1995-VIL-389-GUJ-DT

Equivalent Citation: [1996] 222 ITR 831, 131 CTR 127, 84 TAXMANN 515

GUJARAT HIGH COURT

Date: 21.12.1995

BANYAN AND BERRY

Vs

COMMISSIONER OF INCOME-TAX

BENCH

Judge(s)  : C. K. THAKKER., RAJESH BALIA 

JUDGMENT

The judgment of the court was delivered by

RAJESH BALIA J. --- The Income-tax Appellate Tribunal, Ahmedabad Bench B, by its order dated April 6, 1993, has referred the following questions of law to this court for its decision which are said to have arisen out of the Income-tax Appeal No. 5230/Ahd of 1991 relating to the assessment year 1988-89.

The questions which have been referred at the instance of the assessee in R. A. No. 709/Ahd of 1992 are :

" (i) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the sum of Rs. 1,48,24,876 became taxable in the hands of the firm which according to the assessee stood dissolved through dissolution deed dated August 16, 1984 ?

(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the case would be governed by the Supreme Court decision in the case of McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148 and not by the Supreme Court decision in CWT v. Arvind Narottam [1988] 173 ITR 479 and by the Madras High Court decision in the case of M. V. Valliappan v. ITO [1988] 170 ITR 238 ?

(iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that even after the income is taxed protectively or with remarks to that effect in the hands of the members of association of persons, the same income can be validly taxed again in the hands of the firm constituted by the same members as partners ? "

The following two questions have been referred at the instance of the Commissioner of Income-tax in R. A. No. 872/Ahd. of 1992 :

" (i) Whether, the Appellate Tribunal is right in law and on facts, in holding that the award amount of Rs. 1,48,24,876 is not taxable in the hands of the assessee-firm under the provisions of section 176(3A) read with section 189(1) of the Act ?

(ii) Whether, the Appellate Tribunal is right in law and on facts in holding that the provisions of sections 28(iv), 60 and 63 of the Act were not applicable in the instant case ? "

The facts as appear from the statement of case and found by the Tribunal may be noticed at the outset.

Banyan and Berry was a partnership firm under a deed of partnership executed on November 16, 1982, with sixteen partners. The business of the firm was of contractors, engineers and builders. A private limited company under the name and style of Banyan and Berry Construction Private Limited was incorporated on April 16, 1983. A transfer deed was executed between the firm, Banyan and Berry (hereinafter called, " the firm ") and Banyan and Berry Construction Private Limited (hereinafter called " the company "), by virtue of which it was agreed that subject to the provisions contained in the agreement, the firm would transfer to the company with effect from July 1, 1984, all the assets and liabilities of the firm together with the goodwill thereof with an intention that the firm's business may be taken over as a running concern by the company with effect from July 1, 1984. There was specific provision in the agreement to the effect that the benefit of additional claims relating to construction of dam at Mazam Irrigation Scheme would not stand transferred to the company. The relevant clause of the agreement reads as under :

" 5(d). The firm was awarded a contract for construction of earthen dam for Mazam Irrigation Scheme in the Sabarkantha District. The said work has been completed and handed over to the State Government and the firm has submitted its final bill to the Irrigation Department, Government of Gujarat. In addition to the final bill so submitted, the firm has also submitted further claims to the Government of Gujarat in connection with the said work. Notwithstanding anything herein contained benefits of the said claim shall not stand transferred to the company and the vendors shall be entitled to pursue the said claims and retain any amount that may be allowed by the Government or otherwise recovered in respect of the said claim or any part thereof and for the purpose of such recovery the vendors shall be entitled to use the firm's name and style and to be in the said name and style. "

Thereafter, the firm was dissolved by a dissolution deed dated August 16, 1984. Clause 7 of the dissolution deed reads as under :

" (7) The parties hereto are not undertaking any further business activity in the said firm and have no outstanding business save and except to the extent of pursuing aforementioned claims against the Government of Gujarat in respect of the contract of construction of earthen dam for Mazam Irrigation Scheme in the Sabarkantha District."

Terms Nos. 1 and 2 of the said dissolution deed read as under :

" (1) The partnership firm of Banyan and Berry shall stand dissolved with effect on and from the date of execution of these presents and each of the parties hereby released the rest of them from all proceedings, accounts, cost, claims and demand in respect of the partnership and the terms, conditions and covenants contained in the said deed of partnership dated November 16, 1982, made between the parties hereto, but without prejudice to any right of remedies arising under these presents.

(2) The aforementioned claims against the State of Gujarat in respect of the contract for construction of an earthen dam for Mazam Irrigation Scheme in the Sabarkantha District have on this dissolution of partnership been allotted to and shall be treated as an actionable claim jointly enforceable as tenant in common by the parties hereto and each of the parties hereto shall be entitled to a share in the net amount realised or recovered by any proceedings in respect of the said claims in the same proportion as his share in the profits and losses of the said partnership specified in paragraph 7 of the said deed of partnership dated November 16, 1982."

For pursuing the said claim under the said dissolution deed, three of the partners were authorised to do all acts, deeds, matters and things about the recovery and relation of the said claims, on behalf of all.

The facts regarding the claim are that the firm was awarded a contract for construction of a dam for Narmada Irrigation Scheme in Sabarkantha District. The work of this contract was completed on May 15, 1984. The firm submitted its final bill to the Irrigation Department of the Government of Gujarat. The firm also submitted a further claim in connection with the said work which primarily consisted of price escalation and extra items, as per conditions of the contract. Thereafter, the Government of Gujarat accepted part of the claims and paid two sums respectively on June 29, 1984, and November 23, 1984, totalling Rs. 2,48,944 on May 31, 1985. Since the firm was dissolved, it was claimed that the amounts belong to the partners of the firm in their individual capacity in proportion to their share in the profit of the firm as per the provisions of the dissolution deed dated August 16, 1984, and the said amount was assessed in the hands of the partners in the assessment year 1986-87 directly in proportion of their profit ratio. The claims which were not accepted by the Government were referred to an arbitrator. The arbitrator made an interim award on August 27, 1986, awarding Rs. 95,80,700 in favour of the contractors. A final award was made on January 27, 1987, for an additional sum of Rs. 49,44,570. The two amounts were received on November 26, 1986, and on May 5, 1987, respectively, by the partners of the firm directly. This was in view of the letter dated October 9, 1986, written to the officer on Special Duty, Irrigation Department, wherein it was requested that in view of the dissolution of the firm, it was necessary to amend the name of the original claimants by including that the claimant firm was dissolved and the names of the 16 partners be added. The Government, vide its letter dated November 26, 1986, written to the Superintending Engineer, Irrigation Department, made it clear that there was no objection to the proposal regarding making the payment of interim award to the partners directly in accordance with their share in the partnership deed. Likewise the partners were directly paid the amount of final award as well.

It may be noticed that the construction work at Mazam was completed before the transfer of business. The final bill was also submitted and payment thereof was received prior to the transfer of business. So also the claim for additional sums on account of escalation clause and price of the extra claim was lodged with the Government prior to said transfer.

The firm did not file any return of income. A notice in respect of the aforesaid sums received by the partners under the award was issued under section 139(2) by the Assessing Officer in response to which the return was filed showing nil income. It was claimed by the assessee that the sum of Rs. 1,48,24,876 was a capital receipt and not taxable. The Assessing Officer brought to tax the above mentioned sum for the following reasons :

" (1) The partners received benefit from the business carried on by the partnership firm. The claim arises from the business and there was a direct nexus between the business carried on by the firm and claim which resulted in receiving the sum by the partners. The amount was, therefore, taxable under section 28(iv) of the Act being the value of any benefit or perquisite, whether convertible into any money or not, arising from the business ;

(2) The amount was taxable under the provisions of sections 60 and 63 of the Income-tax Act, however, neither the provisions of sections 60 and 63 were set out in full nor was it explained how these sections can be invoked.

(3) The provisions of section 176(3A) provided for taxation of all those receipts which were related to the business activity before its discontinuance. The award amount received after dissolution of the firm was an integral part of the business receipts of the firm, Banyan and Berry. It was therefore, taxable under section 176(3A). "

The assessing authority also held that the claim had arisen from the business and it is a benefit the value of which in terms of money is chargeable as income under section 28(iv) of the Act. The Assessing Officer was also of the view that the provision of sections 60 and 63 of the Act were also attracted for holding the said sums as taxable. The Assessing Officer was also of the view that formation of the company, handing over the running business of the firm and dissolution of the firm was made with an ulterior motive to escape the tax liability either in the hands of the firm or in the case of partners under section 176(3A). In these circumstances of the case, the assessee's contention that receipts are not taxable under section 176(3A) was not accepted. Accepting that the assessee has confirmed that the firm is dissolved, it held that it amounted to discontinuance of the business by the firm and attracts the provisions of section 176(3A) of the Act. The receipts were held to be related to business of the firm, receipt of which were deferred due to litigation or dispute.

On these provisions it was held that the amount received was income under section 2(24) read with section 28(iv) and taxable in the hands of the assessee under sections 60, 63 and 176(3A) of the Income-tax Act, 1961, because according to him, section 176(3A) in very unambiguous language provides for taxation of receipts which were directly related to business activities before its discontinuance.

Thus, in his ultimate conclusion, the Assessing Officer accepted the dissolution of the firm as an existing fact and invoked section 176(3A) to bring the receipts to tax in the hands of the firm.

