1. The assessee in this appeal is the partnership firm styled S.Rajamani and S. Thangarajan, carrying on business in manufacture and sale of soap-nut powder. The assessment year is 1974-75, the previous year ending 31-3-1974. The dispute raised in the grounds of appeal by the department pertain to the charge of capital gains in the circumstances stated below.
2. The assessee-firm was originally constituted by a deed of partnership between Shri S. Rajamani and Shri Thangarajan dated 22-3-1955 with effect from 1-4-1954. Certain properties, namely, 288, Thiruvathiyur High Road, Madras-81, were purchased by the two partners in their name and it is common ground that the cost of the purchase was debited to the asset account in the books of the partnership firm and shown as an asset in the balance sheet. Similarly, other properties and assets were subsequently purchased in two names. Subsequently, during the accounting year relevant for the assessment year 1973-74, the two partners, Shri Rajamani and Shri Thangarajan, took five more partners and executed a fresh partnership deed. During the previous year relevant for the assessment year 1974-75 under consideration, the two partners Shri Rajamani and Thangarajan had taken over all the assets of the firm at book value, According to the claim of the assessee, this taking over of the property of the firm originally purchased by the two partners in their names did not result in any transfer so as to attract capital gains. The ITO, however, considered that there was a sale or transfer, which attracted not only assessment of profit under Section 41(2) of the Income-tax Act, 1961 ("the Act") in regard to the assets on which depreciation had been allowed to the assessee, but also capital gains in regard to other assets. He further held that the fair market value of the assets have to be taken for the purposes of determining the amount of capital gains by resort to Section 52(2) of the Act. He, accordingly, made the assessment bringing to charge not only the profit under Section 41(2), but also capital gains. In appeal, the Commissioner (Appeals) deleted both the profit under Section 41(2) and the capital gains in the sum of Rs. 39,320 and Rs. 96,727, respectively. In deleting the amounts, the Commissioner (Appeals) held that since the properties of the firm included immovable property, the transfer could be effected in favour of the partners only by means of an instrument in writing and registered under the provisions of the Indian Registration Act. As this has not been done in this case, he held that there was no transfer of the property consisting of the land and building as well as machinery by the firm to the two partners.
Aggrieved by his order, the department is in appeal before us.
3. The contention of the department in its grounds of appeal reiterated before us by the learned departmental representative, is that no registered document is necessary for the transfer of the immovable property belonging to the firm to the partners. It is further submitted that the taking over of the assets of the firm by the two partners concerned resulted in a transfer within the meaning of Section 2(47) of the Act and that, therefore, capital gains charge is attracted in this case. In support of this contention, reliance is placed on the decision of the Madras High Court in CIT v. Bharani Pictures  129 ITR 244.
The assessee's learned representative supported the order of the Commissioner (Appeals) by relying on the decision of the Allahabad High Court in Ram Narain & Brothers v. CIT  73 ITR 423 referred to by the Commissioner (Appeals) in his order for the proposition that an item of immovable property belonging to the firm can be converted into personal property of partners only by means of an instrument in writing and the entries in the accounts of the firm do not have the effect of converting a property of the firm into personal property of the partners, and also relied on the decision of the Supreme Court in Malabar Fisheries Co. v. CIT 120 ITR 49.
4. We have carefully considered the facts and the contentions of the parties on this point. As already stated, the undisputed facts in this case are that the concerned properties and assets were acquired originally by the two partners, Shri Rajamani and Shri Thangarajan, in their names when the partnership consisted of only those two persons as partners and that the transfer of the said properties and assets in favour of those two persons were effected during the relevant previous year when the partnership consisted of other partners also besides them, by means of entries in the books of account and no document in writing was executed. The questions that arise for consideration in this case, therefore, are, firstly, whether there is a transfer by the firm of the property and assets owned by it to the partners so as to attract either charge of profit under Section 41(2) or capital gains charge under Section 45 and secondly, if there was such a transfer, whether the transfer is not effective or valid in the absence of a duly registered instrument in writing, since it involved immovable properties of the firm.
5. In considering the question as to whether the properties and assets concerned belonged to the partnership firm as constituted during the relevant previous year when there were other partners besides the two, namely, Shri Rajamani and Thangarajan, or not, we may take note of certain relevant clauses in the partnership deeds. In the partnership deed dated 1-10-1972, in which the two partners, Shri Rajamani and Shri Thangarajan, took in five more partners, in Clause 9 it is provided that the parties of the first and second parts, namely, Shri Rajamani and Thangarajan, or their duly authorised nominees alone have the power to borrow, pledge, sell or mortgage any of the assets of the partnership for the purpose of the partnership. In Clause 11, it is provided that on the dissolution of the firm for any reason the right to occupy the business place and godown shall vest with the said two partners alone and further that the goodwill will also belong to the said two partners equally. Again, in Clause 14 it is stipulated that on the dissolution of the firm for any reason, the furniture, fittings and other movable and immovable assets which may belong to the partnership shall all be allocated to the parties of the first and second part only at book value or market rate, whichever is lower, and the parties of third to seventh parts shall receive the balance standing to their credit only after making adjustments for profit or loss up to the date of dissolution and further shall have no right to demand revaluation of the assets In the partnership deed dated 5-4-1974, evidencing certain further change by way of retirement of some partners and introduction of new partners also, Clause 9 provides that only the party of the first and second part, namely, Rajamani and Thangarajan or their duly authorised nominees alone will have the power to borrow, pledge, sell or mortgage any of the assets of the partnership for the purpose of partnership ; Clause 11 provides that on the dissolution of the firm for any reason the right to occupy the business place shall rest with the said two partners ; and Clause 13 stipulates that on dissolution of the firm for any reasons the furniture, fittings and other movable and immovable assets which may belong to the partnership shall all be allocated between the parties of the first and second part, namely, the two partners Rajamani and Thangarajan, at book value or market value, whichever is lower, and the other partners shall have no right to demand revaluation of the assets, etc.
