1. This appeal by the assessee is directed against the order dated 3-2-1986 of the Commissioner of Income-tax (Appeals)-I, Madras relating to the assessment year 1980-81.
2. The assessee firm which makes and markets biscuits and which was formerly known as Dollar Biscuit Corporation came into existence sometime in 1967. Initially, it would appear, there were seven partners including one Sri K. Nithyanantham and one Sri P. Venkata Subba Rao.
With effect from 12-7-1972 other five partners retired. With the result that from the said date the said Nithyananiham and P. Venkata Subba Rao continued the business in partnership. The terms and conditions of this partnership are contained in a deed of partnership dated 12-7-1972.
According to this deed, the business was to be carried on at Kathirvedu. Madras-66. Nithyanantham was to contribute Rs. 1,50,000 towards capital of the firm, P. Venkata Subba Rao's share being Rs. 25,000. P. Venkata Subba Rao was to be the production In-charge and he was to be paid a monthly salary of Rs. 1,500 and house rent allowance of Rs. 300. The profit or loss of the partnership was to be shared in proportion to the capital contributed by the partners.
3. On 1-10-1972 three new partners were admitted. Suffice it to note that the capital to be contributed by P. Venkata Subba Rao remained at Rs. 25,000 and that there was no change in the salary and house rent allowance payable to him in his capacity as production in-charge.
4. It would appear that on 1-4-1976 certain changes were effected in the terms and conditions of the partnership deed. The biscuit factory was shifted from Kathirvedu to Sholinganallur. Capital contributions by all the partners (except P. Venkata Subba Rao's which remained constant at Rs. 25,000) under-went a change. Of course, consequent on the change in the pattern of capital contributed by the other four partners the profit sharing ratio underwent corresponding change. Further, the salary of P. Venkata Subba Rao was raised to Rs. 2,000 PM and the house rent allowance payable to him to Rs. 400 pm.
5. On 1-4-1978 a new partnership deed was executed mainly, it would appear, to bring on record the changes that took place on 1-4-1976 - changes that have been noticed in the immediately preceding paragraph.
Venkata Subba Rao continued to be the production in charge.
6. The said partnership deed dated 1-4-1978 for the first time contained a specific provision enabling a majority of the partners to expel other partner(s) in circumstances stated in clause 24 of the deed.
7. On 11-8-1979 five partners of the firm met and considered the matter relating to the retirement of Venkata Subba Rao from the firm. The proceedings of the meeting were minuted, the operative portion of the minutes reading as follows :-- Shri P.V. Subba Rao expressed his intention to retire from the partnership of M/s. Dollar Food Corporation from this the Eleventh day of August one thousand nine hundred and seventy nine and he demands an outright payment of Rs. 35,000 (Rupees thirty-five thousand only) in consideration of his retirement and in full and final settlement of all his accounts including share capital. He also assured that hereafter he will not claim any title, right, interest or any claim monetary or otherwise on the assets, the future profits of the partnership concern M/s. Dollar Food Corporation. He expresses his desire voluntarily and on his own motion. His offer for retirement from the partnership of the firm is accepted by all the other partners and Mr. P.V. Subba Rao hereby releases any and for all claims, over M/s. Dollar Food Corporation, its assets including goodwill, trade mark, patents, quotas, benefits of all contracts and all other rights on all licences including factories licences. Shri P.V. Subba Rao hereby agrees and accepts to sign all the necessary documents relating to the trade mark, income-tax, Factories Act, Central Excise etc., and all connected matters with the Government departments during his period/ tenure with M/s. Dollar Food Corporation.
Shri P.V. Subba Rao, has this day delivered possession of all the assets, titles in M/s. Dollar Food Corporation to the continuing partners with the right to continue and carry on in the trade name and style of "Dollar Food Corporation". He also assures that he will not carry on any business under the name of Dollar Biscuits or under any colourable imitation of the above said name, whether directly or indirectly.
All the partners hereby accept his above proposal and resolves that Shri P.V. Subba Rao retires from today the 11th August, 1979 before business hours.
