Karnataka High Court
Khoday Eswarsa And Sons vs Commisioner Of Gift-Tax on 16 March, 1990
Equivalent citations: ILR1990KAR2403, [1990]186ITR388(KAR), [1990]186ITR388(KARN)
JUDGMENT S.R. Rajasekhapa Murthy, J.
1. These references arise under section 26 of the Gift-tax Act, 1958 ("the Act" for short). T.R.C. Nos. 66 and 67 of 1982 are references under section 26(1) of the act made at the instance of the assessee and T.R.C. No. 26 of 1985 is a reference under section 26(3) of the Act at the instance of the Department. The following three questions are referred by the Income-tax Appellate Tribunal, Bangalore Bench, for our opinion (In T.R.C. Nos. 66 and 67 of 1982) :-
"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that there was a deemed gift taxable under the Gift-tax Act, 1958, for the assessment year 1970-71 in respect of the arrangement in pursuance of the agreement dated November 21, 1969, between the assessee and Messrs. Khoday Industries Pvt., Ltd. ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that a partnership firm is an assessable entity under the provisions of the Gift-tax Act, 1958 ?
(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the gift, if any, in the arrangement was not exempt under the provisions of section 5(1)(xiv) of the Act ?"
2. The following question is referred by the Tribunal on a direction issued by this court in C.P. No. 17 of 1983. (In T.R.C No. 26 of 1985) :
"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in fixing the value of the gift at Rs. 41,92,082 as against Rs. 1,10,25,000 fixed by the Gift-tax Officer ?"
3. These references arise out of a common order passed by the Tribunal on an appeal filed by the Revenue and cross-objections by the assessee.
4. Treating the transfer of the business carried on by a partnership-firm, Messrs. Khoday Eswarsa and Sons, in favour of a private limited company, Messrs. Khoday Industries Pvt., Ltd., by agreement dated November 21, 1969, as a gift under the Gift-tax Act, 1958, the Gift-tax Officer, Central Circle-I, Bangalore, levied Gift-tax on the donor, Messrs. Khoday Eswarsa and Sons by his order dated February 27, 1979. On an appeal filed by the assessee before the Commissioner of Income-tax (Appeals)-I, Bangalore, the appellate authority allowed the appeal and set aside the assessment to gift-tax. The Revenue filed an appeal against the said order before the Income-tax Appellate Tribunal, Bangalore Bench, and the assessee also preferred cross-objections. The Tribunal allowed the Departmental appeal and dismissed the cross-objections filed by the assessee. Thus, the three references arise out of the said order of the Tribunal.
5. The facts that are necessary for answering these references are these :
The assessee, a registered firm, was carrying on business in manufacturing of liquor, carbon paper, typewriter ribbon, ink, stamp-pad, gem-clips and pins, besides running an engineering workshop and other workshops, in aniline printing and twisting of silk yarn, etc. The partnership firm consisted of seven partners. On November 20, 1969, there was a partition in the assessee's family. On November 21, 1969, four partners, Sriyuths K L Ramachandra, K L Narayansa, K L Srihari and K L A Padmanabhasa, left the firm. On the same day, the firm was reconstituted by the remaining partners by taking ten children of the four partners who left the firm. On November 21, 1969, the new firm entered into an agreement with Messrs. Khoday Industries Pvt., Ltd., a company floated by the four erstwhile partners of the firm. Under the agreement, the transferor-firm, referred to as the "licensor" in the agreement, granted "licence and permission" to the private limited company, referred to as the "licence" in the agreement, to carry on and conduct the business of manufacturing Indian-made liquors, carbon paper, typewriting ribbon, etc. There was thus a transfer of the running business in the said articles and, for that purpose, handed over the premises, buildings, plant, machinery and all other equipment which were being used by the licensor for its aforementioned businesses at their factory situated at No. 11, Race Course Road, near the City Railway Station, Bangalore. The period of licence and the permission granted under the agreement was for five years commencing from November 21, 1969. This agreement was, however, subject to termination by either party giving to the other at least six calendar months' notice in writing as provided in clause 3 of the agreement. As a consideration for the agreement and the licence and the permission granted by the licensor to the licensee, the licensee agreed to pay to the licensor, licence fee or compensation calculated at 2 1/2% of the gross sale price of all the products manufactured and sold by the licensee subject to a minimum fee or compensation of Rs. 50,000 per month and a maximum fee or compensation of Rs. 60,000 per month. The licensor reserved the right of inspecting all the premises, buildings, plant, etc., besides the other clauses which are unnecessary to be reproduced for purposes of this reference.
