TMI Blog1980 (8) TMI 27X X X X Extracts X X X X X X X X Extracts X X X X ..... t the partnership deed, in terms, contains recitals to the effect that the three legal heirs had succeeded to the speculation business carried on by the deceased and that they had decided to continue and carry on the said business on the terms and conditions agreed upon between them and recorded in the partnership deed. In the course of the assessee's assessment to income-tax for assessment years 1965-66 to 1969-70, the relevant previous years being S.Ys. 2020 to 2024, a common contention was advanced before the ITO, namely, that the three partners had succeeded by inheritance to the business of speculation carried on by late Mr. Madhukant M. Mehta and that, therefore, the assessee was entitled to carry forward and set off the losses incurred by the deceased in his business against the income from speculation business of the partnership firm. The contention, which was based on the provisions of s. 78(2) of the I.T. Act, 1961 (hereinafter referred to as " the Act "), was rejected by the ITO on the ground that there was no succession to the business of the deceased as neither the assets nor the liabilities of the said business were taken over by the partnership firm and, in any ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the deceased were taken over by the assessee-firm and no link or nexus between the business carried on by the deceased and the assessee-firm was established, there was no succession. Mere similarity of business was not sufficient to establish the link. The AAC also held that the succession by inheritance was also not established because when legal representatives become partners by virtue of a contract between them, there can be no question of inheritance. The appeals preferred by the assessee were, therefore, dismissed. On further appeals preferred by the assessee before the Income-tax Appellate Tribunal, the Tribunal held that in order to succeed in the claim that there was succession by inheritance, it was not necessary to establish that " the partners joining the firm was by inheritance and not by any other mode ". In other words, the view of the Tribunal was that merely because the heirs entered into a partnership, their claim that they have succeeded to the business by inheritance cannot be negatived. The Tribunal further held that for succession what was required to be established is : " ........ that the same business must be carried on preserving substantial ide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s were the same as those of the business of the deceased. (vii) The partnership deed clearly evidenced the intention of the legal heirs who constituted the assessee-firm to continue and carry on the business which was carried on by the deceased." As regards the AAC's view that the recitals in the partnership deed, were " self-serving statements ", the Tribunal observed that there was nothing in law prohibiting an assessee from expressing his avowed intention and arranging his affairs in such a way as to give him the benefit under the law, provided the arrangement was real and acted upon and the advantage accruing to him was bona fide and genuine. The Tribunal held that, in the instant case, there was nothing to compel the legal heirs, particularly the widow and daughter, to carry on the speculation business, when it was not possible for them to know at the time of deciding to continue the business that it would definitely result in profit so that they would be in a position to take advantage of the loss incurred by the deceased. The Tribunal, therefore, concluded that there was, in the instant case, a succession by inheritance within the meaning of s. 78(2). The Tribunal reje ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relevant in this behalf and material for the purposes of this case, reads as under : " Nothing contained in sub-section (1) of section 72, sub-section (2) of section 73, sub-section (1) of section 74 or sub-section (3) of section 74A shall entitle any assessee, being a registered firm, to have its loss carried forward and set off under the provisions of the aforesaid sections. " The aforesaid provisions, read by themselves and in isolation, indicate that the right to carry forward and set off loss is available only to the person who has suffered the loss and, in case of registered firms, to the partners of such firm to the extent that such loss is apportioned among them, and to none else. Section 78, sub-section (2), clarifies that even a successor in business cannot claim to carry forward and set off the loss of his predecessor, save in one and only one case, namely, where the succession is by inheritance. The said sub-section reads as under: " 78. (2) 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... laration that the parties had not taken over " personally " any of the debts of the deceased either in relation to the said speculation business or any of his other debts or liabilities and that as legal representatives they were liable to pay and discharge debts and liabilities of the deceased only out of and to the extent of any estate of the deceased, which might come into their hands as such. The first question, which requires consideration, is whether the finding of the Tribunal that there was, in the instant case, a succession to the business of the deceased has been arrived at on a balanced consideration of the evidence on record and on application of the correct legal tests. In CIT v. K. H. Chambers [1965] 55 ITR 674 (SC), the question for consideration was whether, on the facts and in the circumstances of the case, the assessee there was entitled to relief under s. 25(4) of the Indian I.T. Act, 1922, on the ground that " the person...... carrying on...... business ......... is succeeded in such capacity