Vadilal Dairy Frozen Food Industries v. Income-tax Officer

R. M. Mehta, Accountant Member - These are cross appeals^_ one preferred by the assessee and the other by the Department. As these arise out of the same order of the Commissioner (Appeals) and having been heard together, we dispose of the same by means of a consolidated order.

2. We shall first take up for consideration the assessee's appeal in which the first ground pertains to the addition of a sum of Rs. 1,00,500, being the amount brought to tax by the ITO under section 41(2) of the Income-tax Act, 1961. In making the impugned addition, the ITO recorded the following facts and reasons:

"Gas Cylinders: Opening WDV of 425 gas cylinders nil, additions of 580 gas cylinders during the year at Rs. 7,61,737, depreciation claimed during the year Rs. 7,61,737. Then these 1005(425 + 580) cylinders were revalued by the partners at Rs. 1,00,500 and taken over by the partners at Rs. 1,00,500.

The above assets had been taken over by the partners by crediting the corresponding asset account and debiting the capital accounts in profit sharing ratios. Vide this office notices dated 22nd February, 1985 and 23rd March, 1985, the assessee-firm was requested to show-cause why the firm be not treated as having sold the above assets to its partners. In this case the attention of the assessee-firm was also invited to the case of A.S. Krishna Shetty v. Addl. Commissioner, Mysore reported at (1975) 100 ITR 587 (Kar.).

In the replies dated 1st March, 1985 and 25th March, 1985 on it was stated by the assessee that:

(i) It was not a case of sale, but returning part of the capital to the partners in their profit sharing ratio,

(ii) there was no transfer and hence 100 ITR 587 (Kar.) (supra) would not apply.

I am however unable to agree with the assessee-firm that on these facts and circumstances there was no "transfer" of assets by the firm to its partners. For this reference is made to the commentary by Chaturvedi and Pithsaria (1979) Ed., Vol. I, page 636) where it has been observed as under:

"Under the general principles of law, when a partner brings in, or takes out any asset into or from his partnership firm no sale is involved. But the 1961 Act, introduced a definition for the word "transfer" in section 2 (47), to include "the sale, exchange or relinquishment of the asset or the Extinguishment OF ANY RIGHT THEREIN or the compulsory acquisition thereof under law. As this definition came into effect on and from 1st April, 1962, transaction done before date do not come within this definition and are governed by the general principles of law. Transactions whereby a partner brings in, or takes away a capital asset, into or from the partnership firm on or after 1st April, 1962, shall for all the purposes of the Act, be construed as transfers to or by the firm".

Now let us discuss the aforesaid Karnataka High Court decision reported at (1975) 100 ITR 587 (Kar.) . There the assessee-firm was carrying business as mundy merchants and it also owned a cinema theatre, a rotary oil mill and a coir factory. On 31st March, 1965 the coir factory was transferred in favour of four of the seven partners, the rotary oil Mills was transferred in favour of the three partners. Thereafter the partners who took over the item of properties, entered into separate deeds of partnership in respect of those items of business. The assessee-firm continued to carry on the business of cinema theatre. The question before Hon'ble High Court was whether the aforesaid taking away of some assets of the firm, by the partners, during the subsistence of partnership would amount to "transfer" and, if so, withdrawal of development rebate was called for under section 34 (3)(b) of Income-tax Act, 1961. Following the decision of Supreme Court in Addanki Narayanappa v. Bhaskar Krishnappa AIR 1986 SC 1300 it was observed by the Hon'ble Karnataka High Court that the individual partners of a firm have no exclusive interest in the assets belonging to a firm (so long as a firm is continuing to carry on business). The case of Commissioner v. Dewas Cine Corporation (1968) 68 ITR 240 (SC) was distinguished on the ground that, the case was in respect of distribution of partnership assets on dissolution of firm. In the case before Hon'ble Karnataka High Court, it was not the case of dissolution of firm but taking away of assets by the partners during the subsistence of firm. Rejecting the argument on behalf of the assessee that there was only an adjustment of the rights of the partners in respect of the partnership capital (and hence no transfer in the eyes of law), the Hon'ble High Court held that there was a "transfer" of assets in the above facts and circumstances calling for withdrawal of development rebate.

