TMI Blog1991 (11) TMI 13X X X X Extracts X X X X X X X X Extracts X X X X ..... he relevant years, no other partner. Besides the textile business, the assessees' firm also conducted a business in dry-cleaning and tailoring. That part of the business of the firm was actually styled as " Bright Dry Cleaners ". An agreement dated August 18, 1969, was entered into between the assessees' firm, " Good Morning Stores ", on the one part and the wives of the two partners of the firm on the other part. By the agreement, the assessees' firm sold the dry-cleaning and tailoring business to the wives of the two partners. The wives of the two partners entered into a partnership agreement with each other to carry on the business which was transferred to them under the agreement dated August 18, 1969 (see paragraph 4 of the statement of the case and paragraph 34 of the Tribunal's order). In respect of the assessment years 1970-71 and 1971-72, the Incometax Officer found that the consideration for which part of the business of the assessees' firm was transferred to the respective spouses was inadequate and, consequently, section 64(1)(iii) of the Income-tax Act, 1961 ( " the Act " ), as it then stood, was attracted. Accordingly, the Officer computed the income of each of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r adequate consideration . . . ; " (emphasis supplied). Section 64 appears in Chapter V which deals with " income of other persons included in the assessee's total income ". The provisions of this Chapter treat, for the purpose of assessment, the income of another person, in certain circumstances, as the income of the assessee. The object of the Legislature is to ignore a transfer of assets in certain circumstances, although the transfer itself is valid in law, and include the income arising from the transferred assets in the total income of the transferor. The sections must, therefore, be read with a view to giving full effect to the legislative intent, wherever the circumstances postulated under the sections are attracted. Section 64(1)(iii) refers to income arising directly or indirectly to the spouse of an individual from assets transferred directly or indirectly to the spouse by the individual otherwise than for adequate consideration. Although the transfer of the assets is valid in law even when the consideration is inadequate, in so far as the consideration is inadequate, clause (iii) of the sub-section says that all such income as arises directly or indirectly from such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . " Partnership " is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all (section 4 of the Indian Partnership Act, 1932 ). For this joint venture, they contribute capital which may be either money, or movable or immovable properties having a value in money set on them. Whatever is contributed by a partner ceases to be his exclusive property. The asset which was once in his total ownership is, when contributed to the firm, subjected to the rights of other partners. His exclusive interest in that asset is thus reduced to shared interest. It becomes the trading asset of the partnership and it is vested in all the partners. Each partner has an interest in the property in proportion to his share in the joint venture of the business. No partner can claim or exercise, even to the extent of his share in the business of the partnership, an exclusive right over any partnership property. His right during the subsistence of the partnership is confined to his share of the profit as agreed upon among the partners, and, upon dissolution of the partnership or upon his retirement from the partnership, to the value of the sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the partnership firm as his share to the partnership capital, transformed into an interest shared with the other partners in that asset. Qua that asset, there is a shared interest. During the subsistence of the partnership, the value of the interest of each partner qua that asset cannot be isolated or carved out from the value of the partner's interest in the totality of the partnership assets. And in regard to the latter, the value will be represented by his share in the net assets on the dissolution of the firm or upon the partner's retirement. . . . When a partner retires or the partnership is dissolved what the partner receives is his share in the partnership. What is contemplated here is a share of the partner qua the net assets of the partnership firm. On evaluation, that share in a particular case may be realised by the receipt of only one of all the assets. What happens here is that a shared interest in all the assets of the firm is replaced by an exclusive interest in an asset of equal value. That is why it has been held that there is no transfer. It is the realisation of a pre-existing right......." (emphasis supplied) See also the principle stated in Addanki Narayan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of partnership to make transfers either gratuitously or for inadequate consideration to the spouses of the transferors, and thereby evade the taxes. Such verbal, technical and artificial construction, the law