‘M/s. Mangalore Ganesh Beedi Works’, which was sold to three other partners, as a going concern, but after the dissolution of the partnership firm. Certain considerations received as a result thereof were treated as capital gains on which income tax was charged by the Assessing Officer. The case of the assessees was that it was a capital receipt in their hands, not exigible to income tax. The exact nature of the receipt, treated as capital gain by the Assessing Officer, shall be taken note of subsequently at the appropriate stage.=High Court deals how the business income/revenue income is to be treated/calculated, but the question of taxability at the hands of the assessees has not bee touched upon at all. The upshot of the aforesaid discussion would be to allow the appeals partly only to the extent that business income/revenue income in the Assessment Year in question is to be assessed at the hands of AOP-3, in terms of the orders of the High Court, as AOP-3 retained the tax amount from the consideration which was payable to the assessees herein and it is AOP-3 which was supposed to file the return in that behalf and pay tax on the said revenue income.

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 1234 OF 2012
|VATSALA SHENOY |…..APPELLANT(S) |
|VERSUS | |
|JOINT COMMISSIONER OF INCOME TAX | |
|(ASSESSMENT), MYSORE |…..RESPONDENT(S) |

W I T H
CIVIL APPEAL NO. 1235 OF 2012

CIVIL APPEAL NO. 1236 OF 2012

CIVIL APPEAL NO. 1237 OF 2012

CIVIL APPEAL NO. 1238 OF 2012

CIVIL APPEAL NO. 1239 OF 2012

CIVIL APPEAL NO. 1240 OF 2012

CIVIL APPEAL NO. 1241 OF 2012

CIVIL APPEAL NO. 1242 OF 2012

CIVIL APPEAL NO. 1243 OF 2012

CIVIL APPEAL NO. 1244 OF 2012

CIVIL APPEAL NO. 1245 OF 2012

CIVIL APPEAL NO. OF 2016
(ARISING OUT OF SLP (C) NO. OF 2016
@ SLP (C) NO…..CC 9101 OF 2014)

CIVIL APPEAL NO. OF 2016
(ARISING OUT OF SLP (C) NO. OF 2016
@ SLP (C) NO…..CC 10193 OF 2014)

A N D

CIVIL APPEAL NO. OF 2016
(ARISING OUT OF SLP (C) NO. 14812 OF 2014)

J U D G M E N T
A.K. SIKRI, J.
Delay condoned in Special Leave Petition (C) No…..CC
9101 and 10193 of 2014.

Leave granted.

All these appeals (except Civil Appeal No. 1245 of 2012 and Civil Appeals
arising out of SLP (C) No….CC Nos. 9101 and 10193 of 2014 and SLP (C) No.
14812 of 2014, which are filed by the Revenue) are preferred by the
assessees. The respondent in these appeals is the Joint Commissioner of
Income Tax (Assessment), Special Range, Mysore, who would be referred to as
the ‘Revenue’ hereinafter. It may also be mentioned that these appeals
arise out of a common judgment rendered by the High Court of Karnataka on
December 23, 2010 in the appeals filed under Section 260-A of the Income
Tax Act, 1961 (for short, the ‘Act’) challenging certain aspects of
assessments pertaining to the Assessment Year 1995-1996. In fact, as would
be noticed hereinafter, all these assessees were partners of a partnership
firm known as ‘M/s. Mangalore Ganesh Beedi Works’, which was sold to three
other partners, as a going concern, but after the dissolution of the
partnership firm. Certain considerations received as a result thereof were
treated as capital gains on which income tax was charged by the Assessing
Officer. The case of the assessees was that it was a capital receipt in
their hands, not exigible to income tax. The exact nature of the receipt,
treated as capital gain by the Assessing Officer, shall be taken note of
subsequently at the appropriate stage. Suffice it to state that the
assessees successive appeals to Commissioner of Income Tax (Appeals) and
then to the Income Tax Appellate Tribunal (ITAT) and thereafter to the High
Court have failed, thereby sustaining the order of the Assessing Officer.
With this brief background of the litigation, we advert to the events that
have taken place in some detail.

One S. Raghuram Prabhu started the business of manufacturing beedies in the
year 1939. His brother-in-law joined him in the year 1940 and this sole
proprietorship was converted into a partnership firm with the name ‘M/s.
Mangalore Ganesha Beedi Works’ (hereinafter referred to as the ‘firm’). It
was reconstituted thereafter from time to time and lastly on June 30, 1982.
Partnership deed dated June 30, 1982 was entered between thirteen persons
with the same name. Duration of this firm was five years, which period
could be extended by six months. Thereafter, the affairs of the firm had
to be wound up as provided in Clause 16 of the Partnership Deed. The firm
was dissolved on December 06, 1987 by afflux of time after extending the
life of the firm by a period of six months, as per the terms stipulated in
the Partnership Deed. However, because of the difference of opinion among
the erstwhile partners, the affairs of the firm could not be wound up.
Therefore, two of the partners of the firm filed a petition before the High
Court under the provisions of Part X of the Companies Act, 1956 for winding
up of the affairs of the firm in terms of Section 583(4)(a) thereof. The
said petition was registered as Company Petition No. 1 of 1988.
Significantly, though the firm stood dissolved on December 06, 1987, and
thereafter Company Petition No. 1 of 1988 for the winding up proceedings
after dissolution was filed in the High Court, the business of the
partnership firm continued because of the interim order passed by the High
Court. This was because of the agreement of the partners, as stipulated in
the Partnership Deed itself, providing that on dissolution the firm was to
be sold as a continuing concern to that partner(s) who could give the
highest price therefor. The relevant clauses in the partnership firm
stipulating the aforesaid arrangement are clauses (3) and (16) which read
as under:

“3. The duration of the Partnership shall be five years in the first
instance; but by mutual agreement the parties hereto may extend the said
duration. If during the subsistence of this Partnership any of the
partners desire to retire from the partnership he or she can do so, if all
the other partners agree to the said retirement. However, if all the other
partners do not agree to the said retirement, the partner intending to
retire shall give six months’ notice in writing of his or her intention to
retire and on expiration of the period of the said notice the said Partner
shall cease to be a Partner and subject to Para 14 infra from that date all
his or her liabilities and rights as a Partner of the firm shall come to an
end.

xx xx xx

16. If the Partnership is dissolved, the going concern carried on under
the name of the Firm MANGALORE GANESH BEEDI WORKS and all the trade marks
used in course of the said business by the said firm and under which the
business of the Partnership is carried on shall vest in and belong to the
Partner who offers and pays or two or more Partners who jointly offer and
pay the highest price therefor as a single group at a sale to be then held
as among the Partners shall be entitled to bid. The other Partners shall
execute and complete in favour of the purchasing Partner or Partners at
his/her or their expense all such deed, instruments and applications and
otherwise aid him/her or them for the registration his/her name or their
names of all the said trade marks and do all such deed, acts and
transactions as are incidental or necessary to the said transferee or
assignee Partner or Partners.”

In view of the aforesaid clauses, specific order dated November 05, 1988
was passed by the High Court permitting the group of partners, seven in
number, who had controlling interest, to continue the business as an
interim arrangement till the completion of winding up proceedings.
Ultimately, the orders dated June 14, 1991 were passed in the said company
petition for winding up the affairs of the firm by selling its assets as an
‘ongoing concern’. Though this order was challenged by some of the partners
by filing special leave petition in this Court, the same was dismissed as
withdrawn in the year 1994. In this manner, orders dated June 14, 1991
became final, which had permitted the sale of the firm, as an ongoing
concern, to such of its partner(s), who makes an offer of highest price.
Reserve price of ?30 crores was also fixed thereby mandating that the price
cannot be less than ?30 crores. The successful bidder was also required to
accept further liability to pay interest @ 15% per annum towards the amount
of price payable to partners from December 06, 1987 till the date of
deposit. In the order dated June 14, 1991, it was also directed that the
successful bidder shall deposit the offer price together with interest with
the Official Liquidator within a period of sixty days of the date of
acceptance of the offer.

On the aforesaid terms, these partners individually or in groups offered
their bids. Bid of Association of Persons comprising three partners
(hereinafter referred to as ‘AOP-3’), at ?92 crores, turned out to be the
highest and the same was accepted by the High Court vide order dated
September 21, 1994. AOP-3 deposited this amount of ?92 crores with the
Official Liquidator on November 17, 1994 and with the occurrence of this
event, assets of the firm were treated as having been sold to AOP-3 on
November 20, 1994. Even actual handing over of the business of the firm
along with its assets by the Official Liquidator to the said AOP-3 took
place on January 07, 1995.

From the aforesaid facts, following events which are relevant for the
purposes of these appeals, are recapitulated:

(i) Date of dissolution of the partnership firm is December 06, 1987.

(ii) Company Petition No. 1 of 1988 was filed in the High Court of
Karnataka for winding up of the firm. All steps and formalities for
winding up, thereafter, are taken pursuant to the orders passed by the High
Court from time to time.

(iii) Order dated November 05, 1988 is passed permitting the group of
partners (seven in number) to continue the business as an interim
arrangement till the completion of winding up proceedings.

(iv) Winding up order dated June 14, 1991 is passed fixing minimum price
of ?30 crores for the sale of the dissolved partnership firm as a going
concern to such of its partner(s) who makes the offer of highest price.

(v) The date of deposit of the bid amount of ?92 crores by AOP-3, being
the highest bid, is on November 17, 1994.

With the aforesaid background facts, we advert to the developments that
have taken place on the income tax front.

Since the firm stood dissolved with effect from December 06, 1987, upto
December 06, 1987, it is the firm which had filed the income tax returns in
respect of the income which it had earned, for payment of income tax
thereupon. However, as mentioned above, though the firm was dissolved, but
the business continued because of the orders passed by the High Court
keeping in view the provisions contained in the Partnership Deed. The
income that was earned from the date of dissolution till the date of
winding up and when the firm was sold to AOP-3 was assessed at the hands of
dominant partners controlling the business activities (seven in number) as
“Association of Persons” (AOP), meaning thereby, the income from the
business of the said firm December 06, 1987 till winding up was assessed as
an AOP. At the same time, these assessees were also filing their
individual returns as well.

