1985 PLP 625 (PTD)

B.K. Rawat for Applicant. B.L. Nema for Opposite Party. G. P. SINGH, C. J.‑This is a reference made by the Income‑tax Appellate Tribunal, on a direction by this Court, under section 256 (79 I T R 594 : 1971 T L R 1547 (S C)) of the Income‑tax Act, 1961. The question of law is as follows: "Whether on the facts and in the circumstances of 4he case, the Tribunal was justified in deleting the amount of Rs. 18,379 considered for assessment as profit under section 41 (79 1 T R 594 : 1971 T L R 1547 (S C)) of the Income‑tax Act, 1961."

2. The relevant assessment year is 1968‑69 for which the account year ended on 31st July 1967. The assessee is a partnership firm. The assessee firm originally cons1sted of four partners, viz. Maya Parakash, Balkishandas, Shantiswarop and Kanchimal. Sometime in 1966 in the account year two of the partners of the firm viz. Maya Parakash and Kanchimal retired and formed a separate firm. The assessee firm inducted two other persons as partners. On the retirement of Maya Prakash and Kanchimal, the assessee firm gave them two trucks and a jeep in liquidation of Rs. 48,000which was the amount which the two out going partners were to get from the assessee firm. The written down value of the trucks and the jeep was Rs. 29,

621. The difference between Rs. 48,000 and Rs. 29,216 which came to Rs. 18,379 was taxed by the Income‑tax Officer as profit under section 41(79 I T R 594 : 1971 T L R 1547 (S C) of the Income‑tax Act. The order of the Income‑tax Officer was maintained in appeal by the Appellate Assistant Commissioner. In further appeal, the Tribunal held that there was no sale of the vehicles by the firm to the retiring partners and, there fore, section 41 (79 I T R 594 : 1971 T L R 1547 (S C)) was not applicable.

3. Section 41 (79 1 T R 594 : 1971 T L R 1547 (S C)) applies only where any building, machinery, plant etc. is sold, discarded, demolished or destroyed. In the instant case, the question is whether the assessee firm sold the vehicles to the retiring partners. The Explanation to section 41(79 I T R 594 : 1971 T L R 1547 (S C) defines the expression "sold" to have the same meaning as in subsection (68 ITR 240: AIR 1968 SC 676) of section 32. "Sold" is defined in section 32(68 ITR 240: AIR 1968 SC 676) to include a transfer by way of exchange or a compulsory acquisition under any law for the time being in force but not to include a transfer in a scheme of amalgamation of any asset by the amalgamation company to the amalgamated company where the amalgamated company is an Indian company. Section 2(47) defines "transfer" in relation to a capital asset to include the sale, exchange or relinquishment of the extinguishment of any rights therein or the compulsory acquisition thereof under any law.

4. The Supreme Court has cons1stently held that when there is a d1stribution of the assets of the firm amongst the partners on dissolution, there is no sale, exchange, transfer or extinguishment of the firm's rights in the partnership assets but merely a mutual adjustment of the rights between the partners in the assets which then were jointly owned by them. Reference in this connection may be made to Commissioner of Income‑tax v. Divas Cine Corporation (120 ITR 49: 1990 TLR109), C.

1. T. v. Bankey Lal Vaidya (79 I T R 594 : 1971 T L R 1547 (S C) and Malabar Fisheries Co. v. C. I. T. (1). In Malabar Fisheries Co.'s case, which related to section 34 ((1971) 80 I T R 291 (Guj)) (b), the Supreme Court took into account the extended meaning of the word "transfer" contained in section 2(27) which was not in the 1922 Act. The basis for the decision of the Supreme Court in these cases, as explained in Malabar Fisheries Co.'s case, is that a partnership firm has no legal existence apart from the partners constitut ing it and when one talks of the firm's property or the firm's assets, all that is meant is property or assets in which all the partners have a joint and common interest. Therefore, it is not correct to say that upon dissolution the rights of the firm in its assets are extinguished or trans ferred to the partners. As earlier stated, according to the Supreme Court, the d1stribution, division or allotment of assets to the partners upon dissolution is a mutual adjustment of their rights and not a transfer. In our opinion, the same principle must apply when one or more partners retire and there is no complete dissolution of the firm. The rights of a, retiring partner are to be worked out on the same footing as if the firm stands dissolved. The retirement of a partner so far as he is concerned is dissolution of the firm. He may even ins1st to receive his appropriate share of the assets including the good‑will by an order of sale. The Court will. however, be reluctant to order a sale except in exceptional circum stances and will direct a payment based upon the value of the retiring partner's share at the date of retirement : See Lindley on Partnership, fourteenth Edition p. 227 and Premchand v. Cont. of E. Duty (1983 M P L J 200 at 202 : 1983 T L R 480), at p.

