Vatsala Shenoy vs Jt.Commissioner Of Income Tax

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:

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:

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

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:

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: