1. The asscssee is a registered firm. The last partnership deed was constituted on 4-2-1953. The partners, according to the above deed, were Shri Nandlal Jalan, Vithalbhai Bhimji Mansata and Shiva Prosad Jaiswal. Shri Nandlal Jalan died on 24-4-1976. In Clause 4 of 1953 deed it was provided that the death of any partner shall not dissolve the partnership. The legal representative of the deceased partner shall be admitted into the partnership in place of the deceased partner unless the legal representative elects to sell his shares to the surviving partners at a valuation to be agreed upon with him. The continuing partners executed a fresh deed of partnership on 24-9-1976 in which it was indicated that none of the heirs and legal representatives of Shri Nandlal Jalan since deceased, has approached the parties to be admitted in the partnership in the place and stead of the deceased. However, at the time of making the profit and loss account and balance sheet a due provision was made for Rs. 41,967.63 out of the profits for the legal heirs in view of Section 37 of the Partnership Act. The assessee claimed the deduction for the above amount. The ITO did not discuss the issue in detail. He disallowed the claim of the assessee mentioning that the provision made was not admissible.
2. The assessee came in appeal before the Commissioner (Appeals) and contended that Clause 16 of the old deed provided that the assets and liabilities of the partnership upon dissolution shall be dealt with in accordance with the provisions of the Indian Partnership Act and since the account of the deceased partner was not settled, the legal heirs were entitled to one-third share in view of Sections 14 and 37 of the Partnership Act. The assessee placed reliance on Sections 14 and 37 of the Partnership Act. It was also stated that since the accounts were not settled, the legal heirs filed a suit in the Calcutta High Court in which the firm and the surviving partners were made parties. It was strongly urged that the amount of Rs. 41,967.63 was provided as per Section 37 of the Partnership Act which was obligatory on the surviving partners and, therefore, this amount was clearly allowable as business expenditure/diversion by overriding title or charge. The assessee relied on Vithaldas Thakordas & Co. v. CIT [1946] 14 ITR 822 (Bom.), V.N.V. Devarajulu Chetty & Co. v. CIT [1950] 18 ITR 357 (Mad.), CIT v.Harjivandas Vithal-das [1966] 60 ITR 613 (Guj.) and CIT v. Travancore Sugars & Chemicals Ltd. [1973] 88 ITR 1 (SC). The Commissioner (Appeals) made reference to the ITO and the ITO reported the matter indicating the following points: (i) That, on the facts and in the circumstances of the case, the constitution of the new partnership between the surviving partners is such that profit-sharing ratio is 50 per cent each.
(ii) That the original partnership deed does not speak about the provision for allowing the retiring/deceased partner or his representatives any share of profits of the firm.
(iii) That nowhere the deceased partner exercised nor by (sic) his representatives about any option as contemplated in Section 37 of the Tndian Partnership Act.
(iv) That assuming but not admitting that any profit is payable to the deceased partner or his legal representative, this can be held as an appropriate portion of profits and not a liability for expenses.
(v) That the entry does not show that the liability is payable to late Nandlal Jalan.
(vi) That the capital account of the deceased partner has not been credited with the amount.
(vii) That the alleged liability is a mere provision and not an ascertained liability.
(viii) That the subsequent years' accounts prove that only interest has been charged and no annuity amount was charged in the profit and loss account.
(ix) That the interest charged in profit and loss account has not been credited in the capital account of the deceased partner in the assessment year 1978-79.
