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Judgment
Ratnam, J.—The assessee in this case is an individual. One Ramalingam Pillai and Subramania Pillai, the husband of the assessee, entered
into a deed of partnership on 22-7-1945 for the purpose of carrying on business in the manufacture and sale of certain medicinal products under
the firm name of M/s. The South Indian Manufacturing Company and that business was so carried on and conducted. Subramania Pillai died on
19-2-1972. By another deed of partnership dt. 23-2-1972 entered into between Ramalinga Pillai and the assessee, the assessee became a partner
of the firm ""M/s. The South Indian Manufacturing Company"". Her capital contribution was stated to be that amount which stood to the credit of
her deceased husband Subramania Pillai in the capital account of the firm as on 19-2-1972. For the asst. yr. 1973-74, the assessee returned a loss
of Rs. 1,52,098 claiming that she had succeeded to the business of her husband by inheritance and that the loss amounting to Rs. 2,01,344
sustained in that business should be set off. The ITO allowed only a sum of Rs. 4,338 as set off, being the prior year''s business loss and
disallowing the balance, completed the assessment. Aggrieved by this, the assessee went on appeal before the AAC contending that she was
entitled to set off the loss of her deceased husband, as she had succeeded to her husband''s interest in the partnership. The AAC viewed the matter
as one falling u/s. 78(2) of the Indian IT Act, 1961 (herein after referred to as the Act) and relying upon the decision in Commissioner of Income
Tax, Bombay City Vs. Baimaniben, allowed the appeal, directing the set off of the loss of Rs. 2,01,344 against the income and the carry forward
of the balance. The revenue carried the matter on further appeal to the Tribunal. On a consideration of the provisions in the deed of partnership dt.
23-2-1972 the Tribunal took the view that the assessee had become a partner only by a fresh contract with the erstwhile partner and that she did
not succeed to her husband by inheritance. In that view, s. 78(2) of the Act was held to be inapplicable and the assessee was held not entitled to
set off and carry forward the loss of her deceased husband in the partnership, in which he was a partner, till his death. The order of the AAC was,
therefore, set aside and that of the ITO was restored.
Aggrieved by this, the assessee has come up before this court on a reference u/s. 256(1) of the Act on the following question of law :
Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was not entitled to claim set off
business loss of Rs. 2,01,344 relating to the asst. yrs. 1969-70 to 1972-73 incurred by the assessee''s husband against the buiness income of Rs.
88,977 of the asst. yr. 1973-74 u/s. 78(2) of the IT Act, 1961 ?
The ld. counsel for the assessee contended that the husband of the assessee was initially a partner till his death on 19-2-1972 and on his death
intestate, his interest in the partnership devolved of the assessee, her son and daughter and the assessee had within about three days after the death
of her husband, become a partner of the firm by virtue and in recognition of having inherited, at least in part, her husband''s interest in the erstwhile
partnership and, therefore s. 78(2) of the Act would be attracted. It was also the further contention of the ld. counsel that it would suffice to fulfil
the requirements of s. 78(2) of the Act, if the business was factually carried on by the heir of the deceased partner, with a liability to be taxed on its
profits. In support of these contentions, ld. counsel invited our attention to the decisions in Commissioner of Income Tax, Bombay City Vs.
Baimaniben, ; Commissioner of Income Tax, Bombay City-I Vs. Shamsunder Juthalal (Deceased), and Commissioner of Income Tax, Gujarat Vs.
Madhukant M. Mehta, and Executors of the Estate of J. K. Dubash v. CIT, Bombay City (1951) 19 ITR 182. On the other hand, the ld. counsel
for the revenue submitted that the main thrust of s. 78(2) of the Act is not to allow set off and carry forward of the loss, unless the assessee had
succeeded to the business by inheritance, which was really in the nature of an exception to the general rule of disallowance and that in this case,
though there has been a succession to the business of the erstwhile partnership, such succession was by another partnership which came into being
subsequently consisting of the assessee and another partner of the dissolved partnership and not by inheritance and therefore, s. 78(2) of the Act
will be inapplicable. A further submission made by ld. counsel for the revenue was that in this case the erstwhile partnership consisted of only two
partners and that on the death of one of them, the partnership stood dissolved and that would be the position, even if the terms of the partnership
deed provided contra and the assessee in such a situation could only work out her rights in the net surplus assets of the dissolved partnership, but
that she cannot claim to have become a partner in the partnership by inheritance. Our attention in this connection was drawn to the decisions in M.
