Ramachandra Reddiar v. Commissioner of Income-tax — 1991 DIGILAW 512 (KER)

Judgment :- An ingenious attempt on the part of two assessees who were partners of a firm called "Good Morning Stores, Alleppey' to get the individual tax liability reduced, attracted differing judgments from two judges of this Court constituting the Bench and therefore, in accordance with S.9 of the Kerala High Court Act read with S.23 of the Travancore High Court Act and S.259 of the Income-tax Act, 1961, the matter comes before me for decision according to the opinion of the majority. 2. The main point to be considered is whether the income from assets transferred by the firm in the name of the wives of the two partners of the firm can be included in the individual assessment of the partners as their income. We are concerned with the assessment years 1970-71 and 1971-72, for which the accounting years ended on 16-8-1969 and 16-8-1970 respectively. . 3. The assessees are partners of the firm 'M/s. Good Morning Stores, Alleppey, which carried on business in textiles and also in dry cleaning and tailoring under the name and style of "Bright Dry Cleaners". By agreement dated 18-8-1969, the machinery and equipments used in the dry cleaning and tailoring business were sold to the wives of the two partners who constituted the firm. Apart from the two partners, viz. M/s. P. Ramachandra Reddiar and P. Arjunal Reddiar, there are no other partners in the firm. The wives of the assessees constituted a partnership to carry on the business. The five employees who had been working in the old firm joined the new firm. The old firm discontinued the dry cleaning business and the new firm carried on the business in the same premises. The consideration for the transfer was the written down value of the machinery and the equipments. Not only the machinery and equipments, but the very business itself was transferred. The consideration was inadequate for the transfer of the business undertaking. The Income Tax Officer applied the provision of S.64(1)(iii) of the Income Tax Act, 1961 (for short'the act) as it then stood and computed the income of the assessee by clubbing the assessees' income with the share income derived by the wives as partners of the new firm. On appeal, the appellate Assistant Commissioner sustained the assessment. The Income Tax Officer applied the provision of S.64(1)(iii) of the Income Tax Act, 1961 (for short'the act) as it then stood and computed the income of the assessee by clubbing the assessees' income with the share income derived by the wives as partners of the new firm. On appeal, the appellate Assistant Commissioner sustained the assessment. The assessees carried the matter in further appeal before the Tribunal, and the Tribunal ultimately dismissed the appeal by a consolidated order on 20-3-1981. In dismissing the appeal, the Tribunal rejected the contention of the assessees that because it was a direct transfer by the firm, S.64(1)(iii) was not applicable. The further contention that the nexus between the assets transferred and the income produced was remote was also not accepted by the Tribunal. The Tribunal accepted the contention of the Revenue that there was an indirect transfer of assets by the assessees to their respective spouses, that income arose from the assets transferred, which was the business itself, and, therefore, the profits attributable to the share of the Assessees' spouses in the business arose only from the transfer of the assets by the assessees. The Tribunal held that the assets of the partnership vested in the partners collectively in proportion to their share and direct transfer by the partners representing the firm resulted in an indirect transfer by the partners of their share in such assets in favour of their spouses. Since the business itself was transferred which produced the income of the assessees' spouses, the Tribunal also found that the profit attributable to the share of the assessees' spouses in the business arose direct from the transfer of such assets. In so holding, the Tribunal relied on the decision of the Bombay High Court in Chaturbtrujdas Karnani v. Commissioner of Income-tax, Bombay City (1958) 34ITR 553). The Tribunal was Satisfied that all the requirements of S.64(1)(iii) of the Act were satisfied and the income derived by the assessees' wives was includible in the total income of the assessees. 4. Aggrieved by the decision of the Tribunal, the assessee sought three questions of law mentioned herein-below to be referred under S.256(1) of the Act in the case of each of the assessees for each of the assessment years. 4. Aggrieved by the decision of the Tribunal, the assessee sought three questions of law mentioned herein-below to be referred under S.256(1) of the Act in the case of each of the assessees for each of the assessment years. It is thereafter the Tribunal referred the following questions of law arising out of the consolidated order of the Tribunal dated 20-3-1981 disposing of the two sets of appeals filed by the two assessees for the two assessment years 1970-71 and 1971-72: "1. Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the assessee individual had transferred the assets to his spouse? 2. Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the income arose to the spouse from the assets transferred by the assessee.? 3. Whether on the facts and in the circumstances of the case the Tribunal is right in law in holding that the requirements of S.64(1)(iii) of the Income Tax Act are satisfied?" The Income Tax References were numbered as I.T.R. Nos. 108 to 111 of 1982 and the Division Bench of this Court consisting of Dr. T. Kochu Thommen (J) (as he then was) and K.P. Radhakrishna Menon (J) rendered separate judgments on 3rd November, 1987 differing in their answers to the questions referred. 5. The finding of the Tribunal that the transfer of the business was for inadequate consideration has not been challenged by the assessees and, therefore, it became final. The fact that the firm consisted of only two partners and the firm transferred the Bright Dry Cleaners business itself to the wives of the partners also was not disputed. The only contention of the assessee is. that S.64(1)(iii) is not attracted because the transfer of the business was not effected by an individual to his spouse, but by the firm to the wives of two partners and, therefore, there is no transfer by individual to attract the sub-section. S.64(1)(iii) as it then stood reads thus: "64. Income of individual to include income of spouse, minor child, etc. S.64(1)(iii) as it then stood reads thus: "64. Income of individual to include income of spouse, minor child, etc. (i) In computing the total income of any individual, there shall be included all such income as arises directly or indirectly - (iii) to the spouse of such individual from assets transferred directly or indirectly to the spouse by such individual otherwise than for adequate consideration or in connection with an agreement to live apart". Kochu Thommen, J. (as he then was) held that a firm under the Indian Partnership Act, 1932 is not a distinct legal entity apart from the partners constituting it and the firm's property or assets are only the property or assets of the partner and when transfer of assets is made by the partnership, there will be a reduction in the value of each partner's share and, therefore, it should be construed that the two partners constituting the firm together transferred certain assets of their firm to their respective spouse for inadequate consideration. His Lordship, therefore, held that the provision of S.64(1)(iii) of the Act is satisfied. In that view of the matter, His Lordship answered question No. 3 in the affirmative, i.e. in favour of the Revenue and against the assessees. His Lordship felt it unnecessary to answer question Nos. land 2 in the light of his answer to question No. 3. 6. His Lordship Justice Radhakrishna. Menon, on the other hand, held that a firm, though not a legal entity in partnership law, for the purpose of the Income Tax Act it is a legal entity and that means, no partner can claim exclusive right over the assets of the firm during the subsistence of the partnership and the partner can only assign his share to another, giving the assignee the right to receive share of profits and that means, the exclusive right of a partner in his personal assets upon his introduction into the partnership firm, transform into an interest shared, with other partners in that asset and that during the subsistence of the partnership, the value of interest of each partner cannot be isolated or carved out from the value of the partner's interest in the totality of the partnership assets, which will take place only on the dissolution of the firm. His transfer by individual to his spouse and unless it is established that the transfer of the income fetching assets exclusively belongs to the husband, clubbing of income cannot be permitted. As it was found that the assets admittedly belonged to the partnership, the assessment clubbing the income of the spouse with the total income of the assessee was held to be not sustainable. His Lordship, therefore, answered all the questions in the negative, that is, in favour of the assessee and against the revenue. 7. S.64 is part of the legislative endeavor to overtake and circumvent the tax payers' attempt to reduce tax liability. Normally, the total income of an individual alone is taxable under the Act. But in Chapter V of the Act, income of other persons are also included in the assessee's total income. One such income of other persons includible in the individual's total income is the income arising directly or indirectly to the spouse of such individual from assets transferred directly or indirectly to the spouse by such individual otherwise than for adequate consideration. Admittedly, in this case the transfer was otherwise than for adequate consideration. There was a definite finding to that effect by the Tribunal and the same has not been challenged. The transfer was also to the wives of the assessees, viz. Smt. A. Nagalakshmi, Annai