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Income‑tax Reference No. 53 of 1960, decided on 16th July 1962

Income and capital

‑Termination of partnership Amount paid to retiring partner‑Whether compensation for relinquishment of rights or income‑Assessability‑Firm‑Rectification of partner's assessment after assessment of firm‑Limitation‑Indian Income‑tax Act, 1922, Ss. 26(1), (2) & 35(5).

A and B, who were accountants and auditors, entered into a partnership with C and D. One of the terms of the partnership was that in the event of the determination of the partnership C and D shall be entitled to be paid only their respective shares in such of the net profits of the partnership business earned up to the date of such determination as are comprised in the bills in respect of matters completed by the firm by the date of determination for fees and remuneration as may be actually payable to the firm by the said date and as may be settled by A and actually received by the firm and subject thereto all other profits and the partnership business and the assets and outstandings of the firm shall belong solely and absolutely to A and B. The partnership was terminated on 8th October 1950. C and D were paid a sum of Rs. 22,50.1 for which they passed a receipt which stated that the sum was received "in full settlement and satisfaction of all dues and claims of C and D against A and R or their firm including their shares in the capital profits and outstandings of the said partnership up to the date of their ceasing to be partners as aforesaid". In consideration of the said payment C and D acknowledged that the said partnership business and all the profits, outstandings and assets of the firm shall belong solely and absolutely to A and B who shall have the sole right to carry on and continue the said firm on their own account from the 8th October 1950. As C and D had contributed Rs. 6,000 as capital to the firm the Income‑tax officer held that the balance, viz., Rs. 16,500, represented the share in profits received by‑ C and D and taxed it in the hands of C and D. In the case of assessment of the firm, however, he did not allow the said amount of Rs. 16,500, holding that it was in the nature of capital expenditure, and on this basis he concluded the assessment of the firm. The Tribunal held that on 8th October 1950, the firm was not dissolved but there was only a change in the constitution of the firm and, therefore, the case was governed by the provisions of section 26 (1) of the Act. The Tribunal further held that the amount of Rs. 16,500 paid to C and D was not compensation paid in consideration of their relinquishment of their share in the partnership but was in the nature of sharing income earned by the firm and, therefore, was liable to be taxed in the hands of C and D;

Held, (i) that the term of the parnership referred to above did not mean that C and D were entitled to get only a share in the fees which were till then recovered and not which were earned till the date of determination of the firm and that the sum of Rs. 16,500 could thus only be the share of C and D in the profits and outstanding ; the said amount cannot in any sense be called compensation for relinquishment of their share in the partnership.

(ii) On 8th October 1950, there was only a change in the constitution of the firm and, therefore, the provision of subsection (1) of section 26 and not subsection (2) of section 26 would apply, and the amount in question was liable to be apportioned among the four partners under section 26 (1);

Held further, that though the power under section 35 (5) of the Act to rectify the assessment of a partner consequent upon the assessment of the firm of which he is a partner by including or correcting his share of profit or loss, can be exercised only in cases where the final order of assessment of the firm has been made on or after April I, 1952, where there has been appeal from the Income‑tax Officer's order of assessment, the Income‑tax Officer's order cannot be said to be a final order and if the order on appeal was passed only on or after 1st April 1952, the power to rectify under section 35 (5) can be exercised.

[Case‑Law referred].

STATEMENT OF CASE

In compliance with the requisition of the High Court in Income‑tax Application No. 34 of 1958, dated the 7th of July 195''4, we hereby draw up a statement of the case and refer it to the High Court of Judicature at Bombay under section 66 (2) of the Indian Income‑tax Act. The questions directed to be referred are;

"(1) whether the Tribunal was justified in law in holding that the two sums of Rs. 11,250 (rupees eleven thousand two hundred and fifty) and Rs. 5,000 (rupees five thousand) paid to D. N. Dastur and J. R. Kanga respectively were not in the nature of recoupment for the loss which they suffered by reason of the premature termination of the partnership and premature deprivation of the partnership rights before the full expiry of the term of five years of the partnership