On appeal, the Commissioner of Income-tax (Appeals) found that discontinuation of business under section 176(3A) should not only be treated from the point of view of continuation or cessation of business but also from the point of view of the person carrying on the business. According to him, sub-section (3A) of section 176 is the logical extension of section 189(1) and reading the two provisions together, the firm was liable to be taxed. The Commissioner of Income-tax (Appeals) did not rest his conclusion on the edifice of treating the dissolution of firm as a device to avoid tax. The Commissioner of Income-tax (Appeals) affirmed the assessment though on a different ground.

On further appeal, the Tribunal found that section 189 does not come to aid in bringing the amount of the award to tax in the hands of the firm. The Tribunal also found that as far as section 176(3A) is concerned, it cannot be invoked because it is not a case of discontinuance but continuation of business by the successor-company. However, the Tribunal further found that in the present case the entire business was not taken over. It was of the opinion that the benefit of additional claims did not stand transferred to the company. The additional claims were nothing but claims primarily of escalation in costs due to delay in completion of the contract and also some additional items, etc. These claims were raised as part of the contract. The quantum of these claims was huge. After noticing the business results of the company, the Tribunal also found that in the circumstances, it is found that a substantial part of the business consisting of claims was not transferred to the limited company. In its opinion, realisation of outstanding claims was an integral part of the " business " which was not transferred to the company and for that reason the business in question was not discontinued. The Tribunal agreed with the assessee that section 28(iv) cannot be invoked in the present case. The contention of the assessee that it was not open to the Department to tax the firm once income was taxed in the hands of the partners as members of an association of persons was rejected on the ground that the assessment orders of Shri K. D. Kunjadia for the assessment year 1988-89 shows that what was taxed at that time was only a protective measure. The Tribunal also held that sections 60 and 63 are not applicable to the facts of the present case.

The Tribunal then addressed itself to the question whether the dissolution of the firm can be treated as a device for avoidance of tax and, therefore, covered by the decision of the Supreme Court in the case of McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148.

The Tribunal recorded its conclusions as under :

(i) It appears unusual that after the business of the firm was taken over by the company as a going concern on July 1, 1984, except for the outstanding claims which are under consideration, the firm should have been dissolved.

(ii) The dissolution was not immediate and the firm continued till August 16, 1984, on which date it was dissolved.

(iii) It has to be remembered that the outstanding claims were not some fringe matters which could be attended to without much effort. We have already noted that the claims were of huge amounts, the amount in the letter dated May 25, 1984, from the firm to the Executive Engineer, Irrigation Project, alone being Rs. 1,58,91,625. The follow up of the claim required representation before the arbitrator. Even then it was decided to dissolve the firm, which is far more extreme step than mere retirement of some partner.

(iv) Another unusual feature is that even after dissolution certain important elements of the partnership were continued. The claims were treated as an actionable claim, jointly enforceable as tenants-in-common by the parties thereto.

Each of the erstwhile partners was entitled to share in the award in the same proportion as his share in the profits and losses of the firm. Three of the partners were appointed to do certain acts on behalf of all the erstwhile partners which included the opening of bank accounts.

(v) The claim was treated as an outstanding business and we have also come to the same conclusion earlier that the business of the firm was not discontinued on July 1, 1984.

(vi) The normal expectation would be that the firm should continue but exactly the opposite took place by its dissolution.

On these precincts, the Tribunal concluded that the dissolution of the firm was nothing but a device to avoid tax. The firm was dissolved by a deed but in essence it was a device to avoid tax because there was no purpose in dissolving the firm.

Consequentially, the Tribunal held that dissolution of the firm will be ignored for the purpose of assessment of income and it will be treated that the firm continued even after August 16, 1984, and received awards of the arbitrator. In this view of the matter, the sum of Rs. 1,48,24,876 becomes taxable in the hands of the firm, except to avoid tax.

Having concluded thus, the Tribunal found that income should be assessed on the basis of accrual and not on the basis of receipts and as sufficient facts were not available before the Tribunal to show when the income accrued, the matter was restored to the file of the Commissioner of Income-tax (Appeals) for the purpose of ascertaining the year in which the income in question accrued and restrict assessment only to that part of the income which accrued in the previous year relating to the assessment year 1988-89.

It is in the aforesaid circumstances, that the Tribunal has referred the questions stated hereinabove for decision of this court.

Questions Nos. 1 and 2 referred to above are interlinked and call for the determination of the basic issue whether the dissolution of the firm, vide dissolution deed dated August 16, 1984, can be treated as a device within the meaning of McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148 (SC) and is to be ignored and to treat the firm to be continuing to exist.

Great emphasis has been laid by the Tribunal on the so called " unusual " features, viz., retention of the claim in question with the firm in spite of transferring of the business as a going concern, to treat it as the " remainder " of the business and the terms of the dissolution deed providing for treating the claim as an actionable claim of the joint ownership of the erstwhile partners, its sharing in, the " profit sharing ratio " on realisation and authorising some of the partners to do all the acts for pursuing the claim.

As will be seen presently the so-called unusual features are the usual state of affairs to come in existence as a result of dissolution. Regarding retaining the claim from the facts it is obvious that the firm was engaged in construction business as contractors. Construction of the dam at Mazam was a completed work as on the date of transfer of business to the extent of receipt of regular payment of the final bill under the contract. Only the claim for escalation and extra claim was pending. No part of the business activity relating to the Mazam project was that which was regarded to be transferred to the company. The claim was disputed. It is also not the case that any other pending claim of any other such completed work was transferred to the company and the claim in respect of the Mazam dam was treated differently.

In these circumstances, there could not be anything unusual for the partners, who intended to dissolve the firm on the transfer of business, not to transfer any pending/disputed claim of a completed work.

Likewise the terms of dissolution were in consonance with section 47 of the Partnership Act. Even in the absence of the said terms, the same state would have existed under section 47 of the Partnership Act.

The Tribunal's approach to treat the dissolution as a device to avoid tax because there was no purpose to dissolve it is apparently fallacious and is a result of misdirecting oneself in law. The question is whether in the undisputed facts of the case, it was essential to continue with the firm solely for the purpose of realisation of a disputed claim when all other business has been transferred to the company. No prudent man of commonsense would in fact in such circumstances have continued to keep the firm alive, on any commercial principle.

The Tribunal while referring to clause (7) of the dissolution deed which read that parties hereto are " not undertaking any further business activity " in the said firm and " have no outstanding business " save and except to the extent of pursuing the aforementioned claim against the Government in respect of the contract of construction of the earthen dam for the Mazam Irrigation Scheme in Sabarkantha District opined that the business of the firm was not transferred in its entirety because " pursuing the claim " was treated as an outstanding business and looking to the large magnitude of the claims, the normal expectation in the opinion of the Tribunal would be that the firm should continue but exactly the opposite took place by its dissolution. According to the Tribunal, there was no purpose in dissolving the firm. The Tribunal has also referred to the deed of dissolution under which the claim in question was treated as an actionable claim jointly enforceable by the parties thereto and each of the erstwhile partners was entitled to share the amount received under award in the same proportion as his share in the profits or losses of the firm. Three of the partners were appointed to do certain acts on behalf of the partners which included the opening of bank accounts. On these premises, it was held that there was no purpose in dissolving the firm except to avoid tax and, therefore, the dissolution of the firm was ignored.

It would also be relevant here to notice that the factum of transfer of business as a going concern except the outstanding claim against the Government in respect of construction of earthen dam for Mazam Irrigation Scheme has been held to be genuine and not a device. It is also not in dispute that the only activity of the erstwhile business of the firm which had not reached its end was determination of the aforesaid claim. There is no indication either of the fact that after dissolution the firm carried on any other business activity than the one transferred to the company. The Tribunal has rested its conclusion to hold the dissolution of the firm as a device to avoid tax on the ground of there being no purpose except to avoid the liability of tax which should arise as a result of an award being made in favour of the firm regarding its pending claims about the construction of the earthen dam of the Mazam Irrigation Scheme which may be received some time in the future, and the terms of the dissolution deed which according to the Tribunal spelt out that certain important elements of the partnership were continued as unusual and those factors were stated to be---

(i) The claims were treated as actionable claims.

(ii) The claims were treated as jointly enforceable as tenants-in-common by the parties ;

(iii) The partners were entitled to share in the award in the same proportion as each one has a share in the profits and losses of the firm and ;

(iv) Three of the partners were appointed to do certain acts on behalf of the erstwhile partners which included opening of bank accounts ;

for holding that the said existing partnership after the transfer of business to the company still retained the continuing business and the Tribunal was also influenced by the magnitude of the claims when it repeatedly referred to the fact that the outstanding claims were not some fringe matters which could be attended to without much effort but the claims were of huge amounts, and the follow up of the claim required representation before the arbitrator. The pursuing of the claim was treated by the Tribunal as a business of the firm which was to be carried on by it.

The two questions that call for probing at this juncture are whether the premises aforesaid can reasonably lead to the conclusion in law that the dissolution of the firm was not real but was a device to avoid tax, and, secondly, what is the true scope of the applicability of the principle enunciated in McDowell's case [1985] 154 ITR 148 (SC).