In view of discussion above, it is held that there was a "transfer" of furniture, motor trucks, autorickshaws and gas cylinders by the assessee-firm to its partners on 31st December, 1981. In respect of furniture, motor-trucks, auto-rickshaws the transfer was at book value whereas in the case of gas cylinders the book value (after claiming 100 per cent depreciation) was nil but they were transferred to partners for Rs. 1,00,500. This transfer of gas cylinders was for a consideration of Rs. 1,00,500, which was paid to the firm by debiting the partners' capital a/cs. and hence would amount to sale. Once this is treated as sale, section 41(2) would come to play and profit under that section would work out at sale price minus book value i.e. (Rs. 1,00,500-0) = Rs. 1,00,500. Keeping in view the above discussions profit under section 41(2) to be added to total income would calculate at Rs. 1,00,500."

The Commissioner (Appeals) confirmed the action of the ITO in making the aforesaid addition and did not record any separate reasons in opening so.

3. In the course of his lengthy arguments, the learned counsel for the assessee reiterated the arguments already advanced before the lower authorities. He laid stress on the fact that the cylinders had been given to the partners in their profit sharing ratio only as a return of capital and no `sale' or `transfer' was involved with a view to attract the provisions of section 41(2). He also invited our attention to the fact that along with the gas cylinders certain other items such as furniture, motor-trucks and an auto-rickshaw we also given to the partners, once again in their profit sharing ratio and the latter items had been accepted by the ITO without resorting to the provisions of section 41(2). According to him, the decision of the Karnataka High Court in the case of A.S. Krishna Shetty v. Addl. Commissioner (supra) did not apply to the facts of the present case since that pertained to the return of capital to some of the partners whereas the present situation dealt with a return of capital to all the partners. It was further submitted that insofar as the property of the firm was concerned, it was collectively owned by the partners and they were entitled to take back this property by adjusting it towards their capital. In support of his arguments, the learned counsel for the assessee relied on the following decisions:

Commissioner v. R.M. Chidambaram Pillai (1977) 106 ITR 292 (SC). 2. Addanki Narayanappa v. Bhaskar Krishnappa (supra).

He also referred to a decision of the Gauhati Bench of the Tribunal reported in Bilasiram & Sons v. ITO (1978) TTJ (Gau) 443.

4. The learned Departmental Representative, on the other hand, strongly supported the order of the ITO wherein detailed facts and reasons had been given for making the addition in question. According to him, the provisions of section 41(2) were squarely applicable since the transaction in question was not a return of capital but a sale/transfer. It was also submitted that no dissolution had taken place necessitating the transfer of any assets to the partners. According to him, the order of the Commissioner (Appeals), which confirmed the action of the ITO merits confirmation.

5. We have examined the rival submissions and have also perused the orders of the lower authorities. The material on record to which our attention was invited by the parties has also been duly considered. It appears that the assessee, during the year under consideration, has transferred certain assets to its partners out of which the furniture, motor-trucks and an auto-rickshaw have been transferred at the written down value. This aspect of the matter has been discussed in detail by the ITO as also the reasons for non-attraction of any tax liability to the aforesaid three transfers. The ITO has only taken into consideration the transfer of the gas cylinders for purposes of computing the profit under section 41(2). According to the facts which have been brought forth, the assessee had an opening balance of 425 gas cylinders, the WDV being `nil' since 100 per cent depreciation had been claimed in the preceding assessment year and such depreciation having been allowed under the Rules. During the year under consideration, the assessee had purchased 580 gas cylinders for a sum of Rs. 7,61,737. Once again 100 per cent depreciation was claimed and the figure on 31st December, 1981, being the last day of the year, reflected a `nil' balance. On this date, the assessee transferred the other three assets, namely, furniture, motor-trucks and the auto-rickshaw and the ITO very rightly accepted these transfers since no tax liability was attracted. With a view to transfer the gas cylinders to the partners, the assessee adopted the method of first of all revaluing this asset at a figure of Rs. 1,00,500. For this purpose it passed three separate entries which are as follows;

