Kukreja Agencies Vs. Commissioner of Income-tax - Court Judgment

Dr. B.P. Saraf J.

1. By this reference under section 256(1) of the Income-tax Act, 1961 (for short, 'the Act'), the Income-tax Appellate Tribunal, Nagpur Bench, Nagpur, has referred the following question of law to this court for opinion :

'Whether, on the facts and in the circumstances of the case, it was legal to make a single assessment aggregating the income for both the periods, in view of section 187 of the Income-tax Act, 1961, and the tax charged on such aggregate income as a whole ?'

2. The facts of the case are brief. The assessee is a partnership firm. The assessment year is 1976-77. By added of partnership dated July 5, 1974, a partnership firm was constituted under the name and style of 'Messrs. Kukreja Agencies, Nagpur' with five partners, namely, Shri Kanhaiyalal Hassanand, Shri Arjundas Hassanand, Smt. Vinjihabai Hassanand, Smt. Sarlabai Cheturam and Shri Ghanashyamdas Hassanand. The firm came into existence with effect from the same date. The object of the firm was to carry on business in medicines and drugs. The firm was reconstituted by another partnership deed dated August 1, 1975. As a result of the reconstitution, one of the partners of the old firm, namely, Shri Arjundas Hassanand, retired and in his place, his wife, Smt. Hirabai, was taken in as a partner. The terms and conditions of the reconstituted firm were set out in the new partnership deed. The name of the firm and the nature of the business, however, continued to be the same as before. The reconstituted firm commenced its business from August 1, 1975. The accounting period of the original as well as reconstituted firm was the Diwali year. The accounting period for the assessment year 1976-77 was Diwali 1674-75. The assessee filed two returns of income for the assessment year 1976-77, (1) for the period from November 14, 1974 to July 31, 1975, during which the original firm was in existence; and (2) from August 1, 1975, to November 3, 1975, i.e. the period during which the reconstituted firm carried on the business. The assessee contended that two separate assessments should be made on the two firms as there was a dissolution of the original firm on July 31, 1975, and reconstitution of a new firm thereafter.

3. The Income-tax Officer did not accept this contention of the assessee in view of sub-section (2) of section 187 of the Income-tax Act, 1961. According to him, it was a case of mere change in the constitution of the firm. He, therefore, assessed the reconstituted firm. While doing so, the Income-tax Officer, however, clubbed the income of the original firm and the reconstituted firm for the two periods, namely, from November 14, 1974 to July 31, 1975, and August 1, 1975, to November 3, 1975, respectively, and made a common assessment against the reconstituted firm.

4. The assessee preferred an appeal before the Appellate Assistant Commissioner of Income-tax. The Appellate Assistant Commissioner allowed the appeal following the decision of the Allahabad High Court in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) and held that though under section 187 of the Income-tax Act, 1961, the income of the firm for the whole of the accounting year had to be assessed in the hands of the reconstituted firm as it stood at the time of the assessment, the income reconstituted firm as it stood at the time of the assessment, the income derived by the original firm had to be assessed in the hands of the reconstituted firm separately and without clubbing it with the income of the reconstituted firm itself derived during a part of the relevant accounting period after reconstitution. The Appellate Assistant Commissioner, therefore, directed that the income of the original and the reconstituted firm should be assessed separately in the hands of the reconstituted firm and the tax liability determined accordingly.

5. Against the order of the Appellate Assistant Commissioner, the Revenue preferred an appeal before the Income-tax Appellate Tribunal (for short, 'the Tribunal'). The Tribunal allowed the appeal of the Revenue and reversed the finding of the Appellate Assistant Commissioner following its own decision in another case, namely, I. T. A. No. 815/ (Nag) of 1976-77, dated December 16, 1977. In that decision the Tribunal followed the decisions of the Andhra Pradesh High Court in CIT v. T. Veeraraghavulu Chetty and Sons Co. : [1975]100ITR723(AP) , of the Punjab and Haryana High Court in Nandlal Sohanlal v. CIT and of the Mysore High Court in Karupukula Suryanarayana Shetty and Sons v. CIT : [1973]92ITR141(KAR) , which had taken a view contrary to the one taken by the Allahabad High Court in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) . In these facts and circumstances, at the instance of the assessee, the present reference has been made by the Tribunal to this court.

