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Mahabir Parshad v. Commissioner Of Income Tax
Concise Structured Summary of the Provided Opinion
Factual and Procedural Background
This judgment disposes of I.T. Reference Nos. 39 and 40 of 1976 together because a common question of law is involved.
Facts (as stated in I.T. Ref. No. 40 of 1976): The applicant is a Hindu Undivided Family (HUF). For the relevant year (described as "the previous year") the assessee derived share income from a partnership firm carrying on business in the name M/s. Kewal Ram Uggar Sain (and also M/s. Union Metal Industries as branch). The original partnership instrument dated 30 June 1951 recorded eight partners. Four partners (Kirat Chand, Mahabir Parshad, Sukhbir Parshad and Phool Chand) retired on 19 January 1967 and were paid a total of Rs. 10,00,000 on retirement. Their respective profit shares in the firm were recorded as 3 1/2 annas, 2 annas, 1 1/2 annas and 1 anna per rupee. No deed of dissolution was executed when these four partners retired.
On 20 January 1967 a new partnership instrument was executed for a reconstituted firm that carried the same name and again consisted of eight partners (the four surviving partners from the old firm and four incoming partners). The old firm prepared a balance-sheet as on 19 January 1967 showing debits and credits in respect of outgoing partners. On 28 January 1967 a memorandum was executed by twelve individuals (the four outgoing partners, four surviving partners and four incoming partners).
Tax treatment history: - The Income Tax Officer (ITO) examined payment particulars in relation to sums received by outgoing partners. Concerning Rs. 2,50,000 received by Mahabir Parshad, the ITO treated Rs. 50,000 as the assessee's 1/8th share of goodwill (valued at Rs. 4,00,000) and treated the remaining Rs. 2,00,000 as business profits (revenue receipt). - The Assistant Commissioner (AAC) reversed the ITO's treatment, holding the Rs. 2,00,000 assessment was protective, that the amount was not a revenue receipt and that it was not assessable even as capital gains because of the bar in Section 47(ii) of the Income-tax Act. The AAC directed exclusion of the amount from the assessee's income. - On appeal by the Revenue, the Income-tax Appellate Tribunal (Tribunal) upheld a different view: it held the case squarely covered by the Supreme Court's ratio in CIT v. Gangadhar Baijnath (1972) 86 ITR 19 and treated the contested sum as business receipt.
The Tribunal referred two questions of law to this court (one in each reference) asking whether the Tribunal was justified in law in holding the sums (Rs. 2,00,000 in Ref. No. 40; Rs. 1,50,000 in Ref. No. 39) to be business receipts includible in the computation of the assessee's income.
After hearing counsel and reviewing the record, this court concluded it could not decide the referred questions finally on the facts found by the Tribunal and directed the Tribunal to submit a supplementary statement of the case addressing specific factual allocations (whether the compensation related to capital assets and/or capitalised profit and the amounts involved). The Tribunal was directed to submit the supplementary statement within two months.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in law in holding that a sum of Rs. 2,00,000 (I.T. Ref. No. 40 of 1976) is a business receipt and therefore includible in the computation of the assessee's income?
- Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in law in holding that a sum of Rs. 1,50,000 (I.T. Ref. No. 39 of 1976) is a business receipt and therefore includible in the computation of the assessee's income?
Arguments of the Parties
Assessee's Contentions
- The assessee (retiring partner) contended that the amounts received on retirement represented the value of the partner's share in the distributed assets of the firm rather than revenue/profits arising from business.
- With respect to Mahabir Parshad's Rs. 2,50,000 receipt, the assessee asserted that only the portion representing goodwill (based on quota rights) should be recognized as capital and not the entire sum as revenue.
ITO / Revenue Position
- The ITO rejected the assessee's contention that the payment merely represented a share of distributed assets and treated Rs. 2,00,000 (out of Rs. 2,50,000) as profits and gains from business (revenue receipt), allowing only Rs. 50,000 as goodwill (capital component).
- The Revenue appealed the AAC's reversal of the ITO and sought treatment of the disputed amounts as business receipts.