6. According to Section 14 of the Partnership Act, the property of the firm includes all properties and rights and interest in property originally brought into the stock of the firm or acquired by purchase or otherwise by or for the firm or for the purposes of the business of the firm and further it includes also the goodwill of the business. But this provision is subject to the contract between the partners, which means that the partners can agree to certain properties or assets not being treated as the property of the firm, but as their own individual properties. The question as to whether a property is not the property of the firm is one of fact depending upon the intention and agreement between the partners. The clauses referred to above in the two partnership deeds, according to us, clearly establish an intention to treat the properties and assets of the business as belonging only to the two partners, viz., Shri Rajamani and Shri Thangarajan, and not belonging to the partnership firm as such. It may be noted in passing that in the original deed dated 22-3-1955 when the partnership consisted of only the two partners, there are no such clauses as have been noted above which were present in the partnership deeds executed subsequently when more partners were admitted. If, therefore, the properties and assets of the business carried on by the firm belonged only to Shri Rajamani and Shri Thangarajan all along, and they have taken over the same in the relevant previous year by withdrawing it from the partnership assets, we fail to see how it can be said that there is a transfer involved by the firm of its assets to the two partners.
7. We may also proceed to examine this question on the assumption that the property and assets ceased to be separate property of the two partners, Shri Rajamani and Shri Thangarajan, when they brought it into the business of the firm and disclosed it as the assets of the firm. In that event what we have to consider is whether there is a transfer of the property and assets belonging to or owned by the firm to the two partners. The learned departmental representative in this connection has placed reliance on the Madras High Court decision in Bharani Pictures (supra) which prima facie supports the department's case. In the decision of the Madras High Court, three principles, as we see, have been enunciated in regard to assets brought in by the partners in the partnership firm or acquired by it. The first, on the authority of the decision of the Supreme Court considered by the High Court, is that a partner cannot deal with any individual asset of the firm as he cannot claim any specific share with reference to any individual property either movable or immovable and during the subsistence of the partnership the partner has a right only to get his share of profits from time to time as may be agreed upon and after dissolution of the partnership or with his retirement from it, to get the value of his share in the net partnership assets as on the date of dissolution or retirement after deduction of all liabilities and prior charges. The second proposition is that though under the law of partnership a firm has no legal existence apart from its partners and it is merely a compendious name to describe its partners, the position is different under the income-tax law, according to which the firm and the partners are distinct assessable entities. The law has thus for some specific purposes relaxed the general rigid notions, and extended a limited personality to a firm. It is also stated in this connection that there is nothing in the partnership law to suggest that the firm cannot be treated as an entity for the purpose of dealing with the property (see page 254). Thirdly, that the firm is the owner of the properties held by the firm and that a partner can sell his property to the partnership firm and consequently the firm can sell a property to a partner. The Madras High Court in this case has also referred to, evidently with approval, the following observations of the Karnataka High Court in A.S. Krishna Setty & Sons v. Addl. CIT  100 ITR 587, which has referred to the Supreme Court decision in Addanki Narayanappa v.Bhaskara Krishnappa AIR From the observations of the Supreme Court extracted, it is clear that the individual partners of a firm have no exclusive interest in the assets belonging to the firm. They can become exclusive owners of any of the assets belonging to the firm only by all the partners acting on behalf of the firm conveying or transferring their interest to such individual partners. In that event, it is clear that there is an extinguishment of the rights of the firm in the assets in question on the one hand and acquisition of interest in them by such individual partners. In law, such a transaction does amount to a transfer...
