1. In this case, at the instance of the assessee, the following six question have been referred by the Tribunal to us for our opinion :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the principle of mutuality will not apply and, therefore, the assessee was liable to be taxed
(2) Whether, on the facts and in the circumstances of the case, section 41(2) was applicable
(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the surplus was not capital gains, but was business income
(4) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the status of the assessee was a registered firm and not that of an association of persons
(5) Whether the Tribunal was right in holding that the assessee was not entitled to any relief on the basis of the two circulars relied on by it
(6) Whether the transfer of a going concern is liable to tax under section 45 of the Income-tax Act, or under section 41(2), or is it realisation sale, which is not liable to tax ?'
2. We are concerned in this case with the assessment year 1967-68, the previous year being financial year ending on March 31, 1967. The assessee is a partnership firm. A private limited company by the name of Artex Mfg. Co. P. Ltd. was formed with a view to take over the business of the assessee as a running concern, and the assessee is M/s. Artex Manufacturing Co. An agreement was made between the partnership firm and the limited company on March 31, 1966. In accordance with this agreement, the business carried on till that date by the assessee-firm was sold to the company as a going concern and the partners of the erstwhile firm became shareholders of the company. The partners were given shares in the same proportion in which the partners shared the profits or losses of the firm. The net purchase consideration was fixed at Rs. 11,50,400 and this amount was paid in the shape of 11,504 fully paid equity shares of Rs. 100 each and the shares were allotted in accordance with the shares of the partners in the assessee-firm. The assessee-firm filed its return showing 'nil' income and stated that the partnership firm had been converted into a private limited company with effect from April 1, 1966, and the firm had no income during the previous year ended March 31, 1967. Again, on January 9, 1970, a revised return was filed showing 'nil' income with a note that inasmuch as the firm was converted into a private limited company as a going concern, there was no income chargeable to tax either under s. 41(2) or under s. 45 of the I.T. Act, 1961. It was contended before the ITO that the conditions for invoking s. 41(2) did not apply inasmuch as business was not carried on by the firm during the previous year and the assets were not used during the year for the purpose of the business and hence the balancing charge under s. 41(2) could not be brought to tax. Purporting to rely on the Supreme Court's decision in CIT v. B. M. Kharwar : 72ITR603(SC) , the ITO rejected this contention of the assessee and held that the surplus in respect of certain items was chargeable to tax under s. 41(2) of the Act. On appeal before the AAC the assessee succeeded and it was held by the ACC that the surplus was assessable under the head 'Capital gains' and not under the head 'Business' and as regards the status of the assessee, the ACC held that the assessee must be taxed in the status of an 'association of persons'.
3. Against the decision of the ACC, appeals were filed, both by the assessee and by the revenue, to the Income-tax Appellate Tribunal. The Tribunal held that the surplus was taxable under s. 41(2) as business profits and that the status of the assessee was that of a 'registered firm'. Thereafter, at the instance of the assessee, the six questions set out hereinabove have been referred to us for our opinion.
4. Before we got to the legal position applicable to the facts of the case, it will be necessary for us to refer briefly to the agreement dated March 31, 1966, between the assessee-firm and the private limited company. The agreement was between five partners of the firm of Artex . and in the agreement the private limited company is referred to as the 'company'. The recitals in the agreement mention, inter alia, that the vendors had for some time past been carrying on the business of manufacturing art silk cloth at New Cotton Mill, No. 1 Compound, outside Rajpur Gate, Kankaria Road, Ahmedabad, under the firm name and style of Artex . and it was agreed between the parties that the vendors should sell and the company should purchase all the rented premises taken on monthly rent from the Ahmedabad New Cotton Mills Co. Ltd., situated outside Raipur Gate, Kankaria licences, quota rights, motor cars and other vehicles, stock-in-trade, implements, electric power, telephones, and equipments with which the vendors were connected in connection with the said business. Thirdly, all the book debts and other debts due to the vendors in connection with the said business and the full benefit of all securities for such debts were to be transferred to the company. Full benefits of the pending contracts, engagements and orders in connection with the said business and all cash in hand or in bank and bills and notes in connection with the said business were also to be transferred to the company. Under clause (2) of the agreement it has been recited :
'The consideration for the said sale shall be the sum of Rs. 11,50,400 (rupees eleven lakhs fifty thousand four hundred only) which shall be paid and satisfied by allotment to the vendors of Rs. 11,504 fully paid up equity shares in the capital of the company of Rs. 100 (rupees one hundred) each, to be numbered from 1 to 11,504 inclusive.'
