JAGADISAN J. - This is a reference under section 66 of the Indian Income-tax Act arising out of a controversy between the revenue and the assessee, whether the firm of partnership styled Tyresoles (India), Calcutta, is registrable under section 26A of the Act for the assessment year 1952-53, 1953-54, 1954-55, 1955-56, and 1956-57. The Income-tax Officer refused registration and on appeal by the assessee to the Appellate Assistant Commissioner registration was refused for the first four years, but was granted for the fifth year 1956-57. Both the assessee and the department preferred appeals to the Income-tax Officer. The Tribunal which restored the decision of the Income-tax Officer. The Tribunal however has referred the following questions of law to this court under section 66(1) of the Act at the instance of the assessee :
'1. Whether the firm as constituted up to September 21, 1950, is the same as the one the carried on the business thereafter with only a change in its constitution 2. Whether the firm is entitled to registration for the assessment years 1952-53 to 1956-57 under section 26A 3. If the answer to question No. 2 is in the negative, whether the losses of assessment of 1952-53 and 1955-56 ?'
Tyresoles (India), Calcutta referred to in this judgment as the assessee, was originally a partnership firm consisting of five partners. The articles of partnership were embodied aim a written instrument dated November 5, 1948. The names of the partners, their respective share capital and their profit-sharing ratio are set out herein below :
1. T. Stanes & Co. Ltd.
2. Stanes motors (South India) Ltd.
3. Mr. P. W. Davis
4. Mr. M. P. Davis
5. A. J. Davis
This partnership was for a fixed term of 10 years commencing from September 5, 1948. Clause 5 of the partnership instrument provides that the net profits of the partnership shall belong to and be divisible amongst the partners in the share belonging to them in the ratio of the share capital contributed by the respective partners. The losses also were to be divided in like proportion. Clause 18 is important and it reads as follows : '(i) If during the continuance of the partnership any partner shall die or go into liquidation or determined the partnership by notice pursuant to the provisions hereinbefore contained the surviving partners shall in the proportions in which they are entitled to share in the net profits of the partnership have the option of purchasing as from the date of the dissolution and upon the terms hereinafter appearing the share of the outgoing partner so dying, going into liquidation or determining the partnership as aforesaid to be exercised by giving the outgoing partner or his representatives notice in writing of his intention in both behalf within three calendar months from the date of the death, liquidation or determination as the case may be.' (ii) 'The purchase money shall be the fair value as determined by the auditors of the partnership at the date of the dissolution of the share of the outgoing partner in the partnership net assets and effects including therein the goodwill of the business to be ascertained in case of dispute under the arbitration clause hereinafter contained' ...... (iv) 'The purchase money shall be payable as to so much thereof as shall represent capital by six equal installments at intervals of one calendar month (the first to be paid at the expiration of two calendar months from the date of the dissolution) with interest at the rate of six per cent. per annum on the amount thereof for the time being unpaid' ...... (vi) 'The outgoing partner or his representatives shall do all such acts and execute all such assurances as may be necessary for vesting in the partners exercising the option the assets including the goodwill and property of the partnership at the date of dissolution.'
Clause 18 extracted above prevents the dissolution of the firm which would normally occur in the event of the death of pa partner or in the event of the liquidation of one of the partners which is a limited company registered under the Indian Companies Act. The right of the other partners of the firm who remained, after the death of any one of the partners or after the winding up of any one of the partners of the firm, which is a limited company, to purchase the share of the deceased partner or the extinct partner when availed of would result in a reconstitution of the firm. Clause 19 may also be set out. It is follows : 'Upon dissolution of the partnership in any event not otherwise herein provided for a full and general accounting of the assets, liabilities and transactions of the partnership shall be taken and the assets and property thereof shall with all convenient speed be realised and sold and the debts due to the partnership got in and the proceeds shall be applied in the first place in discharge of the liabilities of the partnership and expenses of liquidating the same and realising the assets thereof and in the next place in payment to each partner or his representatives of any unpaid interest or profits coming to him including his share of the sum for the time being standing to the credit of the reserve fund and of the amount due to him in respect of capital and the surplus (if any) of the moneys realised as aforesaid shall be divided between the partner or their representatives in the shares in which the partners shall be entitled to the net profits of the said business and the partners or their representatives shall execute such instruments for facilitating and effecting and effecting the realisation and division of the assets of the partnership and for their mutual indemnity and release and otherwise as may be requisite or proper.....' This clause deals purely with the adjustment of rights of the partners on dissolution of the firm.