The partners also appreciate the services rendered by Shri P.V. Subba Rao to the firm and extend their hearty thanks and best wishes to him accepting the quantum of Rs. 35,000 (Rupees thirty-five thousand only) demanded by him in full and final settlements of all his accounts as on date.
8. The said minutes were followed by a formal release deed which the said P. Venkata Subba Rao executed on 12-8-1979.
9. On the exit of P. Venkata Subba Rao from the firm, the remaining four partners continued the business in partnership.
10. In the course of the assessment proceedings for the assessment year 1980-81 (relevant previous year being the year ending on 31-3-1980) the assessee firm filed a return of income disclosing an income of Rs. 37,650. The assessee had arrived at the said figure of Rs. 37,650 by debiting to the Profit & Loss A/c, inter alia, a sum of Rs. 1,39,900 as and by way of "trade loss". The said sum was computed in the manner detailed below :--1-4-1973 Opening debit balance 4,560.82Total cash drawings less credits during theperiod 1-4-1973 to 10-8-1979 1,78,483.47Total share of loss debited 82,856.59 2,65,900.88Less : Salary credited during the said period 1,36,000.00 1,29,900.88Less : Transfer from capital A/c 25,000.00 1,04,900.88Add: Amount paid by cheque in settlement 35,000.00 1,39,900.88 The assessee' s case before the ITO was that the said amount represented the amount of compensation paid to P. Venkata Subba Rao, who retired from the firm, that the said compensation was paid to P.Venkata Subba Rao in the interest of the firm; and that, therefore, the same was revenue deductible.
11. None of the aforesaid arguments found favour with the ITO who took the line that the provisions of Section 40(b) of the Income-tax Act were attracted. According to him, "the prohibition in Section 40(b) is absolute and the section makes no distinction as between the payments by way of interest, salary, commission, bonus or remuneration made to a partner as a partner and such payments made to him in a different capacity. In this case the amount of Rs. 1,39,900 was paid to one of the partners Shri P.V. Subba Rao on his retirement in the name of compensation. It is only a remuneration paid to him and as such it is disallowed under provisions of Section 40B.12. Since the addition proposed exceeded Rs. 1 lakh, the ITO prepared a draft assessment order and transmitted it to the IAC under Section 144B of the Act. In response the assessee made the following points before the IAC.:-- Right from the beginning Venkata Subba Rao was the production in-charge and owing to his "non-scientific, lethargic policies" the firm was incurring losses; that in the interest of the firm the other partners were forced to get rid of the said Venkata Subba Rao by paying him a "massive" compensation of Rs. 1,39,900; and that, consequently, the said expenditure was incurred exclusively for the purpose of the assessee's business; and that by the same token the sum in question was revenue deductible. On his part, the IAC took the line that in the facts and circumstances of the case the sum of Rs. 1,39,900 represented capital expenditure. He, therefore, approved the addition of Rs. 1,39,900 proposed by the ITO.13. The assessment came to be made on the aforesaid basis. The assessee was unsuccessful before the CIT (Appeals), who took the line that Venkata Subba Rao being a partner, the payment was hit by the provisions of Section 40(b) of the Act. One of the points urged on behalf of the assessee firm before the CIT (Appeals) was that the said Venkata Subba Rao was essentially a workman and hence the compensation paid to him was retrenchment compensation paid to a worker, which is not hit by the provisions of Section 40(b).
The CIT (Appeals) repelled this argument by observing that even if it was assumed that Venkata Subba Rao was a workman, the compensation paid to him at the time of his retirement was in reality salary paid to him and under Section 40(b) of the Act salary paid to a partner is not revenue deductible.
The CIT (Appeals) also took the line that the case before him was one of writing off the amounts drawn by the partner and as such, it was one of capital outgo. He, therefore, dismissed the appeal. It is in these circumstances that the assessee is now before us.