by another person....... such another person being the assessee ". The following observations were made in the course of the decision after reviewing several authorities ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cluding cash balance) or liabilities were taken over; (2) subsisting contracts, which alone really constituted the business, were not taken over; and (3) outstanding recoveries were not taken over. While it is true that the abovementioned factors are present in the instant case, in our opinion, they are not necessarily destructive of the integrity or identity of the business so as to negative the idea of succession. It is significant to note in this connection that the Tribunal has observed that there was no dispute on the point that the three heirs had carried on the speculation business of the deceased after his death and that the partnership was formed within about one month of the death. The material on record shows that before the firm was brought into existence, the three heirs had effected the outstanding recoveries and that they had also cleared the outstanding transactions. The assets of the business were utilised in making payments to the creditors and in satisfying the income-tax demands outstanding against the deceased to the extent possible. There was still outstanding a substantial income-tax demand against the deceased but no asset was left to satisfy the same. Und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n was claimed by a partnership firm, which is a creature of contract, bearing, in the eye of law, a legal personality different from the heirs and which, for the purposes of the Act, is treated as a " person " and a distinct taxable entity. Such succession, according to the revenue, can be claimed only if the heirs, as such, continued to carry on the same business which the deceased carried on without having brought into existence between themselves the formal relationship of partnership. For the reasons which follow, we are unable to accept the submission. At the risk of repetition, it might be stated that the Tribunal has found in the instant case that there was no dispute that even prior to the execution of the partnership deed, the three heirs had carried on the same speculation business and that the partnership was brought into existence within about a month of the death of the deceased. The Tribunal has further found that even after the partnership was, brought into existence, the business was continued in the same name and in the same premises and the constituents of the assessee's business were the same as those of the business of the deceased. It has been found earlier t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... non-agricultural. The two assessees, in addition to their share in profits, received, salaries for services under the firms. The question which arose was whether the sums so drawn as salaries were wholly liable to income-tax or only to the extent of 40% thereof which fell within the non-agricultural sector. The ITO treated the whole salary as subject to income-tax. The AAC reversed the decision of the ITO.The Income-tax Appellate Tribunal, however, reversed the said decision, following the decision in Mathew Abraham v. CIT [1964] 51 ITR 467 (Mad). A Full Bench of the Madras High Court (in R. M. Chidambaram Pillai v. CIT [1970] 77 ITR 494), which heard the reference, upset its earlier view in Mathew Abraham's case [1964] 51 ITR 467 and upheld the case of the assessee that only 40% of the income by way of salary was liable to the charge of income-tax as that portion of income alone fell within the non-agricultural sector. The Supreme Court (in CIT v R. M. Chidambaram Pillai [1977] 106 ITR 292) affirmed the decision of the High Court after taking into consideration, inter alia, the provisions of ss. 10(4)(b) and 16(1)(b) of the Indian I.T. Act, 1922, and r. 24 of the Indian I.T. Rules ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e and exaction by the Constitution worked out through rule 24. Which means that by that modus operandi we set aside 60% of the total income as representing the agricultural sector, and the salary to partners paid out of it, being only profits, enjoys the same invulnerability to exigibility that rule 24 admittedly confers on the agrarian portion." The revenue's contention in that case substantially was that the Indian law recognises a firm as a person for many purposes and that ss. 10(4)(b) and 16(1)(b) were special provisions enacted to provide against loss of revenue on account of the partners' siphoning off substantial profits in the guise of salary and that such special provisions cannot alter the basic nature of salary and that, therefore, the salary received by the two assessees for services rendered to the two partnership firms was salary all the same, taxable as salary income under s. 10, there being no agricultural salary as such entitled to exemption. While rejecting the submission, it was observed that under s. 3 of the Partnership Act, a firm is not a legal person, but a relationship among persons. Reference was then made to the decision in Dulichand Laxminarayan v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gs and labels. The ultimate conclusion, therefore, was that 60% of the salary income in the hands of the two partners could not be taxed under s. 10. In Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC), a firm consisting of four partners carried on six different businesses. It installed various items of machinery in respect of which development rebate was allowed to it in the course of the previous assessments. The firm was then dissolved and one of its businesses was taken over by one partner, whereas the remaining five businesses were taken over by two of the other partners. The fourth partner received a certain sum in