Income-tax---

----Capital gains---Exemption---Relinquishment of rights over capital assets amount to transfer---Firm--Firm formed to do businesses of exhibition of films---Due to disputes among partners, suit instituted for rendition of accounts and dissolution of partnership by some partners---During pendency of suit, compromise effected and deed of compromise filed in Court-- Pursuant to compromise decree all partners authorising a co-partner to sell partnership property by auction---In auction, property purchased by one of the partners of dissolved firm and relinquishment deed on behalf of firm executed in favour of purchaser---Firm stood dissolved by virtue of compromise decree---Transaction was an outright sale for gains to realise sale proceeds of property---There was no distribution of capital asset in specie on dissolution ---Assessee-firm not entitled to exemption from tax on capital gains arising on sale---Indian Income Tax Act, 1961, Ss.2(47) & 47(ii).

Under section 2(47) of the Income Tax Act, 1961, relinquishment of rights over a capital asset shall be treated as a "transfer". As per the above provision, a sale, exchange or "relinquishment" of a capital asset shall be regarded as a "transfer". Thus, the gains arising from the transfer---may be in the form of a sale or exchange or relinquishment---of a capital asset effected in the previous year are chargeable to income-tax under the head "Capital gains" under the provisions of section 45 of the Act.

A firm was formed to do business of exhibition of films. Due to disputes among the partners, a suit for rendition of accounts and dissolution of the partnership was instituted by some of the partners. During the pendency of the suit a compromise was effected among the partners and a compromise decree was passed by the Court in terms of the said compromise recorded by the Court. Pursuant to the compromise decree a general power of attorney was executed by all the partners in favour of a co-partner authorising him to sell the partnership property by auction. In the auction held, the property was purchased by one of the partners and a deed of relinquishment on behalf of the firm was executed in favour of the purchaser. The Income-tax Officer computed capital gains in the transaction in a sum of Rs.1, 43,420. The assessee-firm contended that the theatre was distributed to one of the partners as part of the dissolution and that the dissolution was complete with the auction of the partnership property and that the capital gain resulting from the auction was exemption under section 47(ii) of the Income Tax Act, 1961. The Income-tax Officer held that the theatre was leased out and there was no firm, that there was a sale of the theatre by auction to one of the partners, that the transfer was by an association of persons, that there was no distribution of any capital asset coming within the purview of section 47(ii) and that, therefore, the assessee was not entitled to claim exemption under the section. Oat appeal, the Appellate Assistant Commissioner confirmed the order of the Income-tax Officer. On further appeal, the Tribunal held that there was distribution of property as a result of dissolution of the firm and that the assessee was entitled to exemption from tax on capital gains on the. sale of the partnership property. On a reference:

Held, reversing the decision of the Tribunal, that the sequence of events suggested that pursuant to the compromise, there was a Court decree for dissolution and on the dissolution of the firm pursuant to the Court decree, the partnership property was sold in auction in final settlement of accounts among the partners. Therefore, the assessee-firm stood dissolved by virtue of Court's compromise decree.

(ii) That the circumstances and manner in which the transaction took place ex facie indicated that the property of the dissolved firm was disposed of by a co-partner by way of auction so as to have a gain in terms of money to the dissolved firm, which money was to be distributed among all the partners on dissolution. Such a disposal was nothing but an outright sale for gains. What is actually exempted under clause (ii) of section 47 is the actual distribution of capital asset in kind on the dissolution of the firm and not the distribution of the sale proceeds that are realised on the transfer of such capital asset. There was a sale and there wits distribution of sale proceeds and not the capital asset in specie on the dissolution of the partnership firm. Therefore, the assessee-firm was not entitled to exemption from tax on capital gains arising from the transaction of sale of partnership property under section 47(ii) of the Act.

James Anderson v. CIT (1960) 39 ITR 123 (SC) applied.

CIT v. Walji Damji (1955) 28 ITR 914 (Bom.); Gowri Tile Works v. CIT (1957) 31 ITR 250 (Mad.) and Muthappa Chettiar (E.M.) v. ITO (1961) 41 ITR 1 (SC) ref.

J. V. Prasad for the Commissioner.

K. Ranganathachari for the Assessee.

JUDGMENT

Y.V. NARAYANA, J.---This is a reference under section 256(2) of the Income-tax Act by the Appellate Tribunal, for the opinion of this Court on the following questions of law:

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in their assumption that the assessee-firm stood dissolved by virtue, of Court's compromise decree, having regard to the observations of the Supreme Court in the case of E.M. Muthappa Chettiar (1961) 41 ITR 1?