The assessees filed the return for the Assessment Year 1995-1996. It is in
this Assessment Year the assets of the firm were sold as ongoing concern to
AOP-3 on September 21, 1994. The Assessing Officer, while making the
assessments, bifurcated this Assessment Year into two periods. One period
from April 01, 1994 to November 20, 1994 (as AOP of the partners who had
continued the business in that capacity in previous years). Second period
from November 20, 1994 till March 31, 1995 (as the business was handed over
to AOP-3 and the assessment was treated as that of AOP-3). While doing so,
the Assessing Officer observed that the entire capital gains on the sale as
a going concern of the business of the firm as well as the proportionate
profits for the period April 01, 1994 to November 20, 1994, when the
controlling AOP was carrying on business as computed in accordance with the
order of the High Court in Company Petition No. 1 of 1988, on a notional
basis a sum of ?9,57,57,007 should be taxed in the hands of the firm.
However, according to the Assessing Officer, to protect interests of the
Revenue, the same amounts were included in the assessment of the AOP for
the first period. The income and tax computations were made separately for
the two periods in the order of assessment. The Assessing Officer
apportioned the consideration among the various assets comprised within the
business with further splitting between short term and long term capital
gains.

While the aforesaid treatment was given to the assessment of the income of
the firm, insofar as the assessees as individuals are concerned, on the
same date the Assessing Officer made assessment in their cases also by
including therein the proportionate share from out of ?92 crores (the
amount of auction bid) as capital gain at their hands and bifurcated the
same into long term and short term gain. The manner in which it is done
can be discerned from one such Assessment Order where the capital gain is
computed in the following manner:

|“INCOME AS RETURNED | | |Rs.29,40,680 |
| | | | | |
|II. Computation of capital gains on account of| |
|transfer of interest in partnership firm M/s. | |
|MGBW out of Rs. 92 crores | |
| | | | | |
|Share of assessee out of Rs. 92| |Rs. | |
|crores | |12,73,55,600 | |
| | | | | |
|A 1 | | | | |
|Goodwill u/s. 48 | | | | |
|r.w.s. 55(1) | | | | |
|76.6% of |Rs.9,75,54,3| | | |
|Rs.12,73,55,600 |90 | | | |
|(See Table 3) | | | | |
|less Cost of |nil | | | |
|acquisition | | |Rs. | |
|(See Table 3) | | |9,75,54,390 | |
|Net Taxable | | | | |
|Goodwill | | | | |
| | | | | |
|A 2 | | | | |
|Sale of Land | | | | |
|(See Table 3) | | | | |
|Market value @ 19% |Rs.12,73,55,| | | |
|of |600 | | | |
|less Cost of |Rs.2,41,97,5| | | |
|acquisition |64 | | | |
|(see Table 3) | | | | |
|13.843% of | | | | |
|Rs.1,53,45,025 | | | | |
| | | | | |
|Indexed Cost |21,24,212 x | | | |
| |259 | | | |
| |100 | | | |
| |55,01,710 | |Rs.1,86,95,85| |
| | | |4 | |
| | | | | |
|TOTAL LONG TERM CAPITAL GAINS (A1+A2) |Rs. |
| |11,62,50,244 |
| | | | | |
|III Short-term Capital gain on| | |
|transfer of | | |
|movable (depreciable asset) u/s. | | |
|50 | | |
| | | | | |
|4.4% of | | |Rs. 56,03,646| |
|Rs.12,73,55,600 | | | | |
| | | | | |
|Less Value / w.d.v. in the | | |
|beginning of | | |
|accounting year – 31.03.1994 |Rs.2,09,224 | |
|13.843% of Rs.15,11,404 | | |
| | | | | |
|SHORT TERM CAPITAL GAINS | |Rs. 53,94,422 |
| | | | | |
|IV Share of Notional/Proportionate Profit – |Rs. |
|revenue receipt |1,32,55,640 |
| | | | | |
|TOTAL INCOME (I + II + III + IV) | |Rs. |
| | |13,78,40,987 |
|TOTAL INCOME EXCLUDING LONGTERM CAPITAL-GAINS |Rs. |
| |2,15,90,743” |
As can be gathered from the above, the total proceeds of ?92 crores are
first apportioned among the assessees in the ratio in which they had
received the said amount. Thereafter, this amount is divided into long
term capital gains and short term capital gains. Two components of long
term capital gains are taken into consideration, namely goodwill and sale
of land. Likewise, short term capital gain is arrived at in respect of
transfer of movables which were depreciable assets. For the purposes of
calculation/ computation, figures were taken from Table II incorporated in
the Assessment Order itself mentioning the market value of these assets.
This Table II reads as under:

|S.No.|Asset |%age |Sales/Market|Amount in |
| | | |Value |assessee’s |
| | | | |case |
|1. |Land as per H.S. |19.00 |17,47,90,000|2,41,97,564 |
| |Seshagiri – Registered| | | |
| |Valuer | | | |
|2. |Buildings as per H.S. |4.10 |3,80,00,000 |56,06,646 |
| |Seshagiri – Registered| | | |
| |Valuer | | | |
|3. |Plant & Machinery |0.30 |25,00,000 | |
| |estimated on the basis| | | |
| |of Swamy & Rao’s | | | |
| |Report | | | |
|4. |Goodwill – being |76.60 |70,47,10,000|9,75,54,390 |
| |balancing figure | | | |
| |remaining out of total| | | |
| |figure of 92,00,00,000| | | |
| |also being almost same| | | |
| |figure if super profit| | | |
| |method is adopted | | | |
| |Total |100.00 |92,00,00,000|12,73,55,600 |