6. The Gift-tax Officer treated the transfer of the business by the firm to the private limited company as a gift under the Gift-tax Act made for inadequate consideration and levied gift-tax on the value of the deemed gift which was computed at Rs. 1,10,25,000. The Gift-tax Officer held that there was a transfer of property within the meaning of section 2(xiv) of the Act under the agreement dated November 21, 1969, by the firm in transferring the profit-making apparatus, lock, stock and barrel to Khoday Industries Private Limited and further held that the consideration received by the assessee was inadequate and the provision of section 4(1) of the Act were attracted. The Gift-tax Officer calculated the market value of the gift on the date of transfer and arrived at the date of the deemed gift at Rs. 1,10,25,000 and levied gift-tax thereon. Recording a finding that it was a case of a transfer otherwise than for adequate consideration, the difference between the market value of the property on the date of the transfer and the value of the consideration was considered as a gift made by the transferor under section 4(1)(a) of the Act. While determining the value of the gift, the Gift-tax Officer took into consideration the book profits of the transferor firm for the immediately preceding ye ar ending March 31, 1969, and took five times this profit, discounted at 5%, as the value of the deemed gift. The computation was made having regard to the five-year period for which the business was transferred. The Gift-tax Officer also rejected the contention of the assessee that it was a case of a transfer made bona fide for the purpose of the business carried on by the assessee firm.
7. In the appeal preferred by the assessee against the Gift-tax Officer's order, the Commissioner of Income-tax (Appeals) confirmed the following findings of the Gift-tax Officer :
(i) that there was a gift made by the assessee under the agreement of transfer;
(ii) that the firm which made the gift was an assessee under the Act; and
(iii) that the consideration for the transfer was not adequate.
8. The appellate authority, however, held that the deemed gift made by the assessee under the agreement dated November 21, 1969, was exempt under section 5(1)(xiv) of the act on the ground that the gift made was for the purpose of the business of the donor. The first appellate authority, taking into consideration clause 3 of the agreement which provided for termination of the licence and permission with six months' notice by either party, held that the capitalised value at the discount of 4% per annum as per the rules for five years was Rs. 74,86,562 and that the amount of rent received and the interest-free deposit of Rs. 2 lakhs works out to 10% of the capitalised value and that this was a reasonable consideration for transfer.
9. The Appellate Tribunal reversed the finding of the first appellate authority so far as it related to exemption under section 5(1)(xiv) and held that it was a case of a deemed gift under section 4(1)(a) of the Act and the transfer was for inadequate consideration. The Tribunal, however, recomputed the capitalised by the transfer at Rs. 41,92,000 as against Rs. 1,10,25,000 as computed by the Gift-tax Officer. The Tribunal applied the provisions of section 6(2) read with rule 11 of Gift-tax Rules. The method adopted by the Tribunal in arriving at the value aforementioned is discussed in paragraph 13 of its order.
10. In the reference made at the instance of the assessee, the three questions which arise for consideration are :
"(i) Whether there was a deemed gift taxable under the Act ?
(ii) Whether a partnership firm could be an assessable entity under the provisions of the Act ? and
(iii) Whether the gift, if any, was exempt under section 5(1)(xiv) of the Act ?"
11. In the reference made at the instance of the Department, the question for consideration in :
"Whether the reduction of the value of the gift as computed by the Gift-tax Officer is correct ?"
12. Sri Sarangan, learned counsel for the assessee, challenged the findings recorded by the Appellate Tribunal and argued that the Tribunal was not justified in concluding that there was a deemed gift attracting the levy under the Gift-tax Act notwithstanding clause 3 which provided for revocation of the agreement by either party with six montsh' notice. The main thrust of the argument of learned counsel was that irrevocability is an essential feature of a gift and the Tribunal erred in ignoring the said clause and in determining the value of the gift under section 6(2) of the Act. It was also argued by learned counsel that the first appellate authority, Deputy Commissioner (Appeals), rightly exempted the gift under the provisions of section 5(1)(xiv) of the Act. It was also argued that the firm cannot be an assessee under the provisions of the Gift-tax Act.
