Andhra HC (Pre-Telangana)
V.C. Venkata Subbaiah Chetty And Sons vs Commissioner Of Income-Tax on 21 January, 1988
Equivalent citations: [1988]171ITR590(AP)
JUDGMENT A. Raghuvir, J.
1. The firm, M/s. V. C. Venkata Subbaiah Chetty & Sons, is a dealer in textiles and also carries on money-lending. The firm consisted of three partners. One among the three died on January 26, 1976. Thereupon, the firm was dissolved. In the income-tax proceedings for the assessment year 1976-77, on behalf of the dissolved firm, the income was returned as Rs. 68,269. It was represented that the stock of cloth was sold to one of the partners. The purchaser paid Rs. 2,04,114.36 being the book value of the cloth to the firm. The sale proceeds, after dissolution, were distributed among the three partners - V. Balaiah Gupta Rs. 98,557.18, V. Subrahmanyam - Rs. 98,557.18 and V. Subbamma, the spouse of the deceased partner, was allotted Rs. 7,000.
2. The Income-tax Officer rejected the "sale" and distribution of the proceeds. He held that the firm cannot "self-create profit" and estimated the firm's profit by adding ten per cent to the book value of cloth and thus added Rs. 20,411 to the total income of the firm. The assessee's appeal was allowed accepting the representation made on behalf of the firm. Later, in further appeal by the Revenue, the Appellate Tribunal held that the sale by the firm was not acceptable and the order of the Income-tax Officer was confirmed. At the instance of the assessee, two questions are referred. The substance of the questions during the debate was split into (1) Whether, in law, the stock as on January 26, 1976, in cloth could be sold to one of the partners; (2) Whether the closing stock can be valued at cost price or market price at the distribution among partners. The substance of the two questions is stated as the two question are stated in an involved manner. The questions will be stated afterwards.
3. The assessee in this case argued that on the death of one of the three partners on January 26, 1976, the firm was dissolved. Thereupon, a balance-sheet was prepared. It is argued that before the accounts were closed, the stock of cloth was sold to one of the partners by the firm, at the book value of Rs. 2,04.114.36. The sale proceeds were adjusted among the partners according to the shares of the partners. The sale and distribution of the amounts was not illegal. The two questions be answered to support the sale and distribution of the amounts as shown to the Income-tax Officer. The argument thus advanced by the assessee requires the understanding of the principles incorporated in the Indian Partnership Act, 1932.
4. Under the Partnership Act, 1932 ("the Act"), property brought by the partners or property acquired by the firm in the course of its business is in law considered the property of the partnership. A partnership is entitled upon dissolution to a share in the accretions along with the property brought by him. This is recognised in sections 14 and 15 of the Act. Section 14 reads :
"The property of the firm. - Subject to contract between the partners, the property of the firm includes all property and rights and interest in property originally brought into the stock of the firm, or acquired, by purchase or otherwise, by or the firm, or for the purposes and in the course of the business of the firm, and included also the goodwill of the business.
Unless the contrary intention appears, property and rights and interest in property with money belonging to the firm are deemed to have been acquired for the firm."
5. The property of the firm is the "joint estate" of the partners as distinguished from the "separate estate" of partners. The expressions partnership property, partnership stock, partnership assets, joints stock and joint estate convey that property is owned by all the partners collectively and every partner is entitled, as against all other partners, to have the property of the firm applied in payment of the debts and liabilities of the firm, and to have the surplus distributed among the partners or their representatives according to their rights (section 46 of the Act). Section 48 prescribes the mode of settlement of accounts of the firm after dissolution. What is meant by the share of a partner is his proportion of the partnership assets after they have been relied converted into money, and all the partnership debts and liabilities have been paid or discharged. After debts are paid residue remaining property is to be divided among the partners. No partner has a right to take any portion of the partnership property and assert that that property is his property exclusively. No such right can be asserted either during the existence of the partnership or after its dissolution.
6. The firm is a body conceptually distinct from its partners. In keeping partnership accounts, "the firm is made debtor to each partner for what the partner brings into the common stock. A partner is made a debtor to the firm for all that he takes out of that stock. The partners are not indebted to each other. The partner is a debtor or creditor only to the firm. The partners are agents and sureties of the firm; its agent for the transaction of its business; its sureties for the liquidation of its liabilities. The liabilities of the firm are regarded as the liabilities of the partners only in case they cannot be met by the firm and discharged out of its assets". These concepts were enunciated by the Privy Council, in interpreting the Act, in Bhagwanji Morarji Goculdas v. Alembic Chemical Works Co. Ltd., AIR 1948 PC 100. See what the Privy Council said (at page 101) : "Before the Board it was argued that under the Indian Partnership Act, 1932, a firm is recognised as an entity apart from the persons constituting it, and that the entity continues so long as the firm exists and continues to carry on its business. It is true that the Indian Partnership Act goes further than the English Partnership Act, 1890, in recognising that a firm may possess a personality distinct from the persons constituting it, the law in India in that respect being more in accordance with the law of Scotland, than with that of England. But the fact that a possesses a distinct personality does not involve that the personality continues unchanged so long as the business of he firm continues. The Indian Act, like the English Act, avoids making a firm a corporate body enjoying the right of personal succession. The agreement of December 7, 1907, was made between the company and four named individuals, and when all of those four individuals had ceased to be members of the firm. there was no privity between the company and the firm as it then existed." With this brief resume, we turn to the specific provisions in the Income-tax Act.