5. Under clause (5) it was stated that on the April 1, 1966, the possession of the premises shall, as far as practicable, be given to the company and the consideration aforesaid consisting of fully paid up shares shall be satisfied subject to the provisions of the agreement and thereafter the vendors shall, at the demand by the company and at the expenses of the company, execute and do all such assurances and such things for vesting such premises in the company and giving full benefit to the company as shall be reasonably required.
6. Thus, it is clear that so far as the agreement of sale is concerned, there was in fact no itemisation of the value of the different items of assets that were being transferred by the assessee-firm to the private limited company. But it appears that information was given by the assessee to the income-tax authorities and this information thus furnished by the assessee-firm showed that machinery and dead stock which were revalued by M/s. Hargovands Girdharlal were of the value of Rs. 15,87, 296 and other assets were of the value of Rs. 25,86,677 thus making a total of Rs. 41,73,973. As against these items of assets, the liabilities were capital of partners - Rs. 3,02,014, debts, etc. - Rs. 25,75,010, development rebate - Rs. 1,46,549 and these liabilities totaled to Rs. 30,32,573 and the excess of assets over liabilities came to Rs. 11,50,400. It has also been pointed out by the ITO that the plant, machinery and deed stock as re-valued came to Rs. 15,87,296 whereas the written down value of the plant, machinery and dead stock as per the assessee's books came to Rs. 4,36,896 and hence the difference between the valuation put by the valuers, M/s. Hargovandas Girdharlal, and the written down value, as Rs. 11,50,400. In a separate table prepared by the ITO for determining profits under s. 41(2) of the I.T. Act it was pointed out that the amount for which the plant, machinery and dead stock were transferred came to Rs. 15,87, 296 whereas the written down value as per income-tax records was Rs. 3,32,276. Thus, the difference came to Rs. 12,55,020 and that was the income which was brought to tax under s. 41(2) of the Act, but ITO proceeded on the footing that for the purpose of s. 41(2), the balancing charge came to Rs. 11,50,400. The principal question that we have to ask ourselves is as to whether the principle laid down by the Supreme Court in B. M. Kharwar's case  72 ITR 603 would apply to the facts of the present case.
7. In CIT v. B. M. Kharwar  (SC), the facts were that the assessee was a firm which carried on business of manufacturing, purchasing and selling cloth. The assessee-firm closed its manufacturing side of the business and transferred its machinery to a private limited company in the share capital of which the partners of the firm had the same interest as they had in the asserts and profits of the partnership. In the assessment year 1959-60, the ITO brought to tax under s. 10(2)(vii), prov. (ii) of the Indian I.T. Act, 1922, being equivalent to s. 41(2) of the 1961 Act, the sum of Rs. 40,743 being the excess realised over the written down value of the machinery. But the Income-tax Appellate Tribunal held, relying upon the decisions in CIT v. Homi Mehta's Executors : 28ITR928(Bom) , Rogers & Co. v. CIT  (Cal), that the firm transferred the machinery only with a view to carry on the business as a company rather than as a firm, and by that transfer no profit in a business sense could be deemed to have resulted to the firm. On these facts, the Supreme Court held that the taxing authorities were not entitled, in determining whether a receipt was liable to be taxed, to ignore the legal character of the transaction which was the source of the receipt and proceed on what they regarded as 'the substance of the matter'. The taxing authority was entitled, and was indeed bound, to determine the true legal relation resulting from a transaction. If the parties had chosen to conceal by a device the legal relation, it was open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction could not be displaced by probing into the 'substance of the transaction'. That a principle applied alike to cases in which the legal relation was recorded in a formal document, and to cases where it had to be gathered from evidence-oral and documentary, and the conduct of the parties to the transaction. The Supreme Court held that the observations in Kikabhai Premchand v. CIT : 24ITR506(SC) , to the effect that in revenue cases regard must be had to the substance of the transaction rather than its mere from could not be read as throwing any doubt on the principle that the true legal relation arising from a transaction alone determined the taxability of a receipt arising from the transaction. The observation was casual and it was not necessary for the purpose of the case. As regards the liability to tax of the transaction, it was held that where machinery of a factory belonging to a firm was transferred to a private limited company, assuming that thereby readjustment of the business relationship was intended, the liability to be taxed under the second proviso to s. 10(2)(vii) of the Indian I.T. Act, 1922, in respect of the readjustment had to be determined according to the strict legal form of the transaction. The company was a legal entity distinct from the partnership under the general law, the transfer of the machinery was by the firm to the company, and the legal effect of the transaction was to convey for consideration the rights of the firm in the machinery to the company. If the transaction resulted in excess realisation over the written down value of the machinery to the firm, the liability to tax, if any, arising under the Act could not be avoided merely because in consequence of the transfer the interest of the partners in the machinery was substituted by the interest in the shares of the company which owned the machinery. It was also held, by virtue of the amendment made in the second proviso to s. 10(2)(viii), ever under a realisation sale, the excess over the written down value, not exceeding the difference between the original cost and the written down value, was liable to be brought to tax.