6. Before we take up for decision the question referred by the Tribunal, it may be expedient to mention that at one point of time there was a sharp cleavage of opinion between the different High Courts in regard to the clubbing of income in the case of change in constitution of the firm within an accounting year in view of the provisions of section 187(2) of the Act. The Allahabad High Court in CIT v. Shiv Shankar Lal : [1977]106ITR342(All) had taken a view that section 187(2) speaks of the person who is to be assessed in the case of change in the constitution under section 187(2). The assessment has to be made in such a case on the firm as constituted at the time of making the assessment. But so far as the computation of income and determination of tax payable is concerned, it has to be done having regard to the constitution of the firm at the relevant time during the accounting year when the income had been earned and the provisions of the Act applicable to assessment of the income of such firm. The income of the original firm cannot be clubbed with the income of the reconstituted firm. The High Courts of Andhra Pradesh, Punjab and Haryana and Mysore took a contrary view. Even in the Allahabad High Court, the controversy did not come to an end with the decision in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) . The matter again came up for consideration before a Full Bench of threes judges which affirmed the decision of the Division Bench and again before a Full Bench of five judges which reversed the same. The controversy ultimately came up before the Supreme Court in Wazid Ali Abid Ali v. CIT : [1988]169ITR761(SC) . The Supreme Court considered the various decisions of the Allahabad High Court including the Division Bench decision in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) , the three-judge Full Bench decision in Badri Narain Kashi Prasad v. Addl. CIT : [1978]115ITR858(All) , the five judge Bench decision in Vishwanath Seth v. CIT : [1984]146ITR249(All) and other decisions of the different High Court on this point. The Supreme Court also considered the entire scheme of the Act in regard to the assessment of the firms and considered the conflicting decisions on the point in that context. Factually, in the case before the Supreme Court, there was a change in the constitution of the firm in the midst of the accounting year. The Tribunal held that the profits should be divided and the part pertaining to the first period assessed as that of a registered firm (as during that period the firm was entitled to registration) and the remaining part assessed as that of an unregistered firm. This view of the Tribunal was not approved by the High Court. The High Court was of the opinion that dividing the profits as held by the Tribunal was not permissible. On appeal, the Supreme Court reversed the decision of the High Court and held that the Tribunal was right in directing the apportionment of profits attributable to the period prior to the change in the constitution of the firm and the period subsequent thereto. The Supreme Court thus approved the approach of the Division Bench of the Allahabad High Court in Shiv Shankar Lal Ram Nath's case : [1977]106ITR342(All) and disapproved the contrary decision of the five-judge Bench of the same court in Vishwanath Seth's case : [1984]146ITR249(All) . The Allahabad High Court in CIT v. Basant Behari Gopal Behari and Co. : [1988]172ITR662(All) , however, did not accept this conclusion as the ratio of the Supreme Court judgment in Wazid Ali Abid Ali's case : [1988]169ITR761(SC) . According to it, the Supreme Court did not lay down any such proposition and hence, despite the decision in Wazid Ali Abid Ali's case : [1988]169ITR761(SC) , the five-judge Full Bench decision of the Allahabad High Court held the field.

