Andhra HC (Pre-Telangana)
Bhaktimala Beedi Factory vs Commissioner Of Income Tax on 29 December, 1995
Equivalent citations: [1996]219ITR6(AP)
Author: P. Venkatarama Reddi
Bench: P. Venkatarama Reddi
JUDGMENT P. Ramakrishnam Raju, J.
1. The Tribunal, Hyderabad Bench "A", referred the following two questions to the High Court for its opinion, viz. :
" (1) Whether the Tribunal was right in law in holding that the royalty paid for the use of the trademark and goodwill is not allowable as a deduction ?
(2) Whether, on the facts and in the circumstances, when the assessee has not admitted any liability to commission payment in the earlier year, the payment of a commission on a settlement during this accounting year is not a proper deduction in computing the income of this year ?"
2. Before answering the reference, it is necessary to refer to a few facts relating to the issue which ultimately led to the above reference.
Bhaktimala Beedi Factory, Tirupati (hereinafter called "the assessee") is a registered firm. The said firm filed its returns of income for the asst. yr. 1987-88 and for the accounting period ending on 31st March, 1987, showing a total income of Rs. 6,54,075. The ITO 'A' Ward, Tirupati, by his order dt. 3rd March, 1988, determined the total income at Rs. 8,79,560. The assessee claimed that a sum of Rs. 2,00,000 was payable to the Srinivasula Reddy Family Trust towards goodwill of the business and the trademark and, accordingly, a sum of Rs. 2,00,000 was credited to the account of Srinivasula Reddy Family Trust on 31st March, 1987, itself which was disputed by the Assessing Officer (AO). Therefore, the grievance of the assessee is about the inclusion of a sum of Rs. 2,00,000 for purpose of assessing the firm's income.
The claim of the assessee for deduction of the said sum arises in the following circumstances :
Bhaktimala Beedi Factory was started by one Sri C. Srinivasula Reddy way back in 1940 and the trademark was registered in 1944 and in 1946 in the name of the partners of Bhaktimala Beedi Factory. After the family partition, a partnership was formed w.e.f. 1st April, 1964, comprising Sri Srinivasula Reddy and his three sons. On 2nd July, 1986, an agreement-cum-trust deed was executed by all the four partners whereunder they agreed that the goodwill of the business together with the registered trademarks should cease to be the assets of the assessee-firm w.e.f. 2nd July, 1986, and become the property of the trust known as "Sri Srinivasula Reddy Family Trust". The sole trustee shall be C. Srinivasula Reddy during his lifetime and thereafter Sri C. Venkatrama Reddy shall be the sole trustee. The survivor of either of them shall have a right to nominate by will or otherwise his successors not more than four in number. It is provided in the trust deed that the property and income of the trust shall belong to the three sons of C. Srinivasula Reddy and the minor sons of those three sons in the proportions mentioned in the deed. Clause 4 of the deed provides that in spite of the goodwill and the trademarks ceasing to be the partnership asset of Bhaktimala Beedi Factory, the said firm shall have the continued right to use the goodwill and the trademark up to the period ending on 31st March, 1992. For such user of goodwill and trademarks by the assessee-firm, the deed provides that a sum of Rs. 2,00,000 shall be paid to the trust in a lump sum on or before 31st March, 1987, and a royalty thereafter at the rate of three per cent of the sale value of beedies for each financial year commencing from 1st April, 1987. As per the directions of the trust deed, a sum of Rs. 2,00,000 was credited to the trust from out of the profits of the assessee. As already stated, the ITO disallowed this item of Rs. 2,00,000 on the ground that the goodwill was an asset of the firm and the partners had no right to deal with it except at the time of dissolution of the firm. Aggrieved by the said assessment order, the assessee unsuccessfully filed an appeal before the AAC and further appeal to the Tribunal, Hyderabad Bench "A". However, the assessee approached the Tribunal seeking for a reference of the above questions for the opinion of the High Court and the Tribunal referred questions Nos. 4 and 5 about which a reference was already made.