AAC and Tribunal Positions (administrative adjudicators)
- The AAC held the ITO's assessment of Rs. 2,00,000 to be protective, concluded the amount was not a revenue receipt, and further concluded it was not assessable even as capital gains because of the bar in Section 47(ii) of the Income-tax Act; the AAC directed exclusion of the amount from income computation.
- On appeal by the Revenue, the Tribunal applied the Supreme Court's decision in CIT v. Gangadhar Baijnath and concluded that where a person joins a partnership at will (in the course of business) and later receives a payment on termination/settlement of rights, such payment represents profits which the assessee would have made if the contract had been performed; accordingly the Tribunal treated the contested sums as business receipts.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| CIT v. Gangadhar Baijnath [1972] 86 ITR 19 (Supreme Court) | The principle that where a person, in the course of his business, enters into a partnership terminable at will and on termination receives payment in settlement of his rights arising from that partnership, such payment represents profits which the assessee would have made had the contract been performed. | The Tribunal relied on this ratio to treat the amounts paid to retiring partners as business receipts. The Tribunal held the present case to be squarely covered by this precedent. This court (on reference) recorded the Tribunal's reliance on that ratio but required further factual clarification before finally deciding the referred questions. |
Court's Reasoning and Analysis
After hearing counsel and considering the record, the court proceeded as follows:
- The court noted the factual findings and documentary material placed before the Tribunal, including (a) the total sum of Rs. 10,00,000 paid to the four outgoing partners, (b) the ITO's estimation of goodwill (half share of goodwill valued at Rs. 2,00,000) and its deduction from total compensation, and (c) the existence of a memorandum dated 28 January 1967 (Clause (3) and an annexed schedule) indicating full and final settlement and transfer of rights, titles and interests in the firm’s movable and immovable properties to the reconstituted firm.
- The court observed that Clause (3) of the memorandum and the schedule explicitly stated that the reconstituted firm became the absolute and irrevocable owner of all movable and immovable properties, assets and liabilities (including stock-in-trade, land, machinery, plant and equipment, etc.) specified in the schedule. On this basis the court concluded that the compensation paid to retiring partners included amounts attributable to capital assets.
- Given the overlap of possible capital and revenue elements in the overall Rs. 10,00,000 settlement (and the ITO's differing allocation), the court found that the referred legal questions could not be finally decided on the facts as found by the Tribunal without further factual and quantification assistance from the Tribunal.
- Consequently the court identified two discrete factual issues requiring clarification from the Tribunal:
- (1) Whether the compensation paid to the outgoing partners related to capital assets, and if so, the amount of compensation attributable to capital assets;
- (2) Whether the compensation also represented capitalised profit, and if so, the amount thereof.
- On the basis that these factual allocations were material to the legal characterisation (capital vs. revenue) of the payments and to the application of precedent (such as Gangadhar Baijnath), the court directed the Tribunal to prepare and submit a supplementary statement of the case addressing those points within two months.
Holding and Implications
Holding:
The court did not decide the referred legal questions finally on the record before it and directed the Income-tax Appellate Tribunal to submit a supplementary statement of the case within two months addressing specific factual allocations (whether the compensation related to capital assets and/or capitalised profit and the amounts involved).
Implications:
- Immediate effect on parties: The Tribunal must clarify and quantify the portions of the Rs. 10,00,000 compensation that relate to capital assets and to capitalised profit. Until the Tribunal supplies that supplementary statement and the court adjudicates further, the legal question whether the contested sums (Rs. 2,00,000 in Ref. No. 40 and Rs. 1,50,000 in Ref. No. 39) are business receipts includible in income remains undetermined.
- The opinion does not purport to lay down a new legal precedent; rather it seeks further factual findings from the Tribunal so that the referred legal questions can be finally determined in accordance with applicable law and precedent (including the Supreme Court decision referenced).
This summary is limited strictly to information contained in the provided opinion and does not add or infer facts beyond the opinion's text.
1. This judgment will dispose of I.T. Ref. Nos. 39 and 40 of 1976. Since a common question of law is involved in both these references, the same are being disposed of by a common judgment.
