Andhra HC (Pre-Telangana)
Commissioner Of Income-Tax vs Bhanodaya Industries on 27 September, 2001
Equivalent citations: [2002]253ITR350(AP)
JUDGMENT S. Ananda Reddy, J.
1. At the instance of the Revenue, the Income-tax Appellate Tribunal, Hyderabad Bench-A, Hyderabad, referred the following questions for the opinion of this court under Section 256(2) of the Income-tax Act, 1961 (hereinafter referred to as "the Act"), said to arise out of its order in ITA No. 208 of 1980, dated July 15, 1981, for the assessment year 1976-77 :
"1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law in holding that assets were not sold within the meaning of Section 41(2) and hence no profit under Section 41(2) can be brought to tax ?
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law in holding that capital gain has to be computed by taking one half of the sale price instead of full and deducting therefrom the cost of one half joint share to the assessee-firm ?"
The facts leading to the reference are :
The assessee was a firm consisting of two partners, viz., P. Madanagopala Rao and J. G. Williams, each of whom had a half share. On May 21, 1975, the above two partners together with two others, namely, T. Anjayya and D. Venkateswara Rao, constituted another firm, known as "Pioneer Industries". The assessee-firm revalued some of its assets and they were made over to Pioneer Industries. In the assessment proceedings, the question of capital gains arising out of the aforesaid transaction was raised. Though it was contended for the assessee-firm that there was no capital gains from out of the transaction, the Assessing Officer did not agree with the said contention. According to the Assessing Officer, Pioneer Industries was a separate entity from the assessee. As the assets were made over to the said Pioneer Industries from the assessee-firm, the said transaction amounts to transfer. Accordingly, the Assessing Officer computed the profits both under Section 41(2) and capital gains in respect of the assets involving in the transaction as under :
Asset WDV as on 1-4-1975 Appraisal value Total gain 41(2) profit Capital gain
1.
Machinery 24,996 70,000 45,904 18,462 26,542
2. Bldgs.
Electrical equipment 40,068 4,158 60,000 15,774 11,167 4,607
3. Furniture and fixtures, typewriters 4,009 1,828 10,450 4,613 3,748 865
4. AAK 3528 (Car) 13,747 28,000 14,253 5,799 8,454 On appeal, the Appellate Assistant Commissioner agreed with the view of the assessee that there was no transfer of assets in the transaction by relying upon a decision of the Supreme Court in the case of CIT v. Hind Construction Ltd. and deleted both the profits under Section 41(2) and capital gain as computed by the Assessing Officer. The Revenue carried the matter in appeal to the Appellate Tribunal. The Appellate Tribunal agreed with the view of the Appellate Assistant Commissioner in so far as profits under Section 41(2) in the light of the decision of the Supreme Court. But, however, with reference to the capital gains, the Tribunal disagreed with the Appellate Assistant Commissioner by referring to the decision of the Supreme Court in the case of Malabar Fisheries Co. v. CIT . According to the Tribunal, to the extent of reduction of the rights of the two partners in the transferred assets to the new firm, there was a transfer and to that extent the gains if any had to be computed as capital gains. Not satisfied with the said order of the Appellate Tribunal, the Revenue got the reference of the above two questions.
Learned standing counsel contended that with reference to the profits computable under Section 41(2), as the Appellate Assistant Commissioner as well as the Appellate Tribunal followed the decision of the Supreme Court, the Department may not be in a position to contend that there was a sale and, therefore, the profits arising under the transaction are liable to be computed under Section 41(2) of the Act. In that view of the matter the first question is to be answered against the Revenue and in favour of the assessee.
Coming to the second question, the contention of learned standing counsel is that there was a transfer from the assessee-firm to a new firm, i.e., Pioneer Industries. When once there was a transfer of assets from one entity to another entity, the transfer is full and complete in so far as the liability to capital gains is concerned. The contention of learned standing counsel is that the Tribunal had committed an error in accepting the contention of the Revenue only to the extent of half share in respect of the assets transferred by the assessee-company to Pioneer Industries. Therefore, according to learned counsel, there is a transfer to the extent of the entire assets and not confining to half share and, therefore, the capital gains have to be computed on the full value of the assets.