A perusal of the aforesaid entries clearly reveals the fact that each of these entries are contra entries but these have resulted in transferring gas cylinders, earlier the property of the firm, to the partners. This transfer could have only come into being provided the entry for revaluation would have been passed since it was not possible to transfer something in the books, the value of which was Zero. We would like to observe that entries for "revaluation" are normally passed in the books of account in the following circumstances:

1. On the dissolution of a firm;

2. On the retirement of certain partners;

3. On the induction of new partners.

This revaluation is necessary since in any of the aforesaid situations the rights and liabilities of the partners have to be determined and adjusted. According to us it seems rather strange that the entry for revaluation in respect of gas cylinders should be passed when none of the aforesaid three situations exist. As mentioned earlier we would reiterate that this was a "ploy" to transfer the cylinders to the partners and that also at a nominal figure of Rs. 1,00,500 whereas on the same date i.e. 31st December, 1981, the assessee had written-off the gas cylinders to the tune of Rs. 7,61,737. However, the figure of Rs. 1,00,500 is not disputed by the Department and we do not make any observations on this aspect of the matter.

6. In case the aforesaid distribution of the assets was at the time of dissolution of the firm or retirement of a partner it May, not have posed a very difficult proposition. But in the instant case the position is that the distribution is during the existence of the firm as also with the same set of partners. It is in these circumstances that one has to examine whether the transaction in question constitutes a sale/transfer. In this connection it would be relevant to reproduce the following observations of the Hon'ble Supreme Court in Addanki Narayanappa v. Bhaskar Krishnappa (supra):

"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. 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…..." (p. 1303).

The position elaborated later in the same judgment as follows:

"…....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 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. He would not be able to exercise his right even to the extent of his share in the business of the partnership. As already stated his right during the subsistence of the partnership is to get his share of profits from time to time as May, be agreed upon among the partners and after the dissolution of the partnership or with his retirement from partnership of the value of his share in the net partnership assets as on the date of dissolution or retirement after a deduction of liabilities and prior charges"……(p. 1304)

7. The aforesaid decision of the Supreme Court has also been considered by the Hon'ble Karnataka High Court (supra). According to us there has been a transfer of the property of the firm, namely, gas cylinders, in favour of its partners and the consideration or price is paid by the partners to the firm by adjustment entries in their respective accounts. In other words, the twin ingredients to invoke the provisions of section 41(2) are present and duly satisfied. Looking at it another way, the firm has gained since on revaluation the corresponding credit to the account of the partners would have to be discharged by making a payment to them. This has, however, been overcome by passing a contra entry in the accounts of the partners. The net effect, however, as mentioned earlier, is the transfer of the gas cylinders to the partners. We would further like to observe that profit under section 41(2) has to be computed on the basis of the WDV of an asset as compared to the sale consideration etc. Written Down Value is understood to mean the cost of the asset less the depreciation allowed. In respect of these gas cylinders, the WDV as per the books of account is `nil' since 100 per cent depreciation has been claimed and allowed in accordance with the Income-tax Rules. The figure of Rs. 1,00,500, which is the value attributed to these gas cylinders on revaluation, is neither the cost nor the WDV. This would mean that the figure of Rs. 1,00,500 is not to be reduced by any other figure since the WDV of the cylinders is `nil' (figure of Rs. 1,00,500 on revaluation to be ignored). As we have already held that the transfer in question constitutes a sale/transfer and further the revaluation being a mere ploy, the provisions of section 41(2) would be clearly attracted on the ground that the gas cylinders have ceased to be the property of the firm and have become the property of the partners. In the result, the action of the Commissioner (Appeals) is confirmed.

