Madras High Court
Commissioner Of Income-Tax vs M.K. Chandrakanth And Ors. on 30 July, 2002
Equivalent citations: [2002]258ITR14(MAD)
Author: V.S. Sirpurkar
Bench: V.S. Sirpurkar
JUDGMENT
1. The respondents (hereinafter referred to as "the assessees") were partners in a firm manufacturing scented betel nut known as "Asoka", along with two other brothers. The firm came into existence by an instrument of partnership dated May 11, 1973, and it is unnecessary to notice the changes that took place in the constitution of the firm subsequent to the formation of the partnership, but it is, however, necessary to notice the change in the composition of the partners on September 6, 1976, when a limited company under the name and style, "Asoka Betelnut Company Private Limited" was admitted as a partner along with the assessees with the result, the firm became reconstituted with four partners. The firm was subsequently dissolved on March 31, 1977, by an instrument of dissolution dated April 11, 1977. Prior to the dissolution, an item of property known as Asoka Building which comprised land on which was situate the residential house as well as factory premises was purchased by the firm out of the funds of the firm on January 25, 1973. There is no dispute that the residential building and the land appurtenant thereto were utilised for their residential purposes by the three assessees who resided there jointly. The firm claimed depreciation with reference to the portion of the property wherein the factory building was situate and had not claimed depreciation for the remaining portion which was utilised by the three assessees as residential building. It is also relevant to notice herein that the income from the portion used for residential purposes by the three brothers was also not shown in the hands of the firm. The firm was dissolved on April 11, 1977, and the assets were distributed among the various partners. So far as the factory building is concerned, the company partner took over the factory building and the appurtenant land valued at Rs. 20 lakhs and the residential portion of the building was taken over by the three assessees. The total value of the properties of the firm on the date of dissolution was Rs. 32 lakhs and the company partner's share in the property being 1/4th was Rs. 8 lakhs. As the company took over the factory building worth Rs. 20 lakhs, the company paid Rs. 4 lakhs to each of three assessees and each one of the assessee invested Rs. 4 lakhs in the approved securities slightly exceeding a sum of Rs. 4 lakhs and claimed exemption with reference to the investments made of Rs. 4 lakhs under Section 54A of the Income-tax Act, 1961, which was also granted. In so far as the residential house which was allotted to the assessees is concerned, one of the brothers sold his 1/3rd share in the residential property to a third party on December 1, 1978, and the third party became the joint owner of the property in the residential building and the remaining two brothers released their respective shares in the residential building in favour of a third party for consideration by document dated February 24, 1979. Thereafter, the assessees purchased a property in Coimbatore and the value of the purchase price of the property purchased for each brother came to Rs. 4 lakhs. The assessees claimed exemption under Section 54 of the Act on the sale of the residential house on the score that capital gain was not exigible in respect of the residential house sold by them. The Income-tax Officer, in the order of assessment passed by him, accepted the case of the assessees and granted the necessary exemption under Section 54(i) of the Act.
2. The Commissioner of Income-tax, Coimbatore, in exercise of his revisional powers under Section 263 of the Act, held that the firm was the owner of the property and, hence, he held that one of the conditions prescribed in Section 54 of the Act, namely, that prior to the date of sale, the property should be owned by the assessees for a period of two years was not complied with. The Commissioner of Income-tax was of the view that though the assessees might have resided in the property even prior to the date of dissolution of the firm, it was not sufficient to claim exemption under Section 54 of the Act as the assessees became the owners of the property on the date of dissolution of the firm, i.e., on April 11, 1977. He therefore held that the grant of exemption under Section 54 of the Act by the Income-tax Officer was erroneous and prejudicial to the interests of the Revenue and set aside the order of the Income-tax Officer and directed the Income-tax Officer to redo the assessment in accordance with law.
3. The assessees carried the matter in appeal before the Income-tax Appellate Tribunal, Madras, challenging the order of the Commissioner of Income-tax. The Appellate Tribunal held that since the property became the property of each of the brothers in the manner prescribed under Section 49(1), it was not a short-term capital asset and the assessees have complied with all the conditions prescribed in Section 54 of the Act and therefore the assessees were entitled to exemption under Section 54 of the Act. The Appellate Tribunal thus allowed the appeals preferred by the assessees.