13. Sri G. Chandrakumar, learned standing counsel for the Department, argued in support of the order of the Appellate Tribunal upholding the levy of gift-tax and also submitted that the value of the gift, as reduced by the Tribunal, requires interference and that the Gift-tax Officer's order, in this regard, should be restored. Learned standing counsel argued that the conclusion of the Gift-tax Officer as well as the Tribunal that the transfer, in the present case, was rightly treated as a deemed gift under section 4(1)(a) of the Act should be upheld. It was also his contention that, on the finding recorded by the Tribunal that it was a deemed gift, section 6(2) of the Act was rightly applied to the facts of the case.
14. The first question that arises for consideration in this case is :
"Whether there was a deemed gift under the agreement dated November 21, 1969, which was liable to tax under section 4(1)(a) of the Gift-tax Act ?"
15. It is, therefore, necessary to analyse the terms of the agreement under which the transfer took place. The assessee which is a registered firm was carrying on various businesses such as manufacture of liquor, carbon paper, typewriter ribbon, etc., and was a well-established business having a reputation in the market. Under the agreement in question, the assessee firm parted with all the businesses carried on by it, except silk and twisting of silk-yarn. All the premises, buildings, plant and machinery and other paraphernalia used by the assessee were given away by virtue of the transfer. The period of licence and permission as described in the agreement was for five years from November 21, 1969. The consideration for the transfer was that the licensee should pay 2 1/2 per cent. of the gross sale price, less excise duty, etc., subject to a minimum of Rs. 50,000 and a maximum of Rs. 60,000 per month. Khoday Industries Private Limited, the company in whose favour the transfer was made, had been formed by four of the partners of the assessee-firm who went out of the firm.
16. On a careful consideration of the various clauses of the agreement, one undisputed fact that emerges is that the entire business/businesses stood transferred to the transferee-company for a period of five years. The Appellate Tribunal, while upholding the Gift-tax Officer's order, has also taken into consideration the possibility of the renewal of the period of licence having regard to the other attendant circumstances. The entire income-earning apparatus was transferred to the company and the transferee was free to carry on the business of manufacture of several products which had acquired goodwill and a reputation in the market. Though some powers of inspection as to the quality of the products and plant and machinery were reserved to the transferors, for all practical purposes, the transferee company stepped into the shoes of the firm and took over the entire running business.
17. The Act is a self-contained enactment. The definition of "transfer of property" in section 2(xxiv) of the Gift-tax Act is a special definition for purposes of the Gift-tax Act. The purpose of this section is to rope in artificial devices which are intended to confer a gift on the donee. The definition of "gift" under section 2(xii) is wide enough to include many transactions which could not ordinarily be described as transfer of property. It has a wider import than the meaning given to "gift" in section 122 of the Transfer of Property Act. Moreover, the definition of "gift" in the Gift-tax Act is also an inclusive definition and gives an artificial extension of the meaning of the word "gift" by the use of a fiction implied by the words "deemed to be a gift under section 4". (Keshub Mahindra v. CGT [1968] 70 ITR 1 (Bom)). It is necessary under the Act to find out as to whether a transaction falls within the provisions of section 4, and for this purpose two quite separate enquiries have to be made, viz. :
(i) the existence of a "transfer of property"
(ii) the extent of consideration given, that is, whether the consideration is adequate. Any transaction whereby a person disposes of the property without adequate consideration would be a gift. The motives which prompt a gift are immaterial.
18. This case involves essentially a construction of the agreement under which the business was transferred. For this purpose, the intention of the parties to the transfer becomes relevant apart from the other clauses considered cumulatively. It is the transaction of transfer under the agreement that attracts the levy of gift-tax.