In McDowell's case [1985] 154 ITR 148 (SC), the assessee was a manufacturer of Indian liquor under the Andhra Pradesh Excise Act. Excise duty was levied on the manufacture of liquor and the manufacturer was not entitled to remove the same from the distillery unless the duty imposed under the Excise Act had been paid. According to the assessee, the buyers of Indian liquor from the distillery obtained distillery passes for release of liquor after making payment of excise duty directly to the State exchequer and presented the same at the distillery whereupon the bill of sale or invoice was prepared by the distillery showing the price of liquor, but excluding the excise duty. The assessee in its turnover of sales had included only that part of the price as was received by it as per invoice/bill but did not include the excise duty which was payable by it but was paid by the buyer at the time of obtaining permit. The tax authorities desired to include the excise duty which was payable by the manufacturer by treating the excise duty so paid as part of the sale price, constituting its taxable turnover. It may further be noticed that prior to its amendment, under the rules under the Excise Act in 1981, there was no provision prohibiting the removal of liquor from the store unless the excise duty has been paid by the holder of D-2 licence before such removal. Prior to the aforesaid amendment in the Rules when excise duty levied in the circumstances stated above was sought to be included in the taxable turnover, when the matter reached the Supreme Court, the court opined in its judgment in the case of McDowell and Co. Ltd. v. CTO [1977] 1 SCR 914 ; 39 STC 151, 158 (see also at page 162 of 154 ITR) :

" That intending purchasers of the Indian liquor who seek to obtain distillery passes are also legally responsible for payment of the excise duty which is collected from them by the authorities of the excise department "

and the court further came to the conclusion that the excise duty did not go into the hands of assessee and did not become part of the circulating capital. Therefore, the sales tax authorities were not competent to include in the turnover of the appellant the excise duty which was not charged by it but was paid directly to the excise authorities by the buyers. When the assessee had again agitated after the amendment and when the matter reached the Supreme Court, as aforesaid, the correctness of the decision in its earlier case referred to above was referred to a larger Bench.

It was the stand of the manufacturer that it was a condition precedent for the buyer of its finished goods that the buyer pays the excise duty to the excise authorities directly, and on production of the receipts, liquor is issued from the distillery by way of sale under the supervision of the excise authorities and in view of such arrangement, the excise duty did not go into the common till of the assessee and it does not become a part of the circulating capital.

R. N. Mishra J., delivering the leading judgment came to the conclusion on the merits that (at page 165 of 154 ITR) :

" . . . the incidence of excise duty is directly relatable to manufacture, but its collection can be deferred to a later stage as a measure of convenience or expediency . . . the conclusion of this court at page 921 of the reports [1977] 1 SCR 914 that intending purchasers of the Indian liquors who seek to obtain distillery passes are also legally responsible for payment of the excise duty is too broadly stated. The ' duty ' was primarily a burden which the manufacturer had to bear and, even if the purchasers paid the same under the Distillery Rules, the provisions were merely enabling and did not give rise to any legal responsibility or obligation for meeting the burden."

It was further held that :

" We are, therefore, clearly of the opinion that excise duty though paid by the purchaser to meet the liability of the appellant, is a part of the consideration for the sale and is includible in the turnover of the appellant. The purchaser has paid the tax because the law asks him to pay it on behalf of the manufacturer. "

Having thus concluded on the merits of the controversy and taking notice of the fact that the payment of excise duty is the legal liability of the manufacturer, its payment is a condition precedent for the removal from the store and the payment by the purchaser is on account of the manufacturer, according to normal commercial practice, the excise duty should have been reflected in the bill either as merged in the price or shown separately, the court came to the conclusion that the consideration for sale is thus the total amount and not what is reflected in the bill. That is to say, the true state of existing affairs were taken into account by the court and not what was shown to exist by it under a legally concluded agreement. It was in that set of circumstances, the question about the jurisdiction of the tax authority to lift the veil and to obliterate the distinction between the methods of tax evasion and avoidance of tax through tax planning came to be discussed. Justice Mishra stated the position thus:

" Tax planning may be legitimate provided it is within the frame work of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges."

The court also quoted with approval the decision of this High Court in CIT v. Sakarlal Balabhai [1968]69 ITR 186, 200 (Guj) which decision was affirmed by the Supreme Court in appeal in CIT v. Sakarlal Balabhai [1972] 86 ITR 2 (at page 170 of 154 ITR) :

" Tax avoidance postulates that the assessee is in receipt of an amount which is really and in truth his income liable to tax but on which he avoids payment of tax by some artifice or device. Such artifice or device may apparently show the income as accruing to another person, at the same time making it available for use and enjoyment to the assessee as in a case falling within section 44D or mask the true character of the income by disguising it as a capital receipt as in a case falling within section 44E or assume diverse other forms ... But there must be some artifice or device enabling the assessee to avoid payment of tax on what is really and in truth his income. If the assessee parts with his income producing asset, so that the right to receive income arising from the asset which, theretofore, belonged to the assessee is transferred to and vested in some other person, there is no avoidance of tax liability : no part of the income from the asset goes into the hands of the assessee in the shape of income or under any guise. . . ."

Justice Chinnappa Reddy in his separate opinion examined the ambit and the scope of the oft quoted observation of Lord Tomlin in IRC v. Duke of Westminster [1936] AC 1 ; 19 TC 490, 520 (at page 152 of 154 ITR) :

" Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. "

In this connection, it is pertinent to notice what Lord Diplock observed in IRC v. Burmah Oil Co. Ltd. [1982] STC 30 explaining the Westminster case (at page 156 of 154 ITR) :

" It would be disingenuous to suggest, and dangerous on the part of those who advise on elaborate tax-avoidance schemes to assume, that Ramsay's case [1982] AC 300 (HL), did not mark a significant change in the approach adopted by this House in its judicial role to a pre-ordained series of transactions (whether or not they include the achievement of a legitimate commercial end) into which there are inserted steps that have no commercial purpose apart from the avoidance of a liability to tax, which in the absence of those particular steps would have been payable. The difference is in approach. It does not necessitate the overruling of any earlier decisions of this House ; but it does involve recognising that Lord Tomlin's oft-quoted dictum in IRC v. Duke of Westminster [1936] AC 1 at page 19, [1935] All ER Rep 259 at page 267, ' Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be,' tell us little or nothing as to what method of ordering one's affairs will be recognised by the courts as effective to lessen the tax that would attach to them if business transactions were conducted in a straight forward way. "

Lord Scarman in Furniss v. Dawson [1984] 1 All ER 530, 533 (HL) opined (at page 157 of 154 ITR) :

" What has been established with certainty by the House in Ramsay's case [1982] AC 300 is that the determination of what does, and what does not, constitute unacceptable tax evasion is a subject suited to development by judicial process. The best chart that we have for the way forward appears to me, with great respect to all engaged on the mapmaking process, to be the words of Lord Diplock in IRC v. Burmah Oil Co. Ltd. [1982] STC 30 at page 32, which my noble and learned friend, Lord Brightman, quotes in his speech. These words leave space in the law for the principle enunciated by Lord Tomlin in IRC v. Duke of Westminster [1936] AC 1 at page 19 ; [1935] All ER rep 259 at page 267, that every man is entitled, if he can to order his affairs so as to diminish the burden of tax. The limits within which this principle is to operate remain to be probed and determined judicially. "

The aforesaid opinions, amongst the decisions English and Indian, form the bedrock of the final conclusion about the scope of judicial probe into any transaction.

In final conclusion after referring to number of decisions English as well as Indian, it was said (at page 160 of 154 ITR) :

" In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. "

From the aforesaid, it is apparent that on the factual aspect the court was considering a case where in a going business a liability to pay duty which was legally of the assessee and which on such payment was to become part of its cost of commodity sold by it and to become part of its selling price to the buyers, was as a result of arrangement between the seller and buyer split into two, namely-duty so far paid separately directly to the tax authorities and the balance so paid to the seller ; the arrangement was existing solely for the purpose of not paying the tax and it is not a transaction in reality of receiving a lower price than the one on which it was marketing. The court nowhere said that every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act ; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation made in McDowell's case [1985] 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity.

It was with this consciousness that the court has used these expressions while deprecating the schemes of tax avoidance in the name of tax planning. All the expressions used by their Lordships in deprecating the methodology of tax avoidance through tax planning by resorting to " colourable devices ", " dubious methods or subterfuge " have special significance in the legal world.

In the context of the present discussion, the meaning assigned to " colourable " in Brown's Judicial Dictionary has been defined as the " reverse of bona fide."

Black's Law Dictionary explains " colourable " to mean " that which is in appearance only, and not in reality, what it purports to be, hence counterfeit, feigned, having the appearance of truth ".

So also a device. The context in which the expression device has been used in its ordinary dictionary meaning as per the Shorter Oxford Dictionary means " ingenuity, something devised, arrangement, plan, contrivance, a plot or a trick. Black's Law Dictionary refers to device as contrivance, a scheme, trick. Subterfuge---According to the ordinary meaning as per the Shorter Oxford English Dictionary means that to which one refers for escape or concealment ". Subterfuge on historical principles means, an article or device to which a person refers in order to escape the force of an argument, an excuse with which conceals a clue.

So also the expression dubious refers to a doubtful or of questionable character.

