9911796707
TMI Blog1997 (1) TMI 49X X X X Extracts X X X X X X X X Extracts X X X X ..... 144B was served on the assessee on March 30, 1978, to which the assessee filed its objections as regards the additions proposed. The assessee-firm had charged the profit and loss account, an amount of Rs. 2,50,350 as the expenditure incurred in the name of compensation to retiring partners with the following break-up : Rs. 1. Smt. R. V. Mehta 98,250 2. Miss D. B. Mehta 48,375 3. Shri P. V. Mehta 1,02,725 According to the assessee, this expenditure was admissible as an expense of business under section 37 of the said Act, because the above erstwhile partners belonging to the group of the partner, Mr. P. V. Mehta, who did not look after the business of the assessee efficiently and due to his mismanagement, the project had failed, were, in the larger interest of business, made to retire by giving the above payments to them. The I.A.C.B.R.I., Baroda, held that these payments were not admissible as business expenditure, because they were made by one group of proprietors to the other for the purchase of the proprietary rights in the business. The Income-tax Officer by order dated June 29, 1978, accordingly disallowed the said expenditure of Rs. 2,50,350 claimed by way of compe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was clear that the payments made to the retiring partners, which are described as compensation, were in fact payments made in lieu of the rights of the retiring partners and there was nothing in the deed to suggest that the payments were made for the purpose of running the business. Learned counsel further argued that getting rid of an inconvenient and inefficient employee or an agent in the interest of the business of the firm was entirely a different matter from making payment to the retiring partners of the firm in lieu of their rights in the firm. Learned counsel appearing for the assessee submitted that the expenses were incurred by the firm for efficient running of its business because the management of Mr. P. V. Mehta, who was a partner, resulted in losses and the only way in which the business could be run profitably was to make his group retire. It was submitted that the firm had incurred huge losses and nothing was payable to the outgoing partners on their account and, therefore, the expenses incurred by the firm should necessarily be treated as expenses incurred on revenue account. It was further contended that a partnership-firm was a distinct taxable entity and is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that a registered firm is treated as an assessable unit only for the years during which its composition remains unchanged and on change the reconstituted firm is to be registered afresh. Furthermore, under section 187 of the said Act where there is a change in the constitution of the firm, the assessment is to be made on the firm as constituted at the time of making the assessment as provided therein. The provisions relating to assessment of firms under the said Act indicate, that even the said Act recognises the fact that by change in composition, the firm gets reconstituted meaning thereby, the earlier firm composed of all the existing partners ceases and a new firm is constituted as per the change, which requires a fresh registration. Therefore, retirement of a partner which has the effect of changing the constitution of the firm in this context is required to be viewed in the light of the provisions of the Partnership Act, which alone deals with the question of the constitution of firms, their reconstitution and dissolution, as also with the rights and duties of the continuing partners, as well as the outgoing partners. The Income-tax Act does not contain any provision having b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... titled to continue the business of the said partnership from December 4, 1974, as per their absolute choice and further that they shall be entitled to use the firm name for the purpose of continuing the business of the said partnership. It was also stipulated that the continuing partners will be entitled to all the rights, title and interest of the said partnership inclusive of all quota rights, tenancy rights, import and export licences and all other benefits and privileges, as also contract rights. The continuing partners were entitled to the sole and exclusive right to endorse, collect and release all the outstandings of the firm and its claims. The retiring partners were absolved from their liabilities from the date of their retirement. Under the said deed the retiring partners relinquished all their right, title and interest in the assets, actions, claims, demands, benefits, privileges and goodwill of the partnership and in consideration of full discharge of such rights and in full satisfaction of their claim in respect of the amounts contributed by them towards the capital of the partnership and in full satisfaction of all sums of money due to them in respect of their account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e deed which described the payments having been made to the outgoing partners in satisfaction of their legal rights and interests in the assets and goodwill of the firm. We are told that the partnership firm was a partnership at will. In that event any partner could have given a notice in writing to the other partners, of his intention to dissolve the firm as provided by section 43 of the Partnership Act. The outgoing partners had, under section 36 of the Partnership Act, the right to carry on a business competing with that of the firm and under section 37 they had a right in certain cases to, share subsequent