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Judgment
Balasubrahmanyan, J.—In this reference by the Income Tax Appellate Tribunal, Madras, under s. 256(1) of the I.T. Act the question of law
propounded for our decision is as follows :
Whether, on the facts and in the circumstances of the case, the sum of Rs. 47,203 which represented the assessee''s share of the difference
between the book value and the market value of the net assets of the firm as on June 30, 1960, is assessable as capital gains u/s 12B(1) of the
Indian Income Tax Act, 1922 ?
The assessee was one among four equal partners in a partnership fir called ""V. K. N. Palaniappa & Co."" In the year 1960, the assessee retired
from the firm with the consent of the other partners. Under the terms of the assessee''s retirement from the firm, which were to be valued as on
June 30, 1960, and one-fourth share of the net value of the assets referable to the assessee''s share should be paid over to him. Working on this
basis the total assets of the firm were valued in the sum of Rs. 4,65,250. The total liabilities stood at Rs. 2,76,437. The net value of the assets was
arrived at in the sum of Rs. 1,88,813. One-fourth part of the value of the firm''s net assets referable to the assessee''s share came to Rs. 47,203.25
This amount of Rs. 47,203, among others was received by the assessee on retirement, from the remaining partners of the firm in the account year
ended March 31, 1961.
In the course of the assessment proceedings for the relevant assessment year 1961-62, the ITO took the view that the amount of Rs. 47,203,
which simply represented the difference between the book value of the assets and their market value as on June 30, 1960, was assessable in the
hands of the assessee as capital gains exigible to tax under s. 12B of the Indian I.T. Act, 1922. Before the ITO, the contention of the assessee was
that the mere surplus of the firm''s assets over the firm''s liabilities referable to his share cannot be treated as capital gains resulting form any sale,
exchange, transfer or relinquishment by him of a capital asset. But the ITO rejected this contention and levied tax on Rs. 47,203. His order was
confirmed in appeal by the AAC for a further consideration. This time the Asst. Commissioner came to a different determination. He held that no
capital gains emerged to the assessee on the settlement of his accounts with the other partners on his retirement from the firm. The I.T. Dept.
preferred an appeal to the Tribunal from this order. But the Tribunal dismissed the appeal and confirmed the decision of the AAC.
In this reference made by the Tribunal at the instance of the Commissioner of Income Tax, his learned counsel submitted that the amount of Rs.
47,203 had to be properly brought to charge as capital gains. Learned counsel did not, however, contend that this receipt arose from a sale,
transfer or exchange of a capital asset. The point urged was that the assessee''s retirement from his firm necessarily involved a relinquishment by
him of his interest in the partnership and the amount received by him on the settlement of accounts was the consideration received by him for such
relinquishment.
We do not accept this contention as well founded. It is based on a misunderstanding of the legal attributes of the retirement of a partner from a
partnership firm.
The Supreme Court had occasion to lay down what the real nature of a partner''s share is in Addanki Narayanappa and Another Vs. Bhaskara
Krishtappa and Others, . On a survey of the provisions of the Indian Partnership Act, 1932, supplemented by a reference to the general principles
of partnership law from English decisions, the Supreme Court observed that no partner can deal with any portion of the partnership property as his
own. His right, according to the learned judges, was only to obtain such profits, if any, as fall to his share from time to time during the subsistence
of the partnership, and, upon dissolution of the firm, to a share in the surplus assets of the firm which remain after satisfying the liabilities of the
creditors.
In another case, decided by them, the Supreme Court had an occasion to deal with the nature of the dissolution of a firm and the consequences
of a settlement or adjustment of the respective interests of partners interest on such dissolution. This case, which arose under the Indian I.T. Act is
Commissioner of Income Tax, Madhya Pradesh Vs. Dewas Cine Corporation, . In this case the Supreme Court reiterated their view that on the
dissolution of a firm, the only right of a partner is to have the property of the firm realised and the proceeds applied in payment of the debts and
liabilities of the firm and to have the surplus distributed among the partners or their representatives according to their rights. The court further
observed that this distribution of surplus was only for the purpose of adjustment of the rights of partners in the assets of the partnership. They made
it quite clear that this process does not amount to any transfer of assets. Although the Supreme Court made these observations pertinently in the
context of what happens at the dissolution of a partnership firm, the case earlier cited in Addanki Narayanappa and Another Vs. Bhaskara
Krishtappa and Others, , was a case where there was a retirement and mutual settlement of accounts between the retiring partner and the partners
who remained in the firm. It was, therefore, observed by the Supreme Court that there was no difference in the legal position of a partner obtaining
a share from the partnership, bait at the time of dissolution or be it at the time of his own retirement. In either event it was a mere adjustment of his
rights at the time of his sundering his relationship with the partnership.
