1. Rudrappan, who is the assessee in this income-tax reference, is since deceased and his legal representatives have been brought on record. The assessee, Rudrappan, was a partner in a registered partnership firm of eight persons called 'Universal Paper Tube Company', Coimbatore. The partners' shares in that firm were equal. The assessee contributed Rs. 15,000 as and towards his share of capital in the firm. Under the terms of the partnership, this amount held to be returned at the time when the assessee left the firm. Actually, the assessee retired from the firm with effect from April 1, 1971. During the period of three proceeding years ending with March 31, 1971, the firm had run into losses. The assessee's share of the losses amounted to Rs. 20,831.28. under the agreed terms of the retirement of the assessee, the capital contribution of Rs. 15,000 paid by him was returned to him and his share of accumulated loss, namely, Rs. 20,831.28 was also forgone. The ITO treated this sum of Rs. 20,831 as income derived by the assessee from the firm and subjected it to assessment as part of his assessable profits under the head business. The assessee appealed against the assessment. His contention was that this sum of Rs. 20,831 cannot be regarded as a receipt taxable under the head 'Business' but must be dealt with as a long-term capital gain. It was under this head that he had returned the amount in his return of income. The AAC rejected the assessee's contention. He upheld the action of the ITO in bringing to assessment the sum of Rs. 20,831 under the head 'Business' on the score that s. 41(1) justified the charge. In the further appeal by the assessee to the Tribunal, the question in controversy was whether the amount could be regarded as long-term capital gains or whether it should be assessed as a revenue receipt chargeable under the head 'Business'. The Tribunal found that the sum of Rs. 20,831 was styled as payment towards the assessee's share of goodwill in the accounts of the firm, which continued the business on the assessee's retirement from the partnership. The Tribunal found that the goodwill of the firm itself had not been evaluated at any time till the date of retirement of the assessee from the partnership. On these facts, the Tribunal proceeded to examine whether the amount could be properly brought to change as a revenue receipt taxable under the head 'Business'. Before the Tribunal, as before the AAC, the Department's stand on this issue was that the sum of Rs. 20,831 represented a loss which had been incurred by the assessee in the earlier years, but in respect of which the assessee obtained a relief or benefit from his firm by way of remission from liability to share the loss. The Tribunal, however, rejected this contention holding that the loss referred to in s. 41(1) is not kind of loss which the assessee in this case had to contend with, which was only his share of losses from the firm for the preceding three years. According to the Tribunal, the expression 'loss' in s. 41(1) must be read along with 'expenditure or trading liability' spoken of in that section and in that sense such a loss can only mean that loss which enters into the computation of the profits under the head 'Business' as a deduction or allowance. On the above reasoning, the Tribunal held that the ITO was not right in regarding this sum of Rs. 20,831 as a revenue receipt taxable under the head 'Business' but it ought to be properly brought to tax under the head 'long-term capital gains'.
2. In this reference by the Tribunal, made at the instance of the Department, we are asked to consider the correctness of the Tribunal's conclusion, on the basis of the following question of law :
'Whether, on the facts and in the circumstances of the case, the sum of Rs. 20,831 received by the assessee on the occasion of retirement from the firm was not a revenue receipt taxable to income-tax ?'
3. We have earlier narrated the point in controversy between the assessee on the one hand and the Department on the other. We have also traced the course of proceedings right from the assessment stage up to the order of the Tribunal in appeal. Given a broader approach than what the previous course of proceedings permit, we might have been inclined to hold that the sum of Rs. 20,831 was a pure and simple payment towards the assessee's share of the partnership goodwill. Not only because it was so described, but there is nothing to show that it was anything else. Mr. Jayaraman, learned counsel for the Department, said that this payment of Rs. 20,831 could not possibly be towards the assessee's share of goodwill from the firm, even though it was described as such in the firm's accounts. The reason Mr. Jayaraman adduced was that it was an amount which was identical with the figure of the assessee's share of accumulated losses for the last three years. We do not think it is a proper way to understand the nature of the settlement between the assessee and the continuing partners of the firm. A payment towards goodwill must be judged according to the character of the payment and not on the basis of the figure it represents. It is very likely that a retiring partner may not be interested in demanding and obtaining the entire share of goodwill to which he is entitled but might be content to receive some lesser amount which will simply relieve him of his share of losses. Again, if we were free to go into the correctness or otherwise of the very basis of the assessee, we might possibly come to the conclusion that since Rs. 20,831 represents only the assessee's share of goodwill and none the less so for the fact that it is an amount identical with the assessee's share of past losses, the question of the receipt being assessable as capital gains, long-term or short-term, would not arise, because it would be a pure and simple capital receipt under the head 'Business'. However, since the assessee himself had not at any time claimed that this sum is not taxable at all under any head, but had only claimed the amount as not being chargeable under the head 'Business' we are saved from going into these aspects for the present purpose of disposing of this reference.