Within two years after the constitution of the partnership and the commencement of the partnership business which was one for the manufacture and sales of tyresoles, the partner fell out. There was difference of opinion between the three individual partners, P. W. Davis, M. P. Davis and A. J. Davis, who were European planters on the one hand and the two limited companies on the other (T. Stanes And Co. and Stanes Motors (South India) Ltd.). The reason for the dissension between the partners is not far to seek as obviously the individual partners were not satisfied with the way in which the business was carried on as the business was incurring loss. In respect of the accounting year ended June 30, 1949 (assessment year 1950-51), the loss was Rs. 92,773 and in respect of the accounting year ended June 30, 1950 (1951-52), the loss was Rs. 44,407. In this state of affairs in September, 1950, the three individual partners who may be conveniently described as the 'Davis group' resolved to retire from the partnership and to this course the two other partners who may be called the limited companies readily agreed. The terms and conditions of this arrangement were embodied in a document styled as a deed of dissolution dated September 21, 1950. It is necessary to set out the several clauses of its document as the ultimate decision in this case largely depends upon its construction. The document refers to the Davis Group as the retiring partners and to the limited companies as the continuing partners. Clause 1 of this deed of dissolution is as follows : 'The said partnership between the parties hereto in the business of manufacturing and selling tyresoles, etc., carried on by them under the said deed or partnership in hereby or be dissolved by mutual consent so far as the retiring partners are concerned on this the 21st day of September, 1950, and the said business shall from that date be carried on by the continuing partners as their business and notice of such dissolution should be forthwith advertised in the Fort. St. George Gazette, Madras, and notified to the customers of the said partnership.' Clauses 3 runs thus : 'The continuing partners shall on the execution of this deed at once pay the retiring partners, Mr. A. J. Davis, a sum of Rs. 9,739-11-6, Mr. P. W. Davis, a sum of Rs. 16,367-10-9 and M. P. Davis, a sum of Rs. 27,277-13-0, being the amounts agreed upon between the retiring and the continuing partners as consideration for the purchase of the farmers interest. The continuing partners further agree to pay the retiring partner up to November 4, 1958, from the time when the losses sustained by the partnership have been made good out of the profits of the carrying on of the business by the continuing partners in the future or if the said T. Stanes & Co. Ltd. draw any commission from the business during the said period before previous losses have been made good, 2 1/2 % of the annual net profits, if any, of the business as certified by the auditors, Messrs. Fraser and Ross, annually to be shared between them in the proportion in which they were entitled to share profits under the said partnership deed, dated the 5th November, 1948.' Clause 6 reads thus : 'In consideration of the said sums paid to the retiring partners by the continuing partners on the execution of this deed and of the covenants and agreements on the part of the execution of this deed and of the covenants and agreements on the part of the said continuing partners hereinbefore contained each of the said retiring partners as beneficial owner hereby assigns and relieases unto the said continuing partners all their respective shares and interests of and in the said business of the said partnership hereby dissolved and the property, assets, credits, effects and goodwill thereof, to hold the same unto the said continuing partners absolute.' Clause 7 : 'The continuing partners shall be at liberty to collect all the assets of the late partnership and to demand, sue for recovery, receive and give full and effectual receipts and discharges for all debts and effects or due or owing to or belonging to the late partnership and to settle and effects or due or owing to or belonging to the late partnership and to settle all accounts relating to the said business and to compound for or release any debts or claims belonging thereto and to institute any actions or other proceedings for compelling payment or delivery thereof and for the purposes aforesaid or any of them to use the name of the retiring partner upon indemnifying him against all costs and liability incurred by such use.' Clause 8 : 'The continuing partners shall pay all debts and liabilities of the late partnership and shall indemnify the retiring partners against the same and all actions, proceedings, costs, claims and demands in respect thereof.' The nomenclature of the document which is styled as a deed of dissolution and the reference to the partnership in several clauses of the instrument as the 'late partnership' have weighed with the Income-tax officer and the Tribunal in determining the turn scope and character of the instrument.