Though notice was served on the assessee, none appeared for the assessee.
Before considering the contention of learned counsel, it would be proper to refer to the relevant provisions of the Act as well as the Indian Partnership Act, 1932 :
Clause (47) of Section 2 of the Income-tax Act, 1961, reads :
"Section 2. In this Act, unless the context otherwise requires, . . . (47) 'transfer', in relation to a capital asset, includes,--(i) the sale, exchange or relinquishment of the asset; or (ii) the extinguishment of any rights therein ; or . . ."
Section 4 of the Indian Partnership Act, 1932, defines "partnership", "partner", "firm", and "firm name". Section 4 reads :
"Section 4. Definition of 'partnership', 'partner', 'firm', and 'firm name': 'Partnership' is the relation between persons who have agreed to share the profits of business carried on by all or any of them acting for all.
Persons who have entered into partnership with one another are called individually 'partners' and collectively 'a firm', and the name under which their business is carried on is called the 'firm name'."
A perusal of the above clearly shows that a firm has no legal existence. It is not a legal person. A partnership is a relationship, which subsists between persons ; but a firm is not a person ; it is merely a collective name for individuals, who are members of a partnership. It is neither a legal entity nor is it a person. The issue with reference to the firm, its partners and its assets was considered by the Supreme Court in the case of Malabar Fisheries Co. v. CIT and the relevant observations are as under (page 59) :
"In Addanki Narayanappa v. Bhaskara Krishnappa , this court after quoting with approval the aforementioned passages occurring in Lindley on Partnership, 12th edition, made the following observations in the context of partners' rights during the subsistence as well as upon the dissolution of a firm (p. 1303) :
'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 any one. 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 Claluse (b) of Section 48.
Having regard to the above discussion, it seems to us clear that a partnership firm under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it, and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks of the firm's property or firm's assets all that is meant is property or assets in which all partners have a joint or common interest."
From the above observations, it is clear that the properties vest in all the partners of the firm and no partner of a firm has got any specific interest in respect of the assets of the firm. But, at the same time, the firm as such has no right or interest, though it is an assessable entity under the provisions of the Act for firm tax. Here admittedly certain of the assets owned by the assessee-firm are made over to the Pioneer Industries, which was formed by the partners of the assessee-firm with two more partners. If the new firm had been constituted with the same two partners, there cannot be any transfer, as the same partners would have been holding the same interest in the assets. But, here, two more partners were included in the new firm to which the assets were made over. As a result the assets made over to the new firm would be owned by four partners in equal shares instead of two partners hitherto owned. The result is the interest of the partners of the assessee-firm was reduced from half to 1/4th. Therefore, there is an extinguishment of right and interest in so far as half of their interest in the assets that were made over to the new firm. There is no dispute that the said transfer had resulted in extinguishment of the part of the rights of the partners, which amounts to transfer within the terms of Section 2(47) of the Act. As held above, the transfer was only to the extent of half share of each of the partner, i.e., to the extent of half share in the assets that were made over to the new firm. The Tribunal, therefore, accepted the contention of the Revenue in so far as the transfer and the liability to capital gains to the extent of half of the share in the assets transferred. But the contention of the Revenue is that as the assets were completely made over by the assessee-firm to the new firm, there was a complete transfer and therefore the gains arising on such transfer are liable to capital gains. The said contention is devoid of merit, as according to the Revenue transfer was effected by the assessee-firm to the new firm, though they are not legal entities, which could effect such transfer. The transfer was to be effected only by the partners owning the assets of the firm and such transfer was effected only to the extent of half of the assets made over by the assessee-firm to the new firm and, therefore, the Tribunal had rightly held that the capital gains, if any, arising out of the transfer was only half of the assets made over by the assessee-firm to the new firm, Pioneer Industries.
Under the above circumstances, we do not find that there is any error that has been committed by the Tribunal in coming to the above conclusion. Accordingly, we answer the second question in the affirmative, against the Revenue and in favour of the assessee.
In the result, the R. C. is answered accordingly.