Karnataka H.C :the capital gains arising out of the sale of the assets of the firm was assessable in the hands of the outgoing individual partners of the erstwhile firm

High Court Of Karnataka

Raghurama Prabhu Estate Vs. JCIT (Asstt.)

Assessment Year 1995-96

Section : 45

V.G. Sabhahit And B. Manohar, JJ.

ITA. Nos. 134 To 140, 144 To 147 Of 2000

December  23, 2010 

JUDGMENT

V.G. Sabhahit, J. – I. T. A. Nos. 134 of 2000, 135 of 2000, 136 of 2000, 137 of 2000, 138 of 2000, 139 of 2000, 140 of 2000, 144 of 2000, 145 of 2000, 147 of 2000 and 146 of 2000 arise out of a common judgment passed by the Income-tax Appellate Tribunal, Bangalore Bench, Bangalore (hereinafter called “ITAT”), in I. T. A. Nos. 946, 952 to 957 and 959/Bang/1998 (assessment year 1995-96) dated July 31, 2000, Mrs. Arathi Shenoy v. Joint CIT (Asstt.) [2000] 246 ITR (AT) 1 (Bangalore) [SB], wherein the Income-tax Appellate Tribunal has dismissed the appeals and confirmed the order passed by the Commissioner of Income-tax (Appeals). The appeals I. T. A. Nos. 144 of 2000, 147 of 2000 and 146 of 2000 are filed by the Revenue being aggrieved by the observations made by the Vice-President of the Tribunal regarding calculation of the capital gains. These appeals along with the other five appeals filed by the Revenue against the order of the Tribunal were disposed of by a common order dated December 19, 2002. Being aggrieved by the said order of the Division Bench of this court dated December 19, 2002, B. Raghurama Prabhu Estate v. Joint CIT [2003] 264 ITR 124 (Karn), Civil Appeals Nos. 4232, 4242, 4234, 4233, 4235, 4236 and 5322 of 2003 M. Janardhana Rao v. Joint CIT [2005] 273 ITR 50 (SC) were filed. Similarly, I. T. A. Nos. 69-70 of 2001 are filed by the Revenue being aggrieved by the order passed by the Income-tax Appellate Tribunal in Appeals Nos. 946, 952 to 957 and 959/Bang/1998, dated July 31, 2000, for the assessment year 1995-96. The hon’ble Supreme Court has passed a common order on January 28, 2005, Mangalore Ganesh Beedi Works v. CIT [2005] 273 ITR 56 (SC), along with other appeals filed against the income-tax appeals by setting aside the order passed by this court in I.T.A. Nos. 134 to 140 of 2000 and remitted the matter to this court for fresh disposal in accordance with law for framing the substantial questions of law. In obedience to the direction of the hon’ble Supreme Court dated January 28, 2005, the following substantial questions of law have been framed in these appeals after hearing the learned counsel appearing for the parties :

“(i) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the capital gains arising out of the sale of the assets of the firm was assessable in the hands of the outgoing individual partners of the erstwhile firm ?
(ii) Whether, at any point of time, any AOP comprised 7 outgoing partners had come into existence which can be said to have become the owner of the assets of the firm and had sold the same to the AOP-3 ?
(iii) Whether, on the facts and in the circumstances of the case, it can be held that the transfer of business of the firm as going concern in favour of the association of three persons was merely relinquishment of shares held by the other outgoing partners ?
(iv) Whether, in the facts of the present case, the Tribunal was right in concluding that the capital gains arising out of the sale of the business of the firm as a going concern was liable to be assessed in the individual hands of the erstwhile partners, except the three, who as an AOP have purchased the assets of the firm ?
(v) Whether the sale of the assets of the firm was a slump sale and if so, whether it was liable to capital gains tax ? (vi) Whether the Vice President of the Tribunal has committed an error of law in laying down the manner in which the capital gains is to be computed ?
(vii) Whether, in the facts and circumstances of the case, the Tribunal was right in holding that the income earned by an association consisting of 13 persons for a period of 234 days that is, till November 20, 1994, was assessable in the hands of those 13 persons or not ?”
  1. The above substantial questions of law were explained to the learned counsel appearing for the parties and the learned counsel appearing for the parties agreed that the above were only substantial questions of law that are required to be answered by this court.
  2. The materials facts of the case giving rise to the abovesaid substantial questions of law are as follows :

In 1939, the late S. Raghuram Prabhu started the business of manufacturing beedis. Subsequently, his brother-in-law, Sri Madhav Shenoy, also joined him in the business as a partner and thus M/s. Mangalore Ganesha Beedi Works (for short “MGBW”), the firm, came into existence with effect from March 28, 1940. Thereafter, the said firm was reconstituted from time to time. The last reconstitution of the firm was evidenced by a partnership deed dated June 30, 1982, and, according to the averments made in the deed, the last reconstitution of the firm became effective from June 6, 1982, and, according to the deed of partnership, the firm comprised the following 13 partners :

Sl. No. Name of the partners % of share
1. B. Raghurama Prabhu 14.50
2. M. Janardhana Rao 7.65
3. M. Ananda Rao 7.65
4. M. Vinoda Rao 7.50
5. M. Pushpalatha w/o Subraya Baliga 12.50
6. Hemalatha w/o Raghunath Shenoy 12.50
7. M. Suresh Rao 7.55
8. M. Vishwanath Rao 7.55
9. M. Ramanatha Rao 2.50
10. Jaganath Shenoy 2.50
11. Vatsala Shenoy D/o M. Janardhana Rao 7.55
12. M. Gopinath Shenoy 2.50
13. Arathi Shenoy D/o M. Janardhana Rao 7.55
  1. Clause 3 of the partnership deed provided for the duration of the firm. This clause reads as under :

“3 The duration of the partnership shall be five years in the first instance ; but by mutual agreement the parties hereto may extend the said duration. If during the subsistence of this partnership any of the partners desire to retire from the partnership he or she can do so, if all the other partners agree to the said retirement. However, if all the other partners do not agree to the said retirement, the partner intending to retire shall give six months’ notice in writing of his or her intention to retire and on expiration of the period of the said notice the said partner shall cease to be a partner and subject to para 14 infra from that date all his or her liabilities and rights as a partner of the firm shall come to an end.”

  1. Clause 16 of the partnership deed had made specific provisions for the manner in which the affairs of the firm were to be wound up after its dissolution. It reads as under :

“16 If the partnership is dissolved, the going concern carried on under the name of the firm, Mangalore Ganesh Beedi Works, and all the trade marks used in the course of the said business by the said firm and under which the business of the partnership is carried on shall vest in and belong to the partner who offers and pays or two or more partners who jointly offer and pay the highest price therefor as a single group at a sale to be then held as among the partners shall be entitled to bid. The other partners shall execute and complete in favour of the purchasing partner or partners at his/her or their expense all such deeds, instruments and applications and otherwise aid him/her or them for the registration his/her name or their names of all the said trade marks and do all such deed, acts and transactions as are incidental or necessary to the said transferee or assignee partner or partners.”

