1. The assessees, whose appeals for the assessment year 1979-80 are dealt with by this consolidated order, are three brothers. The eldest of them is Shri M.K. Kuppuraj, the second brother is Shri M.K.Chandrakant and the third brother is Shri Ananthakumar. Together with three minors, who were admitted to the benefits of partnership, the three brothers by a partnership deed dated 14-4-1970 were partners in a business manufacturing scented betel nuts known as 'Asoka'. By a subsequent deed dated 13-4-1972, there was a change in the inter se shares. A further instrument of partnership was executed on 11-5-1973 by which the minors came to be excluded from the benefits of the partnership. By yet another partnership deed dated 6-9-1976, the limited company 'Asoka Betel nut Co. (P.) Ltd.' was taken as a partner by the three brothers. An item of property known as 'Asoka Building', which comprised of land on which was situated residential house as well as factory premises, was purchased out of the funds of the firm on 25-1-1973. The factory building and the land appurtenant thereto were utilised for purposes of business of the firm and the residential building and the land appurtenant thereto were utilised for residential purposes of Shri Kuppuraj, Shri Chandrakant and Shri Ananthakumar, who resided there jointly. The firm in its assessment claimed depreciation based on 60 per cent of the cost of the property, i.e., relating to the factory building and on the remaining 40 per cent, which was used for residential purposes, no depreciation was claimed. The income from the portion used for residential purposes by the three brothers was also not shown in the hands of the firm. On 11-4-1977, a dissolution deed was drawn up dissolving the firm with effect from 31-3-1977. The assets were distributed amongst the various partners. Subsequently, a document stated to be one of partition was drawn up on 22-11-1978. In this document a value of Rs. 32 lakhs was placed on the entire properties of the firm, i.e., the factory building, the residential building and the land. The company partner took over the factory building and appurtenant land thereto, which was valued at Rs. 20 lakhs and the other three partners, viz., the brothers took over the remaining property, viz., the residential house and the appurtenant land. In the entire value of the property of Rs. 32 lakhs, the company's share being one-fourth was Rs. 8 lakhs. Since the company took over the property worth Rs. 20 lakhs, an amount of Rs. 12 lakhs was paid to the three brothers. The share of each brother, thus, came to Rs. 4 lakhs and this amount of Rs. 4 lakhs was shown by each of the brothers as a sale to Asoka Betel nut Co. (P.) Ltd. Each of the brothers invested in approved securities an amount slightly exceeding Rs. 4 lakhs. Thus, in respect of the sale consideration of Rs. 4 lakhs, full exemption became available under Section 54E of the Income-tax Act, 1961 ('the Act'), in the case of each of the brothers.
2. Shri Chandrakant sold his one-third share in the residential property by document No. 3962 of 1978, dated 1-12-1978 to Smt. Gualani.
Consequent to this, Smt. Gualani became a joint owner with the remaining two brothers in the property. The remaining two brothers Shri Kuppuraj and Shri Ananthakumar in their turn released their interest in the property to Smt. Gualani by a document dated 24-2-1979. Shri Chandrakant showed the sale value of the property to Smt. Gualani at Rs. 3,00,000 in his case. Shri Kuppuraj showed the value of the released property at Rs. 3,30,000 and Shri Ananthakumar showed the value of the released property at Rs. 3,30,000.
3. The brothers had purchased jointly a property known as 'Hawarden Bungalow' in Coimbatore shortly thereafter and the value of purchase price of each brother came to about Rs. 4 lakhs. Thus, under the provisions of Section 54 of the Act, they claimed that no capital gain was exigible in respect of the residential household.4. We have elaborately set out the facts which is reflected in a cryptic manner in the computation of long-term capital gain as made by each of the brothers and the exemption claimed by them while filing their returns.
5. In the case of each brothers, the ITO while making the assessment observed that the capital gain was exempt under Section 54E.6. The Commissioner on a scrutiny of the records, was of the view that exemption from capital gains was wrongly allowed. However, the Commissioner has elaborated only on the exemption allowed in respect of the fresh purchase of residential house. In the order passed by the Commissioner in revision there is no mention of any objection against the grant of exemption of capital gains consequent to the investment in approved securities. Eventually, the Commissioner no doubt has set aside the assessment in each case stating that the ITO had not quantified how much is the exemption under Section 54 and under Section 54E and, therefore, the assessment should be redone giving exemption only under Section 54E and withdrawing the exemption under Section 54.
7. The objection of the Commissioner to the grant of exemption under Section 54 was that the house property in which the brothers were residing was not owned by them for more than two years, since the property was obtained only on 1-4-1977 by them, when the firm, in which they were partners and which firm owned the property, was dissolved.
Though the partners were staying in the said property earlier, as observed in the order of the Commissioner, he also did not consider that the requirement of their stay in the property for two years prior to its transfer was satisfied since they became owners only with effect from 1-4-1977 and the stay prior to that period was not as owners since at the material time prior to 1-4-1977, it was the firm which was the owner. Yet another objection which the Commissioner found was that the income from this property had not been offered for tax as income from house property.
