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Judgment
Balasubrahmanyan, J.—The assessee in this group of tax cases is a tax lawyer. He was taken as a partner in a law firm in the year 1967. He
was expelled from it on January 23, 1970. He, thereafter, continued his law practice on his own. But he took up the matter of his expulsion with his
erstwhile partnership. On February 2, 1970, the assessee and his former partners settled their outstanding differences and entered into what they
called ""Heads of Agreement"". Under the terms of this settlement, it was, inter alia, agreed that all work with the assessee as on January 23, 1970,
as regards company law and taxation may be taken by him and the continuing partners shall not be entitled to any fee in respect of such work. The
implication was that the assessee should alone be entitled to the entire fees for all his work in these case up to January 23, 1970. There was,
however, one particular company law work in respect of Binny''s amalgamations. The assessee was entitled to fees as counsel for work done to
this company up to January 23, 1970. It was, however, agreed that the assessee was entitled to receive the fee from Binny Limited only of an
amount equivalent to one-fourth of the firm''s bill on this account. These two points of agreement are set out in cls. 3 and 4 of the Heads of
Agreement. Having regard to the important part they have played in the controversy between the parties, we set out the text of these clauses :
The continuing partners agree that in respect of Binny''s amalgamation bill for work done up to 23-1-1970 Mr. Reddi shall be entitled to
receive from Binny Limited fee as counsel equivalent to 1/4th of the firm''s bill on that account.
All work except as provided for herein with Mr. Reddi as regards taxation, company law and relative matters may be taken by him subject to
clients wishes and the continuing partners shall not be entitled to any fee in respect of such work.
Pursuant to these terms, the assessee subsequently received from Binny Limited 1/4th of the fee bill of the firm up to January 23, 1970. As for
the fees in respect of other work to which the assessee was entitled under clause 4, the money came to the assessee in a span of three years after
the date of his expulsion. The amounts were Rs. 2,18,300, Rs. 1,26,835 and Rs. 62,550 in the three years ended April 30, 1970, April 30, 1971,
and April 30, 1972. These amounts which the assessee received in the relevant years related to work done by him to the taxation and company
law clientele prior to January 23, 1970, when he was a partner of the law firm.
The peculiar feature of the Heads of Agreement as well as their implementation was that fees to which the assessee was entitled up to January
23, 1970, came to him directly from the clientele and not through the law firm of which he was a partner during the relevant time. Whether it was a
portion of the fee as in Binny''s case or the whole of the fees as in the other cases the assessee got them direct. The assessee, however, claimed
that these receipts in his hands were not properly assessable as part of his professional earnings, but must be kept out of the assessment as receipts
of a capital nature. The ITO, however, did not accept this contention in toto. He made a distinction between the amount received by the assessee
from Binny Limited and other amounts received by him from other clients. The ITO was prepared to treat the amount received from Binny Limited
as capital in nature. He, however, regarded all the other receipts as part of his professional earnings and, accordingly, chargeable to Income Tax in
his hands in the relevant years of receipt.
The assessee appealed against the assessments. The AAC allowed the appeals, holding that the amounts assessed were not part of the
assessee''s revenue receipts. This decision was confirmed by the Tribunal when the Department took the matter in appeal. The Tribunal in an
elaborate order expressed its view that the amounts in question are of a capital nature when they reached the hands of the assessee.
The Department has brought this reference before us now on the following question of law :
Whether, on the facts and in the circumstances of the case, the amounts of Rs. 2,18,300, Rs. 1,26,835 and Rs. 62,550 were taxable as income in
the hands of the assessee for the assessment years 1971-72, 1972-73 and 1973-74 ?
We think the matter in dispute is a simple one resolvable in a simple manner, but needlessly complicated by the Tribunal. Here is an assessee
who is a member of the bar, which means that his source of income is the legal profession. Under the scheme of the Income Tax statute, businesses
as well as professions are dealt with under one single head of charge, entitled ""Profits and gains of business or profession"". Both a business and a
profession are governed by the same provisions in the tax code relating to computation of taxable income, grant of allowances, and deductions and
the like. There are, however, obvious differences between the way in which income is earned in business on the one hand, and the income is
earned in the professions, on the other. In business, there is almost always a capital base for income to emerge. A businessman invests or risks, or
sinks, his capital either on a project or on a capital equipment. By exploiting the project or the equipment, the businessman derives business income
as so much of a return on the capital. The proportion of the fixed capital to other outlays may vary from business to business, but in almost every
case a businessman risks his capital in business, exploits the capital in a commercial way, and gets his return as income periodically. The Privy
Council''s metaphor in AIR 1932 138 (Privy Council) , such as ""the fruit of a tree"", and ""the crop of a field"" are apt to describe the mode of
income-earning peculiar to trade, business or commerce, and more observably in industry. Not so in the case of the income of professional people
like lawyers, doctors, chartered accountants, etc. Although they or their parents might have spent a good lot on their education, their professional
qualifications and the like, the money so spent does not enter into the reckoning when the practice is set up. It is no sense their investment of capital
and when the professional men earn their living they do not do so by risking any capital. On the contrary, they live by their wits, by rendering
services to their clients and putting a price on those services, which is called ""fees"". If the clients pay the fees, that at once is the measure of the
income of the professional class.