profits. In a partnership at will where dissolution is made by giving a notice to other partners, the partners have a right to have the business wound up after the dissolution. There are rules laid down for settlement of accounts between the partners in section 48 of the Partnership Act. In settling the accounts of a firm after dissolution, the goodwill is to be included in the assets and can be sold either separately or with the other property of the firm. These provisions indicate that a retiring partner who otherwise had a right to participate in the business forgoes valua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ral Auto Parts Co. v. CIT [1981] 128 ITR 519 (Delhi), a similar question arose in the context of payment of amounts by the continuing partners of the firm in order to acquire the right, title and interest of the retiring partners in the assets of the former firm and the Delhi High Court took the view that, where a certain sum of money is paid by the continuing partners of a firm in order to acquire the right, title and interest of the retiring partners in the assets of the former firm, the payment made cannot be said to be incidental to the carrying on of the business but that is incidental to a reconstitution of the framework of the business itself. The cases of relationship between the partners and the firm cannot be equated with the relationship that may exist between a company and its employees or managing agents. A payment made by a company to its directors or managing agents should be a payment made by a distinct legal entity, while a firm not being a distinct legal entity separate from its partners, payment made to the outgoing partners was clearly a payment of capital nature relatable to the settlement of accounts between the partners, inter se. The payment which was made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mind that tax on an income is a specie of direct taxation which reaches the person who owns or receives the income, as distinguished from indirect taxes where it reaches a thing or article or an activity, like an excise duty is a charge on the activity of manufacture, a sales tax is a tax on the event of sale. A tax on the property levied by the State is a tax on the property itself, but, on the other hand, a wealth tax or an income-tax is a tax on the person who owns the wealth or who earns the income. If keeping this distinction in mind, one were to examine the contention of learned counsel for the assessee that the amount in question was paid by the firm to its outgoing partner to save it from ruination and save the firm from the prospective losses be treated as an expenditure incurred by the firm wholly and exclusively for the purpose of its business, so as to fall in the allowable deduction under section 37 of the Act, is founded on the premise that firm as an entity of business and its income is subject to deductions of all outgoings, which may be necessary for the business irrespective of its ownership. Notwithstanding the fact that the firm has been treated to be a separate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a particular sum, has no relevant bearing on the question of the nature of the payments made to the outgoing partner or change its colour from return of his share in the assets of the firm, to the expenses of the firm for saving it from ruination. The Tribunal, in our opinion, has clearly fallen in error in finding the motive and the reason for agreeing by some of the partners of the assessee-firm to pay a certain sum to outgoing partners to continue to remain the owner of the business as such and on that premise to arrive at a determination of the question about the nature of payment. It may be pertinent to notice that what has been severed is the relationship between the erstwhile five partners who constituted the firm before its existence in the present form. Severance of relationship cannot be with the partner and the firm, but can only be between partners and partners. That is also reflected in the deed of retirement which in unequivocal terms says that " in consideration of the full discharge of their rights, title and interest and goodwill of the said partnership and in full satisfaction of all their claims in respect of the amounts contributed by the said retiring partne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... partners between the existing firm and its partners cannot be considered to be expenses made by the reconstituted firm for severing the trade relationship. Therefore, notwithstanding the finding of the Tribunal that the motive of the continuing partners was to get rid of the retiring partners, on the plea of the assessee itself it cannot be attributed to the firm as a separate and independent entity from its partners. It was a motive of some of joint owners. At best in that event it could be said to be the payment made by the reconstituted firm on behalf of two of its partners of their agreed liability to make payment to the outgoing partners. Reference in this connection be made to the following observations made by P. N. Bhagwati, Chief Justice, as he then was, in the case of CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Guj) : " The interest of a partner in a partnership is not interest in any specific item of the partnership property. It is a right to obtain his share of profits from time to time during the subsistence of the partnership and on dissolution of the partnership or on his retirement from the partnership to get the value of his share in the net partnership asset ..... X X X X Extracts X X X X X X X X Extracts X X X X
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