Bishanlal Ahuja vs Commissioner of Wealth Tax

Syed Shah Mohammed Quadri, J.—These two reference cases arise under the Wealth-tax Act, 1957 (for short, "the Act"). They relate to the same assessee. Referred Case No. 49 of 1987 is in respect of the assessment years 1972-73 to 1977-78, whereas Referred Case No. 50 of 1987 pertains to the assessment years 1978-79 and 1979-80. At the instance of the assessee, the following question is referred to us for our opinion, u/s 27(1) of the Act, in these cases :

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in upholding the inclusion of the entire value of the immovable property of the firm in the hands of the assessee ?"

The facts giving rise to these reference cases may briefly be referred to here. The assessee is a partner in the firm, viz., 3 Aces, Abids Road, Hyderabad. The said firm had originally two partners, the petitioner and his brother, one Shri Jagatram Ahuja. The assessee purchased the share and interest of his brother with effect from April 1, 1971, and thus became the absolute owner of the said property. On January 4, 1972, he converted the said property into a partnership property by constituting a partnership firm of himself and his four daughters. That property is known as "Mohsin-Ul-Mulk Kothi". It comprises a main building having door No. 4-1-969/7 together with the appurtenant land admeasuring 9,877 sq. yards (hereinafter referred to as "the building in question"). For the said assessment years, the net wealth of the assessee was determined treating the entire building in question as the assessee''s property under rule 2 of the Wealth-tax Rules, 1957 (for short, "the Rules"). The assessee appealed to the Commissioner of Income Tax against the order of the Wealth-tax Officer. The appeal was dismissed on the ground that in view of clause 14 of the partnership deed, the assessee was entitled to take over the entire partnership assets including the building in question, so it would have to be considered as the property of the assessee. the assessee then filed the second appeal before the Appellate Tribunal. The Tribunal dismissed the appeal upholding the order of the appellate authority (Commissioner of income tax). Thus, the abovesaid question came to be referred to this court.

Shri Y. Ratnakar, learned counsel for the assessee, submits that the Tribunal erred in confirming the orders of the Wealth-tax Officer and the Commissioner of Income Tax (Appeals) by erroneously interpreting rule 2 of the Rules and, therefore, the question has to be answered against the Revenue. He further submits that the Tribunal did not record a finding on relevant questions of fact and, therefore, the Tribunal has to be directed to record a finding on all the relevant aspects of the case. On the other hand, learned standing counsel for the Revenue submits that rule 2 of the Rules has been properly invoked by the authority and the net wealth was correctly determined and, therefore, the order of the Tribunal cannot be found fault with.

Inasmuch as the entire case rests on an interpretation of rule 2 of the Rules, it would be useful to extract that rule here :

"2. (1) The value of the interest of a person in a firm of which he is a partner or an association of persons of which he is a member, shall be determined in the manner provided therein. The net wealth of the firm of the association on the valuation date shall first be determined. That portion of the net wealth of the firm or association as is equal to the amount of its capital shall be allocated among the partners or members in the proportion in which capital has been contributed by them. The residue of the net wealth of the firm or association shall be allocated among the partners or members in accordance with the agreement of partnership or association for the distribution of assets in the event of dissolution of the firm or association, or, in the absence of such agreement, in the proportion in which the partners or members are entitled to share profits. The sum total of the amounts so allocated to a partner or member shall be treated as the value of the interest of that partner of member in the firm or association."

The above extracted rule deals with the value of the interest of a person in a firm or association of persons of which he is a partner or member. The first step in working out the value of the interest of such a person is to determine the net wealth of the firm or association on the valuation date. The second step is to apportion so much of the net wealth of the firm or association, which is equal to its capital among the partners or the members, in the proportion in which capital has been contributed by them. If there is any residue of the net wealth of the firm or association, the third step would be to allocate the residue of the net wealth among the partners or members : (a) in accordance with the agreement of the partnership or association for distribution of the assets in the event of dissolution of the firm or association; or (b) in the absence of any such agreement, in the proportion in which the partners are entitled to share the profits. The sum total of the amounts so allocated, would be the value of interest of each of the partners or members.

We shall explain the operation of the rule by the following example : suppose the net wealth of the firm or association of persons, consisting four persons, A, B, C, and D, is Rs. 30 lakhs and its capital is Rs. 20 lakhs. Out of the said amount of net wealth, an amount of Rs. 20 lakhs will have to be allocated among the four partners of the firm in proportion to the capital contributed by them; if ''A'' has contributed one-half, then a sum of Rs. 10 lakhs will be allocated to him, if ''B'' has contributed 1/4th, a sum of Rs. 5 lakhs will be allocated to him and the balance of Rs. 5 lakhs will be allocated to the other partners C and D who have contributed 1/8th each. To that extent, there is no difficulty and indeed the assessee as well as the Revenue agree. The difficulty, if any, could have arisen in this case with regard to the allocation of the residue amount only. But on construction of rule 2 and clause 14 of the partnership deed, the Revenue allocated the entire value of the building in question to the assessee on the ground that by virtue of clause 14 of the partnership deed, he has the option to purchase the whole property at the book value; the assessee, on the other hand, contended that clause 14 of the partnership deed did not automatically convert the property of the firm as the property of the assessee; in other words, the assessee would submit that as the contingency mentioned in clause 14 did not occur, so, the question of treating the property as that of the assessee would not arise.

We shall now read clause 14 of the partnership deed, which is extracted below :

"It is agreed that in the event of the dissolution of partnership and/or distribution among the partners of the assets of the partnership including the Mohsin-Ul-Mulk Kothi referred to above, the first party shall have the first option to take over the assets at the book values on the date of dissolution and/or distribution of assets. If the first party does not exercise his option to take over the assets of the partnership firm, it may then be open to all or any of the other parties to take over the assets of the partnership and not otherwise."

A plain reading of the above clause shows that it is in two parts. The first makes it clear that in the event of the dissolution of the firm or distribution among the partners, of the assets of the partnership firm including the building in question, the assessee has the first option to take over the assets at the book value on the date of dissolution or distribution of the assets; the second part deals with a situation which may arise on failure of the assessee to exercise the option to take over the assets of the firm and provides that the partners will take over the assets of the firm. However, it is not clear as to whether the take over of the assets by the partners should be in the ratio of their contribution to the capital or on the basis of the sharing of the profits of the firm. Be that as it may, on a careful reading of clause 14, it becomes obvious that it gives an option to the assessee to purchase the property at the book value in the event of dissolution of the firm. The contingency mentioned in the first part not having arisen and the option not having been exercised, rule 2(1) of the Rules cannot be so construed as to allocate the entire amount representing the value of the building in question to the assessee. In a situation like the one, which arises in the present case, where in the year of assessment there has been neither a dissolution of the firm nor the distribution of the assets of the firm, even the residue of net wealth of the firm would have to be allocated to the partners in the proportion in which they are entitled to share the profits as pointed out above in construing rule 2(1) of the Rules. For these reasons, we are unable to uphold the contention of the Revenue that the net wealth of the partnership will automatically become the assessee''s property. The Appellate Tribunal had not construed rule 2(1) and clause 14 of the partnership deed correctly. Consequently, the relevant issue, viz., what is the share of the assessee in the residue of the net wealth of the firm would have to be determined by the Tribunal on ascertaining in what proportion the profits of the firm will be shared by the assessee and other partners. We, therefore, answer the question in the negative, that is, in favour of the assessee and against the Revenue and leave it open to the Tribunal to consider the matter afresh in the light of the interpretation of rule 2(1) of the Rules and clause 14 of the partnership deed indicated above.

The references are accordingly answered. No costs.