G.C. Bharuka, J.
1. In the present appeals, the assessee is an association of persons comprised of three members (in short the AOP-3). These appeals relate to the asst, yr. 1995-96. These members were the erstwhile partners of the dissolved firm which was carrying on business of manufacturing Beedies under the firm name 'M/s Mangalore Ganesha Beedi Works'. The firm was comprised of 13 partners. It stood dissolved on 6th Dec., 1987, by efflux of time. Thereafter, the business was carried on behalf of all the erstwhile partners as an AOP till the affairs of the firm was finally wound up. The assets of the firm were ultimately sold to the present assessee under the orders of this Court in a winding up proceedings on 20th Nov., 1994. On and from 21st Nov., 1994, the business of the erstwhile dissolved firm became that of the present assessee. Thus during previous year for the asst, yr. 1995-96, from 1st April, 1994 to 20th Nov., 1994, the business was being carried for and on behalf of all the AOP comprised of erstwhile 13 partners (i.e., for 234 days). But for the period 21st Nov., 1994, to 31st March, 1995, the business was carried on by and on behalf of the purchasing AOP i.e., assessee (for 131 days).
2. Before entering into the facts in detail, we find it advantageous to clarify a basic fact which has led to certain amount of confusion at all stages of the proceedings. This confusion had arisen primarily because of the name 'Mangalore Ganesha Beedi Works' (in short 'MGBW') successively adopted by three different taxable entities, namely, a partnership firm, an AOP consisted of 13 members and another AOP consisting of 3 members. For the sake of convenience, we will be referring to the said taxable entities as 'the firm', 'AOP-13' and 'AOP-3'. At this very stage, we may state that in the year 1993, the number of members of AOP-13 reduced to twelve because one of its members namely, Sri Vinod Rao, having 7.5 per cent share, had transferred his interest by a deed of assignment dt. 3rd July, 1993, to 7 out of other members leading to rise in their shares. But, the assignment of interest does not have any material relevance for deciding the legal issues involved herein.
3. In the present case, on behalf of the assesses-AOP-3, initially returns was filed showing total income of Rs. 4,95,67,570. But subsequently the same was revised showing loss at Rs. 11,11,77,020. The AO completed the assessment under Section 143(3) of the IT Act, 1961, determining the income at Rs. 1,16,49,03,204. This determination was made by the AO by including the income of AOP-13, which, was for 234 days as well as the capital gains which was arisen out of the sale of the assets of the firm in the hands of AOP 3. The AO also disallowed various deductions and revenue expenditure which had been claimed by the assesses-AOP. The assessee, therefore, went in appeal before CIT(A) who granted certain reliefs to the assessee.
4. Aggrieved by the order of the appellate authority, both the Department andthe assessee preferred appeals to the Tribunal. The Tribunal allowed almost allthe claims of the assessee. Therefore, the Department has preferred the presentappeals.
About the firm
5. Some time in 1939, late S. Raghuram Prabhu started the business of manufacturing Beedies, Subsequently, his brother-in-law, Sri. Madhav Shenoy also joined him in the business as a partner. Thus, M/s Mangalore Ganesh Beedi Works, the firm, came into existence w.e.f. 28th March, 1940. Thereafter, it was reconstituted from time to time. The last re constitution of the firm is evidenced by a partnership deed dt. 30th June, 1982, According to the averments made in the deed, the last re constitution of the firm became effective from 6th July, 1982. According to the deed of partnership, the firm comprised of the following 13 partners.
Name of the partners
percentage of share
M.Pushpalatha W/o Subraya Baliga
HemalathaW/o Raghunath Shenoy
VatsalaShenoy D/o M. Janaradhana Rao
ArathiShenoy D/o M. Janardhana Rao
6. Clause (3) of the partnership deed provided for the duration of the firm. This clause reads 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'.
