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Cit, Up v. Sh. Bankey Lal Vaidya (Dead) By Lawyers .
Factual and Procedural Background
The respondent, acting as Karta of a Hindu undivided family, entered into a partnership with Devi Sharan Garg for manufacturing and selling pharmaceutical products and related literature. Upon dissolution of the partnership on 27 July 1946, the firm’s assets—including goodwill, machinery, furniture, medicines, a library and copyrights—were valued at ₹2,50,000. Under the dissolution arrangement, Garg took over the business and assets while the respondent received ₹1,25,000 as the money-value of his share.
During assessment year 1947-48 the Income Tax Officer sought to tax ₹70,000 of that amount as capital gains. Successive appeals to the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal failed, though the Tribunal reduced the figure to ₹65,000. At the Tribunal’s instance, the following question was referred to the Allahabad High Court under section 66(1) of the Indian Income-tax Act, 1922: “Whether, on a true interpretation of sub-section (1) of section 12-B of the Income-tax Act, the sum of ₹65,000 has been correctly taxed as capital gains?” The High Court answered in the negative. The revenue, armed with a certificate, appealed to the Supreme Court, resulting in the present decision.
Legal Issues Presented
- Whether the payment of ₹1,25,000 to the respondent upon dissolution of the firm constituted a “sale, exchange or transfer” of capital assets so as to attract liability to tax under section 12-B(1) of the Indian Income-tax Act, 1922.
Arguments of the Parties
Appellant (Revenue)
- Contended that the respondent’s receipt of ₹1,25,000 amounted to capital gains arising from a “sale, exchange or transfer” of capital assets within section 12-B(1).
- Relied on James Anderson v. CIT, urging that where assets are realised and cash distributed, the transaction falls outside the protective proviso and is taxable.
Respondent
- Maintained that the payment represented merely his share of the distributed assets on dissolution, not a sale or transfer, and therefore lay outside the ambit of section 12-B(1).
- Argued that the proviso excluding transfers upon dissolution of a firm applied, so no capital-gains tax could be levied.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| James Anderson v. CIT | If capital assets are sold and cash distributed to legatees, the proviso to section 12-B(1) does not protect the transaction; resulting gains are taxable. | Distinguished; the present case involved no sale of assets but distribution of value upon dissolution, so the Anderson principle did not apply. |
| Commissioner of Income Tax, Madhya Pradesh v. Dewas Cine Corporation | “Sale” under the Act denotes transfer of property for a price; allocation of partnership assets to partners on dissolution is not a sale. | Followed; supported the finding that adjustment of partners’ rights through distribution of assets (or their money-value) does not amount to a taxable sale or transfer. |
Court's Reasoning and Analysis
The Supreme Court held that liability under section 12-B(1) arises only upon a “sale, exchange or transfer” of capital assets. Analysing the dissolution arrangement, the Court found:
- No sale or exchange occurred; the respondent did not convey his share to Garg for a price but simply received the monetary equivalent of that share during distribution of partnership assets.
- Distribution of assets (whether in specie or as their assessed money-value) is a recognised method of settling the accounts of a dissolved firm and constitutes neither sale nor transfer.
- The third proviso to section 12-B(1) specifically excludes transfers of capital assets upon dissolution of a firm from the ambit of “sale, exchange or transfer.”
- James Anderson was inapplicable because that case involved an actual sale of assets by an executor, whereas the present case involved internal adjustment between partners.
- Reliance on Dewas Cine Corporation reinforced the view that allotment of assets to partners on dissolution is not a sale for tax purposes.
Holding and Implications
The appeal was dismissed; the question referred was answered in the negative.
Consequently, the ₹65,000 received by the respondent was not taxable as capital gains. The decision confirms that, under the 1922 Act, distribution of a partner’s share upon dissolution of a firm—whether by allotment of assets or payment of their monetary value—does not constitute a sale, exchange or transfer attracting capital-gains tax. The ruling clarifies the scope of section 12-B(1) without establishing new precedent beyond reaffirming existing principles.
J.C Shah, C.J— The respondent who is the Karta of a Hindu undivided family entered on behalf of the family into a partnership with one Devi Sharan Garg to carry on the business of manufacturing and selling pharmaceutical products and literature relating thereto. On July 27, 1946 the partnership was dissolved. The assets of the firm which included goodwill, machinery, furniture, medicines, library and copyright in respect of certain publications were valued at the date of dissolution at Rs 2,50,000. The respondent was paid a sum of Rs 1,25,000 in lieu of his share and the business together with the goodwill was taken over by Devi Sharan Garg.
