,Income-tax---

-----Firm---Assessment---Succession or change in constitution---General principles---Death of one of two partners---Firm gets dissolved---Constitution of another firm by surviving partner and another person---Amounts to succession of old firm by new firm--Two assessments to be made---Indian Income Tax Act, 1961, Ss.187 & 188---Indian Partnership Act, 1932, S.42(c).

If the formation of R new firm is preceded by a dissolution of the erstwhile firm on account of the death of a partner, it would be a case of succession covered by- the provisions of section 188 of the Income Tax Act, 1961. Further, in order to constitute a succession under the said provisions, there is no legal requirement that any partner of the old firm should not be a partner in the new firm. Likewise, when a dissolved firm is succeeded by another firm in which some of the partners of the old firm are members, nothing in section 187(2) converts such a case of succession into a case of change in the constitution of the firm. This legal position is clearly spelled out because of the contingency provided in the proviso to subsection (2) of section 187 apart from the fact that this position also obtains on a correct interpretation of the provisions contained in section 188. Under section 42(c) of the Indian Partnership Act, 1932, the death of a partner automatically brings about a dissolution of the firm unless there is a contract to the contrary, namely, that death of a partner shall not affect the continuity of the firm. The position is, however, different when a firm consists of any two partners because the moment one out of the two partners dies, the firm automatically and inevitably comes to an end. Even a contract to the contrary in such a contingency cannot save the dissolution of the firm.

At the inception of the previous year relevant to the assessment year 1978-79, the assessee-firm consisted of two partners, R and P. In the midst of the relevant previous year, i.e., October 9, 1977, one out of the two partners died. Three days thereafter, on October 12, 1977, the lone surviving partner joined hands with one S. A fresh deed of partnership was drawn up to carry on the business of the firm under the same name and style under which the erstwhile firm had carried on its business. Two returns of income, one each in respect of the two broken periods were filed. The Income-tax Officer, however, framed a single assessment for the entire relevant previous year and clubbed the income of the two broken periods and assessed the tax liability accordingly. The Tribunal held that two assessments should be made. On a reference:

Held, that on the death of one out of the two partners which constituted the erstwhile firm, the firm stood automatically dissolved. That apart, the partnership deed did not contain any provision that the firm would continue un dissolved notwithstanding the death of any partner. It was also important to note that there was an interregnum of three days between the dissolution of the first firm and the constitution of the second firm. The new firm had succeeded to the old firm and, by virtue of the provisions of section 188, separate assessments for the pre - and post-change periods had to be made.

C.I.T. v. Kunj Beharj Shyam Lal (1977) 109 ITR 154 (All.); CIT v. Seth Govindram Sugar Mills (1965) 57 ITR 510 (SC) and Dahi Laxmi Dal Factory v. ITO (1976)103 ITR 517 (All.) ref.

JUDGMENT

R.K. GULATI, J.---Under section 256(1) of the Income Tax Act, 1961 (for short "the Act"), the Income-tax Appellate Tribunal has referred the following question of law for the opinion of this Court:

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in upholding the order of the Commissioner of Income-tax (Appeals) directing the Income-tax Officer to frame two separate assessments for the periods April 1, 1977, to October 10,1977 and October 12,1977, to March 31,1978?"

The assessee is a firm. The dispute relates to the assessment year 1978-79 with the relevant previous year ending on March 31, 1978. At the inception of the previous year to the assessment year in question, the firm consisted of two partners, viz., Ram Bilas and Prem kumar. In the midst of the relevant previous year, i.e., October 9, 1977, one out of the two partners died.

Three days thereafter, on October 12, 1977, the lone surviving partner joined hands with one Sushi] Kumar. A fresh deed of partnership was drawn up to carry on the business of the firm under the same name and style under which the erstwhile firm had carried on its business. Two returns of income, one each in respect of the two broken periods, were filed. The Income-tax Officer, however, framed a single assessment for the entire relevant previous year and clubbed the income of the two broken periods and assessed the tax liability accordingly. He rejected the plea that two separate assessments were required to be made in respect of the two returns.