Dissolution of the firm
7. According to the above Clause (3) of the partnership deed, the partnership was to dissolve on 5th June, 1987. But, because of mutual agreement between the partners as provided in the above Clause (3) itself, the duration was extended for a further period of 6 months i.e., upto 5th Dec., 1987. Therefore, in terms of Section 39 r/w Sections 40 and 42(a) of the Partnership Act, 1932, the firm stood dissolved w.e.f. 6th Dec., 1987. As a consequence of the dissolution of the firm, the affairs of the firm were required to be wound up in the manner provided in Clause (16) of the partnership deed.
8. Clause (16) of the partnership deed had made specific provisions for the manner in which the affairs of the firm were to be would up after its dissolution. It reads as under ;
'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 at which sale nobody other than 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.'
Winding up of the firm by sale of its assets
9. It is a matter of record that despite dissolution of the firm, because of differences between the erstwhile partners, the affairs of the firm could not be wound up. So two of the partners of the firm filed a petition before this 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. This petition was numbered as Co.P. No. 1/1988. By order dt. 3rd/5th Nov., 1988, this Court permitted the group of partners (7) having controlling interest to continue the business as an interim arrangement till the completion of winding up proceedings. Subsequently, under order dt. 14th June, 1991, this Court framed the scheme for winding up of the affairs of the firm by selling its assets as a going concern. Para. 29 of the order contains the scheme. Clauses (i), (iii) and (v) of this scheme are material for the present purposes and accordingly are being reproduced hereunder :
'(i). The dissolved partnership firm Mangalore Ganesh Beedi Works as a going concern shall be sold to such of its partner/s, who makes an offer of a highest price, the same not being less than the minimum (reserved) price of Rs. 30 crores (Rs. Thirty crores) within 11th July, 1991, accepting further liability to pay interest at 15 per cent per annum towards the amount of the price payable to partner/s from 6th Dec., 1987, till the date of deposit;
(ii) xxx xxx
(iii) If no offer for purchase of the dissolved partnership-firm as a going concern, adverted to in Clause (ii) above, is received within the stipulated time or if any of the offers made by the partner/s is not accepted by the Court, the Official Liquidator shall invite offers for purchase of the dissolved partnership-firm as a going concern from the public including the partners by giving publicity in three consecutive issues of two English daily national newspapers which have vide circulation in the country and one Kannada daily newspaper having vide circulation in Karnataka, the time allowed for making offers being at least 45 days between the last publication and the date fixed for receipt of the offers.....
(iv) xxx xxx
(v) If the sale of the dissolved partnership-firm as a going concern in favour of any partner or partners or an outsider is accepted by the Court, such offered shall, within 60 days from the date of the acceptance of the offer, deposit with the Official Liquidator the price or such part of the price together with interest on the total amount of the price at 15 per cent per annum from 6th Dec., 1987, till the date of deposit, which may become liable to be paid to the partner or partners towards their share of the price in the partnership-firm together with interest on such amount;'
10. Some of the partners of the dissolved firm assailed the above order before the Supreme Court by preferring in SLP 10680/191 but the same was ultimately dismissed as withdrawn on 8th April, 1994.
11. Pursuant to the above scheme framed by this Court, several partners either individually or in groups offered their bids. The bid offered by an AOP comprised of three partners, namely, M. Vishwanath Rao, M. Jaganath Shenoy and M. Gopinath Shenoy (hereinafter referred to as the 'AOP-3') was found to be the highest being of Rs. 92 crores. Therefore, it was accepted by this Court vide its order dt. 21st Sept., 1994. The said order was to the following effect.
'The highest bid amount of Rs. ninety-two crores is accepted and the group of persons offering the said amount are directed to deposit within 60 days from today with the Official Liquidator the entire amount of ninety-two crores together with actual profits earned from 6th Dec., 1987, till 31st March, 1994, and proportionate profit from 1st April, 1994, till the date of deposit in terms of the orders of this Court earlier issued in C.A. No. 313/1994.'