(2) Whether the Tribunal was justified in law in holding that the said sum of Rs. 16,250 (rupees sixteen thousand two hundred and fifty) is liable to be apportioned under the first proviso to section 26 (1) among four partners including the said Dastur and Kanga

(3) Whether the Tribunal was justified in law in directing the Income‑tax Officer to modify the assessment in the individual cases of Dastur and Kanga and their share income in spite of the fact that their assessments had become final and binding on the Department on the decision of the Tribunal in their cases "

2. The undisputed facts of the case are;

(i) Shri D. D. Shroff, his son, Shri R. D. Shroff, Shri Dastur and Shri Kanga were carrying on business of auditors, accountants and income‑tax consultants as a firm. The partner ship came into being on February 1, 1949. An indenture was drawn up on March 7, 1949. The deed is annexed hereto as Annexure "A" and forms part of the case.

(ii) The said deed provided that the duration of the partnership shall be five years as from February 1, 1949, it having commenced from the said date. D. D. Shroff held a share of 7 annas in the rupee of 16 annas and the remaining three, annas 3 each. The accounts of the said firm of four partners were being maintained on cash basis and used to be made up to the 31st December each year. The firm name was D. D. Shroff & Co.

(iii) There were disputes among the parties and Dastur and Kanga went out of the partnership on October 8, 1950.

(iv) On October 10, 1950, Rs. 22,500 was paid by D. D. Shroff and R. D. Shroff. A receipt was passed, the material parts of which read as under;

"Received from Messrs Dinsha Darabshaw Shroff and Rutton Dinsha Shroff the sum of Rs. 22,500 in full settlement and satisfaction of all our dues and claims against them and/or their firm of Messrs D. D. Shroff & Co., chartered accountants (in which we have ceased to be partners by mutual agreement as from the 8th day of October 1950), under or by virtue of the partnership agreement of the said firm dated 7th March 1949, or otherwise howsoever including our shares in the capital profits and outstandings of the said partnership up to the date of our ceasing to be partners as aforesaid. In consideration of the said payment we acknowledge that the said partnership business and all the profits, outstandings and assets of the sail firm belong solely and absolutely to the said Messrs Dinsha Uarabshaw Shroff and Rutton Dinsha Shroff who have the sole right to carry on and continue the said firm on their own account as from the 8th day of October 1950, and we will be practising as chartered accountants either in partnership or individually from the 8th day of October 1950, in Bombay or at any place or places in the Republic of India."

(v) After October 10, 1950, D. D. Shroff and R. D. Shroff carried on business as. a partnership with shares of 0‑12‑0 and 0‑4‑0, respectively. Hereinafter they will be referred to as the smaller firm as the firm name continued to be D. D. Shroff & Co. A copy of the partnership deed after reconstitution is annexed hereto as Annexure "B" and forms part of the case.

(vi) After October 10, 1950, Dastur and Kanga carried on business independently.

(vii) The firm of D. D. Shroff & Co. was assessed to income‑tax. It was registered under section 26‑A. Copies of the application for registration and the order under section 26‑A are annexed hereto as Annexures "C" and "D" respectively and form part of the case.

(viii) For the assessment year 1951‑52, the relevant previous year was from January 1, 1950; to December 31, 1950. Only one assessment was made.

(ix) For the said previous year, the accounting period was January 1, 1950, to December 31, 1950, but the accounts were made up in two parts;

1st part : January 1, 1950, to October 10, 1950.

2nd part : October 11,' 1950, to December 31, 1950.

Income and expenditure accounts for the two parts were separately drawn.

(x) In the assessment of the firm the payment of Rs. 16,500 was disallowed as being capital expenditure.

(xi) In the assessment of the recipients, Dastur and Kanga, the receipts were originally included as income receipts as under;

Dastur gsf 11,500

Kanga Rs.5,000

(xii) Dastur and Kanga both came up in appeal and it was finally decided by the Tribunal that the receipts are not taxable. The orders of the Tribunal dated March 11, 1954, are annexed .hereto as Annexures "E" and "F" and form part of the case.