T. Sughre & Ors. v. Babu AIR 1952; M.S.V. Narayanan Chettiar Vs. M.S.M. Umayal Achi, and Commissioner of Income Tax, Madhya
Pradesh, Nagpur and Bhandara Vs. Seth Govindram Sugar Mills, . Commissioner of Income Tax, Gujarat Vs. Madhukant M. Mehta, relied on by
the assessee was distinguished by the ld. counsel for the revenue on the ground that that decision dealt with a situation where all the legal
representative of a deceased to and carried on the business as such and subsequently, had formed a partnership. According to the ld. counsel for
the revenue, the decision in CIT, U.P. v. Smt. Saroj Agarwal (1971) 83 ITR 875 would clinch the issue in favour of the revenue.
Before we embark upon a consideration of these rival submissions, it would be necessary to refer briefly to the terms of the deed of partnership
between Ramalinga Pillai and Subramania Pillai, the husband of the assessee in first instance and between Ramalinga Pillai and the assessee,
subsequently. Annexures E and F to the statement of the case contain the deeds of partnership dt. 22-7-1945 and 23-2-1972 respectively. The
deed dt. 22-7-1945, after referring to the carrying on of the business by Ramalinga Pillai and Subramania Pillai (husband of the assessee) from
1937 onwards proceeded to state that the business of the partnership shall be preparation and sale of certain medicines and agency business
known as United Medical Agencies and that the firm name shall be ""The South Indian Manufacturing Company"". Clause (3) provided that the
business shall continue until determination. The other clauses are not necessary for purpose of this case. It is significant to note that there is no
provision to the effect that despite the death of one of the partners, the partnership shall be deemed to continue. Nor is there any provision that
surviving partner can continue the partnership business as before by taking in the legal representative of a deceased partner. What will be the effect
of such clauses, even if they were there, we shall advert to later in the course of this judgment. In the deed of partnership dt. 23-2-1972 entered
into between Ramalinga Pillai and the assessee, after referring to the carrying on of the business in partnership between Ramalinga Pillai and
deceased Subramania Pillai, the husband of the assessee, from 1945 onwards in accordance with the terms of a deed of partnership dt. 27-2-
1945, the death of Subramania Pillai on 19-2-1972 has been referred to and it is further stated that as a result of the death of Subramania Pillai
that partnership was dissolved. Regarding the capital contribution of the assessee, clause (4) of the deed of partnership dt. 23-2-1972 provided
that the amount that stood to the credit of deceased Subramania Pillai in his capital account in the books of the dissolved partnership as on 19-2-
1972 shall be placed to the credit of the assessee as her share of capital under the partnership deed dt. 23-2-1972. It is in the backdrop of the
aforesaid provisions in the partnership deeds that the applicability of s. 78(2) of the Act and the claim of the assessee to set off and carry forward
the loss has to be considered.
Section 78(2) of the Act runs as follows :
Where any person carrying on any business or profession has been succeeded in such capacity by another person otherwise than by inheritance
nothing in this Chapter shall entitle any person other than the person incurring the loss to have it carry forward and set off against his income.
