Commissioner of Income Tax vs Gunturu Kannambhai and Co.

Y.V. Anjaneyulu, J.—Pursuant to the directions of this Court u/s 256(2) of the income tax Act, 1961 (''the Act''), the Tribunal referred to the following three questions of law for the opinion of this Court. This reference is at the instance of the Commissioner and relates to the assessment year 1971-72: 1. Whether, on the facts and in the circumstances of the case, the receipt of the sum of Rs. 1,69,456 is a capital receipt?

Whether, the Appellate Tribunal is justified in holding that no action can be taken to assess the receipt in the hands of the predecessor firm u/s 41(1), particularly in the absence of any appeal or cross-objections against the direction of the Appellate Assistant Commissioner?

Whether, on the facts and in the circumstances of the case, there is a change in the constitution of the firm or succession by another firm?

The assessee is a partnership firm constituted under a deed of partnership dated 15-1-1970. The firm consisted initially of nine partners. Partners Shri P. Thatamma died on 14-1-1970. On 15-1-1970, the present assessee-firm came into existence. Apart from the eight surviving partners of the previous firm, another Shri K.S. Venkateswar was admitted as a partner. The assets and liabilities of the previous partnership were taken over as a going concern by the present assessee-firm. The assessee filed a return for the period 15-1-1970 to 31-7-1970 corresponding to the assessment year 1971-72 and claimed separate assessment of its income for the above period. It was claimed that there was dissolution of the previous firm on the death of the partner Shri P. Thatamma, on 14-1-1970 and that the assessee-firm constituted under the deed of partnership dated 15-1-1970 should be held to be a separate firm succeeding to the business carried on by the previous firm. It appears, the previous firm also filed a return of its income for the period 1-8-1969 to 14-1-1970 and claimed assessment up to that date for the assessment year 1971-72. The ITO accepted the above claim regarding the dissolution of the predecessor firm and the succession by the assessee-firm and made two separate assessments according to the return filed. 2. In the return filed for the period 15-1-1970 to 31-7-1970, the assessee declared income of Rs. 74,245. It may be mentioned that the assessee-firm carried on business as contractors under Balimela Dam Project, Chitrakonda, which was in continuation of business carried on by the predecessor firm. The income of Rs. 74,245 declared in the return was arrived at in the profit and loss account drawn by the assessee-firm after taking into consideration on the credit side a sum of Rs. 1,69,456 received by way of competition pursuant to an arbitrator''s award dated 24-1-1970. It was claimed before the ITO that the predecessor firm, which was dissolved on 14-1-1970, had incurred some expenditure on certain works which never formed part of the original agreement with the Government and it preferred a claim for reimbursement of the expenditure and, consequently, matters were referred for a claim for reimbursement of that expenditure before the State Government. Dispute seems to have arisen regarding the claim for reimbursement of the expenditure and, consequently, the matters were referred for arbitration as provided in the agreement between the predecessor firm and the State Government. The arbitrator gave the award on 24-1-1970 under which, it appears, a compensation of Rs. 1,69,456 was awarded. This amount was payable to the predecessor firm, but as the predecessor firm ceased to exist on the day when the award was given, the amount was paid to the assessee-firm. During the course of the assessment enquiry, the ITO held that the books of account maintained by the assessee were defective to the work receipts. The income so determined was Rs. 2,11,149. To the income as determined, the ITO added the sum of Rs. 1,69,456 referred above on the ground that the provisions of section 41 of the Act were attracted in view of the assessee''s contention that the expenditure in respect of the compensation awarded by the arbitrator was incurred in the earlier years. The assessee filed an appeal to the AAC, questioning the correctness of the inclusion of the sum of Rs. 1,69,456 in the assessee''s total income. It was claimed that the expenditure was incurred by the dissolved predecessor firm and the compensation in question was referable to the business carried on by the dissolved firm. It was further claimed that the provisions of section 41 are not applicable on the facts and in the circumstances of the assessee''s case. The AAC held that the amount of compensation could be considered as income only in the hands of the dissolved firm. The AAC noticed the provisions of section 170(1) of the Act and held the view that the income accruing to the predecessor firm was liable to be taxed in the hands of the predecessor firm was not proper. In that view, the AAC deleted the sum of Rs. 1,69,456 from the assessment made in the hands of the assessee. He observed that the ITO may consider inclusion of the above said sum in the hands of the predecessor firm. The assessee''s appeal was, accordingly, allowed.