(xiii) In the case of the firm, i.e., the present assessee, the payments were disallowed. The Tribunal came to this conclusion after protracted hearings arid remands. The order of the Tribunal is annexed hereto as Annexure "G" and forms part of the case. They further decided that it should be disallowed in the hands of the bigger firm, i.e., in the period January 1, 1950, to October 10, 1950. Further that it should be apportioned as under (vide Annexure "H", Income‑tax Officer's computation forming part of the case)‑

1st period Share of Share Share outstand‑ Total income ings Mr. D. D. Shroff 0‑7‑0 Rs. 17,763 Rs. Rs. 17,763 D. N. Dastur 0‑3‑0 Rs. .7,613 Rs. 11,500 Rs. 19,113 J. R. Kanga 0 ‑3‑0 Rs. 7,613 Rs. 5,000 Rs. 12,613 R. D. Shroff 0‑3‑0 Rs. 7,613 Rs. .. Rs. 7,613 ------------------------------------------------------------------- 1‑0‑0 Rs. 40,602 Rs. 16,500 Rs. 57,102 2nd period Mr. D. D. Shroff 0‑12‑0 Rs. 34,563 Rs. Rs. 34,563 R. D. Shroff 0‑ 4‑0 Rs. 11,521 Rs. Rs. 11,521 ------------------------------------------------------------------- 1‑0‑0 Rs.46,084 Rs. Rs.46,084

3. The disputed facts and findings of the Tribunal are;--

(a) Whether there was a dissolution or termination of the partnership or there was only a change in the constitution

The Tribunal found that there was a change in the constitu tion only.

(b) Whether the payment was for compensation or payment for premature termination ; and, if so, by whom

The Tribunal found that the payment was of the nature of sharing of income made by the bigger firm.

(c) Whether the Tribunal could give a finding which will increase the liability of Dastur and Kanga after their assessments were finalised by the decision of the Tribunal in their cases

The Tribunal found that they were partners in the firm‑ of D. D. Shroff & Co. up to the date of change of constitution. The shares needed amendment as a result of the final determination of income and respective shares of the firm and gave this direction in the case of the firm.

4. The questions as directed are referred.

5. Both parties agree to the statement of the cash.

M. P. Amin for the Applicants.

G. N. Joshi with R. J. Joshi for Respondent No. 1.

R. J. Kolah for Respondent No. 2.

JUDGMENT

TAMBE, J

.‑On drawing up a statement of case the Tribunal has referred the following three questions under subsection (2) of section 66 of the Indian Income‑tax Act (hereinafter referred to as the Act);

"(1) Whether the Tribunal was justified in holding that the two sums of Rs, 11,250 (rupees eleven thousand two hundred and fifty) and Rs. 5,000 (rupees five thousand) paid to D. N. Dastur and J. R. Kanga respectively were not in the nature of recoupment for the loss which they suffered by reason of the premature termination of the partnership and premature deprivation of the partnership rights before the full expiry of the term of five years of the partnership

(2) Whether the Tribunal was justified in law in holding that the said sum of Rs. 16,250 (rupees sixteen thousand two hundred and fifty) is liable to be apportioned under the first proviso to section 26(1) among four partners including the said Dastur and Kanga

(3) Whether the Tribunal was justified in law in directing the Income‑tax Officer to modify the assessment in the individual cases of Dastur and Kangi and their share income in spite of the fact that their assessments had become final and binding on the Department on the decision of the Tribunal in their cases "

Shri D. D. Shroff, his son, Shri R. D. Shroff, Shri Dastur and Shri Kanga entered into a partnership for carrying on the business of auditors, accountants and income‑tax consultants. The terms agreed to by these four partners are as per Exh. A to the statement of case. The partnership commenced from 1st February 1949, and its duration was for a period of five years. Sri D. D. Shroff held seven annas share and the other three partners held 3 annas' share each. The accounting year of firm was the calendar year. The firm was known as "D. D. Shroff & Co." It appears that some time in 1950, disputes arose between the partners, and Shri Dastur and Shri Kanga went out of the partnership on 8th October 1950. On 10th October 1950, D. D. Shroff and R. D.Shroff paid a sum of Rs. 22,500 to the two outgoing partners, Dastur and Kanga. The material part of the receipt passed by these two partners is in the following terms;