That is to say what has been deprecated as tax planning for avoidance of tax are those acts which have doubtful or questionable character as to their bona fide and righteousness. Not all legitimate acts of a taxpayer which in the ordinary course of conducting his affairs a person does and are under law he is entitled to do, can be branded as being of questionable character on the anvil of McDowell's case [1985] 154 ITR 148 (SC). We are unable to read in the aforesaid decision that any act of an assessee which results in reduction of his tax liability or expectation of tax benefit in future amounts to colourable device, a dubious method or subterfuge to avoid tax and can be ignored if the acts are unambiguous and bona fide, merely on the ground that treating those as deliberate would result in tax liability in future.

While planning adopted as a device to avoid tax had been deprecated, the principle cannot be read as laying down the law that a person is to arrange his affairs so as to attract maximum tax liability, and every act which results in tax reduction, exemption of tax or not attracting tax authorised by law is to be treated as device of tax avoidance.

The decision in McDowell's case [1985] 154 ITR 148 (SC) came to be considered by their Lordships of the Supreme Court in the case of CWT v. Arvind Narottam [1988] 173 ITR 479. That was a case which arose under the Wealth-tax Act. One Narottam Lalbhai, executive, executed three trust deeds for the benefit of the assessee, his wife and his children and grand-children. All the three trust deeds are couched in identical terms, except in regard to the minimum amounts payable to the beneficiaries out of the income of each year. However, there was one further difference in detail, while the first two deeds specified a period of 18 years from the date of execution as the period during which the net income could be distributed to the beneficiaries, while the third specified a period of 30 years. Under each of the trust deeds, the settlor specified the interest of the beneficiaries in the trusts. The Wealth-tax Officer made the assessment orders for the relevant assessment years by including the entire value of the assets held by the trusts as the wealth of the assessee under section 21(2) of the Wealth-tax Act. On appeal, the liability of the assessee to wealthtax was confined only to the value of the minimum amounts payable under the trust deeds for his maintenance. Reliance was placed by the Revenue on McDowell's case [1985] 154 ITR 148 (SC) to discard the legal consequences flowing from the construction of the trust. Both the learned judges constituting the Bench have given their separate opinions.

Chief Justice Pathak, in his opinion said :

" Reliance was also placed by learned counsel for the Revenue on McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148 (SC). That decision cannot advance the case of the Revenue because the language of the deeds of settlement is plain and admits of no ambiguity."

Justice S. Mukherjee said, after noticing McDowell's case [1985] 154 ITR 148 (SC) :

" Where the true effect on the construction of the deeds is clear, as in this case, the appeal to discourage tax avoidance is not a relevant consideration. But since it was made, it has to be noted and rejected. "

The real question to be asked while examining is whether the act of an assessee falls in the category of a colourable device, a dubious method or subterfuge or an act of which the judicial process may not accord approval. Carrying on a trade is the fundamental right guaranteed under article 19 of the Constitution of India. The right to carry on trade includes the right not to carry on any trade. How and in what form business is to be carried on is also part of that freedom. Business is carried on individually, collectively, by constituting a partnership firm, or forming an association of persons or by a company. The formation and dissolution of partnerships are governed by statutory provisions under the Indian Partnership Act. The very concept of partnership is founded on an agreement between the persons who share the profits of business carried on by all or any of them acting for all. Collectively persons who have agreed to share the profits of business carried on by them are called firm. Bringing into existence of a firm depends upon the volition of the parties. So also its dissolution rests on their volition or on the premise of agreement. The persons cannot be compelled to continue to remain in the same bond of a firm once they decide to dissolve it except as envisaged under the statute. It is not required anywhere under the Act, that a partnership can be dissolved only after the affairs of the firm have been fully wound up and nothing remains to be adjusted between the partners or nothing remains to be discharged as liability by the partners or realisation of the outstanding to the firm are adjusted. On the contrary, the scheme of the Partnership Act clearly envisages that in point of time a dissolution of the firm takes place anterior to winding up of the affairs of the firm which include finalising the accounts, discharge of liabilities, outstanding on the date of dissolution of the firm, realisation of the outstanding to the firm and adjustment of accounts of the remainder of the assets of the firm.

Chapter VI of the Partnership Act deals with the dissolution of a firm. Sections 40 to 44 deal with various modes of dissolution of firms. Section 40 provides that a firm may be dissolved with the consent of all the partners or in accordance with the contract between the partners.

Section 41 provides that apart from voluntary dissolution, the firm may be compulsorily dissolved by the adjudication of all or but one of the partners insolvent or by the happening of any event which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on in partnership.

Section 42 provides that in certain events subject to contract between the partners a firm stands dissolved on the happening of envisaged contingencies, viz., by the efflux of time, if it is constituted for a fixed term ; by the completion of one or more adventure if it is constituted for carrying out one or more undertakings ; by the death of one or more partners and by the adjudication of a partner as an insolvent.

Section 43 prescribes the mode of dissolution, where the partnership is at will. The firm can be dissolved--by any of the partners by giving a notice in writing to all the partners of his intention to dissolve the firm and it stands dissolved from the date mentioned in the notice as to the date of dissolution and if no date in mentioned in the notice from the date of the communication of notice.

Section 44 deals with a case where the court orders dissolution of a firm in a suit filed by the partner/s on the ground mentioned in it or on any other ground which renders it just and equitable that the firm should be dissolved.

Sections 45 to 49 contain the scheme as what ensues dissolution of firm. Section 45 provides that notwithstanding the dissolution of a firm, the partners continue to be liable as such to third parties for any act done by any of them which would have been an act of the firm if done before the dissolution, until public notice is given of the dissolution.

Section 46 provides that on the dissolution of the firm every partner or his representative is entitled, as against all the other partners or their representatives, to have the property of the firm applied in payment of the debts and liabilities of the firm, and to have the surplus distributed among the partners or their representatives according to their rights.

So also section 47 provides that after the dissolution of a firm the authority of each partner to bind the firm, and the other mutual rights and obligations of the partners, continue notwithstanding the dissolution, so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise.

Section 46 postulates that even after dissolution the debts and liabilities of the firm may remain to be discharged and for such discharge of debts and liabilities, the property of the firm remains liable. That is to say, these actions of the firm which had their origin while the firm was in existence but did not reach their culmination until before dissolution may reach culmination/termination after dissolution. Continuance of the firm is not envisaged, on the contrary, it assumes that the firm has ceased to exist.

Likewise, section 47 also comes into operation only when dissolution has taken place. Continuance of partners' authority to bind each other and not continuance of the firm, has been provided only for the purpose of winding up the affairs of the company. Dissolution of the firm is the accepted premise on which the provision operates.

Sections 48 to 51 provide the mode of settling of accounts between the partners, after dissolution.

Section 50 read with section 16 deals with personal profits earned after dissolution of the firm but before the affairs of it have been completely wound up. Such profits earned out of any transaction of the firm or from the use of the property or the business connection of the firm, is to be made available for settling the accounts of the firm to be disbursed among the partners of the firm, unless such partner has bought the goodwill of the firm to use the firm name on dissolution.

Noticing the scheme of the provisions of the Partnership Act relating to dissolution makes it apparent that there is nothing abnormal or a contrivance or a thing like device where there is a time lag between the date of dissolution of the firm and winding up of the affairs of the firm as they remain outstanding on the date of dissolution. On the contrary such a state of affairs is envisaged normally to come into existence as a result of dissolution of the firm. It makes out clearly the distinction between dissolution of the firm resulting in cessation of its existence and the continuing authority of erstwhile partners, not as a firm but as persons in charge to wind up the affairs of firm, to bind each other by their act in the matter of pending actions, realisation of assets, etc. Merely because something has remained to be realised on account of the firm on the date when the firm is sought to be dissolved by consent of all the partners, it cannot be said that the only purpose for which the firm is dissolved is to get rid of the effect of such realisation which is outstanding on the date of dissolution. Such realisation by all the partners or one acting on behalf of the partners for the benefit of all the partners to be shared, or dealt with in accordance with the profit-sharing ratio of the partners during its existence is in fact the legal effect of a lawful, valid and bona fide dissolution. Even if no such agreement of treating a pending claim as an actionable claim and dividing it in the profit-sharing ratio on having a favourable award and authorising a few of the partners to pursue the claim had been made part of the dissolution deed in question, the same result would have flown from the provisions of section 47 of the Act. As we have noticed the remainder of the firm's property is to be disbursed between the partners in their profit-sharing ratio, the authority of the partners to do all acts necessary and their status of agency of all for one and one for all continue to exist for the purpose of winding up of the affairs of the firm which remains outstanding as on the date existing, continue to exist until the winding up is complete. It cannot be said that something which is not otherwise envisaged in law was so plotted as a scheme or device by the partners for some purpose other than to bring about the legitimate consequence of a dissolution. Therefore, in our opinion, considering the legal effect of these terms in the agreement by the Tribunal for holding in favour of continuation of existence of firm were wholly irrelevant and unwarranted. In fact, the conclusion flies in the face of the provisions of the Partnership Act.

Apart from the provisions of the Partnership Act, the provisions of the Income-tax Act also do not support the principle that the firm continues to exist for the purpose of earning income after dissolution. The relevant provisions of Chapter XV, Part F & L and Chapter XVI leave no room of doubt that a situation has been envisaged under the Act where if the firm is dissolved on a particular date and the income relating to the business which was carried out by a firm during its existence may be received later on and for that situation, the existence of the firm is not a condition precedent.

