1. This is a reference at the instance of the Commissioner and the following question of law has been referred to us under s. 66(1) of the Indian I. T. Act, 1922.
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that no profit could arise on the transfer of 2,365 shares of Edward Textiles ltd. by the assessee-firm to its partner ?'
2. We are concerned in this reference with the assessment year 1958-59, the accounting year being Maru year 2013-14. The assessee before us is the firm of Messrs. Kaluram Puranmal. The said firm had sever partners and the constitution and the shares were as follows :
Name of partners SharePurshottamlal 0-2-3Motilal 0-2-6Hariram 0-2-3Babulal 0-2-0Bannalal 0-2-6Basudeo 0-2-6Banwarilal 0-2-0
3. In the beginning of the accounting year the assessee sold 111 shares of Edward Textiles Ltd. though sharebrokers, M/s. Jamnadas Morarji, for a sum of Rs. 26,365. On this transaction a profit of Rs. 1,588 was realised. This profit was held to be taxable and added to the income of the firm and about the same there is no controversy whatsoever.
4. The assessee-firm also transferred the remaining 2,365 shares of the very company more or less equally amongst its seven partners at Rs. 223.22 per share which was its average purchase price. The ITO rejected the assessee's contention that this transaction between the firm and its partners was merely a distribution of this particular asset amongst themselves. He noted that the disstribution amongst the partners at the average cost price had taken place within one month of the sale of 111 shares which were sold though regular brokers at the market rates. He found no difference between the two sets of transactions except that in the latter transaction the partners had been debited with the book value of the shares instead of the market rate. In his view such a transfer or release, even if it is made to the partners, is required to be accounted for at the market price. He regarded this understatement a profit on the firm and, therefore, the sum of Rs. 42.040 as worked out by him was added to the assessee's income.
5. The assessee carried the matter in appeal to the AAC. In the said appeal, it was urged that the alleged profit of Rs. 42,040 was erroneously and improperly added inasmuch as the distribution of shares amongst the partners could never amount to a sale and there can, therefore, be no question of estimating notional profit in respect of such transaction. Reliance was placed on two decisions of the Supreme Court which are referred to in para. 8 of the order of the AAC. Reliance was also placed on the decision of the Tribunal in the appeal of a sister concern of the assessee, and giving due regard to the observations in these decisions the AAC held in favour of the assessee. In his view, the addition of the fictional profit of Rs. 42,040 was wholly unjustified. This was because, according to the AAC, a person cannot make profit out of himself and since the firm was indistinguishable from its partners except for the purposes of taxation, it could not be regarded as having earned this notional profit. The addition of Rs. 42,040 was accordingly directed to be deleted.
6. The ITO carried the matter in further appeal to the Income-tax Appellate Tribunal. After extracting the facts the Tribunal upheld the view of the AAC, holding that this was an arrangement by the partners mutually agreed upon for withdrawal of the assets of the firm from its business. In its view, therefore, the distribution of the shares amongst the partners could not result in a trading profit to the firm. It was contended by the departmental representative before the Tribunal that the assessee had adopted a device for reducing its profits by transferring shares to the partners, which argument was not expressly gone into by the Tribunal, which decided in favour of the assessee upholding the view of the AAC on the general principles above indicated.
7. In this reference, Mr. Joshi on behalf of the revenue has submitted that as far as Income-tax law is concerned, a firm is a distinct assessable entity, and he drew out attention to the observations to this effect to be found in CIT v. A. W. Figgies & Co. : 24ITR405(SC) . He also submitted that the decision in Sir Kikabhai Premchand v. CIT : 1SCR219 , had no application inasmuch as the firm being considered in the said decision was a sole proprietary firm, whereas we have to consider the case of a regular partnership firm of seven partners. It was pointed out to us that the seven partners did not have an equal share of the profits although the distribution of the shares between the seven was more or less equal.
8. The learned counsel for the assessee, on the other hand, submitted that the Tribunal was right in the view that it took, viz., that the transaction could not be regarded as a normal commercial transaction between two separate commercial entities. In his submission, although for purposes of taxation and assessment the firm was required to be regarded as a separate assessable entity, this would not imply that in the present case the firm had entered into any commercial transaction with each of its seven partners. He further submitted that in the alternative, there was no warrant to bring to tax as income of the firm the fictional or notional profit in the manner in which it was done by the ITO. He submitted that there was no evidence on record to warrant the conclusion to the effect that a device had been adopted by the assessee to reduce its profits. It was his further contention that even if the scheme or device or arrangement had been envisaged by the firm as would restrict its profits, this was permissible and would not warrant taxation in the assessee's hands of the fictional or notional profits.