Illam, Mullakkal, Alleppey, and Smt. Radhamani, S.K.R. Colony, Mullakkal, Alleppey, who are the wives of Arjuna Reddiar and Ramachandra Reddiar respectively, the assessees in this case. Thus the transferees are the wives of the assessees and the transfer is for inadequate consideration. The assets transferred have been detailed in the assessment order. Admittedly, the firm 'Good Morning Stores, Alleppey' had only two partners, viz. Sri.P. Ramachandra Reddiar and Arjuna Reddiar and that firm was also carrying on the business in tailoring and dry cleaning under the name and style 'Bright Drycleaners and Out fitters'. The firm discontinued the said business and sold the machinery and equipments used in that business as a going concern to the wives of the two partners. The business premises continued to be the same and services of the staff were also continued. Even though in the agreement of sale it has been shown that the machineries and equipments were sold, in effect the business in its entirety was sold as a going concern. The business premises continued to be the same and services of the staff were also continued. Even though in the agreement of sale it has been shown that the machineries and equipments were sold, in effect the business in its entirety was sold as a going concern. If S.64(1)(iii) is read substituting the names of the partners and their wives, it will read as "in computing the total income of Ramachandra Reddiar and Arjuna Reddiar (the individual assessees) there shall be included all such income as arises directly or indirectly to Radhamani and Nagalakshmi (who are spouses of Ramachandra Reddiar and Arjuna reddiar ) from assets transferred directly or indirectly to Radhamani and Nagalakshmi by Ramachandra Reddiar and Arjuna Reddiar otherwise than for adequate consideration." The transfer is in form by the firm 'Good Morning Stores'. But 'Good Morning Stores' is only a partnership. It is well known that firm is not a legal person. The firm name is only the name under which the partners carry on their business. It is only a conventional name implicating persons who, on particular occasions when the same is used, are members of the firm. It is a compendious way of expression for designating the persons comprising or constituting the partnership. Therefore, when it is said that a firm is transferred, it only means that all the partners have transferred the business. In other words, behind the firm 'Good Morning Stores' are the two partners viz. Ramachandra Reddiar and Arjuna Reddiar who are the sole partners of the firm on the date of transfer of the 'Bright Drycleaners' business to M/s.Radhamani and Nagalakshmi who are none other than the wives of the two partners. Since the firm has no legal existence, the partnership property will admittedly vest in all the partners, and since there are only two partners, viz. Ramachandra Reddiar and Arjuna Reddiar, they are owners of the property. No doubt, under the Income Tax Act, for the purpose of assessment, firm is a legal entity. But under the partnership law the firm is not a legal entity, but only consist of individual partners for the time being. Ramachandra Reddiar and Arjuna Reddiar, they are owners of the property. No doubt, under the Income Tax Act, for the purpose of assessment, firm is a legal entity. But under the partnership law the firm is not a legal entity, but only consist of individual partners for the time being. In the decision reported in Commissioner of Income Tax, Madras v. R.M. Chidambaram Pillai (106 ITR 292), the Supreme Court posed the question, "is the firm a person or a mere short name for a collection of persons commercially convenient, but not legally recognised?" The Supreme Court quoted with approval from "Lindley on Partnership" 12th edition, page 28 as follows: "The law, ignoring the firm, looks to the partners composing it; any charge amongst them destroys the identity of the firm; what is called the property of the firm is their property, and what are called the debts and liabilities of the firm are their debts and their liabilities. In point of law, a partner may be the debtor or the creditor of his co-partners, but cannot be either debtor or creditor of the firm of which he is himself a member, nor can he employed by his firm, for a man cannot be his own employer." Thereafter the Supreme Court observed: "In some systems of law this separate personality of a firm apart from its members has received full and formal recognition as, for instance, in Scotland. That is, however, not the English common law conception of a firm. English lawyers do not recognise a firm as an entity distinct from the member composing it. Our partnership law is based on English Law and we have also adopted the notions of English Lawyers as regards a partnership firm." Thus, the Supreme Court held that the firm is not an entity or person in law, but merely an association of individuals and the firm name is only a collective name of those individuals who constitute the firm. In other words, the firm name is merely