Received from Messrs Dinsha Darabshaw Shroff and Rutton Dinsha Shroff the sum of Rs. 22,500 in full settlement and satisfaction of all our duss and claims against them and/or their firm of Messrs D. D. Shroff & Co., chartered accountants (in which we have ceased to be partners by mutual agreement as from the 8th day of October 1950), under or by virtue of the partnership agreement of the said firm dated 7th March 1949, or otherwise howsoever including our shares in the capital profits and outstandings of the said partnership up to the date of our ceasing to be partners as aforesaid. In consideration of the said payment we acknowledge that the said partnership business and all the profits, outstandings and assets of the said firm belong solely and absolutely to the said Messrs Dinsha Darabshaw Shroff and Rutton Dinsha Shroff who have the sole right to carry on and continue the said firm on their own account as from the 8th day of October 1950, and we will be practising as chartered accountants either in partnership or individually from the 8th day of October 1950, to Bombay or at any place or places in the Republic of India."

After October 10, 1950, the business of the partnership firm was carried on by the remaining two partners, D. D. Shroff and R. D. Shroff, and the shares were readjusted, D. D. Shroff holding 12 annas share and R. D. Shroff 4 annas. The retiring partners, Dastur and Kanga, carried on business individually. For the assessment year 1951‑52 only one assessment was made on the firm. The accounting period, however, was divided into two periods : (1) from January 1, 1950, to October 10, 1950, and (2) from October 11, 1950, to December 31, 1950. We are here concerned with the first period of January 1, 1950, to October 10, 1950, and the dispute centres round the sum of Rs. 16,500 out of the aforesaid sum of Rs. 22,500 paid by D. D. Shroff and R. D. Shroff to the outgoing partners, Dastur and Kanga. It is not in dispute that Rs. 6,000 out of the said amount of Rs. 22,500 represents contributions to the capital made by these two partners. The dispute which arose relates to the said balance of Rs. 16,500. The Income‑tax Officer held that it represented the share in profits received by Dastur and Kanga and in this view of the matter it was taxed in the hands of Dastur and Kanga. The Income‑tax Officer, however, in the case of the assessment of the firm, did not allow the said amount of Rs. 16,500 holding that it was in the nature of capital expenditure, and on this basis concluded the assessment of the firm. The assessment orders of the Income‑tax Officer in the case of the individual assessments of the two partners, Dastur and Kanga, and of the firm are of date 12th November 1951. Feeling aggrieved by the inclusion of the said amount of Rs. 16,500 in their individual assessments, Dastur and Kanga appealed to the Appellate Assistant Commissioner. Feeling aggrieved by the disallowance of the said amount of Rs. 16,500 in its assessment, the firm represented by M/s. D: D. Shroff and R. D. Shroff went up in appeal to die Appellate Assistant Commissioner. In the appeal of the firm the Appellate Assistant Commissioner confirmed the order of the income‑tax Officer. The appeal filed by Dastur and Kanga in the case of their individual assessments were allowed by the Appellate Assistant Commissioner. Feeling aggrieved by the orders made by the, Appellate Assistant Commissioner in the individual assessment of Dastur and Kanga the Commissioner of Income‑tax filed two appeals before the income‑tax Appellate Tribunal ; one against J. R. Kanga and the other against D. N. Dastur. Feeling aggrieved by the disallowance of the said amount of Rs. 16,500 the firm also went up in appeal before the Tribunal. It appears that these appeals were not heard together. The two appeals by the Commissioner of Income‑tax against the partners were heard and dismissed by the Tribunal on 11th March 1954. The appeal filed by the firm, it appears, was heard sometime in the year 1956, and the Tribunal by its order dated 12th March 1956, remanded the case and asked for a further report on certain points. After the remand report was received, the appeal was again heard after issuing notices both to Mr. Dastur and Mr. Kanga and these two ex‑partners were also heard at time of hearing the appeal. The Tribunal held that on 8th October 1950, the firm was not dissolved but there was only a change in the constitution of the firm and, therefore, the case was governed by the provisions of subsection (1) of section 26 of the Act. The Tribunal further held that the payment of the amount of Rs. 16,500 to the two partners, Dastur and Kanga, was not compensation paid in consideration of their relinquishment of their share in the partnership but on the other band the payment was in the nature of sharing income earned by the firm consisting of all the four partners and, therefore, was liable to be taxed in the hands of these two partners. The contention raised by the two partners that the aforesaid finding of the Tribunal would amount to the enhancement of the tax liability of the two partners, their assessments having become final, was not accepted by the Tribunal. On these aforesaid findings, the Tribunal directed the apportionment of the total income of the firm. Applications made by the two ex‑partners, Dastur and Kanga, under subsection (1) of section 66 of the Act failed. As already stated, the Tribunal has now submitted the aforesaid three questions under subsection (2) of section 66 of the Act to this Court.