7. On a careful perusal of the decision of the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) , we find it difficult to agree with the Allahabad High Court and read the Supreme Court decision the way the Allahabad High Court has read it in CIT v. Basant Behari Gopal Behari and Co. : [1988]172ITR662(All) . It, therefore, becomes necessary to analyse carefully the decision of the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) , in order to ascertain the ratio thereof. The Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) was dealing with appeals against the decision of the Allahabad High Court in I. T. R. No. 163 of 1970 and also an appeal against a judgment of the Gujarat High Court which was reported in Addl. CIT v. United Commercial Co. : [1977]108ITR264(Guj) . We shall briefly refer to the controversy in the Allahabad case which was the subject matter of appeal. It was a case where there was a change in the constitution of the partnership firm during the accounting year. The accounting year was from November 5, 1963, to November 4, 1964. The change took place on June 4, 1964. No application was filed for fresh registration consequent to the change in the constitution as contemplated by section 184(8) of the Act though a declaration in Form No. 12 had been filed. The Tribunal held that the firm was entitled to registration only up to the date of change, i.e. June 4, 1964, and not thereafter as it had not complied with the requirements of section 184(8) of the Act. The Tribunal, therefore, held that the total income had to be apportioned between the partners who were entitled to receive the profits accordingly as they were entitled to share the profits, the firm being assessed as a registered firm in respect of the profits ending on June 4, 1964, and as an unregistered firm in respect of the profits for the remaining part of the pervious year. The High Court held that there was no warrant for this view of the Tribunal. On appeal, the Supreme Court held : 'we are unable to agree with the High Court', Referring to the conclusion of the Tribunal the Supreme Court observed : 'in our opinion, this conclusion is correct'.

8. The Supreme Court thus approved the view of the Tribunal that the firm should be assessed as a registered firm up to the date of the change in the constitution and as an unregistered firm thereafter. This was also the view that had been taken later by the Allahabad High Court itself in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) , which was approved by the three-judge Full Bench in Badri Narain Kashi Prasad v. Addl. CIT : [1978]115ITR858(All) . The Full Bench observed that two different assessment orders have to be passed though against the firm as constituted at the time of making the assessment, one in respect of income derived by it before reconstitution, and the other in respect of income derived by it after its reconstitution. But a larger Full Bench of five judges of the Allahabad High Court in Vishwanath Seth v. CIT : [1984]146ITR249(All) overruled both the aforesaid decisions - the Division Bench decision in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) and the Full Bench decision in Badri Narain Kashi Prasad v. Addl. CIT : [1978]115ITR858(All) . The five judge Full Bench held that under the general law of partnership under the Indian Partnership Act as well as under section 187 of the Income-tax Act, 1961, in the case of reconstitution of a firm, it retains its identity and is assessable in respect of the entire previous year. All these decision were noticed by the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) . Dealing with the five-judge Full Bench decision of the Allahabad High Court, the Supreme Court observed (at page 777) :

'In view, however, of the scheme of Chapter XVI of the Act, we are unable to agree; if we were left with the general position under the Indian Partnership Act, we might have agreed. That decision of the High Court, however, did not deal with the controversy....'

9. This decision of the Supreme Court, to which we will revert a little later, should have concluded the controversy but for the decision of the Allahabad High Court soon thereafter in CIT v. Basant Behari Gopal Behari and Co. [188] 172 ITR 662, wherein the Division Bench of the said High Court again reversed the decision of the Tribunal wherein it had held that two separate assessments should be made even in the case of a change in the constitution of the firm and subsequent decision of the same court following this decision. The Allahabad High Court took the view that the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) , to overruled its five-judge Full Bench decision in Vishwanath's case : [1984]146ITR249(All) . According to the Division Bench, the full Bench decision 'was not read to the advantage of the revenue saying that the full Bench decision did not deal with the controversy in issue'. The High court further took the view that there was no occasion for the supreme court in Wazid Ali's case : [1988]169ITR761(SC) , to overrule the full bench decision in Vishwanath's case : [1984]146ITR249(All) . The decision of the Supreme Court was sought to be distinguished by the high court in the following words (at page 667) :

'Whereas the question before the Supreme Court was whether for the first part of the previous year in which the constitution of a firm remained intact and unchanged, the benefit of continued registration could be given, the question in Vishwanath Seth's case : [1984]146ITR249(All) was whether two assessments for the two broken periods before and after the change in the constitution of the firm during the previous year could be made.'

10. In that view of the matter the Allahabad High Court held that the Full Bench decision continued to be a binding decision despite the decision of the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) . This decision was followed in subsequent decision of the Allahabad High Court. We have given our careful consideration to the decision of the Allahabad High Court in CIT v. Basant Behari Gopal Behari and Co. : [1988]172ITR662(All) , which has raised a fresh dispute as to the true effect of the decision of the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) . As earlier indicated, we find it difficult to subscribe to the view taken by the Allahabad High Court.

