(1) The question that has been referred to us is:
'Whether on the facts and in the circumstances of the case, the Tribunal was justified in disallowing the claim of the assessee that it was entitled to write off Rs. 20,598/- as a bad debt under Section 10(2)(xi) of the Act?'
(2) The assess is a partnership which was constituted under a deed dated the 19th October, 1952, with five partners. The business of the firm is that of dealing in kuppas, cotton, yarn and cloth. The firm supplied cotton to Aron Spinning and Weaving Mills Limited and on that account a sum of Rs. 20,598/- was owing to the assessee. During the assessment year ending 14-11-1955, the assessee wrote off this amount as irrecoverable. In the assessment for the year 1956-57, the claim to treat this sum as a bad debt in the computation of the income was negatived by the Income-tax Officer on the ground that it had been prematurely written off. In the following assessment year, the claim was not apparently raised. In the assessment for the year 1958-59, the assessee claimed to set off this bad debt. In this regard, reliance was placed upon a copy of the order dated 1-8-1958 of the Official Liquidator High Court of Kerala, which stated that there would be no amount available for payment to the ordinary creditors as dividend.
The Income-tax Officer rejected the claim for this assessment year. His reasons were that the bad debt had been written off by the firm consisting of five partners in the account year ending with 14-11-1955. On the very next day, the constitution of the firm had been changed and it became one with nine partners. He accordingly thought that the new firm had not taken over the asset in question, that is the claim against Aron Spinning Mills, since it had already been written off. The assessee contended before the Income-tax Officer that the firm was a continuing entity and that therefore whether so expressed or not, the assessee firm as reconstituted had taken over all the assets and liabilities. This plea was not accepted.
(3) The matter was taken up in appeal to the Appellate Assistant Commissioner. He took the view that the Income-tax Officer had not correctly understood the position. He pointed out that there was no dispute that the claim was not genuine or the debt had not really become bad. He held that the firm consisting of nine partners is only a continuation of the firm consisting of five partners, and that form the recitals in the partnership deed, it could be seen that the business continued uninterrupted. When the debt was written off in the account year ending on 14-11-1955, the assessee could not foresee that the claim would be rejected as premature. By merely writing off the assessee did not give up its rights to recover the amount if it could possibly be done. It bided its time and renewed the claim when it was established that no part of the amount could be recovered. He observed:
'Having said in one year that the write off of a debt is premature, he cannot turn round in another year and say that the claim cannot be allowed for the simple reason that the entries relating to the write off are not to be found in the latter books at all. So far as the departmental records are concerned, the debt, though written off, still subsists. When the firm consisting of nine partners continued the business of the firm consisting of five partners by taking over all the assets and liabilities, it became entitled to the claim for deduction in the appropriate assessment of the write off of the debt due form the Aron Spinning and Weaving Mills Limited, even though the debt was actually written off in the books of any earlier year..........'
He accordingly upheld the claim of the assessee.
(4) The Department took the matter is appeal to the Appellate Tribunal. While the Tribunal accepted the position that it is not necessary for the assessee to write off back, in its books the debt after the original write off had not been accepted by the Department, it thought that there was a fundamental obstacle to the assessee getting any relief. It observed that the write off was on 14-11-1955 and on the very next day, a new partnership came into existence. There was no special arrangement with regard to this particular debt. It observed:
'Notwithstanding the general legal principle that a new partnership steps into all the rights and liabilities of the old partnership, in the absence of anything to the contrary, the debt is no longer that of the assessee. Therefore, the first cardinal principle for allowance of a debt, that there must be a subsisting debt to enable a write off on being satisfied as to the irrecoverability, is absent in this case.'
He then proceeded to observe that since the interest in this outstanding amount was that of five partners.
'If the present write off is allowed, nine partners would be benefited by it. That means the original five persons would get less credit than they were entitled to and there is nothing to show that on this arrangement the new partnership was entered into. The new four partners have lost nothing to entitle them to the benefit of the write off: On this reasoning, which is somewhat difficult to follow, the Tribunal set aside the order of the Appellate Asst. Commissioner and resorted that of the Income-tax Office.
(5) The assessee moved the Appellate Tribunal to refer a question of law to this Court. The Tribunal declining to do so, the assessee moved this court and under the directions of this Court, the question set out earlier stands referred to us for determination.