On the first question Mr. Amin appearing for the two partners contends that the amount of Rs. 16,500 received by these two partners was nothing but compensation received by them for the relinquishment of their shares and, therefore, is not income in their hands. He placed reliance on the decisions in Commissioner of Income‑tax v. Sind Central Provident Funds Society Ltd. (1939 I T R 333) and V. Rangaswami Naidu v. Commissioner of Income‑tax ((1957) 31 I T R 711). The argument advanced is founded on the terms of clause (21) of the partnership deed and it would be convenient to read it at this stage;

"(21). In the event of the determination of the partnership by efflux of time or any other cause whatsoever the said Dara Nasserwanji Dastur or his legal representatives and the said Jamshedji Rustomji Kanga or his legal representatives shall be entitled to be paid only their said respective shares in such of the net profits of the partnership business earned up to the date of such determination as are comprised in and based upon such of the bills in respect of matters completed by the firm by the said date of determination for fees and remuneration as may be actually payable to the firm by the said date and as may be settled by the said Dinsha Darabshaw Shroff and actually received by the firm in respect of such bills, and subject thereto all other profits and the partnership business and the assets and outstandings of the firm shall belong solely and absolutely to the said Dinsha Darabshaw Shroff and Rutton Dinsha Shroff or the survivor of them and failing such survivor to the legal representatives of the said Dinsha Darabshaw Shroff:"

It is the argument of Mr. Amin that under this clause, on determination of the partnership, all that Dastur and Kanga were entitled to get was a share in the bills which have actually been recovered by the firm up to the date of determination. It is an admitted position that by the date of determination of the v partnership all the bills had not been received by the firm and, therefore, Rs. 16,500 which has been paid to the two partners, I could not be a share in the profits nor could it be in the nature of income. It would necessarily follow that it was compensation paid for relinquishment of their partnership rights in the firm. We are unable to construe this term to mean that the two partners were entitled to get only a share in the fees which were till then recovered and not which were earned till the date of determina tion of the firm. Apart from it, even assuming that on a true construction of this clause, the two partners, Dastur and Kanga, were entitled to receive only a share in the fees actually recovered till that date and not in the fees though earned had remained unrecovered, even then, that clause would not come in the way of the other two partners, viz., the Shroffs, from giving a share to Dastur and Kanga in the fees that, had been earned up to the date of the determination of the partnership but which had remained unrecovered. The real question which falls for consi deration is what really has been paid to the outgoing partners at the time they went out. Whether the amount of Rs. 16,500 represented the amount of compensation or represented the share of profits in the income of the firm. What happened then is evidenced by the receipt passed by the two partners at the time they received the amount of Rs, 22,500 and it is clear from the .receipt that the said amount of Rs. 22,500 constituted three items: (1) share in the capital; (2) share in the profits and (3) share in the outstandings. It is an admitted position that Rs. 6,000 out of the said amount of Rs. 22,500 represented the capital contributed by the two partners. The balance of Rs. 16,500 thus could only be the share of Dastur and Kanga in the profits and outstandings. It, therefore, follows that the said amount cannot in any sense be called a compensation for relinquishment of their share in the partnership. The two decisions on which reliance was placed by Mr. Amin, therefore, have no application to the facts of the present case.

Our answer to the first question is in the affirmative.