11. A perusal of the relevant provisions of the Act itself will go to show the fallacy in the view taken by the Allahabad High Court. Under the Income-tax Act, 1961, a partnership firm is a taxable entity distinct from its partners. It is an assessee under section 2(7) of the Act. It may be a registered firm or an unregistered firm. In either case, it is subject to tax. Registration depends on the fulfillment of the requirements of certain provisions of the Act. The treatment of registered firm and unregistered firm for the purpose of assessment and levy of tax is completely different and different consequences flow form registration. Chapter XVI of the Act containing sections 182 to 189 deals with 'Special provisions applicable to firms.' Section 182 deals with the assessment of registered firms. Section 183 deals with the assessment of unregistered firms. Sections 184 and 185 deal with the manner of registration and section 186 deals with cancellation of registration. Section 184(7) of the Act provides that registration granted to a firm shall have effect for every subsequent assessment year provided there is no change in the constitution of the firm or the shares of the partners and the firm furnishes within the specified time a declaration in the prescribed form to that effect. Sub-section (8) makes it clear that :' where any such change has taken place in the previous year, the firm shall apply for fresh registration for the assessment year concerned in accordance with the provisions of the section'. From the provisions relating to registration constrained in section 184, particularly sub-sections (7) and (8) thereof, it is clear that registration once granted continues only so long as there is no change in the constitution of the firm. With the change in the constitution, the registration granted to the firm comes to an end and it has to apply for fresh registration failing which the reconstituted firm shall be treated as an unregistered firm. Sections 187, 188 and 189 deal with the procedure to be adopted for assessment of a firm in the event of change in constitution, succession and dissolution. Section 187 deals with change in constitution. It provides that :

'Where, at the time of making an assessment under section 143 of section 144, it is found that a change has occurred in the constitution of a firm, the assessment shall be made on the firm as constituted at the time of making the assessment :'

12. Section 188 provides for assessment in the case of succession of one firm by another firm by another firm It says :

'Where a firm carrying on a business or profession is succeeded by another firm, and the case is not one covered by section 187, separate assessments shall be made on the predecessor firm and the successor firm in accordance with the provisions of section 170.'

13. It may be mentioned therein that section 170 of the Act deals with the procedure of assessment, etc., in the case of succession of the business or profession otherwise than on death. Section 189 lays down the manner of assessing a firm which has been dissolved or business that has been discontinued. In such a case, the assessment has to be made of the total income of the firm as if no such discontinuance or dissolution had taken place. A new section, namely, section 188A, has been added by the Direct Tax Laws (Amendment) Act, 1987, with effect from April 1, 1989, to make every person and the legal representative of any such person who is deceased, who during the previous year was a partner of the firm, jointly and severally liable along with the firm for the amount of tax, penalty and other sum payable by the firm. From a careful perusal of the scheme of these three sections, it is clear that in the case of change in the constitution of the firm at any time, even after the end of the previous year but before the assessment, the assessment has to be made on the firm as constituted at the time of making the assessment. This section thus speaks of the firm on whom the assessment is to be made and says that it is the firm as constituted at the time of making the assessment who shall be liable for assessment. It has nothing to do with the manner of computation of income or the determination of the tax payable in respect of the business carried on during the relevant previous year. It may be that the firm was registered during a part of the previous year and unregistered during the remaining part of the years as a result of change in the constitution and again registered at the time of making assessment consequent to fulfilment of the requirements for registration contained in section 184 of the Act or vice versa. Assessment in such a case will be made on the firm as constituted on the date of making the assessment. If the firm as constituted during the relevant previous year was an unregistered firm and the firm as constituted at the time of making the assessment is a registered firm, though the assessment shall be made on the registered firm by virtue of section 187 of the Act, the income shall have to be computed and tax determined taking into account the firm as an unregistered firm. If the position is the reverse, then the assessment will be made in the hands of the unregistered firm but the computation of income, determination of tax, etc., will all be made in the manner applicable to a registered firm. This illustration makes it abundantly clear that section 187 simply provides on whom the assessment is to be made in the case of change in the constitution of the firm. It does not deal with the computation of income or determination of tax payable. This is evident also from the fact that the other two sections, namely, sections 188 and 189 also deal with the very same aspect. Section 188 says that in the case of succession, both the predecessor firm and the successor firm shall be assessed separately in respect of the income earned by them. Section 189 to deals with the assessment of a firm which has been dissolved or has discontinued its business by the time the case is taken up for assessment by the assessing authority and provides that the same shall be made treating the firm, for the purposes of assessment, as a continuing one. In other words, the dissolved firm will be assessed as if no dissolution or discontinuance had taken place. This being the scheme of the provisions of the Act in regard to the assessment of firms, it is evident that section 187, which deals with the mode of assessment in the case of change of constitution, is only a machinery section. As observed by the Allahabad High Court in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) :