8. Now, it must be borne in mind that the entire assets and liabilities of the partnership were not transferred to the limited company. The business of the firm as a whole was not transferred for a slump price to the limited company but only the machinery on the manufacturing side of the business of the firm was transferred to the newly formed limited company and the consideration was received by the partners of the firm in the shape of shares of the company and the shares were allotted to the partners on the same basis as their shares in the profits of the partnership firm.
9. In B. M. Kharwar's case : 72ITR603(SC) , the Supreme Court was not dealing with a case of transfer of business as a whole by a firm to a limited company. A case of that type is to be found in CIT v. Mugneeram Bangur & Co. (Land Department) : 57ITR299(SC) . In that case, the firm which carried on the business of buying land, developing it and then selling it, pursuant to an agreement sold the business as a going concern with its good will and all stock-in-trade, etc., to a company promoted by the partners of the firm, the company undertaking to discharge all debts and liabilities, development expenses, and liability in respect of deposits made by intending purchasers. The consideration of Rs. 34,99,300 was paid by the allotment of shares of the face value of Rs. 34,99,300 to the partners or their nominees. The schedule to the agreement indicated how the sum of Rs. 34,99,300 was arrived at. On these facts, the Supreme Court held that the sale was the sale of a whole concern and no part of the price was attributable to the cost of the land and no part of the price was taxable. The fact that in the schedule to the agreement the price of the land was stated did not lead to the conclusion that part of the slump price was necessarily attributable to the land sold. What was given in the schedule was the cost price of the land as it stood in the books of the vendor and even if the sum of Rs. 2,50,000 attributed to goodwill could be added to the cost of the land, there was nothing to show that that represented the market value of the land. In arriving at its conclusion the Supreme Court held that the facts in Mugneeram Bangur's case : 57ITR299(SC) were very similar to the facts of the case which came up before the Privy Council in Doughty v. Commissioner of Taxes  AC 327. After quoting extensively from the decision of the Privy Council in Doughty's case  AC 327, Sikri J., as he then was, speaking for the Supreme Court, observed at p. 305 of the report :
'It follows from the above that once it is accepted that there was slump transaction in this case, i.e., that the business was sold as a going concern, the only question that remains is whether any portion of the slump price is attributable to the stock-in-trade.'
10. It was argued before the Supreme Court in Mugneeram Bangur's case : 57ITR299(SC) by counsel appearing on behalf of the revenue that there was profit attributable to the sale of land which was the stock-in-trade of the vendors. It was first contended that in the schedule to the agreement the value of the land and the value of goodwill and other items was specified. It was contended that although the amount of Rs. 2,50,000 was shown as the price of goodwill, it was really the excess value of the land sold along with other assets. Secondly, it was contended by the revenue, relying on the passage in Doughty's case  AC 327 that the vendor's business was a business of purely buying and selling land. The Supreme Court observed (p. 305) :
'In our opinion, on the facts of this case it cannot be said that the vendors were carrying on the business of purely buying and selling land. In this case the vendors were engaged in buying land, developing it and then selling it. The agreement itself shows that the vendors had already incurred debts and liabilities for development expenses such as opening out roads, laying out drains and sanitary arrangements, providing electricity and providing for a school.
It seems to us that in the case of a concern carrying on the business of buying land, developing it and then selling it, it is easy to distinguish a realisation sale from an ordinary sale, and it is very difficult to attribute part of the slump price to the cost of land sold in the realisation sale. The mere fact that in the schedule the price of land is stated does not lead to the conclusion that part of the slump price is necessarily attributable to the land sold. There is no evidence that any attempt was made to evaluate the land on the date of sale. As the vendors were transferring the concern to a company, constituted by the vendors themselves, no effort would ordinarily have been made to evaluate the land as on the date of sale. What was put in the schedule was the cost price, as it stood in the books of the vendors. Even if the sum of Rs. 2,50,000 attributed to goodwill is added to the cost of land, it is nobody's case that this represented the market value of the land.