The principles laid down by the Supreme Court in the two aforesaid cases were applied by the Gujarat High Court in Commissioner of Income
Tax, Gujarat Vs. Mohanbhai Pamabhai, , which pertinently raised a question as to whether an amount received by a partner on his retirement can
be regarded as a ""transfer"" within the meaning of s. 2(47) of the I.T. Act 1961. The expression ""transfer"" in s. 2(47), in relation to a capital asset,
was defined to include ""the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition
there of under any law"". In the case before the Gujarat High Court, the partner received a certain amount in respect of his share in the partnership.
This amount was worked out by taking the proportionate value of his share in the net partnership assets after deduction of liabilities and prior
charges. It also included a proportionate share in the value of the goodwill of the partnership. The learned judges of the Gujarat High Court held
that the receipt of this proportionate share of the net assets of the partnership on the basis of the break-up value of the firm''s assets as on the
dated of retirement cannot be regarded as a transfer, strictly so called. They further observed that even under the wide and comprehensive
definition of ""transfer"" in the I.T. Act, which included the relinquishment of a capital asset and the extinguishment of any rights therein, what happens
on the retirement of a partner could not be regarded as a transfer. They held that when a partner retires from a firm, and, the amount of his share in
the net partnership account, after deduction of liabilities and prior charges, is determined on the taking of accounts, what he receives is his share in
the partnership, and not any consideration for transfer of his interest in the partnership to the continuing partners. They underlined the position that
what the partner received, on retirement, was his own share in the partnership which he received in terms of money. In this transaction, therefore,
the learned judges saw no element of transfer in the partnership assets by the retiring partner to the continuing partners. Apart from the two
Supreme Court decisions on which they placed reliance, they also referred to an earlier Full Bench decision of their own High Court in Velo
Industries Vs. Collector, Bhavnagar, . This case arose under the Bombay Stamp Act, 1958. The question in that case was, what the character of
the transaction is when a partner retires from the partnership and the amount of his share in the net partnership assets, after deduction of liabilities
and prior charges, is determined on taking accounts on the footing of a notional sale of the partnership assets and the share, so determined, is given
to him. It was contended for the Revenue authority that the transaction must be held to be a conveyance or sale and liable as such to stamp duty.
The Full Bench of the Gujarat High Court, however, held that the retirement of a partner in those circumstances and the receipt by him of his share
of the net surplus assets of the partnership did not involve any element of sale. The principle behind this Full Bench decision was also adopted by
the learned judges in deciding the case under s. 45 of the I.T. Act.
A Bench of this court has had occasion to touch upon a question of this kind in Commissioner of Income Tax Vs. Abdul Cader Motor Service,
. That was a case where a partner sued his other partners for dissolution of partnership and for rendition of accounts. The partnership firm had
carried on road transport business. Its assets included a certain number of buses. The suit ultimately ended in a compromise. Under the terms of
the compromise decree, the partner who filed the suit was to be paid a sum of Rs. 85,000 and costs. The decree further provided that if a
particular bus, which was being run by the partnership, was transferred to him along with the route permit, then the plaintiff would enter full
satisfaction of the decree. In the assessment of the firm a question was raised by the ITO as to whether there was a sale of the particular bus in
question to which reference had been made in the terms of the compromise decree. According to the ITO, on the terms of the compromise, it must
be held that there was a sale of the bus with the consequence that s. 41(2) of the Act applied to that transaction. A Bench of this court, to which
one of us was a party, however, held that there was no sale whatever of the bus, in the events that happened. It was contended for the Department
in that case that there was no dissolution of the firm and, in the absence of a dissolution, the partner must be regarded as having retired from the
partnership, although the suit was one for dissolution. The Bench considered the question from two angles : (1) as a transaction on the dissolution
of the firm; and (2) as a transaction on retirement. In either event, the decision was that there was no sale involved in the terms of the compromise
decree. In the course of the further discussion of the question, reference was also made to the decision of the Supreme Court in Commissioner of
Income Tax, Madhya Pradesh Vs. Dewas Cine Corporation, and the decision of the Full Bench of the Gujarat High Court in Velo Industries Vs.