'Section 187, even by implication, does not create a fiction that the income derived by the old firm becomes the income of the reconstituted firm. Normally, it is the various items of income that accrue to a particular assessee which alone can, for the purpose of computing the Income-tax payable by him, be aggregated..... This Chapter (Chapter XVI) does not contain any provision that for the purpose of computing Income-tax payable by a firm, the income derived by it has to be added to the income of the firm as it stands after reconstitution. Accordingly even though the reconstituted firm may be liable to be assessed in respect of the income derived by the firm before its reconstitution, i.e., the income of the old firm cannot be added to the income of the new firm. It necessarily follows that in such a case it becomes necessary to pass different assessment orders, though against the newly constituted firm, in respect of income derived by the old firm and that derived by the new firm.'

14. It was further observed (at page 346) :

'As stated earlier, section 187 merely makes the new firm liable to be assessed in respect of the income derived by the old firm.'

15. The High Court, therefore, held (at page 347) :

'that the income derived by the old firm had to be assessed in its hands (reconstituted firm) separately and without clubbing it with the income derived by it during the relevant accounting year.'

16. We are fully in agreement with this view. We are also clear in our mind that this decision has in terms been approved by the Supreme Court in Wazid Ali v. CIT : [1988]169ITR761(SC) . The ratio of this decision of the Supreme Court is absolutely clear as is evident from the following discussion of the facts and law as found therein.

17. Dealing with the appeal from the Allahabad High Court judgment involving a change in the constitution of a firm, the Supreme Court noted the following facts (at page 775 of 169 ITR) :

'Qamaruddin, one of the partners, died on June 4, 1964, within the relevant time, and his son, Fariduddin, joined the firm as a partner. Before the expiry of November 4, 1964, that is to say, the previous year which expired on November 4, 1964, the assessee had filed a declaration in Form No. 12 for the relevant assessment year 1965-66 under section 184(7) of the Act. We are of the opinion that in this case, on the death of Qamaruddin and the inclusion of Fariduddin, there was a change in the constitution of the firm. It did not dissolve the firm but brought about a change in the constitution of the firm. Fresh deed had to be executed under sub-section (8) of section 184. This follows from an analysis of the different sections of the Act. The application was not filed for the whole of the assessment year and so, for part of the assessment year, the firm was registered and for the rest, the firm was not registered. The Tribunal held that the assessee would be entitled to the benefit of registration up to June 4, 1964, that is to say, a part of the previous year. The Tribunal further held that the total income be apportioned between the partners who were entitled to receive the profits accordingly as they were entitled to share profits, the firm being assessed as a registered firm in respect of the profits ending on June 4, 1964, and as an unregistered firm in respect of the profits for the remaining part of the previous year. In our opinion, this conclusion is correct. The High Court has held that there is no warrant for this view. We are unable to agree. As a matter of fact, an analysis of the different sections of the Act leads to that conclusion and there is no contrary provision in the Act. Such a conclusion is logical and equitable and would do justice to both the Revenue as well as to the assessee.'

