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Kantilal and Sons Vs. Second Income-tax Officer - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided On
Judge
Reported in(1985)14ITD388(Mum.)
AppellantKantilal and Sons
RespondentSecond Income-tax Officer
Excerpt:
.....year was the samvat year 2035, the appellant claimed a sum of rs. 10,460 as commission paid to shri deepak kantilal doshi, ex-partner in its profit and loss account. in support of this claim, it produced the deed of partnership and the deed of retirement. according to the deed, dated 6-10-1979, shri deepak k. doshi, the retiring partner, was to be paid 15 per cent of the net profits in this year and subsequent nine years.after examining the assessee's claim, the ito held that the payment made and agreed to be made was nothing but a sort of goodwill or payment in lieu of his future profits. he was of the view that it was a capital payment which could not be allowed to be debited in the profit and loss account of the assessee-firm. he, therefore, disallowed this amount of rs. 10,460.4......
Judgment:
1. Since these two appeals, filed by the same appellant, raise a common issue, they are disposed of by a common order for the sake of convenience.

2. The appellant, Kantilal & Sons, is a partnership firm carrying on business in all sorts of bolts, nuts, rivets, washers and screws. They are also the distributors of bolts, nuts and rivets manufactured by the Indian Steel & Wire Products Ltd., Tatanagar. In the present appeals, we are concerned with the assessments of this firm for the assessment years 1980-81 and 1981-82.

3. In the first year 1980-81, for which the previous year was the Samvat year 2035, the appellant claimed a sum of Rs. 10,460 as commission paid to Shri Deepak Kantilal Doshi, ex-partner in its profit and loss account. In support of this claim, it produced the deed of partnership and the deed of retirement. According to the deed, dated 6-10-1979, Shri Deepak K. Doshi, the retiring partner, was to be paid 15 per cent of the net profits in this year and subsequent nine years.

After examining the assessee's claim, the ITO held that the payment made and agreed to be made was nothing but a sort of goodwill or payment in lieu of his future profits. He was of the view that it was a capital payment which could not be allowed to be debited in the profit and loss account of the assessee-firm. He, therefore, disallowed this amount of Rs. 10,460.

4. Following the same line of reasoning, the ITO disallowed a sum of Rs. 33,884, which was debited in the profit and loss account for the Samvat year 2036 relevant for the assessment year 1981-82.

5. The assessee took up the matter in appeal and contended before the Commissioner (Appeals) that the payment was only in the nature of revenue expense and that the ratio of the decision of the Supreme Court in the case of Devidas Vithaldas & Co. v. CIT [1972] 84 ITR 277 would apply to the facts of the present case. The Commissioner (Appeals) examined the contentions of the assessee and held that Shri Deepak K.Doshi, who retired from the partnership, with effect from 1-7-1979, was taken into the partnership itself only on 7-11-1978, that he was the son of the partner, Shri Kantilal Doshi and that during the relevant period, he was 21 years old. The Commissioner (Appeals) further found that Shri Deepak K. Doshi went out of the partnership because he wanted to enrole himself as an articled clerk for qualifying as a chartered accountant. Having regard to these facts, namely, Shri Deepak K. Doshi was a partner only for a period of eight months and had no prior business experience, the Commissioner (Appeals) held that it could not be said that the payment made to him was towards utilisation by the appellant-firm of his goodwill. He pointed out that even in the retirement deed, there was no mention that it was towards the use of Shri Deepak K. Doshi's goodwill that it was agreed that he should be paid annually at the rate of 15 per cent of the net profits. He pointed out that the deed merely stated in clause 3 that the assets of the partnership-firm including goodwill, book debts and stock-in-trade had not been evaluated and that the accounts of the firm had not been made up excepting up to the period 1-7-1979. He also referred to clause 4 of the deed of retirement, where it was stated that in pursuance of the outgoing of the retiring partner, Shri Deepak K. Doshi and in consideration of what was stated in clause 3, the continuing partners had agreed to pay to Shri Deepak K. Doshi at the rate mentioned above.