14. Shri R. V. Easwar, the learned counsel for the assessee, took us through the facts and circumstances of the case and vehemently contended that the CIT (Appeals) was not justified in dismissing the assessee's appeal. He argued that Venkata Subba Rao was a liability to the firm and it was, therefore, that in the interest of the firm the remaining partners considered it fit not only write off the sum of Rs. 1,04,900 owed by the said Venkata Subba Rao to the firm, but also to pay a further sum of Rs. 35,000 as compensation. Shri Easwar's position was that the sum in question should be allowed either as an expenditure wholly and exclusively incurred for the purpose of the business of the firm, or as a trading loss, or as a bad debt. In this regard he referred to and relied upon the following cases : B.W. Noble Ltd. v.Mitchell 11 TC 372; G. Scammell & Nephew, Ltd. v. Rowles H.M. Inspector of Taxes 22 TC 479; F.E. Dinshaw Ltd. v. CIT [1959] 36 ITR 114 (Bom.) and Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 (SC).
15. In view of the foregoing, therefore, urged Shri Easwar, the assessee is entitled to succeed.
15A. On his part, Shri A. Banerji, the learned Departmental Representative, strongly supported the impugned order of the CIT (Appeals). He particularly drew our attention to the minutes of the meeting of the partners held on 11-8-1979 and contended that there was nothing in the said minutes to indicate that the other partners expelled Venkata Subba Rao either because of his lethargy or because of want of commitment on his part. The minutes, on the contrary, make it clear that Venkata Subba Rao offered to quit if he was paid a sum of Rs. 35,000 and the other partners accepted the offer and paid the sum of Rs. 35,000 accordingly.
The release deed dated 12-9-1979 also is absolutely silent on the "troubles created by Venkata Subba Rao".
According to Shri Banerji this is a clear case of retirement of the partner from the firm and consequently the assessee cannot claim revenue deduction in respect of Rs. 1,39,900. In this regard he referred to and relied on the Delhi High Court in the case of General Auto Parts Co. v. CIT [1981] 128 ITR 519.
16. We have looked into the facts of the case. We have considered the rival submissions.
17. In this case two branches of law, namely the Income-tax Act, 1961 and the Indian Partnership Act, 1932 meet and cross. Under the Income-tax Act, it is well settled, any expenditure incurred wholly and exclusively for the purpose of business is revenue deductible. Here, commercial expediency is one of the grounds on which the particular item of expenditure could be regarded as being revenue deductible.
But the matter does not rest there. It will also have to be seen whether the expenditure in question was incurred on capital account. If the expenditure was incurred on that account, then it is not revenue deductible.
18. To turn now to the Indian Partnership Act, 1932, it is well settled that, unlike the Scottish Law, which invests a firm with a personality of its own, the Indian and the English Laws do not recognise a firm as an entity apart from the persons constituting it. As pointed out by the Privy Council in the case of Bhagwanji Morarji Goculdas v. Alembic Chemical Works Co. Ltd. AIR 1948 PC 100 the Indian Partnership Act, 1932 goes further than the English Partnership Act, 1890 in recognising that a firm may possess a personality distinct from the persons constituting it. The Indian Law in that respect is more in accord with the Scottish Law than with the English Law. Yet the Indian Act, like the English Act, avoids making a firm a corporate body, enjoying the right of perpetual succession.
19. In the case of Jabalpur Ice Mfg. Association v. CIT[1955] 271TR 88, the Nagpur High Court had an occasion to consider, in the context of Section 26A of the Income-tax Act, 1922, the question whether a firm as such is entitled to enter into a partnership with another firm or individuals. On an exhaustive review of the case law on the subject, the Nagpur High Court ruled that, even though the Indian Partnership Act, 1932 treats the firm as distinct from its members in certain respects, yet, it does not invest the firm with a legal personality capable of entering into a partnership with another firm or individuals. In that regard the court further ruled that the definition of the term 'person' contained in Section 3(42) of the General Clauses Act could not be imported to hold that a firm was a person, and that consequently it can enter into a partnership with another firm or individuals, 20. Next in chronology is the Supreme Court decision in Dulichand Laxminarayan v. CIT [1956] 29 ITR 535. In that case also the question was whether a firm can enter into a partnership with another firm or individuals. After noticing, inter alia, the aforesaid two reported cases, the Supreme Court held that even under the Indian Partnership Act, 1932, a firm is not regarded as an entity separate and distinct from the members composing it; and that this position in law is not in any way altered merely because both the English and Indian Laws have for some specific purposes relaxed their rigid notions and extended a limited personality to a firm.
