Commissioner of Income-tax Vs. Kamala Devi - Court Judgment

K.A. Thanikkachalam, J.

1. In compliance with the order of this court, dated March 28, 1983, the Tribunal referred the following question for the opinion of this court under Section 256(2) of the Income-tax Act, 1961 (hereinafter referred to as 'the Act') :

' Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law in directing the Income-tax Officer to reassess the capital gains as long-term capital gains ?'

2. There was a partnership firm consisting of five partners, which purchased a property on July 4, 1962, and on June 14, 1973, the partners withdrew the property from the firm and held it as co-owners, and thereafter, on February 25, 1974, the five partners sold the property. The Income-tax Officer assessed the capital gains arising from the property as short-term capital gains on the basis that it was sold in the year in which it was acquired by the partners from the firm. On appeal, the Appellate Assistant Commissioner also agreed with the conclusion arrived at by the Income-tax Officer. On further appeal, the Appellate Tribunal found that in Section 2(42A) short-term capital asset means a capital asset held by an assessee for not more than 60 months immediately preceding the date of its transfer. Section 49(1)(iii)(b) referred to capital assets becoming the property of an assessee on distribution of assets on the dissolution of the firm. The Appellate Tribunal found that on the principles enunciated by the Supreme Court in the case of Malabar Fisheries Co. v. CIT : [1979]120ITR49(SC) , conversion of joint property into separate property was only a matter of agreement and the individual partners were, therefore, the owners of the property from the time of purchase initially as partners of the firm and later as individuals. Therefore, it was found that the capital asset had been held by them for more than 60 months and the capital gains arising from the transfer could not, therefore, be assessed as short-term capital gains.

3. Learned standing counsel appearing for the Department submitted that there was no dissolution in the present case. One of the assets of the partnership firm was withdrawn by the partners and later on it was sold by them jointly. According to learned standing counsel, as per the provisions of Section 14 of the Indian Partnership Act, the partnership firm is the owner of the property. Therefore, during the subsistence of the partnership firm, the partners cannot say that they are the owners of the properties held by the firm. Even according to the income-tax law, partnership has been considered as a separate entity and an assessable unit. Therefore, the partners, who are entitled to have the profits as per their profit sharing ratio, cannot claim to be the owners of any particular property, identifying the same as belonging to a particular partner. Therefore, according to the learned standing counsel, the partners cannot be held to be prior owners of the property sold by them after the said property was withdrawn from the partnership firm. Inasmuch as the property was purchased with the funds belonging to the firm, the firm alone is the owner of the property, over which the partners cannot claim their ownership during the subsistence of the partnership firm.

4. We have heard learned standing counsel appearing for the Department. We have also heard counsel appearing for the assessee, who reiterated the arguments as advanced before the Tribunal.

5. The fact remains that there were five partners in the partnership firm. The partnership firm purchased an immovable property situated at 11 and 12, Raudappa Mudali Street, Madras, by a registered sale deed, dated July 4, 1962. On June 14, 1973, the partners withdrew the property from the firm and held it as co-owners, and thereafter on February 25, 1974, the five partners sold the property.

6. The point for consideration is, whether the capital gains arising from the property should be considered as short-term capital gains or long-term capital gains. Under Section 2(42A) short-term capital asset, means a capital asset held by an assessee for not more than 60 months immediately preceding the date of its transfer. Explanation 1 says that in the case of a capital asset, which becomes the property of the assessee in the circumstances mentioned in Section 49(1), there shall be included the period for which the asset was held by the previous owner referred to in that Section. Section 49(l)(iii)(b) referred to capital asset becoming the property of an assessee on distribution of the assets on the dissolution of the firm. It is the contention of learned standing counsel appearing for the Department that there was no dissolution in the present case, but there was only the withdrawing the property from the partnership asset. Therefore, the provisions of Section 49(1)(iii)(b) of the Act cannot be made applicable to the facts of this case. Thus, reading the definition along with the Explanation, it is clear that the capital asset shall be treated as having been held by an assessee even during the period in which it was held by a firm in which the assessee was a partner. But, according to the Department, inasmuch as the firm was the owner of the property, prior to its withdrawal, it cannot be said that the assessees were the owners of the property, even during the period in which it was held by a firm in which the assessee was a partner. But, according to the Department, inasmuch as the firm was the owner of the property, prior to its withdrawal, it cannot be said that the assessees were the owners of the property, even during the time when the property was held by the firm as its asset. In other words, according to the Department, the period during which the property was considered to be that of the partnership firm should be excluded and the ownership of this property should be considered in the hands of the assessee from the date of the withdrawal by declaration, dated June 14, 1973. Therefore, the real dispute is in the matter of calculating the period in which the property was in the hands of the assessees as owners.