The Commissioner (Appeals) held that it could not be seen how from this it could be concluded that the payment in question was towards the use of the goodwill of Shri Deepak K. Doshi. He further held that the only conclusion that could be drawn in the circumstances of the case was that, there was no goodwill at all which could be said to have belonged to Shri Deepak K. Doshi and, therefore, there could be no question of any payment towards the use of the same. He further held that the decision of the Supreme Court in Devidas Vithaldas & Co.'s case (supra) relied on by the appellant was not applicableto the facts of the present case. He further held that Shri Deepak K. Doshi did not render any services to the assessee-firm after he ceased to be a partner thereof and that on the amount lying to his account in the partnership, interest was also being paid. The Commissioner (Appeals), therefore, finally held that what was in fact done, was only an application of the firm's income and it could not be said that there was any diversion by overriding title but that it was only a case of mere diversion of profits. The Commissioner (Appeals) hence held that the payment could not be considered as an item of expenditure. He, therefore, upheld the disallowance of the payment of Rs. 10,460 for the assessment year 1980-81. Following this decision, he upheld the disallowance of Rs. 33,884 in the appeal for the assessment year 1981-82. The appellant feels aggrieved by these orders of the Commissioner (Appeals). Hence, the present appeals to the Tribunal.

6. Shri R.C. Desai, the learned counsel for the appellant, submitted that the appellant-firm came into existence from 1974, that on 7-11-1978, there was a change in the constitution of the firm when three new partners were admitted with effect from 1-11-1978 and that according to clause 5 of the deed of partnership dated 7-11-1978, all the business assets and liabilities of the previous firm were taken over and carried on by the new firm as a going concern. He pointed out that Shri Deepak K. Doshi, who was shown as partner No. 5 in this deed was one of the new partners, who had joined the firm on 1-11-1978. He referred to clauses 13 and 14 of the deed, which provide for the retirement of a partner and the ascertainment of the retiring partner's share in the partnership-firm including the value of the goodwill of the business. Shri Desai submitted that partner Shri Deepak K. Doshi retired from the firm on 1-7-1979 to join the chartered accountant's course as an articled clerk. The learned counsel next referred to the deed of retirement dated 6-10-1979 and pointed out that under Clause 2 of this deed, the retiring partner Shri Deepak K. Doshi released his share in the profits and other assets of the partnership and further declared that he had no right, title or interest in the profits or other assets of the partnership save and except to the extent mentioned thereafter. Shri Desai then relied on clauses 4 arid 6 of this deed and submitted that a charge was created on the future profits and assets of the appellant-firm in favour of the retiring partner and it is in pursuance of this charge that 15 per cent of the net profits of the assessee-firm were diverted by an overriding title and that this amount due to the retiring partner under these two clauses was not the income of the appellant-firm at all. In this connection, Shri Desai also relied on clause 7 of the new deed of partnership, dated 6-10-1979, which provided for the mode of computation of the net profits only "after deduction of the 15 per cent payable to Shri Deepak K. Doshi as agreed to in the deed of retirement referred to above.

7. On the above materials, Shri Desai argued that there was diversion of income by an overriding title as there was an express charge created by clauses 4 and 6 of the deed of retirement and that, therefore, the income was diverted even at its source before its accrual to the appellant-firm. In support of this, Shri Desai relied on the decision of the Supreme Court in the case of CIT v. Sitaldas Tirathdas [1961] 41 ITR 367 and pointed out that according to this decision, there would be a diversion by an overriding title when a charge is created on assets by mutual agreement. Shri Desai also relied on the decision of the Bombay High Court in CIT v. C.N. Patuck [1969] 71 ITR 713 at 720, 721, 725 and 726 and submitted that according to this decision, a charge may be created even without there being anything in writing. Shri Desai also pointed out that this decision relied on their earlier decision in the case of Seth Motilal Manekchand v. CIT [1957] 31 ITR 735 and pointed out that this decision of the Bombay High Court was not overruled by the Supreme Court decision in the case of Sitaldas Tirathdas (supra).

8. Shri Desai next argued that assuming there was no charge created in favour of the retiring partner, Shri Deepak K. Doshi, yet there was an enforceable obligation against the appellant-firm created by the deed of retirement and, therefore, there could be no accrual of income to this extent to the appellant-firm.

9. It was also submitted that the amount payable to the retiring partner was allowable as revenue expenditure, as the continuing partners had the use of the interest of the retiring partner, Shri Deepak K. Doshi, in the goodwill and other assets of the firm. In this connection, Shri Desai submitted that the business of the appellant-firm was originally carried on by a partnership firm consisting of Kantilal and his brother Kirtanlal from 1940 to 1974 with equal shares under the name and style of Kantilal & Bros., that the business of the said firm was in hardware and that they were the agents for the products of the Indian Steel & Wire Products Ltd. of the Tata group for the whole of Bombay city and Bombay presidency. He, however, fairly stated that there was no import quota rights involved in the present case. He also submitted that in 1974, the old firm was dissolved and the present partnership firm between Kantilal and his children was formed, but that the present firm could obtain the 50 per cent share in the Tata agency only in 1978 and that the said Tata agency continues till date. Shri Desai submitted that this agency rights were valuable rights and similarly, the assessee-firm had valuable tenancy rights in the shop at Nagdevi Street, which is the hub of hardware market in Bombay and that its godown was also there. Shri Desai argued that the retiring partner, Shri Deepak K. Doshi, had his valuable rights in the agency and also in the tenancy rights and these rights were not evaluated and credited to his account at the time of his retirement as could be seen from clause 3 of the deed of retirement and it is for the user of these valuable rights belonging to the retiring partner, Shri Deepak K. Doshi, that the continuing partners of the assessee-firm agreed to pay at the rate of 15 per cent of the net profits of the partnership firm during the term of ten years. Shri Desai submitted that the facts of the present case were similar to the case of Devidas Vithaldas & Co. (supra) and also of the Bombay High Court in the case of CIT v. Natwarlal Mohanlal & Co. [1976] 105 ITR 748. Shri Desai also relied on the decision of the Bombay High Court in CIT v. Crawford Bayley & Co. [1977] 106 ITR 884, where a payment made to the widow of a deceased partner was held to be allowable as a result of an obligation in the nature of a trust and as a diversion of income by overriding title. He also submitted that the Commissioner (Appeals) was in error in rejecting the appellant's contentions and in sustaining the disallowances in both these years.

10. Shri R. Raju, the learned departmental representative, submitted that the findings of the Commissioner (Appeals) clearly established that there was no diversion of income by an overriding title. He pointed out that the appellant-firm was not a partnership between strangers, but a partnership between a father, his sons and daughter-in-law. According to Shri Raju, there was no charge created in favour of the retiring partner and that by the deed of retirement, the partners of the firm had actually applied only a portion of their income after its accrual. In support of this, Shri Raju relied on the clauses in the deed of retirement and clause 7 of the new deed of partnership dated 6-10-1979 and pointed out that this 15 per cent was payable only out of the profits of the firm after accrual of such profits. He submitted that it was only a bounty or boon granted by the appellant-firm to the retiring partner, whose contribution either to the firm's goodwill or to its other assets was almost. Shri Raju argued that all the assets including the tenancy rights of the shop and the godown and the agency right were already there in existence and there was no question of any contribution made by Shri Deepak K. Doshi, who was a partner for a short period of eight months only to justify the payment of this sum as for the user of his share in that. He, therefore, submitted that the decision of the Commissioner (Appeals) was correct and that the same should be upheld. Shri Raju further submitted that the decisions relied on by the learned counsel turned on the facts and circumstances of each case and that those decisions were not applicable to the facts of the present case.

11. We have carefully considered the submissions urged on both sides in the light of the materials placed before us.

12. A perusal of the three documents placed before us shows that Shri Deepak K. Doshi joined the partnership firm on 1-11-1978 and retired from the firm on 1-7-1979. By Clause 2 of the deed of retirement, dated 6-10-1979, the said Shri Deepak K. Doshi released his share in the profits and other assets of the partnership and further declared that he has no right, title or interest in the profits or other assets of the partnership save and except and to the extent mentioned thereafter.

Clause 3 of this deed of retirement reads as follows : 3. The assets of the partnership firm including goodwill, book debts, stocks-in-trade are not valued and the accounts of the firm are not taken or made up by the parties hereto except of and for the profits of the partnership up to 1st July, 1979.