Section 170 deals with the succession of business otherwise than on death, that is to say, where a business is succeeded, as a going concern by one " assessee entity " to " another assessee entity " that entity under the Act ceases to be an assessee in respect of business which has been succeeded by another, and the successor assessee becomes the assessee for the purpose of taxing the income arising from such business. This assumes that the business is not discontinued. Under the scheme of section 170 where persons carrying on business have been succeeded by any other person, who continues to carry on that business, the predecessor is assessed in respect of income up to the date of succession and the successor is assessed in respect of the income since the date of succession. This apart, other provisions make it clear that in the case of succession, there is a water tight compartment of period income up to which is assessable in the hands of the transferor, namely, up to the date the business is carried on by it. Section 170 also does not envisage that when a transfer of business takes place, the transferor or the predecessor must cease to exist. We may also notice here that though under the general law, a firm is not a person of separate juristic entity, according to the definition of " assessee " under section 2(7) read with section 2(31), a firm is a separate unit of assessment independent of the persons constituting it and has to be assessed as a separate entity.

Likewise, in our opinion, the transfer of the business as a going concern excepting the retention of right to the pending claim, cannot be termed as colourable device to achieve the object of avoiding tax on a sum, the quantum of which was uncertain, and there was only likelihood of its receipt in future on dispute being decided in favour of the claimants. There was no basis for the Tribunal to hold that dissolution of the firm after the transfer of business was a mere device and not a genuine act of parties.

The conclusion of the Tribunal that the mere realisation of an outstanding claim relating to business which was carried on by the firm itself constitutes a business for which the firm ought to have existed until it is realised, is, in our opinion, founded on irrelevant considerations and is not supported by any legal principle.

There is ample authority for the proposition that the realisation of assets by a person in charge of the winding up of the business owned by a person or in charge of winding up of the entity is not an activity which can ordinarily be called business and cannot amount to carrying on business on that ground alone.

In CIT v. National Mills Co. Ltd. (In liquidation) [1958] 34 ITR 155 (Bom), Chief Justice Chagla stated the general principle :

" The asssssee may stop doing business altogether, and these assets may cease to have the character of business or commercial assets. Then, they take on an entirely different character. They become capital assets, and qua those assets the assessee is not carrying on any business, but qua those assets the assessee has become their owner. As an owner the assessee may also exploit those assets and receive income. But the income which it receives is no longer business income because no business is being carried on and the assets are not business assets. "

In the case of winding up of a company where, after deciding to wind up the company, the affairs of company are placed under liquidation, in the course of winding up, the liquidator takes on certain activities and the question has often been raised, whether realisation during the course of winding up amounts to income from any business carried on by the company or official liquidator.

The term business in respect of profits or gains of any business, profession or vocation carried on by an assessee so as to be subject to income-tax has also come up for consideration. The Privy Council in the case of CIT v. Shaw Wallace and Co. [1932] 2 Comp Cas 276 ; AIR 1932 PC 138 ; L. R. 59 IA 206, pointed out that the fundamental idea underlying each of these words is the continuous exercise of an activity and the same central idea is implicit in the words " carried on by him " occurring in section 10(1) of the Indian Income-tax Act, 1922, which corresponds to section 28(1) of the 1961 Act.

Keeping in view the aforesaid principle when a question arose before their Lordships of the Supreme Court in the case of Liquidators of Pursa Ltd. v. CIT [1954] 25 ITR 265 wherein a company, the appellant before the Supreme Court, negotiated to sell a business of growing sugarcane and manufacturing sugar intending to wind up the company, and concluded the agreement for sale of the factory during the previous year relevant to the assessment year in question. The income-tax authorities treated the surplus made by the company on the sale of buildings, plant and machinery as profits under the relevant provisions of the Indian Income-tax Act, 1922. The Tribunal as well as the High Court found that the company was carrying the business and treated the surplus arising out of such sale of buildings, plant and machinery as income of the business. Reversing the decision of the High Court, the court held :

" Turning to the facts to be gathered from the records it is quite clear that the intention of the company was to discontinue its business and the sale of the machinery and plant was a step in the process of the winding up of its business. The sale of the machinery and plant was not an operation in furtherance of the business carried on by the company but was a realisation of its assets in the process of gradual winding up of its business which eventually culminated in the voluntary liquidation of the company. Even if the sale of the stock of sugar be regarded as carrying on of the business by the company and not a realisation of its assets with a view to winding up. . . . Section 10(2)(vii) can have no application to the sale of any such machinery or plant. "

It may be noticed that realisation of assets in the aforesaid case was not after winding up but even before, when it was only intending to wind up the business activities of the company by transferring the factory as a going concern, yet such realisation were not held to be carrying on business, but merely realisation of capital.

In somewhat similar circumstances, as in the present case, the question arose before their Lordships of the Supreme Court in Narain Swadeshi Weaving Mills v. CEPT [1954] 26 ITR 765. The assessee was a partnership firm carrying on the manufacturing business and was consisting of three partners, a father and his two sons. They decided to incorporate a public limited company with the object of taking over the business from the assessee-firm. The three partners along with two relatives of the partners were the directors of the company. The company purchased only the building and leasehold rights from the assessee-firm and took over from the firm all leasing equipment and machinery at an annual rent. Though the firm continued to exist thereafter, the activity of the firm realising rents of the assets belonging to the firm was not held to be a commercial activity.

The dictum of Lord Atkin of the Privy Council in Liquidator, Rhodesia Metals Ltd. v. Commissioner of Taxes [1940] 3 All ER 422, 425 was :

" Prima facie, the sale by a liquidator of the whole undertaking of a company would result in a capital asset . . . . "

Greene L. J. in Wilson Box (Foreign Rights) Ltd. v. Brice (Inspector of Taxes) [1936] 20 TC 736 ; 3 All ER 728 (CA), affirming the decision of Lawrence J. to the effect that consideration received by the company in liquidation was a capital receipt and not a receipt from the carrying on of the business by the liquidator, observed (at page 750 of 20 TC) :

" The facts that the liquidation took place, and that the liquidator acted in a particular way because those interested in the shares of the company had agreed that the liquidation should take place and that the assets should be sold, appear to me to be no evidence whatever to justify the finding of the Commissioners. Most companies have in their memorandum a power to sell their assets, and it is a very common thing indeed for companies, when they are reconstructed and sell their assets in whole or in part, to have an arrangement or an agreement between the shareholders beforehand, deciding what is to be done, agreeing that certain resolutions shall be passed putting the company into liquidation and agreeing that the assets of the company in the liquidation shall be disposed of by the liquidator in a particular way. To accept the proposition which has been put before us would really come to this, that whenever a company acted in that way, the act of the liquidator in selling the assets would be an act of the company trading, instead of an act of realisation . . . . in my opinion they were nothing more or less than receipts by the liquidator on realisation by him in the ordinary course of his duty as liquidator to realise and get in the assets of the company. "

In case of CIT v. Chrestian Mining Co. Ltd. (In liquidation) [1968] 70 ITR 371 (Cal), under the terms of a compromise, the assessee-company and a firm by name C & Co. had jointly obtained a mica lease for twenty years. On May 28, 1953, the assessee-company agreed to the lease being given to C & Co. in consideration of C & Co. paying a lump sum consideration and a further sum equivalent to 50 per cent. of the net profits earned by C & Co. during the currency of the lease. After having entered into the aforesaid agreement with C & Co., the assessee-company went into voluntary liquidation and along with its liquidator assigned its right to receive the said royalty and also all other benefits available to it under the lease agreement dated May 28, 1953, to another company for a consideration of Rs. 5 lakhs. The Revenue authorities sought to assess the aforesaid sum of Rs. 5 lakhs as business income in the hands of the assessee. The assessee claimed it to be a capital receipt as the consideration was for realising the assets during the course of the liquidation.

The Calcutta High Court came to the conclusion that (at page 380 of 70 ITR) :

" . . . what the liquidator has done in obtaining the receipt for Rs. 5,00,000 is that he has sold and/or transferred and/or assigned the mining lease and the rights completely and for ever and free from all encumbrances in order to realise and get in the assets of the company in liquidation. "

The Allahabad High Court in Vijay Laxmi Sugar Mills Ltd. v. CIT [1972] 86 ITR 402, stated the general rule to be :

" When the liquidator of the company is engaged in merely realising the assets of the company, he cannot be said to be carrying on business."

In our opinion, continuation of the authority of each partner to bind the firm and other mutual rights and obligations of the partners even after dissolution in terms of section 47, does not put the partners (keeping in view that partners and firms are two distinct entities for the purposes of income-tax) in more exalted position of a liquidator realising the assets of the company in liquidation. We have noticed above that even the realisation of an asset of a company which took place before actual liquidation but manifesting intention to wind up, was held to be an act of realisation of asset and not carrying on business of the company.

In the case at hand, the firm transferred its business as a going concern to the company and it stopped undertaking any further business activity. The settlement of claims of completed work at Mazam with the Government remained the only outstanding affair of the firm. The claim was not an accepted claim. The entitlement under the agreement as well as the quantum both were the subject-matter of determination. It could probably be called only an activity relating to realisation of assets of the firm in the course of its winding up but could not in any sense be termed as carrying on business. Realisation of an asset after dissolution much less mere pursuit of a disputed claim cannot be termed as " business " for carrying on which the firm ought to continue to exist.

