R. N. MISRA J. - I. Ramkrishnaiah & Sons, Berhampur, was a partnership firm with seven partners. The deed of partnership dated October 10, 1963, indicated the interest of each of the partners in the following manner :
I. Ramchandra Rao
I. Ananda Rao
I.V. N. Rao
During the relevant assessment year 1972-73 (previous year ending with March 31, 1972), Kanakaraju died on August 4, 1971. Clause 10 of the partnership deed provided :
'The partnership shall continue until such time as the partners determine. The firm shall not be dissolved by the death or retirement of a partner but may be continued by the surviving or remaining partners on such terms and conditions as may be agreed upon.'
As a fact, however, the partners dissolved the firm, settled the accounts and drew up a new partnership with effect from August 5, 1971, with the remaining six partners. For the assessment year in question, two returns were filed by the assessee, one for the period from April 1, 1971, to August 4, 1971, and the other form August 5, 1971, to March 31, 1972. The Income-tax Officer, however, made one assessment only so far as the firm is concerned by invoking section 187 of the Income-tax Act (hereinafter referred to as 'the Act'). In the case of the partners, the Income-tax Officer treated the two period separately for computing the taxable income. For the first period income was assessed at Re. 62,020 and tax thereon worked out to Rs. 4,888 leaving a divisible profit of Rs. 57,132. For the second period, the total income was computed at Rs. 85,370 with a tax liability of Rs. 8,754 and the divisible profit of Rs. 76,616. In the hands of the firm, the Income-tax Officer demanded tax of Rs. 24,252 in place of Rs. 13,642 being the total of the two tax amounts indicated above. There was thus an additional demand of Rs. 10,610 on account of the two periods having been treated as one in the hands of the firm.
The assessee appealed to the Appellate Assistant Commissioner and contended that section 187(2) of the Act did not comtemplate the clubbing together and charging tax in respect of two different periods in accounts. The appellate authority, however, was of the view that section 187 of the Act directly applied. Relying upon the provisions of section 42 of the Partnership Act and clause 10 of the partnership deed and the definition in section 187(2) of the Act, the Appellate Assistant Commissioner upheld the demand raised by the Income-tax Officer while disapproving of the action of the Income-tax Officer in showing the figures of the two periods separately.
Before the Tribunal, the assessee reiterated its stand. The Tribunal held :
'..... The facts of the case are quite simple and, as found by the Appellate Assistant Commissioner, the assessee, in both cases, being a firm, on the death of a partner, the firm was reconstituted and continued to carry on the same business with the same assets and liabilities and under the same name. In both cases the partnership deed provided that the firm shall not be dissolved by the death or retirement of a partner. The firm as reconstituted has been assessed. But the only dispute is whether the assessment should be made on the total income of the entire previous year or whether the income for the period before the reconstitution and the income for the period after the reconstitution should be separately assessed. The answer to this question depends entirely on the construction of section 187 of the Income-tax Act, 1961.'
The Tribunal referred to certain authorities and ultimately concluded against the assessee.
Upon the assessee's application, the following question has been referred for the opinion of this court :
'Whether, on the facts and in the circumstances of the case, and on a true interpretation of section 187, the total income of the entire previous year in which a change in the constitution took place is liable to the assessed to income-tax in the hands of the firm as constituted at the time of assessment ?'
Section 170, 187 and 188 of the Act, which are relevant, as far as material, provide :
'170. (1) Where a person carrying on any business or profession (such person hereinafter in this section being referred to as the predecessor) has been succeeded therein by any other person (hereinafter in this section referred to as the successor) who continues to carry on that business or profession, -
(a) the predecessor shall be assessed in respect of the income of the previous year in which the succession took place up to the date of succession;
(b) the successor shall be assessed in respect of the income of the previous year after the date of succession.'
'187. (1) Where at the time of making an assessment under section 143 or section 144 it is found that a change has occurred in the constitution of a firm, the assessment shall be made on the firm as constituted at the time of making the assessment :
Provided that -
(i) the income of the previous year shall, for the purposes of inclusion in the total incomes of the partners be apportioned between the partners who, in such previous year, were entitled to receive the same; and
(ii) when the tax assessed upon a partner cannot be recovered from him, it shall be recovered from the firm as constituted at the time of making the assessment.
(2) For the purposes of this section there is a change in the constitution of the firm -
(a) if one or more of the partners cease to be partners or one or more new partners are admitted, in such circumstances that one or more of the person who were partners of the firm before the change continue as partner or partners after the change; or
(b) where all the partners continue with a change in their respective shares or in the shares of some of them.'