8. The next ground in the assessee's appeal (Nos. 4 & 5) pertains to the disallowance of a sum of Rs. 1,94,472 in respect of the wages paid to the employees. The learned counsel for the assessee, however, stated that he had instructions not to press this ground for our consideration. This accordingly stands rejected.

9. The next ground in the appeal pertains to the assessee's claim for deduction under section 80-G. The ITO allowed a deduction of Rs. 8,805 out of Rs. 13,805 disallowing the balance of Rs. 5,000. The Commissioner (Appeals) confirmed the action of the ITO and in doing so observed as under:

"10. The next objection is against the action of the ITO in not allowing the deduction of Rs. 5,000 under section 80G of the Income-tax Act. The appellant has claimed deduction at 50 per cent in respect of the following amounts:

The first donation is not eligible for deduction under section 80G as the concern is not registered with the Commissioner for the purpose of section 80G. As far as donation to Revenue Unity Blindness is concerned, the assessee-firm during the course of assessment proceedings has furnished a copy of notification from Ministry of Finance, Government of India that BLINDMEN'S ASSOCIATION, AHMEDABAD WAS APPROVED by the Indian Council of Medical Research under section 35(1) (ii). However, as per provisions of section 35 such donation must be in respect of scientific research. A perusal of receipt from Blindmen's Association furnished by the assessee-firm shows that Rs. 5,000 was on account of donation for kite flying competition. In view of this, both the above payments cannot qualify for deduction under section 80G.

11. In view of the above facts the action of the ITO in disallowing an amount of Rs. 5,000 bring 50 per cent of Rs. 10,000 is held to be in order and hence calls for no interference".

10. Before us, the learned counsel for the assessee stated that the disallowance was confirmed inspite of the fact that necessary certificates were placed on record but omitted to be considered. According to him the entire payment had been made for business considerations and the same merited deduction in full. It was, however, submitted that since the evidence on record had not been properly perused, the matter should be restored back to the Commissioner (Appeals) to enable the assessee to bring the relevant evidence to his attention and seek the necessary relief. The learned Departmental Representative strongly supported the action of the Commissioner (Appeals) but stated that he had no objection if the matter goes back for a re-examination.

11. In the light of the aforesaid, we set aside the order of the Commissioner (Appeals) in respect of the issue under consideration and restore the matter once again to his file for a re-examination and after perusing the factual evidence already placed on record.

12. The last ground in the assessee's appeal pertains to the disallowance of a sum of Rs. 10,000 under section 40A(2) out of the total payment of Rs. 43,000 made to Ranchod Lal & Sons.

13. The ITO for reasons stated in para 10 of his order made the impugned disallowance. According to him, the partners of Ranchod Lal & Sons were closely related to the assessee-firm. The ITO was also dissatisfied with the nature of the services rendered by the recipient firm to the assessee-firm.

14. The Commissioner (Appeals) confirmed the disallowance on the ground that a similar point which had come up for consideration in the appeal of the sister concern of the assessee-firm had been dealt with in the same manner. She accordingly confirmed the disallowance as made by the ITO.

15. Before us, the learned counsel for the assessee submitted that the disallowance had been upheld on wrong facts and premises and the relevant evidence which was available on record had been ignored by the learned Commissioner (Appeals). It was further stated that relevant arguments advanced before the Commissioner (Appeals) and further supported by written submissions had not been duly considered and the matter had been disposed of on the short ground of a similar decision being taken in the case of the sister concern. It was requested that the matter May, be sent back for a proper re-examination in the light of the facts available on records as also the decision taken in the case of the sister concern. The learned Departmental Representative, although strongly supporting the order of the Commissioner (Appeals), stated that he had no objection to the course of action being adopted as suggested by the assessee's counsel.

