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TMI Blog1985 (11) TMI 5X X X X Extracts X X X X X X X X Extracts X X X X ..... ards share in the assets of the firm, goodwill of the firm and compensation for the restrictive covenant for five years and its quantification is reasonable on the facts found in the case ? (4) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that there was no 'transfer' involved even under the provision of the Income-tax Act, 1961, when a partner retires from a partnership and that, therefore, the assessee cannot be assessed to capital gains tax on the surplus realised ? (5) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the compensation received by the assessee cannot be taxed as income or capital gains in the hands of the assessee ? (6) Whether, on the facts and in the circumstances of the case, the entire amount paid by the assessee as compensation to Shri G. D. Naidu and Shri G. D. Gopal and others could not be disallowed as capital expenditure and that an amount referable to the restrictive covenant agreed to by the parties should be allowed as a deduction in the hands of the assessee under section 37 of the Income-tax Act ? (7) Whether, on the facts and in the circums ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... On 1-4-1963: Shri G. D. Naidu, Shri G. D. Gopal and Shri C. R. Balasubramaniam retired from the firm and Shri Chinnaswami Gounder, Abdul Wahab Rowther and P. S. Mohideen Abdul Khadar were admitted as partners of the firm-- Next on, On 25-5-1963: eight more partners, who had been in the firm from its commencement, retired and five new partners (Mohd. Abdul Khadar, Abubakar, Ramaswamy Gounder, Gani and Sarvadeen) were admitted as partners. This was followed up by another change, On 14-12-1963: when one more partner, who had been in the firm from its commencement, retired. Finally, immediately on the close of the previous year, On 1-4-1964: Abdul Wahab Rowther, Mohideen Abdul Khadhar, Md. Abdul Khadar and Abu Baker retired giving place to Subhanna Gounder, Muthuswami, Ahmed Khadhar and Abdul Azeez, --resulting in the firm being constituted by eight persons, S. Chinnaswami, Subhanna Gounder, Ramaswami Gounder, Muthuswami, Gani, Sarvadeen, Abdul Azeez and Ahmed Khadar. The changes in the other firms were similar. It may thus be seen that during the financial year 1963-64, all the old partners of the firm retired in stages, so that by April 1, 1964, the firm composed entirely of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,25,000 cash down within December 1, 1963. Though agreed to this agreement in principle, on account of some small dispute, final settlement has not yet been made. Coimbatore, Yours faithfully, 1-4-1963. (Sd.) G. D. Naidu." At the left hand bottom of the letter appears the following endorsement : " I agree to the above terms (Sd.) T. S. M. Gani." There is a similar letter by G. D. Gopal with the figures " Rs. 1,00,000 in the place of " Rs. 1,25,000 " in the second paragraph. To complete the narrative, it may be mentioned that the payments were made to the erstwhile partners of their share amounts by crediting the share capital account of the firm and debiting the various partners. Thus the credits of the former partners to their capital account were squared up with reference to the dates April 1, 1963, May 29, 1963, and December 14, 1963, respectively. The sum of Rs. 2,25,340.07 said to be due to G. D. Naidu and G. D. Gopal was exhibited in the firm's balance-sheet for the year ending March 31, 1964, as part of property and assets with the following narration : "Compensation-Rs. 2,25,340.07. The position is similar with no material differences in other cases. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n in the view that no question of warding off competition could arise as the firm had a monopoly route and it was not easy to put on more buses in that route. The payment for the continuation of the business in the same name free of competition only amounted to payment for enhancement of goodwill and resulted in an enduring advantage. Therefore, it was capital expenditure and not revenue. The Income-tax Officer also observed that the payment was not for business considerations and, therefore, it could not be allowed as deduction, under section 37 of the Income-tax Act, in the hands of the firm. In the case of the recipients, the Income-tax Officer found that, the entire amount was receivable and was received by the two assessees and, that, therefore, there was no evidence to substantiate the alleged entitlement of the labourers to any part of the compensation amounts. The Income-tax Officer then referred to the great part played by G. D. Naidu in building up the structure of all these companies and in rendering them prosperous by his financial abilities, personal skill and industrial acumen amidst great difficulties and came to the conclusion that the compensation received should b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal account. But to the extent the contribution is attributable to item (c), the compensation paid is a deductible expense in computing the income of the firm as the firm has not acquired any asset or advantage of enduring nature by securing this covenant. (iii) The value of these three components of the compensation amount can be evaluated as follows: (a) The assets of the firms are not worth much and the payment to the retiring partners to the extent of the amounts in the capital accounts would cover the share of assets in the firm. (b) The value of the goodwill in the case of Alandurai Service can be estimated at Rs. 75,000 being the two years' purchase price of the average annual profit for a period of past six years. On the same basis, the goodwill attributable to the other firms should be computed. (c) The balance would represent the compensation paid for the restrictive covenant and it should be allowed as a deduction in each of the five cases. The Tribunal held that the payments made by the firms are allowable as deductions only in part. The Tribunal had given figures