The underlying general principal is that the right of carry forward and set off loss is confined only to the person, who has actually suffered the loss
and not others, Section 78(2) of the Act recognises an exception. That enables the legal representatives of a deceased person succeeding to the
business of the deceased by inheritance and carrying on the business in such capacity to claim the right of carry forward and set off of loss. Before
the benefit of s. 78(2) of the Act can be availed of, it is necessary to establish succession to the business or profession of one person by another by
inheritance. If such succession is by a mode other than inheritance, then s. 78(2) may not apply. The assessee in this case is only one of three heirs
of her deceased husband. It cannot, therefore, be assumed that in such capacity she had succeeded to the interest of her deceased husband in the
partnership constituted under the terms of the partnership deed dt. 22-7-1945. At least as regards a 2/3 share in the interest of the deceased in the
partnership constituted under the deed of partnership constituted dt. 22-7-1945, the assessee cannot claim to have succeeded to that interest of
her husband. In other words, the assessee cannot be heart to project a claim that she had become entitled to the entirety of her deceased
husband''s interest in the partnership by inheritance, especially when there is no dispute that the assessee has a son and a daughter, who will also be
class I heirs along with the assessee, under the Hindu Succession Act, 1956. Apart from this, the legal impact of the provisions of the Indian
Partnership Act, 1932, would also render the claim of the assessee as one not based on any inheritance but relatable only to a contract. On the
death of the husband of the assessee on 19-2-1972, the partnership stood dissolved as it consisted of only two persons. Under s. 42(c) of the
Indian Partnership Act, 1932, a firm is dissolved by the death of a partner, though this is stated to be subject to a contract between the partners. In
this case, there is no contract contra in the partnership dt. 22-7-1945. Even on the footing that there was such a contract, as we shall presently
see, on the death of one of two partners of the partnership, the firm automatically to an end there was no partnership, which survived thereafter and
into which a third party including the heirs of deceased partner, could be introduced. It may perhaps be that out of respect for the wishes of or
even owing to the earlier directions of a deceased partner, the surviving partner may take in and enter into a fresh partnership with the heir or heirs
of a deceased partners; but that would again be a new partnership based on contract and not referable to inheritance. Section 31 of the partnership
Act provides that no person shall be introduced as a partner into a firm without the consent of all the existing partners and this again is subject to a
contract between the partners and the provisions of s. 30 of the Indian Partnership Act, 1932. The concept of introduction of a third party into a
partnership contemplates the subsistence of a partnership. With reference to a partnership of two persons, which stands dissolved on the death of
one of them it can have no application, for there is no partnership, into which a new partner can be inducted without the consent of the other
partners. Bearing in mind these considerations flowing from the provisions of the Indian Partnership Act, 1932, it would at once be obvious that on
the death of Subramania Pillai on 19-2-1972 intestate, the partnership, which consisted of Ramalinga Pillai and Subramania Pillai, stood dissolved.
The subsequent taking in of the assessee as a partner under the terms of the partnership deed dt. 23-2-1972 was only as a result of the entering
into of a new partnership between Ramalingam Pillai and the assessee. In other words, there was no question of the assessee having stepped into
the shoes of deceased Subramania Pillai by reason of her having inherited his interest his interest in the partnership. Besides, as noticed earlier, in a
case where the partnership consists of two partners, on the death of one of them, the partnership stands dissolved and thereafter, there is no
question of the legal representative of the deceased partner stepping into his place and attaining the status of a partner. Indeed, to recognise such a
situation would have the effect of almost compelling the surviving partner of a dissolved partnership to take in the legal representative of the
deceased partner, even against his wishes and that would be the negation of the very basis of partnership, which is traceable to a contract between
the parties. We may also mention that partnership is not a matter of heritable status, but purely one of contract and no heir of a deceased partner
can claim to have become a partner without the consent expressed or implied of the other. Further, under the provisions of s. 46 of the Indian
Partnership Act, 1932, on the dissolution of a firm, every partner of his representative as against the other partners or their representatives, has the
right to have the property of the firm applied in payment of the debts and liabilities of the firm and to have a distribution of the surplus amongst the
partners or their representatives, according to their rights. The right, therefore, of a legal representative of a deceased partner in a partnership
consisting of two partners which is dissolved on the death of one of them, would only normally be the right conferred by s. 46 of the Indian
Partnership Act, 1932 referred to earlier. Indian Partnership Act, 1932, it would at
And now we notice a few decisions on the aforesaid facts of the matter. Mt. Sughra and Others Vs. Babu, considered the effect of death of one
of two partners in a partnership. The position in such cases was summed up by a Justice Agarwal at page 507 thus :
The general rule is that a partnership is dissolved after the death of a party. This rule is, however, subject to a contract to the contrary. When it is
said that a partnership will not be dissolved by the death of one party, what is meant is that the partnership will continue to between the surviving
partners, even after the death of a partner. It follows that in order that the exception to the general rule may apply, the original partnership must
consist of more than two partners. In the case of a partnership consisting of only two partners, no partnership remains on the death of one of them
and, therefore, it is a contradiction in terms to say that there can be a contract between the two partners to the effect that on the death of one them,
the partnership will not be dissolved, but will continue. Nor is the position affected by bringing in the heirs of the deceased partner on the scene.