Before discussing the crucial question arising in the case, namely, whether there was in fact a dissolution of the firm constituted under the instrument dated November 5, 1948, or whether that firm was merely reconstituted after the retirement of the Davis Group of partners, we shall refer to some other facts. The book results of profits and losses for the five years in question are as follows :
up to 21-9-1950 loss from 22-9-1950 to 30-6-1951
There was no division and allocation of the loss incurred for the five years fully July 1, 1950, to June 30, 1955. The losses commencing from 1950-51 were carried toward from year to year and it was only after the closing of the books for the year ended June 30, 1955, there was a division of profits between the two limited companies in the proportion of 51 per cent. and 49 per cent.
For the assessment year 1952-53, two applications for registration of the firm were filed under section 26A. One was a renewal application in respect of the profits up to 21 September, 1950, the date of the alleged dissolution signed by the five partners and the others was an application for registration for the period thereafter signed only by the two partners, the limited companies. For the subsequent assessment years applications for renewal of registration were filed signed by the two limited companies, quite properly, as even if there was a reconstitution of the firm Davis group had retired.
The Income-tax Officer refused to register the firm for any of the assessment year for the following reasons : (1) For the period up to September 21, 1950, registration cannot be had as there was no distribution of the losses in the individual folios of the partner in the partnership accounts. (2) The original partnership, though for a period of ten years from November 5, 1948, was dissolved on the execution of the document dated September 21, 1950, and that there was no fresh instrument of partnership between the two limited companies and that the basic requirement of the applicability of section 26A, namely, the existence of a written instrument, was absent.
The Appellate Assistant Commissioner, who heard the appeals preferred by the assessee, refused registration for the first four years on the ground that there was no allocation and adjustment of profits or losses between the individual partners in those years as required by law, in conformity with the shares of the partners under the articles of partnership. The Appellate Assistant Commissioner observed thus in his order : 'Inasmuch as the losses of the first two years and the profits of the second two years as per books were not so divided or credited in the accounts, the certificates given by the appellant in support of their applications for registration and renewal of registration are not correct at all. As this Statutory requirement has not been fulfilled, the appellant is not entitled to the benefits of registration for these years. I accordingly confirm the Income-tax Officers orders refusing to grant registration to the firm on this ground.' For the assessment year 1956-57, the Appellate Assistant Commissioner held that the assessee was entitled to registration as in his view there was no dissolution of the original partnership but was only a reconstitution as per the terms of the deed dated September 21, 1950, and as admittedly in respect of this year there has been a division of profits between the partners in the ratio of 51% and 49%, the shares to which they are entitled.
The Income-tax Appellate Tribunal deferred from the view of the Appellate Assistance Commissioner and held that there was in fact a dissolution, that the terms of the documents dated September 21, 1950, could not be construed as bringing about an arrangement by way of reconstitution of the firm, that that instrument cannot be treated or construed as an instrument of partnership between the two limited companies and that registration should be refused on the short ground that the partnership sought to be registered is not evidenced by an instrument in writing. It is this view which has been challenged before us. The registration for the period prior to September 21, 1950, was refused on the ground and there was no distribution of losses between the partners.
The dissolution and reconstitution of a partnership are two different legal concepts. The dissolution puts an end to the partnership, but reconstitution keeps its subsisting, though in another form. A dissolution followed by some of the erstwhile partner taking over the assets and liabilities of the dissolved partnership and forming themselves into a partnership is not reconstitution of the original partnership. The partnership formed after the dissolution is a new partnership and not a continuation of the old partnership, for it would be a contradiction in terms to say that what ceased to exist was continued. A reconstitution of a firm a partnership necessarily implies that the firm never became extinct. What it denotes is a structural alternation of the membership of the firm, by addition or reduction of members, and an incidental redistribution of the shares of the partners.