  1. Pursuant to clause 3 of the partnership deed, the partnership stood dissolved by efflux of time on June 5, 1987, however, by mutual agreement among the partners as provided in clause 3 itself, the duration was extended for a further period of six months, i.e., up to December 5, 1987, and, therefore, the firm stood dissolved with effect from December 6, 1987. Thereafter, the affairs of the firm had to be wound up after its dissolution under clause 16 of the partnership deed as referred to above. However, because of the difference of opinion among the erstwhile partners, the affairs of the firm could not be wound up. Therefore, two of the partners of the firm filed a petition before this court under the provisions of Part X of the Companies Act, 1956, for winding up of the affairs of the firm in terms of section 583(4)(a) thereof. The petition was registered as Company Petition. No. 1 of 1988. In the said petition by order dated November 5, 1988, this court permitted the group of partners (7) having the controlling interest to continue the business as an interim arrangement till the completion of winding up proceedings. However, subsequently by order dated June 14, 1991, in modification of the earlier order the court framed the scheme for winding up of the affairs of the firm by selling its assets as a going concern. Paragraph 29 of the order contains the scheme. Clauses (i), (iii) and (v) of this scheme are reproduced hereunder :
“(i) The dissolved partnership firm, Mangalore Ganesh Beedi Works, as a going concern shall be sold to such of its partner/s, who makes an offer of the highest price, the same not being less than the minimum (reserved) price of Rs. 30 crores (rupees thirty crores) within July 11, 1991, accepting further liability to pay interest at 15 per cent. per annum towards the amount of the price payable to partner/s from December 6, 1987, till the date of deposit . . .
(iii) If no offer for purchase of the dissolved partnership firm as a going concern, adverted to in clause (ii) above, is received within the stipulated time or if any of the offers made by the partner/s is not accepted by the court, the official liquidator shall invite offers for purchase of the dissolved partnership firm as a going concern from the public including the partners by giving publicity in three consecutive issues of two English daily national newspapers which have, wide circulation in the country and one Kannada daily newspaper having, wide circulation in Karnataka the time allowed for making offers being at least 45 days between the last publication and the date fixed for receipt of the offers . . .
(v) If the sale of the dissolved partnership firm as a going concern in favour of any partner or partners or an outsider is accepted by the court, such offerer shall within 60 days from the date of the acceptance of the offer, deposit with the official liquidator the price or such part of the price together with interest on the total amount of the price at 15 per cent. per annum from December 6, 1987, till the date of deposit, which may become liable to be paid to the partner or partners towards their share of the price in the partnership firm together with interest on such amount ;”
  1. The abovesaid scheme was assailed by some of the partners before the hon’ble Supreme Court in Special Leave Petition No. 10680 of 1991 which was ultimately dismissed as withdrawn in 1994. In response to the scheme framed by this court by order dated June 14, 1991, several partners either individually or in groups offered their bids. The bid offered by an AOP comprised of three partners, namely, M. Vishwanath Rao, M. Jaganath Shenoy and M. Gopinath Shenoy (hereinafter referred to as the “AOP-3”) was found to be the highest being of Rs. 92 crores and the same was accepted by this court, vide its order dated September 21, 1994, and the following order was passed on the said day :

“The highest bid amount of rupees ninety-two crores is accepted and the group of persons offering the said amount are directed to deposit within 60 days from today with the official liquidator the entire amount of ninety-two crores together with actual profits earned from December 6, 1987, till March 31, 1994, and the proportionate profit from April 1, 1994, till the date of deposit in terms of the orders of this court earlier issued in Civil Appeal No. 313 of 1994.”

  1. 8. At the instance of the three partners offering the highest bid, clause (1) of the order dated September 21, 1994, was amended by a subsequent order dated September 19, 1994. The modified clause (1) of the order dated September 21, 1994, reads as under :

“The highest bid amount of rupees ninety-two crores is accepted and the group of partners offering the said amount are directed to deposit that part of the bid amount of rupees ninety-two crores which is proportionate to the shares held by the outgoing partners together with profits on the same basis from December 6, 1987, till the date of deposit, within a period of 60 days from September 29, 1994, in any of the nationalised banks in the name of the official liquidator. The rest of our order dated September 21, 1994, remains intact.”

