Case: M/S.Sree Narayana Chandrika Trust Vs. Commnr. Of Gift Tax, Kerala

The appellant is a charitable institution registered as a public trust which spends its receipts on charitable purposes and is partner in a firm known as "Chandrika Enterprises". By a partnership deed dated 1.4.1980 the appellant was inducted into the said partnership upon contribution of Rs. 1,000 to the total capital of Rs. 1,61,000 and given a share of 45% in the profit of the said firm. There were in all 8 partners apart from the appellant and the partnership deed recited the contribution of each partner towards the capital of the firm as also the varying share of profit/loss of each partner. With effect from 1.10.1982 the partnership was reconstituted by a deed dated 1.10.1982. A new partner, Smt. M.U. Indira was inducted into the partnership. Consequent upon the induction of said new partner, who contributed a sum of Rs. 25,000 towards the capital, the shares of the profit/loss of all the partners were reshuffled, being increased in the case of some and reduced in the case of the others. The share of profit/loss of each partner prior to 11.10.1982 and thereafter is as under:2. Clause 9, 10, and 11 of the said partnership deed provide that all the partners had a right to carry on the business of the firm for the common advantage of the firm, though C.K. Jinan (Partner No.3) was to be the managing partner and in overall charge of the affairs of the firm and C.N. Purushuthaman (Partner No.1) was to be the administrative partner and incharge of the day to day affairs of the firm and allowed a salary of Rs. 1000 per month until otherwise decided by other partners. The bank accounts of the firm were to be operated by the Managing partner C.K. Jinan or administrative partner C.N. Purushuthaman. As a result of the reconstitution of the firm w.e.f. 1.10.1982, the appellants share in the profit/loss of the firm was reduced from 45% to 30%.3. The Gift Tax Officer, taking the view that the reduction of the share of the profit/loss of the appellant from 45% to 30% andin favour of the other partners amounted to a gift, issued a notice under section 16 of the Gift Tax Act calling upon the appellant assessee to file a return of a gift. The assessee filed a return showing the value of the taxable gift at nil for the assessment yearBy an assessment order dated 31.12.1985 the Assessing Officer held that relinquishment of 15% of the share of the the profits of the firm by theamounted to a gift and, therefore, attracted the provisions of the Gift Tax Act. He took the average profits of the firm for the year79 at Rs. 7,36,650 and, after reducing therefrom interest on capital @ 12% and managerial remuneration, arrived at 3 years purchase price at Rs. 21,16,000. He worked out that 15% of this amount i.e. Rs. 3,17,400 had been surrendered without consideration by the assessee. Consequently, after giving exemption under section 5(2) he held that amount of Rs. 23,12,400/ee challenged the assessment order by appeal before the Commissioner of Gift Tax (Appeals). Two contentions were urged by the appellant assessee. First, that there was no goodwill of the firm which was capable of being assessed in terms of money, and second, that inasmuch as M.U. Indira had made a capital contribution and was inducted as partner, there was no situation of a gift at all. The appeal was dismissed.5. The assessee carried the matter in appeal to the Income Tax Appellate Tribunal. Before the tribunal the assessee did not seriously canvas the question of goodwill and the issue was held against theThe tribunal took the view that the question, whether there had been a gift of a share by the assessee in the goodwill of the firm, would depend on whether the value of the assets of the firm exceeded its total liabilities. Since there was no material on this aspect of the matter, it would normally be necessary to remand the matter, but since the assessee was liable to succeed on another contention there was no need to remand the matter to the Assessing Officer. The tribunal took note of the fact that the incoming partner, Smt. M.U. Indira, had contributed Rs. 25,000/as her share of the capital; the usefulness of her service to the firm had not been disputed by the Revenue. Though the Revenue was of the view that the incoming partner had been given her share only on account of the reduction of the share of the appellant, it was only partly true. The Tribunal pointed out that it was not a case of mere reduction of the share of the appellant, the difference being allotted to the incoming partner, but it was a case of complete realignment of the shares of all the partners consequent upon reconstitution of the firm and that unless and until interest of the concerned partner is ascertained and quantified it could not be said that the consideration for transfer is adequate or not. Relying upon the judgment of this Court in Sunil Siddharthbhai vs. Commissioner ofAhmedabad (156 ITR 509) , the tribunal held that even though there was a transfer by the assessee in favour of the incoming partner and the existing partners, inasmuch as the consideration for the transfer, which is the right to get the value of his share for the partner, cannot be valued during the subsistence of the partnership, it was not possible to consider and quantify the question of adequacy or inadequacy of consideration. In such an event, it could not be held that there was any gift exigible to tax.6. The Revenue sought for and obtained a reference of the following two questions to the High Court under Section 26(1) of the Gift Tax Act. The two questions referred to the High CourtWhether on the fats and in the circumstances of the case the Tribunal is right in law and fact in holding that even though the reconstitution of the firm resulted in the reduction of the share of profit of thethere was not gift exigible to tax in its hands?2) Whether, on the facts and in the circumstances of the case the Tribunal is right in law and fact in holding that even though there was a transfer by the assessee in favour of the incoming partner and existing partners, the consideration for the transfer could not be evaluated during the subsistence of the partnership and so the question of adequacy or inadequacy of consideration could not be quantified and so there was not gift exigible toThe High Court answered the questions in the negative and against the assessee. The Assessee is in appeal by special leave.