One partner, cannot, by his own contract, impose a partnership upon his heirs or legal representatives. Partnership is not a matter of status; it is a
matter of contract. No heir can be said to become a partner with another without his consent express or implied.
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When, however, there are more than two partners and when there is a contract between the partners that the partnership will not be dissolved by
the death of one of them, the old partnership continues as between the surviving partners and the heirs, if they come in, may come in the place of
the deceased partner and become partners upon the old terms. In such a case, it will not be a new partnership, but will be treated as the old
partnership which continues without a break.
To similar effect is the decision in M.S.V. Narayanan Chettiar Vs. M.S.M. Umayal Achi, . Ramachandara Iyer, J., as he then was, observed thus :
It is no doubt true that the death of a partner in most cases would dissolve the partnership. But that rule is subject to any contract to the contrary
between the partners. If the intention of the partners was that the death of one of them was not to result in the dissolution of the firm, such an
agreement could be given effect to. In such cases the partnership as between the surviving partners will continue. There may also be cases where
under the agreement between the original partners the legal representatives of the deceased partner may be entitled to join in the firm in the shoes
of the deceased partner. But the application of this rule will be difficult in the case of a firm composed only of two partners. In that case if one of
the partners died, there will not be any partnership existing to which the legal representatives of the deceased partner could be taken in. In such a
case the partnership would come to an end by the death of one of the two partners, and if the legal representatives of the deceased partner joins in
the business later, it should be referable to a new partnership between them.
The Supreme Court in Commissioner of Income Tax, Madhya Pradesh, Nagpur and Bhandara Vs. Seth Govindram Sugar Mills, had occasion to
consider this very question. A sugar mill was owned by an HUF consisting of two branches and after a partition, the two Kartas entered into a
partnership in 1943 with a view to carry on the business of the sugar mill. The deed of partnership provided that the death of any of the parties
shall not dissolve the partnership and that the heir or the nominee of the deceased partner should take his place. One of the two partners died
leaving behind him three widows and two minor sons. The other partner continued the business in the firm name and the firm applied for
registration on the basis of the partnership agreement of 1943. All the authorities declined registration in the view they took that after the death of
one of the partners, there was no partnership between the members of the two families, but the High Court was of the opinion that the Tribunal and
the other authorities had misdirected themselves in reaching the conclusion that the parties could not be regarded as partners and that the status of
the assessee for asst. yr. 1949-50 was that of a firm within the meaning of s. 16(1)(b) of the IT Act, 1922. It was contended before the Supreme
Court that on the death of one of the two partners, the firm of seth Govindram Sugar Mill was dissolved and thereafter, the income of the said
business could be assessed only as that of an AOP. Dealing with this question, after referring to the specific provisions in the deed of partnership,
to the effect that the death of any of the parties shall not dissolve the partnership and that the heir or nominee of the deceased partner shall take the
place of a deceased partner in the partnership, the Supreme Court referred to the views expressed by the Allahabad High Court in Mt. Sughra and
Others Vs. Babu, and in M.S.V. Narayanan Chettiar Vs. M.S.M. Umayal Achi, and also the view expressed by Calcutta High Court in Hansraj
Monant v. M/s. Gorak Nath Pandey (1961) 66 C.W.N. 262 and repelled the argument that the contract was an overriding one and would be