does not countenance: see CIT v. C. M. Kothari [1964] 2 SCR 531 ; [1963] 49 ITR 107 (SC), 110 and Sunil Siddharthbhai v. CIT [1985] 156 ITR 509, 523 (SC). It is the legislative intent that, whatever be the device adopted by the assessee, the consequences of the statutory provisions must follow in all cases where an individual, whether a partner or otherwise, has directly or indirectly transferred assets to his wife otherwise than for adequate consideration and income directly or indirectly arises therefrom. In the present case, what is directly transferred by the firm is an indirect transfer by each of the partners of his beneficial interest to the extent of the devaluation caused by the inadequate consideration, and the income which directly arises from the assets transferred by the firm is the income which indirectly arises from the assets indirectly transferred by the partner, namely, the devalued portion of his beneficial interest. I would in this connection recall the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... HAKRISHNA MENON J. (3-11-1987)-The assessment years under consideration are 1970-71 and 1971-72, the corresponding previous years respectively being the accounting periods ended on August 16, 1969 and August 16, 1970. There are two assessees. They are the partners of the firm, by name, M/s. Good Morning Stores., Alleppey (hereinafter referred to as the " old firm " ), which carried on businesses in textiles and also dry cleaning and tailoring under the name and style of Bright Dry Cleaners. While so, as per an agreement dated August 18, 1969, the business carried on under the name and style " Bright Dry Cleaners " was sold by the old firm, M/s. Good Morning Stores to the wives of the assessees who constituted a new firm. The old firm thus discontinued this line of business activity ; and the said business, after the transfer, was carried on by the new firm. The consideration for the transfer, as seen from the agreement, was the written down value of the machinery and equipment the transferor firm was using to carry on the dry cleaning and tailoring business under the name and style " Bright Dry Cleaners ". This consideration was found to be inadequate by the assessing authority. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ply section 64(1)(iii) of the Income-tax Act and compute the income of the assessees by clubbing the same with the share incomes derived by their wives as partners of the new firm Before I deal with these points, I shall first state the law. 'Though, under the partnership law, a firm is not a legal entity but only consists of individual partners for the time being, for tax law, income-tax as well as sales tax, it is a legal entity' has been declared by the Supreme Court in State of Punjab v. Jullundur Vegetables Syndicate, AIR 1966 SC 1295. In the same strain are the subsequent decisions of the Supreme Court, namely, CIT v. R. M. Chidambaram Pillai [1977] 106 ITR 292 ; Sunil Siddharthbhai v. CIT [1985] 156 ITR 509 and also the rulings of this court ITO v. C V. George [1976] 105 ITR 144 (Ker) [FB], A. Abdul Rahim, Travancore Confectionery Works v. CIT [1977] 110 ITR 595 (Ker) [FB]. It is also well-established that (at page 49 of 120 ITR) " a partnership firm, under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... partnership in which all the partners would have interest in proportion to their share in the joint venture of the business of partnership. The person who brought it in would, therefore, not be able to claim or exercise any exclusive right over any property which he has brought in, much less over any other partnership property. He would not be able to exercise his right even to the extent of his share in the business of the partnership. As already stated his right during the subsistence of the partnership is to get his share of profits from time to time as may be agreed upon among the partners and after the dissolution of the partnership or with his retirement from partnership the value of his share in the net partnership assets as on the date of dissolution or retirement after deduction of liabilities and prior charges. It is true that even during the subsistence of the partner ship a partner may assign his share to another. In that case what the assignee would get would be only that which is permitted by section 29(1), that is to say, the right to receive the share of profits of the assignor and accept the account of profits agreed to by the partners emphasis supplied) The Sup ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ested in the whole of the partnership property on the basis of equality between them, but it is not always clear in relation to any particular item of partnership property whether they are interested therein as tenants-in-common, or as joint tenants without benefit of survivorship, so far as a beneficial interest is concerned, It follows from this community of interest that no partner has a right to take any portion of the partnership property and to say that it is his exclusively. No partner has any such right, either during the existence of the partnership or (in the absence of agreement) after it has been dissolved. " (emphasis