United Coir Works vs Commissioner of Income Tax

K.P. Radhakrishna Menon, J.—The assessee is before us. It is a registered firm having the name, the United Coir Works. The assessee filed two returns of income, one for the period from August 17, 1974, to April 15, 1975, and the other for the period from April 16, 1975, to August 16, 1975, both relating to the previous year relevant to the assessment year 1976-77. To a query of the assessing authority as to why two returns were filed, the assessee gave the explanation which, briefly stated, is this : During the period from August 17, 1974, to April 15, 1975, the business was carried on by a registered firm with the partners C.V. Mathew, C.M. George and C.M. Mathew. This business was sold to a new firm with the partners C.V. Mathew, C.M. George, C.M. Mathew and P.I. Alexander, constituted on April 16, 1975. The two firms which carried on the business during the periods aforesaid are two distinct and different legal entities. The firm which came into being prior to April 16, 1975, sold its business as a running concern to the firm which was constituted on April 16, 1975. The assessment, therefore, is required to be made u/s 188 of the Income Tax Act.

The assessing authority, however, was of the view that the assessee could not be said to be the successor-firm, within the meaning of Section 188, because the partnership deed dated April 16, 1975, constituting the firm had effected only a change in the constitution of the old firm ; and, as such, there is no scope to make the assessment u/s 188. Accordingly, the assessment was made u/s 187. This order of assessment was appealed against and the Commissioner of Income Tax (Appeals) who heard the appeal, by his order dated October 25, 1978, upheld the view of the assessing authority and consequently dismissed the appeal. To uphold the view of the assessing authority, the Commissioner of Income Tax (Appeals) pressed into service the decision of this court in Excel Productions, Alleppey Vs. The Commissioner of Income Tax, Kerala, Ernakulam, . The second appeal taken therefrom was dismissed by the Appellate Tribunal which also was of the view that the question raised before it was covered by the ruling in Excel Productions. Accepting the application of the assessee u/s 256(1), the following question is referred to this court for our opinion :

"Whether, on the facts and in the circumstances of the case and in view of the provisions of Clause 13 of- the deed dated November 21, 1974, the Tribunal was justified in holding that there was no dissolution on April 16, 1975, of the old constitution and, therefore, only one assessment could be made of the income of the business from August 17, 1974, to August 16, 1975 ? "

The question has not been very happily worded. The real question that arises for consideration is whether the assessment made in terms of Section 187 is sustainable or not. The answer depends upon the construction of Sections 187 and 188 read with section 170 of the Income Tax Act. We shall now extract these sections (leaving out irrelevant parts):

"187. Change in constitution of a firm.--(I) Where, at the time of making an assessment u/s 143 or section 144, it is found that a change has occurred in the constitution of a firm, the assessment shall be made on the firm as constituted at the time of making the assessment:

(2) For the purposes of this section, there is a change in the constitution of the firm-

(a) if one or more of the partners cease to be partners or one or more new partners are admitted, in such circumstances that one or more of the persons who were partners of the firm before the change continue as partner or partners after the change ; or ...

Succession of one firm by another firm .--Where a firm carrying on a business or profession is succeeded by another firm, and the case is not one covered by section 187, separate assessments shall be made on the predecessor firm and the successor firm in accordance with the provisions of Section 170.

Succession to business otherwise than on death.--(1) Where a person carrying on any business or profession (such person hereinafter in this section being referred to as the predecessor) has been succeeded therein by any other person (hereinafter in this section referred to as the successor) who continues to carry on that business or profession,--

(a) the predecessor shall be assessed in respect of the income of the previous year in which the succession took place up to the date of succession ;

(b) the successor shall be assessed in respect of the income of the previous year after the date of succession."

These two sections are concerned only with the person upon whom the liability for the tax can be imposed. Section 187 provides that, if a change in the constitution of the firm occurs in the course of an assessment, i.e., before the assessment is made, the firm which will be made liable for the tax is the firm as constituted at the time of assessment. To say that there is a change in the constitution of the firm it shall be shown that, at least one of the partners of the firm before the change continues as a partner after the change. Does that mean that the firm which succeeds the firm carrying on business or profession cannot claim an assessment u/s 188 if some of its partners happen to be the partners of the firm which it succeeded. The answer must be in the negative ; because, first of all, section 188 does not contain any such prohibition. Secondly, this section envisages a case of succession of the firm carrying on business or profession by another firm and to determine as to whether there is any such succession, reference shall be made not to section 187 but only to section 170. To substantiate succession, the two elements that should be established are the identity and continuity of business. If these two are established, in our view, the succession contemplated u/s 188 is also established. It should, in this connection, be remembered that it is not the partners of the firm who succeed the firm carrying on business or profession, but only a different and distinct firm which also is a legal entity distinct and different from the partners who constitute it, for the purposes of assessment. u/s 170, the firm succeeding the firm carrying on the business is called the "successor" and the firm carrying on the business is called the "predecessor". The effect of this section is that the predecessor is assessable in respect of the income of the successor-firm up to the date of succession whereas the successor can be made liable for tax only in respect of the income after the date of succession. In other words, the income of the year of succession requires to be apportioned between the "predecessor" and "successor" for the purpose of assessment and the actual assessment shall be made u/s 188. If that be the position, it is unnecessary or rather irrelevant to decide the issue whether the successor-firm is constituted by partners of whom some are partners of the predecessor-firm. Merely because some of the partners of the predecessor-firm happen to be partners of the successor-firm will not disentitle the successor-firm to claim the assessment made u/s 188. To put it briefly, to have an assessment u/s 188, it is enough if it is established that, during the relevant year of assessment, there existed two distinct and different firms, and the firm carrying on the business or profession was succeeded by the other firm. These principles shall be borne in mind while deciding the issue, namely, whether the assessment requires to be made u/s 187 or u/s 188.