12. At the instance of the three partners offering highest bid, Clause (1) of the order dt. 21st Sept., 1994, was amended by a subsequent order dt. 19th Sept., 1994. The modified Clause (1) of the order dt. 21st Sept., 1994, read as under:
'The highest bid amount of Rs. ninety-two crores is accepted and the group of partners offering the said amount are directed to deposit that part of the bid amount of rupees ninety-two crores which is proportionate to the shares held by the outgoing partners together with profits on the same basis from 6th Dec., 1987, till the date of deposit, within a period of 60 days from 29th Sept., 1994, in any of the nationalised banks in the name of the Official Liquidator. The rest of our order dt. 21st Sept., 1994, remains in tact.'
13. Pursuant to the above order, the AOP-3 deposited the bid amount on 17th Nov., 1994, with the Official Liquidator. As per the order passed by this Court the assets of the firm as a going concern were to be treated as having been sold to the 'Purchasing AOP' on 20th Nov., 1994, It is again a matter of record that the business of the firm along with its assets were handed over by the Official Liquidator attached to this Court to the AOP-3 on 7th Jan., 1995, vide his report 10/95 and sale proceeds along with bank interest accrued thereon were distributed by the Official Liquidator under the orders of this Court amongst the outgoing partners on 2nd Feb., 1995.
14. Keeping in view the foregoing facts, various questions of law have been dealt with by the Tribunal in the impugned order. We will be considering these questions of law arising out of the Tribunal order consecutively.
Question No. (1).--Whether the Tribunal has erred in holding that the income of the business which was being carried on by and on behalf of AOP-13 till upto 20th Nov., 1994, could not have been assessed in the hands of the present assessee i.e., AOP-3?
15. According to us, the answer to the above question is self evident from the question itself. The assets of the dissolved firm were deemed to have been sold under the orders of this Court on 20th Nov., 1994. Therefore, till upto 20th Nov., 1994, the business was of AOP-13. The business of the erstwhile firm had been carried on after its dissolution with the mutual consent as well as direction of this Court. This fact becomes evident from the order dt. 11th April, 1990, passed by the Division Bench of this Court in O.S.A. No. 2/1989 wherein it was inter alia, held that:
'No doubt, according to the partnership dt. 13th June, 1982, the partnership was to continue for a period of five years. But, it is not disputed by either side that the partners agreed that the partnership should be continued on the same terms and conditions contained in the deed of partnership for a further period of six months and even after the expiry of the further period of six months, they have continued the business.'
15a. This Court in the above order had again observed that:
'Further, business of the partnership is permitted to be continued during the pendency of the winding up proceedings, It is not disputed before us that the business of the partnership had been continued even after 13th June, 1987, (sic 6th Dec., 1987), by mutual consent in the same manner as it was being carried on before expiry of the term of the partnership.'
16. In the above view of the matter, the Tribunal was justified in holding the income arising out of the business of the erstwhile firm for the first part of the period namely, for 234 days as well as the capital gains arising out of the sale of the assets of the firm to the present assesses-AOP 3 could not have been assessed in the hands of assesses-AOP-3. So far as AOP-3 is concerned, the income assessable is the actual profits earned for the year ended 31st March, 1995.
Question No. (ii)--Whether the Tribunal was right in holding that the assessee was entitled to deduction of Rs. 13,96,08,653 as revenue expenditure being interest and service charges paid to financial institutions ?
17. It is not in dispute and is borne from the records that members of assesses-AOP-3 had jointly borrowed a sum of Rs. 113.75 crores from banks and other financial institutions in their collective names for making payments against the purchase of the assets of the dissolved firm as a going concern. Keeping in view these facts, the CIT(A) found the claim to be admissible as a revenue expenditure. The Tribunal could not find any error on this account. Since, the facts are admitted, inference drawn therefrom on deductions claimed are of revenue in nature, in our opinion, the finding of the Tribunal has to be upheld.
Question No. (iii)--Whether Rs. 12,24,700 claimed as revenue expenditure by the AOP constituted by the three partners of the erstwhile firm MGBW can be allowed as permissible deduction in the hands of the said AOP under Section 37 of the IT Act, 1961, as being laid out or expended wholly and exclusively for the purpose of business of the said AOP?