It becomes apparent that the approach adopted by the Assessing Officer was
to take into consideration market value of the assets of the firm, viz.
land, building and plant & machinery, which had already been evaluated by
the Registered Valuers as reflected in the Table above. The market value
of these three assets was ?21,52,90,000. Since total sale consideration at
which the firm was sold was ?92 crores, balance amount of ?70,47,10,000 was
treated as representing goodwill of the firm which was taxed as long term
gain. This mode of arriving at short term and long term capital gain and
taxing it accordingly by the Assessing Officer has received the stamp of
approval by the Commissioner of Income Tax (Appeals) and the Income Tax
Appellate Tribunal, as well as the High Court.

Mr. Ajay Vohra, learned senior counsel appearing for the assessees,
submitted, with great emphasis, that the aforesaid approach is incorrect,
invalid and impermissible in law. Two broad arguments, on the basis of
which he attacked the rationale of the aforesaid assessments, are the
following:

(i) After referring to the averments made in the winding up petition that
was filed in the Karnataka High Court, order of winding up and the final
order of confirmation of sale, Mr. Vohra pointed out that the firm was
admittedly sold as a going concern. Predicated on this fact, his submission
was that there could not have been any capital gain on the sale of ongoing
concern. For this purpose, he drew sustenance from the definition of
‘capital asset’ as contained in Section 2(14)(a) of the Act as well as
Section 45 of the Act. Section 2(14)(a) is to the following effect:
“2(14) “capital asset” means –

(a) property of any kind held by an assessee, whether or not connected with
his business or profession;

xx xx xx”

He submitted that the expression ‘property of any kind’ was of widest
amplitude, as held in Commissioner of Income Tax, Bombay City I v. Tata
Services Ltd.[1] Therefore, assets of the partnership were to be treated
as capital assets.

He, thus, argued that undertaking that was transferred as a going concern
was a capital asset. However, at that time, there was no provision as to
how the asset of the firm when wold is to be computed as a capital gain.
The learned counsel pointed out that such a provision was introduced for
the first time (vide Finance Act, 1999) by inserting Section 50B to the Act
with effect from April 01, 2000, laying down the mechanism for computation
of capital gains in case of slump sale. For, such slump sales prior to
April 01, 2000 were, therefore, not taxable, was the submission of the
learned counsel. It was argued that precisely this very issue had been
clinchingly determined by this Court in PNB Finance Limited v. Commissioner
of Income Tax I, New Delhi[2] in the following manner:
“16. In the case of Artex Manufacturing Co. this Court found that a valuer
was appointed, that valuer submitted his valuation report in which itemized
valuation was carried out and on that basis the consideration was fixed at
Rs.11,50,400. Therefore, the sale consideration had been arrived at after
taking into account the value of plant, machinery and dead stock as
computed by the valuer and, consequently, it was held that the surplus
arising on the sale was taxable under section 41(2) of the Act and not as
capital gains. In the circumstances, the judgment of this court in the
case of Artex Manufacturing Co. was not applicable to the present case.
Further, this court in the case of CIT v. Electric Control Gear Mfg. Co.
[1997] 227 ITR 278 has held that whether (sic) the business of the assessee
stood transferred as a going concern for slump sale price, in the absence
of evidence on record as to how the slump price stood arrived at, section
41(2) had no application. It is interesting to note that the judgment in
the case of Electric Control Gear Mfg. Co. is given by the same Bench which
decided the case of Artex Manufacturing Co. In fact, both the judgments
are reported on after other in 227 ITR at pages 260 and 278 respectively.
In the present case, as can be seen from the impugned judgment of the Delhi
High Court, the judgment of this court in Electric Control Gear Mfg. Co. is
missed out. That judgment has not been considered by the High Court. As
stated above, this court has clarified its judgment in Artex Manufacturing
Co. in its judgment in the case of Electric Control Gear Mfg. Co.
Therefore, section 41(2) has no application to the facts of the present
case.