Section 47 envisages that after dissolution of the firm, the authority of the partners continues. For application of section 47, dissolution of the firm is an accepted premise. On the acceptance of that premise, the necessary consequence is that the partners in their capacity as firm when they decided to dissolve the firm stop doing business in the identity of a firm and the assets which belong to the firm on the date of dissolution cease to have a character of business or commercial assets. They assume the character of capital liable to be applied for payment of debts and distributed amongst the partners in accordance with the terms of agreement to dissolve read with the relevant provisions of the Indian Partnership Act. Realisation of amount on award having made in favour of the claimant cannot, in the circumstances be said to be a realisation through carrying on business by the firm. Such realisation was by the partners, during winding up of the affairs of the firm. No factor pointed out by the Tribunal either cumulatively or singularly to detract from this position and, therefore, in our opinion, the reliance on McDowell's case [1985] 154 ITR 148 (SC) for treating the dissolution as a mere device to avoid tax by treating the realisation of actionable claims as the business to be carried on by the firm was misplaced.

In the case of Indraprastha Steel Industries Ltd. v. ITAT [1973] 88 ITR 138, the Delhi High Court took the view that " mere realisation of interest of business or profits or selling its stores and spares after the closure of business is not continuation of business ".

The same view was expressed by the Madras High Court in the case of P. V. Gajapathi Raju v. CIT [1989] 176 ITR 238, when it said that " collection of outstanding dues does not amount to carrying on of business ".

The Kerala High Court in the case of S. P. V. Bank Ltd. v. CIT [1980] 126 ITR 773 took the view that a banking company, the business of which has been taken over by another bank is not doing business when it is engaged in realizing the outstanding of its takeover business.

The same opinion was expressed again by that High Court in the case of CIT v. Kar Valves Ltd. [1987] 168 ITR 416 (Ker), when the Revenue sought to tax the compensation received by and outstanding dues from customers on being realised by the company whose business was taken over by the Government and it held that after takeover of its business by the Government if the company is busy realising the compensation from Government and outstanding dues from customers, it cannot be held to be doing any business.

Before parting with this discussion, it would be relevant to notice two decisions of the Supreme Court. In the case of CIT v. Lahore Electric Supply Co. Ltd. [1966] 60 ITR 1, the apex court was concerned with an assessee, an electric supply company which was acquired by the Government of the then Province of Punjab. The question arose about certain receipts by it whether they constituted an income from business carried on by the assessee. The factors relied on for the purpose of finding that the company was carrying on business or at least intended to carry on business were that (1) the company did not sell its undertaking as a going concern ; (2) it continued in possession of all assets of its undertakings other than those appertaining to the Lahore electric supply undertaking ; (3) it continued to hold deposits made by consumers of electricity supplied by the Lahore electric supply undertaking which had to be returned to them with interest ; (4) it had no intention of going into liquidation ; (5) the directors' report showed that the directors were " considering if they could possibly purchase some manufacturing concern which might become an additional source of profit to the shareholders " ; and lastly there was nothing to show that there was permanent discontinuance of the business of the company. It was on these factors that the Tribunal had come to the conclusion that the company had not ceased to carry on the business. The High Court agreed with the Tribunal's finding on that ground because there was nothing to show that it intended to go into liquidation and because by keeping its staff and establishment it indicated that it would resume business, for otherwise it would not have retained them. The court overruled the conclusion of the Tribunal as well as the High Court by holding that none of the aforesaid grounds mentioned above lead to the conclusion that the company intended to carry on business. The court said that the mere fact that the company had not gone into liquidation would not establish that it had the intention to do business. If it were not so, then in the case of all trading companies it had to be held that they were always doing business. There is neither authority nor principle to support such a proposition.

The court also opined :

" It would, therefore, appear that the business was closed and the company had not established an intention to resume it. That would be enough to show that no business was carried on and it would be irrelevant to enquire whether the business was permanently closed ... Payment of outstanding liabilities is not an activity which can ever produce such a result. It cannot be said, therefore, that because liabilities of a closed business were outstanding, it has to be held that either the business was continuing or that an intention to resume business must be inferred."

From the aforesaid, it is apparent that the case before the apex court was one in which the interests of the assessee has not come to an end. After the business apparatus was taken over, it continued to retain possession of all assets of its undertaking other than those appertaining to the undertaking which was taken over by the State. It manifested no intention of liquidating the company and there were some overt intentions of directors to acquire some other companies run by the company. Yet, from these factors taken cumulatively, the apex court was not prepared to agree with the findings of the authority below that the existence of aforesaid factors amounted to carrying on business by the firm.

If in that light the facts of the present case are viewed, the firm had parted with its business apparatus to the newly incorporated company, it has retained the actionable claim in respect of construction of the dam at Mazam Irrigation Project, which was already completed including the undisputed payment having been received by the assessee. Only the disputed claim regarding that completed project remained outstanding was retained by the firm. The partners of the firm manifested their intention not to carry on business except to the extent of realising the actionable claim outstanding against the Government in respect of the transaction completed before transfer of the business to the company and after dissolution of the firm they acted in unison in terms of section 47 of the Indian Partnership Act for the purpose of realising the actionable claim and for distribution of the assets of the dissolved firm. Applying the test laid in the Lahore Electric Supply Co.'s case [1966] 60 ITR 1 (SC), it would be appropriate to say that it would be laying down strange law to hold that where a firm has ceased to exist, it must still be deemed to continue merely because realisation of assets and liquidation of liabilities of that business remains to be completed. In doing so, it carried on no business activity as discussed above.

The effect and impact of the process of dissolution and distribution of assets and discharge of liabilities have aptly been stated by the apex court in the case of Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 :

" Dissolution of a firm must, in point of time, be anterior to the actual distribution, division or allotment of the assets that takes place after making accounts and discharging the debts and liabilities due by the firm. Upon dissolution the firm ceases to exist : then follows the making up of accounts, then the discharge of debts and liabilities and thereupon distribution, division or allotment of assets takes place inter se between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division or allotment of assets to the erstwhile partners, is not done by the dissolved firm...It is not correct to say that the distribution of assets takes place eo instanti with the dissolution of the firm or that it is effected by the dissolved firm."

Applying the aforesaid test and keeping in view the provisions of the Partnership Act, the conclusion is irresistible that mere realisation of the assets, apart from carrying on of any activity which can be properly called business, in the facts and circumstances of the aforesaid case cannot be said to be " a business " retained by the firm, after transfer of its business as a going concern to the successor company and it continued to carry on the business in terms of realising the assets after such transfer of the business. In treating realisable assets and proceedings taken therefor as carrying on business, in our opinion, the Tribunal was in error. Reliance on the principle of McDowell's case [1985] 154 ITR 148 (SC) was also misplaced for treating the dissolution of the firm, which took place some time after the transfer of the asset but before realisation of asset remaining with it, by the deed of dissolution as a colourable exercise device or dubious method or subterfuge, plan for evasion, or avoidance of tax. On the plain reading of the document in the facts and circumstances, it was clearly an act by the partners in the ordinary course of human conduct once they decided not to carry on any business in their joint entity as a firm. There is not even a suggestion that apart from realisation of the sum in question, after the business of the firm was taken over by the company, there was any inclination or act on the part of the erstwhile partners suggesting that the business of the firm had not actually ceased or they ever intended to carry on business of the firm clandestinely or in any other manner.

The Tribunal also misdirected itself in law in searching for a purpose to dissolve the firm beyond transfer of business as a going concern to the company. In fact after the firm transferred its running business as a going concern to the company, there was no purpose left to continue with the firm unless the partners desired to do some other business as a firm. In the absence of such eventuality, dissolution of the firm was the only logical act on their part. It would be strange to say that they should have continued to keep the firm in existence until the disputed claim was settled, only for the purpose of incurring tax liability in case an award is made in their favour. In other words, as per the Tribunal's reasoning the person must continue to carry on business, not in the ordinary course for earning profit by business activity, but to incur the tax liability, only or else it shall be deemed to be a mere device to avoid tax, as if person has no freedom to carry or not to carry on trade. We see no rationale to support this.

Taking any other view would mean that a firm can never cease to exist unless it is fully wound up and the last penny of its assets or liabilities have been realised and adjusted and the remainder property divided between the partners because until then it can always be said that all assets and liabilities of the firm relating to the business which was being carried on by the firm, their realisation or discharge having relation to the said business, the firm must always been deemed to continue and any action taken otherwise which may ultimately have impact on the tax liabilities would be a device to avoid tax and not a genuine transaction. That would be setting at naught the various statutory provisions of the Partnership Act as well as of the Income-tax Act which deal with the situation arising out of a dissolution of the firm which as held by the Supreme Court, ordinarily takes effect anterior in point of time to distribution or division or allotment of assets as a result of dissolution of the firm,

In this connection, we may refer to the decision relied on by learned counsel for the Revenue in the case of Saligram Ruplal Khanna v. Kanwar Rajnath, AIR 1974 SC 1094. Strong reliance was placed on the following observation of their Lordships of the Supreme Court, wherein their Lordships said :

" The proposition, in our opinion, cannot be disputed that after dissolution, the partnership subsists merely for the purpose of completing pending transactions, winding-up the business, and adjusting the rights of the partners ; and for these purposes, and these only, the authority, rights, and obligations of the partners continue. "

The contention is that the realisation of an actionable claim which had arisen prior to the alleged dissolution of the firm is a transaction within the meaning of the Partnership Act and for action within such realisation the firm is deemed to continue to exist. We are unable to read anything in that judgment which would go to suggest that continuing the authority of the partners to realise the outstandings of the firm and their authority to mutually bind each other leads to further conclusion that such realisation amounts to carrying on business and the firm can be said to be carrying on the business in making such realisation. On the contrary, the words used by the apex court are " for these purposes, and these only " the authority of rights and obligations of the partners continue (emphasis supplied). The court further went on to clarify that it is not deciding the issue of continuing or cessation of business, when it said " the proposition of law referred to by Mr. Desai that the dissolution does not necessarily follow because a partnership has ceased to do business " would not be of any material help to the appellants because we are not basing our conclusion of the dissolution of the firm of the parties upon the fact that the partnership had ceased to do business. Therefore, the operation of section 47 was confined to continuing the authority of partners for binding each other regarding the affairs of winding up and in that sense realisation of assets or carrying on with the pending proceedings was held to be part of that authority which the partners retain after the dissolution of the firm and applying that test it was held that the consent given by one of the partners in a pending proceeding after dissolution of the firm was binding on every partner. However, there is nothing to suggest that the court laid down any such proposition that a firm continues to exist to carry on business and is liable as a firm in respect of any realisation of assets made after it has ceased to exist on its dissolution. Section 47, in our opinion, therefore, can have no application to extend the tax liability in respect of any receipts after the firm dissolved by having resort to section 47 of the Partnership Act.

