The Commissioner Of Gift Tax v. K. A. Abdul Razak — 1991 DIGILAW 317 (KER)

JUDGMENT K.A. Nayar, J. 1. The main question to be considered in the income-tax referred case and the original petitions is the same, and that is, when minors are admitted to the benefits of a partnership with contribution by the minors towards capital resulting in redistribution of capital in accordance with the profit-sharing proportion, whether there is a gift involved in the said reconstitution. In the income-tax referred case, we are concerned with the assessment year 1975-76. The assessee therein was a partner of the firm, Messrs. K. A. K. P. Kunhamoo and Co. On January 1, 1975, the assessee gifted Rs. 2,500 to each of his four minor sons. The return of gift for this transaction was filed by the assessee for the assessment year 1975-76 wherein the taxable gift shown was Rs. 5,000. Prior to January 1, 1974, the assessee's share in the partnership firm was 25 per cent. On January 1, 1974, the four minor sons of the assessee were admitted to the benefits of the partnership by a deed entered into on that day. According to this, the four minor sons were together allotted 20 per cent. share in the profits of the firm while the assessee's share in the firm was reduced to 5 per cent. While completing the assessment, the Gift-tax Officer considered that the assessee had surrendered 20 per cent. of his interest in the firm with effect from January 1, 1974, and such surrender amounted to a gift taxable under the Gift-tax Act, 1958. He worked out the goodwill of the firm at Rs. 2,13,972 and 20 per cent. of the same, viz., Rs. 42,794, was treated as the proportionate value of the goodwill transferred by the assessee in favour of his four minor sons. Adding this to the cash gift of Rs. 10,000 and allowing the deduction under Section 5(2) of the Gift-tax Act, 1958, the taxable gift was fixed at Rs. 47,794. The assessee objected to the Gift-tax Officer's views before the Appellate Assistant Commissioner. Adding this to the cash gift of Rs. 10,000 and allowing the deduction under Section 5(2) of the Gift-tax Act, 1958, the taxable gift was fixed at Rs. 47,794. The assessee objected to the Gift-tax Officer's views before the Appellate Assistant Commissioner. The assessee's contentions were that there was no goodwill for the firm at the time of reconstitution on January 1, 1974, and that this is not a case where the assessee's share in the firm was reduced without reducing the share of the capital proportionately since there was contribution towards capital by the four minors when they were admitted to the benefits of partnership and hence no gift was involved in the reconstitution. It was also contended that the manner of evaluating the goodwill by capitalisation of the average profit at three times by the Gift-tax Officer was excessive. The Appellate Assistant Commissioner did not allow the first contention of the assessee. He held that the firm must be considered to have a goodwill in view of the fact that the net profit of the firm for the earlier years from 1970-71 onwards have been in excess of Rs. 2 lakhs and due to the number of years of standing in the particular line of business, the business competition that existed in the locality and the reputation the firm enjoyed in the particular centre. He held that there was a diminution in the share of interest of the assessee and a consequent increase in the shares of the four minors and, therefore, there was a liability to gift-tax to the extent of the value of the rights surrendered in favour of his minor children. The Appellate Assistant Commissioner, however, allowed a reduction of Rs. 9,374 in the value of the goodwill assessed by the Gift-tax Officer. In further appeal before the Tribunal, the assessee raised the same contention. Following the decision of this court in V.O. Marhose v. CIT [1975] 98 ITR 504, the Tribunal held that there is a gift exigible to gift-tax in this case. The Tribunal also held that the firm, Messrs. K.A.K.P. Kunhamoo and Co., was possessed of goodwill at the relevant time. Following the decision of this court in V.O. Marhose v. CIT [1975] 98 ITR 504, the Tribunal held that there is a gift exigible to gift-tax in this case. The Tribunal also held that the firm, Messrs. K.A.K.P. Kunhamoo and Co., was possessed of goodwill at the relevant time. The Tribunal, however, held that the method of evaluation of the interest forgone by the assessee in the firm adopted by the Gift-tax Officer and the Appellate Assistant Commissioner is not proper as they confined their attention only to one of the assets of the business in goodwill. The Tribunal held that the interest that is forgone by the assessee is to be determined by ascertaining the value of the assessee's interest in the partnership and deduction therefrom of the consideration, if any, for the transfer of the assessee's share or interest in the partnership. The assessee's contention that the contribution of Rs. 10,000 towards capital made by the four minors would amount to adequate consideration for purposes of gift-tax was not accepted by the Tribunal. They held that the extent of the contribution should be evaluated with reference to the value of the interest transferred by the assessee to determine the