  1. Pursuant to the above order, the AOP-3 deposited the bid amount of Rs.92 crores on November 17, 1994, with the official liquidator and as per the order passed by this court, the assets of the firm as a going concern were to be treated as having been sold to the “purchasing AOP” on November 20, 1994. It is again a matter of record that the business of the firm along with its assets was handed over by the official liquidator attached to this court to the AOP-3 on January 7, 1995, vide his Report No. 10 of 1995 and the sale proceeds along with bank interest accrued thereon were distributed by the official liquidator under the orders of this court amongst the outgoing partners on February 2, 1995. However, the firm could not be wound up due to one or the other reason and the same was continued even thereafter under the supervision and direction of this court and the final order of winding up was passed by this court. However, neither the firm nor the AOP-3 nor the assessee who got the amount towards the realisation of the assets of the going concern disclosed the said amount received as capital gains during the assessment year 1994-95. The income of the business for the period subsequent to dissolution of the firm from December 19, 1987 till up to the assessment year 1994-95 was all through returned as income of the AOP-13 and was accepted as such by the Department. Despite this fact, the Assessing Officer took the view that: (i) the assessees were liable to pay capital gains tax on their respective shares in the sale price of the assets of the firm being Rs. 92 crores ; and (ii) they were also liable to be assessed on their share in the proportionate/ notional profit for the period during which the business was run for and on behalf of the AOP-13. The Assessing Officer rejected their objections regarding chargeability of the capital gains based on the pleas that : (i) the sale was slump in nature ; and (ii) the transaction amounted to their retirement from the firm/AOP or relinquishment of their share. Being aggrieved by the same, an appeal was filed before the Commissioner of Income-tax (Appeals)-III, Bangalore, wherein the appeal was partly allowed. Being aggrieved by the same, the respondent-assessees filed an appeal before the Tribunal, Bangalore, and being aggrieved by the said order, the assessees have preferred I. T. A. Nos. 134-140 of 2000 under section 260A of the Income-tax Act (hereinafter called as “the Act”) wherein the Revenue has filed I. T. A. Nos. 144 of 2000, 147 of 2000 and 146 of 2000.
  2. We have heard the learned counsel appearing for the appellants in I.T.A. Nos. 134-140 of 2000 and the learned counsel appearing for the Revenue/appellants in I. T. A. Nos. 144 of 2000, 147 of 2000 and 146 of 2000 and reply arguments of the assessee and the Revenue in these appeals.
  3. Learned counsel appearing for the appellants in I. T. A. Nos. 134 to 140 of 2000 submitted that these appeals raised the question relating to the issue of taxability on capital gains directly in the hands of the individual appellants who are erstwhile partners/members in the dissolved firm of MGBW and the AOP-13 which carried on the business of MGBW as a going concern since the date of dissolution December 6, 1987, until November 20, 1994. Seven appellants have been taxed as if they have transferred their respective interests in the same business and what took place on November 20, 1994, was not the sale as a going concern of the entire business as ordered by this court in the company petition. It is submitted that the AOP-12 is distinct and separate from an AOP of 3. It was this AOP of 12 which was taxed since the firm was dissolved by efflux of time as per clause 16 of the deed for a number of assessment years up to and inclusive of the assessment year 1994-95. During the course of the previous year ending March 31, 1995, for the assessment year 1995-96, the business as a going concern of the said AOP of 12 was sold because of a dispute among the erstwhile partners of MGBW to give effect to the provisions of clause 16 of the partnership deed which provided that only the partners or groups among them could bid for the business as a going concern. Learned counsel further submitted that an AOP of 3 members not the group of the present appellants made the successful bid and the business of MGBW was accordingly handed over to them by this court. These 3 members were also among the 12/13 who constituted the AOP which was carrying on the business till the date of auction of the assets of the firm. Depreciation was allowed in respect of the assets of the business of the erstwhile partners in the hands of the AOP of 12/13 till the date of auction allowed by the Department proving that the Department recognised that the business as a whole was the asset of the said AOP of 12/13 for owners alone can be granted depreciation. It is further contended that the business was sold as a going concern which is the very essence of the concept of a slump sale which was recognised by this court in B. Raghurama Prabhu Estate v. Joint CIT (Assessment) [2003] 264 ITR 124 (Karn) passed on the earlier occasion and, therefore, could not be taxed. It is also contended that the valuation has been made as per the directions of this court when the appellants were not the members of the said firm and the appellants did not make any offer and when the six members expressed their inability to make a proper offer as the business had not been valued the court thought it appropriate to utilize the services of the chartered accountant to find out the value of the business to enable themselves to make an offer. Therefore, it was not a valuation that was made in an agreement to sell, it was not binding, it was not at the instance of any of the partners much less the present appellants and it was with reference to the date of the dissolution of the firm on December 6, 1987, and the chartered accountant had only considered the tangible assets of the firm apart from goodwill. They took no account of the personnel, the business organisation, the structure of the business, etc., of the going concern and, therefore, in view of the decision of the apex court in PNB Finance Ltd. v. CIT [2008] 307 ITR 75 (SC), the reference to the transfer as a going concern has specifically observed that a business undertaking consists not only of tangible items and goodwill but also manpower, tenancy rights and any licences, etc., held by the business and in the instant case, there were about 1,50,000 workers direct/indirect number of tenanted premises, values of trade marks and copyrights amounting to licences. These factors were not considered by the chartered accountants. Learned counsel further submitted that there was no valuation done of the business as a going concern as on the date of auction, namely, November 20, 1994, which was the date of sale/transfer. It was not as if there were contracting parties, it was not as if any such contracting parties entered into an agreement where the different assets of a going concern were got valued by them for the purpose of bringing about the transfer and there was no identity of minds necessary for an agreement, etc. It is only when there is such an agreement between the contracting parties which spells out the itemized figures of the various assets comprised in the business, there is a possibility of apportioning the slump sale consideration as laid down by the hon’ble Supreme Court in PNB Finance Ltd. v. CIT [2008] 307 ITR 75 (SC) and where the transfer of the entire business as a going concern involved and the contract indicates item-wise consideration. Section 41(2) would stand attracted with regard to the amount of surplus to the extent of the difference between the written down value of the depreciable asset(s) so transferred and the actual cost thereof. Learned counsel also relied upon the decision of the Supreme Court in CIT v. Artex Manufacturing Co.[1997] 227 ITR 260 (SC) in support of his contention. Learned counsel further submitted that the decision in Artex’s case [1997] 227 ITR 260 (SC) will not be applicable in view of the subsequent decision of the hon’ble Supreme Court in CIT v. Electric Control Gear Mft. Co. [1997] 227 ITR 278 (SC). Learned counsel further submitted that once the court comes to the conclusion that there is a transfer as a going concern of the business of MGBW as established by the facts, the question of capital gains as such can never arise directly as done in the hands of either the partners of the firm or in the hands of the members of an AOP depending upon whether the firm or the AOP is the seller. Learned counsel further submitted that not only are the individuals not liable even the AOP of 12 will not be liable. Therefore, the substantial questions of law may be answered in favour of the assessee/appellants.
  4. Learned senior counsel, Sri Indra Kumar, appearing for the Revenue submitted that in view of the order passed by this court in the company petition, the assets of MGBW were valued by a chartered accountant as a going concern which included all tangible and intangible properties and the highest bid of AOP-3 was accepted and admittedly the said amount has been distributed by the official liquidator to the individual partners of the firm and AOP-13 in view of the provisions of section 45(3) and (4) of the 1961 Act. The decision relied upon by the learned counsel appearing for the assessee pertains to the period prior to April 1, 1988, from which date the provisions of section 45(3) and (4) of the Income-tax Act, 1961, were introduced will not be of help to the assessee in the present case and the order passed by this court in the company petition is clear that the sale must be deemed to have been made as assets of a going concern were auctioned among the group of partners and, therefore, appropriate orders have been passed for dissolution of the firm and payments have also been made to the appellants/every partner. Learned counsel further submitted that the decision relied on by the learned counsel appearing for the assessee does not apply to the present case having regard to the facts of the case. Clause 16 of the partnership deed provides that in case of dissolution, the business concern of MGBW as a whole should be sold among the partners and, therefore, there is transfer of capital asset as defined in section 2(14) of the 1961 Act and transfer as defined under section 2(47) of the 1961 Act and, therefore, the order passed by the Tribunal is justified. Learned counsel further submitted that I. T. A. Nos. 144, 146 and 147 of 2000 are filed by the Revenue being aggrieved by the directions given by the Vice-President of the Tribunal regarding computation of capital gains which were wholly unnecessary having regard to the facts of the case and, therefore, the said directions issued by the Vice-President may be set aside and submitted that when the Vice-President has passed an order concurring with the decision of other Members, he could not have by himself issued certain directions which cannot be sustained and liable to be set aside and the same is also contrary to the provisions of section 45 of the Act and the sub-section itself states the market value on the date of the transfer and therefore the said observations and directions made by the Vice-President regarding the computation of capital gains may be quashed.
  5. In reply, learned counsel appearing for the assessee submitted that the decision relied upon by the assessee is helpful to him even after the inclusion of section 45(3) and (4) with effect from April 1, 1988, and the decision of the Tribunal is contrary to law as per the decision relied upon by him and submitted that the appeals may be allowed.
  6. We have given careful consideration to the contention of the learned counsel appearing for the parties and scrutinised the material on record in the light of the decisions relied upon by the learned counsel for the parties in these appeals. Before considering the contentions of the parties, it is necessary to bear in mind the legislative history pertaining to section 45(1).
  7. It is necessary to bear in mind the legislative history of the provisions of capital gain presently contained in section 45 of the 1961 Act. The present section corresponds to section 12B of the Indian Income-tax Act, 1922, which was couched in the following terms :

“12B.(1) The tax shall be payable by an assessee under the head ‘Capital gains’ in respect of any profits or gains arising from the sale, exchange, relinquishment or transfer of a capital asset effected after the 31st day of March, 1956, and such profits and gains shall be deemed to be the income of the previous year in which the sale, exchange, relinquishment or transfer took place.”