In this connection, reliance was also placed on a judgment in the case of Ghanshyamdas Chhotalal v. STO [1964] 15 STC 128 (MP) ; AIR 1964 MP 161. It was a case that has arisen under the C. P. and Berar Sales Tax Act. There the firm was dissolved after liability to pay tax had arisen but before assessment. A question arose as to whether the proceedings against the firm would be continued in respect of the transactions effected by it while it was in existence. It was in the aforesaid context, the following observations were made by the court (headnote of AIR 1964 MP 161) :

" The liability of the firm to assessment to tax in respect of the transactions effected by it while it was in existence does not disappear after its dissolution. The liability of the firm to pay tax under the Act arises during the very period of its existence when its turnover exceeds the taxable limit. When the amount of tax payable by the firm is determined after assessment, that amount really becomes a quantified debt owed by the firm to the State. If the assessment is not made and the tax amount is not determined before the dissolution of the firm, the liability to pay tax does not disappear. It continues to exist, and can be quantified by making an assessment and determining the tax amount in winding up proceedings. The combined effect of sections 47 and 49 of the Partnership Act is that though a partnership is dissolved it is deemed to continue for the purpose of winding up its business and discharge of partnership debts. If a partnership is deemed to continue for the discharge of its liabilities incurred while it was in existence, then an assessment under the Act can be made against the firm in respect of sale transactions effected by it while it was in existence and doing business. The amount of tax determined in such an assessment would be a State debt recoverable from and out of partnership assets even after dissolution and in the hands of the partners or otherwise. "

It is apparent that the court was dealing with liability of sales tax which had arisen on account of sales which had taken place prior to its dissolution and was not dealing with any liability which had arisen after its dissolution. Secondly, it was relating to a statute where the levy was on the transaction and not on the person, as distinguished from the Income-tax Act where the levy is on the person and not on the transaction. The aforesaid view was taken in respect of transactions which had already become the subject-matter of levy and the question was only where the firm was in existence when the liability had arisen, whether under the provisions of section 47 read with section 49 that liability could be enforced against the firm as an affair of winding up so as to attract the applicability of section 47. Here, we are concerned with a case where liability to tax, if any, had arisen after the firm ceased to exist and for that purpose the provisions of section 47 cannot be extended by treating the firm as continuing to exist for such subsequent period by considering that discharge of such liability in respect of the asset of the firm on account of realisation of the assets of the dissolved firm is a liability to which the provisions of section 47 or section 44 can be attracted. This is apart from the fact that we are of the view as discussed above that section 47 has no application to the case of the present nature, for the purpose of deeming the firm in existence and treating realisation of the assets as an activity of the business which was being carried on by the dissolved firm.

The argument was also sought to be raised by the assessee in its support that in terms of section 42(b) of the Partnership Act, when the firm transferred its business as a whole, it stood dissolved. As the issue about the dissolution of firm under section 42(b) was not raised or decided by any of the authorities and, in our opinion, the said question does not arise out of the Tribunal's order, we do not propose to go into that issue.

As a result of the aforesaid discussion, our answer to questions Nos. 1 and 2 are in the negative, that is to say, in favour of the assessee and against the Revenue.

Question No. 3 referred to us at the instance of the assessee need not detain us long. It is settled law that where there is doubt or ambiguity about the real entity in whose hands a particular income is to be assessed, the assessing authority is entitled to have recourse to making protective assessment in the case of one and regular assessment in the case of the other. However, making of protective assessment does not affect the validity of the other assessment inasmuch as if ultimately one of the entities is really found to be liable to the assessment, then, the assessment in the hands of that entity alone remains the effective assessment and the other becomes infructuous. The levy is enforceable only under one assessment and not under both. Question No. 3 is, therefore, answered in the affirmative, that is to say in favour of the Revenue and against the assessee.

In Jagannath Hanumanbux v. ITO [1957] 31 ITR 603, the Calcutta High Court held that it is open to the Department to make assessments on two persons in respect of the same income, where it is doubtful which assessee is really liable to the charge, because unless such " protective " or " alternate " assessment is made, assessment proceedings against the party ultimately found to be liable may become time barred ; but the Department cannot recover the tax from both the assessees in respect of the same income. We are in respectful agreement.

A similar view was expressed by the Allahabad High Court in Smt. Hemlata Agarwal v. CIT [1967] 64 ITR 428. The question arose in the circumstances where certain income was assessed in the first instance in the status of the Hindu undivided family of husband. That was set aside. Assessment was then made against the husband which was challenged before the Appellate Assistant Commissioner. In the course of assessment of the husband, a finding was recorded that the wife was not engaged in any business. However, having doubts in his mind that on challenge the assessment in the case of the husband may be set aside, the Income-tax Officer thought it prudent to issue a notice under section 34(1)(a) to the wife also ex majorie cautela. It was urged before the High Court that the Income-tax Officer having made the assessment of the husband, section 34(1)(a) could not apply for issuing notice to the wife. The court held, though ultimately the wife's petition succeeded :

" In our view this is not tantamount to a change of opinion but a more cautious approach of the Income-tax Officer by way of a protective assessment to avoid the recurrence of technical quashing as in the case of the Hindu undivided family ... The Income-tax Officer had to guard against the expiry of limitation in the peculiar predicament in which he was placed . . . . "

That brings us to the questions which have been referred at the instance of the Revenue. The first question referred to us at the instance of the Revenue relates to the question whether the amount in question can be brought to tax in the hands of the assessee-firm under the provisions of section 176(3A) read with section 189 of the Act. In this connection, it would be appropriate to quote the two provisions :

" Section 176(1). Notwithstanding anything contained in section 4, where any business or profession is discontinued in any assessment year, the income of the period from the expiry of the previous year for that assessment year up to the date of such discontinuance may, at the discretion of the Income-tax Officer, be charged to tax in that assessment year.

(2) The total income of each completed previous year or part of any previous year included in such period shall be chargeable to tax at the rate or rates in force in that assessment year, and separate assessments shall be made in respect of each such completed previous year or part of any previous year.

(3) Any person discontinuing any business or profession shall give to the Income-tax Officer notice of such discontinuance within fifteen days thereof.

(3A) Where any business is discontinued in any year, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the person who carried on in the business has such sum been received before such discontinuance.

(4) Where any profession is discontinued in any year on account of the cessation of the profession by, or the retirement or death of, the person carrying on the profession, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the aforesaid person had it been received before such discontinuance.

(5) Where an assessment is to be made under the provisions of this section, the Income-tax Officer may serve on the person whose income is to be assessed or, in the case of a firm, on any person who was a partner of such firm at the time of its discontinuance or, in the case of a company, on the principal officer thereof, a notice containing all or any of the requirements which may be included in a notice under sub-section (2) of section 139 and the provisions of this Act shall, so far as may be, apply accordingly as if the notice were a notice issued under sub-section (2) of section 139.

(6) The tax chargeable under this section shall be in addition to the tax, if any, chargeable under any other provision of this Act.

(7) Where the provisions of sub-section (1) are applicable, any notice issued by the Income-tax Officer under sub-section (2) of section 139 or sub-section (1) of section 148 in respect of any tax chargeable under any other provisions of this Act may, notwithstanding anything contained in sub-section (2) of section 139 or sub-section (1) of section 148, as the case may be, require the furnishing of the return by the person to whom the aforesaid notices are issued within such period, not being less than seven days, as the Income-tax Officer may think proper. "

" Section 189. (1) Where any business or profession carried on by a firm has been discontinued or where a firm is dissolved, the Income-tax Officer shall make an assessment of the total income of the firm as if no such discontinuance or dissolution had taken place, and all the provisions of this Act, including the provisions relating to the levy of a penalty or any other sum chargeable under any provision of this Act, shall apply, so far as may be, to such assessment.

(2) Without prejudice to the generality of the foregoing sub-section, if the Income-tax Officer or the Appellate Assistant Commissioner in the course of any proceeding under this Act in respect of any such firm as is referred to in that sub-section is satisfied that the firm was guilty of any of the acts specified in Chapter XXI he may impose or direct the imposition of a penalty in accordance with the provisions of that Chapter.