question whether there was adequacy of consideration. They considered the fact that the capital contribution of Rs. 10,000 made by the minors came as withdrawal from the capital account of the assessee in the firm and held that it is to be treated as consideration for the transfer and held that this amount should be adjusted against the value of the property transferred on admission of the minors to the benefits of the partnership. In that view of the matter, they directed the Gift-tax Officer to evaluate the interest of the assessee in the firm which has been forgone in favour of the minors and adjust the amount of contribution of capital made by them and thus determine the value of the taxable gift. The Revenue felt that the decision of the Tribunal that the gift of capital by the assessee himself to the minors admitted to the benefits of the partnership should be treated as consideration for the gift of his interest surrendered in favour of the minor is not right. The Revenue felt that the decision of the Tribunal that the gift of capital by the assessee himself to the minors admitted to the benefits of the partnership should be treated as consideration for the gift of his interest surrendered in favour of the minor is not right. According to the Revenue, the correct value of the gift is the value of the interest in the firm forgone by the assessee in favour of the minor children which will be the same as in interest acquired by the minors in the firm. Therefore, this value as well as the cash gifts of Rs. 10,000 made to the minors are to be taken as the gift made by the assessee in this particular transaction. Hence, aggrieved by the decision of the Tribunal, at the instance of the Commissioner of Gift-tax, the following question of law has been referred under section 26(1) of the Gift-tax Act, 1958, to this court : "Whether, on the facts and in the circumstances of the case and also in view of the gift of capital by the assessee himself, the Tribunal is right in holding that the capital contributed by the minors should be treated as consideration for the gift of interest surrendered in favour of the minors ?" 2. Original Petitions, viz., O. P. Nos. 7508 of 1986, 1149 of 1987 and O. P. No. 1316 of 1987, are referred to be heard by a Division Bench. 3. In O. P. No. 7508 of 1986, the assessee surrendered 15 per cent. of his interest in the firm, Messrs. Chelur Corporation, in favour of his son, Suryaprakash, in the assessment year 1979-80. The Gift-tax Officer took the view that the said surrender of interest by the petitioner in favour of his son was a transaction attracting gift-tax liability within the meaning of section 4 of the Gift-tax Act, 1958. For the assessment year 1980-81, the petitioner who was a partner in the firm, Messrs. Mercantile and Marine Services, reconstituted the firm admitting the petitioner's son, Suryaprakash, to the partnership. The petitioner relinquished 5 per cent. of his share which, according to the Gift-tax Officer, was without consideration and a gift liable to gift-tax. The assessment of the petitioner was challenged in revision before the Commissioner of Gift-tax, Cochin. It was contended that there was only a reconstitution of the firms in the regular course of business. The petitioner relinquished 5 per cent. of his share which, according to the Gift-tax Officer, was without consideration and a gift liable to gift-tax. The assessment of the petitioner was challenged in revision before the Commissioner of Gift-tax, Cochin. It was contended that there was only a reconstitution of the firms in the regular course of business. The petitioner was growing old and, as a matter of business expediency, the petitioner admitted his son into the firms and that the son brought in his own capital and rendered services to the firms which were adequate consideration. Since the reconstitution was in the regular course of business, it was contended that the assessee is entitled to get exemption under Section 5(1)(xiv) of the Gift-tax Act, 1958. The evaluation of the gift liable to be taxed was also questioned. It was contended that the assessee's son had brought in his own capital while joining the respective firms and the assessee's share of profit was decreased only from the rearrangement of the constitution of the firm and, therefore, it could not be termed as a gift within the meaning of Section 2(xii) of the Gift-tax Act, 1958. The contribution of capital by the incoming partner, rendering service to the respective firms and sharing future liabilities and losses, would constitute sufficient consideration. It was also submitted that the reconstitution of the firm is in the regular course of business and, therefore, exempted under Section 5(1)(xiv) of the Gift-tax Act, 1958. But the authorities rejected this contention. The Commissioner, in revision for the assessment years 1979-80 and 1980-81, held that the relinquishment of the interest in the firm was without any consideration. 4. In O. P. No. 1149 of 1987, for the assessment year 1980-81, the petitioner who was a partner in the firm, Messrs. Mercantile and Marine Services, with 25 per cent. share reconstituted the firm admitting the petitioner's brother, Sri Suryaprakash, to the partnership, relinquishing 5 per cent. share in respect of which he was assessed to gift-tax. In this case also, the assessee unsuccessfully contended that there was only a reconstitution of the firm in the regular course of business and that the brother brought in his own capital. The revision filed was rejected by the Commissioner. 