On appeal, the Commissioner of Income-tax (Appeals) directed that there ought to have been two assessments. The second appeal filed at the instance of the Revenue was dismissed by the Income-tax Appellate Tribunal. The Revenue having felt aggrieved, got the question of law, set out earlier, referred for the opinion of this Court.

We have heard learned counsel for the parties. The controversy that we are required to

address is whether on facts there was a reconstitution of the firm, there being only a change in the constitution of the firm, or it was a case of succession of one firm by another firm. If the case falls in the former category, the assessment framed by the Income-tax Officer could not have been disturbed, whereas if it was a case of succession, two assessments were called for as held by the Income-tax Appellate Tribunal.

Subsection (1) of section 187 of the Act lays down that where, at the time of making an assessment -it is found that a change has occurred in the "constitution of the firm", the assessment shall be made on the firm as constituted at the time of making the assessment. The import of the expression, "change in the constitution of the firm" for the purposes of section 187 is defined in subsection (2) of section 187, vide its clauses (a) and (b). For this case, clause (a) alone is relevant. It says that there would be a change in the constitution of the firm, if one or more of the partners cease to be partners or one or more new partners are admitted, in such circumstances that one or more of the persons who were partners of the firm before the change, continue as partner or partners after the change. There is also a proviso attached to subsection (2) of section 187. The said proviso reads:

"Provided that nothing contained in clause (a) shall apply to a case where the firm is dissolved on the death of any of its partners."

This proviso was inserted with retrospective effect from April 1, 1975, by the Taxation Laws (Amendment) Act, 1984. It may be' mentioned that the said proviso was not available on the statute book when the Income-tax Appellate Tribunal passed its order in appeal giving rise to this reference.

Section 188 of the Act which speaks of succession of one firm by another firm provides for separate assessments to be made on the predecessor and successor firms, where the firm carrying on a business or profession is succeeded by another firm, and the case is not one covered by section 187. A Full Bench of this Court in Dahi Laxmi Dal Factory v. ITO (1976) 103 TTR 517, had occasion to consider the provisions of sections 187 and 188 of the Act. In that case, the firm consisted of two major partners while some minors were also admitted to the benefits of partnership. As a result of the death of one of the major partners, the firm was reconstituted. The question that had cropped up for decision was, whether the income of the entire previous year, both of the pre-change and post-change periods, could be aggregated and a single assessment made. By a majority it was held (headnote):

" ....But where a firm is dissolved either by agreement of the partners or by operation of law and another firm takes over the business, that will be a case of succession governed by section 188 of the Act, even though some of the partners of the two firms are common. In the present case, the old firm was constituted by- two partners. One of them died and there was no stipulation in the partnership deed that the firm shall not stand dissolved on the death of a partner. Even if there had been such a stipulation, the firm could not have been saved from dissolution, because, after the death of J., only one partner wad left and one man cannot constitute a firm, and the firm automatically came to an end since the erstwhile firm stood dissolved on the death of one of the partners, the petitioner firm which took over the same business could be assessed only in accordance with section 188 and a single assessment for the whole year was not valid."

In another Full Bench decision in CIT v. Kunj Behari Shyam Lal (1977) 109 ITR 154 (All.), by majority, it was held by this Court (headnote):

" ....though the partnership deed of an erstwhile firm did not contain any stipulation to the effect that the firm will not dissolved on the death of one of the partners, but, by virtue of section 42(c) of the Indian Partnership Act, 1932, the firm stood dissolved, the firm which took over the business after the dissolution of the erstwhile firm, could not be said to be a reconstituted firm and section 188 and not section 187 of the 1961 Act would apply and, in such a case; two separate assessments should have been made on the two firms:'

Applying the ratio decidendi of the decisions noticed above to the facts of the instant case, in our opinion, the question referred to this Court must be answered in the affirmative.