Collector, Bhavnagar, . The learned judges agreed with the basis of the decision of the Full Bench of the Gujarat High Court.
The learned standing counsel for the Department drew our attention to a decision of the Bombay High Court in Commissioner of Income Tax,
Bombay City-III, Bombay Vs. Tribhuvandas G. Patel, , as a decision in the Department''s favour. That was a case where a partner of a firm
served notice of dissolution, and followed it up by a suit for dissolution and accounts. Ultimately, however, the disputes between the parties were
settled out of court. Under a deed of settlement the partner, who filed the suit for dissolution, agreed to retire from the firm with effect from a given
date, allowing the other partners to continue the business of the firm. On the occasion of such retirement he was paid certain lump sums as well as
certain other agreed sums. One of the items of payment made by the other partners to the retiring partner was Rs. 4,77,941 as and towards his
share in the assets of the firm, other than goodwill. The question was whether this amount was susceptible to assessment as capital gains. The
learned judges of the Bombay High Court held that the transaction in question amounted to a transfer in the sense of relinquishment by the partner
of his rights in the partnership and hence any gains. The following observations at p. 116 may be quoted as the basis of the decision :
... a retiring partner while going out and while receiving what is due to him in respect of his share, may assign his interest by a deed or he may,
instead of assigning his interest, take the amount due to him from the firm and give a receipt for the money and acknowledge that he has no more
claim on his co-partners. The former type of transactions will be regarded as sale or release or assignment of his interest by a deed attracting stamp
duty while the latter type of transaction would not. In other words, it is clear, the retirement of a partner can take either of two forms, and apart
from the question of stamp duty, with which we are not concerned, the question whether the transaction would amount to an assignment or release
of his interest in favour of the continuing partners or not would depend upon what particular mode of retirement is employed and, as indicated
earlier, if instead of quantifying his share by taking accounts on the footing of notional sale, parties agree to pay a lump sum in consideration of the
retiring partner assigning or relinquishing his share or right in the partnership and its assets in favour of the continuing partners, the transaction would
amount to a transfer within the meaning of section 2(47) of the Income Tax Act.
The view of the learned judges seems to be that where, on the retirement of a partner, accounts are settled and adjusted as between him and
the remaining partners in the same manner as on a general dissolution of the firm, then whatever amounts the retiring partner receives cannot be
regarded as received on a transfer or extinguishment or relinquishment of his right, but where, on the contrary, without going through the motions of
valuation of the assets of the partnership and of ascertaining the proportionate share of the retiring partner in the net assets a lump sum is received,
ad hoc, by the retiring partner from the rest, then, according to the learned judges, it would amount to a consideration received by the retiring
partner either for assigning his interest or for relinquishing his share in the partnership in favour of the remaining partners. In the former case
according to the learned judges, no capital gain accrues. They were, however, certain that in the latter case, which was the kind of case they were
dealing with in their reference, there would be liability for gains tax.
In the course of their judgment, the learned judges of the Bombay High Court referred to two decisions of the Supreme Court in Addanki
Narayanappa and Another Vs. Bhaskara Krishtappa and Others, and Commissioner of Income Tax, Madhya Pradesh Vs. Dewas Cine
Corporation, . They also referred to the decision of the Gujarat High Court in Commissioner of Income Tax, Gujarat Vs. Mohanbhai Pamabhai, .