19. To infer or to conclude that the transaction has resulted in a gift, the intention must be to enter into a transaction with intent to diminish the value of one's asset and to increase the value of another. It is not the genuineness of the transaction, but the intended effect of it on the fiscal purposes establishes that is relevant. It is from this point of view that the existence of the transaction and the existence of the required intention must be investigated together having regard to the multilateral acts constituting a scheme or design.
20. The definition of "transfer of property" in the Gift-tax Act is an inclusive definition. The definition deals with the transfer of property in various ways. The words "disposition", "conveyance","assignment","settlement","delivery", etc., are used to describe various modes of transfer of property. The enumeration of the several words in the section seems to indicate that it is more appropriately associated with what property or interest therein is transferred. The transfer of property, as defined in the Gift-tax Act, may not otherwise fall within the ordinary meaning of transfer. It envisages the transfer of property only to the extent of the beneficial interest which ceases to belong to the settlor. The term "transaction" in section 2(xxiv)(d) of the Act has a special meaning and significance. It is used with reference to situations in which there is something in the nature of a contract, agreement or arrangement between persons. In this sense, it has been used to convey the extended meaning beyond the normal and limited connotation for purposes of clause (xxiv) of section 2 of the Gift-tax Act.
21. Therefore, on the facts of the present case and on a proper and careful consideration of all the relevant clauses of the agreement dated November 21, 1969, it can reasonably be concluded that there was a transfer of all the income-earning assets for inadequate consideration, resulting in a gift attracting the provisions of section 4(1) of the Gift-tax Act.
22. The next point for enquiry is whether there was inadequate consideration for transfer to attract the provisions of section 4(1) of the Act ? Section 4 deals with deemed gifts. All transactions which are in the nature of or in essence gifts are envisaged and dealt with in this section. To cover such types of transactions which confer an element of bounty or benefit but are passed off under camouflage of transfer for valuable consideration, these provisions are designed. The purpose of this sub-section is to rope in artificial devices which are intended to confer a gift on the donee, as already stated.
23. Where the property is transferred for less than adequate and full consideration in money or money's worth, the amount by which the value of the property exceeds the value of the consideration shall be deemed to be a gift and shall be included in computing the value of the gift. There is a similar provision in the Australian Gift Duty Assessment Act and the New Zealand Estate Duty and Gift Duties Act. The value of gift for the purpose of the Australian Act is the inadequacy of the consideration in the opinion of the Commissioner. Same is the law under the New Zealand Act.
24. The question of inadequate consideration has to be construed in a broad commercial sense. The essence of a transfer is the passing of control over the economic benefits of a property rather than any technical changes in title (See the decision in Dr R. B. Kamdin's case [1974] 95 ITR 476 (Bom)).
25. We, therefore, uphold the concurrent finding of all the three authorities that the transfer was for inadequate consideration resulting in a deemed gift under the Act. Therefore, we find no substance in the contention of the assessee that there was no gift.
26. Learned counsel for the assessee, however, relied on section 6(2) of the Act and rule 11 of the Rules, which real :
"6(2) Where a person makes a gift which is not revocable for a specified period, the value of the property gifted shall be the capitalised value of the income from such property during the period for which the gift is not revocable."
"Rule 11. (1) In the case of property referred to in sub-section (2) of section 6 of the Act, the capitalised value of the income shall be taken to be the product of the number of complete years included in the period for which the gift is not revocable and the average of the income received from the property during the three years or such lesser period of complete years in which such property was in existence, preceding the previous year for the year of assessment after discounting it at a rate of 4 per cent. per annul :
Provided that where the property was in existence for less than one complete year preceding the previous year for the year of assessment or came into existence in the previous year for the year of assessment, the income from such property for one complete year shall be the income which would have been receivable, if the property were in existence for one complete year.
(2) The income from such property for each of the years for which it is to be determined shall, for the purposes of this rule, be the amount of the total receipts received or receivable for each such year, reduced by the amount of expenditure which, in the opinion of the Gift-tax Officer, would reasonably be incurred for the purposes of making or earning the income :
Provided that where there are no receipts or where the total of the receipts is, in the opinion of the Gift-tax Officer, lower than the receipts which an owner of ordinary prudence would obtain or earn on such property or properties similar to that during the relevant period, the Gift-tax Officer shall, after giving the assessee a reasonable opportunity of being heard, determine the income on the basis of receipts which such owner would obtain."