7. In Addanki Narayanappa v. Bhaskara Krishnappa, : [1966]3SCR400 , the Supreme Court, while considering a question of similar nature, held as under (page 1303) :

' From a perusal of these provisions it would be abundantly clear that whatever may be the character of the property which is brought in by the partners when the partnership is formed or which may be acquired in the course of the business of the partnership, it becomes the property of the firm and what a partner is entitled to is his share of profits, if any, accruing to the partnership from the realisation of this property, and upon dissolution of the partnership to a share in the money representing the value of the property. No doubt, since a firm has no legal existence, the partnership property will vest in all the partners and in that sense every partner has an interest in the property of the partnership. During the subsistence of the partnership, however, no partner can deal with any portion of the property as his own. Nor can he assign his interest in a specific item of the partnership property to any one. His right is to obtain such profits, if any, as fall to his share from time to time and upon the dissolution of the firm to a share in the assets of the firm which remain after satisfying the liabilities set out in Clause (a) and sub-clauses (i), (ii) and (iii) of Clause (b) of Section 48.'

8. So also in Malabar Fisheries Co. v. CIT : [1979]120ITR49(SC) , the Supreme Court, while considering the provisions of Sections 2(47), 34(3)(b) and 155(5) of the Income-tax Act, held as under (headnote) :

'A partnership firm under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks of the firm's property or the firm's assets all that is meant is property or assets in which all partners have a joint or common interest. It cannot, therefore, be said that, upon dissolution, the firm's rights in the partnership assets are extinguished. It is the partners who own jointly or in common the assets of the partnership and, therefore, the consequence of the distribution, division or allotment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between partners and there is no question of any extinguishment of the firm's rights in the partnership assets amounting to a transfer of assets within the meaning of Section 2(47) of the Income-tax Act, 1961. There is no transfer of assets involved even in the sense of any extinguishment of the firm's rights in the partnership assets when distribution takes place upon dissolution.'

9. This court had an occasion to consider a question of similar nature while dealing with Section 5(1)(iv) of the Wealth-tax Act, 1957, in R. Venkatavaradha Reddiar R. v. CWT : [1995]214ITR76(Mad) . In that decision, this court after considering all the decisions on this aspect, culled out the legal principles in the following manner (page 90) :

' (1) a firm has no legal existence and as such it cannot hold any property ;

(2) it is the partners, who own the partnership property as such;

(3) partners alone should have the benefit of the exemption under Section 5(1)(iv), when their individual assessments are taken up to the extent of their respective shares in the net wealth of the partnership firm ;

(4) the mere fact that a partner cannot claim to be entitled to any portion of the property owned by a firm as exclusively belonging to him will not completely disentitle him from seeking the benefit of exemption under Section 5(1)(iv) of the Act, so long as he is the owner of the house property even though as a partner in a firm ;

(5) For the purpose of the exemption under Section 5(1)(iv), it is not necessary that the partner should be able to say that the property or any specific part thereof exclusively belongs to him.'