4. The prices point in controversy in the reference, we have earlier indicated, falls within a narrow compass. It is, whether s. 41(1) would apply in order to enable the ITO to bring to charge the amount of Rs. 20,831 as income taxable under the head 'Business' in the year in which he obtained it as a benefit. Section 41(1) lays down a procedure by which allowances and deductions granted to an assessee in prior years can be offset in subsequent year's assessment following later developments under which it becomes clear that the real reason for the allowance or deduction earlier granted no longer subsists. The section speaks of an allowance or deduction having been granted in a earlier year in respect of 'loss, expenditure or trading liability incurred by the assessee'. In such a case, where in any subsequent year the assessee obtains, whether in cash or in any other manner, any amount in respect of any such 'loss, expenditure or trading liability' by way of remission or cessation of that liability, to the extent the assessee is a gainer or a beneficiary, he shall be deemed to be in receipt of profits and gains to that extent and be liable to be charged to income-tax, on the basis that the value of the benefit or the amount of remission represents the income of that subsequent year. On the world of this provision, it is not sufficient that an allowances or deduction had been granted in assessment to the assessee in an earlier year, but that the allowance or deduction so granted must relate to a loss, expenditure or trading liability. The claim of the Department in this case is that the assessee's accumulated share of losses in the firm for the last three years amounting in all to Rs. 20,831 must be regarded as a loss incurred by the assessee within the meaning of s. 41(1) of the Act. This was the argument addressed to us by Mr. Jayaraman as well.
5. We do not agree with this submission. The expression 'loss' is used in business jargon as well as in the I.T. Act in at least two different senses. Where the result of a year's trading is a minus quantity, that is called a loss. The accountant would describe it as a debit balance in the P & L account. This is one sense in which the expression 'loss' is used. But even where the net result of a year's trading is a profit or a credit balance in the P & L account, there may be individual items of losses incurred by the person carrying on the business which might get embedded in that account. Easy illustration of these losses, which may be called itemised losses for the sake of distinguishing them from the other kind, are loss of stock-in-trade by natural process or by fire, loss of circulating capital or money by exbezzlement of an employee, and the like. What s. 4(1) deals with are losses of the latter kinds, namely itemised losses. For, it is only in respect of the losses incurred by the assessee in the course of a business that a 'deduction' or 'allowance' is given or can be given. Where the year's trading result in a net loss, that loss is not such a los with respect to which any 'deduction' or 'allowance', properly so called, is or can be given either under the I.T. Act or under any accountancy principle. That loss is a computed loss, not a loss incurred. If it is regarded in a loose sense, as a loss incurred, it is a loss incurred in the carrying on of the business as a whole, which is the result of a year's trading. Itemised losses incurred in this or that item of business transaction would come in for deduction or allowance in the computation of business results for the year as a whole which may happen to result in a net loss or a net profit for the year. Where itemised losses incurred by an assessee are allowed or deducted by the Income-tax Department in any given assessment year, then such a loss would properly enter into consideration for the purpose of application of s. 41(1) in any subsequent year should the assessee come by some benefit or remission with respect to that very item of loss.
6. In the present case, assuming that the assessee was compensated for his earlier years' share of losses when he was given Rs. 28,831 by the continuing partners, that amount can hardly be regarded as benefit or a remission given to him in respect of any loss incurred by him and in respect of which any allowance or deduction had been granted to him in any earlier assessment year, within the meaning of s. 41(1) of the Act, since the loss was the outcome of the trading result of the firm in the past years and not an item of loss incurred by him in the course of any business carried on by him.
7. An argument was addressed by Mr. Jayaraman to the effect that if under the partnership law, a firm is to be regarded, in the broad sense, only as a compendious term to describe the constituent partners, any loss in the business of the firm must be regarded, to the extent of the share of each partner, as a loss incurred by that partner. This proposition might be accepted as correct if by loss is meant the loss arrived at, at the end of a year's trading, as a matter of computation of the year's results. Indeed, provision for the sharing of the firm's losses by the partners is to be found in ss. 75 and 78 of the I.T. Act and other related provisions. These provisions do not really touch the question of itemised losses even of a firm. In the very nature of things, they cannot, because what they deal with is a loss which is a matter of computation of a year's trading. In the computation of the firm's trading results for a year there might be items of profits as well as items of losses. When a partner's share in the ultimate trading result of a firm is computed, then it is the net loss or the net profit which would come in for allocation. Under s. 67 of the Act, it is enacted that in computing the total income of a partner of a firm, the net result of the computation of the total income of the firm, whether it is a net profit or a net loss, must be computed first and then his share must be ascertained therefrom. This shows that any share of a partner, whether it be a share in the net profit or net loss of the firm, cannot be dissected to discover whether it includes any share in an itemised loss of the firm. The itemised loss of the firm gets merged in the crucible of the firm's net profit or net loss for the year.
8. Having regard to these consideration, we hold that the Tribunal was right in treating the sum Rs. 20,831 received by the assessee on the occasion of his retirement from the firm as not liable to be assessed as a revenue receipt under s. 41(1) of the Act, and that it must be regarded as payment to the assessee as consideration for his relinquishing his interest in the partnership firm including his share of the goodwill. On the assessee's own pleadings, the Tribunal, in our opinion, was also right in holding that tax has have got to be levied on the amount, treating it as a long-term capital gain considering that no other basis for tax treatment of this amount was put forward by the assessee himself at the assessment stage.
9. In the result, the reference is answered in favour of the assessee and against the Department. The assessee will be entitled to costs. Counsel's fee Rs. 500.