TMI Blog1974 (9) TMI 20X X X X Extracts X X X X X X X X Extracts X X X X ..... ioner claimed that on the death of Jethalal the old firm stood dissolved on 21st June, 1969, and on the following day the new firm took over the business and, therefore, two assessments should be made, one against the old firm and the other against the new firm for the respective periods during which they were in existence during the relevant previous year. The Income-tax Officer did not accept this claim of the petitioner and passed one assessment order for the whole year against the petitioner-firm. The petitioner's revision application to the Commissioner also failed. The petitioners have now approached this court under article 226 of the Constitution. The case of the department before the income-tax authorities as also before us is that the petitioner-firm was the result merely of the reconstitution of the old firm and, as such, the case was covered by section 187 of the Income-tax Act, 1961, and one assessment had to be made against the reconstituted firm. The assessee's case is that it is a case of succession of one firm by another firm and the assessment should be made on the two firms separately under section 188 of the Income-tax Act. When the matter came up before the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t will be made upon the reconstituted firm even though income has to be divided between the partners who were actually entitled to a share in such income. The first question to be decided is as to what does the expression " reconstitution of the firm " mean. A firm in common law is not a legal entity but is merely a compendious name of persons who agree to carry on business in partnership. But under the Income-tax Act a firm has been given a legal status in a limited sense inasmuch as it is a separate taxable entity and is subject to tax which is popularly called " firm tax ". But even then the words " firm " and " partnership ", etc., have to be given the same meaning as they have under the Indian Partnership Act. It is so provided in section 2(23) of the Act which reads : " 2. (23) In this Act, 'firm', 'partner' and 'partnership' have the same meanings respectively as in the Indian Partnership Act, 1932, with one difference, viz.,. that for the purposes of this Act 'partner' includes a minor admitted to the benefits of partnership. " Therefore, we will have to refer to the Indian Partnership Act to find out as to what is understood of the expression " reconstitution of a fi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of reconstitution of a firm as understood in the Indian Partnership Act nor does it obliterate the distinction between reconstitution and dissolution. When it talks of a partner ceasing to be a partner it refers to section 32 of the Indian Partnership Act and when it talks of admission of a new partner it refers to section 31 of the Indian Partnership Act. It may be restated here that by incoming and outgoing of a partner the firm is not dissolved. Bat once a firm is dissolved either by agreement or by operation of law, the question of reconstitution does not arise even when the new firm has common partners and takes over the same business. A firm in order to be reconstituted must remain in existence. In Commissioner of Income-tax v. A. W. Figgies Co. the Supreme Court made the following observation at page 408 : " It is true that under the law of partnership a firm has no legal existence apart from its partners and it is merely a compendious name to describe its partners but it is also equally true that under that law there is no dissolution of the firm by the mere incoming or outgoing of partners. A partner can retire with the consent of the other partners and a person can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... extinct. What it denotes is a structural alteration of the membership of the firm, by addition or reduction of members, and an incidental re-distribution of the shares of the partners. " It is not correct to say that section 187 is merely a machinery section and is not a charging section. It may not be charging section in the sense that it does not by itself authorise the imposition of tax but nevertheless it does affect the liability of a person to pay the tax. By virtue of this section the reconstituted firm which in a sense is a new firm becomes liable to pay the tax for the whole year even though a part of the tax would be payable by the erstwhile firm. As the liability to pay the tax of a firm is joint and several of all the partners, the new partners who are introduced will become liable to the payment of tax on profits in which they had no share. In a way this provision casts a vicarious liability upon a person who, in fact, is not liable to pay the tax. This being the position this provision has to be construed very strictly. It must also be borne in mind that the dissolution of a firm takes place not only by a voluntary act of the partners but by operation of law over w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er of Income-tax and Kaniram Ganpatrai v. Commissioner of Income-tax. Now, in the present case, the old firm was constituted by two partners. One of them died and there was no stipulation in the partnership deed that the firm shall not stand dissolved on the death of a partner. Indeed, even if there had been such a stipulation the firm could not have been saved from dissolution because after the deaths of Jethalal only one partner was left and one man cannot constitute a firm. The firm automatically came to an end. Moreover, an agreement between the partners that on the death of one of them his legal heir would be taken as a partner does not make the legal heir automatically a partner, because he is not bound by a contract to which he was not a party. This proposition admits of no doubt after the following pronouncement by the Supreme Court in the case of Commissioner of Income-tax v. Seth Govindram Sugar Mills Ltd. " Partnership, under section 4 of the Partnership Act, 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 5 of the said Act says that the relation of partnership arises from c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... took over the same business could be assessed only in accordance with section 188 and a single assessment for the whole year was not valid. Now, I turn to the decision of the Supreme Court in the case of Shivram Poddar v. Income-tax Officer, which, I must confess, has presented a good deal of difficulty. In that case the Supreme Court was concerned with the interpretation and application of section 44 of the Indian Income-tax Act, 1922, before its amendment in 1958. Section 44 provides : " Where any business, profession or vocation carried on by a firm or association of persons has been discontinued, or where an association of persons, is dissolved, every person who was at the time of such discontinuance or dissolution a partner of such firm or a member of such association shall, in respect of the income, profits and gains of the firm or association, be jointly and severally liable to