supplied) Regarding the share of a continuing partner in an on-going partnership, the learned author Lindley has stated thus (at page 463) "The reason is that during the continuance of the partnership, each partner is entitled to require the partnership property to be applied for the purposes of the partnership and no partner is entitled to the several enjoyment of his share. Secondly, when, on the determination of the partnership, the beneficial interest falls into possession, it takes effect subject to the right of the other partners to have the pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 68 ITR 240 ; CIT v. Bankey Lal Vaidya [1971] 79 ITR 594; Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 ; by the Punjab and Haryana High Court in Kay Engineering Co. v. CIT [1971] 82 ITR 950 ; by the Kerala High Court in CIT v. Nataraj Motor Service [1972] 86 ITR 109 and by the Gujarat High Court in CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393, the Supreme Court in Sunil Siddharthbhai's case [1985] 156 ITR 509 has held " that when a partner retires or the partnership is dissolved, what the partner receives is his share in the partnership. What is contemplated here is a share of the partner qua the net assets of the partnership firm". Having understood the position (regarding the nature of the partner's A interest in the assets of the partnership) thus, let us consider whether the taxing authorities were right in applying section 64(1)(iii), as it stood then, and clubbing the assessee's income with the share incomes derived by the wives as partners of the new firm carrying on the business, which the old firm had originally transferred to the wives of the assessees, in computing the assessable income of the assessees. Section 64(1)(iii) as it stood then (omitting unnecessary parts t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d should belong to the individual exclusively. Here it is relevant to note that legislation like this is designed to circumvent the growing tendency seen among the taxpayers to avoid or reduce tax liability by transfer of income-fetching assets directly or indirectly to their spouses. Even after such transfers, the taxpayer would continue to have control over the assets and the income therefrom. Only on establishing that the asset transferred exclusively belonged to the individual the income derived therefrom by the spouse can be clubbed with the income of such individual. I am fortified in this view by the judicial pronouncements mentioned hereunder., CIT v. C. M. Kothari [1963] 49 ITR 107 (SC). " It is argued that the first requisite of the section is that the assets must be those of the husband and that is not the case here. It is true that the section says that the assets must be those of the husband.." (emphasis supplied) Considering an identical provision in the English Act, Lord Macmillan in A. G. Chamberlain v. Inland Revenue Commissioners [1943] 25 TC 317 (HL), has observed thus (at page 329): "This legislation ... (is) designed to overtake and circumvent a growing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the assets to their spouses " is unsustainable. The assessment clubbing the incomes of the spouses with the total income of the assessees, therefore, is not sustainable in law. Notwithstanding the decision of the Supreme Court in Sunil Siddharthbhai's case [1985] 156 ITR 509 restating the principle highlighted in Narayanappa's case, AIR 1966 SC 1300, counsel for the Revenue submitted that, whatever be the position regarding the nature of a partner's interest in the assets of the firm, the fact remains that the assessees who are the partners of the old firm transferred the business of dry-cleaning and tailoring, by name Bright Dry Cleaners, as a running business, to the new firm constituted by the wives of these partners with a view to avoid payment of tax. Dilating on this point, he submitted that the business which was transferred to the spouses must be treated as business carried on by the assessees as they are the only partners of the firm and, under law, the business carried on by a firm is business carried on by its partners. In support of this argument, he relied on the decision of the Supreme Court in CIT v. Ramniklal Kothari [1969] 74 ITR 57. The observation is this (he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hereby implied that expenditure properly allowable in earning the profits, salary, interest, commission or other remuneration is not to be allowed in determining the taxable total income of the partner. The receipt by the partner is business income for the purpose of section 10(i), and being business income, expenditure necessary for the purpose of earning that income and appropriate allowances are deductible therefrom in determining the taxable income of the partner. " The observation extracted above is not in any way inconsistent with the principle enunciated by the Supreme Court in Narayanappa's case, AIR 1966 SC 1300, and restated in Sunil Siddharthbhai's case [1985] 156 ITR 509 (SC) while considering the position the partners occupy in relation to the property/asset of the firm. This ruling, therefore, will not apply