17. As regards applicability of section 45 is concerned, three tests are
required to be applied. In this case, section 45 applies. There is no
dispute on that point. The first test is that the charging section and the
computation provisions are inextricably linked. The charging section and
the computation provisions together constituted an integrated code.
Therefore, where the computation provisions cannot apply, it is evident
that such a case was not intended to fall within the charging section,
which, in the present case, is section 45. That section contemplates that
any surplus accruing on transfer of capital assets is chargeable to tax in
the previous year in which transfer took place. In this case, transfer
took place on July 18, 1969. The second test which needs to be applied is
the test of allocation/attribution. This test is spelt out in the judgment
of this Court in Mugneeram Bangur and Co. (Land Department) [1965] 57 ITR
299. This test applies to a slump transaction. The object behind this
test is to find out whether the slump price was capable of being
attributable to individual assets, which is also known as item-wise
earmarking. The third test is that there is a conceptual difference
between an undertaking and its components. Plant, machinery and dead stock
are individual items of an undertaking. A business undertaking can consist
of not only tangible items but also intangible items like, goodwill, man
power, tenancy rights and value of banking licence. However, the cost of
such items (intangibles) is not determinable. In the case of CIT v. B.C.
Srinivasa Setty reported in [1981] 128 ITR 294, this court held that
section 45 charges the profits or gains arising from the transfer of a
capital asset to income-tax. In other words, it charges surplus which
arises on the transfer of a capital asset in terms of appreciation of
capital value of that asset. In the said judgment, this Court held that
the “asset” must be one which falls within the contemplation of section 45.
It is further held that, the charging section and the computation
provisions together constitute an integrated code and when in a case the
computation provisions cannot apply, such a case would not fall within
section 45. In the present case, the banking undertaking, inter alia,
included intangible assets like, goodwill, tenancy rights, man power and
value of banking licence. On the facts, we find that item-wise earmarking
was not possible. On the facts, we find that the compensation (sale
consideration) of Rs.10.20 crores was not allocable (sic) item-wise as was
the case in Artex Manufacturing Co.”

Mr. Vohra pointed out that in the instant case itself, insofar as AOP-3 is
concerned (who were the successful bidders and purchased the assets of the
firm), they were treated as purchasers of an ongoing concern by this Court
in the case of their assessment in Mangalore Ganesh Beedi Works v.
Commissioner of Income Tax, Mysore & Anr.[3]
In nutshell, his argument was that since it was a sale of an
ongoing concern, it had to be treated as a slump sale within the meaning of
Section 2(42C) of the Act and, therefore, it was not permissible for the
Assessing Officer to assign the amount of ?92 crores into different heads
of land, building and machinery and treating balance amount as goodwill.
It was a capital asset as an ongoing concern which was sold at ?92 crores
and in the absence of provisions relating to mode of computation and
deductions at the relevant time, which were inserted subsequently only with
effect from April 01, 2000, as per PNB Finance Limited, the consideration
was to be treated as capital receipt and no capital gain was payable
thereon.

Two incidental submissions were also made on this aspect, which are:

(a) Even if the provisions of capital gain were applicable and the amount
was to be taxed as the capital gain, valuation of goodwill, as done by the
Assessing Officer, was contrary to law. It was submitted that the manner
in which the goodwill was valued showed that cost of acquisition was
treated as ‘Nil’. However, it could not be so having regard to the
provisions of Section 48. He contrasted the same with Section 55(2) which
was inserted with effect from April 01, 2002 and deals with ‘cost of
acquisition’ for the purposes of Sections 48 and 49 stipulating that
insofar as capital asset in relation to goodwill of a business is
concerned, cost of acquisition would be the cost at which it was purchased
from the previous owner. According to him, this yardstick could not have
been applied prior to April 01, 2002 in the absence of any statutory scheme
and the instant case needed to be covered by the law laid down by the
courts in this behalf in various judgments. The learned counsel referred
to the following judgments in support:
(i) CIT v. B.C. Srinivasa Setty[4]
(ii) Mangalore Ganesh Beedi Works
(iii) Areva T & D India Ltd. v. The Deputy Commissioner of Income Tax[5]
(iv) Commissioner of Income Tax & Anr. v. Associated Electronics &
Electricals Industries (Bangalore) (P) Ltd.[6]

(b) Without prejudice to the aforesaid contentions, his other submission
was that if at all the capital gain tax was payable, liability to pay the
same was that of the partnership firm and not the individual partners by
virtue of Section 45(4), which reads as under:
“45. Capital gains. – (1) Any profits or gains arising from the transfer
of a capital asset effected in the previous year shall, save as otherwise
provided in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F, 54G and 54H, be
chargeable to income-tax under the head “Capital gains”, and shall be
deemed to be the income of the previous year in which the transfer took
place.

xx xx xx

(4) The profits or gains arising from the transfer of a capital asset by
way of distribution of capital assets on the dissolution of a firm or other
association of persons or body of individuals (not being a company or a co-
operative society) or otherwise, shall be chargeable to tax as the income
of the firm, association or body, of the previous year in which the said
transfer takes place and, for the purposes of section 48, the fair market
value of the asset on the date of such transfer shall be deemed to be the
full value of the consideration received or accruing as a result of the
transfer.”
Second submission of the learned senior counsel for the assessees pertained
to the payment of tax on the income which the business earned from April
01, 1994 till November 20, 1994. The learned counsel argued that as per the
orders of the High Court in the winding up petition, 40% of this income was
retained by AOP-3 as a tax component because of the reason that for
business income of the earlier years, after the dissolution, the same was
taxed as an AOP. Therefore, the individual partners could not be taxed on
the said business income in the year in question, as held in M/s.
Radhasoami Satsang, Saomi Bagh, Agra v. Commissioner of Income Tax[7] and
Commissioner of Income Tax v. Excel Industries Ltd.[8] His related
submission was that in any case this amount was not received by the
assessees as it was retained by AOP-3 and, therefore, tax was not payable
by the assessees.