The difference between a business and a profession is more pronounced in partnerships. A partnership business like a proprietary one needs
capital and almost the first thing that has got to be secured for starting a trading partnership is the contribution by partners to the capital of the firm.
In the case of professional partnerships, however, such as in a law firm, the matter of greatest concern is not the capital base, but the existence of
suitable men who could draw clientele, and this has to do with what may be called the personal equation. A professional partnership especially that
of lawyers can be started with little or no capital contributions from the partners. A law firm or an accountant''s firm runs not on partnership capital,
but on the professional talent of its members. Such a partnership by no means involves the risking or sinking of any capital by any of the
participating lawyers or accountants. It would almost seem that the old legal definition of partnership had yielded place to a new definition only to
accommodate professional partnerships. Under the ancient definition, a partnership required the contribution of labour or capital by those who
become partners. The present day definition has eschewed all reference to capital. It is enough that a business (which includes, under the
partnership law, a profession) is carried on by all the contracting parties or any one of them acting for all.
Although we have observed that professional partnerships need little or no capital to start with as compared to trading or industrial partnerships,
the partnership law and practice always marked a clear distinction between the contribution of capital by the partners and the contribution of their
labour. Further, where a business is being carried on by a partnership especially in industrial concerns, there is a distinction between fixed capital
and circulating capital, between capital assets and trading assets, and so on. This distinction is maintained right through the career of the
partnership. Even during the dissolution of a firm the distinction is clearly drawn. In this respect, the partnership dissolution basically differs from the
dissolution of an incorporated company. Lord Atkin, giving the judgment of the Privy Council in CIT v. P R A L Muthu Karuppan Chettiyar
[1935] 3 ITR 208, held that the principles applicable to the winding up of a company and the distribution of its assets on liquidation were not
applicable to a dissolution of a partnership. The Noble Lord observed thus (p. 210) :
On the dissolution of a partnership an outgoing partner has the right to receive not as in the case of a shareholder in the winding up of a company
only a share of the assets, but to receive payment of his profits, profits which were his before dissolution and which do not cease to be his on
dissolution.
Those general considerations touching the formation, existence and dissolution of partnerships in general and professional partnerships in
particular will, we think, provide a proper perspective from which to examine the conclusions of the Tribunal in this case. The Tribunal''s
determination was as follows :
Since payments have been received by the assessee with the knowledge and consent of the firm it can only be regarded as a disbursement by the
firm out of its assets in the balance-sheet, i.e., its capital and not a share of profits to be divided with the assessee. If the firm pays to the assessee,
in settlement of its partnership affairs an amount in cash, it would certainly not be taxable as income. If instead of making a cash payment, it directs
the persons who owes amounts to the firm to hand them over to the assessee, it would not make any difference.
The view of the Tribunal seems to be this : when the assessee was expelled and following his expulsion there was a settlement between the
parties on outstanding issues between them, the fact-situation was analogous to that cf a dissolution of a firm. According to the Tribunal, where
there is a dissolution of a firm or a retirement of a partner from from the firm following a settlement of accounts, any payment made to an outgoing
partner must be regarded as receipts of a capital nature in his hands.
It is precisely this notion of the quality of the receipt in the outgoing partners hands which has been condemned in no uncertain terms by Lord
Atkin in the passage we have quoted earlier. The idea that whatever is paid to a partner on a dissolution is only capital receipt, overlooks the
fundamental position of partnership law and practice that a partner is entitled to his share of the profits and also to his share of the capital and when
he gets out of the partnership he is entitled to demand his share in each and if they are paid to him, they partake of the same character as that from
out of which the amount in each case is paid. Lord Atkin reminded us that if a partner is entitled to a share of profits, but has not withdrawn the
amount, the fact that the amounts are paid to him on dissolution will not make any difference to the revenue character of that payment in his hands.
In our judgment, the Tribunal''s decision is based on a misconception of the law.