(2)Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in holding that the auction of the assessee-firm's property held among the partners was not a sale, especially in view of the decision of the Bombay High Court in the case of CIT v. Walji Damji (1953) ITR 914 and that of the Madras High Court in the case of Gowri Tile Works v. CIT (1957) 31 ITR 250?

(3) Whether, on the facts and in the circumstances of the case, the Appellate tribunal was justified in law in holding that the provisions of section 47(ii) of the Act applied to the case and that the assessee firm was entitled to have the capital gains excluded from its hands, especially in view of the decision of the Supreme Court in the case of James Anderson v. CIT (1960) 39 ITR 123?"

Brief facts: A partnership firm was formed under the name and style of "Saraswati Talkies" at Jaggaiahpet in the year 1949 to do the business of exhibition of films. The firm started its business from October 20, 1950, onwards. After four years, disputes arose between the partners. One of the groups filed a suit---O. S. No.52 of 1954---before a Civil Court for rendition of accounts and for dissolution of the partnership firm. Later on, the partners compromised the matter at the intervention of elders and entered into a compromise. As per the terms of the compromise, the possession of the theatre was to be given to one of the partners. viz, M . Nageswara Rao, who should take possession of the theatre on the expiry of them, existing lease on August 21, 1973. The compromise was recorded by the Civil Court and a decree was passed in terms of the compromise. Pursuant to the said compromise decree, a general power of attorney was executed by all the partners on August 6, 1973, in favour of the said M. Nageswara Rao authorising him to manage the theatre after the expiry of the lease till it was sold. The sale was to be through an auction initially among the partners and if the price offered by the highest bidder among the partners was not considered adequate, an open auction was to be held. An auction among the partners was held on August 21, 1973. One of the partners, namely, G. Venkateswarlu, agreed to purchase the theatre for a sum of Rs.3,10,000. Accordingly, the general power of attorney holder, i.e., Nageswara Rao, executed a relinquishment deed in favour of the highest bidder, i.e., G. Venkateswarlu. Thereupon, the Income-tax Officer computed the capital gains on the above transaction at Rs.1, 43,420. It is the case of the assessee that the theater was distributed to one of the partners as part of the dissolution and that the dissolution was complete with the auction of the partnership property. It was, therefore, contended that the capital gain resulting from the auction was exempt under section 47(ii) of the Act. The Income-tax Officer held that the theater was leased out and there was no firm. He also found that there was sale of the theatre by auction to one of the partners, that the transfer was by an association of persons and lastly that there was no distribution of any capital asset coming within the purview of section 47(ii) of the Act and, therefore, the assessee was entitled to claim exemption under section 47(ii) of the Act. Thereafter, the assessee preferred an appeal before the Appellate Assistant Commissioner, who confirmed the assessment order. The matter was then carried before the Appellate Tribunal. The Appellate Tribunal held that there was distribution of the property as a result of the dissolution of the firm and that the assessee is entitled to have the capital gains excluded from the computation. Aggrieved by the said finding the Revenue filed an application under section 256(1) of the Act seeking reference of the questions of law for the opinion of this Court but the said application was rejected by the Appellate Tribunal. Thereupon, in an application under section 256(2) this Court directed the Tribunal to state the case and refer the abovementioned questions for the opinion of this Court. Hence, this reference.