18. In Wazid Ali's case : [1988]169ITR761(SC) , the Supreme Court also noticed the divergence of the views of the High Courts on this aspect. Dealing with the three decisions of the Allahabad High Court, viz., the decision of the Division Bench in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) , the Full Bench of three judges in Badri Narain Kashi Prasad v. Addl. CIT : [1978]115ITR858(All) and the Full Bench of five judges in Vishwanath Seth v. CIT : [1984]146ITR249(All) , the Supreme Court in no less clear terms approved the decision of the Division Bench in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) , and the three-judge Bench in Badri Narain Kashi Prasad v. Addl. CIT : [1978]115ITR858(All) , and did not agree with the view taken by the five-judge Bench in Vishwanath Seth v. CIT : [1984]146ITR249(All) . This view is further substantiated by the fact that the Supreme Court categorically disapproved the view taken by the Full Bench of the Madhya Pradesh High Court in Girdharilal Nannelal v. CIT : [1984]147ITR529(MP) , which was contrary to the one taken by the Division Bench and the three-judge Bench of the Allahabad High Court in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) and Badri Narain Kashi Prasad v. Addl. CIT : [1978]115ITR858(All) , respectively. Referring to the Madhya Pradesh decision, the Supreme Court observed at page 778 (of 169 ITR) :

'The Full Bench of the Madhya Pradesh High Court in Girdharilal Nannelal v. CIT : [1984]147ITR529(MP) , held that any matter for which a provision was made in the Income-tax Act, 1961, was to be governed by it, notwithstanding anything different or to the contrary contained in the general law relating to that matter. It was further held that in the case of a change in the constitution of a firm during the accounting year, the income earned by the firm before such change was to be clubbed with the income earned after such change and a single assessment had to be made on the firm for the entire accounting period....'

19. The Supreme Court held (at page 778) :

'On an analysis of the different sections of the Act, we are unable to agree with this conclusion.'

20. We do not think that despite these clear pronouncements of the Supreme Court, it is possible still to say that the Supreme Court has not affirmed the judgment of the Division Bench of the Allahabad High Court in CIT v. Shiv Shankar Lal Ram Nath : [1977]106ITR342(All) .

21. We are supported in our conclusion by the Rajasthan High Court in CIT v. Ganeshdas Jagdish Prasad and the Patna High Court in CIT v. Shree Shankar Vastralaya : [1991]192ITR488(Patna) . The Rajasthan High Court was dealing with a case of a firm where there was a change in the constitution during the previous year. Two returns had been filed. The Income-tax Officer made a single assessment clubbing the income of the two firms. The Tribunal held that two assessments should have been made in the hands of the reconstituted firm. Following the decision of the Supreme Court in Wazid Ali's case : [1988]169ITR761(SC) , the High Court approved the view taken by the Tribunal and held that the Tribunal was justified in directing that two assessments should be made in the hands of the reconstituted firm. Similarly, the Patna High Court in CIT v. Shree Shankar Vastralaya : [1991]192ITR488(Patna) , also held that in view of the law as finally settled by the Supreme Court in Wazid Ali v. CIT : [1988]169ITR761(SC) , in the case of change in the constitution of the firm, the income for the two periods cannot be clubbed and there has to be necessarily two separate assessments.

22. In the light of the foregoing discussion, we are of the clear opinion that in the case of change in the constitution of a firm during an accounting year, the income derived by the original firm shall be assessed in the hands of the reconstituted firm separately from the income derived by it (the reconstituted firm) during the remaining part of the accounting year. The income of the two firms - the firm as it stood before reconstitution and the firm as reconstituted-shall not be clubbed together for the purpose of assessment and determination of tax. That, however, as already observed, may not be possible also in very many cases. Needless to say, in view of the provisions of section 187 of the Act, the assessment will have to be made on the firm as constituted on the date of making the assessment.

23. In view of the foregoing discussion, the question of law referred to us is answered in the negative and in favour of the assessee. Under the facts and circumstances of the case, we make no order as to costs.