7. The words "transfer" and "sale" were not defined in the Indian Income-tax Act, 1922. The two words are defined in the Income-tax Act, 1961, in clause (47) of section 2. In CIT v. Dewas Cine Corporation , a case under the 1922 Act, it was explained that when a firm is dissolved, the assets of the partnership can be realised by sale of its assets and after the debts are discharged, the property allotted is not a sale. This was again elaborated in CIT v. Bankey Lal Vaidya : ".... the property allotted to a partner in satisfaction of his claim to his share, cannot be deemed in law to be sold to him". The following passage explains further (at p. 50 of 120 ITR) : "Upon dissolution, the firm ceases to exit, then follows the making up of accounts, then the discharge of debts and liabilities and thereupon distribution, division or allotment of assets takes place inter se between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division or allotment of assets among the erstwhile partners, is not done by the dissolved firm. In this sense, there is no transfer of assets by the assessee (dissolved firm) to any person."
8. Under the Income-tax Act, 1961, the concepts were further enunciated in the case of Malabar Fisheries & Co. v. CIT . In that case, the definitions of "sale" and "transfer" were considered. The ratio in the earlier case was affirmed to hold that in law there cannot be any sale favour of a partner by the firm.
9. This discussion answers the first question in the affirmative, We may now extract the question : "Whether, on the facts and in the circumstances of the case, the stock-in-trade as on January 26, 1976, can be valued notionally at its market price of Rs. 2,24,525 even though it has actually been transferred to the erstwhile partners and the widow of the deceased partner though at cost price and there were no closing stocks as such by the date of closure of the books, i.e., January 26, 1976 ?" The question is involved because sale is accepted in the words "even though it has actually been transferred to the erstwhile partners."
10. The next question whether on the dissolution of the firm, the stock are to be valued according to the market price or according to the book value.
11. It is necessary to trace the practice in U.K., for that practice is followed in India. In the leading case in the U.K., it was held : "If no definite and uniform usage to the contrary is established, the assets of the partnership for the purpose of winding up after the dissolution should be taken, not at the book value but at their fair value to the firm. Merely because the account is settled for one purpose in a particular manner, it does not follow, as pointed out by Lord Wrenbury in the same case, that method of taking account would be good also for another purpose. The annual accounts are never taken with a view to determine the right of a deceased partner or that of a retiring partner. The object of annual settlement is only for the definite purpose of assessing the profits at the end of the year and so long as the partnership is continued, it does not make any difference to the partners even if national value is taken as the value of the assets." (Cruikshank v. Sutherland [1932] 92 LJ Ch 136). The ratio in Cruikshank v. Sutherland was adopted by the Madras High Court in Muhammad Ussain Sahib v. Abdul Gafoor Sahib, , in that how stock-in-trade between the partners is to be valued was considered rather elaborately. it was held (at p. 759) : "The object of the annual settlement is only for the definite purpose of assessing the profits at the end of the year and so long as the partnership is continued, it does not make any difference to the partners even if notional value is taken as the value of the assets. The asset at the book value continues to belong to the firm and whatever fluctuations there may be in the value of that asset, the benefit or the loss of it would accrue to the firm. But the situation is totally different when the firm is dissolved or when a partner retires. The settlement of his account must be not on a nominal basis but on a real basis, that is, every asset of the partnership should be converted into money and the account of each partner settled on that basis... The assets have to be valued, of course, on the basis of the market value on the date of the dissolution."
12. The decision in Muhammad Ussain Sahib v. Abdul Gafoor Sahib, , for historical reasons binds this court and it may not be necessary to state the history at this point of time as it is well known. The case in was relied on in A.L.A. Firm v. CIT by the same court under the Income-tax Act which held : "The result of this decision is that in the present case the stock-in-trade had to be valued at their market value."
13. The decision in A.L.A. Firm v. CIT was seriously assailed by the assessee during the debate. The assessee argued that in , section 184 of the Income-tax Act with its full implications was not considered. The conclusion is not preceded by any discussion and, therefore, it is argued that the conclusion is not well-founded and also not well-considered. We have earlier stated that the issue is no more res integra in this court because of the decision in Muhammad Ussain Sahib v. Abdul Gafoor Sahib, .
14. The second question reads : "If the answer to question No. 1 is in the affirmative : (a) Whether the concept of sale at market value can be applied to a case of distribution of assets of the dissolved firm among its erstwhile partners; (b) Whether the option to value the closing stocks at cost or market price, whichever is less, is available to the firm after its dissolution ?" The first part in (a) is answered in the negative and the second part in (b) is answered in the negative to mean that the goods are to be valued at the market price after dissolution.
15. We answer the first question in the affirmative and against the assessee. Parts (a) and (b) of the second question are answered in the negative and in favour of the Revenue. No costs.