Question No. 1.---The contention of the assessee on this point is that the firm stood dissolved with effect from the date on which auction of the partnership property was held, i.e., with effect from August 21, 1973. While so, it is the contention of the Revenue that the transfer took place long after the dissolution. The Appellate Tribunal, however, recorded a finding of fact that the assessee-firm stood dissolved by virtue of the Court's compromise decree. This finding is now under challenge. Under section 44 of the Partnership Act, the Court may dissolve the partnership on any of the following grounds---(a) that a partners has become of unsound mind; (b) that any of the partners has become in any way permanently incapable of performing his duties as partner; (c) that any of the partners is guilty of conduct which affects the carrying on of the business; (d) that any of the partners commits breach of agreements relating to the management of - the affairs of the firm; (e) that-any of the partners has transferred the whole of his interest in the firm to any third party; (f) that the business of the firm cannot be carried on except at a loss; (g) on any other grounds which render it just and equitable that the firm should be dissolved. In the case in hand, it is the admitted case of the assessee that pursuant to the eruption of disputes among the partners, the firm stood dissolved under the decree of the Court. Therefore, the clause that is relevant for the purpose of the case on hand is clause (g) of section 47. It is settled law that the date of dissolution of a partnership at will, in a case falling under clause (a) of section 44, shall be the date on which the decree is passed by the civil Court. In a case falling under clause (b), it shall be date on which one of the partners becomes incapable of performing his duties as partners. In a case falling under clause (c), the date of dissolution shall be the date on which misconduct is established. In a case falling under clause (d), the Court, shall fix a date on which the conduct of any of the partners has rendered it impossible for the relation of partnership to continue to subsist. Thus, the dissolution will come into effect on the date fixed by the Court. Similarly, in a case falling under clause (g), the partnership firm stands dissolved with effect from the date, which can be fixed by the Civil Court or, if no date is fixed in the judgment, from the date of decree of the Civil Court. Coming back to the case on hand, it is not known as to when exactly the Civil Court passed the compromise decree and what are the terms of the said decree: Even the deed of compromise is not produced before us. Therefore in the absence of the above particulars, it may be difficult to determine as to on what date the dissolution comes into effect. But, the events that have taken place in this case which are brought on record are sufficient to arrive at a just conclusion in this regard. They are narrated chronologically here: Consequent upon the eruption of disputes among the partners, a suit for rendition of accounts and for dissolution of partnership came to be instituted by some of the partners and during the pendency of the suit, there was a compromise among them and a deed of compromise was accordingly prepared and filed into Court. The civil Court passed a decree in terms of the compromise. Thereafter, pursuant to the said compromise decree, all the partners authorised Mr. Nageswarea Rao, a co-partner, to sell away the partnership property by holding an auction. Auction was held on August 21, 1973, and the property was purchased by one of the partners, G. Venkateswarulu, for a valuable consideration of Rs.3,10,000. The above sequence of events would per se suggest, without any inference, that pursuant to the compromise, there was a Court decree for dissolution and on the dissolution of the firm pursuant to the Court decree, the partnership property was sold away in auction in final settlement of accounts among the partners. The Tribunal also recorded a similar finding on this aspect, which, in our opinion, is based on undisputed facts. Therefore, the findings of the Appellate Tribunal in this regard cannot be said to be wholly assumptive in nature. There is clear distinction in the factual position that is obtaining in this case and in the case reported in E.M. Muthappa Chettiar v. ITO (1961) 41 ITR 1 (SC). In the above-cited case, there were disputes between the two existing partners. One of the partners (Tyagarajan) announced in a newspaper that the firm stood dissolved with effect from a certain date but the other partner, i.e., Muthappa, did not accept the said statement and filed a civil suit. The Civil Court fixed a certain date as the date of dissolution of the firm. On appeal to the High Court, the High Court refixed the date as March 10, 1949. The matter was then appealed in the Supreme Court. During the pendency of the proceedings in the Supreme Court in the year 1951, the profits of the business of the firm for the calendar year 1942 and the broken period January 1 to March 4, 1943, were assessed to tax by the income-tax authorities after issuing a notice to the managing partner of the firm, i.e., Tyagarajan. It was contended by Muthappa before the Supreme Court that during the relevant period, the firm was not dissolved and that the assessment after notice to only one partners and without notice to him was, therefore, not binding on him. The Supreme Court held that the question whether the firm was dissolved or not was sub judice at time when the assessment proceedings were commenced and, therefore, all those contentions cannot be raised by Muthappa at that juncture. The above are the observations of the Supreme Court in the above cited case, which, in our opinion,. are no more applicable to the fact situation obtaining in the instant case. Therefore, the said decision is of no use in determining the question either way. 1n view of what is stated supra, we answer the question upholding the finding of the Appellate Tribunal.

Questions Nos.2 and 3:---The issues involved in these two questions are interrelated with each other. Hence, we propose to deal with them jointly. The contention of the assessee although is that the relinquishment of property, after dissolution of the firm, in favour of one of the partners is nothing but distribution of the capital asset of the partnership-firm and that there was no gain accrued to the assessee out of the said transaction. It is, therefore, contended that assessee is entitled to the exemption under section 47(ii) of the Act. On the other hand, it is contended by the Revenue that the transaction is an outright sale by the partners of the firm consequent on the dissolution of the partnership firm. It is further contended that there was no distribution of capital assets in specie and that since the transaction was one for gain, the assessee is liable to pay capital gains tax on the said transaction. It is, therefore, contended that the exemption claimed under section 47(ii) of the Act cannot be extended to the assessee.