to the case in hand. When a partnership transfers some of its assets during the subsistence of the partnership either gratuitously or otherwise than for adequate consideration, such transfer would result in the reduction of the value of each partner's share. To the extent there is reduction in the value of the partner's share in the partnership assets, there i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture transactions of the partnership, and " it may diminish in value depending on accumulating liabilities and losses with a fall in the prosperity of the partnership firm ". The Supreme Court, in the said decision, has further declared that " the evaluation of a partner's interest takes place only when there is a dissolution of the firm or upon his retirement from it ". If that be the position in law, it will be too much for the Revenue to contend for the position that the transfer of the business by the firm (no doubt the transfer was effected by the partners, but indisputably for and on behalf of the firm), to the new firm of which the wives of the assessees are partners is a dubious method adopted by the assessees to transfer their assets to their wives to avoid payment of tax in respect of the income that is received from the said assets. It, therefore, follows that the transfer by the old firm of the running business by name " Bright Dry Cleaners " to the new firm of which the wives of the assessees are the partners cannot be considered to be a transfer falling within the mischief of section 64(1)(iii). In other words, the transaction ( assuming it forms part of a, tax planni ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the conclusions on which the High Court is to exercise such advisory jurisdiction is illustrated by this case. " From what is stated above, it is clear that the assessing authority was not right in treating the share incomes derived by their spouses as partners of the new firm, as the incomes of the assessees while computing their assessable income. The questions, therefore, are answered in the negative, that is, in favour of the assessees and against the Revenue. We have, in our separate judgments, differed in our answers to the questions referred. Accordingly, place the papers before the Honourable the Chief justice for orders under section 9 of the Kerala High Court Act, 1958 (Act 5 of 1959), read with section 23 of the Travancore-Cochin High Court Act, 1125 (M.E.) (Act V of 1125). K. A. NAYAR J. (28-11-1991). - An ingenious attempt on the part of two assessees who were partners of a firm called "Good Morning Stores, Alleppey" to get their individual tax liability reduced, attracted differing judgments from two judges of this court constituting the Bench, and, therefore, in accordance with section 9 of the Kerala High Court Act read with section 23 of the Travancore High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bunal. The Tribunal accepted the contention of the Revenue that there was an indirect transfer of assets by the assessees to their respective spouses, that income arose from the assets transferred, which was the business, itself, and, therefore, the profits attributable to the share of the assessees' spouses in the business arose only from the transfer of the assets by the assessees. The Tribunal held that the assets of the partnership vested in the partners collectively in proportion to their share and direct transfer by the partners representing the firm resulted in an indirect transfer by the partners of their share in such assets in favour of their spouses. Since the business itself was transferred which produced the income for the assessees' spouses, the Tribunal also found that the profit attributable to the share of the assessees' spouses in the business arose directly from the transfer of such assets. In so holding, the Tribunal relied on the decision of the Bombay High Court in Chaturbhujdas Karnani v. CIT [1958] 34 ITR 553. The Tribunal was satisfied that all the requirements of section 64(1)(iii) of the Act were satisfied and the income derived by the assessees' wives wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly to the spouse by such individual otherwise than for adequate consideration or in connection with an agreement to live apart. Kochu Thommen J. (as he then was), held that a firm under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it and the firm's property or assets are only the property or assets of the partners and when transfer of assets is made by the partnership, there will be a reduction in the value of each partner's share and, therefore, it should be construed that the two partners constituting the firm together transferred certain assets of their firm to their respective spouses for inadequate consideration. His Lordship, therefore, held that the provision of section 64(1)(iii) of the Act is satisfied. In that view of the matter, his Lordship answered question No. 3 in the affirmative, i.e., in favour of the Revenue and against the assessees. His Lordship felt it unnecessary to answer questions Nos. 1 and 2 in the light of his answer to question No. 3. His Lordship justice Radhakrishna Menon, on the other hand, held