Applying these principles to the facts of the case on hand, let us see whether the assessment should be completed by applying section 187 or made u/s 188. The facts found by the Tribunal and relevant in this context are :

"It is not in dispute, indeed there cannot be a dispute on this, as the preamble to the deed of April 16, 1975, clearly contemplates the taking over by the new constitution of the business of the earlier constitution as a going concern with all the assets and liabilities. It should also be mentioned at this stage that in the books of the old constitution certain entries were made on April 16, 1975. The entries were made in two accounts, one that is styled "Realisation Account" and the other styled "Entries relating to sale of business to new firm". These accounts are reproduced below :

Realisation Account

Dr. (Rs.) Cr. (Rs.)

1975

April 16 To value of fixed assets transferred 17,783.57

By value of fixed assets allotted to partners : C. M. George andC. M. Mathew C. M. George andC. M. Mathew

64,580

To profit on realisation transferred to partners 46,796.43

64,580.00 64,580

Entries relating to sale of business to new firm

Dr. (Rs.) Cr. (Rs.)

1975

April 16 Purchase a/c. 7,877.49

Sundry parties 2,74,202.25

To Fixed assets

130.00

" Bank accounts

4,372.54

" Sundry debtors

75,693.83

" Goodwill

5,000.00

" Stock

1,96,883.37

(being the assets and liabilities taken over by the new firm) In the books of the new constitution, the following entries were made on the same date, namely, April 16, 1975.

1975

Dr. (Rs.) Cr. (Rs.)

April 16 Fixed assets 130.00

Bank accounts 4,372.54

Sundry debtors 75,693.83

Goodwill 5,000.00

Stock 1,96,883.37

To Vendor''s account

7,877.49

" Sundry parties a/c. (being assets and liabilities of the old firm taken over transferred)

2,74,202.25

Fixed assets 64,580.00

To C. M. George

32,290.00

" C. M. Mathew

32,290.00

(being the assets introduced by these partners)".

Referring to these entries, this is what the Tribunal has stated :

"Entries have also been made regarding the transfer of the business from the old firm to the new firm".

These findings read with the preamble of the deed constituting the successor firm clearly show that with effect from April 16, 1975, the firm constituted on that date has succeeded to the business carried on by the old firm and if that be so the assessment ought to have been made u/s 188. The Tribunal, however, relying on Clause 13 of the deed of partnership constituting the old firm held that what in fact had been done by executing the deed dated April 16, 1975, was only to reconstitute the old firm. The Tribunal, in support of this view, has relied on Excel Productions Excel Productions, Alleppey Vs. The Commissioner of Income Tax, Kerala, Ernakulam, which decision, in our view, shall be confined to the facts of that case. The facts of that case clearly show that the firm involved there was only a reconstituted firm. There was, therefore, no need for this court to go into the question as to whether the assessment should be made u/s 188 or applying section 187. That was a case where the assessment could not have been made u/s 188 at all. The observations in that judgment, assuming the said observations suggest that even if a case falls u/s 188, the assessment shall be made u/s 187, therefore, are obiter dicta.

From the discussion above, it is clear that the finding of fact which provides the basis for the assessment applying the provisions of Section 187 is based upon a misconstruction of the statute. The said finding, therefore, can be interfered with. We, therefore, hold that those findings are liable to be vacated. A question, however, would arise as to whether the matter can be disposed of here itself without being remitted to the Tribunal for a fresh enquiry. We are of the view that it is unnecessary to remit this matter because the findings of the Tribunal, extracted elsewhere in this judgment, would clearly show that the new firm in fact has succeeded the old firm carrying on the business the income of which is sought to be assessed. The assessment, therefore, can be made only u/s 188.

The question, accordingly, is answered in the negative and in favour of the assessee.

A copy of this judgment under the signature of the Registrar and the seal of this court shall be forwarded to the Income Tax Appellate Tribunal, Cochin Bench.