In our view the sale was the sale of the whole concern and no part of the slump price is attributable to the cost of land. If this is so, it is clear from the decision of this court in Commissioner of Income-tax v. West Coast Chemicals and Industries Ltd. : 46ITR135(SC) and Doughty's case  AC 327 , that no part of the slump price is taxable.'
11. It must be pointed out that at the time relevant for the decision of the Supreme Court in Mugneeram Bangur's case : 57ITR299(SC) , the provisions as to capital gains were not part of the income-tax law in India. The agreement of sale was dated July 7, 1948, and thereafter the transaction of transfer by the partnership firm to the limited company had taken place and the provisions as to capital gains were introduced in the Indian I.T. Act, 1922, only in 1956. Hence, the only question before the Supreme Court in Mugneeram Bangur's case : 57ITR299(SC) was whether under the provisions relating to balancing charge under s. 10(2)(vii), prov. (ii), similarly to s. 41(2) of the I.T. Act, 1961, the amount could be brought to tax. The Supreme Court was not concerned with the question of capital gains on the properties. The same was the position in Doughty's case  AC 327 (PC) and the same was the position before the Supreme Court in CIT v. West Coast Chemicals and Industries Ltd. : 46ITR135(SC) .
12. All these decisions, namely, Mugneeram Bangur's case : 57ITR299(SC) Kharwar's case : 72ITR603(SC) , West Coast Chemicals' case : 46ITR135(SC) and Doughty's case  AC 327 , were considered by a Division Bench of this High Court in Sarabhai M. Chemicals P. Ltd. v. P. N. Mittal, Competent Authority, IAC (Special Civil Application NO. 1394 of 1973 with Special Civil Application No. 1481 of 1973, both decided by a common judgment on February 5, 1980-since reported in : 126ITR1(Bom) . There, it was pointed out that in Kharwar's case : 72ITR603(SC) , the partnership firm was not transferring its entire business to the limited company, whereas in Mugneeram Bangur's case : 57ITR299(SC) , the firm was transferring its entire business as a going concern to the limited company and that this was the point of distinction between the two decisions of the Supreme Court, namely, the decision in Kharwar's case : 72ITR603(SC) and the decision in Mugneeram Bangur's case : 57ITR299(SC) . After considering these decisions. It was pointed out by the Division Bench (p. 21) :
'It is clear, therefore, that such a question of balancing charge would arise only if there is sale of a particular asset of the business or particular building, plant of machinery. For the purpose of s. 41(2), all that we are concerned with is certain special types of assets, namely, building, plant, machinery, furniture or fixture.'
13. It was also pointed out by the Division Bench (p. 22) :
'It is well settled that business is property and the undertaking of a business is a capital asset of the owner of the undertaking. When an undertaking as a whole is transferred as a going concerned together with its goodwill and all other assets, what is sold is not the individual itemised property but what is sold is the capital asset consisting of the business of the undertaking and any tax that can be attracted to such transaction for a slump price at book value would be merely capital gains tax and nothing else but capital gains tax. Plant or machinery or any fixture or furniture is not being sold as such. What is sold is the business of the undertaking for a slump price. If the capital asset, namely, the business of the undertaking, has a greater value than its original cost of acquisition, then, capital gains any be attracted in the ordinary case of a sale of an undertaking and that is precisely what has been indicated in Doughty's case  AC 327 and in Mugneeram bangur's case : 57ITR299(SC) . In Kharwar's case : 72ITR603(SC) , in our opinion, relied upon by Mr. Desai for the respondents, deals with a different situation where, out of the total assets of the business, only machinery was sold and then it was a clear case of s. 41(2) or equivalent provisions of the Indian I.T. Act, 1922, being attracted to such a transaction.'
14. It was pointed out that in Killick Nixon and Co. v. CIT : 49ITR244(Bom) , a Division Bench of the Bombay High Court dealt with a transaction where a partnership firm sold all its assets and liabilities including goodwill and other contracts to two companies in consideration of the allotment of shares to the value of Rs. 90 lakhs and it was pointed out by the Division Bench that if the sale even of the business as a whole, included a sale of the capital assets of the business, the gain arising on such sale as was attributable to the capital assets would be a capital gain.