lieu of his share in the assets of the, firm. The question which arose for consideration was whether the rebate allowed to the firm could be withdrawn on the ground that there was sale or transfer of the machinery within the meaning of s. 34(3)(b) read with s. 2(47) of the Act. The ITO and, on appeal, the AAC held that s. 34(3)(b) applied and that the development rebate was liable to be withdrawn. The Income-tax Appellate Tribunal, however, took the contrary view and held that there was no sale or transfer within the meaning of s. 34(3)(b) in the transaction i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... were made : " The position as regards the nature of a firm and its property in Indian law under the Indian Partnership Act, 1932, is almost the same as in English law. Here also a partnership firm is not a distinct legal entity and the partnership property in law belongs to all the partners constituting the firm." Having then referred to the decision of the Privy Council in Bhagwanji Morarji Goculdas v. Alembic Chemical Works Co. Ltd. [1948] 18 Comp Cas 205; AIR 1948 PC 100 and Addanki Narayanappa's case, AIR 1966 SC 1300, the ultimate conclusion was recorded in the following words: " Having regard to the above discussion, it seems to us clear that 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 of the firm's property or firm's assets all that is meant is property or assets in which all partners have a joint or common interest. If that be the position, it is difficult to accept the contention that upon dissolution the firm's rights in the partnership assets are extinguished ...... In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... loss suffered by her husband during the period that he was a partner of the firm. In Sitaram Motiram Jain v. CIT [1961] 43 ITR 405 (Guj), the assessee, who carried on business as a sole proprietor, suffered a loss in his business and became entitled to carry forward a certain sum on account of such loss under s. 24(2) of the Indian I.T. Act, 1922. During the next accounting period the assessee took his brother as a partner in the said business which was taken over by the new firm. The partnership was registered under the provisions of s. 26A. The partnership earned profits in the very first year and a certain sum of the profits came to the share of the assessee. The assessee claimed to set off against the said sum the loss incurred by him when the business was carried on by him as a sole proprietor. The claim was allowed by the ITO but the loss could not still be wholly set off. In the subsequent accounting period the firm again made profits and the assessee received a certain portion thereof as his share.The claim to set off the carried forward loss as against such sum advanced by the assessee was rejected by the ITO. On appeal, the AAC upheld the decision. Meanwhile, the Commi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business carried on by a person on his sole account has been continued by that person in partnership with another, the provisions relating to set-off would apply." The ultimate conclusion was that the assessee was entitled to claim the benefit of the loss which he had incurred while he carried on the business in proprietorship and that he was entitled to set off such loss as against the income earned by him as a partner in the firm in the subsequent accounting periods. These decisions, in our opinion, leave no room for doubt that the submission made on behalf of the revenue is fallacious. In almost all those cases, a similar contention was advanced, considered and rejected. The decisions are an authority for the proposition that a firm has no distinct legal entity apart from the partners constituting it and that although, in the income-tax law, a firm is a unit of assessment and it has certain attributes simulative of personality, the business carried on by the firm is, in the eye of law, the business carried on by the partners collectively; the profits of the partnership firm are the profits earned by the partners, whichever may be the mode or form in which they reach them; t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... res of the partners, but the firm did not appear to have been actually dissolved at any stage. In 1947, however, the partnership was converted into a limited company. In the course of its assessment for the assessment year 1947-48, the assessee claimed the benefit of relief under s. 25(4) of the Indian I.T. Act, 1922, on the ground that the firm had been succeeded by a private limited company. The claim was disallowed by the ITO and, on appeal, by the AAC, on the ground that the partners of the firm in 1939 being different from the partners of the firm in 1947, no relief could be given. The Income-tax Appellate Tribunal, however, held that the relief contemplated by s. 25(4) was to be given to the business and not to the persons carrying on the business and that mere changes in the constitution of the firm had to be ignored. The firm, according to the Tribunal, was to be regarded for the purposes of the income-tax law as having a separate juristic existence apart from the partners carrying on the business and that the firm could be carried on even if there was a change in its constitution. The High Court upheld the view taken by the Tribunal. In the appeal before the Supreme Court, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... carrying on business in partnership and the mercantile, usage which recognises the firm as a distinct person or quasi-corporation. Then followed the observations quoted below upon which great reliance has been placed on behalf of the revenue in the instant case (p. 409) : " But under the Income-tax Act the position is somewhat different. firm can be charged as a distinct assessable entity as distinct from its partners who can