We may mention here that the profits of the firm for the two periods, i.e., from 1-11-1978 to 1-7-1979 and for the subsequent period after the retirement of Shri Deepak K. Doshi have been ascertained on the time basis as could be seen from the copy of the profit and loss account filed for the Samvat year 2035. Further, the goodwill of the firm does not figure as an asset of the partnership in the books of the firm.

13. The present claim of the appellant-firm is based on the two clauses 4 and 6 of the deed of retirement and they are quoted below : 4. In pursuance of the outgoing of the retiring partner Shri Deepak K. Doshi and in consideration of what is stated in clause 3 above, the continuing partners have agreed to make annual payment to the retiring partner Shri Deepak K. Doshi during the term of 10 years calculated at the rate of 15 per cent in the net profits of the said partnership which the continuing partners will hereafter carry on in the name of Kantilal & Sons provided that nothing contained in this deed shall constitute or be deemed to constitute any future partnership between the parties to this deed or between Shri Deepak K. Doshi and the continuing partners.

6. It is hereby agreed between the parties that the income, stock-in-trade, cash balance and other tangible movable assets of the partnership shall remain charged for securing the performance of the above obligation of the continuing partners to make the annual payment to the retiring partner.

It is the appellant's claim that a charge has been created on all the tangible movable assets of the partnership and its income, for securing the performance of the obligation of the continuing partners to make the annual payment in accordance with clause 4 quoted above to the retiring partner.

14. Clause 7 of the deed of partnership executed by the continuing partners on 6-10-1979 reads as follows : 7. The net profits of the partnership business after defraying all expenses, such as salary, rents, etc., and the payment to be made to Deepak Kantilal Doshi, namely, 15 per cent of the net profit as agreed to in the deed of retirement dated 6-10-1979 and other incidental expenses, shall be divided between the partners in the following proportion : It would be noticed that the net profit of the partnership business of the new firm is to be ascertained after meeting all the expenses, including the payment to be made to Shri Deepak K. Doshi as per the stipulation in the deed of retirement dated 6-10-1979.

15. It is necessary to refer to three more clauses of the deed of partnership, dated 7-11-1978, which was executed by the partners of the appellant-firm on the admission of Shri Deepak K. Doshi as partner along with others. Clause 5 of this deed of partnership reads as follows : 5. The assets including stock-in-trade, furniture and fixtures together with all liabilities of business of dealing in hardware, mill-gin-stores, tools and allied goods carried on by the said Kantilal with Smt. Sudha Bipin Doshi and Shri Jayesh K. Doshi in the firm name and style of Kantilal & Sons as their partners have been taken over by this partnership as a going concern.

This clause shows that this partnership took over the business of the earlier partnership along with its assets and liabilities as a going concern. Clauses 13 and 14 of this deed of partnership read as follows : 13. The partner/partners desiring to retire from partnership shall been titled to do so by giving three calendar months, notice in writing to the other partner/partners.

14. If the partnership shall be determined by the notice pursuance to the last preceding clause, the partners to whom notice is given may within one month from the receipt of such notice elect either to have the partnership wound up or to purchase the share of the partner giving notice at the net value thereof as ascertained by Kantilal Lalchand Doshi and in making such valuation, the goodwill of the business shall also be taken into account.

16. It emerged in the course of the hearing of the appeals that the business of this partnership firm was originally carried on by Kantilal and his brother Kirtan Lal and that the said partnership was in existence from 1940 to 1974, when the said firm was dissolved and the partnership firm between Kantilal and his children was formed. There is no dispute that the value of the goodwill for the share of the retiring partner in the goodwill of the appellant-firm was not ascertained and credited to his account. The appellant's claim is-that it is having a valuable agency rights which had come down from 1940 for the products of the Indian Steel & Wire Products Ltd. of the Tata group for the whole of Bombay city and the State of Maharashtra and also tenancy rights in the shop and godown where the said business is being carried on. These facts have not been controverted before us.

17. It is further seen that interest at 6 per cent per annum is credited on the credit balance in the account of the retiring partner, Shri Deepak K. Doshi. The net profit of the business of the firm is ascertained after debiting the amount of 15 per cent of the profits, which is described as commission paid to Shri Deepak K. Doshi.