4. The Revenue has sought for a reference and the Appellate Tribunal has stated a case and referred the following question of law for our consideration : "Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the capital gains from the sale by the assessee of the residential house would be exempt under Section 54 of the Income-tax Act and setting aside the order passed by the Commissioner under Section 263 of the Act ?"
5. Mr. T. C. A. Ramanujam, learned senior standing counsel for the Revenue submitted that the conditions prescribed in Section 54 of the Act are not satisfied as the property sold by the assessees was the property of the firm and only after dissolution of the firm, the assessees became the owner of the property. Learned counsel also submitted that one of the conditions prescribed in Section 54 of the Act was not fulfilled as the assessees were not the owners of the residential building for a period of two years prior to the date of sale and therefore he submitted that the Appellate Tribunal erred in holding that the assessees are entitled to the exemption sought for.
6. Mr. R. Meenakshisundaram, learned counsel for the assessees, submitted that all the conditions prescribed under Section 54 of the Act are satisfied and hence the order of the Tribunal needs no interference.
7. We have carefully considered the submissions made by counsel for the Revenue as well as counsel for the assessees. The question whether the assessees are entitled to exemption under Section 54 of the Act depends upon the proper interpretation of Section 54 of the Act. Section 54 of the Act, in so far as material for the purpose of the case, reads as under :
"54. Where a capital gain arises from the transfer of a capital asset to which the provisions of Section 53 are not applicable, being buildings or lands appurtenant thereto the income of which is chargeable under the head 'Income from house property', which in the two years immediately preceding the date on which the transfer took place, was being used by the assessee or a parent of his mainly for the purposes of his own or the parent's own residence, and the assessee has within a period of one year before or after that date purchased, or has within a period of two years after that date constructed, a house property for the purposes of his own residence, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, that is to say,--
(i) if the amount of the capital gain is greater than the cost of the new asset, the difference between the amount of the capital gain and the cost of new asset shall be charged under Section 45 as the income of the previous year ; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or
(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under Section 45 ; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain."
8. A close reading of Section 54 indicates that the following conditions should be fulfilled by an assessee to claim exemption under Section 54 of the Act,
(i) There must be some capital gains arising from the transfer of a capital asset.
(ii) The capital asset transferred must be buildings or lands appurtenant thereto and the income of which is chargeable under the head "Income from the house property".
(iii) The transferred property should have been used by the assessee or his, parent for a period of two years immediately preceding the date on which the transfer took place.
(iv) The capital asset should have been used by the assessee or a parent of his, mainly for the purpose of his own or the parent's own residence for a period of two years prior to the date of transfer.
(v) The assessee has within a period of one year before or after the date purchased or has within a period of two years before or after the date constructed, a house property for the purpose of residence.
9. In so far as the facts of these cases are concerned, there is no dispute that the house property was purchased by the firm out of the funds of the firm and on the dissolution of the firm, the property was allotted to the assessees. The firm has not claimed depreciation on the assets used by its partners. Section 47(ii) of the Act prescribes that any distribution of capital assets on the dissolution of the firm is not a transfer for the purpose of Section 45 of the Act and the term "short-term capital asset" is defined in Section 2(42A) of the Act to mean that in a case where the capital asset became the property of the assessee in the circumstances mentioned in Section 49(1) of the Act, the period for which the asset was held by the previous owner had to be taken into consideration. Therefore, in determining the question whether the house property in question is a long-term capital asset or not, it is necessary to take note of the period during which the property was held by the firm prior to the dissolution and if that is taken into account, there is no difficulty in holding that the house property was a long-term capital asset at the time of transfer. Secondly, the property was a residential building with appurtenant land, the income from the property was assessable and in fact assessed under the head "Income from the property" at the time of transfer. Therefore, the first two conditions mentioned under Section 54 of the Act are fully satisfied as it was not claimed to be a business asset of the firm.