482. When a partner retires, there is a mutual adjustment of rights between him and the remaining partners and there is no question of sale or transfer by the firm in favour of the retiring partner even if some asset is allocated to the retiring partner in satisfaction of the value of his share which he ought to receive. This is so because, as earlier explained, the partnership property is not held by the firm which is not a legal entity. This view is directly supported by three decisions of the Gujarat High Court with which we respectfully agree, Velo industries v. Collector, Bhavnagar (1971) 80 1 T R 291 (Guj), C. I. T: v. Mohanbhai Pamabhai (4), C. I. T. v. Dilip Engineering Works (1291 TR688:1982T L R N 0 C 69(Guj).

5. The learned Standing Counsel for the Department submitted before us that in case of dissolution the firm ceases to be in existence and, therefore, there cannot be any transfer by the firm to the partners when the assets are distributed, but when a partner retires the firm continues to exist and, therefore, there can be a transfer or sale by the firm in favour of the retiring partner when the retiring partner is allotted a particular asset in lieu of his share in the partnership assets. It is true that the decisions of the Supreme Court to which reference has already been made are all cases of dissolution but the law laid down in those decisions that there is no transfer of assets by the partnership in favour of the partners when the assets are distributed on dissolution but merely a mutual adjust ment of the rights amongst, the partners, is based essentially on the legal proposition that a firm not being a legal entity does not own the partner ship assets which are owned by the partners collectively. The fact that a firm comes to as end before the d1stribution of assets in case of dissolu tion and, therefore, there could be no transfer' by the firm was taken merely as an additional ground to support the decision in Malabar Fisheries Co.'s case. This additional ground is no doubt not available in a case where a. retiring partner is given his share in the assets of the firm, but the main ground that the partnership is not legal entity and does not own the assets and, therefore, the d1stribution of assets between the retiring partner and the remaining partners is a mutual adjustment of their rights and not a transfer by the firm is also available in the case of retirement. The learned Standing Counsel relied upon a decision of this Court in Popular Engineering Co. v. C. I. T. (1983) 140 I T R 398). In that case, it was not disputed before the High Court that if the firm prior to its dissolution section 41(2) of the Act makes a sale in favour of one of the partners would be attracted. In view of this stand, the only question before the Court was whether the transfer took place before or after dissolution of the firm. The finding of fact reached by the Tribunal concluded this question and so the decision of the Court went against the assessee. The case is, therefore, d1stinguishable. There is, however, an observation that the Supreme Court in Malabar Fisheries Co.'s case had taken the same view which does not appear to be correct. As earlier stated by us, the decision in that case by the Supreme Court was based mainly on the ground that the assets of a firm are not held by the firm which is not a legal entity. It was only as an additional ground that it was said that as the firm ceases to be in ex1stence after dissolution there can be no transfer from the firm to the partners when the assets are distributed after dissolution. The following two passages from that judgment will make the position clear :‑‑ "Having regard to the above discussion, it seems to us clear that partnership firm under the Indian Partnership Act, 1932, is not a d1stinct 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 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 d1stribution, division or allotment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm's rights in the partnership assets amounting to a transfer of assets within the meaning of section 2 (47) of the Act. In our view, therefore, there is no transfer of assets involved even in the sense of any extinguishment of the firm's rights in the partnership assets when d1stribution takes place upon dissolution." "There is yet another reason for rejecting the contention of the counsel for the revenue that is that the second condition required to be satisfied for attracting section 34 (3) (b) cannot be said to have been satisfied in the case. It is necessary that the sale or transfer of assets must be the assessee to a person. Now every dissolution must in point of time be anterior to the actual distribution, division or allotment of the assets that takes place after making up accounts and discharging the debts and liabilities due by the firm. Upon dissolution the firm ceases to exist, then follows the making up of accounts, then the discharge of debts and liabilities and thereupon distribution, division or allotment of assets takes place inter se between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division or allotment of assets to the erstwhile partners, is not done by the dissolved firm. In this sense there is no transfer of assets by the assessee (dissolved firm) to any person."

6. Some other cases were also cited by the learned Standing Counsel, but they are not directly in point as they do not relate to retirement of a partner. It is, therefore, not profitable to refer to them here.

7. For the reasons given above, we answer thus in the affirmative, in favour of the assessee and. There will be no order as to costs of this reference. M. B. A. Reference answered in affirmative.