3. Learned counsel for the petitioner submits that the partnership being a creature of the agreement among the partners can be varied or modified by the partners in any manner as they like at any time. The trademark and the goodwill being an asset of the partnership can be transferred to the family trust and the assessing authority cannot take exception to such a course under the impression that it is a device to avoid tax. It is also the contention of learned counsel for the petitioner that the assessee is entitled to reduce the tax liability by making suitable adjustments permissible under law.
Sri S. R. Ashok, learned standing counsel for Income-tax, submits that the family trust is only a device to evade tax. Inasmuch as there is no consideration for transfer of the goodwill and the trademark in favour of the family trust, the same cannot be lawful. He further submits that the partners alone are parties to the trust deed and since the partnership firm is not a party to the document, the assets belonging to the partnership firm cannot be legally transferred in favour of the family trust, more so when all the beneficiaries are not partners of the firm.
4. The ITO relying on the observations of the Supreme Court in Addanki Narayanappa vs. Bhaskara Krishnappa took the view that the partners cannot alienate any assets of the partnership-firm without reference to the firm since the property which is brought in by the partners into the partnership firm or acquired later, becomes the property of the firm and the right of a partner is only a share in the profits or a share in the value of assets on dissolution. The ITO further observed that by transferring the asset of the firm to a trust in which all the partners are not beneficiaries, an attempt to avoid payment of tax was evident. The CIT(A) as well as the Tribunal took the same view and further observed that the goodwill cannot be evaluated in monetary terms so long as the partnership firm continues to run the business and, therefore, it cannot be the subject-matter of transfer. The Tribunal pointed out that "it is, therefore, clear that the ownership of trademark and goodwill vest with the assessee-firm, the partners of which have also no right much less by any consent inter se for the deal". The Tribunal also observed that the transaction seems to be artificial inasmuch as it provides that in spite of the goodwill and the trademark ceasing to be the asset of the partnership firm, it shall have a continued right to use it for a period, i.e., up to 31st March, 1992. The learned Members of the Tribunal also held that the claim of the assessee was liable to be disallowed on the ground that the expenditure in question was in the nature of a capital expenditure because an enduring asset was acquired by making the lump sum payment. In this regard, it may be noted that this particular ground is a new ground not put forward by the Departmental authorities.
5. As already mentioned, the assessing and the appellate authorities relied on the decision of the Supreme Court in Addanki Narayanappa's case (supra). In that case, the Supreme Court observed that during the subsistence of a partnership, no partner can deal with any portion of the property as his own nor can he assign his interest in any specific item of the partnership property to anyone. In the said case, the main question before the Supreme Court was about the admissibility of a relinquishment deed executed by some of the members of the partnership firm in proof of dissolution of the partnership firm as well as settlement of accounts whereunder both movable and immovable properties were conveyed and hence whether the said document of relinquishment was compulsorily registrable under s. 17(1)(c) of the Registration Act and the Supreme Court answered the question in the negative. The said decision does not help the Revenue for more than one reason. Firstly, some partners alone executed the settlement deed while in the present case, all the partners have joined in the execution of the relinquishment deed; and secondly, relinquishment of assets in immovable property is not involved in the present case as in the other case and moreover, the question of registration does not arise in this case as no part of the immovable property of the partnership firm is involved in the transfer. It may be pointed out that in a later case, reported in CIT vs. Juggilal Kamlapat , the Supreme Court after noticing the earlier judgment, held the view that a relinquishment whether it relates to conveyance of immovable property or not, does not require registration. The observations of the Supreme Court in this regard are relevant and accordingly extracted :
"The deed of relinquishment, in this case, was in respect of the individual interest of the three Singhania Brothers in the assets of the partnership firm in favour of the Kamla Town Trust, and, consequently, did not require registration, even though the assets of the partnership firm included immovable property, and was valid without registration."
In view of these decisions, the controversy whether a relinquishment deed executed by some of the partners in respect of their share of assets in the partnership firm including immovable property requires registration or not is set at rest.