Coming to the first submission of the assessees, it can be seen that it is
founded on the premise that the assets of the firm were sold to AOP-3 as a
going concern with further premise that it was a slump sale. It is pointed
out that the firm was doing business even after the winding up petition was
filed and as a going concern, it was put to sale.

Mr. Radhakrishnan, learned senior counsel appearing for the Revenue, has
refuted the aforesaid premise of the argument by submitting that though it
was sold as a going concern, nevertheless, the assets were that of a
dissolved firm as the firm had come to an end on December 06, 1987 by
afflux of time. In order to establish this fact, learned counsel took us
through the record, including the winding up petition which was filed in
the High Court as well as the orders passed therein, which are relied upon
by the assessees themselves.

After going through the records, we find that the Revenue has been able to
substantiate the aforesaid submission. We have already noticed that the
firm was dissolved on December 06, 1987 by afflux of time. This event
happened as per the terms stipulated in the partnership deed itself. The
necessity for filing the petition under the Companies Act arose because of
differences between the erstwhile partners that had erupted, pertaining to
the affairs of the firm. No doubt, in the said petition interim order
dated November 05, 1988 was passed by the High Court permitting the group
of persons (seven in number), having controlling interest in the firm, to
continue the business. However, this was done as an interim arrangement
till the completion of winding up proceedings. Pertinently, insofar as the
firm is concerned, it did not carry on business thereafter as an existing
firm. On the contrary, few ex-partners with controlling interest were
allowed to continue the business activity in the interregnum as a stopgap
arrangement. Another important fact which needs a mention is that,
insofar as the firm is concerned, it did not file income tax returns after
the date of dissolution. Obviously so, as it stood dissolved and was no
more in existence. Precisely for this reason, the income that was
generated from the business, after the dissolution, was assessed by the
income tax authorities in the hands of such erstwhile partners as an AOP.
It is this AOP which was filing the returns and getting the same assessed
in that capacity and paying the income tax thereupon. Further, in the
orders passed by the High Court from time to time in the said petition,
insofar as the firm is concerned, it has always been described as ‘the
dissolved partnership firm’. Thus, the assets which were sold ultimately
on November 20, 1994 were of a dissolved partnership firm, though as a
going concern.
Once we straighten the factual position in the manner stated
above, the whole legal edifice of the assessees case crumbles down.

At this stage, we would like to clarify one more factual aspect. During
the pendency of the winding up petition before the High Court, the High
Court had passed various orders which included an order for valuation of
the assets of the firm. This valuation was done to enable the Court to fix
the reserve price for the purpose of inter se bidding between the erstwhile
partners and/or association of erstwhile partners. The Chartered
Accountants had done the valuation and submitted reports on the basis of
which base price was fixed at ?30 crores taking into account the value of
various assets. These assets valued at ?30 crores are sold for ?92 crores.
Thereafter, AOP-3, the successful bidder, deposited the amount of bid in
respect of the share of nine other partners and a settlement was also
prepared recording the value of the assets of the firm after deducting the
liability of the said nine partners. The net value of the assets so
arrived at and distributed among the nine partners.

What follows from the aforesaid facts is that the firm stood dissolved with
effect from December 06, 1987; the company petition had to be filed by two
partners in view of eruption of disputes among the partners; the business
was carried on by the partners with controlling interest as an interim
arrangement; the income was assessed in their hands as AOP and not in the
hands of the firm which had already been dissolved; assets of the company
were put to sale in accordance with Clause 16 of the Partnership Deed of a
dissolved firm, though as a going concern; and outgoing partners (assessees
herein) received their net share of the value of the assets of the firm out
of the amount received by way of sale of the assets of the firm as per
Clause 16 of the Partnership Deed.
On the aforesaid facts, it becomes clear that asset of the firm
that was sold was the capital asset within the meaning of Section 2(14) of
the Act. It is not even disputed. Once it is held to be the “capital
asset”, gain therefrom is to be treated as capital gain within the meaning
of Section 45 of the Act.

The assessees, however, are attempting the wriggle out from payment of
capital gain tax on the ground that it was a “slump sale” within the
meaning of Section 2(42C) of the Act and there was no mechanism at that
time as to how the capital gain is to be computed in such circumstances,
which was provided for the first time by Section 50B of the Act with effect
from April 01, 2000. However, this argument fails in view of the fact that
the assets were put to sale after their valuation. There was a specific
and separate valuation for land as well as building and also machinery.
Such valuation has to be treated as that of a partnership firm which had
already stood dissolved.

Section 2(42)C defines ‘slump sale’ and reads as under:
“ “slump sale” means the transfer of one or more undertakings as a result
of the sale for a lump sum consideration without values being assigned to
the individual assets and liabilities in such sales.

Explanation 1. – For the purposes of this clause, “undertaking” shall have
the meaning assigned to it in Explanation 1 to clause (19AA).

Explanation 2. – For the removal of doubts, it is hereby declared that the
determination of the value of an asset or liability for the sole purpose of
payment of stamp duty, registration fees or other similar taxes or fees
shall not be regarded as assignment of values to individual assets or
liabilities.”