On the second question Mr. Amin argued that on 8th October 1950, the firm was dissolved and there was not merely a change in the constitution of the firm and therefore, the provisions of subsection (2) of section 26 and not subsection (1) of section 26 would apply. Again the answer is in the receipt and it does not speak of any dissolution, but on the other hand speaks of these two partners ceasing to be partners in the partnership firm. The receipt further acknowledged that on their ceasing to be partners in the partnership business all the assets, profits and outstandings of the said firm belonged solely and absolutely to the said Messrs D. D. Shroff and R. D. Shroff, who have the sole right to carry on and continue the said firm.

These being the terms of the receipt, there is no force in the contention raised by Mr. Amin.

Our answer to the second question, therefore, is also in the affirmative.

On the third question it is the contention of Mr. Amin that the provisions of subsection (5) of section 35 came into force on 1st April 1952, the assessment of the firm as well as the assess ment of the individual partners was concluded and had become final on 12th November 1951, and, therefore, the provisions of subsection (5) of section 35 of the Act would have no application to the present case and the Tribunal was consequently in error in directing the rectification of the assessment of the partners. Reliance is placed on a decision of their Lordships of the Supreme Court in Income‑tax Officer, Madras v. Habibulla ((1962) 44 I T R 809). We find it difficult to accept this contention. The material part of subsection (5) of section 35 reads:

"Where in respect of any completed assessment of a partner in a firm it is found on the assessment or re‑assessment of the firm or on any reduction or enhancement made in the income of the firm under section 31, section 33 . . . .that the share of the partnering the profit or loss of the firm has not been included in the assessment of the partner or, if included, is not correct, the inclusion of the share in the assessment or the correction thereof, as the case may be shall be deemed to be a rectification of a mistake apparent from the 'record within the meaning of this section, and the provisions of subsection (1) shall apply thereto accordingly, the period of four years referred to in that subsection being computed from the date of the final order passed in the case of the firm."

From the provisions of subsection (5) of section 35 it is clear that within a period of four years from the date of the order of the Tribunal made under section 33 the assessment orders passed in the case of individual partners could be rectified in accordance with the final order made by the Tribunal in the case of the assessment of the firm. The applicability of the provisions of this subsection has been considered by their Lordships of the Supreme Court in the aforesaid case on which reliance has been placed by Mr. Amin, and the rule laid down is that the power to rectify the assessment of a partner consequent upon the assess ment of the firm of which he is a partner by including or correct ing his share of profit or loss can be exercised only in a case where the assessment of the firm has been made on or after April 1, 1952. The Income‑tax Officer has no jurisdiction under clause (5) of section 35 of the Act to rectify the assessment of a partner of a firm consequent upon the assessment of the firm in a case where the firm's assessment was completed before April 1, 1952.

It has to be seen whether the assessment order in the case of the firm in the instant case can be said to have been completed before the 1st of April 1952. On the facts of the present case, in our view, it cannot be said that there was any final order passed in the matter of assessment of the firm prior to 1st April 1952. It is indeed true that the assessment order of the firm passed by the Income‑tax Officer was on 12th November 1951. But then that order cannot be said to be a final order because the firm had appealed first to the Appellate Assistant Commissioner and then to the Tribunal, and the final order made by the Tribunal in appeal was in the year 1957. The final order in the assessment of the firm, therefore, on the facts of the present case, was made long after 1st April 1952, and subsection (5) of section 35, therefore, could have application to the facts of the present case. In the case before their Lordships, the facts were different, and the order of the Income‑tax Officer in the matter of assessment of the firm had become final at a date earlier than 1st April 1952, and taking advantage of the provisions of subsection (5) of section 35 of the Act, the Income‑tax Officer in the year 1954 sought to rectify the individual assessment of the partners.

Mr. Joshi also has referred us to the provisions of sub section (5) of section 33 which in terms empowers the Appellate Tribunal to authorise the Income‑tax Officer to amend and make the necessary changes in the assessment made on a partner in consequence of the order made by the Tribunal in the case of assessment of the firm. Under those provisions also the Tribunal, in our opinion, was justified in giving the directions it had given.

Our answer to the third question also is in the affirmative. The applicants shall pay the costs of both the respondents.

Questions answered in the affirmative.

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