The English law does not recognise a reconstitution without dissolution where a member wants to retire without the consent of the other partners. Lindley in his partnership Law states : 'There is only one method by which a partner can retire from a firm without the consent of his co-partners, and that by dissolving the firm.' But the Indian Partnership Act has enacted a special provision for retirement of a partner, and that is section 32 which reads as follows :
'32. (1) A partner may retirei - (a) with the consent of all the other partners, (b) in accordance with an express agreement by the partners, or (c) where the partnership is at will, by giving notice in writing to all the other partners of his intention to retire.....'
Section 17 of the Partnership Act provides :
'17. Subject to contract between the partners -
(a) where a change occurs in the constitution of a firm, the mutual rights and duties of the partners in the reconstituted firm remain the same as they were immediately before the change, as far as may be...'
In T. C. No. 12 of 1955, Ramachandra Iyer J., as he then was, pointed out that retirement of a partner need not necessarily have the effect of the dissolution of the firm in law. The learned judge observed : 'The firm, though originally constituted with five partners, continued to function after its reconstitution by the retirement of two of its original five partner. A retirement of a partner may sometimes happen by dissolving the firm. It can also take place without any such dissolution. Section 32 of the Indian Partnership Act enumerates the circumstances in which a partner may retire from a firm without a dissolution (in such cases the number of the remaining partners should be two or more). The remaining partners would then continue to carry on the business of the firm, and such continuance does not involve the concept of the dissolution of the firm as originally constituted and the formation of a new firm by the other partners. Section 17(a) for the Partnership Act prescribes that the mutual rights and duties of the partners in the reconstituted firm remain (subject to the contract between the parties) the same as they were immediately before the change, as far as may be.'
We have now to address ourselves to the question of the proper interpretation of the so-called deed or dissolution dated September 21, 1950. Mr. S. Ranganathan, learned counsel for the department, laid considerable stress on the words 'dissolution' and 'dissolved' and 'late' occurring in various parts of the instrument. Mr. Ramamani, learned counsel for the assessee, was not less insistent in harping upon the expressions 'continuing partner' and 'retiring partners' used throughout the instrument in support of his contention that the real intention of the parties was a retirement of three partners and are reconstitution of the firm and not a dissolution and a formation of a fresh partnership. In our opinion, the test of the pudding is in the earning and the true scope of the instrument can readily be ascertained from what actually happened instead of merely depending upon expressions which the parties might have under some mistaken notion loosely used. The Davis group went out of the partnership. They received consideration for their retirement and that consideration consisted not merely of lump sum payments, but also of some amounts which may on the happening of a contingency be made payable to them : vide clause 3 of the instrument. The two limited companies who bought out the shares of the outgoing partners took over all the assets and liabilities of the firm, and carried on the business with no change except that the partnership which originally consisted of five members became a partnership of two members. Even the profit-sharing ratio of the surviving partners was not in any way changed after the instrument dated September 21, 1950. Their shares were in the ratio of their capital investment. It is true that their shares increased from 26 and 25 per cent. to 51 and 49 per cent. but that was because of the increase of capital contributed by them respectively. The integrity of the business as it was under the previous instrument of partnership dated November 5, 1948, was in no way broken on September 21, 1950, and it is impossible to say that there was a dissolution in fact of the entire partnership. Clause 1 of the document dated September 21, 1950, is indeed significant when it recites that the partnership is dissolved so far as the retiring partners are concerned. A full and compete dissolution of the partnership between all the partners would certainly have not been described in this manner if in fact such a dissolution was intended by the parties. The clause that provides for the continuance of the business of the surviving partners and which enables the outgoing partners to a share of profits which the firm may earn in future after September 21, 1950, till November 4, 1958, after adjustment of the previous years losses including such commission as T. Stanes & Co. May draw, quite significantly emphasise the intention of the parties that there was to be no dissolution of the firm. No member of a dissolved firm can insist as a term of dissolution that the quondam partnership business should be carried on by the other members for his benefit also. Such a stipulation is wholly repugnant to dissolution. Now there cannot be both a dissolution and a continuance. But in the case of a retirement of a partner it is open to the outgoing partner to bargain for a share in the future profits of the firm after his retirement as consideration for his retirement. A clause of this description (clause 3 in the deed September 21, 1950) is so much against the grain of dissolution and is so harmonious with retirement of partners resulting in reconstitution that it should be taken as a circumstance indicating reconstitution. The absence of any fresh deed of partnership between the two surviving partners also indicates not a dissolution but a continuance of the old firm. We are unable to construe the provisions of the document as having effectuated a dissolution and in our opinion that document merely embodies the arrangement by which three of the partners retired from the firm.