  1. Section 45 of the Income-tax Act, 1961, however, reads as follows :

“45. Capital gains.-Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 53 and 54, be chargeable to income-tax under the head ‘Capital gains’, and shall be deemed to be the income of the previous year in which the transfer took place.”

In the year 1964, by section 12 of the Finance Act, 1964, the following new sub-sections were inserted as under :

“(2) Notwithstanding anything contained in sub-section (1), every equity shareholder to whom any shares are allotted by the company by way of bonus shall, unless such shares are issued wholly out of the share premium account, be chargeable to income-tax under the head ‘Capital gains’ in respect of such shares on an amount equal to the fair market value of such shares on the date next following the expiry of the period of thirty days from the date of such allotment and such amount shall be deemed to be the income of the previous year in which the date next following the aforesaid period of the thirty days falls :

Provided that income-tax shall not be chargeable under this sub-section if such shares are included in the stock-in-trade of the assessee or if such shares were allotted before the 1st day of April, 1964 :

Provided further that nothing contained in section 48 shall apply to the income chargeable under the head ‘Capital gains’ under this sub-section.

Explanation.-For the removal of doubts, it is hereby declared that income chargeable under the head ‘Capital gains’ under this sub-section shall, for the purposes of this Act, be treated as capital gains relating to capital assets other than short-term capital assets.

(3) Where any shares in respect of which an assessee is chargeable to income-tax under the head ‘Capital gains’ under sub-section (2) are transferred by him before the expiry of the period of thirty days referred to in that sub-section, any profits or gains arising from such transfer shall not be included in his total income.

(4) Save as otherwise provided in sub-section (3), nothing contained in sub-section (2) shall be deemed to preclude the inclusion of any profits and gains arising from the transfer of any shares referred to in that sub-section in the total income of the assessee for any previous year in which such shares are transferred by him.”

  1. The above sub-sections, namely, (2) to (4) of section 45 were, however, omitted by section 13 of the Finance Act, 1966, with effect from April 1, 1966. However, the Taxation Laws (Amendment) Act, 1984, inserted a new sub-section (2) with effect from 1st April, 1985, i.e., from the assessment year 1985-86 onwards and by the Finance Act, 1987, which came into effect from April 1, 1988, in sub-section (1) of section 45, the words “54E, 54F and 54G” were substituted for “54E and 54F” and after sub-section (2), the present sub-sections (3), (4) and (5) were inserted. At that time, clause (a) of sub-section (5) contained the words “in which such compensation or part thereof, or such consideration or part thereof, was first received” in place of “in which the transfer took place” and clause (c) was not there. Sub-sections (3) and (4) which were in existence between April 1, 1964, and March 31, 1966.
  2. The scope and effect of the above amendments was explained by the Board in a circular as follows (see [1987] 168 ITR (St.) 87, 100) :

“Capital gains on transfer of firms’ assets to partners and vice versa and by way of compulsory acquisition

24.1 One of the devices used by assessees to evade tax on capital gains is to convert an asset held individually into an asset of the firm in which the individual is a partner. The decision of the Supreme Court in Kartikeya V. Sarabhai v. CIT [1985] 156 ITR 509 (SC) has set at rest the controversy as to whether such a conversion amounts to transfer. The court held that such conversion fell outside the scope of capital gain taxation. The rationale advanced by the court is, that the consideration for the transfer of the personal asset is indeterminate, being the right which arises or accrues to the partner during the subsistence of the partnership to get his share of the profits from time to time and on dissolution of the partnership to get the value of his share from the net partnership assets.

24.2 With a view to blocking this escape route for avoiding capital gains tax, the Finance Act, 1987, has inserted new sub-section (3) in section 45. The effect of this amendment is that profits and gains arising from the transfer of a capital asset by a partner to a firm shall be chargeable as the partner’s income of the previous year in which the transfer took place. For purposes of computing the capital gains, the value of the asset recorded in the books of the firm on the date of the transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of the capital asset.

24.3 Conversion of partnership assets into individual assets on dissolution or otherwise also forms part of the same scheme of tax avoidance. Accordingly, the Finance Act, 1987, has inserted new sub-section (4) in section 45 of the Income-tax Act, 1961. The effect is that profits or gains arising from the transfer of a capital asset by a firm to a partner on dissolution or otherwise shall be chargeable as the firm’s income in the previous year in which the transfer took place and for the purposes of computation of capital gains the fair market value of the asset on the date of transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer.

24.4 As a consequential measure, clause (ii) of section 47 has been omitted and sub-clause (b) of clause (iii) of section 49(1) has been amended.

24.5 Under the existing provisions where capital gains accrue or arise by way of compulsory acquisition of assets, the additional compensation is taken into consideration for determining the capital gain for the year in which the transfer took place. To provide for rectification of assessment of the year in which the capital gain was originally assessed, section 155(7A) was introduced. The additional compensation is awarded in several stages by different appellate authorities and necessitates rectification of the original assessment at each stage. This causes great difficulty in carrying out the required rectification and in effecting the recovery of additional demand. Another difficulty which arises is in cases where the original transferor dies and the additional compensation is received by his legal heirs. In the latter type of cases, proceedings have to be initiated against the legal heirs. Repeated rectification of assessments on account of enhancement of compensation by different courts often results in mistakes of computation of tax.”

  1. The words “capital asset” have been defined under section 2(14) of the Income-tax Act, 1961 as follows :

“(14) ‘capital asset’ means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include-

(i) any stock-in-trade, consumable stores or raw materials held for the purposes of his business or profession ;
(ii) personal effects, that is to say, movable property (including wearing apparel and furniture) held for personal use by the assessee or any member of his family dependent on him but excludes-
(a) jewellery ;
(b) archaeological collections ;
(c) drawings ;
(d) paintings ;
(e) sculptures ; or
(f) any work of art.
Explanation.-For the purposes of this sub-clause, ‘jewellery’ includes-
(a) ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals, whether or not containing any precious or semi-precious stone, and whether or not worked or sewn into any wearing apparel ;
(b) precious or semi-precious stones, whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel ;
(iii) agricultural land in India, not being land situate-
(a) in any area which is comprised within the jurisdiction of a municipality (whether known as a municipality, municipal corporation, notified area committee, town area committee, town committee, or by any other name) or a cantonment board and which has a population of not less than ten thousand according to the last preceding census of which the relevant figures have been published before the first day of the previous year ; or
(b) in any area within such distance, not being more than eight kilometres, from the local limits of any municipality or cantonment board referred to in item (a), as the Central Government may, having regard to the extent of, and scope for, urbanisation of that area and other relevant considerations, specify in this behalf by notification in the Official Gazette ;
(iv) 61/2 per cent. Gold Bonds, 1977 (or 7 per cent. Gold Bonds, 1980) (or National Defence Gold Bonds, 1980) issued by the Central Government ;
(v) Special Bearer Bonds, 1991, issued by the Central Government ;
(vi) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999, notified by the Central Government.”
  1. The word “transfer” has been defined in section 2(47) of the Income-tax Act, 1961 as follows :