5. In O. P. No. 1316 of 1987, for the assessment year 1980-81, the petitioner who was a partner in the firm, Messrs. The revision filed was rejected by the Commissioner. 5. In O. P. No. 1316 of 1987, for the assessment year 1980-81, the petitioner who was a partner in the firm, Messrs. Mercantile and Marine Services, with 25 per cent. share reconstituted the firm admitting the petitioner's brother, Sri Suryaprakash, to the partnership, relinquishing 5 per cent share which, according to the Gift-tax Officer, was a taxable gift. He held so rejecting the self-same conclusions raised by the assessee that there was only a reconstitution of the firm in the regular course of business and that the brother brought in his own capital. The revision filed was also dismissed as in the earlier case. 6. Under section 3 of the Gift-tax Act, 1958, tax in respect of gift, if any, made by a person during the previous year at the rate specified in Schedule I will have to be paid. The term "gift" has been defined to mean transfer by one person to another of any existing movable or immovable property made voluntarily and without consideration in money or money's worth. It also includes the transfer or conversion of any property referred to in Section 4 which is deemed to be a gift under that section and Section 4 deems, among others, a release, discharge or surrender, forfeiture or abandonment of any debt, contract or other actionable claim or of any interest in property by any person, the value of the release, discharge, surrender, forfeiture or abandonment, to the extent to which it has not been found to the satisfaction of the Assessing Officer to have been bona fide, to be a gift made by the person responsible for the release, discharge, surrender, forfeiture or abandonment. Further, where a person, absolutely entitled to a property, causes or has caused the same to be vested in whatever manner in himself and any other person jointly without adequate consideration and such other person makes an appropriation from or out of the said property, the amount of the appropriation used for the benefit of the person making the appropriation or for the benefit of any other person shall be deemed to be a gift made in his favour by the person who causes or has caused the property to be so vested. In CGT v. Chhotalal Mohanlal [1987] 166 ITR 124, the Supreme Court held that on reconstitution of a firm with minor sons of a partner admitted to the benefits of partnership, there will be a gift of the goodwill. The Supreme Court held that (at page 127) : "Once goodwill is taken to be property and with the admission of the two minors to the benefits of partnership in respect of a fixed share, the right to the money value of the goodwill stands transferred, the transaction does constitute a gift under the Act. Since there has been no dispute about valuation of the goodwill as made by the Gift-tax Officer, with the conclusion that there has been a gift in respect of a part of the goodwill, the answer to the question referred has to be in the affirmative, that is, it constitutes a gift under the Act." But, in this case, the Supreme Court was considering a case where the minors did not make any capital contribution to the partnership. The Supreme Court observed that reconstitution of a firm admitting in minors to the benefits of the partnership would involve a gift under the Act. The Karnataka High Court, in D.C. Shah v. CGT [1982] 134 ITR 492, held that there is no gift involved where, as a result of the reconstitution, there was reduction in the shares of erstwhile partners and allocation of shares to new partners who agreed to contribute capital and also agreed to work for the firm. Capital contribution made by the new partners and agreement to render service as well as to share the future liabilities and losses would constitute consideration in such cases for the transfer. In coming to such conclusion, the Karnataka High Court relied on the decision in CGT v. Ali Hussain M. Jeevaji [1980] 123 ITR 420 of the Madras High Court, CGT v. Karnaji Lumbaji [1969] 74 ITR 343 (Guj), CGT v. Sardar Wazir Singh [1975] 99 ITR 104 (All) and CED v. Kantilal Nemchand [1978] 115 ITR 89 (Bom). Further, in CGT v. J.N. Marshall [1979] 120 ITR 613, the Bombay High Court considered the question whether the Tribunal is right in holding that, under section 3 of the Gift-tax Act, 1958, gift-tax can be levied only if there is a gift as defined in the Act. Further, in CGT v. J.N. Marshall [1979] 120 ITR 613, the Bombay High Court considered the question whether the Tribunal is right in holding that, under section 3 of the Gift-tax Act, 1958, gift-tax can be levied only if there is a gift as defined in the Act. Under Section 2(xii) of the Act, one of the essential conditions for a gift is that the transfer must be without consideration in money or money's worth. The burden of proving that a particular transfer is a gift is upon the Revenue by showing that the transfer was