The Commissioner (Appeals), accordingly, discussed the arguments of the assessee but, however, he found that the legal heirs did not exercise their option in view of Section 37 of the Partnership Act. It was also noted by him that the assessee had only paid interest in the subsequent two years. He found that there was no agreement on the basis of which the profit and/or interest would have been paid to the legal heirs and finally he concluded that the assessee merely made a provision but there was no ascertained liability. Accordingly, he did not accept the claim of the assessee. The Commissioner (Appeals) in detail has discussed the matter in para 5 of his order as follows: 5. I have carefully considered the facts and circumstances of the case and the submission made before me. The point for determination is as to whether the amount of Rs. 41,967 can be allowed as business expenditure or as a diversion by overriding title. The learned Counsel for the appellant has laid a great emphasis upon Section 37 of the Partnership Act according to which it was obligatory on the surviving partners to make a provision of the deceased partner's share to the legal representatives. Section 37 of the Partnership Act provides that the legal representatives are entitled on the option to be exercised by them to such share of the profits as may be attributable to the use by the firm of the deceased partner's share of the property of the firm or to interest at 6 per cent per annum on the amount of his share in the property of the firm. In the present case the legal representatives have not exercised any option and the provision for one-third share has been made by the appellant suo moto. It appears that in the subsequent years instead of one-third of profits only interest has been provided. Since no option was exercised by the legal representatives it cannot be said that the amount provided by the appellant is in accordance with the provisions of Section 37 of the Partnership Act. In view of this the question that it is diversion at source by overriding title does not arise. It also cannot be allowed as a business expenditure since it is not an expenditure which is laid out for the purpose of carrying on business. The profits for this year amounted to Rs. 1,25,902 out of which one-third was credited to the annuity account and the remaining amount has been divided equally amongst the surviving partners. Thus the amount of Rs. 41,967 is clearly an appropriation of profits after the profits have been earned and is not an outgoing of the business. The learned Counsel for the appellant has relied upon several decisions as mentioned above but in these cases the facts were different. The payments made in all these cases were as per agreements and these payments were necessary for the carrying on of the business. In the present case the amount provided is neither on the basis of any agreement nor is in accordance with the provisions of Section 37 of the Partnership Act. Moreover, even if it is to be considered as business liability, it is clearly a provision and not a liability that has accrued. As mentioned above the amount has been provided suo moto and not according to any option exercised by the legal representatives. It has also not been credited to the deceased partner's account but has been taken to the liabilities account. If it was an ascertained liability which was definitely payable to the legal representatives, then there was no reason for not crediting the account of the deceased partner with this sum. Moreover in the current year one-third share has been provided while in the subsequent years only interest has been credited. This clearly shows that the quantification of the liability was also not fixed. I, therefore, agree with the ITO that it is a case of mere provision which cannot be allowed as a deduction. The addition of Rs. 4 is, therefore, sustained.
3. Shri N.K. Poddar, the counsel for the assessee, has filed a paper book containing 48 pages. The paper book included: 3. Extract of entry passed in journal in respect of liability under Section 37 of the Indian Partnership Act, 1932, to the estate of the deceased partner, N.L. Jalan, for the year ended on 31-3-1977.
4. Balance sheet and profit and loss account for the year ended on 31-3-1977.
5. List of outstanding liabilities as appearing in the balance sheet as at 31-3-1977.
6. Extract of entry passed in journal in respect of liability under Section 37 of the Indian Partnership Act, 1932 to the estate of the deceased partner, N.L. Jalan, for the year ended on 31-3-1978.
7. Balance sheet and profit and loss account for the year ended on 31-3-1978.
8. List of outstanding liabilities as appearing in the balance sheet as at 31-3-1978.
9. Extract of entry passed in journal in respect of liability under Section 37 of the Indian Partnership Act, 1932 to the estate of the deceased partner, N.L, Jalan, for the year ended on 31-3-1979.
10. Balance sheet and profit and loss account for the year ended on 31-3-1979.
11. List of outstanding liabilities as appearing in the balance sheet as at 31-3-1979.
12. Copy of assessment order in respect of the assessment year 1978-79.
13. Copy of order dated 12-8-1981 passed by the AAC in respect of the assessment year 1978-79.
14. Copy of order dated 22-7-1977 passed by the Hon'ble High Court at Calcutta in the matter of Jalan Distributors v. Promode Kumar Jalan [Suit No. 271 of 1976].