for Alandurai Service. The Tribunal directed that on the same basis, the goodwill attributab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the firm. In this connection, she also contended that it is the substance of the matter that should be taken into account and not the form that has been adopted by the assessee in order to evade or avoid payment of tax. Colourable devices in order to evade tax could not be encouraged. She referred to the decision in McDowell and Co. Ltd. v. Commercial Tax Office), [1985] 154 ITR 148 (SC). That related to avoidance of excise duty by dealer by making the purchaser pay the excise duty and thereby trying to reduce the taxable turnover of the dealer. While dealing with the general question as to whether tax avoidance devices should be permitted or encouraged, the Supreme Court, after a consideration of the English decisions, deprecated the practice and observed (p. 160) : " We think that the time has come for us to depart from the Westminster principle as emphatically as the British courts have done and to dissociate ourselves from the observations of Shah J. and similar observations made elsewhere. The evil consequences of tax avoidance are manifold. First, there is substantial loss of much needed public revenue, particularly in a welfare State like ours. Next, there is the serio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... axation. It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of 'emerging' techniques of interpretation as was done in Ramsay , Burma Oil and Dawson, to expose the devices for what they really are and to refuse to give judicial benediction." Let us now assume that the parties intended that all the old partners should retire and the new partners should take over the business of the firm., The question for consideration is what is the nature of the transaction. There can be no doubt that so far as the old partners are concerned, it amounted to a dissolution of the partnership and the receipt of the amounts was distribution or division or allotment of the assets of the firm among the partners. So far as the cash compensation paid by the new partners referable to the assets and goodwill of the firm are concerned, the cash takes the place of the assets of the partnership and that is the normal way of dissolving a partnership also. The compensation paid or relatable to the restrictive covenant not to carry on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was a transfer of assets within the meaning of the words 'otherwise transferred' occurring in section 34(3)(b) of the Income-tax Act. The High Court answered the second question in the affirmative and against the assessee and in view of that answer, declined to answer the first question. On a further appeal, the Supreme Court held (p. 59): " .. ...... it seems to us clear that a partnership firm under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks of the firm's property or firm's assets, all that is meant is property or assets in which all partners have a joint or common interest. If that be the position, it is difficult to accept the contention that upon dissolution, the firm's rights in the partnership assets are extinguished. The firm as such has no separate rights of its own in the partnership assets but it is the partners who own jointly or in common the assets of the partnership and, therefore, the consequence of the distribution, division or allotment of assets to the partners which flows upon dissoluti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of the selling agent. Under the deed of assignment, the assessee-company was to pay the assignor firm, in consideration of the assignment, " as and by way of royalty an amount equivalent to 75 per cent. of their profits and commission, remuneration and other moneys received from the manufacturers ". The question was whether the sum of Rs. 7,93,837 being 75 per cent. of its net profits paid by the assessee-company to the firm was allowable as a business deduction. The assessee was a new company at the time when it acquired the benefit of the sole selling agency agreement. On those facts, it was held that it had acquired under the assignment, the right to carry on the business of sole selling agency on a long-term basis subject to renewal of the agreement, stipulating to pay 75 per cent. of its annual net profits, and that, therefore the expenditure related to the acquisition of a capital asset and was not admissible as a deduction. We are unable to see how this decision is in any way helpful to learned counsel for the Revenue for contending that there was any acquisition of any benefit in the present case. Further, as seen from the facts in this case, the right to carry on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are answered in favour of the assessee and against the Revenue. So far as the amount received by the old partners referable to their share in the partnership and the goodwill is concerned, though they are received on capital account as held by the Supreme Court in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC), it is only a distribution of the assets of the partnership among the partners involving no transfer of an asset and, therefore, there could be no question of any capital gains also. The question whether the compensation received for restrictive covenant can be taxed as income or capital is directly covered by the decision in CIT v. Saraswathi Publicities [1981] 132 ITR 207 (Mad). In that case, it was held that a receipt referable to the restrictive convenient was a capital receipt not liable to income-tax. The decision in CIT v. N. Palaniappa Gounder [1983] 143 ITR 343 (Mad), is an authority for the position that the compensation received by the outgoing partners or the old partners in respect of their share in the partnership cannot be taxed as revenue receipts nor can it be said that there was any element of capital gains arising merely because of the valuation of h ..... X X X X Extracts X X X X X X X X Extracts X X X X
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