(6) At the outset it may be stated that there is no dispute that the amount has become incapable of realisation. Nor do we find anything in the orders of the Departmental Officers or the Tribunal to show that it had become bad at any point of time not relevant to the present assessment year. If the fundamental obstacle which the Tribunal refers to, namely, that he debt is not that of this assessee but that of a different firm consisting of a different set of persons, does not exist, then it is common ground that the set off should be available in the present case. We have therefore to see how far the view taken by the Income-tax Officer, which has been upheld by the Tribunal on this aspect of the matter, is sound in law.
(7) Mr. Ramagopal, counsel for the assessee, contended that the Income-tax Act treats a partnership as a legal entity and that the general principles of partnership law cannot be applied without considering the special status which a firm enjoys under the Income-tax Law. Reference was made in this context tot a decision of the Supreme Court in Commissioner of Income-tax West Bengal v. A. W. Figgies and Co., : 24ITR405(SC) . That was a case which called for the interpretation of S. 25(4) of the Income-tax Act, the question being whether despite several changes in the constitution of the partnerships, the assessee which was finally converted into a limited company in 1947, was entitled to succession relief under S. 25(4) of the Act. In that case, it was found that in spite of mere changes in the constitution of the firm, the business of the firm continued to be the same right from its inception till the time it was succeeded by the limited company. On the basis of certain observations found in this judgment Mr. Ramagopal suggests that since the same business was being continued by the firm of nine partners, the principle of this decision should apply. Their Lordships pointed out that S. 25(4) specifically disregarded any change in the personnel of the partners for the purposes of granting succession relief. The provisions of that section indicated that a mere change in the constitution of the partnership does not necessarily bring into existence a new assessable unit or a distinct assessable entity, and in such a case, there is no devolution of the business as a whole.
Factually it was found that the business of tea-brokers was originally started by the partnership concern consisting of tree partners. Income-tax was paid by that entity under the Act of 1918. In 1924, one partner went out, his share being taken over by the remaining two. In 1926, a new partner was introduced. In 1932, another partner retired and up to 1939, the partnership consisted of two persons. There were again subsequent changes of partners and finally in 947 the partnership was converted into a limited company. There was a provision in the partnership deed of 1939 that on the retirement of any partner, the partnership would not be determined but would be carried on by the remaining persons. Their Lordships observe:
'From the Statement of the case it does not appear that apart from mere change in the personnel of the partners and in their respective shares, there was any actual dissolution of the firm and any devolution of its assets and liabilities or a succession to its business by any outside person.' That seems to be the real test to apply in a case of this kind and not what Mr. Ramagopal suggests, viz., because the same business of dealing in cotton, etc., was carried on by the successor firm, the firm should be treated as a single entity right through.
(8) Two other decisions cited before us, namely, Shivram Poddar v. Income-tax Office Central Circle II Calcutta, : 51ITR823(SC) and Nagji Purshottam and Co. v. Commissioner of Income-tax, : 51ITR849(SC) also deal with partnership firms. In the first case, the question of the validity of a notice addressed to a partner of a dissolved firm arose; in the second, it was whether the subsequent partnership was entitled to succession relief. These decisions however afford no direct assistance on the question before us.
(9) The Tribunal has not appreciated the effect of the various provisions of the Partnership Act and in particular the relevant clauses of the deeds of partnership governing the assessee firm. Whether or not a partnership stands dissolved would be the result of the specific undertaking or agreement between the partners. A partnership is defined in S. 4 of the Partnership Act to be the relation between persons who have agreed to share the profits of a business carried on by all or any of the acting for all. Section 5 lays down that the relation of a partnership arises from contract and not from status. While Chapter VI deals with the dissolution of a firm, such dissolution is always subject to a contract between partners. Section 31 of the Act provides that no person shall be introduced as partner into a firm without the consent of all the existing partners. Sub-section (2) of this section protects a newly introduced partner with regard to his liability for any act of the firm done before he became a partner.