As for the decisions of the Supreme Court, the learned judges were inclined to restrict the principles decided therein as applicable in strictness only
to cases of general dissolution of partnership which involves the taking of accounts and the receipt by a partner of his share in the assets of the
partnership on the basis of that accounting. They were inclined to hold that the Supreme Court''s decisions cannot be applied to a case where, on
retirement, a partner agrees to take a lump sum from the other partners without valuation of the assets of the partnership and without arriving at his
share of the net assets Referring to the basis of the Gujarat decision in Commissioner of Income Tax, Gujarat Vs. Mohanbhai Pamabhai, , the
learned judges observed that the decision in Addanki Narayanappa and Another Vs. Bhaskara Krishtappa and Others, , could not be applied
straightaway to cases arising under the provisions relating to capital gains taxation under the I.T. Act. According to the learned judges, the
Supreme court was dealing in Narayanappa''s case only with the question as to whether an instrument executed by a partner in favour of the other
partners with reference to his interest in the partnership required registration, or not and it was only in that context that the Supreme Court
according to the learned judges, had done away with the distinction between dissolution and retirement. To adopt this reasoning of the Supreme
Court for the purposes of capital gains taxation and make no distinction between dissolution, on the one hand, and the retirement of a partner on
the other, was not correct, according to the learned judges of the Bombay High Court. They pointed out that the Indian Partnership Act, 1932, did
not have a specific provision for taking of accounts and settlement of accounts on the retirement of a partner. The learned judges accordingly held
that the question whether there was any transfer involved on the retirement of a partner would depend on the manner in which the retirement takes
place. It was in this context that the learned judges had held that where the partner took a lump sum consideration on retirement, without reference
to taking of accounts or ascertainment of the value of the net assets and his own proportionate share in such net assets, then that mode of
retirement would involve an element of transfer since it involved a relinquishment by the retiring partner of his interest in favour of the remaining
partners.
With respect, we cannot see why retirement of a partner from a firm should be treated as having different kinds of attributes according to the
mode of settlement of the retiring partner''s accounts in the partnership. In our view, whether the retiring partner receives a lump sum consideration
or whether the amount is paid to him after a general taking of accounts and after ascertainment of his share in the net assets of the partnership as on
the date of his retirement, the result, in terms of the legal character of the payment as well as the consequences thereof, is precisely the same. For
as observed by the Gujarat High Court in Commissioner of Income Tax, Gujarat Vs. Mohanbhai Pamabhai, , when a partner retires from the firm
and receives an amount in respect of his share in the partnership, what he receives is own share in the partnership and it is that which is worked out
and realised. Whatever he receives cannot be regarded as representing some kind of consideration received by him as a result of transfer or
assignment or extinguishment or relinquishment of his share in favour of the other partners. We hold that even in a case where some kind of a lump
sum is received by the retiring partner, it must be regarded as referable only to the share capital or by way of his exertions as a partner. In true
sense, therefore, whether it is a dissolution or a retirement and whether in the latter case, the retirement is on the basis of a general taking of
accounts or on the basis of an ad hoc payment to the retiring partner, what the partner obtains is nothing more and nothing less than his own share
in the partnership. A transaction of this kind is more fittingly described as a mutual release or a mutual relinquishment. In the very case dealt with by
the Bombay High Court, the particular amount paid by the remaining partners in favour of the retiring partner was only a payment in consideration
of which there was a mutual release, a release by the retiring partner in favour of the remaining partners and a release by the remaining partners in
favour of the retiring partner. The idea of mutual release is appropriate to a partnership, because a retired partner will have no hold over the future
profits of the firm and the partners who remain in the partnership release the retired partner from all further obligations towards the liabilities of the
firm. We therefore unqualifiedly accept the decision of the Gujarat High Court as based on a correct view of the law and the legal relations which
result on the retirement of a partner from the partnership. With respect, we do not subscribe to the distinction sought to be drawn by the learned
judges of the Bombay High Court between an ad hoc payment to a retiring partner and a payment to him after ascertaining his net share in the
partnership.
In the present case, there was an agreement to which all the partners have subscribed their hand on the retirement of the assessee from the
partnership. In that agreement it was clearly stated that the partners had valued all the assets and liabilities of the firm as on the date of the
retirement on an agreed basis and as set out in the schedules to the agreement. It was on this basis that the assessee''s share in the net assets was
worked out. We are, therefore, satisfied that there is no element of capital gains merely because the valuation on the retirement of the assessee
from the firm resulted in an excess of Rs. 47,203 over the book value of the net assets of the firm referable to his share in the partnership. The
question referred to us is accordingly answered in the negative and in favour of the assessees. There will be no order as to costs.