10. The Madhya Pradesh High Court in Ratansi Narayan Patel v. CIT : [1988]173ITR547(MP) , while considering the provisions of Sections 2(29), 2(42A) and 45 of the Income-tax Act, 1961, held as under (headnote) :

'The whole concept of partnership is to embark upon a joint venture and for that purpose to bring in as capital, money or even property including immovable property and once that is done, whatever is brought in would cease to be the exclusive property of the person who brought it in. A partner has no exclusive right over any such property and he cannot also exercise any right in such property even to the extent of his share in the partnership because his right during the subsistence of the partnership is to get his share of profits from time to time as may be agreed upon among the partners and after dissolution of the firm to get the value of his share in the net partnership assets as on the date of dissolution. These are restrictions over the right of ownership of partners and they do not militate against the legal position that the partners collectively own the partnership property. The property really vests in the partners collectively in proportion to their shares.'

11. It was further held 'that notwithstanding the reconstitution of the firm, R, on the death of one of its partners, the constitution of a new firm, V, on the dissolution of the firm, R, and subsequent dissolution of the firm, V, the two assessees at every point of time right from November 3, 1967, held the partnership assets to the extent of 25 per cent. each. The assets held by the two assessees, on July 8, 1975, had, therefore, been held for more than 60 months and consequently constituted 'long-term capital assets'. The gains were, therefore, assessable as long-term capital gains'.

12. In CIT v. K. Saraswathi Ammal : [1981]127ITR404(Mad) , this court, while considering the provisions of Section 85 of the Income-tax Act, 1961, as modified by Section 31 of the Finance Act, 1968, extracted a passage, which runs as under (page 407) :

' 'The property of the firm' is statutorily defined in Section 14 of the Partnership Act ; the property that has been brought in by the partners and the property that is acquired by a firm will be the property of the firm. According to Section 14 of the Partnership Act, when one talks of the property of the firm, it has to be remembered that a firm as such is not a legal entity ; nor can a firm as such, according to the English concept, hold property. This is the reason why the Supreme Court in two decisions held that when the firm is dissolved and the partnership assets are distributed among the partners, there will be no transfers of the property of the firm in favour of the partners so as to attract the provisions of the Income-tax Act, for capital gains. The decisions are CIT v. Bankey Lal Vidya : [1971]79ITR594(SC) , CIT v. Dewas Cine Corporation : [1968]68ITR240(SC) . These two decisions clearly show that in general law, the firm cannot be treated as the owner of the shares in Kalinga Tubes Ltd. But, for the purpose of the Income-tax Act, the firm has been made a legal entity just as a person, as a firm is included in the definition of the term 'person' under the Income-tax Act. The firm is a separate entity for the purpose of assessment and, therefore, a firm will be entitled to the exemption under Section 85. Whatever that be, we are not concerned with that now, and we do not wish to express any opinion on that matter. As far as the individuals who make up the partners of the firm are concerned, we have no doubt that the properties, which are called the assets of the firm, really vest in the partners of the firm. This has also been said by the Supreme Court in the decision in Narayanappa v. Bhaskara Krishnnappa, : [1966]3SCR400 .'

13. Learned standing counsel appearing for the Department relied upon the decision of this court in CIT v. Bharani Pictures : [1981]129ITR244(Mad) , in order to support his contention that it is the partnership firm, which is the owner of the assets of the firm. In the abovesaid decision, it was held that in the case of partnership assets, the partners could not treat themselves as owners. By reason of the assessee being a partner, the assessee was not the co-owner of the property. It was the firm which was the owner. The assessee's right to the property arose only by reason of the release deed. This view was taken by this court while considering the provisions of Sections 41(2), 45, 47(iii) and 52 of the Income-tax Act, 1961, and Sections 2(xviii) and 4 of the Gift-tax Act, 1958. In the same decision, this court also pointed out that the legal fictions are only for a definite purpose. They are limited to the purpose for which they are created and should not be extended beyond their legitimate field. A statutory fiction introduced in one enactment cannot be incorporated in all other Acts. Therefore, it remains to be seen that even though according to Section 14 of the Partnership Act, the firm is stated to be the owner of the partnership assets, but in reality the partnership firm cannot function without the partners and it is the partners who are the real owners of the property according to their profit sharing ratio.

