2005 (7) TMI 73 - HC - Income Tax

(1) Whether Tribunal was right in law in holding that the assessee had claimed depreciation on the machinery and, therefore, the assessee is liable to tax on profits of Rs. 2,13,705 u/s 41(2)? (2) Whether, Tribunal was right in law in holding that the assessee is liable to tax on profits u/s 41(2) even though depreciation was claimed by the partnership firm which was dissolved and the machinery were allotted to the assessee who sold the same after dissolution of the firm? - Having noticed the difference between the status of the partners of a living partnership firm and that of a dissolved firm, the assessee/applicant cannot be said to be a person who had reaped the fruits of the depreciation enjoyed by the firm when it was a living partnership firm. The sale of properties of the dissolved partnership will not attract tax on the amount of the depreciation enjoyed by the partnership firm. That amount cannot be brought to tax. Thus, questions are answered in the negative, i.e., against the Revenue and in favour of the assessee

Summary

Issues Involved:
1. Applicability of Section 41(2) of the Income-tax Act, 1961, on profits from the sale of machinery by the assessee.
2. Tax liability under Section 41(2) on profits from machinery sold by the assessee, which was previously depreciated by a dissolved partnership firm.

Issue-wise Detailed Analysis:

1. Applicability of Section 41(2) of the Income-tax Act, 1961:

The Tribunal held that the assessee is liable to tax on profits under Section 41(2) of the Income-tax Act, 1961, as the machinery sold by the assessee had previously been depreciated by the dissolved partnership firm. The Tribunal relied on the Supreme Court's judgment in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49, which stated that the firm's property is not distinct from the partners' property.

Statutory Provisions:

Section 41(2) specifies that if any building, machinery, plant, or furniture, which was used for business purposes and sold, exceeds the written down value, the excess amount is taxable. The explanation in Section 41(2) clarifies that the provision applies even if the business is no longer in existence.

Consideration:

The facts reveal that the assessee was a partner in a firm that was dissolved. The firm had claimed depreciation on certain assets, which were later sold by the assessee. The Tribunal's decision was based on the principle that the firm and its partners are not distinct entities, and thus, the depreciation benefit should be recouped from the assessee.

2. Tax Liability under Section 41(2) on Profits from Machinery Sold by the Assessee:

The assessee argued that the depreciation was claimed by the dissolved firm, not by the assessee individually, and thus, Section 41(2) should not apply. The assessee relied on several judgments, including Bist and Sons v. CIT [1979] 116 ITR 131, where the Supreme Court held that the firm and the Hindu undivided family (HUF) are distinct entities, and depreciation allowed to the HUF could not be taxed in the hands of the firm.

Relevant Case Laws:

- Bist and Sons v. CIT: The Supreme Court held that the firm and HUF are distinct entities, and depreciation allowed to one cannot be taxed in the hands of the other.
- CIT v. B.R. Chawla: The Delhi High Court held that the successor to a firm cannot be taxed under Section 41(1) for refunds received by the firm.
- CIT v. Shri Sat Parkash: The Punjab and Haryana High Court held that the refund received by the partners of a dissolved firm cannot be taxed under Section 41(1).

Consideration:

The court considered the distinction between a living partnership firm and a dissolved firm. It was established that during the subsistence of the partnership, the firm has a distinct status, and its partners have separate identities. Upon dissolution, the firm ceases to exist, and its assets are distributed among the partners. The court held that the assessee, as a successor to the dissolved firm, cannot be taxed for the depreciation claimed by the firm.

Conclusion:

The court concluded that the sale of properties of the dissolved partnership does not attract tax on the depreciation enjoyed by the firm. The assessee cannot be taxed under Section 41(2) for the depreciation claimed by the dissolved firm. The questions referred were answered in the negative, against the Revenue and in favor of the assessee. The reference was disposed of with no order as to costs.