10. The next question is whether within two years immediately preceding the date on which the transfer took place the property was used by the assessee or a parent of his mainly for the purposes of his own or the parent's own residence. There is no dispute that the assessees were using the house property even from the date of the purchase for the purposes of residence not only prior to the date of dissolution of the firm but also subsequent to the date of dissolution of the firm. We are of the opinion that the user of the property as residence is one of the essential conditions to be fulfilled to claim exemption under Section 54 of the Act. Learned counsel for the Revenue submitted that though the assessees might have used the property, they became the owner of the property subsequent to the date of dissolution of the firm and till the date of dissolution of the firm, they were not the owners of the house property and mere residence in the property without any right is not sufficient. We are unable to accept the said submission. Though under the income-tax law, a firm is treated as a separate assessable entity, under the general law of partnership, a firm name is a compendious mode to designate the partners. It is well settled that property of a firm is the property of partners and the use by the firm is the use by the partners. Therefore, when the assessees used the property prior to the dissolution of the firm for their residence, it must be held that they were owners of the property and they were using the property in their own right for the purpose of residence. A similar view was taken by a Bench of this court in CIT v. Kamala Devi [1997] 227 ITR 701. The question that arose before this court was whether a particular capital asset should be treated as a short-term capital asset or long-term capital asset, and this court, following a decision of the Supreme Court in Addanki Narayanappa v. Bhaskara Krishnappa, , held that a firm is not a legal entity and assets cannot be held to be of the firm. It was also held that it is the partners who own the properties and the firm is treated as a separate entity only for the purpose of assessment under the Income-tax Act and the properties really belong to the partners of the firm. The decision relied upon by learned counsel for the Revenue, viz., CIT v. Bharani Pictures was considered in Kamala Devi's case , and it was distinguished as not applicable on the facts of the case. Moreover, this court in R. Venkatavaradha Reddiar v. CWT [1995] 214 ITR 76, held that it is the partners who own the property and the firm is not a legal entity under the general law of partnership. We therefore hold that each of the assessees was using the building for the purpose of residence in his own right for the purpose of residence for more than two years. Therefore, the condition of use of the house property in their own right as owners of the property is satisfied.
11. Learned counsel for the Revenue relied upon the decision of the Kama-taka High Court in the case of Smt. Vijayalakshmi v. CIT [1975] 100 ITR 648. The facts of that case are that the assessee purchased a house property which was let out to her husband which was subsequently sold and she claimed exemption under Section 54 of the Income-tax Act. The Karnataka High Court held that since the property was let out to her husband, only her husband had legal right to the possession of the property and her right to reside in the house was only as a member of the family and the property was used only by her husband mainly for the purpose of residence. Therefore, the Karnataka High Court held that the wife was not entitled to exemption under Section 54 of the Act In our view, it is not necessary to express our view on the correctness of the view taken by the Karnataka High Court in Smt. Vijayalakshmi's case [1975] 100 ITR 648, but the decision of the Karnataka High Court is distinguishable as in that case, the user of the property by the wife was held to be not in her right as an owner of the property. However, the instant case, the partners were owners of the property and they used the property for their residence in their own right.
12. Another decision that was relied upon by learned counsel for the Revenue is the decision of this court in CIT v. K. Gangiah Chetty and Sons [1995] 214 ITR 548. The facts of that case are that the partnership firm was the assessee and a portion of the house property belonging to the firm was let out and the remaining portion was kept by the partners for their residence and the property was sold and exemption under Section 54 of the Act was claimed by the firm. The court held that the firm was not entitled to claim exemption under Section 54 of the Act on the ground that the relief under Section 54 of the Act would be available to individuals or a Hindu undivided family and not to an artificial assessable entity, like a firm. The decision of this court in K. Gangiah Chetty and Sons case [1995] 214 ITR 548 is not applicable to the facts of the case as in that case, the exemption was claimed by the firm and not by the partners of the firm.
13. The Bombay High Court in CIT v. J.M. Mehta and Bros. [1995] 214 ITR 716 has taken the view that a firm is not a legal entity and is a compendious name for the partners who constitute it and it is the partners who own the property and not the firm. We therefore find no difficulty in holding that the third condition prescribed in Section 54 of the Act is also satisfied as the assessees were using the house property for the purpose of their own residence. It is not in dispute that the assessees have fulfilled all other conditions prescribed in Section 54 of the Act. We therefore hold that the Appellate Tribunal was correct in coming to the conclusion that the assessees are entitled to exemption under Section 54 of the Act.
14. Accordingly, we answer the common question of law referred to us in the affirmative, in favour of the assessees and against the Revenue. No costs.