As per the aforesaid definition, sale in question could be
treated as slump sale only if there was no value assigned to the individual
assets and liabilities in such sale. This has obviously not happened. It
is stated at the cost of repetition that not only value was assigned to
individual assets, even the liabilities were taken care of when the amount
of sale was apportioned among the outgoing partners, i.e. the assessees
herein. Once we hold that the sale in question was not slump sale,
obviously Section 50B also does not get attracted as this section contains
special provision for computation of capital gains in case of slump sale.
As a fortiorari, the judgment in the case of PNB Finance Limited also would
not apply.

In the aforesaid scenario, when the Official Liquidator has distributed the
amount among the nine partners, including the assessees herein, after
deducting the liability of each of the partners, the High Court has rightly
held that the amount received by them is the value of net asset of the firm
which would attract capital gain. Scope of Section 45 of the Act was
explained in Commissioner of Income Tax, Faridabad v. Ghanshyam (HUF)[9]
and we would like to reproduce the following discussion from the said
judgment:
“16. The following conditions need to be satisfied for taxing a transaction
as capital gains viz. the subject-matter must be a capital asset, the
transaction must fall in the definition of “transfer”, there must be profit
or loss called “capital gains” and that the taxpayer has claimed exemption
in whole or in part by complying with legal provisions (like Section 54-F).

17. Section 45(1) of the 1961 Act speaks about capital gains arising out
of “transfer” of a capital asset. The definition of the expression
“transfer” is contained in Section 2(47) of the 1961 Act. It has very wide
meaning. What is taxable under Section 45(1) of the 1961 Act is “profits
and gains arising from a transfer of a capital asset” and the charge of
income tax on the capital gains is a charge on the income of the previous
year in which the transfer took place.

18. Capital gain(s) is an artificial income. It is created by the 1961
Act. Profit(s) arising from transfer of capital asset is made chargeable to
income tax under Section 45(1) of the 1961 Act. From the scheme of Section
45, it is clear that capital gains is not an income which accrues from day-
to-day during a specific period but it arises at a fixed point of time,
namely, on the date of the transfer. In short, Section 45 defines “capital
gains”, it makes them chargeable to tax and it allots the appropriate year
for such charge. It also enacts a deeming provision. Section 48 lays down
the mode of computation of capital gains and deductions therefrom.”

In para 45 of the judgment, the Court also stated that capital
gains under Section 45 of the Act are not income accruing from day to day.
It is deemed income which arises at a fixed point of time, viz. on the date
of transfer.

When we apply the said legal principle to the facts of the instant case, we
find that the partnership firm had dissolved and thereafter winding up
proceedings were taken up in the High Court. The result of those
proceedings was to sell the assets of the firm and distribute the share
thereof to the erstwhile partners. Thus, the ‘transfer’ of the assets
triggered the provisions of Section 45 of the Act and making the capital
gain subject to the payment of tax under the Act.
Insofar as argument of the assessees that tax, if at all, should have been
demanded from the partnership firm is concerned, we may only state that on
the facts of this case that may not be the situation where the firm had
dissolved much before the transfer of the assets of the firm and this
transfer took place few years after the dissolution, that too under the
orders of the High Court with clear stipulation that proceeds thereof shall
be distributed among the partners. Insofar as the firm is concerned, after
the dissolution on December 06, 1987, it had not filed any return as the
same had ceased to exist. Even in the interregnum, it is the AOP which had
been filing the return of income earned during the said period. The High
Court has touched upon this aspect in greater detail in para 30 of its
judgment. Since we agree with the same, we reproduce below the discussion
in the said para:
“30. In view of the provisions of Section 45 it is clear that in the
present case, the effect of the sale conducted by this court among partners
and under Clause 16 of the said Partnership Deed, is that once the
partnership is dissolved, the partners would become entitled to specific
share in the assets of the firm which is proportionate to their share in
sharing the profits of the firm and they are placed in the same position as
the tenants in common and for the purpose of dissolution and u/s 47 of the
Indian Partnership Act, 1932, it is clear that even after the dissolution
of the firm, the authority of each partner to bind the firm and the other
mutual rights and obligations of the partners continue notwithstanding the
dissolution so far as may be necessary to wind up the affair of the firm
and to complete transactions begun but unfinished at the time of the
dissolution. Therefore, for realisation of the assets, discharging the
liability of the firm and settling the accounts of the partners, etc., the
firm will continue to exist despite the dissolution and not for any other
purpose. The material on record in the instant case would clearly show
that after dissolution of the firm on 06.12.1987, the firm has never filed
any return and in view of the order of this court permitting the partners
to carry on the business in the interest of employees, return was filed by
AOP-13 consisting of erstwhile 13/12 partners for accounting profits and
seeking depreciation in the assets of the firm and continued to do business
in view of the order of this court that there was no agreement among the
partners to continue the business during the pendency of the winding up
proceedings. Further having regard to Clause 16 of the Partnership Deed of
the dissolved firm, it is clear that the partners intended that the assets
of the firm should not be sold to an outsider. It is well settled that
every act of the partner would be binding on the firm and also the partners
interse and Clause 16 of the Partnership Deed which has been culled out
supra clearly shows that if Partnership is dissolved, the going concern
carried on under the name of the Firm MANGALORE GANESH BEEDI WORKS and all
the trade marks used in course of the said business by the said firm and
under which the business of the Partnership is carried on shall vest in and
belong to the Partner who offers and pays or two or more Partners who
jointly offer and pay the highest price therefor as a single group at a
sale to be then held as among the Partners shall be entitled to bid. The
other Partners shall execute and complete in favour of the purchasing
Partner or Partners at his/her or their expense all such deed, instruments
and applications and otherwise aid him/her or them for the registration
his/her name or their names of all the said trade marks and do all such
deed, acts and transactions as are incidental or necessary to the said
transferee or assignee Partner or Partners. The final order passed by this
court to wind up the affairs of the firm would clearly show that the
property of the firm is purchased by the association of 3 partners who
submitted their highest bid and that other partners had to given an
undertaking that they may not interfere with the carrying on business which
is vested in the name of MGBW and all the trademarks used in the course of
said business and therefore it is clear that the appellants who are
erstwhile partners were not successful bidders for continuation of business
in the individual capacity of the MGBW and in view of Clause 16, all
tangible and intangible assets vested with Association of 3 partners whose
highest bid of Rs.92 crores was accepted and admittedly after the passing
of the order of this court on 20.11.1994, all the appellants herein and
other out-going partners have given requisite undertaking as per the order
of this court and the MGBW as a going concern under the name and style MGBW
and all trademarks used in the course of said business by the said firm and
all tangible and intangible assets of the firm vested with the purchasers
erstwhile 3 partners who paid the highest bid and the appellants have
received consideration of the conveyance and their respective share in the
sale of net assets of the firm after their undertaking that they cannot
interfere with the business of MGBW which is vested with all assets in
favour of 3 partners have received the value of their net asset which has
been distributed by the Official Liquidator and AOP 3 who have purchased
the business of the old firm, succeeded to it and constituted a new firm in
the same name (vide order defendant (sic – dated) 14.06.1991 in the Company
Petition) and therefore it is clear that the order passed by the Assessing
Authority confirmed in the first appeal and by the Income Tax Appellate
Tribunal (Special Bench) holding that the appellants as erstwhile partners
are liable to pay capital gain on the amount received by them towards the
value of their share in the net assets of the firm are liable for payment
of capital gains u/s 45 of the Act. The said finding is justified and
accordingly we answer the substantial question of law in favour of the
Revenue and against the assessee.”
In view of our aforesaid discussion, the arguments that valuation of
goodwill was wrongly done may also not survive. In any case, we find that
no such plea was taken by the assessees in the High Court or before the
Tribunal or lower authorities.