“(47) ‘transfer’, in relation to a capital asset, includes,-

(i) the sale, exchange or relinquishment of the asset ; or
(ii) the extinguishment of any rights therein ; or
(iii) the compulsory acquisition thereof under any law ; or
(iv) in a case where the asset is converted by the owner thereof into or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment ; or
(iva) the maturity or redemption of a zero coupon bond ; or
(v) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882) ; or
(vi) any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other AOP or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.

Explanation.-For the purposes of sub-clauses (v) and (vi), ‘immovable property’ shall have the same meaning as in clause (d) of section 269UA.”

  1. 21. In order that section 45 may be attracted, there must be transfer of a capital asset. The expression “transfer” is defined in section 2(47) and “capital asset” is defined in section 2(14) of the Income-tax Act. Such transfer must be effected in the previous year and some profit or gain must arise from such transfer. If these conditions are fulfilled, section 45 provides that such profit or gain is chargeable to income-tax under the head “Capital gains” and the same shall be deemed income of the previous year in which the transfer has taken place. Since the section creates an item of “artificial income” its provisions should be strictly construed. Thus, section 45 brings to charge capital gains and its ingredients are :
(i) the existence of a capital asset owned by the assessee ;
(ii) the transfer of such asset during the previous year ;
(iii) arisal of profits and gains from transfer of such assets ; and
(iv) such profits and gains must accrue and arise to the assessee.
  1. In a recent decision in CIT v. Ghanshyam (HUF) [2009] 315 ITR 1 (SC); [2009] 8 SCC 412, the hon’ble Supreme Court had an occasion to consider the scope and ambit of provisions of section 45 wherein capital gain is taxed and the hon’ble Supreme Court has observed as follows (page 9) :

“The following conditions need to be satisfied for taxing a transaction as capital gain, viz,. the subject-matter must be a capital asset, the transaction must fall in the definition of ‘transfer’, there must be profit or loss called ‘capital gains’ and that the taxpayer has claimed exemption in whole or in part by complying with the legal provisions (like section 54F).

Section 45(1) of the 1961 Act speaks about capital gains arising out of ‘transfer’ of a capital asset. The definition of the expression ‘transfer’ is contained in section 2(47) of the 1961 Act. It has very wide meaning. What is taxable under section 45(1) of the 1961 Act is ‘profits and gains arising from a transfer of a capital asset’ and the charge of income-tax on the capital gains is a charge on the income of the previous year in which the transfer took place. Capital gain(s) is an artificial income. It is created by the 1961 Act. Profit(s) arising from transfer of capital asset is made chargeable to income-tax under section 45(1) of the 1961 Act. From the scheme of section 45, it is clear that capital gains is not an income which accrues from day-to-day during a specific period but it arises at a fixed point of time, namely, on the date of the transfer. In short, section 45 defines ‘capital gains’, it makes them chargeable to tax and it allots the appropriate year for such charge. It also enacts a deeming provision. Section 48 lays down the mode of computation of capital gains and deductions therefrom.”