without consideration."The decision in CGT v. N. Palaniappa Mudaliar [1978] 113 ITR 440 (Mad) and CGT v. Kamaji Lumbaji [1969] 74 ITR 343 (Guj), are also authorities for the same proposition. In CGT v. Smt. Kamla Devi Bhanot [1988] 171 ITR 398, 403, the Madhya Pradesh High Court also came to the same conclusion. If there is any capital contribution by or on behalf of the minors who are admitted to the benefits of the partnership, there can be no gift in respect of the goodwill. In Sharadkumar Shrikrishna v. CGT [1986] 160 ITR 332, the Madhya Pradesh High Court held that (at page 335) : ". . . . it would not be possible to lay down as a general rule that there has been a gift in respect of the goodwill whenever a firm is reconstituted and the share in the goodwill of one of the partners is reduced as has been held in the decision referred to above : Manaklal Motilal Agrawal v. CGT [1984] 147 ITR 670 (MP)." 7. This court has already held in K. K. Achuthan v. CGT [1988] 170 ITR 518 (Ker) that, where, as a result of reconstitution, the assessee-partner relinquished a part of his share in favour of his sons who were existing partners in the firm, there is a gift. In doing so, this court followed the decision in CGT v. Chhotalal Mohanlal [1987] 166 ITR 124 (SC). Here also, there was no capital contribution by the partner. The question whether the reconstitution of a firm by inducting one or more new partners in an existing firm would involve transfer or gift will depend upon the appreciation and interpretation of the terms of the document. Here also, there was no capital contribution by the partner. The question whether the reconstitution of a firm by inducting one or more new partners in an existing firm would involve transfer or gift will depend upon the appreciation and interpretation of the terms of the document. In CGT v. V. M. Philip [1985] 154 ITR 819 (Ker), the assessee who owned a plantation as proprietary business decided to form a partnership with his son to run the business and transferred 50 per cent. of his interest in the proprietary business to his son who contributed rupees one lakh as his share of the capital for the partnership business. The Gift-tax Officer assessed the value of the gift diminished by the sum of rupees one lakh as share capital. The Commissioner held that the sum of rupees one lakh could not be taken into account in computing the amount on which gift-tax was payable as the contribution by the son was not a payment to the assessee in consideration of the assets transferred to him by the assessee. But the Tribunal set aside the order of the Commissioner. On a reference a Division Bench of this court held that the transaction did not involve any gift. But the assessee had not challenged the finding of the Gift-tax Officer as to the existence of a gift. It was held that the Tribunal was right in holding that the consideration of rupees one lakh had passed from the son to the father for admitting the son to the partnership and the only amount which was taxable was the value of assets gifted after deducting the sum of rupees one lakh. 8. In Income tax Reference No. 280 of 1982, the finding of the Tribunal has not been challenged. There was a reconstitution of the firm on January 1, 1974, whereby two new partners in addition to four minor sons of the assessee were admitted. Before the reconstitution, the assessee was entitled to 25 per cent. in the partnership. It was reduced to 5 per cent. after the reconstitution. The finding was that the assessee had transferred a part of his interest in the firm to his minor sons, after obtaining the consent of the other partners. There is also a finding that the firm is possessed of goodwill. in the partnership. It was reduced to 5 per cent. after the reconstitution. The finding was that the assessee had transferred a part of his interest in the firm to his minor sons, after obtaining the consent of the other partners. There is also a finding that the firm is possessed of goodwill. The Tribunal held that, in order to determine whether any gift-tax is exigible on the assessee, it is necessary to ascertain the value of his interest and also to find out whether there is any consideration for the transfer of the assessee's share of interest in the partnership. That the minor has contributed a capital sum of Rs. 10,000 was not in dispute. The only limited question referred to this court is whether the Tribunal was right in holding that the capital contributed by the minors should be treated as consideration for the gift of interest surrendered in favour of the minor. On the facts and circumstances in this case. It is so and so we answer the question referred in the affirmative and against the Department. The reference is answered accordingly. Even though this will dispose of the original petitions as well, it is necessary to re-examine the question of liability to gift-tax of the petitioners in the original petitions. Therefore, we quash the impugned orders in the original petitions and direct the Gift-tax Officer to pass fresh assessment orders according to law and in the light of this judgment. A copy of this judgment under the seal of this court and the signature of the Registrar will be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.