No doubt, under section 45, all the profits or gains arising from the transfer of a capital asset effected in the previous year shall be chargeable to income-tax under the head "Capital gains". But, the statute provided certain exemptions in section 47 to the above provisions. Clause (ii) of section 47 is relevant for our present purpose, which is extracted hereunder:

"47. Transactions not regarded as transfer.--Nothing contained in section 45 shall apply to the following transfers:

(i) Any distribution of capital assets on the total or partial partition of a Hindu undivided family;

(ii) any distribution of capital assets on the dissolution of a firm, body of individuals or other association of persons;..."

As has been held by us, the transaction took place after the dissolution of the partnership firm. The general power of attorney .holder conducted an auction on that day to dispose of the partnership firm's asset and in that auction, the highest bidder was one G. Venkateswarlu, who was one, of the partners of the dissolved firm. He purchased the property for a valuable consideration of Rs.3,10,1000. Thereafter, the general power of attorney holder of the firm executed a document which was styled as "relinquishment deed" on behalf of the firm, conveying the right and title of the dissolved partnership firm in favour of the purchaser ---Venkateswarlu. As per the recitals in the relinquishment deed, the amount of Rs.3,10,000 should be apportioned between all the partners of the firm in proportion to their respective shares. Since the purchaser of the property happened to be one of the partners himself, he, i.e., Venkateswarlu, agreed to pay a sum of Rs.3,00,312.50, after deducting the share amount which is payable to him by the firm on dissolution, to the dissolved firm. The circumstances and the manner in which the transaction took place ex facie indicates that the property of the dissolved firm was disposed of by the general power of attorney holder by way of auction so as to have a gain in terms of money to the dissolved firm, which money was to be distributed among all the partners on dissolution. In our opinion, such a disposal is nothing but an outright sale for gains. What is actually exempted under clause (ii) of section 47 is the actual distribution of capital asset in kind on the dissolution of the firm and not the distribution of the sale proceeds that are realised on the transfer of such capital asset. As has been held by the Supreme Court in James Anderson v. CIT (1960) 39 ITR 123, there is a clear and vital distinction between the capital assets and their sale proceeds. It held that (Page 129).

"If capital assets are sold first and a distribution of the sale proceeds is made afterwards, then the sale precedes distribution and what is distributed is not capital assets but the sale proceeds thereof."

The Supreme Court further explained the position in the following terms:

"...as long as there is distribution of the capital assets in specie and no sale, there is no transfer for the purpose of the section; but as soon as there is a side of the capital assets and profits or gains arise therefrom, the liability to tax arises..."

In the instant case also, there was clear sale and there was distribution of sale proceeds and not the capital asset in specie on dissolution of the partnership firm. Therefore, applying the ratio decided by the Supreme Court in James Adersons' case (1960) 39 ITR 123, we hold that the transaction was an outright sale transaction which was made only with a view to realise the sale proceeds of the property so that the said amount can be distributed among all the partners on the dissolution of the firm. Another contention is raised on behalf of the assessee that relinquishment of right over the property does not amount to either sale or any other alienation. It is contended that what actually transpired under the deed was the relinquishment of the right and title of the dissolved partnership firm over the property in favour of one of the partners of the firm and such a transaction cannot be called a sale a sale transaction for the purpose of realisation of its value. It is submitted that the auction was conducted only with a view to ascertain the value of the property as on that day. It is, therefore, contended that the transaction that took place under the relinquishment deed does amount to distribution of capital asset and not otherwise. But, we are not in agreement with this contention. As per section 2(47) of the Act, relinquishment of rights over a capital asset shall be treated as a "transfer". As per the above provisions, a sale, exchange or "relinquishment" of the capital asset shall be regarded as a "transfer". Thus, the gains arising from the transfer---may be in the form of a sale or exchange or relinquishment---of a capital asset effected in the previous year is chargeable to income-tax under the head "Capital gains", under the provisions of section 45. For these reasons, the contention of the assessee that he is entitled to the exemption under section 47(ii) is unsustainable. In view of what is stated supra, we answer the two questions in favour of the Revenue and against the assessee.

The reference is answered accordingly.

M.R.A./4033/FC Reference answered.