2. The facts as given in I.T. Ref. No. 40 of 1976, may thus be stated. The applicant assessee is an HUF. The financial year was the previous year. The assessee had been deriving share income from a partnership firm working in the names, (i) M/s. Kewal Ram Uggar Sain, and (ii) M/s. Union Metal Industries, respectively, at head office and branch office. The firm, M/s. Kewal Ram Uggar Sain, was constituted as per instrument of partnership dated 30th June, 1951. It consisted of eight partners out of whom four partners, namely, Sarvshri Kirat Chand. Mahabir Parshad, Sukhbir Parshad and Phool Chand, retired from the partnership on 19th January, 1967. At the time of their retirement, the said four partners were paid a total sum of Rs. 10,00,000. The said four outgoing partners had in the profits of the said firm shares to the extent of 3 1/2 annas; 2 annas; 1 1/2 annas and 1 anna per rupee respectively. The interest of these outgoing partners in the assets of the said partnership had not been specified to be different. No deed of dissolution was executed when these four partners went out.
3. However, on 20th January, 1967, a new instrument of partnership was executed. The new partnership was also to work in the name and style of the old firm and it was again to consist of eight partners amongst whom four were the surviving partners of the old firm and the other four came in as new partners. The old firm prepared its balance-sheet as on 19th January, 1967, showing an amount of Rs. 1,01,069 odd standing to the debit of the outgoing partner, Shri Kirat Chand, and certain amounts standing to the credit of the outgoing partners, Sarvshri Mahabir Parshad, Sukhbir Parshad and Phool Chand. Eight days subsequent to the execution of the new instrument of partnership, all the twelve individuals, including the four outgoing partners of the old firm, the four surviving partners of the old firm and the four incoming partners to the new firm, executed a memorandum dated 28th January, 1967.
4. While dealing with the amount of Rs. 2,50,000 received by the outgoing partner, Shri Mahabir Parshad, the ITO noted that the said amount had been received by Mahabir Parshad in lieu of his share in the business including quota rights, quota entitlements, trade mark, ISI mark, import/industrial Licences and other movable and immovable properties belonging to the old firm standing in the name of all or any of the partners of the firm. The ITO repelled the assessee's contention that the amount received by him represented the value of his share in the distributed assets of the firm. He, however, accepted the assessee's contention to the limited extent that the said amount included the value of the assessee's share of the firm's goodwill (based on quota rights). The ITO estimated the total value of the firm's goodwill as on 19th January, 1967, at Rs. 4,00,000 (by implication) and computed the value of the assessee's 1/8th share at Rs. 50,000. The balance amount of Rs. 2,00,000 was treated by the ITO as the assessee's profits and gains from the business.
5. On appeal, the AAC held that the assessment of Rs. 2,00,000 was of a protective nature, and that the amount in question was not a revenue receipt and further it was not assessable even as capital gains because of the bar in Section 47(ii) of the I.T. Act (hereinafter referred to as "the Act"). The order of the ITO was, therefore, reversed and the amount in question was directed to be excluded from the computation of the assessee's income.
6. On an appeal filed by the Revenue, the Appellate Tribunal held that the present case was squarely covered by the ratio of the judgment of their Lordships of the Supreme Court in CIT v. Gangadhar Baijnath [1972] 86 ITR 19. The Tribunal held as follows in para. 8 of its judgment:
"8. The proposition laid down by the Supreme Court in the case of Gangadhar Baijnath, was that if a person in the course of his business entered into a partnership terminable at will and later on termination of the contract of partnership, such person received any payment in settlement of his right as a result of the termination of the contract, the amount of such payment represented profits which the assessee would have made if the contract had been performed. The Supreme Court had also before laying down the said propositions noticed that the assessee in the case of Gangadhar Baijnath [ 1972] 86 ITR 19 (SC), had various business activities and that his joining the partnership firm was only one such activity. The assessee's learned representative contended that in the instant case there was no material on record to show either that the assessee at the time of joining the old firm in June, 1951, had any business activity at all or that his joining the old firm was one of the business activities already carried on by the assessee. This certainly would be a distinguishing feature warranting exclusion of the applicability of the ratio in Gangadhar Baijnath's case to the present case. We are, however, unable to hold that by joining the old firm, the assessee had not replaced one trading activity by another or that the act of joining the firm was not just one of the activities of business earlier carried on by the assessee. We find that the opening recital of the partnership deed dated