  1. The contentions of the counsel appearing for the parties and the decisions relied on by them have to be considered in the light of the abovesaid provisions of section 45 of the 1961 Act.
  2. The material on record would clearly show that the firm MGBW was dissolved on December 6, 1987, and there was no further agreement among the partners to continue the business of the firm. After the dissolution of the firm, the assets of the firm were required to be distributed amongst the partners in proportion to their profit-sharing ratio. However, in view of clause 16 of the partnership deed wherein it is clearly stipulated that a sale shall be held among the partners by which sale nobody other than partners shall be entitled to bid and a company petition was filed before the High Court for winding up the business of the firm as per clause 16 of the partnership deed and in the said Company Petition No. 1 of 1988, this court directed that in the interest of more than 1,50,000 employees who were employed throughout the State, the business should be continued till the actual winding up proceedings would come to an end and, therefore, the business continued as per the direction of the company court in the interest of the employees and in view of clause 16 of the partnership deed and after 1987, the assessments were filed by the AOP up to 1994-95 showing the profits and claiming depreciation in respect of the assets of the firm. It may also be noted at this stage that after the winding up of the partnership and dissolution process started, one of the partners, Mr. Vinod Rao, assigned his shares in favour of 7 other partners by assignment dated July 3, 1993. Thereafter, assessment was being filed by the AOP-12. The fact that this court passed various orders including the valuation of the assets of the firm and ordered that the partners or association of partners shall submit their bid and the highest bid would be accepted and on the basis of the valuation made by the chartered accountant, the basic price was fixed at Rs. 30 crores is also not in dispute. The fact that 3 partners (hereinafter called AOP-3) submitted their bid and 7 other partners also submitted their bid and the bid submitted by the 3 partners for Rs. 92 crores was found to be the highest bid and the same was accepted by the court and the official liquidator was directed to receive the amount and distribute the same among the outgoing partners cannot be disputed in view of the specific order passed by this court and the material on record would further show that the final order in the company petition was passed on November 20, 1994, and thereafter the 3 partners who had submitted their highest bid for Rs. 92 crores sought for modification of the order for deleting the direction that amount attributable to them as partners from being deposited and the same was accepted and thereafter the said 3 partners whose bid was accepted have deposited the amount of bid in respect of the shares of 9 other partners and a statement was also prepared regarding the value of the assets of the firm and after deducting the liability of the 9 partners, the net value of the assets was arrived at and distributed among the 9 partners and the direction given by this court for filing an undertaking that the 3 partners would continue the business of the firm and the other 9 partners would not interfere with carrying on business by the 3 partners whose highest bid has been accepted and the order of this court dated June 14, 1991, and September 21, 1994, culled out supra (pages 10 and 12) is also indisputable and, therefore, having regard to the abovesaid admitted and indisputable facts of the case, it is clear that there was winding up of the firm MGBW on December 6, 1987, and thereafter proceedings were taken in the company petition filed by two of the partners for dissolution of the firm by realising the assets of the firm in view of clause 16 of the partnership deed and that the outgoing partners-appellants herein have received their net share of the value of the assets of the firm out of the amount received by way of sale of assets of the firm as a going concern conducted as per order of this court after deducting their individual liability in the firm cannot be disputed and, therefore, it is clear that there was transfer (sale) of capital asset and the assets of the firm were purchased by 3 erstwhile partners of the partnership firm and by the order of this court dated June 14, 1991, and November 20, 1994, they also undertook by filing an undertaking before this court as per the order passed by this court on November 20, 1994, that they would not interfere with the running of the business by the successful bidders, namely, 3 partners who have paid the value of the highest bid offered by them and from thereafter as per order dated June 14, 1991, the erstwhile partners who purchased the business of the old firm succeeded to it and constituted a new firm in the same name “MGBW” and thereafter the official liquidator has distributed the amount amongst the 9 partners including the appellants herein after deducting the liability of each of the partners and, therefore, what is received by the partners is the value of the net assets of the firm is established and, therefore, the capital gain is attracted as observed by the hon’ble Supreme Court in CIT v. Ghanshyam (HUF) [2009] 315 ITR 1 (SC) ; [2009] 8 SCC 412 as referred to above. The decisions rendered prior to April 1, 1988, have to be considered in the light of the amendment of the provisions of section 45 with effect from April 1, 1988, and deletion of the clause in the definition of transfer in section 2(47) of the 1961 Act. Profits and gains arising from transfer of a capital asset would clearly show that there is tax for capital gain and the same is attracted as the capital asset within the amendment of section 2(14) has been transferred under section 2(47) of the 1961 Act and the crucial question is as to who are the persons who are liable to pay the capital gain and whether it is the outgoing erstwhile persons who have received the value of the net asset in the firm or capital gains has to be paid by the firm or AOP-13/12. According to the appellants, the appellants are not individually as such outgoing partners of the erstwhile firm MGBW are not liable to pay tax on capital gains as according to them, they have only received their share which they already had in the firm and there is no transfer of any capital asset and, therefore, it is the AOP or firm or AOP-13/12, i.e., liable to pay capital gain tax. The Assessing Officer, the first appellate authority and the Tribunal have held that the capital gain is to be charged to the income of the appellants who are the erstwhile partners as they received value of their net asset in the firm which is dissolved and, therefore, there is transfer of capital asset by them in favour of the firm for consideration and they have realised the value of the assets of the firm which has been purchased by 3 partners who had submitted the highest bid as outgoing partners and have undertaken that they will not interfere with the said 3 partners carrying on the business of the firm as per clause 16 of the partnership deed. In support of their contention, the appellants are relying upon the decision of the hon’ble Supreme Court in the cases of CIT v. Artex Manufacturing Co. [1997] 227 ITR 260 (SC) and CIT v. Electric Control Gear Mft. Co. [1997] 227 ITR 278 (SC) wherein the hon’ble Supreme Court was considering the question as to whether the transfer of assets of the firm in favour of the company in consideration of allotment of shares to the partners in proportion to the value of the assets in the firm would attract capital gain and in the said cases having regard to the facts of the said cases which was in respect of a transfer prior to 1988 before amendment of section 45(3) and (4), the hon’ble Supreme Court held that the same would attract capital gain under section 45 of the Act and these are not helpful to the appellants in the present case.
  3. Similarly, the decision of the Supreme Court in CIT v. Bankey Lal Vaidya [1971] 79 ITR 594 (SC) wherein there were two partners in the firm and the same was dissolved, one partner receiving from the other the value of his share in assets, the sale or transfer of capital asset held to attract capital gain under section 12B of the Indian Income-tax Act in view of the amended provisions of section 45(3) and (4) inserted by the Finance Act, 1987, with effect from April 1, 1988. The said decision is also not helpful to the appellants in the present case.
  4. It is clear from the close scrutiny and consideration of the material on record and in the light of the decisions of the apex court after the amendment of section 45 with effect from April 1, 1988, that in the present case, the partnership firm-MGBW has been dissolved with effect from December 6, 1987, and the same has been accepted by the Revenue and thereafter no assessment has been made on the firm. After dissolution of the firm, the firm has ceased to hold assets of the firm and the assets of the firm were required to be distributed as per clause 16 of the partnership deed. Since there was no mutual agreement among the partners, two of the partners had to approach this court by filing a company petition and thereafter all proceedings pertaining to dissolution of the firm have been conducted under the directions of this court and not by the agreement of the partners. There was no agreement among the partners that the business of the firm should be extended beyond December 6, 1987. There was also no agreement among the partners regarding the distribution of the assets and value of the firm as per clause 16 of the partnership deed and this court in the company petition filed for winding up of the proceedings after dissolution in view of clause 16 of the partnership deed has passed the orders from time to time which clearly show that the said order has been passed to protect the interest of more than 1,50,000 employees of the firm spread all over Karnataka and the sale has been conducted in accordance with the direction issued by this court among the partners. Before conducting the sale, this court has taken care to see that the sale would be realistic and the value should be based on objective and scientific reasons. This court got the valuation of the assets done by the chartered accountant who has valued the assets of the firm with reference to the value of the goodwill and with reference to the plant and machinery and other tangible assets at Rs. 30 crores and, therefore, this court has taken care to see that the property is to be sold among the partners or a group of partners who submit the highest bid subject to reserve of Rs. 30 crores. It is not disputed that 3 partners had submitted a bid for Rs. 92 crores and the other 7 partners had submitted their bid for an amount which was less than Rs. 92 crores and, therefore, the bid submitted by the 3 partners was accepted as the highest bid and the same has been accepted by the High Court. Therefore, what was auctioned by the official liquidator as per the direction issued by this court was assets of the firm-MGBW, of which the assessees were the outgoing partners and what has been sold by the outgoing partners is the assets of the firm (Killick Nixon and Co. v. CIT [1967] 66 ITR 714 (SC). The amount was ordered to be deposited in the account of the official liquidator attached to the High Court and the official liquidator has distributed the amount as per the statement prepared by the outgoing partners who were the erstwhile partners by deducting their liability in the firm and value of the net asset has been distributed to them as per the statement annexed to the com pany application as follows :

Details of shares of partners of MGBW in the sale, notional profit accumulated profit—following sale of the firm as a going concern in February, 1995