2. In proceedings for assessment of the respondent for the year 1947-48 the Income Tax Officer sought to bring an amount of Rs 70,000 to tax as capital gains. The contention raised by the respondent that no part of the amount of Rs 1,25,000 received by the respondent represented capital gains was rejected by the Income Tax Officer, Appellate Assistant Commissioner and the Income Tax Appellate Tribunal. The Tribunal however reduced the amounts capital of gains brought to tax to Rs 65,000. The Tribunal referred the following question to the High Court of Allahabad under Section 66(1) of the Indian Income Tax Act, 1922:
“Whether on a true interpretation of sub-section (1) of Section 12-B of the Income Tax Act, the sum of Rs 65,000 has been correctly taxed as capital gains.”
The High Court answered the question in the negative. Against that order, with certificate granted by the High Court, this appeal has been preferred.
3. Section 12-B(1), insofar as it is relevant provides:
“The tax shall be payable by an assessee under the head ‘Capital gains’ in respect of any profits or gains arising from the sale, exchange or transfer of a capital asset effected after the 31st day of March, 1946 ... and such profits and gains shall be deemed to be income of the previous year in which the sale, exchange or transfer took place:
Provided....
Provided further….
Provided further that any transfer of capital assets ... on the dissolution of a firm or other association of persons, ... shall not, for the purposes of this section, be treated as sale, exchange or transfer of the capital assets;
* * *”
4. Liability to pay capital gains arises under Section 12-B(1) if there be a sale, exchange or transfer of capital assets. There was no sale or exchange of his share in the capital assets of the firm by the respondent to Shri Devi Sharan Garg. Nor did he transfer his share in the capital assets. The assets of the firm included the goodwill, machinery, furniture, medicines, library and the copyright in respect of certain publications. A large majority of the assets were incapable of physical division and the partners agreed that the assets be taken over by Devi Sharan Garg at a valuation, and the respondent be paid his share of the value in money. Such an arrangement, in our judgment, amounted to a distribution of the assets of the firm on dissolution. There is no clause in the partnership agreement providing for the method of dissolution of the firm or for winding up of its affairs. In the course of dissolution the assets of a firm may be valued and the assets divided between the partners according to their respective shares by allotting the individual assets or paying the money-value equivalent thereof. This is a recognised method of making up the accounts of a dissolved firm. In that case the receipt of money by a partner is nothing but a receipt of his share in the distributed assets of the firm. The respondent received the money-value of his share in the assets of the firm; he did not agree to sell, exchange or transfer his share in the assets of the firm. Payment of the amount agreed to be paid to the respondent under the arrangement of his share was therefore not in consequence of any sale, exchange or transfer of assets.
5. To persuade us to take a different view, reliance was placed on behalf of the Revenue upon James Anderson v. CIT. In that case the assessee held a power of attorney from the executor of a deceased person, in the course of the administration of his estate. He sold certain shares and securities belonging to the deceased for distribution among the legatees. The excess realised by sale was treated by the Income tax Department as capital gains. The contention of the assessee that since the sale of the shares and securities fell within the purview of the third proviso to Section 12-B(1) it could not be treated as a sale of capital assets within the meaning of Section 12-B(1), was rejected by this Court. This Court observed that the object of the third proviso to Section 12-B(1), in providing that “any distribution of capital assets under a will” shall not be treated by sale, exchange or transfer of capital assets for the purpose of Section 12-B was that as long as there was distribution of capital assets in specie and no sale, there was transfer for the purposes of that section, but if there was a sale of the capital assets and profits or gains arose therefrom, the liability to tax arose, whether the sale was by the administrator or executor or a legatee, and that the expression “distribution of capital assets” in the third proviso to Section 12-B(1) meant distribution in specie and not distribution of sale proceeds. That case has no application. There was no distribution of capital assets between the legatees: the assessee had pursuant to the authority reserved to him from the executor of the deceased person sold the shares and securities, and from the sale of shares and securities capital gains resulted. In the case in hand there is no sale and payment of price, but payment of the value of share under an arrangement for dissolution of the partnership and distribution of the assets. The rights of the parties were adjusted by handing over to one of the partners the entire assets and to other partner the money-value of his shares. Such a transaction is not in our judgment a sale, exchange or transfer of assets of the firm.
6. In CIT v. Dewas Cine Corporation in dealing with the meaning of the expression “sale” and “sold” as used in Section 10(2)(vii) of the Income Tax Act, 1922, this Court observed that the expression “sale” in its ordinary meaning is a transfer of property for a price and adjustment of the rights of the partners in a dissolved firm by allotment of its assets is not a transfer for a price. In that case the assets were distributed among the partners and it was contended that the assets must in law be deemed to be sold by the partners to the individual partners in consideration of their respective shares and the difference between the written-down value and the price realised should be included in the total income of the partnership under the second proviso to Section 10(2)(vii). This Court observed that a partner may, it is true, in an action for dissolution insist that the assets of the partnership be realised by sale of its assets, but property allotted to a family in satisfaction of his claim to his share, cannot be deemed in law to be sold to him.
7. We therefore agree with the High Court that the question referred to must be answered in the negative.
8. The appeal fails and is dismissed with costs.
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