binding on the surviving member, so that on the death of one of the partners, his heir would be automatically inducted into the partnership. In doing
so, after referring to s. 31 and s. 42(c) of the Partnership Act, the Supreme Court observed as follows :
The fundamental principle of partnership, therefore, is that relation of partnership arises out of a contract and not out of status. To accept the
argument of the ld. counsel is to negative the basic principle of law of partnership. Section 42 can be interpreted without doing violence either to
the language used or to the said Partnership Act can appropriately be applied to a partnership where there are more than two partners. If one of
them dies, the firm is dissolved, but if there is a contract to the contrary, the surviving partners will continue the firm. One the other hand, if one of
the two partners of the firm dies, the firm automatically comes to an end and, thereafter, there is no partnership for a third party to be introduced
therein and, therefore, there is no scope for applying clause (c) of s. 42 of the such a situation. It may be that pursuant to the wishes of the
directions of the deceased partner, the surviving partner may enter into a new partnership with the heirs of the deceased partner but that would
constitute a new partnership. In this light, s. 31 of the partnership Act falls in line with s. 42 validity of a contract between the partners to introduce
a third party without the consent of all the existing partners; it presupposes the subsistence of a partnership of two partners which is dissolved by
the death of one of them for in that event there is no partnership at all for any new partner to be inducted into it without the consent of others.
Ultimately, the Supreme Court came to the conclusion approving the view taken by the Allahabad and Madras High Courts and rejecting the view
expressed by the Madhya Pradesh, Nagpur and Calcutta High Courts that the partnership, in that case, came to an and on the death of one of the
two partners. It is thus seen that even in a case where there was a provision in the partnership deed that the business of the partnership shall
continue despite the death of one of the two partners of the partnership, the Supreme Court held that the partnership will not survive on the death
of one of them. The position would be a fortiorari in this case, where there is no provision to the effect that the partnership would continue despite
the death of one of the partners. Therefore, on the death of Subramania Pillai on 19-2-1972, the partnership business which was carried on by
Ramalingam Pillai and Subramaniam Pillai under the terms of the deed of partnership dt. 22-7-1945, stood dissolved. Thereafter, the assessee was
taken in as a partner pursuant to the deed of partnership entered into between the surviving partnership entered into between the surviving partner
Ramalingam Pillai and the assessee. Indeed clause (4) of the deed of partnership dt. 23-2-1972 proceeded on the basis that the earlier partnership
constituted under the deed dt. 22-7-1945, had been dissolved on the death of Subramania Pillai viewed in the light of the terms of the deeds of
partnership, the provisions of the Indian Partnership Act, 1932, and the decisions referred to earlier, the conclusion is inescapable that on the death
of Subramania Pillai, the husband of the assessee on 19-2-1972, the partnership business carried on pursuant to the deed of partnership dt. 22-7-
1945 stood dissolved and by yet another deed dt. 23-2-1972, the assessee was taken in as a partner, after referring to and accepting the
dissolution of the earlier partnership between Ramalingam Pillai and Subramaniam Pillai. We are therefore of the view that on the facts and in the
circumstances of this case, there had been a succession to the partnership business which was carried on under the terms of the deed of the
partnership dt. 22-7-1945 between Ramalingam Pillai and Subramania Pillai by another partnership consisting of Ramalingam Pillai and the
assessee under the terms of yet another deed of partnership deed dt. 23-2-1972. There is thus no question of the assessee having succeeded to
the interest of her husband by inheritance so as to claim the benefits of s. 78(2) of the Act.