18. This question has been considered by the Tribunal in para. 12.5 of the impugned order. The relevant facts in this regard have been dealt with appropriate details in para. 17 of the order of the CIT(A). It is a matter of record that the two of the outgoing partners of the dissolved firm had filed company application in Co. A 433/1994 with the prayer to recall the order dt. 21st Sept., 1994, passed in Co. A 313/1994 by which this Court had accepted the highest bid in a sum of Rs. 92 crores offered by the three members of AOP-3. This prayer was made by alleging fraud against the members of the assessee. The AO as well as the first appellate authority has rightly found that the legal expenses to the extent of Rs. 12,24,700 had been spent by the members of AOP for defending their personal rights. Accordingly, we hold that the Tribunal has erred in taking the view that the legal expenses incurred by the members was for the purpose of defending the business of assesses-AOP. Accordingly, we hold that a sum of Rs. 12,24,700 claimed as legal expenses is not allowable as revenue expenditure in the hands of the assesses-AOP.
Question No. (iv)--Whether the assessee AOP-3 was entitled to claim depreciation on lands, building, plant and machinery for the entire previous year i.e., 1st April, 1994, to 31st March, 1995.
19. The AO as well as the CIT(A) have held that the assesses-AOP had deposited the sale price of the assets of the erstwhile firm with the Official Liquidator on 17th Nov., 1994. The business of the firm was deemed to have been handed over to them on 21st Nov., 1994. Therefore, as noticed above, the business was carried on by and on behalf of the assesses-AOP-3 only for 131 days in the previous year which was less than 180 days. This being the factual position, the assessee AOP-3 was entitled to only 50 per cent of the depreciation in terms of second proviso to Section 32(1) of the Act, The Tribunal has dealt with this aspect in para. 3 of the impugned order. It has proceeded to grant 100 per cent depreciation on a mistaken notion that the assesses-AOP was carrying on business right from 1st April, 1994. This is clearly an error of record. Accordingly, we hold that the assessee was entitled to only 50 per cent depreciation on depreciable assets acquired by it.
Question No. (v)--Whether the assessee was entitled to claim any deduction on the alleged expenditure of acquisition of patent rights, copyrights and knowhow in terms of Sections 35A and 34AB of the Act.
20. In our judgment rendered in income-tax appeal in ITA No. 134/2000 and connected appeals, which have been disposed of by us on this day, we have held that in the present case there was no occasion for transfer of any know-how. It is further clear that in this case, there was no patent right to be acquired. 'Patent' is defined under the Patents Act, 1970, according to which only inventions can be patented. Beedi rolling or Beedi manufacturing is not an invention which can be patented or create any patent right. Further, expenses on trade mark is not covered either under Section 35A or 35AB of the Act. It seems to us that these have been created by the valuers of the assesses-AOP-3 just to devise a claim deduction for which there was hardly any factual or legal base or foundation available. Accordingly, we hold that the Tribunal has erred in directing deduction under ss, 35A and 35AB of the Act.
Question (vi)--Whether the assesses-AOP-3 was entitled to any deduction towards the profit earned from the business for the period of 234 days during which the same was carried by and on behalf of AOP-13.
21. For the period of 234 days under the orders of this Court, the profits in the hands of AOP-13 was to be worked out only on the proportionate basis profits by taking into account the income of two previous years. The High Court had accepted that Rs. 9,57,57,007.35 was the amount of deemed income of AOP-13 for the said period. Out of this, Rs. 8,37,39,503 was the amount payable to non-purchasing partners and accordingly the same was deposited by the assesses-AOP-3, Therefore, the income of assesses-AOP-3 for the previous year pertaining to the assessment year in question could have been worked out only by deducting the said sum out of the total book profit for the entire financial year 1994-95. Keeping in view these aspects, the first appellate authority had directed that the AO to allow deduction in question. The Tribunal has agreed with this finding. We find no error in giving such deduction.
Question No. (vii)--Whether, the Tribunal had erred in directing the AO to capitalise the value of trade marks, copyright and technical know-how by treating the same as plant and machinery and grant depreciation thereon ?