Learned counsel for the department does not dispute that if there was no dissolution in fact the articles of partnership dated November 5, 1948, read with the modification introduced under document dated September 21, 1950, would sufficiently satisfy the requirement of law regarding the necessity of a written instrument to obtain registration. It is however contended for the department that the profit-sharing ratio of the two surviving partners after the retirement of the Davis group is not disclosed on the face of the two documents dated November 5, 1948, and September 21, 1950, and that, in fact, the shares of these two partners were determined only by a resolution dated June 20, 1951. That resolution reads as follows : 'It is also hereby resolved that the profits and losses of the new partnership will be divided between the continuing partners in the proportion of the capital above mentioned.' We must point out that this resolution did not for the first time fix the shares of the two members of the partnership. Clause 5 of the document dated November 5, 1948, clearly provides that the profits and losses shall be shared amongst the partners in the ratio of their respective share capital. In our opinion the profit-sharing ratio of the partners is apparent ex facie on the two documents referred to. Learned counsel for the assessee conceded that in respect of the first four years, 1952-53, 1953-54, 1954-55 and 1955-56, the application for registration cannot be sustained as admittedly there was no distribution and division of profit or losses as required by the rule. He has necessarily to concede this position in view of the decision of this court in Surajmalls v. Commissioner of Income-tax. If follows that the assessee would be entitled to registration for the assessment year 1956-57.
Question No. 1 is answered in the affirmative and in favour of the assessee. Question No. 2 is answered in favour of the assessee in respect of the assessment year 1956-57 and against the assessee in respect of the other years 1952-53 to 1955-56. Question No. 3 relates to the right claimed by the assessee to set off the losses for assessment year 1950-51 and 1951-52 in the assessments of 1952-53 and 1955-56. The Tribunal held against the assessee in respect of the losses of the assessment years 1950-51 and 1951-52 only on the ground that there was no change in the constitution of the firm within the meaning of section 24(2), proviso (e). We have now held that there has been change in the constitution of the firm and it follows that in regard to the two years the assessee would be entitled to relief by way of carrying forward the losses attributable to the shares of the continuing partners. In respect of the loss of the assessment year 1951-52 sought to be set off in the assessment year 1955-56 we do not think that the assessee will be entitled to any relief in view of what has been pointed out by the Appellate Tribunal in its order. The Tribunal observes : 'The claim relates to the 1955-56 assessment. But in the intervening two years, 1953-54 and 1954-55, there were profits against which a portion of these losses now sought to be set off could have been set off. This the assessee failed to claim at the relevant time. This contention was not taken before the Appellate Assistant Commissioner and does not arise out of his order. The appeal is liable to be rejected on this ground.' In our opinion, the assessee is clearly disentitled to have the losses of 1950-51 and 1951-52 set off against the income of the assessment year 1955-56 for the above reason set out by the Tribunal. Question No. 3 is therefore answered in favour of the assessee only in respect of the assessment year 1952-53 and against the assessee in respect of the other year 1955-56. As both the department and the assessee have partly succeeded and failed, there will be no order as to costs in this reference application.
Question answered accordingly.