Court's reasoning:
14. The facts found in the present case are that the incoming partner (M.U. Indira) had contributed Rs. 25,000 towards her share of the capital. The value of her services or usefulness to the firm as partner has not been disputed by the Revenue authorities. As pointed out by this Court in D.C. Shah case (supra), the mere fact that upon reconstitution of the firm the share of one partner decreased and that of another increased cannot lead to the inference that the former had gifted the difference to the incoming partner. There is no other material placed on record by the Revenue to show that, in the facts and circumstances of the case, particularly taking into consideration the obligations of all the partners in the partnership deed dated 1.10.1982, there was inadequate consideration for the reallocation of 12% of the share in favour of the incoming partner. In our view, the contribution of Rs. 25,000 towards the capital together with the obligations undertaken of sincerely and faithfully carrying on the business for common advantage of the firm was adequate consideration for reallocating the share of the profits and giving 12% of the share in favour of the incoming partner M.U. Indira. That C.K. Jinan was the managing partner and C.N. Purushuthaman was the administrative head, did not take away the obligations of the other partners including those of M.U. Indira which arose generally under the Partnership Act, as well as under the partnership deed dated 1.10.1982.15. We are of the view that even assuming that there was a transfer of 12% of the share profit/loss in favour of the incoming partner M.U. Indira by the appellant assessee, it was not a situation of transfer for inadequate consideration so as to amount to a taxable gift within the meaning of section 4(1)(a) of the Gift Tax Act,that case a partner of a partnership firm having retired, two minor sons of an existing partner were admitted to the benefits of the partnership. This Court held that relinquishment of the share of an existing partner in favour of the minors who are admitted to the benefits of the partnership without any consideration amounted to a gift by the said partner in favour of the minors. The reason was that the goodwill of the firm is the property of the firm and, upon admission of the two minors to the benefits of the partnership, the right to the money value of the capital stands transferred. Since this transfer is without consideration, insofar as minors are concerned, the transaction would amount to a taxable gift under the giftthe position is very different, when, during the subsistence of a partnership, an asset of the partnership becomes the asset of only one of the partners thereof, there is, in such a case, a transfer of that asset by the partnership to the individual partner. Where such transfer is for less than the value of that asset, there is a deemed gift to the extent of the difference under the provisions of section 4(1)(a) of the Gift Tax Act, 1958. Learned counsel for the Revenue contended that what was said by this Court in B.T. Patil case (supra) was equally applicable to the case of the present appellant before us.13. Although it may be possible to say in the appellants case that relinquishment of the share of a profit/loss by a partner in favour of the inducted partner may amount to a transfer, we are unable to accept the contention that it was for inadequate consideration so as to amount to a taxable gift within the meaning of section 4(1)(a) of the Gift Taxwas also a case where, upon reconstitution of the firm, an incoming partner who contributed certain amount of capital was given a share in the partnership which was relinquished in his favour by an existing partner. The High Court held that having regard to the nature and constitution of a firm and the implication of the judgment of the Supreme Court in Gheevarghese case [1972 ITR 83, 403] a mere reallocation of shares would not result in a gift. The fact that there was some contribution by the incoming partners coupled with the obligation under the partnership deed upon the incoming partner to participate in the business and work for it diligently would constitute adequate consideration. There was an obligation upon all the partners to work for the progress of the business, albeit for administration convenience or overall guidance one of them might have been nominated as a managing partner, but that does not mean that the service to be rendered by other partners was either negligible or in any way diminished or could be left out of account. Hence, it was held that there was adequate consideration for the transfer by way of reallocation of shares. The judgment in DC Shah (supra) came to be appealed to this Court at the instance of the Revenue. The appeal came to be disposed of by this Court by a judgment in Civil Appeal Nos.of 1984 on September 25, 1996, wherein it was held "that the share of one partner is decreased and that of another partner correspondingly increased does not lead to the inference that the former had gifted out to the latter. The profit sharing ratio in a firm can vary for a number of reasons, among them the ability of partners to devote time to the business of the firm. The gift of a partners share to another partner has to be established be relevant evidence. The onus of doing so is on the Revenue. It has not been discharged in the present case."