21. In the case of CIT v. R.M. Chidambaram Pillai [1977] 106 ITR 292, the Supreme Court reiterated the principle that a firm is a "mere short-hand name for a collection of persons, commercially convenient but not legally recognised", even though it has some attributes of personality.
22. The legal view of a firm has been summarised by Lindley as follows:-- The firm is not recognised by English lawyers as distinct from the members composing it. In taking partnership accounts and in administering partnership assets, courts have to some extent adopted the mercantile view, and actions may now, speaking generally, be brought by or against partners in the name of their firm; but, speaking generally, the firm as such has no legal recognition. The law, ignoring the firm, looks to the partners composing it; any change 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 he cannot be either debtor or creditor of the firm of which he is himself a member, nor can he be employed by his firm, for a man cannot be his own employer.
[Emphasis supplied] (at page 28 Lindley on Partnership, Tenth Edition).
As has been pointed out by the Madras High Court in the case of R.M.Chidambaram Pillai v. CIT[1970] 771TR 494 (FB) that precisely is the legal position of a firm under the Indian Partnership Act as well.
23. In the case before us the assessee claims revenue deduction in respect of a sum of Rs. 1,39,900, a sum which consists of the excess of the aggregate of (i) the sums drawn by Venkata Subba Rao and (ii) his share in the loss of the firm over the aggregate of (a) salary credited to his account and (b) capital contributed by him. The sum of Rs. 35,000 paid by the assessee firm to Venkata Subba Rao at the time of his retirement is also included in the said sum. The assessee's case is that the said sum is revenue deductible, because it was laid out wholly and exclusively for the purpose of business. Alternatively, it is claimed that the said sum is revenue deductible as trading loss or as bad debt incurred by the firm.
24. We are unable to agree. The position in law, as we have seen, is that a firm does not have a corporate personality of its own. It is merely a compendious name for a collection of individuals who have agreed to share profits of the business carried on by all or any of them acting for all. It is, therefore, that, in point of law, the partners being co-adventurers, a partner may be a debtor or creditor of his copartner but he cannot be either debtor or creditor of the firm of which he himself is a member. On this score alone the assessee's claim is fit to be rejected.
25. The assessee's case is first that the said sum of Rs. 1,39,900 was expenditure incurred wholly and exclusively for the purpose of business. We fail to see how the share of loss debited to Venkata Subba Rao's account as also the sums withdrawn by him from the firm could be regarded as an expenditure simpliciter. In this very case the firm had paid salary to Venkata Subba Rao and the salary so paid can properly be regarded as expenditure simpliciter, but by operation of law no revenue deduction is allowed in respect of salary paid by a firm to its partners.
26. The same consideration will apply to the sum of Rs. 35,000 paid to Venkata Subba Rao on his retirement in full and final settlement of his claims.
27. The sum in question cannot also be regarded as a trading loss for the simple reason that as between the assessee firm and the said P.Venkata. Subba Rao there-was no trading relation at all.
28. There is no question of treating the aforesaid sum as bad debt either. Now the assessee makes and markets biscuits. Clearly it is not the assessee's case that it had supplied biscuits to him in the course of its business and that consequent on the failure of Venkata Subba Rao to pay the consideration therefor a bad debt has arisen. A partner, in relation to his separate business, may be a debtor of the firm of which he is a partner, but that is not the case here.
29. In view of the foregoing, therefore, the assessee's claim is fit to be rejected. We may now notice certain cases having a direct bearing on the issue involved in this case.
29A. Earliest in chronology is the Bombay case of Amarchand Madhavji & Co. v. CIT [1935] 3 ITR 462. There, initially there were six partners in a firm. Four of them retired and the debts due to the firm by the retiring partners were treated as debts due to the firm constituted by the remaining partners. Subsequently, the balance of debts remaining due was written off in the books of account of the firm as irrecoverable and a revenue deduction in respect thereof claimed.
Deciding the issue against the assessee-firm, the Bombay High Court observed : These debts due from previous partners were never revenue of the continuing firm and they were never brought into the income-tax accounts as revenue. They were capital sums and all that had happened in the Samwat year 1987 was that the firm lost part of its capital assets. There is no ground on which that loss can be written off against revenue of the year in which the loss finally occurred.
We then have the Allahabad case of Girdhari Lal Gian Chand v. CIT [1971 ] 79 ITR 561. There the assessee firm was carrying on business as commission agents. It also dealt in Gur and Shakkar on its own account.
It originally consisted of nine partners including a Jagannath Prasad who was a working partner. The said working partner retired from the firm and the time of his retirement there was a debit balance in his capital account, which at the end of Samvat year 2011-2012 stood at Rs. 95,544 and comprised: (i) on account of excess drawing and share of loss Rs. 5,242 and (ii) on account of interest charged by the firm Rs. 39,302. At the end of the previous year relevant to the assessment year 1956-57 the assessee firm wrote off the entire amount of Rs. 94,544 and claimed the amount as a revenue loss. The ITO disallowed the claim on the ground that it was a loss of capital and not of revenue and his decision was upheld by the AAC and the ITAT. Deciding the issue against the assessee firm, the High Court of Allahabad held that debts due from retiring partners are capital sums and the loss of such amount could not be written off against the profits of the year in which they were written off and claimed as bad debts. In this regard the court further held that as the assessee-firm was a successor to the original firm of nine partners and took over the business with all its assets and liabilities, which constituted the consideration for such take over, the amount in question, which was an asset in the hands of the succeeding firm, cannot be held to be a trading loss.
The ratio of the aforesaid two decisions are squarely applicable to the case before us.
30. We may now deal briefly with the four cases referred to and relied upon by the learned counsel for the assessee. It may be recalled that he relied on four cases namely, B.W. Noble Ltd.'s case (supra), G.Scammell & Nephew Ltd.'s case (supra), F.E. Dinshaw Ltd.' s case (supra) and Empire Jute Co. Ltd.'s case (supra). All the four cases were concerned with companies having a corporate personality of their own. We are, however, dealing with a firm, which, in law, does not possess such a corporate personality. For this reason alone the said cases cannot avail the assessee.
Secondly, the Noble case proceeded on the footing that the payment made by the company to get rid of one of its directors was not more than a payment to get rid of a servant in the course of the business and that consequently it was revenue deductible. We are, however, dealing with the case of a partner who, it is well settled, is not a servant of the firm.
In G. Scammell & Nephew Ltd.'s case (supra) it was found that the company had to pay a sum of 7,500 to one of its directors and the sum so paid was held to be revenue deductible because, otherwise the company would not have been able to realise a treading debt of 10,562.
Clearly the decision turned on the fact that what was in jeopardy was a trading debt. In this regard the following observations of Sir Wilfrid Greene, M.R. are noteworthy :-- Of course, if the facts had been, and there had been a competent finding of fact showing that part of that indebtedness was indebtedness in respect of a loan transaction of a capital nature or something of that kind, different considerations might well have emerged, and it is to be understood that my judgment in this case is founded upon the approach to that account which I have described.
The Bombay case of F.E, Dinshaw Ltd. (supra) also avail the assessee.
Besides being a case of a company having a corporate personality of its own, it was a case where compensation was paid by the company for terminating the employment of the managing director. We have before us, on the contrary, a case of a partner.
The decision in the case of Empire Jute Co. Ltd. (supra) turned on the peculiar facts of the case. There the expenditure in question was found to have been incurred by the assessee for the purpose of removing a restriction on the number of working hours for which it could operate its looms with a view to increasing its profits. It was, therefore, that it was held that, the expenditure was revenue in nature and as such, allowable as a deduction under Section 10(2)(xv) of the 1922 Act.
It was also held that by the purchase of loom hours no new asset was created and there was no addition to or expansion of the profit making apparatus of the appellant. Clearly, the ratio of the said decision is inapplicable, to the case before us.