We now advert to the second argument.

It is argued that insofar as income of the firm in the Assessment Year in
question is concerned, it could not be taxed at the hands of the assessees.
We find merit in this submission.

First, and pertinently, it is an admitted case that 40% of the said income
was allowed by the High Court to be retained by the successful bidder (AOP-
3) precisely for this very purpose. This 40% represented the tax which was
to be paid on the income generated by the ongoing concern being run by the
Association of Persons, as authorised by the High Court. Secondly, in the
previous years, the Department had taxed the AOP and this procedure had to
continue in the Assessment Year in question as well {See – M/s. Radhasoami
Satsang, Saomi Bagh, Agra and Excel Industries Ltd.}
From the judgment of the High Court, we find that this aspect
has been dealt with very cursorily, without taking into consideration the
aforesaid aspects highlighted by us. The entire discussion on this issue
is contained in para 31, which reads as under:
“31. The concurrent finding on question of fact that value of profit
received during interregnum period for a period of 234 days is to be
treated as revenue income having regard to the reasons assigned that said
profit is calculated on the basis of notional profit calculated on two
years average profit and from this average 40% was to be deducted and the
net amount was to be paid, the finding is unassailable…”

The aforesaid discussion of the High Court deals how the
business income/revenue income is to be treated/calculated, but the
question of taxability at the hands of the assessees has not bee touched
upon at all.

The upshot of the aforesaid discussion would be to allow the appeals partly
only to the extent that business income/revenue income in the Assessment
Year in question is to be assessed at the hands of AOP-3, in terms of the
orders of the High Court, as AOP-3 retained the tax amount from the
consideration which was payable to the assessees herein and it is AOP-3
which was supposed to file the return in that behalf and pay tax on the
said revenue income.
Insofar as the appeals preferred by the Revenue are concerned, they arise
out of the protected assessment which was made at the hands of the
partnership firm. As we have upheld the order of the Assessing Officer in
respect of payment of capital gain tax by the assessees herein, these
appeals are rendered otiose and are disposed of as such.
There shall be no order as to costs.

………………………………………J.
(A.K. SIKRI)

………………………………………J.
(N.V. RAMANA)

NEW DELHI;
OCTOBER 18, 2016.
———————–
[1]
(1980) 122 ITR 594 (Bombay)
[2] (2008) 13 SCC 94 : 307 ITR 75
[3] (2016) 2 SCC 556 : (2015) 378 ITR 640
[4] (1981) 2 SCC 460 : 128 ITR 294
[5] (2012) 345 ITR 421 (Delhi High Court)
[6] (2016) 130 DTR 0222 (Kar)
[7] (1992) 1 SCC 659 : 193 ITR 321
[8] (2014) 13 SCC 459 : 358 ITR 295
[9] (2009) 8 SCC 412

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