'188. Where a firm carrying on a business or profession is succeeded by another firm, and the case is not one covered by section 187, separate assessments shall be made on the predecessor firm and the successor firm in accordance with the provisions of section 170.'
Section 170 obviously does not apply to succession on death of the person carrying on a profession, business or vocation while section 187 deals with a case of assessment of a firm involving a change in the constitution. Section 187 and 188 are intended to meet two different situations in regard to assessment of firms. Under section 187, the mandate to the Income-tax Officer is that assessment shall be made on the firm as constituted at the time of making the assessment, while under section 188 which involves a case of succession of one firm by another, separate assessments - one up to the date of succession and the other from the date of succession - are contemplated. To avoid the overlapping in the provisions of section 187 and 188 of the Act, in the latter section, it has been clearly stated 'and the case is not covered by section 187.'
In section 187(2) of the Act, a definition of the phrase 'change in the constitution of the firm' has been given. If one or two of the partners cease to be partners or one or more new partners are admitted, the circumstances being that one or more of the persons who were partners of the firm before the change continue as partner or partners after the change or where all the partners continue with a change in their respective shares or in the shares of some of them, a change in the constitution of the firm is said to take place. The essential feature is that one or more of the old partners is or are retained as partner or partners while the others may change; or all the partners may remain the same but their respective profit sharing ratio may undergo a change. In a case coming within this range and the change taking place in the midst of a year, section 187(1) indicates that there shall be only one assessment for the entire year made on the reconstituted firm but the apportionment of the profits will separately be made on the two sets of partners for the two broken periods. In other words, the reconstituted firm pays the assessed tax on the firm for the whole year and the partners pay tax on their respective individual shares earned by them. When, however, the firm carrying on business is succeeded by another firm, notwithstanding the feature that some of the partners of the old and new firms may be the same, section 188 would be applicable.
When a partner retires from a firm it will be open to the remaining partners to continue it or dissolve it and constitute a new firm to carry on the business. In the former event, the firm, continues with a change, but in the latter event, the new firm is a separate entity which has succeeded to the business and merely because the business is similar or identical, it cannot be taken to be a change in the constitution. Whether there is a change in the constitution or dissolution would be a question to be decided on the interpretation of the relevant clauses in the partnership deed and other circumstances available in each case. Where a partner dies and there is no clause in the original deed or other implied agreement to continue the firm despite death, there is a dissolution is provided under section 42(c) of the Partnership Act and the mere fact that the business has been continued cannot lead to the inference that there has been only a change in the constitution.
In the present cases, clause 10 had an enabling provision that the surviving or remaining partners could continue the business on such terms and conditions as may be agreed upon. On the death of one of the partners, however, as a fact, the partners brought their business to a close, settled the accounts and on the following day drew up a new partnership deed with the remaining six partners. These being the facts, we are of the view that the first firm came to an end and the second firm succeeded to the business. The process would not be covered by a change in the constitution of the firm as defined in section 187(2) of the Act and, therefore, section 188 of the Act would apply to the present case.
Counsel for the relied upon the ratio of the Full Bench decision of the Allahabad High Court in the case of Dahi Laxmi Dal Factory v. Income-tax Officer : 103ITR517(All) , while learned standing counsel relied upon two decisions, one being of the Punjab High Court in the case of Dharam Pal Sat Dev v. Commissioner of Income-tax and the other of the Madras High Court in the case of Kaithari Lungi Stores v. Commissioner of Income-tax : 104ITR160(Mad) . We had also been referred to two earlier decisions of the Supreme Court in the cases of Shivram Poddar v. Income-tax Officer : 51ITR823(SC) and Commissioner of Income-tax v. Kirkend Coal Co. : 74ITR67(SC) . Both these cases were under section 26 of the Indian Income-tax Act of 1922 where the provisions were somethat different and the definition of the term 'change in the constitution of the firm' was not available.
On our analysis of the provisions of sections 170, 187, 188 of the Act and taking the tell-tale features of the case into account, we are of the view that the revenue has gone wrong in applying section 187 of the Act to the facts of this case. Two separate assessments should have been made in accordance with the provisions of section 170.
Our answer to the question referred, therefore, is :
On the facts and in the circumstances of the case, and on a true interpretation of section 187, the total income of the entire previous year in which a change in the constitution took place was not liable to be assessed to income-tax in the hands of the firm as constituted at the date of assessment, but the assessment should have been completed under section 188 of the Act read with section 170 thereof.
We make no direction for costs.
PANDA J. - I agree.