9. As far as the latter arguments are concerned, we were referred to the decisions of the Supreme Court in CIT v. A. Raman & Co. : 67ITR11(SC) and CIT v. Calcutta Discount Co. Ltd. : 91ITR8(SC) . In A. Raman & Co.'s case : 67ITR11(SC) , it has been observed that the law does not oblige a trader to make the maximum profit that he can out of his trading transactions. Income which he could have, but has not earned, is not made taxable as income accrued to him. These observations which are summarized in the ultimate paragraph of the headnote need not detain us further but are broadly to the effect that it is permissible for any assessee to arrange his commercial affairs in a way that the charge of tax is distributed, and this only amounts to avoidance of tax liability and is not prohibited by law. Observations in a similar vein are to be found in Calcutta Discount Co. Ltd.'s case : 91ITR8(SC) . It has been observed therein that ever where a trader transfers his goods to another at a price less than the market price, then, unless the transaction is not a bona fide one, the taxing authorities cannot take into account the market price of those goods, ignoring the real price fetched, to ascertain notional or fictional profits from the transaction and to tax the same in the hands of the trader.
10. It appears to us that it is not proper for us to go into the interesting question raised by Mr. Desai as they do not arise from the order of the Tribunal. It appears that both the AAC and the Tribunal on the facts and circumstances upheld the broad contention advanced on behalf of the assessee that since the firm was indistinguishable from the partners and, therefore, in law merely a compendious name for the totality of the partners, the ITO was in error in proceeding on the footing that there was a transaction - a commercial transaction - of sale of shares between the firm and in seven partners. Before us counsel for the revenue as well as for the assessee have adopted the same extreme positions but it is not possible to agree with either. In Income-tax law a partnership firm is a distinct assessable legal entity. From this, it would not follow that all transactions between the firm and its partners, whatever be their nature, whatever be the reasons therefor, are to be regarded as equivalent of ordinary transactions between two separate legal entities. Similarly, from the fact that in general jurisprudence a firm is not invested with legal personality it would not follow that any transaction between the firm and its partners will be required to be considered as an internal partnership arrangement and cannot be regarded as giving rise to legal consequences similar to a transaction between two separate entities. In the realities of commercial life one will find a firm borrowing from or lending to its partner, giving premises on lease to or taking premises on lease from its and similarly selling or purchasing goods and other assets to or from its partners, Merely because a transaction is between a firm and its partner it will not result in the consequence or application of the principle that since the firm is not separate in law from its partners, there cannot be any trade or profit as between the two or flowing from the transaction between the two. Whether it is a distribution of assets, whether such distribution has resulted in a profit, whether the national profit can be taxed or not, will be required to be decided on other considerations; and unfortunately for us the necessary finding are not on the record. It is not possible for us to uphold the decision of the Tribunal in the rather simplistic manner in which it has been arrived at by holding that such transaction would not attract tax. However, by saying that even such transaction can attract tax, it would not follow that the transaction in the instant case will attract tax on the basis of alleged notional profit as was done by the ITO. We are of opinion that the transaction between the firm and its partners cannot be looked at as the Tribunal has done and by itself is no ground for setting aside or striking down the additions made by the ITO. However, merely because shares having a market price higher than the purchase price have been distributed amongst the partners at the average purchase price it will not make the alleged notional or fictional profit automatically taxable in the hands of the assessee. This can only be done if there is necessary factual basis for coming to such conclusions as were urged by the departmental representative before the Tribunal or similar ones; and even then the contentions of the assessee earlier indicated would be required to be considered which we have not done since they do not arise from the order of the Tribunal. The same will be required to be considered by the Tribunal when the case goes back to it.
11. In this view of the matter, the question referred to us is answered in the negative and against the assessee. We make it clear that the Tribunal will go into the other aspects as will now arise for its consideration as indicated by us earlier. For this purpose, the Tribunal may consider the record as it exists and it will obviously have the right to remand the matter for further elicitation of facts.
12. In the circumstances of the case, the parties are directed to bear their own costs of this reference.