The ITO filed an appeal before the Tribunal questioning the correctness of the orders of the AAC deleting the sum of Rs. 1,69,456 from the assessment. Curiously, the first contention urged by the ITO before the Tribunal was that, there was merely a change in the constitution of the firm on the death of one of the partners on 14-1-1970 and, therefore, one single assessment was liable to be made under the provisions of section 187 of the Act. The revenue urged before the Tribunal that the assessee-firm constituted under the deed of partnership on 15-1-1970 could not be considered to be a separate firm and must be held to be in continuation of the old firm with only a change in the constitution. The revenue also contended that, in any event, the AAC should have sustained the assessment of the sum of Rs. 1,69,456 in the assessee''s hands. Resisting the ITO''s appeal, the assessee seems to have not only supported the order of the AAC in deleting the income in question, but raised a further plea that the sum of Rs. 1,69,456 was not assessable in the hands of the predecessor firm also either u/s 41 or otherwise.

The Tribunal held that the revenue could not be permitted to raise the plea that the assessee-firm was merely in continuation of the earlier firm and that there was merely a change in the constitution of the firm. The Tribunal pointed out that the ITO himself had accepted the plea that the assessee-firm succeeded to the business carried on by the predecessor firm on the basis that there was dissolution of the predecessor firm on 14-1-1970. Even on merits, the Tribunal held that the assessee-firm should be held to be a successor within the meaning of section 188 of the Act of the earlier firm. In that view, the revenue''s plea that there was merely a change in the constitution of the firm was rejected. Dealing with the merits, the Tribunal held that the realisation by the assessee of the sum of Rs. 1,69,456 under the arbitrator''s award dated 24-1-1970 was in the nature of realisation of an old asset belonging to the predecessor firm. The Tribunal held that the receipt in the hands of the assessee was a capital receipt and as such cannot be included in its business income. The Tribunal had also dealt at considerable length with the assessee''s contention that the sum of Rs. 1,69,456 was not assessable as income in the hands of the predecessor firm also. The Tribunal found fault with the direction given by the AAC to consider inclusion of the income in the hands of the predecessor firm. The Tribunal held that the predecessor firm cannot be taxed on the above-mentioned sum either u/s 41 or otherwise. The appeal filed by the ITO was, accordingly, rejected by the Tribunal. The application filed by the Commissioner u/s 256(1) for reference of certain questions of law to this Court was rejected by the Tribunal. The Commissioner thereupon moved this Court u/s 256(2) and obtained a direction to the Tribunal to refer the questions of law to this Court for its opinion. It is pursuant to this direction that the Tribunal has now referred the abovementioned questions of law to this Court.

It is convenient to dispose of the second question first. It is certainly improper on the part of the Tribunal to go into the question whether the predecessor firm was liable to concern with the question whether the predecessor firm was liable to be taxed on the sum of Rs. 1,69,456. The Tribunal was merely concerned with the question whether the above-mentioned sum was liable to be taxed in the hands of the assessee-firm. For arriving at a decision on this point, it was not necessary for the Tribunal to go into the question whether the predecessor firm was liable to be taxed in respect of the abovementioned sum either u/s 41 or otherwise. In fact, the AAC did not give any categorically direction for the assessment of the income in the hands of the direction for predecessor firm. All that the AAC did was to direct the ITO to consider the inclusion of the abovementioned sum in the hands of the predecessor firm. If and when the ITO took action for considering the assessment of the sum of Rs. 1,69,456 in. the hands of the predecessor firm, it would be open to the predecessor firm to advance all contentions available to it to prevent the assessment. It is not for the assessee-firm to contend that the sum in question was not liable to be taxed in the hands of the predecessor firm. It is equally not open to the Tribunal to take upon itself a detailed examination of this question and record its findings on the assessability or otherwise of the said sum in the hands of the predecessor firm. In our opinion, the Tribunal committed an error in entertaining the assessee''s plea in the above regard and in recording its findings on the question. We, therefore, answer the second question to the effect that the Tribunal would not have gone into the question regarding the assessability or otherwise of the sum of Rs. 1,69,456 in the hands of the predecessor firm. Whatever has been stated by the Tribunal in the above regard shall, therefore, be disregarded.

We shall now take up the third question whether, on the facts and in the circumstances of the case, there is a change in the constitution of the firm or succession by another firm. At the outset, we must state that we are somewhat surprised at the revenue''s attitude in pursuing this question. Before the ITO there was claim that the predecessor firm was dissolved on 14-1-1970 and the present assessee-firm came into existence on 15-1-1970 under a deed of partnership executed on that day. The firm, as was in existence till 14-1-1970, filed one return for the assessment year 1971-72 declaring income up to the period 14-1-1970. The assessee-firm filed another return for the same assessment year 1971-72 declaring income for the period 15-1-1970 to 31-7-1970. The claim that there was a dissolution of the predecessor firm and that the assessee-firm succeeded the predecessor firm was accepted by the ITO and two separate assessments were made, one on the predecessor firm on income up to the date of dissolution and another on the assessee-firm from 15-1-1970, when it came into existence. The ITO passed orders of the assessment on the basis and also registered the present firm by his order dated 20-0-1973. These facts would clearly indicate that the revenue accepted that the assessee-firm is a successor to the predecessor firm within the meaning of section 188. The assessee filed an appeal before the AAC and it merely related to the assessability of the sum of Rs. 1,69,456 in the assessee''s hands. The ITO did not make any claim before the AAC that the assessee-firm is not a successor firm, but there is merely a change in the constitution within the meaning of section 187(2). When the AAC deleted the sum of Rs. 1,69,456 from the assessment, the ITO filed an appeal before the Tribunal and for the first time, a contention was urged that the assessee-firm could not be considered to have succeeded the predecessor firm and there was merely a change in the constitution following the death of Shri P. Thatamma on 14-1-1970. The revenue''s contention before the Tribunal in this regard runs counter to its own acceptance of the assessee''s claim that there was dissolution on 14-1-1970 and the present assessee-firm succeeded to the business carried on by the predecessor firm. The Tribunal was justified in declining to permit the revenue to raise this plea before the Tribunal. The Tribunal referred to the fact that on the death of the partner Shri P. Thatamma, the account books were closed and profit ascertained and a new set of account books was opened on 15-1-1970 by the assessee-firm and they were closed on 31-7-1970. The Tribunal was justified in holding, based on these facts, that the ITO gave a categorical finding that the old firm was dissolved on the death of the partner Shri P. Thatamma and that the present assessee-firm came into existence under a fresh partnership deed, with effect from 15-1-1970. The Tribunal was, therefore, quite right to argue that there was only a change in the constitution of the firm on 15-1-1970 and the business continued without any interruption. We are constrained to observe that this contention has been taken by the revenue light heartedly in a desperate attempt to sustain the assessment of Rs. 1,69,456 without realising the consequences. The revenue should have known that if there was no succession and there was merely a change in the constitution of the firm altogether, different considerations would prevail regarding the assessability of the sum in question. We feel that the revenue should not take up contradictory stands to suit its convenience from time to time a change which is often levelled by the revenue against the taxpayer. For the aforesaid reasons, we are satisfied, on the facts and in the circumstances of the case that there was dissolution of the firm on 14-1-1970 and the assessee-firm succeeded to the business carried on by the predecessor firm within the meaning of section 188. Indeed, that was the assessee''s claim and on a scrutiny, the ITO accepted. We, accordingly, answer the third question to the effect that the assessee-firm succeeded to the business carried on by the predecessor firm and there was dissolution of the predecessor firm on 14-1-1970.