an expression, only a compendious mode of designating the persons who have agreed to carry on business in partnership. In Malabar Fisheries Co. v. Commissioner of Income-Tax, Kerala (1979) 120 ITR 49 the different notions regarding the nature of the firm between the commercial man and lawyers 'have been explained by the Supreme Court. In Malabar Fisheries Co. v. Commissioner of Income-Tax, Kerala (1979) 120 ITR 49 the different notions regarding the nature of the firm between the commercial man and lawyers 'have been explained by the Supreme Court. The legal notion of a firm differs from the commercial notion of the same, for the firm is not recognised by English lawyers as distinct from the members composing it. The Supreme Court held: "In English jurisprudence a firm is only a compendious name for certain persons who carry on business, or have authorised one or more of their number to carry it on, in such a way that they are jointly entitled to the profits and jointly liable for the debts and losses of the business. Further, it is true that partnership property is regarded as belonging to the firm, but that is only for the purpose of distinguishing the same from the separate property of the partners composing the firm." Thereafter the Supreme Court held that the position as regards the nature of a firm and its property in Indian law under the Indian Partnership Act, 1932, is almost the same as in English law. Here also a partnership firm is not a distinct legal entity and the partnership property in law belongs to ail the partners constituting the firm. In Addanki Narayanappa v. BhaskaraKrishnappa (AIR 1966 SC 1300) the Supreme Court held that as a firm has no legal existence, the partnership property will vest in all the partners and, in that sense, every partner has an interest in the property of the partnership. Of course, during the subsistence of the partnership no partner can deal with any portion of the property as his own, nor can he assign his interest in the property to anyone. But there cannot be any doubt that all the partners constituting the firm can transfer the assets. Therefore, when the firm' Good Morning Stores', of which M/s. Ramachandra Reddiar and Arjuna Reddiar are the only partners, transferred one of its business with its assets, viz. 'Bright Dry Cleaners' to two ladies who are none other than the wives of the partners, it is to be held that there was a transfer indirectly by the two partners. The law looks to the partners. What is called the property of the firm is their property and what is called the liability of the firm is their debts. 'Bright Dry Cleaners' to two ladies who are none other than the wives of the partners, it is to be held that there was a transfer indirectly by the two partners. The law looks to the partners. What is called the property of the firm is their property and what is called the liability of the firm is their debts. In Regional Director, E.S.I.C., Trichurv.Ramanuja Match Industries (AIR 1985 SC 278) the Supreme Court held that the partnership business belongs to the partners and each one of them is owner thereof In Dy. Commissioner, Sales Tax (Law) v. M/s.Kelukutty (AIR 1985 SC 1143) the Supreme Court held that the provisions contained in taxation law does not confer a corporate personality on the firm. The Supreme Court observed: "The firm is an assessable unit separate and distinct from the individual partners, who as individuals constitute assessable unit*separate and distinct from the firm. It is on that basis that the provisions of the tax law are structured into a scheme providing for the assessment of partnership income. We do not think the principle goes beyond the purpose of that scheme. It does not confer a corporate personality on the firm. Beyond the area within which that principle operates, the general law, that is to say, the partnership law holds undisputed domain." 8. Counsel for the assessees referred to a large number of decisions to show that in tax matters firm is a legal entity. The decisions referred are State of Punjab v. M/sJullunder Vegetables Syndicate (AIR 1966 SC 1295), Income Tax Officer, Assessment II, Calicut v. C.V. George ((1976) 105 ITR 144), Commissioner of Income Tax, Madras v. E.M. Chidambaram Filial ((1977) 106 ITR 292), Abdul Rahim, Travancore Confectionery Works v. Commissioner of Income-tax, Kerala), (1977) 110 ITR 595) and Sun/ 7 Sidharthbhai v. Commissioner of Income-Tax, Ahmedabad ((1985) 156 ITR 509). These are authorities for the proposition that a firm can be taxed as a legal entity, but they are not authorities for the proposition that the firm is a separate entity in law distinct from the partners constituting it time to time. The separate legal status given to the firm extend only for the purpose of assessment and they do not go any further. The separate legal status given to the firm extend only for the purpose of assessment and they do not go any further. In other words, when partners constitute a firm, in general law the firm does not get a corporate personality and it has no