Sl. No. Name of member Ratio Share of bid amount Share of -notional -profit Share of profit in pending distribution account Net amount due as per court order Interest paid by the bank for two months Amount actually paid (4 + 5)
1 2 3 4 5 6 7 8 9
1. B.Raghuram Prabhu Estate 16.059 14,77,42,800 1,53,77,630 10,14,85,033 23,75,97,191 17,81,979 23,93,79,170
2. M. Janardhan Rao 8.472 7,79,42,400 81,12,533 5,35,38,900 12,43,60,259 9,32,702 12,52,92,961
3. M. Pushpalatha 13.843 12,73,55,600 1,32,55,641 8,74,80,995 20,31,95,506 15,23,966 20,47,19,427
4. M. Hemalatha 13.843 12,73,55,600 1,32,55,641 8,74,80,996 20,38,55,824 15,28,918 20,53,84,742
5. M. Suresh Rao 8.361 7,69,21,200 80,06,239 5,28,37,435 12,27,49,322 9,20,619 2,36,69,941
6. M. Vatsala Shenoy 8.361 7,69,21,200 80,06,239 5,28,37,435 12,29,19,274 9,21,894 2,38,41,168
7. M. Arathi Shenoy 8.361 7,69,21,200 80,06,239 5,28,37,435 12,28,64,629 9,21,485 12,37,86,114
Cheques issued on Corporation Bank 114,60,73,570
Unpaid Group (Amounts retained as deposits)
8. M. Ananda Rao 7.650 7,03,80,000 73,25,411 5,27,41,722
9. M. Ramanath Shenoy 2.500 2,30,00,000 23,93,925 1,72,35,856
8,37,39,498
Continuing Group
10. M. Vishwanath Rao 7.550 6,94,60,000 Notional shares retained in AOP
11. M. Jagannath Shenoy 2.550 2,30,00,000
12. M. Gopinath Shenoy 2.550 2,30,00,000
Total 100% 92,00,00,000

Note : Notional profits-Notional profit for 234 days, i.e., April 1, 1994, to November 17, 1994, as per the order of the High Court in Civil Appeal No. 412 of 1994 given to the outgoing partners-Rs. 8,37,39,498.

Accrued interest-Interest allowed on the deposit lying with Corporation Bank at interest applicable to SB account for months of December, 1994, and January, 1995, i.e., Rs. 85,31,560.

Actual profit earned from December 6, 1987, to March 31, 1994, credited to the profit distribution account is after adjusting the amount due by M. Vinod Rao who surrendered his right to the first 7 members.

  1. Thereafter, this court has declared by order dated November 20, 1994, that the proceeding of dissolution is completed and that undertaking shall be given by the outgoing partners in favour of 3 partners whose successful bid was accepted and they should not interfere with the said 3 erstwhile partners carrying on business of the firm in consideration of the amount deposited by them as per the order of this court and in view of confirmation of sale of the assets of the firm in favour of the said 3 persons. Therefore, it is clear that the contention of the appellants that the value of the assets could not be ascertained and, therefore, tax on capital gains could not be imposed cannot be accepted as valuation has been given by the group of partners by assessing the value of the assets and the assets had already been valued by the chartered accountant. Similarly, there is no merit in the contention of the learned counsel for the appellants that since the transaction was only adjustment of shares by the partners and there was no sale as such the appellants were not parties to the same and the same was conducted by the official receiver attached to the High Court and, therefore, the individual partners, the appellants herein who are the erstwhile partners and received the value of the assets cannot be taxed for capital gains.
  2. 28. The nature of interest of the partners in the firm during subsistence of partnership and after its dissolution with reference to sections 14, 15, 29, 32, 38 and 48 of the Partnership Act, 1932, has been considered by the hon’ble Supreme Court in Addanki Narayanappa v. Bhaskara Krishnappa, AIR 1966 SC 1300 as follows :

“The provisions of sections 14, 15, 29, 32, 37, 38 and 48 make it clear that whatever may be the character of the property which is brought in by the partners when the partnership is formed or which may be acquired in the course of the business of the partnership it becomes the property of the firm and what a partner is entitled to is his share of profits, if any, accruing to the partnership from the realisation of this property and upon dissolution of the partnership to a share in the money representing the value of the property. No doubt, since a firm has no legal existence, the partnership property will vest in all the partners and in that sense every partner has an interest in the property of the partnership. During the subsistence of the partnership, however, no partner can deal with any portion of the property as his own. Nor can he assign his interest in a specific item of the partnership property to anyone. His right is to obtain such profits, if any, as fall to his share from time to time and upon the dissolution of the firm to a share in the assets of the firm which remain after satisfying the liabilities set out in clause (a) and sub-clauses (i), (ii) and (iii) of clause (b) of section 48. The whole concept of partnership is to embark upon a joint venture and for that purpose to bring in as capital money or even property including immovable property. Once that is done whatever is brought in would cease to be the exclusive property of the person who brought it in. It would be the trading asset of the 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 an 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. It is true that even during the subsistence of the partnership a partner may assign his share to another. In that case what the assignee would get would be only that which is permitted by clause 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. Lindley on Partnership, 12th Edn. p.375, Ref. to English and Indian Case Law Discussed. [1947] AIR 1947 Lahore 13 [FB] approved ; AIR 1959 AP 380 [FB] affirmed.”

  1. In Dilip Chinubhai Shah v. CIT [2002] 253 ITR 680 (Guj), a Division Bench of the Gujarat High Court had an occasion to consider the question as to whether on the facts and circumstances of the case, the capital gain of Rs. 34,425 was liable to be included in the income of the assessee. In the said case, Chinubhai Motilal Shah died intestate on February 20, 1965, and was survived by his three daughters, four sons and widow. After his death, one of his properties, a residential house, devolved upon his four sons. By executing a memorandum deed dated March 27, 1973, the said property was given to the HUFs of the four sons. Though the residential house was not partitioned by metes and bounds under the said memorandum, with effect from March 26, 1973, the HUFs of the four sons had acquired equal shares in the said property and the four sons of the late Chinubhai Motilal Shah had filed their returns after the execution of the memorandum dated March 27, 1973, and in the returns of their HUFs, their respective shares of income from property arising from the property had also been shown. However, it was the contention that there was no partition by metes and bounds and share of each HUF had been determined by virtue of the memorandum dated March 27, 1973. During the assessment year 1979-80, two of the families, one of which was the assessee, disposed of their rights in the property in favour of the other two families by executing the sale deed dated July 7, 1978, and during the previous year ending on March 31, 1979, two families ceased to be joint owners in respect of the property whereas the families of two brothers became joint owners of enhanced shares in the property and on the said facts, the Gujarat High Court having regard to the provisions of section 45 has observed as follows (pages 684-685) :

“It is not in dispute that the assessee had shown its share of income from the said property in its return after the property was partitioned with effect from March 26, 1973. Had the property not been partitioned with effect from March 26, 1973, in pursuance of the memorandum dated March 27, 1973, the assessee-HUF would not have shown income arising from the said house property in its returns filed for the assessment year 1974-75 and onwards. This fact clearly denotes that the assessee-HUF had got its one-fourth share in the property in pursuance of the memorandum dated March 27, 1973, and by virtue of the deed dated July 7, 1978, the assessee had sold its share to the HUF of Shri Jitendra Chinubhai Shah.

It is pertinent to note that the said property was not owned by a BOI or an AOP as contended by the learned advocate appearing for the assessee. There was no AOP or BOI as on July 7, 1978, which was the owner of the entire property. As stated hereinabove, four different families were having their distinct share, though not defined by metes and bounds, as on July 7, 1978, and the share of the assessee was in fact sold to another HUF on that day.