8. The learned counsel appearing for the appellants relied on the language of the provisions of Section 54. We set out below the provisions as they stood at the material time : 54. Profit and sale of property used for residence.-Where a capital gain arises from the transfer of a capital asset to which the provisions of Section 53 are not applicable, being buildings or lands appurtenant thereto the income of which is chargeable under the head 'Income from house property', which in the two years immediately preceding the date on which the transfer took place, was being used by the assessee or a parent of his mainly for the purposes of his own or the parent's own residence, and the assessee has within a period of one year before or after that date purchased, or has within a period of two years after that date constructed, a house property for the purposes of his own residence, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, that is to say,- (i) if the amount of the capital gain is greater than the cost of the new asset, the difference between the amount of the capital gain and the cost of the new assets shall be charged under Section 45 as the income of the previous year ; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or (ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under Section 45 ; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain.
He submitted that the exemption could be had where capital gains arose from the transfer of a capital asset, which represented building or land appurtenant thereto, the income of which was chargeable under the head 'Income from house property'. There was a further condition that preceding the date of transfer for at least two years, the property should have been used by the assessee for his residence. According to the learned counsel, the condition that the assessee should have been the owner of the asset also for the period of two years for which he resided was not stipulated in the section. In the present case, on the date of transfer, admittedly, each assessee was the owner and the income would have been assessable under the head 'Income from house property'. Merely because no assessment was made, there was no bar to the grant of exemption because all that the section required was that income would have been chargeable from the assets transferred under the head 'Income from house property'. Certainly, the income in the present case would have been chargeable under the head 'Income from house property'. He, therefore, submitted that the exemption was rightly allowed.
9. The learned departmental representative, on the other hand, submitted that the section has to be read as a whole and it was clear that the requirement was that the assessee should have been the owner for a period of two years at least prior to the date of transfer apart from the factum of residence for that period. The learned departmental representative also relied on the reasoning in the order of the Commissioner, which is common to all the cases.
10. We have considered the rival submissions. Each of the brothers was a partner in the erstwhile firm, which owned the property. They got the property consequent to the dissolution of the firm and distribution of assets. Therefore, the property became the property of each of the brothers in the manner prescribed under Section 49(l)(iii)(b) of the Act. They obtained the property on 1-4-1977. From this date, no doubt, the sale took place within a period of less than two years. If this period subsequent to 1-4-1977 is taken in isolation, the asset would be a short-term capital asset in their hands. But the provisions of Explanation to Section 2(42A) of the Act, which define 'short-term capital asset', states that in the case of a capital asset, which became the property of the assessee in the circumstances mentioned in Section 49(1), then the period for which the asset was held by the previous owner had also to be taken into consideration. The asset having been purchased by the firm in 1973, if such period of ownership by the firm is also taken into consideration, as it has to be, the asset was not a short-term capital asset in the hands of each of the brothers. The exemption under Section 54 is not available to short-term capital asset; but since the asset is not a short-term capital asset in the hands of the assessee as long as other conditions are satisfied, exemption under Section 54 would be available. At the time of transfer each of the assessees was the owner of the asset to the extent stated.
Since the asset consisted of a building with appurtenant land used for residence, the notional income therefrom would be chargeable under the head 'Income from house property' at the time of transfer. The first set of requirements of Section 54 are, therefore, fully satisfied.
11. We now come to the expression 'which in the two years immediately preceding the date on which the transfer took place, was being used by the assessee'. We are unable to agree with the learned departmental representative that the word 'which' would imply that the asset should also have been owned for two years prior to the date of transfer. A plain reading of the section does not warrant any such interpretation.
We would also add that the qualifying nature attributed to the word 'which' in CIT v. C. Jayalakshmi  132 ITR 82 (Mad.) relied on by the learned departmental representative, does not help the proposition sought to be canvassed. As far as the user is concerned, even according to the order of the Commissioner and the facts as found by us, admittedly, each of the brothers was using the building for the purpose of residence even when it belonged to the firm. Thus, prior to the transfer by them, they were using the building for purposes of their residence for a period of more than two years. Because they were partners they stayed in their own right and the ratio of the case of Smt. Vijayalakshmi v. CIT  100 ITR 648 (Kar.), relied on by the learned departmental representative, has no application. Hence, the requirement of residence is fully satisfied. The new acquisition has been made within the stipulated period and that requirement is also satisfied. Therefore, the capital gains from the sale of the residential house would be exempt under the provisions of Section 54.
We have already indicated how the capital gains from the property taken over by Asoka Betel nut Co. (P.) Ltd. was exempt because of the investment in approved securities under the provisions of Section 54E.Therefore, the ITO was not in error in exempting the total capital gains in the hands of each of the assessees. Accordingly, the order passed by the Commissioner in each of the assessees' case it set aside and the assessment as made by the ITO in each case is restored.
12. The learned counsel submitted before us that the Commissioner was precluded from exercising his jurisdiction in the cases of Shri Chandrakant and Shri Ananthakumar because in those two cases appeals had been filed to the Commissioner (Appeals) and though the point of capital gains was not agitated, there was merger of the order of the ITO in the appellate order because the Commissioner (Appeals) could have rectified the assessments if he had considered the allowance of exemption of capital gains to be erroneous since it was a matter specifically considered by the ITO. We do not pronounce on this in the view that we have taken, viz., that on merits, the order of the ITO was not erroneous. The result is, that the appeals are allowed.