point of law, a partner may be the debtor or the creditor of his co-partners, but he cannot be either debtor or creditor of the firm of which he is himself a member, nor can he be employed by his firm, for a man cannot be his own employer.”
12. This, we conceive, is the law in India too and no decision has been quoted before us which has taken a different view. There can, therefore, be no question of relinquishment or even of extinguishment of any right or of interest in the property held by a firm, again in the sense of property used for the business of the firm. In the light of what we have stated above that a firm (which was the assessee in I.T.Rs Nos. 115 to 118 of 1970) does not as such have any interest in the “property of the firm” there cannot be any relinquishment by the firm of any asset or of any extinguishment of any interest therein of the firm. With great respect we are unable to agree with the view taken in the decision in I.T.Rs Nos. 115 to 118 of 1970.
13. However, as we indicated earlier, that question does not specifically arise before us. The question here is what happens when a person brings in property which belonged to him exclusively, for the purpose of the business of the firm which was to be formed with him as a partner. Is there any extinguishment of any right that he had in the property by the above process? This is not an easy question to answer. But the priciples stated by the Supreme Court in Addanki Narayanappa v. Bhaskara Krishnappa, AIR 1966 SC 1300, we think, furnish an answer. We find the dicta of the case correctly stated in the headnote of the report, in these terms:
“The provisions of sections 14, 15, 29, 32, 37, 38 and 48 make it clear that whatever may be the character of the property which is brought in by the partners when the partnership is formed or which may be acquired in the course of the business of the partnership it becomes the property of the firm and what a partner is entitled to is his share of profits, if any, accruing to the partnership from the realisation of this property, and upon dissolution of the partnership to a share in the money representing the value of the property. No doubt, since a firm has no legal existence, the partnership property will vest in all the partners and in that sense every partner has an interest in the property of the partnership. (Underlining is ours). During the subsistence of the partnership, however, no partner can deal with any portion of the property as his own. Nor can he assign his interest in a specific item of the partnership property to anyone. His right is to obtain such profits, if any, as fall to his share from time to time and upon the dissolution of the firm to a share in the assets of the firm which remain after satisfying the liabilities set out in clause (a) and sub-clauses (i), (ii) and (iii) of clause (b) of section 48. The whole concept of partnership is to embark upon a joint venture and for that purpose to bring in as capital money or even property including immovable property. Once that is done whatever is brought in would cease to be the exclusive property of the person who brought it in. It would be the trading asset of the partnership in which all the partners would have interest in proportion to their share in the joint venture of the business of partnership. The person who brought it in would, therefore, not be able to claim or exercise any exclusive right over any property which he has brought in, much less over any other partnership property……”
(Underlining is ours).
14. It is thus clear that every partner has an interest in the property of the partnership. What is more, the person who brought in the property for the purpose of the business of the firm would not be able to claim or exercise any exclusive right over the property. Such a situation can arise only, if there was an extinguishment of some right of the partner in the property which was exclusively his and which was brought in for the purpose of the business of the firm. Without such extinguishment, it is inconceivable that the other partners would get an interest in that property. That interest which a partner gets in the property of the firm (property of the firm is used in the general sense), the Supreme Court held, in the very same case, is movable property. The interest, therefore, the partner gets is not something illusory. It is something substantial and tangible, termed by the Supreme Court as a right to property though of course it is only movable property. Such substantial rights can come into existence, as we have already indicated, only on a corresponding extinguishment of the exclusive right of the partner in the property that he brought in for the purpose of the business of the firm. This is sufficient for the purpose of attracting section 2(47) of the Act which speaks of “extinguishment of any rights therein”, “therein” standing for “capital asset” which term is defined in section 2(14) of the Act. It is not contended before us that the machinery brought in by Abdul Rahim for the formation of the partnership is not “capital asset”. There was thus a transfer of a capital asset within the meaning of section 2(47) attracting sections 34(3)(b) and 155(5) of the Act. The transfer is clearly by the assessee in this case.
15. We, therefore, answer the question referred to us in the affirmative, that is, in favour of the department and against the assessee. Being a question of law on which there has been no authoritative ruling of this court, we direct the parties to bear their respective costs.
16. A copy of this judgment under the seal of the High Court and the signature of the Registrar will be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.
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