Quite apart from any reference to the principles laid down in Muthu Karuppan Chettiyar''s case [1935] 3 ITR 208 , the Tribunal''s conclusion
is unsupportable even on factual consideration. The assessee, as we earlier pointed out, joined the law firm in the year 1967. Under the partnership
deed, which is on record he was entitled to a share in the net profits of the firm equivalent to 13% thereof. What does this mean in the context of
the constituents and personal of this law firm ? The record shows that there were as many as 12 partners, all of them practicing lawyers and each
being given his aliquots share in the firm''s profits. Just as the assessee, out of consideration for his expertise, was entrusted with Income Tax and
company law work, other partners who have their own specialization must have been entrusted with such work as they could do best. Despite the
distribution of legal work in this fashion as between the different partners, the scheme of the partnership is that professional repeats from cases
handled by all the partners would come into the reckoning in the profit and loss account of the firm every year and it is out of such net profits that
the assessee was to get 13% and the other partners their respective shares. If the assessee had not been expelled in mid-term but had been
allowed to remain in the partnership, there can be no doubt whatever that the fees for the work done by him up to January 23, 1970, as well as
subsequently would have gone to swell the profits of the firm of which he was entitled to 13%. What happened under the Heads of Agreement was
that instead of his being given 13% of the element of profits in the fees which had accrued due on the legal work which he had done up to January
23, 1970, it was agreed that he should take not merely 13% but 100% of those fees. Whether it was 13% or the whole of the fees would not alter
the character of the receipt. Therefore, quite apart from Muthu Karuppan Chettiyar''s case [1935] 3 ITR 208 , the Tribunal''s view does not fit in
with the very terms of the partnership deed and the Heads of Agreement which together must determine the quality of the receipts and their tax
treatment in the hands of the assessee.
We may now advert to certain factual inaccuracies which the Tribunal had permeated itself while dealing with the controversy in the case The
Tribunal observed, for instance, that ""the amounts received by the assessee are not traceable or in any way relatable to any services to the payers
of these amounts."" The view of the facts entertained in the above passage is against the teeth of the Heads of Agreement. If the assessee had not
rendered any services is it possible that he should have claimed and got the right which was conferred on him under clause 4 of the Heads of
Agreement. A reference to clause 3 clearly shows that even for Binny''s the assessee had done work as counsel in the amalgamation of that
concern to January 23, 1970. This must be the case with the other clients in matters of Income Tax and company law covered by clause 4 of the
Heads of Agreement.
It is needless to multiply quotations from the Tribunal''s order. We are satisfied that there is no basis either factual or legal for the conclusion of
the Tribunal that the receipts in question are of a capital character.
The assessee who appeared in person submitted that Muthu Karuppan Chettiyar''s case [1935] 3 ITR 208, does not apply to the case on
hand. Accordingly to the assessee he gave up his share of the assets of the law firm and, hence, it was in consideration therefore, that he was given
the right to receive the fees for services which he had rendered to the firm''s clientele earlier. There is nothing in the Heads of Agreement to
suggest, their express or implied, to support the assessee''s contention. Clause 1 of the Heads of Agreement merely reiterates that after the
expulsion of the assessee from the firm, the remaining partners would be entitled to continue the partnership unabated. This clause is nothing but a
reiteration of the terms of the main partnership deeds. Even accepting the assessee''s contention that the right to receive the fees for work done up
to January 23, 1970, was given to him in consideration of his giving up his other demands on the firm, that would not really alter the nature of the
receipt. It is impossible to view the present situation as in any way different from the retirement of a partner from a firm and a consequential
accounting between the retired partner and the remaining partners. In such a situation, the character of the receipt obtained by the outgoing partner
cannot be any different from the character of the payments made to a partner under on out and out desolation. In other words, the principle of
Muthu Karuppan Chettiyar''s case [1935] 3 ITR 208 must apply a fortiori.
Some mention was made in the Tribunal''s order about the method of accounting of the assessee as well as his erstwhile firm being maintained
on cash basis. In our view, the method of accounting has nothing whatever to do with the tax treatment of the amounts in question since the
appropriate principle is to be derived from Muthu Karuppan Chettiyar''s case [1935] 3 ITR 208 .
We have earlier pointed out that no sooner was the assessee expelled from the partnership than he continued his professional practice entirely
on his own. This shows that there was a continuity in the carrying on of his profession. While he was a member of the partnership, what he did was
to exercise his profession. It did not matter to his professional practice that he was expelled from the partnership. The assessee might, in one sense,
be regarded as turning over a new leaf, but he did not start a new profession. In Seldom v. Croom-Johnson [1932] 1 KB 759; 16 TC 740, a
question arose on a barrister''s Income Tax assessment whether his becoming a King''s counsel from his being a junior barrister would amount to
setting up a new possession, Rowlett J. referred to the distinction between the setting up of a new profession and setting up of a new business. He
observed that both the junior barrister and the king''s counsel carry on the same profession and the assessee was still acting in the same way as
before, practising the art of advocacy, even before he became the King''s counsel. This decision is an illustration of the nature of the legal
profession. Come what may, the legal profession remains the same. Once a lawyer always a lawyer. With the assessee''s expulsion from the law
firm one chapter in his career was closed. But then it was the beginning of the next one. The assessee apparently wished to make a clean breast of
the past by choosing a new accounting year. But this does not alter the fact that his profession was continuous. If so much is granted, it does not
matter when and in what year the assessee''s receives his fees so long as those are paid in consideration of service which he had done purely in a
forensic character.
Having regard to these circumstances, our answer to the question of law is against the assessee and in the Department''s favour. Since the
Department has succeeded in these tax reference, the assessee will pay the cost of the Department. Counsel''s fee Rs. 500. One set.