Section 17 is important in this context. Section 17(a) states that subject to contract between the partners, where a change occurs in the constitution of a firm, the mutual rights and duties of the partners in the re-constituted firm remain in the same as they were immediately before the change as far as may be. That postulates that the introduction of a new member or a change in the constitution of the firm does not put an end to the firm. What is clear from all of these provisions is that since a partnership is the creature of a contract, it is open to the partners to agree that the firm shall not stand dissolved on the occurrence of any particular contingency which, without such a safeguard, would in law result in the dissolution of the firm. If therefore the partners have agreed to that effect, viz., that the firm shall not stand dissolved by the taking of new partners, the firm as an entity, in so far as the Income-tax Act is concerned, must necessarily be regarded as continuing for the purposes of that Act.
(10) At this stage we may refer to the partnership agreements which are on record. The partnership as has already been stated, was commenced on the 19th October, 1952 with five persons. It contained a clause that the retirement, insolvency or death of any of the partners, for the time being of the firm, shall not dissolve the firm. On the 15th November, 1955, the five partners, along with four others, executed another deed of partnership. After tracing the commencement of the partnership, which seems to have started even in 1950, under a deed, dated 5-6-1950, and continued under the deed of 1952, the deed states:
'Whereas R. Rama Shetty and R. R. Srinivasamurthy the first two of the abovenamed parties to this deed of partnership have been for some time past seriously thinking in consultation with their other partners as how best to re-organise their partnership so that its growing business may be successfully handled and developed and whereas it was decided between them that in the best interests of the business it was wise and expedient to expand the partnership by admitting into it four more young men of trust and integrity.......................................................................
Whereas the said partnership of the firm agreed to admit and admitted the four parties, numbered (6) to (9) above, as partners of the firm with effect from the fifteenth day of November,. One thousand nine hundred and Fifty five, subject to the terms and conditions mentioned hereinafter...........................' These clauses clearly show that it was by an agreement between the existing partners that four more partners were brought in for the purpose of continuing the already existing business. While it may be that for the purposes of obtaining a registration of the firm under S. 26-A and the assessment of the individual members of the partnership as a result of such registration, the introduction of new partners may have different consequences, we are unable to see how it can be said that in the light of the agreement specifically embodied in the deed of partnership, the rights and liabilities of the firm of five partners did not become the rights and liabilities of the enlarged firm with nine partners. The business as the unit continued unbroken. It was only the interest of the partners that altered. It is therefor impossible to accept the conclusion reached by the Tribunal that the firm was a new entity to which the asset in the shape of the outstanding realisable form Arson Spinning and Weaving Mills did not stand transferred. In fact, neither in the appellate order nor in the statement of the case by the Tribunal do we find any reference to these recitals that are found in the partnership deed.
(11) The other ground advanced by the Tribunal that if the write off is to be allowed at the present time, it would ensure to the benefit of the nine partners, and that the new four partners having lost nothing to entitle them to the benefit of the write off, the write off should not be allowed, seems to us to be wholly irrelevant. Since a partnership is the result of a mutual agreement between the parties, it is open to the partners to adjust their rights and liabilities in any manner they please. That can have no impact upon the right to set off a bad debt. If the bad debt is one which is a liability of this assessee and not that of any other assessee, as the Tribunal assumed, without carefully examining the position, then the write off cannot be refused.
(12) We may refer to a passage in Lindley on Partnership (12th edition). Dealing with the effect of a change in a firm, the learned author observes of page 44:
'Another most important consequence of the principle that on any change amongst the persons composing the partnership, there is in fact a new partnership and not a mere continuation of the old one, is that although, upon a change in a firm, it may be agreed between the partners of the old and the new firms, that the rights and obligations of the old shall devolve upon the new partners, this has no effect upon third parties unless they accede to it.'
It is clear that in so far as the rights and obligations are concerned, it is a matter of contract between the partners themselves and it is only in so far as its effect on third parties is concerned that different consequences may follow. It is entirely for the partners of the firm as re-constituted to agree with regard to the rights and obligations of what may he called the old firm. It is only in cases where the interest of third parties are concerned that the old and the new partnership can not be distinguished, but as among the partners, the new partnership by reasons of the contract can take over the rights and liabilities of the old partnership. For such purposes it is not a new partnership that has come into existence but only a reconstitution of an existing partnership.
(13) We are accordingly of the view that the Tribunal was not justified in disallowing the claim of the assessee in the circumstances of the case. The question is answered in favour of the assessee. The assessee will be entitled to its costs. Counsel's fee Rs. 250.
(14) Reference answered.