22. From the facts as noticed above and various orders passed by this Court in the winding up proceedings, it is quite clear that there was no assets of the firm like copyright or technical know-how to which any value could have been assigned. So far as trade mark is concerned, it had the value but that was taken to be the part of the tangible assets, It was recognised by this Court that main asset of the firm was the goodwill earned by the Beedies manufactured by it. Curiously, after purchasing the assets of the firm, the assesses-AOP-3 through its valuer got bifurcated the value of the goodwill being Rs. 72 crores in the ratio of 50 per cent know-how, 30 per cent copyright and 20 per cent for trade mark thereby rendering the value of the goodwill to 'zero'. The AO as well as the CIT(A) rejected the claim of the assesses-AOP-3 that they can claim any depreciation or deduction in respect of trade marks, copyright and technical know-how. But, the Vice President without giving any good reasons has directed that the trade mark, copyright and technical know-how should be treated as part of plant and machinery and self assessed value given by the assessee should be capitalised and accordingly depreciation should be granted.
23. In our opinion, the direction given by the Tribunal is bereft of any acceptable reasoning. It is also not supported by the orders passed by this Court in the winding up proceedings and the stand taken by the parties in these proceedings, It is quite apparent to us that the valuer had split the goodwill into 3 parts and assigned values to them by rule of thumb. Obviously, for enabling the assesses-AOP-3 to take benefits of depreciation and deductions under Sections 35A and 35AB of the Act. In our considered opinion, the alleged value of the trade mark, copyright and technical know-how cannot be capitalised for grant of depreciation. Accordingly, the direction given by the Tribunal is set aside.
Question No. (viii)--Whether Rs. 68,94,34,272 or any part thereof which represents undistributed and accumulated profits of AOP-13 for the period 6th Dec., 1987, to 31st March, 1994, could have been allowed by the Tribunal as revenue expenditure in the hands of AOP-3?
24. As already noticed, after the firm was dissolved on 5th Dec., 1987, admittedly, from 6th Dec,, 1987, till the date of assets of the firm were sold as a going concern i.e., on 21st Nov., 1994, the business of the firm was carried on by and on behalf of AOP-13. This AOP was regularly assessed to income-tax. But since winding up proceedings were still pending, the profits earned by AOP-13 was not distributed among the members of erstwhile partners of the firm and remained accumulated in the hands of AOP-13 only. After the highest bid offered by the assesses-AOP-3 was accepted, final order passed was to the following effect:
'The highest bid amount of Rs. 92 crores is accepted and the group of persons offering the same, are directed to deposit within 60 days from today with the official liquidator the entire amount of Rs. 92 crores together with actual profits earned from 6th Dec., 1987, till 31st March, 1994, and proportionate profit from 1st April, 1994, till the date of deposit in terms of orders of this Court issued in Co. A 370/94'
25. The assessee had deposited the amount in question in terms of the above order. A sum of Rs. 68,94,34,272 was share of the non-purchasing partners in the accumulated profits earned by AOP-13, This profit has absolutely nothing to do with the business carried on by the assesses-AOP-3 after purchase of the assets of the firm. This amount represented the deposits of erstwhile non-purchasing partners. The payment was capital in nature, therefore, both the AO as well as the CIT(A) had rejected the frivolous claim made by the assesses-AOP-3. But, curiously, the Tribunal in a slip sort method and without even applying itself to the facts of the case, has directed for deduction of the amount in question as revenue expenditure. Therefore, this direction given by the Tribunal is also set aside.
Question No. (ix).--Whether the assessee was entitled to deduction of Rs. 69,49,209 representing the interest paid to the outgoing partners ?
26. The facts in this regard had been discussed in details by the CIT(A) in para. 22 of its order. It has not been disputed by the Department even before us that the amount in question represents the interest paid to the outgoing partners. Admittedly, the recipient of interest amount were not the members of the assesses-AOP-3. Therefore, the Tribunal was right in agreeing with the finding of the CIT(A) that the amount in question should have been allowed as a revenue expenditure.
27. For the aforesaid reasons, the appeals filed by the Department are allowed in part. The parties to bear their own costs.