8. From the propositions of law as per the decision of the Madras High Court it is clear that according to the Madras High Court's view, the assets of a partnership firm acquired by it or brought in by the partners belonged to it and are owned by it and it is the firm which has rights over such assets and naturally when there is an extinguishment or transfer of such rights to any individual partner or partners, there is a transfer attracting capital gains charge. We are undoubtedly bound by the law declared by the Hon'ble Madras High Court, sitting as we do under its jurisdiction, and we would have straightaway accepted the department's stand in this case, but for the fact that the legal position in this connection is, according to us, differently stated by the Supreme Court in Malabar Fisheries Co. (supra), a decision though reported earlier in the Income-tax Reports is a decision rendered subsequent to the decision of the Madras High Court in Bharani Pictures (supra) which evidently explains the fact that there is no reference to the Supreme Court case in the Madras High Court decision. According to us, the Supreme Court takes a contrary view in regard to the position in law of a partnership vis-a-vis the property held by it. In this decision of the Supreme Court it has referred to its earlier decision in Addanki Narayanappa (supra), which decision has been referred to and more than one extract quoted therefrom in the Madras High Court decision, and stated the law as under at page 59 : Having regard to the above discussion, it seems to us clear that a partnership firm under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks of the firm's property or firm's assets all that is meant is property or assets in which all partners have a joint or common interest. If that be the position, it is difficult to accept the contention that upon dissolution of the firm's rights in the partnership assets are extinguished. The firm as such has no separate rights of its own in the partnership assets but it is the partners who own jointly or in common the assets of the partnership and therefore the consequence of the distribution, division or allotment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm's rights in the partnership assets amounting to a transfer of assets within the meaning of Section 2(47) of the Act. In our view, therefore, there is no transfer of assets involved even in the sense of any extinguishment of the firm's rights in the partnership assets when distribution takes place upon dissolution.
The Supreme Court was no doubt concerned in this case with distribution of the assets held by the firm amongst the partners on dissolution, but the fact of dissolution does not, according to us, make any difference to the law declared by the highest court of the country, namely, the Supreme Court, in this decision is that the firm in general law is not a distinct legal entity apart from the partners constituting it and equally so that the firm as such has no separate rights of its own in the partnership assets and all that one means when talking of the firm's property or firm's asset, is the property or assets in which all the partners have joint and common interest. In the Madras High Court decision notice has been taken of the fact that income-tax law recognises a partnership as a separate entity for the purpose of taxes.
It only, according to us, means that the partnership is separately assessable apart from the partners as a distinct entity for the purpose of taxation or charge to income-tax. There is no reference to any other provisions of the income-tax law in the decision of the Madras High Court which abrogates the position under the general law that a partnership is not a separate legal entity and it cannot own any property or assets or have any rights therein as stated by the Supreme Court in Malabar Fisheries Co.'s case (supra). In fact, the Madras High Court, for the view taken that the partnership is a separate entity capable of being the owner of assets, has referred to and relied upon the earlier decision of the Supreme Court in Addanki Narayanappa's case (supra), but the Supreme Court in Malabar Fisheries Co.'s case (supra) has referred to the same decision and reiterated the position that the partnership is not a separate legal entity apart from the partners constituting it and it can have no separate rights of its own in the partnership assets. If, therefore, a partnership firm cannot be the owner of any property or assets and can have no separate rights in the same according to general law and there is no provision in the income-tax law which seeks to abrogate this position and notionally vests in the partnership firm the ownership or rights in the properties or assets held by it, we fail to see how there can be a transfer from the assessee-firm to the two partners in this case so as to divest the title and rights of the partnership in such assets and vest them in the two partners. It may be that during the subsistence of the partnership a partner has a right only to his share of profits from time to time as may be agreed upon and after dissolution of the firm or with his retirement from it he has right only to get the value of his share in the net partnership assets as on the date of dissolution or retirement after deduction of liabilities or prior charges and he may have no specific share with reference to any individual property, either movable or immovable, though in this case, as we have already noticed, there is intention to the contrary in the subsisting partnership deed.
It may also be that in the property or assets of the firm all the partners have joint and common interest and by reason of entries in the accounts and the transactions carried out the property and assets vest only in two of them, namely, Shri Rajamani and Shri Thangarajan, and there is consequently a change of ownership from that of all the partners to that of only two partners. Whether this change amounts to a transfer so as to attract capital gains or not is a question which we are not concerned with in this appeal, where the assessee is a partnership firm and the stand of the department is that there is a transfer by the firm to the partners resulting in capital gains or profits under Section 41(2) arising to the firm. We, therefore, hold, respectfully following the law declared by the Supreme Court in Malabar Fisheries Co.'s case (supra), which must be held to supersede or override the proposition of law stated by the Madras High Court in Bharani Pictures' case (supra), that the charge under Section 41(2) and capital gains is not attracted in this case. Lastly, even on an assumption that the firm is the owner of the property and assets and there is a transfer of the same to the two individual partners, we agree with the assessee's contention that the transfer in order to be valid and effective so as to attract capital gains in this case or addition of profit under Section 41(2) must be by means of an instrument in writing since the property of the assessee involved immovable assets. We do so because the contention is supported by a decision of the Allahabad High Court in Ram Narain & Brothers v. CIT  73 ITR 423 and the proposition of law laid down therein has the agreement or concurrence of the Madras High Court as stated in the case of Bharani Pictures at page 250 of the report. For all the reasons stated above, we uphold the order of the Commissioner (Appeals) holding that there is no justification for levy of profit under Section 41(2) or capital gains in respect of the impugned transaction.