16. We have examined the rival submissions and are of the view that the matter be restored back to the file of the Commissioner (Appeals) with a view to bring on record the relevant facts and also taking into account the arguments advanced by the assessee including the written submissions. The learned Commissioner (Appeals) would also examine whether the facts of the assessee's case and those of the sister concern, namely, Vadilal Soda Fountain are identical before applying the appellate decision in that case to the facts of the assessee's case. The decision of the Commissioner (Appeals) is accordingly set aside in respect of this ground.

17. As regards the Departmental appeal, the first ground pertains to the sum of Rs. 6,304 which was disallowed by the ITO under the provisions of section 40A(3) but which the Commissioner (Appeals) has allowed as a deduction.

18. The ITO in the course of the assessment proceedings found that the assessee had made a payment of the said sum on 28th August, 1977 to Das Brothers & Co., Calcutta for the purchase of wooden sticks. According to the ITO this payment was made in cash in violation of section 40A(3). The assessee's explanation was that since the purchases had been effected at Calcutta, where the assessee did not have a bank account, the payment in cash became necessary. The ITO did not accept this argument on the ground that the assessee could have made the payment by demand draft which could have been purchased from a bank in the name of the Calcutta party. It was further observed that no evidence had been produced to the effect that the party insisted on the payment in cash. The Commissioner (Appeals), however, allowed the assessee's claim on the ground that the same was covered by the exceptions to rule 6-DD.

19. The learned Departmental Representative, in the course of his arguments, strongly supported the order of the ITO and advanced arguments on lines similar to these as adopted by the ITO in making the addition. The learned counsel for the assessee on the other hand reiterated arguments identical to those as advanced before the ITO and the Commissioner (Appeals). He also invited our attention to 108 ITR 8 (Statute) wherein the various exceptions to rule 6-DD had been detailed. According to him one of these mention as a situation where the assessee did not have a bank account at the place at which the transaction was effected. He accordingly made an impassioned plea for the confirmation of the decision taken by the Commissioner (Appeals).

20. We have examined the rival submissions and have also perused the material on record to which our attention was invited. We are of the view that the assessee's case is fully covered by the exceptions to rule 6-DD and the decision of the Commissioner (Appeals) merits confirmation. The first ground in the Revenue's appeal is accordingly rejected.

21. The only other surviving ground in the Revenue's appeal pertains to the sum of Rs. 7,500 paid as membership fee to Rajpath Club and Sports Club. The ITO rejected the assessee's claim on the ground that it was not the firm which was a member of these clubs but the partners. According to him the expenditure in question was of a personal nature and did not merit any deduction. The Commissioner (Appeals), however, accepted the assessee's claim and in doing so observed as follows:

"6. The next objection is to the disallowance of an amount of Rs. 7,500 paid to Rajpath & Sports Clubs. In this regard the appellant firm had explained that these Clubs are their consumers and in order to increase their business it is essential to become a member of the same. My attention has also been drawn to the decision of the Ahmedabad. `A' Bench, Tribunal decision in Income-tax Appeal No. 1927/Ahd/81 in the case of Vulcan Alloys & Industries (P) Ltd. v. ITO dated 29th September, 1982. In the light of the above decision it is urged that in their case these clubs were also the consumers of their products and the membership merits to be allowed as a deduction.

7. On a consideration of the facts and circumstances and the decision of the Ahmedabad Tribunal relied on by the appellant, ITO is directed to allow the amount of Rs. 7,500 paid on account of membership fee of Rajpath & Sports Club".

22. The Departmental Representative in respect of this issue as well supported the order of the ITO. The learned counsel for the assessee, on the other hand, supported the order of the Commissioner (Appeals) and advanced identical arguments as before the first appellate authority.

23. We have examined the rival submissions and have also given our due attention to the order of the Tribunal (supra) referred to in the order of the Commissioner (Appeals). A copy of the same was in fact provided to us during the course of hearing. After going through the same, we are of the view that the Commissioner (Appeals) has rightly allowed the assessee's claim and her order in this respect requires to be upheld.

24. In the result, the assessee's appeal is partly allowed for statistical purposes whereas the Revenue's appeal is dismissed.