14. In K.I. Viswambharan and Brothers v. CIT : [1973]91ITR588(Ker) , a Full Bench of the Kerala High Court, while considering the provisions of Sections 45, 54(i) and 114 of the Income-tax Act, 1961, Section 2 of the Finance (No. 2) Act, 1967, and Section. 14 of the Indian Partnership Act, 1932, held (headnote) :

'That for purposes of assessment to tax, the Income-tax Act treats a registered firm as an entity distinct from the partners. Under the specific provisions of the Partnership Act relating to the property of a firm and the judicial pronouncements on the matter, a firm is legally competent to own or hold property and also to deal with such property. Any property or gain derived by a firm in pursuance of the sale of a capital asset, owned or held by the firm is, therefore, exigible to tax in accordance with the relevant provisions of the Income-tax Act.'

15. The matter does not rest there. What was assessed in the hands of the firm should be circulated in the assets belonging to each of the partners in accordance with the profit sharing ratio. In fact, the partnership firm itself is not a legal entity. It can act only through its partners. Even in the matter of sale of the assets of the partnership firm, it is only the partners who have got to execute the sale deed since the partnership firm is not a legal person.

16. Further, learned standing counsel for the Department in order to support his contention that the partnership firm is the owner of the partnership assets, relied upon the decision of this court rendered in T.C. No. 798 of 1983, dated March 11, 1996, in the case of CIT v. R. Rangaswamy Naidu : [1997]224ITR113(Mad) wherein this court held that 'it may be true that a partnership firm cannot be treated as a legal entity so as to enter into a contract of sale. The abstract proposition that the partnership is not a legal entity is not correct. It is true that, under the law of partnership, a firm has no legal existence apart from its partners and it is merely a compendious name to describe its partners. But under the income-tax law, the position is different. The firm and the partners are distinct assessable entities. The law has thus for some specific purposes relaxed its general rigid notions and extended a limited personality to a firm. There is nothing in the partnership law to suggest that a firm cannot be treated as an entity for the purpose of dealing with the property. During the subsistence of the partnership, the partnership acting through any particular partner authorised for the purpose or through all the partners will be in a position to deal with the asset. The position as to who can deal with the partnership property is a matter of agreement. Under Section 19 of the Partnership Act, the implied authority of a partner does not empower him to acquire immovable property for the firm or transfer immovable property belonging to the firm. In the absence of any agreement between the partners, if any occasion arises for dealing with the immovable property of the firm, then it would be necessary for all the partners to join the instrument'. The above passage was taken by the Tribunal from the decision in CIT v. Bharani Pictures : [1981]129ITR244(Mad) .

17. As already pointed out, the assessment made in respect of the income earned by the partnership firm does not rest there, but it has got to be extended by reflecting the same in the assessment of each of the partners.

18. This is because the firm cannot act by itself and any act of the firm can be done only through the partners. Therefore, it is not possible for us to say that the partnership firm and the partners are different and the partners have got no right over the partnership property according to their profit sharing ratio. In the present case five of the assessees were partners in the firm. They withdrew one of the assets from the partnership firm and it was sold by all the partners. The sale proceeds were divided among themselves according to their profit sharing ratio. Therefore, the Tribunal came to the conclusion that the five partners are the owners of the property, which was withdrawn and sold from the time when the property was brought into the firm as its asset. Therefore, the partners were always owners of property, earlier as partners of the firm, and later as co-owners. Therefore, inasmuch as the asset in the present case has been held by the assessees for more than 60 months, the asset cannot be regarded as short-term capital asset. Hence, the Tribunal was of the view that the assessment of capital gains as short-term capital gains cannot be sustained. Therefore, the Tribunal set aside the order of the authority below and directed the Assessing Officer to reassess the capital gains as long-term capital gains.

19. In view of the decisions cited supra, and on appraising the facts arising in this case, we hold that there is no infirmity in the order passed by the Tribunal in coming to the conclusion that the capital gain in the present case should be treated as long-term capital gain. In that view of the matter, we answer the question referred to us in the affirmative and against the Department. No costs.