6. It is true that the principle is now well-settled that during the subsistence of a partnership, no partner can claim a specific item of the firm's property as his own nor can he assign his interest in any specific item of partnership property. But there is no legal bar against all the partners by mutual agreement relinquishing or transferring a particular asset of the partnership property in favour of a third party. Goodwill undoubtedly constitutes property of the firm and it is a transferable asset, vide s. 14 of the Partnership Act, and the observations of the Supreme Court at paragraph 21 in CED vs. Mrudula Nareshchandra and Golden Chemical Works vs. CIT . If all the partners agree that an asset or property of the firm shall cease to be so and it should vest with some other person or body, there is nothing in the Partnership Act which prohibits such arrangement. Section 11 of the Partnership Act says that the mutual rights and duties of the partners of a firm will be determined by contract between the partners - express or implied - and such contract may be varied by the consent of all the partners. Section 14 while saying that the property of the firm includes the goodwill of the business and other rights and interests in property, nevertheless makes it clear that it is subject to contract between the parties. Again, s. 15 postulates that the property of the firm shall be held and used by the partners exclusively for the purpose of the business, "subject to contract between the partners". In Halsbury's Laws of England Vol. 35, at paragraph 108, it is stated : "Partners may transfer the partnership property to one of themselves, and such a transfer is valid against the firm's creditors if it is done in good faith and if it has been completed, but if the agreement remains executory, the property remains joint".
In P. Ramachandra Reddiar vs. CIT after referring to the decision in Narayanappa's case (supra), the Kerala High Court observed thus :
"There cannot be any doubt that all the partners constituting the firm can transfer the assets. Therefore, when the firm 'Good Morning Stores', of which Ramachandra Reddiar and Arjuna Reddiar are the only partners, transferred one of its businesses with its assets, viz., 'Bright Dry Cleaners' to two ladies who are none other than the wives of the partners, it is to be held that there was a transfer indirectly by the two partners. The law looks to the partners. What is called the property of the firm is their property and what is called the liability of the firm is their debts."
In Ram Narain & Bros. vs. CIT , the Allahabad High Court held that an item of immovable property belonging to a firm can be converted into their personal property by means of an instrument in writing and such instrument must be registered under s. 17(1)(b) of the Registration Act. As in the instant case, there is no transfer of immovable property, the question of registration does not arise. But the ratio of that decision indicates that all the partners conjointly can transfer an item of property belonging to the firm even though any one of the partners individually may not be competent to do so. The passage in Lindley on Partnership also supports the view that "it is competent for the partners by mutual agreement amongst themselves to convert that which was partnership property into the separate property of an individual or vice versa". We are, therefore, of the view that the assessing and the appellate authorities including the Tribunal went wrong in thinking that having regard to the judgment of the Supreme Court in Narayanappa's case (supra), an asset in the partnership cannot be transferred even by mutual consent during the subsistence of the partnership. We cannot also agree with the view expressed by the CIT(A) and the Tribunal that the goodwill of a firm is incapable of valuation and, therefore, it cannot be the subject-matter of transfer. The difficulty, if any, in evaluating the goodwill is not a ground to hold that it is not an asset which is transferable.
7. Learned standing counsel for the IT Department mainly argued, as pointed out earlier, that the deed in question was executed by the individual partners of the firm but not by or on behalf of the firm and, therefore, there is no transfer in favour of the family trust in the eye of law. We are unable to accept this contention. The mere absence of express words that the deed transferring goodwill of the firm to the asset was executed by them for and on behalf of the firm is not conclusive. Section 22 of the Partnership Act lays down that "in order to bind a firm, an act or instrument done or executed by a partner or other person on behalf of the firm shall be done or executed in the firm name, or in any other manner expressing or implying an intention to bind the firm". Here, it could be said that by executing the instrument transferring an asset of the firm, all the partners had an intention to bind the firm. Otherwise, the document does not convey any sense. What is done by all the partners of the firm can be treated as "an act of the firm" within the meaning of s. 2(a) of the Partnership Act.