Having disposed of question Nos. 2 and 3, we now address ourselves to the first question referred, namely, whether, on the facts and in the circumstances of the case, the receipt of the sum of Rs. 1,69,456 is a capital receipt. In our opinion, the real question that arises for consideration is whether the sum of Rs. 1,69,456 is liable to be taxed as income in the hands of the assessee. We have already set out the facts in detail and it is not necessary to restate them. Section 170 deals with cases of succession and the relevant principles governing the assessability of the income in the hands of the predecessor and in the hands of the successor. The ITO was obviously aware of the statutory provisions contained in section 170 and recorded a finding that the sum of Rs. 1,69,456 is an assessable income in the assessee''s hands u/s 41. We are satisfied that the provisions of section 41 have no application in the assessee''s case and the AAC was justified in deleting the sum from assessment on that; ground. At the same time, the AAC noticed the provisions of section 170 accrued to the predecessor firm and (sic), consequently, it was assessable in the hands of the predecessor firm u/s 170(1)(a). Although the AAC applied his mind rightly to the question, there is no indication in the order as to why the AAC held the view that the sum accrued as income to the predecessor firm? When the matter came up in appeal before the Tribunal, the revenue failed to pursue the matter in the above direction. The revenue did not urge any contention before the Tribunal, even as an alternative measure, that the sum in question should be held to have accrued as income to the assessee-firm falling for the assessment u/s 170(1)(a). The Tribunal did not, therefore, consider the question from that point of view. The Tribunal proceeded on the basis that the realisation of the above-mentioned sum is like realisation of any asset taken over on succession and, therefore, constituted a capital receipt. If, what was realised by the assessee was an asset taken over by the assessee-firm from the predecessor firm, the view held by the Tribunal is unexceptionable. The facts on record do not, however, indicate that when the assessee-firm took over the assets on 15-1-1970, there was any right vested in or asset created in favour of the predecessor firm to realise the sum of Rs. 1,69,456. Shri Ch. Sreerama Rao, the learned counsel for the assessee, vehemently contended that a right already accrued in favour of the predecessor firm to realise the sum in question and the arbitration was for the limited purpose of quantifying the amount payable.

The learned counsel urged that the quantifications of the award amount by the arbitrator under an award dated 24-1-1970 did not create any new asset. According to the learned counsel, there was merely a postponement of the quantification and the right already vested in the predecessor firm and that right, when it was taken over by the assessee-firm during the course of succession, constituted an asset in the assessee''s hands. The learned counsel further proceeded to state that indeed the right to receive reimbursement of the expenditure incurred by the predecessor firm vested in it in the years in which the expenditure was incurred. We are unable to accept the later part of the submission of the learned counsel for the assessee. If the predecessor firm had incurred some expenditure on some works, unconnected with the agreement, it was not automatically entitled to receive reimbursement. On the contrary, the facts would show that some disputes have arisen, although it is not clear from the record whether such disputes are in connection with the reimbursement or in the matter of quantification. The authorities below including the Tribunal has not referred to the nature of disputes, the matters which were referred to arbitration and the eventual decision of the arbitrator under the award dated 14-1-1970. The award is also not made part of the record and we have, therefore, not been able to look for ourselves to the nature of the arbitratory proceedings. We are, therefore, unable to appreciate property the contention of the learned counsel for the assessee that the arbitration proceedings were for the limited purpose of quantification of the sum payable and there was no dispute in principle that the predecessor firm was entitled to reimbursement. If the evidence would indicate that the right of the predecessor firm to receive reimbursement was accepted in principle and matters were referred to the arbitrator only to quantify the amount, there is force in the contention of the learned counsel for the assessee that when the quantification was made, no new right is created. If, on the contrary, the evidence would show that the right of the predecessor firm to receive reimbursement was not accepted even in principle, but was disputed and the matter was referred to the arbitrator not merely for the purpose of quantification, but for the purpose of determining whether there was liability to pay the amount it should then be said that there was no right vested in or an asset created in favour of the predecessor firm at the time when the assets were taken over by the assessee-firm.