During the course of hearing learned counsel for the assessee placed before us a copy of the partnership deed under which the erstwhile firm in the instant case was constituted. The deed of partnership specifically stipulates that the duration of the business will be "at will". There is no clause in the deed of partnership which envisages that on the death of a partner, the firm shall not result in its dissolution. As already noticed, if the formation of the new firm is preceded by a dissolution of the erstwhile firm on account of the death of a partner, it would be a case of succession covered by the provisions of section 188 of the Act. Further, in order to constitute a succession under the said provision, there is no legal requirement that any partner of the old firm should not be a partner in the new firm. Likewise, when a dissolved firm is succeeded by another firm in which some of the partners of the old firm are members, nothing in section 187(2) converts such a case of "succession" into a case of "change in the constitution of the firm". This legal position, in our opinion, admits of no doubt and is indeed, clearly spelled out because of the contingency provided in the proviso to subsection (2) of section 187 of the Act, apart from the fact that this position also obtains on the correct interpretation of the provision contained in section 188 of the Act.

The proviso aforesaid envisages that clause (a) of subsection (2) of section 187 shall not apply to a case where the firm is dissolved on the death of any of its partners. In order that a case be covered within the mischief of the proviso, dissolution of the firm must be on account of the death of a partner and not otherwise. It cannot be disputed that in the instant case, the new firm came to be constituted because of the death of a partner of the erstwhile firm. The other relevant consideration is whether the death of a partner resulted in the dissolution of the firm.

Now, under section 42(c) of the Indian Partnership Act, the death of a partner automatically brings about a dissolution of the firm unless there is a contract to the contrary, namely, that the death of a partner shall not affect the continuity of the firm. This much follows from section 42(c) of the Indian Partnership Act. The position is, however, different when a firm consists of only two partners because the moment one out of the two partners dies, the firm automatically and inevitably comes to an end. Even a contract to the contrary in such a contingency cannot save the dissolution of the firm. In CIT v. Seth Govindram Sugar Mills (1965) 57 ITR 510), the Supreme Court while commenting upon section 42 of the Indian Partnership Act ruled (at page 515):

"Section 42(c) of the Partnership Act can appropriately be applied to a partnership where there are more than two partners. If one of them dies, the firm is dissolved; but if there is a contract to the contrary, the surviving partners will continue the firm. On the other hand, if one of the two partners of a firm dies, the firm automatically comes to an end and, thereafter, there is no partnership for a third party to be introduced therein and, therefore, there is no scope for applying clause (c) of section 42 to such a situation. It may be stated that pursuant to the wishes or the directions of the deceased partner the surviving partner may enter into a new partnership with the heir of the deceased partner, but that would constitute a new partnership."

From the above, it follows that on the death of one out of the two partners which constituted the erstwhile firm, the firm stood automatically dissolved. That apart, the partnership deed did not contain any provision that the firm would continue undissolved notwithstanding the death of any partner. In the absence of such a clause, the consequence was that the firm stood dissolved on the death of a partner. It is also of importance to note that there was an interregnum of three days between the dissolution of the first firm and the constitution of the second firm. That being the state of affairs and in view of the provisions contained in the proviso referred to earlier, clause (a) of subsection (2) of section 187 was inapplicable. Thus, it was not a case of "change in the constitution" of the firm within the meaning of section 187 of the Act. The decision of the Income-tax Appellate Tribunal that the new firm had succeeded the old firm and that by virtue of the provisions of section 188 separate assessments for the pre- and post-change periods had to be made and further, one assessment for the entire previous year could not be sustained, was perfectly just in law.

For the reasons stated above, we answer the question in the affirmative, in favour of the assessee and against the Revenue. The assessee shall be entitled to its costs which are assessed at Rs.250.

M.BA./2391/T???????????????????????????????????????????????????????????????????????????????????? Question answered.