Looking to the above facts and the legal position to the effect that the property was not owned by any BOI or AOP, the assessee, who was the owner of the one-fourth share of the said property, sold its share on July 7, 1978, and, therefore, the Revenue had rightly taxed the amount which was earned by the assessee by way of capital gains.

Let us look at the issue from a different angle. It is the case of the assessee that there was an AOP and the said AOP was the owner of the property and on July 7, 1978, there was a dissolution of the said AOP and the share in respect of each individual had devolved upon different individuals. Had it been so, one-fourth share of the said property would have devolved upon each brother or the HUF of each brother. That is not the case here. In the instant case, by virtue of the deed dated July 7, 1978, only two HUFs had remained the owners of the said property because two HUFs, including that of the assessee, had sold their shares to the remaining two HUFs, who had continued to remain not only owners of their respective share, but they also had become owners of the shares of the two HUFs which had disposed of, by way of sale, their shares in favour of the two remaining HUFs. Thus, the submission of the learned advocate appearing for the assessee is not correct, even if we view the issue from this angle.”

  1. In view of the provisions of section 45 it is clear that in the present case, the effect of the sale conducted by this court among partners and under clause 16 of the said partnership deed, is that once the partnership is dissolved, the partners would become entitled to specific share in the assets of the firm which is proportionate to their shares in sharing the profits of the firm and they are placed in the same position as tenants in common and for the purpose of dissolution and under section 47 of the Indian Partnership Act, 1932, it is clear that even after the dissolution of the firm, the authority of each partner to bind the firm and the other mutual rights and obligations of the partners continues notwithstanding the dissolution so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution. Therefore, for realisation of the assets, discharging the liability of the firm and settling the accounts of the partners, etc., the firm will continue to exist despite the dissolution and not for any other purpose. The material on record in the instant case would clearly show that after dissolution of the firm on December 6, 1987, the firm has never filed any return and in view of the order of this court permitting the partners to carry on the business in the interest of employees, return was filed by AOP-13 consisting of the erstwhile 13/12 partners for accounting profits and seeking depreciation in the assets of the firm and continued to do business in view of the order of this court that there was no agreement among the partners to continue the business during the pendency of the winding up proceedings. Further, having regard to clause 16 of the partnership deed of the dissolved firm, it is clear that the partners intended that the assets of the firm should not be sold to an outsider. It is well settled that every act of the partner would be binding on the firm and also the partners inter se and clause 16 of the partnership deed which has been culled out supra clearly shows that if the partnership is dissolved, the going concern carried on under the name of the firm MGBW and all the trade marks used in the course of the said business by the said firm and under which the business of the partnership is carried on shall vest in and belong to the partner who offers and pays or two or more partners who jointly offer and pay the highest price therefor as a single group at a sale to be then held as among the partners shall be entitled to bid. The other partners shall execute and complete in favour of the purchasing partner or partners at his/her or their expense all such deed, instruments and applications and otherwise aid him/her or them for the registration of his/her name or their names of all the said trade marks and do all such deed, acts and transactions as are incidental or necessary to the said transferee or assignee, partner or partners. The final order passed by this court to wind up the affairs of the firm would clearly show that the property of the firm is purchased by the association of 3 partners who submitted their highest bid and that the other partners had to give an undertaking that they may not interfere with the carrying on business which is vested in the name of MGBW and all the trade marks used in the course of the said business and, therefore, it is clear that the appellants who are the erstwhile partners were not successful bidders for continuation of business in the individual capacity of MGBW and in view of clause 16, all tangible and intangible assets vested with the association of 3 partners whose highest bid of Rs. 92 crores was accepted and admittedly after the passing of the order of this court on November 20, 1994, all the appellants herein and other outgoing partners have given requisite undertaking as per the order of this court and MGBW as a going concern under the name and style MGBW and all trade marks used in the course of the said business by the said firm and all tangible and intangible assets of the firm vested with the purchasers erstwhile 3 partners who paid the highest bid and the appellants have received consideration of the conveyance and their respective shares in the sale of the net assets of the firm after their undertaking that they cannot interfere with the business of MGBW which is vested with all assets in favour of the 3 partners have received the value of their net asset which has been distributed by the official liquidator and the AOP-3 who have purchased the business of the old firm, succeeded to it and constituted a new firm in the same name (vide order dated June 14, 1991, in the company petition) and, therefore, it is clear that the order passed by the assessing authority confirmed in the first appeal and by the Income-tax Appellate Tribunal (Special Bench) holding that the appellants as erstwhile partners are liable to pay capital gains tax on the amounts received by them towards the value of their shares in the net assets of the firm and are liable for payment of capital gains under section 45 of the Act. The said finding is justified and accordingly we answer the substantial question of law in favour of the Revenue and against the assessee.
  2. Similarly, the contention of the assessee that the sale is in the nature of slump sale and is not in respect of the separate valuation made and, therefore, not assessable to capital gains cannot also be accepted as it is clear from the perusal of the material on record that the sale that was conducted on the direction of this court among the partners and the consideration received by sale was not by slump sale as the shares of all the partners in the firm which were fixed in proportion to the profit-sharing ratio after the dissolution of the firm and they continued the business as an AOP and not as partners. It is to be noted that what has been sold in the present case by the outgoing partners is the assets of the firm-MGBW. It is also clear from the facts of the case that while fixing the auction of the assets of the firm-MGBW as a going concern, the value has been fixed on the basis of the report of the chartered accountant obtained as per the direction of this court and also after considering the objections filed by the partners to the said report and reserve price of Rs. 30 crores was fixed and no separate valuation was made. During the auction, three of the erstwhile partners quantified the value of the assets of the firm-MGBW as Rs. 92 crores and the offer made by the other partners quantifying the value of the assets of the firm-MGBW was less than Rs. 92 crores. Therefore, the quantification made by the erstwhile partners themselves has been accepted and what has been sold by the outgoing partners is the assets of the firm Killick Nixon and Co. v. CIT [1967] 66 ITR 714 (SC) and wherefore, the said sale would not be a slump sale. In view of the finding on facts, the decision relied upon by the learned counsel appearing for the assessee in CIT v. Agrosynth Chemicals [2010] 327 ITR 135 (Karn) is not helpful to the assessee in the present case.
  3. The concurrent finding on the question of fact that value of profit received during the interregnum period for a period of 234 days is to be treated as revenue income having regard to the reasons assigned that the said profit is calculated on the basis of notional profit calculated on two years’ average profit and from this average 40 per cent. was to be deducted and the net amount was to be paid, the finding is unassailable. Accordingly, we answer the substantial questions of law in favour of the Revenue and against the assessee. In view of the said finding, the appeals filed by the assessee in I. T. A. Nos. 134, 135, 136, 137, 138, 139 and 140 of 2000 are dismissed. The appeals filed by the Revenue in I. T. A. Nos. 144, 146 and 147 of 2000 are allowed by setting aside the direction issued by the Vice-President regarding the computation of the capital gains passed by the Income-tax Appellate Tribunal, Bangalore.

[Citation : 335 ITR 394]

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