Reference may be invited to the decision of the Supreme Court in E.D. Sassoon and Company Ltd. Vs. The Commissioner of Income Tax, Bombay City, the Supreme Court observed:

... income may accrue to an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody.... Unless and until there is created in favour of the assessee a debt due by somebody it cannot be said that he has acquired a right to receive the income or that income has accrued to him." We may also refer to a decision of this Court in MAHALAKSHMI RICE and OIL MILL Vs. COMMISSIONER OF Income Tax, ANDHRA PRADESH., This was a case in which the assessee''s claim for payment of certain amount was accepted by the Government and pursuant to that acceptance, a sum of Rs. 44,000 was paid to the assessee in July 1955. The assessee claimed that the sum paid was referable to the contract entered into with the Government on 9-5-1954 and therefore, income had accrued to him in the year 1954 itself. The assessee, accordingly, urged that the sum of Rs. 44,000, paid in July 1955 could not be included in the assessment year 1956-57. Rejecting the assessee''s contention, this Court held that income could be said to have accrued only on the date when the claim was accepted.

In Lakshman Prakash Vs. Commissioner of Income Tax, the Allahabad High Court, dealing with an identical situation held, that income could be said to have accrued only on the date when the claim for payment is accepted. We may also refer to the decision of the Allahabad high court in COMMISSIONER OF Income Tax, U. P. and Vs. P. V. KALICHARAN JAGANNATH., (This was affirmed by the Supreme Court in The Commissioner of Income Tax, Madras Vs. A. Gajapathy Naidu, , there it was held that ''income can be held to arise or accrue to an assessee only when the assessee obtains a right to receive that income. If an amount is to be taxable as income of the relevant previous year the right to receive it must come into existence in that year.''

Obviously, realising the above basic principles regarding accrual of income, the learned counsel for the assessee, Shri Ch. Sreerama Rao urged that the right to receive the income accrued in favour of the predecessor firm long prior to its dissolution and the arbitration was only for the limited purpose of quantification.

The learned counsel submitted that under the award, dated 24-1-1979, the amount payable was merely quantified and it could not, therefore, be said that the amount paid under the award accrued only on 24-1-1970 on its being ascertained. The learned counsel for the assessee made a grievance that the authorities below did not consider the assessability of the sum in question from the above point of view and did not, therefore, have an occasion to examine in detail the arbitration proceedings and to arrive at a proper decision, when the sum paid under the award dated 24-1-1970 had legally accrued. We find there is justification for this grievance because the authorities below including the Tribunal did not consider the assessability of the sum of Rs. 1,69,456 u/s 170(1)(b) based on principles of accrual. In the absence of any material on record, we are unable to reach on any firm conclusion in the matter as to when the sum paid under the award could be said to have accrued. In the circumstances, we decline to answer the first question referred to us and direct the Tribunal to go into the question in detail while passing an order conformably to this judgment u/s 260(1) of the Act. The Tribunal shall give necessary opportunities to the assessee as well as the revenue to place all the relevant materials regarding the nature of arbitration proceedings and arrive at a proper finding as to when the sum paid under the award accrued bearing the principles set out by us above. Section 170(1)(a) authorises the assessment in the hands of the assessee in respect of the income of the previous year after the date of succession. It is, therefore, necessary for the Tribunal to examine and determine the whole or any part of the sum of Rs. 1,69,456 represented income of the previous year after the date of succession. The extent of income, if any, determined as accruing in the previous year after the date of succession is liable to be assessed in the hands of the assessee for the assessment year under consideration u/s 170(1)(b). Reference is answered, accordingly. In the circumstances of the case, we direct the parties to bear their own costs. Advocate''s fee Rs. 500.