15. Copy of the written submission dated 15-1-1981 made before the Commissioner (Appeals) in course of the hearing of the appeal before him for the assessment year 1977-78.] On the basis of this paper book the counsel for the assessee stated the facts and referred to Clause 4 of the partnership deed of 1953 and the relevant clause of the partnership deed of 1976. It was stated by him that Shri Nandlal Jalan died on 24-4-1976. The remaining two partners continued the business without taking the heirs of Shri Jalan into the partnership business. The heirs of Shri Jalan expressly or impliedly did not show any inclination to not to join the new firm. Under the above circumstances, the heirs were entitled for profit and/or interest in view of Section 37 of the Paitnership Act. He referred to the provision made for Rs. 41,967.63 during the year under appeal for the annuity payable to the heirs. The same is appearing at page 20 of the assessee's paper book. He also referred to the relevant profit and loss account and the balance sheet as at 31-3-1977. Shri Poddar, the assessee's counsel, urged that the Commissioner (Appeals) had indicated that as no option has been exercised by the legal heirs in view of Section 37, the claim of the assessee could not be allowed. Shri Poddar urged that a specific clause was added in the partnership deed of 1953 and, therefore, it was incumbent upon the continuing partners to take into partnership the heirs of Shri Nandlal Jalan. The heirs had not declined and, therefore, there was no question of exercising any option. He clarified the position about the objection of the Commissioner (Appeals) that the assessee has only made provision for interest in the subsequent years. It was stated by Shri Poddar that the heirs were entitled for interest and/or profit whichever was greater.
In the immediately succeeding year there was loss in the business and consequently the provision was made for 6 per cent interest but in the subsequent year the adjustment was made after considering profit. He further explained that the Commissioner (Appeals) was not correct in stating that in the absence of any agreement the claim of the assessee could not be allowed. The claim of the legal heirs was based upon the statutory provision of Section 37 of the Partnership Act and hence no separate agreement was required. He was not correct equally in saying that the deduction was claimed on mere provision and there was no ascertained liability. The liability was ascertained in view of Section 37 of the Partnership Act and hence it was not a provision but it was an ascertained liability which was claimed in the assessment. He also referred to the fact that the heirs subsequently filed a suit in the Hon'ble Calcutta High Court and the injunction was granted. It shows that their consent was not taken while the new partnership was carried on by the existing two partners. The assessee's counsel also referred to the order of the AAC for the assessment year 1978-79 where he allowed the claim of the assessee for that year. He also relied upon the cases relied upon before the Commissioner (Appeals) and further relied upon Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC).
4. Shri B.N. Sarkar, the departmental representative, strongly relied upon the order of the Commissioner (Appeals) and urged that the Commissioner (Appeals) after considering the various case laws cited by the assessee, had come to the conclusion that the heirs did not exercise their option, interest was paid in the subsequent years, there was no agreement for paying profit and/or interest and the claim was based upon the provision. Hence, the claim of the assessee was rightly disallowed.
5. The assessee has claimed deduction for Rs. 41,967.63 payable out of the profits for the year ended on 31-3-1977 to the heirs of Shri Nandlal Jalan, a partner, who expired on 24-4-1976. Shri Jalan along with other two partners were carrying on business on the basis of the partnership deed, referred to above. For the convenience, it would be relevant to quote some of the clauses of the partnership deeds as well as Section 37 of the Partnership Act: 4. The death of any partner shall not dissolve the partnership. The legal representative of the deceased partner shall be admitted into the partnership in place of the said deceased partner unless the said legal representative elects to sell his shares to the surviving partners at a valuation to be agreed upon with him.
And whereas none of the heirs and legal representatives of the said Nandlal Jalan since deceased has approached the parties hereto to be admitted in the said partnership in the place and stead of the said Nandlal Jalan, deceased.