June 30, 1951, clearly mentions that the assessee Mahabir Parshad (described as partner. No. 5 in that deed) had been earlier carrying on business until before 30th June, 1951, in partnership with six other partners (five of them being partners of the firm constituted on 30th June, 1951, and one Padam Parshad who expired before 30th June, 1951). Though the succeeding recital in the said deed suggests that until before 30th June, 1951, the assessee had been carrying on partnership business in a capacity other than as an individual, that would not in our opinion detract from the fact that the assessee's act of joining the firm reconstituted on 30th June, 1951, was either by way of continuation or by way of replacement of the assessee's earlier business activity. The written partnership deed dated 30th June, 1951, was also like the oral partnership deed dated 29th April, 1946, in the Supreme Court case of Gangadhar [ 1972] 86 ITR 19, a partnership at will. Though there is no material on record to show that the assessee or any of the six other partners of the firm working till before 30th June, 1951, owned any of the quota rights, entitlements, licences, etc. owned by all or some of the partners of the firm as on 19th January, 1967, the said factor would not render the propositions of law laid down by the Supreme Court in the case of Gangadhar Baijnath inapplicable to this case. The reason is that in view of our finding regarding the continuance or replacement of the assessee's earlier business activity (until before 30th June, 1951), by the act of joining the reconstituted firm on 30th June, 1951, the receipt of the amount in question has to be held to be a receipt by way of settlement of the assessee's rights resulting from termination of the partnership contract dated 30th June, 1951, as contemplated in the reported case of Gangadhar Baijnath."
7. On an application being made by the assessee, the Tribunal has referred the following question of law for the opinion of this court:
"Whether, on the facts and in the circumstances of the case, was the Income-tax Appellate Tribunal justified in law in holding that a sum of Rs. 2,00,000 is a business receipt and as such includible in the computation of the assessee's income ?"
8. I.T. Ref. No. 39 of 1976 has been made at the instance of another retiring partner of the firm, Shri Sukhbir Parshad. In his case, a sum of Rs. 1,50,000 has been held to be business income and has been assessed as such. The remaining facts are the same as have been narrated while dealing with I.T. Ref. No. 40 of 1976. The following question of law has been referred by the Tribunal for the opinion of this court at the instance of the assessee in this reference :
"Whether, oil the facts and in the circumstances of the case, was the Income-tax Appellate Tribunal justified in law in holding that a sum of Rs. 1,50,000 is a business receipt and as such includible in the computation of the assessee's income?"
9. After hearing the learned counsel for the parties and taking into consideration the material on the record, we are of the opinion that the questions of law referred to this court cannot be decided by us finally oh the facts found by the Tribunal and it would be necessary to ask the Tribunal to submit a supplementary statement of the case on certain points. Total amount paid to the outgoing partners was Rs. 10,00,000. The ITO estimated half share of the goodwill based on quota rights as Rs. 2,00,000. This amount has been deducted from the total compensation received by the retiring partners. A sum of Rs. 10,00,000 was paid to the retiring partners in full and final settlement of the transfer of goodwill, quota rights, quota entitlements and all other rights, titles and interest in the movable and immovable properties of the old firm comprising of the stock-in-trade materials, book-debts, contracts, etc., etc. This is quite clear from Clause (3) of the memorandum dated 28th January, 1967, a copy of which is annex. F with the paper-book. It has been further provided that the reconstituted firm became the absolute and irrevocable owner of all the movable and immovable properties, titles, rights and interest in the properties of the old firm as specified in the schedule. In the schedule we find mention of the land, machinery, plant and equipment, all assets and liabilities of the firm including the stock-in-trade, etc., etc. A look at the schedule clearly points out that the interests in movable and immovable properties were transferred by the outgoing partners and compensation of Rs. 10,00,000 received by them included the capital assets. With a view to answer the questions referred to this court, we deem it necessary to call upon the Tribunal to submit a supplementary statement of the case on the following points:
(1) Did the compensation, paid to the outgoing partners, relate to the capital assets ? If so, what is the amount of compensation payable in that regard ?
(2) Did the compensation also represent the capitalised profit ? If so, what is the amount of compensation payable in that regard ?
10. We accordingly direct the Tribunal to make a supplementary statement of the case and submit the same to this court within two months from today.
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