also be assessed individually ......... The partners of the firm are distinct assessable entities, while the firm as such is a separate and distinct unit for purposes of assessment ...... These provisions of the Act go to show that the technical view of the nature of a partnership under English law or Indian law, cannot be taken in applying the law of income-tax." It is, no doubt, true that these observations appear to help the revenue in that they suggest that the firm being an assessable entity distinct from its partners, the same view as to the nature and status of a partnership under the partnership law cannot be taken in applying the law of income-tax. However, the observations do not advance the case of the revenue for several reasons. In the firs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l bound by the rationes decidendi of those later decisions and we must follow the law therein laid down and not the obiter dicta in Figgies' case [1953] 24 ITR 405 (SC). In the next place, even assuming that we are wrong in this view and that the relevant observations are a part of the ratio decidendi of the decision, it appears to us, with, respect, that having regard to the overall reasoning contained in the judgment and the later pronouncements of the Supreme Court, those observations, despite their apparent width and amplitude, must be read as having been made in the context of s. 25(4) and as intended to be confined to a case governed by the said sub-section. As earlier pointed out, on, a proper construction of s. 25(4), it was held that it, in terms, disregarded a mere change in the personnel of partners. The relevant observations only emphasise that under the law of partnership, firm has no legal existence apart from its partners and that, therefore, if there is a change in the partners, the identity between the old and the reconstituted firm may not, stricto sensu, be said to have been maintained although even under that law there is no dissolution of the firm by the mere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the well-settled legal position referred to earlier, those decisions are really of no assistance. We shall, however, briefly consider them. In Executors of the Estate of Dubash [1951] 19 ITR 182 (SC), the question was whether the succession to business within the meaning of s. 25(4) of the Indian I.T. Act, 1922, took place on the date of death of the testator, since from that date onwards the executors in whom the business got vested carried on the same as per the direction contained in the will, or whether such succession took place when the business was sold to one of the nephews of the testator within a period of one year of his death, as directed in the will. It was held that the succession took place on the former date and not the latter. There is nothing in this decision which throws any light on the point under consideration. In Keshrichand Bhanabhai [1951] 20 ITR 201 (Bom), the question was whether the erstwhile coparceners of an HUF, which was carrying on business, were entitled to the benefit of carry forward and set off of the loss incurred by the joint family business prior to partition under s. 24(2) of the Indian I.T. Act, 1922, in view of the fact that they had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unregistered firm under the previous Act. We do not think, therefore, that even those observations can help the revenue. Smt. Saroj Agarwal [1972] 83 ITR 875 (All) was a case in which the deceased husband of the assessee was a partner in two partnership firms. Within three days of the death of her husband, the assessee adopted a son and on the same day, she joined the two firms in place of her husband as a partner and the adopted son was admitted to the benefits of the partnership. The deceased had an unabsorbed loss from speculation business suffered by him as a partner in the two firms. The assessee claimed that the said loss should be set off against her speculation profits derived by her after joining the two firms. The holding was that the assessee was not entitled to the set-off because under ss. 72 to 74 of the Act, the right to carry forward and set off losses is available only to the person who has suffered the loss and, under s. 78(2), to the person who succeeds him in such capacity by inheritance and not otherwise. Upon the death of the husband of the assessee the partnerships stood dissolved and upon such dissolution, the representative of the deceased partners got no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the lifetime of the deceased, the business carried on by him could not have been inherited by the remaining members of the joint family as contended on behalf of the revenue. Since the Tribunal was not called upon to find these material facts, such a contention cannot be allowed to be raised at this stage. In view of the foregoing discussion, we hold that the Tribunal was right in law in holding that there was a succession by inheritance in this case as contemplated by s. 78(2) of the Act and that, therefore, the assessee is entitled to carry forward and set off the speculation losses of the deceased, Shri Madhukant M. Mehta, against the income from the speculation business earned during the relevant assessment years. That takes us to the second question, namely, whether s. 75(2) prevents the assessee from claiming the set-off of losses in question. The relevant provision has been quoted above. It provides, inter alia, that nothing contained in sub-s. (2) of s. 73 shall entitle any assessee, being registered firm, to have its loss carried forward and set off under the provisions of the said sub-section. The Tribunal rightly held that the said sub-section was not attracted in th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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