37. Where any member of a firm has died or otherwise ceased to be a partner, and the surviving or continuing partners carry on the business of the firm with the property of the firm without any final settlement of accounts as between them and the outgoing partner or his estate, then, in the absence of a contract to the contrary, the outgoing partner or his estate is entitled at the option of himself or his representatives to such share of the profits made since he ceased to be a partner as may be attributable to the use of his share of the property of the firm or to interest at the rate of six per cent per annum on the amount of his share in the property of the firm: It was provided in the deed of 1953 that on the death of a partner the firm shall not dissolve and the representative of the deceased partners shall be admitted into the partnership unless he elects to sell his shares to the surviving partners at a valuation to be agreed upon with him. However, it has been indicated in the subsequent deed of 1976 that none of the deceased heirs approached the parties hereto to be admitted in the said partnership. This fact has been challenged and ultimately the partners through a journal entry has made a provision for Rs. 41,967.63 by way of an annuity and has claimed deduction in the assessment. The claim through a journal entry as appearing at page 20 of the assessee's paper book, was made as follows: Extract from the Journal for the year ended on 31-3-1977 Dr.
Cr.Annuity account 41,967.63To outstanding liabilities 41,967.63 The asscssee has filed the balance sheet and profit and loss account.
The capital account of Shri Nandlal Jalan was appearing separately but the liability created for Rs. 41,967.63 was included in the total outstanding liabilities which was appearing in the balance sheet. The assessee is correct that there was no question of exercising any option by the heirs. According to Clause 4 of the partnership deed of 1953, there was a stipulation by which the legal heirs of the deceased partner was to be admitted into the partnership unless he elects to sell his shares. The legal heirs were not taken in the partnership subsequently because, according to the partnership deed of 1976, the legal heirs did not approach the continuing partners. However, this would not fulfil the conditions contained in Clause 4 of the partnership deed of 1953. The legal heir by the express desire or otherwise had not indicated to not to become a partner in the subsequent firm and to sell his shares. Rather, when the legal heir came to know that the business is continued by the surviving partners without his knowledge, he filed a suit in the Calcutta High Court and got injunction. The necessary papers are appearing at page 40 of the assessee's paper book. The objection of the Commissioner (Appeals) is not correct that in subsequent years the assessee had only made provision for interest and no provision has been made, for profit.
Section 37 of the Partnership Act has been quoted above. It is clear from the section that the legal heir in the circumstances stated in the section was entitled for his share of profit and/or interest at 6 per cent on the capital whichever was greater. The provision for interest was made for the year ended on 31-3-1978 because there was no surplus profit and consequently the provision for interest at 6 per cent was made. The provision for interest for the year ended on 31-3-1979 was made because the legal heir's share of profit came to Rs. 11,825.02 whereas 6 per cent interest amounted to Rs. 14,641.12. As the interest was greater than the one-third profit, the provision was made for interest. Hence the assessee has made provision in subsequent two years in strict compliance with Section 37 of the Partnership Act. The assessee has calculated one-third profit as well as 6 per eent interest on the capital of the deceased. The greater of the two had been provided in the accounts. The Commissioner (Appeals) after analysing the cases cited by the assessee, has indicated that the claim of the assessee could not be allowed because there was no agreement. The agreement in the present case was not required at all. The clauses contained in the two partnership deeds read with Section 37 of the Partnership Act create statutory liability upon the continuing partners to pay a sum as indicated in Section 37 of the Partnership Act to the legal representative. The observation of the Commissioner (Appeals) is not correct that there was a provision and no ascertained liability.
The liability was ascertained in view of Section 37 of the Partnership Act. Under the above circumstances, if the facts of the case along with the various case laws cited by the assessee are taken into consideration, it was correct that there was a liability for the legal heir's share of profit and/or interest and hence the same could be allowed as deduction. The plea of the assessee has been accepted in the subsequent assessment year 1978-79 by the AAC who, vide his order dated 12-8-1981 has allowed the interest claimed by the assessee at Rs. 14,641. Accordingly the claim of the assessee is accepted and the ITO is directed to allow its claims.