We may now refer to Commissioner of Income Tax, Gujarat Vs. Madhukant M. Mehta, relied on by the ld. counsel for the assessee. That
decision really does not assist the assessee, for in that case, there was a succession by three heirs to the speculation business carried on by a
proprietor and all the three heirs carried on the same speculation business as before and thereafter, entered into a deed of partnership. It was under
those circumstances that the link or nexus between the business carried on by the deceased and after his death, by his heirs, earlier as a body of
heirs and subsequently, as partners, was held not to be lost, either in substance or in form and the business carried on by the firm was considered
to have remained the same, which was succeeded to by inheritance by all the heirs, who were also partners and, therefore, the firm was entitled to
carry forward and set off the speculation losses of the proprietor against the income from the speculation business earned in the relevant
assessment years. In this case, the husband of the assessee, Subramaniam Pillai had left, behind him, besides the assessee, a son and a daughter
and they had not joined the assessee or had otherwise carried on the business jointly with the assessee. Besides, insofar as the assessee is
concerned, it had been found already that there had been no succession to the business by inheritance, but that the assessee had been taken in as a
partner in a new business under the terms of a deed of partnership dt. 23-2-1972. In other words, there is no nexus between the partnership
business earlier carried on and the business carried on by the assessee in partnership with Ramalingam Pillai. These distinguishing features would
exclude on the applicability of the ratio of the decision in Commissioner of Income Tax, Gujarat Vs. Madhukant M. Mehta, . Equally, the decisions
in Commissioner of Income Tax, Bombay City Vs. Baimaniben, and Commissioner of Income Tax, Bombay City-I Vs. Shamsunder Juthalal
(Deceased), do not advance the case of the assessee. In CIT, Bombay City v. Bai Maniben (1980) 38 ITR 80 the effect of the death of one of
two partners in a partnership consisting of only two partners had not at all been adverted to or considered. This aspect has also been referred to in
CIT, U.P. v. Smt. Suraj Agarwal (1971) 83 ITR 875 at page 886 thus :
It may be noticed that in this case the question whether on the death of a partner the firm stands dissolved and the right of the representative to
inherit the business that was being carried on by the deceased partner was not considered.
Commissioner of Income Tax, Bombay City-I Vs. Shamsunder Juthalal (Deceased), was a case where the partnership consisted of three partner
and a provision was also made that the death of any partner shall not dissolve the partnership and that unless the surviving partners otherwise
decide, the share of the deceased partner shall be continued till the end of the accounting year in which he died, after which it shall cease and
determine. On the death of one of the partners, the heirs were taken in and one of the heirs, who was a minor, was also admitted to the benefits of
the partnership and the share of the deceased partner was apportioned equally among the heirs. The new partnership agreement stated that the
parties to the agreement agreed to continue with effect from the date of the death of one of the partners in partnership. On the question whether the
sons of the deceased partner could carry forward and set off the share of loss, it was held that on the death of a partner, the partnership would not
be dissolved and the surviving partners had exercised their option to continue the partnership by taking the heirs of the deceased partner and,
therefore, s. 24(2)(iii)(c) of the IT Act, 1922, applied and the heirs of deceased partner could set off the losses suffered by their father. It is thus
seen that there was no dissolution of the partnership in law as we have in this case and despite the death of one of the three partners, the
partnership and its business had continued and in the new partnership, all the heirs of the deceased partner had been taken in as partners including
a minor who was admitted to the benefits of the partnership. In other words, the business was not dissolved and the nexus was there and with
reference to the share of the deceased partner, all his heirs succeeded and were also made partners or were admitted to the benefits of the
partnership, so that the heirs could claim that they had succeeded to the interest of their deceased father by inheritance and the business was also
thereafter carried on with the result that they could claim that the benefits of s. 24(2)(iii)(c) of the IT Act, 1922. That decision is, therefore, clearly
distinguishable and cannot apply to this case. We are unable to agree that the mere fact that the business had been actually carried on by one one
of the heirs in partnership with another, after dissolution of the prior partnership, in accordance with another deed of partnership, with a liability to
be taxed on its business profits, would suffice to attract the application of s. 78(2) of the Act without reference to the other requirements thereof.
We are unable to read either s. 78(2) of the Act or the observations of the Supreme Court in Executors of the Estate of J. K. Dubash v. CIT,
Bombay City (1951) 19 ITR 180 in the manner suggested by the learned counsel for the assessee. Having regard to these considerations, we hold
that the Tribunal was right in concluding that the assessee was not entitled to claim set off of business loss. We, therefore, answer the question in
the affirmative and against the assessee. There will, however, be no order as to costs.