assessment under Chapter IV and for the amount of tax payable and all the provisions of Chapter IV shall, so far as may be, apply to any such assessment. " In the case before the Supreme Court a partner of a dissolved firm challenged the assessment proceedings against him in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e successor under section 26(2) if it was a case of succession. It is only where the business is totally discontinued that a provision like section 44 was necessary. Section 44 of the Act provides for two things. In the first place it ensures the continuity of the application of the machinery provided for the assessment and imposition of tax liability under Chapter IV as is apparent from the following observation of the Supreme Court in the case of C. A. Abraham v. Income-tax Officer, Kottayam : " In effect, the legislature has enacted by section 44 that the assessment proceedings may be commenced and continued against a firm of which business is discontinued as if discontinuance has not taken place. It is enacted manifestly with a view to ensure continuity in the application of the machinery provided for assessment and imposition of tax liability notwithstanding discontinuance of business of firms." Secondly, it provides for the joint and several liability of the partners of a firm whose business is discontinued, a provision which is not found anywhere else in the Income-tax Act. The provision for joint and several liability of the partners was necessary only where the busin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess, assessment has to be made under section 26(2) " has, therefore, to be understood in the context in which it was made. The case of the Kerala High Court in Excel Productions v. Commissioner of Income-tax presents no difficulty. In that case it had been admitted before the High Court, as well as before the Tribunal, that there was a change in the constitution of the firm and not succession. Obviously, section 167 would apply to such a case. The case of R. B. Jessa Ram Fateh Chand v. Commissioner of Income-tax has been decided on the basis of the observations quoted above in the case of Shivram Poddar. In my opinion, the learned judges did not notice the context in which these observations were made and were clearly misled. That decision, in my opinion, does not lay down the law correctly. As regards the other case of Civil Misc. Writ No. 5801 of 1970 (Ram Narain Laxman Prasad v. Income-tax Officer), decided on 20th May, 1971, the correctness of which was also doubted, the same is distinguishable. That was a case dealing with the registration of a firm. There two minors had been admitted to the benefits of partnership and the firm did not execute a fresh deed of partnership wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and (ii) when the tax assessed upon a partner cannot be recovered from him, it shall be recovered from 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 (b) where all the partners continue with a change in their respective ,shares or in the shares of some of them. " " 188. 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. " Relevant portion of section 189 runs thus : " 189. (1) Where any business or profession carried on by a firm has been discontinued or where a firm is dissolved, the Income-tax Officer shall make an assessment of the total income of the firm as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny reference to the Partnership Act in this connection would be irrelevant. Section 188 provides for the manner of making assessment in cases where one firm carrying on business or profession is succeeded by another firm and the case is not covered by section 187 of the Act. This means that section 187 of the Act applies also to a case where the business of a firm is taken over by another firm. It follows that for the purpose of making assessment under section 187, even a case, where one firm is succeeded by another firm, can be regarded as a case of change in the constitution of the firm, provided that the new firm is constituted in the manner described therein. Section 26 of the Indian Income-tax Act, 1922, also made a similar provision regarding the manner in which assessment was to be made in cases where there was a change in the constitution of a firm or where the business of a firm was succeeded by another firm. This section, though not identical to sections 187 and 188 of the Income-tax Act, 1961, was intended to cater to similar situation and ran thus : " 26. (1) Where, at the time of making an assessment under section 23, it is found that a change has occurred in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch for the purpose of the Income-tax Act is a reconstituted firm and it will be deemed that the personality of the old firm survived its dissolution so as to be reflected in the reconstituted firm. I am accordingly unable to agree that merely because a firm stands dissolved on the death of one of the partners constituting it, its constitution cannot undergo a change for the purposes of section 187 of the Income-tax Act. Section 187(2) lays down that for purposes of that section, there is a change in the constitution of a firm if one or more of the partners cease to be partners or one or more 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. This means that where a firm is dissolved and its business is carried on by another firm it will be considered to be a case of change in the constitution of the firm if even a single partner is common to the constitution of the two firms. This provision clearly negatives the argument that section 187 applies only to a case where the firm is not dissolved and that a change in the constitution of a firm occurs only as a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... flecting the personality of the erstwhile firm, comes into existence. This new firm becomes a distinct assessable entity different from the firm before its reconstitution. Section 187 of the Income-tax Act provides that where at the time of making an assessment under section 143 or section 144 it is found that a change has occurred in the constitution of a firm, assessment shall be made on the firm at the time of making the assessment. In other words, just as in the case of an individual assessee dying, his income is assessed in the hands of his legal representatives, as provided in section 159, in the same way the income of the firm before its reconstitution is to be assessed in the hands of the firm as reconstituted in the manner prescribed in section 187. This section even by implication does not create a fiction that the income derived by the old firm becomes the income of the reconstituted firm. Normally, it is the various items of income that accrue to a particular assessee which alone can, for the purpose of computing the income-tax payable by him, be aggregated. Chapter V of the Income-tax Act, however, provides for situations in which while determining the total income ..... X X X X Extracts X X X X X X X X Extracts X X X X
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