8. The next contention of learned standing counsel for the respondent is that the transfer was without consideration and the transfer having been made to only three out of four partners and their minor children, there should have been some consideration and a contract without consideration is void. Learned counsel for the petitioner-assessee submits that there need not be monetary consideration and the fact that the goodwill was transferred to the family trust in order to ensure that the goodwill is not affected by future disputes amongst the partners (as recited in the deed itself) is sufficient consideration. Alternatively, it is contended that the transfer of partnership asset can be said to have been effected on account of natural love and affection between closely related parties and, therefore, it falls within the exception to s. 25 of the Contract Act. We find considerable force in this argument. However, it is not necessary for us to deal with this aspect further because even if the transfer was made without consideration, it could still be regarded as a gift of goodwill to the family trust.
9. Learned standing counsel for the Revenue lastly contended that the transaction is a clear case of tax evasion by adopting a devious method of executing a family trust by all the partners of the firm and so a game of hidden purpose can be seen if the veil is pierced. He relied on the observations of the Supreme Court in McDowell & Co. Ltd. vs. CTO and Sunil Siddharthbhai vs. CIT . In the latter case, it was observed that :
"If the transfer of the personal asset by the assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on a capital gain, it will be open to the IT authorities to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, whether the transaction of transferring the personal asset to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert the personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain."
The observations of Chinnappa Reddy, J., in McDowell's case (supra) have also been relied upon. We cannot accept the contention of standing counsel for the reason that there is no categorical finding by the Tribunal in this regard. The Tribunal merely observed that the "transaction seems to be artificial" because a partnership will have a continued right to use the goodwill for a period even after it ceases to be the asset of the partnership. Learned counsel for the petitioner submits that it is not a case of sham or colourable transaction and even if it is an instance of tax planning within the limits of law, the principle laid down in the aforementioned cases will not apply. As already stated, there is no finding that it is a colourable device solely for the purpose of diverting the income of the firm to another body without payment of tax or that there was no prudent business consideration for the arrangement. It is not found by the assessing or the appellate authorities that the reason given in the deed is a non-existent or a false reason, and the assessee was only motivated by the object of giving some twist to the whole transaction to avoid tax. In the absence of a finding or discussion on a question of fact, it is difficult for us in this reference case to hold that there was no lawful transfer of goodwill.
The Tribunal gave an additional reason for disallowing the expenditure on the ground that this is a capital expenditure because lump sum payment results in the acquisition of an enduring asset by way of goodwill and, therefore, it is not an expenditure laid out for the purpose of business. This is not the ground on which the ITO and the CIT(A) disallowed the deduction. For the first time, the Tribunal expressed this view. It does not appear that the said contention was raised before the Tribunal on behalf of the Revenue. Learned counsel for the assessee relied upon the decision of the Supreme Court in Devidas Vithaldas & Co. vs. CIT and a Full Bench judgment of the Andhra Pradesh High Court in Praga Tools Ltd. vs. CIT (FB) and contended that the lump sum payment made was only for the right to use the goodwill and every year payment has to be made on percentage basis depending on the sales. It is, therefore, contended that the payment has integral connection with the business. It is also contended that the asset is not of an enduring nature as assumed by the Tribunal. We find force in the contention advanced by learned counsel for the petitioner.
In view of the above discussion, we answer the first question in favour of the assessee and against the Revenue.
10. As far as the second question is concerned, we agree with the Tribunal that the disallowance of the commission paid to the agent in the computation of income for the relevant assessment year, i.e. 1987-88, is justified on the facts of the case. As observed by the CIT(A) and reiterated by the Tribunal, the assessee follows the mercantile system of accounting and the expenditure by way of commission paid to the agent related to the asst. yr. 1985-86 and moreover, it was found by the CIT(A) as well as the Tribunal that there was no dispute with regard to the rate of commission payable during the year in which the goods were supplied and, therefore, the commission paid to the agent in the relevant assessment year does not qualify for deduction. We, therefore, answer this question in favour of the Revenue and against the assessee, upholding the order of the Tribunal in this regard.
11. The reference case is thus disposed of. No. costs.