corporate existence in law. The firm name is only a convenient way of referring the names of all the partners constituting the partnership at the relevant time. 9. Counsel also referred to the decisions reported in Commissioner of Income Tax, Madras v. R.M. Chidambaram Pillai ((1977) 106 ITR 292), Malabar fisheries Co. v. Commissioner of Income Tax, Kerala ((1979) 120 ITR 49) and C.V. Mulk v. Commissioner of Agricultural Income-Tax, Kerala ((1979) 120 ITR 671) to show that all partners have joint and common interest in the partnership property and no partner, at any time, can claim that a particular property as his own. This proposition of law is unobjectionable, but the application of the same to the facts in issue is not warranted, for in this case there were only two partners in the partnership and there cannot be any dispute that the property of "Bright Dry Cleaners" were owned by them. Both of them together can transfer the property/ business in question to their wives. When the firm, represented by one of the partners, transfers the business, it is not a transfer by one of them, but a transfer by all the partners, viz. Ramachandra Reddiar and Arjuna Reddiar. The transferees are admittedly their respective wives. Therefore, the decision referred to by counsel will not apply to the facts of this case. 10. Counsel also referred to several decisions to show that no partner can claim exclusive right in the partnership property, but can claim only a share of profits. The decisions referred are Addankinarayanappa v. Bhaskara Krishnappa (AIR 1966 SC 1300), Commissioner of Income-Tax Madhya Pradesh, Nagpur and Bhandara v. Dewas Cine Corporation ((1968) 68 ITR 240), Commissioner of Income-Tax, U.P. v. BankeyLal Vaidya (1971) 79 ITR 594), Kay Engineering Co. v. Commissioner of Income-tax Patiala ((1971) 82 ITR 950), Commissioner of Income-tax, Kerala v. Nataraj Motor Service ((1972) 86 ITR 109, Commissioner of Income-tax, Qujaratv. Mohanabhai Pamabhai ((1973) 91 ITR 393) and Malabar Fisheries Co. v. Commissioner of Income-Tax, Kerala ((1979) 120 ITR 49). v. Commissioner of Income-tax Patiala ((1971) 82 ITR 950), Commissioner of Income-tax, Kerala v. Nataraj Motor Service ((1972) 86 ITR 109, Commissioner of Income-tax, Qujaratv. Mohanabhai Pamabhai ((1973) 91 ITR 393) and Malabar Fisheries Co. v. Commissioner of Income-Tax, Kerala ((1979) 120 ITR 49). So long as the partnership continues, no partner can claim exclusive right over any of the partnership property. The proposition of law is well established. Any partner can claim only a share in the profits of the business. But in this case, the firm consisting of two partners transferred the property and the business to the wives of the partners. There is no case that apart from the two partners there are other persons interested in the property transferred. The property transferred belongs to the two partners and the transferees are the wives of the two partners. Therefore, S.64(1)(iii) is clearly attracted. 11. Counsel also referred to the decision reported in J.B. Greaves v. Commissioner of Income Tax, Bombay City I. ((1963) 49 ITR 107) to show that the assets transferred must be that of the transferer. In this case, the transferor is the partnership and the partnership consisted of Ramachandra Reddiar and Arjuna Reddiar, and the transferees are respective wives of the said partners. When the assets are held by the firm, it means the assets held by the two partners and, therefore, the transfer made is by the assessees to their wives. Hence, in computing the total income of the assessees, the income that arose to the spouses of such individuals from the assets transferred will have to be included under S.64(1)(iii) of the Act. 12. What was transferred was a joint business and, therefore, the profits that went to the share of the wives arose directly from the transfer of the business. The share income accrued to the wives has, therefore, to be clubbed along with the income of the respective assessee in the light of the decision reported in Chaturbhujdas Karnani v. Commissioner of Income Tax, Bombay City I ((1958) 34 ITR 553). 13. In the light of the above discussion, I agree with the judgment of my learned brother Kochu Thommen, (J) (as he then was) and answer question No.3 in the affirmative in favour of the Revenue and against the assessee. 13. In the light of the above discussion, I agree with the judgment of my learned brother Kochu Thommen, (J) (as he then was) and answer question No.3 in the affirmative in favour of the Revenue and against the assessee. In the light of the answer to question No. 3,1 agree that it is unnecessary to answer question Nos.1 and 2. Therefore, I decline to answer question Nos.1 and 2. In the result, according to the majority view, question No. 3 is answered in the affirmative in favour of the Revenue and against the assessee, leaving question Nos. land 2 unanswered as, in the light of the answer to question No. 3, answer to question Nos.1 and 2 became unnecessary. 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.