that a firm, though not a legal entity in partnership law, for the purpose of the Income-tax Act, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansferees are the wives of the assessees and the transfer is for inadequate consideration. The assets transferred have been detailed in the assessment order. Admittedly, the firm "Good Morning Stores, Alleppey' had only two partners, viz., Sri P. Ramachandra Reddiar and Arjuna Reddiar, and that firm was also carrying on a business in tailoring and dry-cleaning under the name and style " Bright Dry Cleaners and Out fitters ". The firm discontinued the said business and sold the machinery and equipment used in that business as a going concern to the wives of the two partners. The business premises continued to be the same and services of the staff were also continued. Even though in the agreement of sale it has been shown that the machinery and equipment were sold, in effect the business in its entirety was sold as a going concern. If section 64(1)(iii) is read substituting the names of the partners and their wives, it will read as "in computing the total income of Ramachandra Reddiar and Arjuna Reddiar (the individual assessees) there shall be included all such income as arises directly or indirectly to Radhamani and Nagalakshmi (who were spouses of Ramachandra Reddiar and Arjuna Re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be his own employer." Thereafter, the Supreme Court observed (at page 298): "In some systems of law this separate personality of a firm apart from its members has received full and formal recognition as, for instance, in Scotland. That is, however, not the English common law conception of a firm. English lawyers do not recognise a firm as an entity distinct from the members composing it. Our partnership law is based on English law and we have also adopted the notions of English lawyers as regards a partnership-firm. " Thus, the Supreme Court held that the firm is not an entity or person in law, but merely an association of individuals and the firm name is only a collective name of those individuals who constitute the firm. In other words, the firm, name is merely an expresssion, only compendious mode of designating the persons who have agreed to carry on business in partnership. In Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC), the different notions regarding the nature of the firm between commercial men and lawyers have been explained by the Supreme Court. The legal notion of a firm differs from the commercial notion of the same, for the firm is not recognised by E ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es not confer a corporate personality on the firm. The Supreme Court observed (at page 163) : " The firm is an assessable unit separate and distinct from the individual partners, who as individuals constitute assessable units separate and distinct from the firm. It is on that basis that the provisions of the tax law are structured into a scheme providing for the assessment of partnership income. We do not think the principle goes beyond the purpose of that scheme. It does not confer a corporate personality on the firm. Beyond the area within which that principle operates, the general law, that is to say, the partnership law, holds undisputed domain. " Counsel for the assessees referred to a large number of decisions to show that, in tax matters, a firm is a legal entity. The decisions referred are State of Punjab v. Jullundur Vegetables Syndicate, [1966] 17 STC 326 ; AIR 1966 SC 1295, ITO v. C. V. George [1976] 105 ITR 144 (Ker) [FB], CIT v. R. M. Chidambaram Pillai [1977] 106 ITR 292 (SC), Abdul Rahim, Travancore Confectionery Works v. CIT [1977] 110 ITR 595 (Ker) [FB] and Sunil Siddharthbhai v. CIT [1985] 156 ITR 509 (SC). These are authorities for the proposition that a firm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... well established. Any partner can claim only a share in the profits of the business. But, in this case, the firm consisting of two partners transferred the property and the business to their wives. There is no case that apart from the two partners, there are other persons interested in the property transferred. The property transferred belongs to the two partners and the transferees are the wives of the two partners.-Therefore, section 64(1)(iii) is clearly attracted. Counsel also referred to the decision reported in J. B. Greaves v. CIT [1963] 49 ITR 107 (Bom) to show that the assets transferred must be those of the transferor. In this case, the transferor is the partnership and the partnership consisted of Ramachandra Reddiar and Arjuna Reddiar, and the transferees are the respective wives of the said partners. When the assets are held by the firm, it means the assets are held by the two partners and, therefore, the transfer made is by the assessees to their wives. Hence, in computing the total income of the assessees, the income that arose to the spouses of such individuals from the assets transferred will have to be included under section 64(1)(iii) of the Act. What was tran ..... X X X X Extracts X X X X X X X X Extracts X X X X
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