27. Learned counsel submitted that, in view of clause (3) of the agreement, as the gift was revocable by giving six months' notice on either side and as the minimum period for computing the value of the gift was one year under rule 11, there was no gift at all.
28. It is true that the non-revocable period has to be taken into account for computing the gift in view of section 6(2) of the Act and the minimum period for computing the value of the gift according to rule 11 is six months. In the present case, the period for which the gift is made is for five years. Though the clause provided for revocation with six months' notice on either side, it was not acted upon. Therefore, the Tribunal was right in upholding the levy of gift-tax on the capitalised value of the gift, taking the gift as for five years. Therefore, the decision of the Bombay High Court in Dr. Kamdin's case [1974] 95 ITR 476 is of no assistance to the assessee.
29. The other contention of the petitioner is that a firm cannot be as assessee under the Gift-tax Act. This contention has to be rejected having regard to the definition of "person" which includes a body of individuals or persons whether incorporated or not. A firm is not a separate legal entity under the general law, but it is a collective name for a body of persons. That the firm is considered as a unit for assessment is also established by the other provisions of the Act, namely, section 21, under which the liability in the case of a discontinued firm or association of persons to pay the gift-tax is fastened on the persons who at the time of discontinuance or dissolution were partners or members. In the Allahabad High Court decision in CGT v. S.B. Sugar Mills , it was held that the firm falls within the category of a body of individuals or persons, whether incorporated or not, as described in section 3 read with section 21 and that the Legislature contemplated gift-tax assessment on a firm. (See also the decision of the Madras High court in CIT v. Bharani Pictures .
30. The other question raised in the reference relates to the exemption under section 5(1)(xiv) of the Act. The contention of the assessee is that it was a case of gift made bona fide for purposes of the business. This has to be rejected as this is a case of gift of the business itself and not a gift in the course of or for carrying on the business profitably.
31. In CGT v. Dr. George Kuruvilla , the Supreme Court observed that there should be evidence on record to prove that the gift was in the course of carrying on of business" of the donor.
32. In CGT v. R. Narasimhan Potti [1972] 83 ITR 296, the High Court of Kerala held that the burden is on the assessee who claims exemption under section 5(1)(xiv) of the Act to prove that the gift was for the profitable carrying on of the business. The High Court further observed that section 5(1)(xiv) can be applied only if it is shown that the gift was made on the ground of commercial expediency or in order to directly or indirectly facilitate the carrying on of the business, profession or vocation. On the facts of the present case, the assessee has failed to prove that the deemed gift is exempt under the provisions of section 5(1)(xiv) of the Act. For the reasons stated above, all the three questions in T.R.C. Nos. 66 and 67 of 1982 are answered in the affirmative and against the assessee.
T.R.C. No. 26 of 1985 :
33. The other question that remains to be considered relates to the valuation of the gift which is referred to this court in T.R.C. No. 26 of 1985 at the instance of the Department.
34. The Gift-tax Officer adopted five times the profit of the immediately preceding year and computed the value of taxable gift at Rs. 1,10,25,000. The Commissioner did not approve of this method. He applied section 6(2A) read with rule 11 of the gift-tax Rules. Taking the period for which the gift was not revocable, viz., five years, he adopted the average income for three previous years and, allowing a discount of 4% per annum, computed the capitalised value at Rs. 74,86,652 as a reasonable consideration for the transfer.
35. However, the Income-tax Appellate Tribunal reduced the inadequacy of consideration to Rs. 41,92,000 by adopting a different method, viz., Table III given in C. A. Gulanikar's Book on Wealth and Gift-tax. No case is made out to interfere with this valuation carried out by the Income-tax Appellate Tribunal and we affirm the same. The Income-tax Appellate Tribunal has also taken into consideration the fact that lease continued for a full period of five years and it was not terminated. The factual position that there was no termination with six months' notice by either party cannot be rejected as wholly irrelevant and is corroborating evidence as to the intention of the parties.
36. Accordingly, this question is answered is answered in the affirmative and in favour of the assessee.