15. Thus, it is clear that if at all there is any surplus in the sense of excess of the consideration for the transfer of the business of the undertaking over the cost of acquisition of the business or undertaking within the meaning of s. 45 of the I.T. Act, 1961, there would be capital gain and such capital gain would be taxable in the hands of the assessee, that is, in the hands of the firm which transferred its business to the limited company. There cannot be any question of any balancing charge arising under s. 41(2) because a balancing charge under s. 41(2) of the I.T. Act, 1961, arises only where any building, machinery, plant or furniture which is owned by the assessee and which was or has been used for the purposes of the business or profession is sold, discarded, demolished or destroyed, and the moneys payable in respect of such building, machinery, plant or furniture, as the case may be, together with the amount of scrap value, if any, exceed the written down value, so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business or profession of the previous year in which the moneys payable for the building, machinery, plant or furniture became due. This is what is known as balancing charge in the language of accountancy and it only arises when any building, plant, machinery or furniture is sold or transferred. In the instant case, what is transferred is not plant, machinery, building or furniture as such. What was transferred was the whole business of the undertaking together with its assets and liabilities and it was not sold by any itemised value or item-by-item price fixed for the different assets of the firm but the entire business of the undertaking together with its assets and liabilities was sold for a slump price. Under these circumstances, in view of the decisions in Magneeram Bangur's case : 57ITR299(SC) , in Doughty's case  AC 327 and in West Coast Chemical's case : 46ITR135(SC) , it is difficult to accept the contention on behalf of the revenue that the provisions of s. 41(2) relating to balancing charge are attracted.
16. As we have pointed out in our decision in Special Civil Application No. 1394 of 1973 [Sarabhai M. Chemicals P. Ltd. v. P. N. Mittal, Competent Authority, IAC - since reported in : 126ITR1(Bom) ], the only provision which can possibly be attracted in a case like the present one is that relating to capital gains, provided of course the conditions for invoking the provisions of s. 45(1) and that group of sections relating to capital gains are satisfied on the facts and circumstances of this case.
17. As regards the two other questions which were agitated before us, namely, regarding the principle of mutuality, it is obvious, in the light of the decision in Kharwar's case : 72ITR603(SC) and also in the light of the decision in Pandit Lakshmikanta Jha v. CIT : 75ITR790(SC) , the principle of mutuality which was pleaded for one behalf of the assessee will not apply in this case and hence the assessee was liable to be taxed on the facts of this case.
18. The only other point which remains to be dealt with is the question of the status in which the assessee can be taxed as regards capital gains. It is clear that the assessee-firm was a firm carrying on business which it transferred with effect from April 1, 1966 to the private limited company of Artex Private Limited. After April 1, 1966, the partnership firm had no business which it was going to carry on and its business together with its assets and liabilities stood transferred to the private limited company with effect from April 1, 1966. It is clear that under s. 42(b) of the Partnership Act, subject to contract between the partners, a firm is dissolved if constituted to carry out one or more adventures or undertakings, by the completion thereof. In this case, with effect from April 1, 1966, the business of the partnership firm no longer existed and, therefore, under s. 42(b), the firm stood dissolved, and only the individual partners of the firm would be liable. Since they would be liable in their capacity as a body of individuals rather than as an association of persons they should be taxed as such under the provisions of the I. T. Act. Under s. 2(31), clause (v), an association of persons or a body of individuals, whether incorporated or not, is a 'person' for the purposes of the I.T. Act, and such a person can be assessed to income-tax. After the transfer of the business of the firm to the limited company, Artex Private Limited, the erstwhile partners of the firm became a body of individuals. They were not an association of persons because there was no business which the association was to carry on but they were a body of individuals and as such they were liable to be assessed in their capacity as a body of individuals. The status of an association of persons or a body of individuals is the same and in that status the erstwhile partners of the firm have to be taxed and the assessee cannot be taxed as a registered partnership firm. It is true that the partners had applied for registration of the firm under s. 184(7) but, if in fact they were a body of individuals and not a partnership firm, their application under s. 184(7) for continuation of registration of the firm makes no difference to the status in which they are to be assessed.
19. In the light of the above discussion, we answer the questions referred to us as follows :
Question No. 1. - in the affirmative, that is, in favour of the revenue and against the assessee;
Question No. 2. - in the negative, that is, in favour of the assessee and against the revenue;
Question No. 3. - in the negative, that is, in favour of the assessee and against the revenue;
Question No. 4. - in the negative, that is, in favour of the assessee and against the revenue;
Question No. 5. - in the negative, that is in favour of the assessee and against the revenue;
Question No. 6. - in the affirmative as to the first part; in the negative as to the second part and the third part is not arise.
20. We may point out that we have not referred to the circulars which were relied upon on behalf of the assessee because, in our opinion, the circulars merely reiterate the position as it emerges from Mugneeram Bangur's case : 57ITR299(SC) .
21. Since the assessee has substantially succeeded in this reference, the Commissioner will pay the costs of this reference to the assessee.