18. On the above facts, it is clear that a charge has been created by mutual agreement between the retiring partner and the continuing partners securing the payment of 15 per cent of the net profits of the partnership business for a period of ten years as specified in clauses 4 and 6 of the deed of retirement. This charge is secured on the income, stock-in-trade, cash balance and other tangible movable assets of the partnership. These clauses also create an enforceable legal obligation against the appellant-firm consisting of the continuing partners and in favour of the retiring partner. This payment seems to have been agreed to by the parties in view of the fact that the interest of the retiring partner in the other intangible assets, such as goodwill, agency rights and tenancy rights of the partnership business were not ascertained at the time of his retirement. The payment in question may also be regarded as for the continuing user of the interest of the retiring partner in the said goodwill, agency rights and tenancy rights of the business. This view of ours is supported by clause 5 of the deed of retirement, which reads as follows: 5. It is hereby agreed by and between the parties that in case at a future time Shri Deepak K. Doshi desires to be admitted as a partner in the partnership firm, the continuing partners shall take him as a partner upon such terms and conditions as may be decided by and between the parties hereto.

This clause enables the parties to admit Shri Deepak K. Doshi, if he so desires, as a partner in the partnership firm at a future date on such terms and conditions as may be agreed to between them at that time.

19. In C.N. Patuck's case (supra), their Lordships of the Bombay High Court held as follows : If the decision in Motilal Manekchand's case [1957] 31 ITR 735 were to be followed, there is no doubt that even without it being held that a charge was created by the decree and the agreement, in the present case, it should be held also that an overriding obligation arose in favour of the two daughters of the assessee by virtue of the provisions contained in the two deeds and upon the other circumstances found in the case.

But we do not propose to base our decision on Motilal Manekchand's case [1957] 31 ITR 735 alone. Since the Supreme Court has clearly laid down the test in Sitaldas's case [1961] 41 ITR 367 (SC) we must too decide this case in the light of that test. Now, it is clear that the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. In deciding the question, the nature of the obligation created in each case is the decisive test. Where, however, coupled with an obligation the terms of the document give rise to an overriding charge, then there can be no doubt that there would be created in favour of the charge-holder such an overriding or superior title as would make the amount due under the charge cease to be the income of the assessee altogether....

In the creation of a charge no particular words are necessary. A charge may be created even without a writing. Whenever a particular property or fund is earmarked or made a security for the payment of a debt a charge would arise on that property or fund. Section 100 of the Transfer of Property Act is no doubt limited to charges in immovable property only but it is not exhaustive of the nature of charges contemplated in Indian law as can be seen from a number of decisions in which charges have been held to be created even against property other than immovable property or against merely a particular fund. It is sufficient if, having regard to all the circumstances of the transaction, the document shows an intention to make the particular property or fund a security for the payment of the money mentioned therein.... (p. 726) This decision of the Bombay High Court fully supports the contentions of the assessee for the allowance of this claim on the basis that there is a diversion of income by an overriding title consequent to the charge created by the deed of retirement in favour of the retiring partner and that at any rate it is an enforceable legal obligation against the appellant-firm and that, consequently, the said amount is not includible in the income of the appellant-firm.

20. The decision of the Supreme Court in Devidas Vithaldas & Co.'s case(supra) also supports the assessee's claim for deduction of this amount as revenue expenditure. In our view, this decision of the Supreme Court as well as the decision of the Bombay High Court referred to above, clinch the issue in favour of the assessee and against the revenue in the present case. We are unable to accept the contentions of the department that the contribution made by the retiring partner to the goodwill of the appellant-firm would be nil, because he was a partner only for a short period of eight months and that what has been provided for in the deed of retirement is only a bounty or boon granted by the continuing partners in favour of the retiring partner. These arguments of the revenue ignore the terms of the documents, which we have quoted above and also their legal effect. Further, these arguments overlook the valuable rights which the retiring partner had acquired when he joined the appellant-firm on 1-11-1978 and which valuable rights were not separately evaluated and credited to his account on the date of his retirement. We, therefore, respectfully follow the decision of the Supreme Court in the case of Devidas Vithaldas & Co. (supra) and of the Bombay High Court in the case of C.N. Patuck (supra) and hold that the assessee is entitled to the deduction of this amount paid to the retiring partner in these two years.


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