(3) Every person who was at the time of such discontinuance or dissolution a partner of the firm, and the legal representative of any such person who is deceased, shall be jointly and severally liable for the amount of tax, penalty or other sum payable, and all the provisions of this Act, so far as may be, shall apply to any such assessment or imposition of penalty or other sum.

Explanation.---The amount of tax referred to in this sub-section shall also include that part of the share of each partner in the income of the firm before its discontinuance or dissolution which the firm could have retained under sub-section (4) of section 182 but which has not been so retained.

(4) Where such discontinuance or dissolution takes place after any proceedings in respect of an assessment year have commenced, the proceedings may be continued against the persons referred to in sub-section (3) from the stage at which the proceedings stood at the time of such discontinuance or dissolution, and all the provisions of this Act shall, so far as may be, apply accordingly.

(5) Nothing in this section shall affect the provisions of sub-section (6) of section 159."

In this connection it will also be relevant to refer to sections 170 and 188, which read as under :

" 170. (1) Where a person carrying on any business or profession (such person hereinafter in this section being referred to as the predecessor) has been succeeded therein by any other person (hereinafter in this section referred to as " the successor ") who continues to carry on that business or profession,---

(a) the predecessor shall be assessed in respect of the income of the previous year in which the succession took place up to the date of succession ;

(b) the successor shall be assessed in respect of the income of the previous year after the date of succession.

(2) Notwithstanding anything contained in sub-section (1), when the predecessor cannot be found, the assessment of the income of the previous year in which the succession took place up to the date of succession and of the previous year preceding that year shall be made on the successor in like manner and to the same extent as it would have been made on the predecessor, and all the provisions of this Act shall, so far as may be, apply accordingly.

(3) When any sum payable under this section in respect of the income of such business or profession for the previous year in which the succession took place up to the date of succession or for the previous year preceding that year, assessed on the predecessor, cannot be recovered from him, the ' Income-tax Officer shall record a finding to that effect and the sum payable by the predecessor shall thereafter be payable by and recoverable from the successor, and the successor shall be entitled to recover from the predecessor any sum so paid.

(4) Where any business or profession carried on by a Hindu undivided family is succeeded to, and simultaneously with the succession or after the succession there has been a partition of the joint family property between the members or groups of members, the tax due in respect of the income of the business or profession succeeded to, up to the date of succession, shall be assessed and recovered in the manner provided in section 171, but without prejudice to the provisions of this section.

Explanation. --- For the purposes of this section ' income ' includes any gain accruing from the transfer, in any manner whatsoever, of the business or profession as a result of the succession."

" 188. Where a firm carrying on a business or profession is succeeded by another firm, and the case is not one covered by section 187, separate assessments shall be made on the predecessor firm and the successor firm in accordance with the provisions of section 170. "

So far as section 189(1) is concerned, historically section 44 corresponded to this provision under the Indian Income-tax Act, 1922. In the first instance, it accepts the fact of discontinuance of the business by the firm which may or may not have been dissolved. In the case of dissolution, the fact of dissolution is accepted whether the business has been discontinued or not. It is on that accepted premise that provision for its deemed continuation has been made for the purpose of making assessment of the total income of the firm. Obviously, the purpose of making assessment of the total income of the firm related to the income of the firm earned by it while it was in existence. There is no assumption that a firm continues to exist for the purpose of earning income from a business which it has discontinued or after it has ceased to exist as a result of dissolution. It would be a paradox to say that a firm has discontinued its business, yet, it is deriving profits from its discontinued business thereafter or to say that a firm has ceased to exist, but continues to earn profit even in the state of non-existence after its dissolution. As soon as a firm is dissolved, all its assets become the capital available for discharge of its liabilities incurred while in existence and to disburse the remainder amongst the partners. As the firm is a separate entity for assessment under the Act which can be assessed as such, for the purpose of continuity in making the assessment of all liabilities including tax or penalty or any other sum chargeable under the provisions of the Act which it had incurred up to its discontinuance of business or dissolution, in that status, a legal fiction has been created for deeming the dissolved firm to exist and it is deemed to exist under the Income-tax Act only for the purpose of assessment and not for any other purpose. But for this provision, perhaps, it would not have been possible to continue or to initiate proceedings against the non-existing firm or in respect of non-existing business in respect of income earned by the firm while in existence or of the business while it was continuing. There being two separate entities, namely, the firm and partners in the individual capacity, it would not have been possible to proceed against the partners in their individual capacity in the absence of this provision to implement the provisions of the Act in respect of the liability which had already been incurred. In our opinion, section 189 cannot extend to income or profits which can be said to have accrued, arisen or received after the discontinuance of such business or dissolution of the firm.

In this connection, we may also notice that section 189 does not lay down procedure for assessment in such cases. However, section 176 which deals with discontinuance of business lays down the procedure that where any business or profession is discontinued in any assessment year, the income of the period from the expiry of the previous year for that assessment year up to the date of such discontinuance may be charged in the same assessment year. It also provides for separate assessments to be made for the completed assessment year and part of the assessment year that is to say that the provision is made for making assessment up to the date of discontinuance of the business only. In the case of dissolution, section 176 specifically does not talk of dissolution. It is apparent that two situations may arise : (1) that by dissolution of the firm, the business carried on by it may not discontinue but may have devolved on some other entity as a result of succession. In that event, section 170 provides that where a person carrying on any business or profession has been succeeded therein by any other person and the successor continues to carry on that profession or business, the predecessor is to be assessed in respect of the income of the previous year up to the date of succession and successor shall be assessed in respect of the income of the part of previous year after the date of succession. In case there is no succession of business, dissolution results in cessation of business also, that is to say, it also amounts to discontinuance of business, then the case would be covered by sub-sections (1), (2) and (3) of section 176 bringing the same result.

Ordinarily, under the Income-tax Act assessment is made for the assessment year in respect of the income earned by the assessee during the previous year ending before the commencement of the assessment year. Sections 170 and 176 both provide exceptions to the rule and permit assessment of the income of the year during the same year, where business is discontinued.

This conclusion is further strengthened from the fact that section 188 clearly deals with the situation where a firm carrying on a business is succeeded by another firm and the case is not covered by section 187, separate assessments are to be made on the predecessor firm and the successor firm in accordance with the provisions of section 170, that is to say, where on account of dissolution there is a case of succession of business or profession which was being carried on by the firm, the assessment of the predecessor firm (dissolved firm) and the successor firm is to be done as in the case of succession of business under section 170 and where it is not a case of succession of business but of discontinuance of business, the provisions of section 176 in the matter of procedure of such assessment is attracted. Therefore, the conclusion, in our opinion, is irresistible, that section 189(1) by itself does not authorise assessment of the firm in respect of any income earned after it ceased to exist and the deeming provision of treating the income of the firm as if such dissolution or discontinuation of its business has not taken place is applicable only in respect of the income which has been earned by it prior to its dissolution or discontinuance of business by it. The fiction created under section 189 does not project into the future transactions.

We are fortified in our conclusion by high authority. Section 189 of the Income-tax Act, 1961, is corresponding to section 44 of the Indian Income-tax Act, 1922, under Chapter V. In Shivram Poddar v. ITO [1964] 51 ITR 823 (SC), Shah J., as he then was, speaking for the court, said :

" The object of the enactment is clear. It is to authorise assessment of tax on income, profits or gain earned in a business, profession or vocation carried on by a firm or association before discontinuance of the business, profession or vocation, or before dissolution a the association.

In CIT v. Raja Reddy Mallaram [1964] 51 ITR 285, the Supreme Court while dealing with the case of assessment of a dissolved association of persons under section 44 of the 1922 Act (now corresponding to section 177 in the Act of 1961) said, section 44 ensures, by a fiction, the continuity of the personality of the association of persons even after its dissolution for the purpose of assessment, and the procedure for assessment after its dissolution of its pre-dissolution income of an association of persons is the same as that of assessment while it continued to exist.

By virtue of section 44, the personality of the association is continued for the purpose of assessment and Chapter IV applied thereto. What can be assessed is the income of the association received prior to its dissolution.

The principle fully applied to dissolution of the firm or discontinuance of the business by the firm as well. Section 44 under the 1922 Act was a composite provision dealing with assessment of income in the case of discontinuance of business by an association of persons or by a firm or dissolution of an association. We may notice prior to its amendment in 1958, the expression " dissolution of firm " was absent. When the new Act came into force repealing the 1922 Act, the provisions of section 44 were re-enacted in separate sections. While section 189 dealt with assessment of income in case of discontinuance of business by the firm or in case the firm is dissolved, section 177 dealt with assessment of income in case of discontinuance of business by an association or its dissolution. The provisions in substance remain the same.

The Rajasthan High Court in the case of George Talkies Circuit v. CIT [1988] 171 ITR 386 held :

" It is clear from the above-quoted provisions that despite the dissolution of the firm on account of its insolvency, it continued to be a subsisting firm under the Income-tax Act for the purpose of assessment of the total income of the firm till the date of its dissolution. They contain deeming provisions for the continuance of the dissolved firm for this limited purpose....The deeming provisions of section 189(1) of the Act are not applicable to the income arising long after the dissolution of the firm. "

The view was reiterated by that court in CIT v. United Trading Co. [1995] 212 ITR 532 (Raj), wherein the court held as under :

" A deeming fiction is created by section 189 in respect of a business or profession carried on by the firm which is discontinued or the firm is dissolved as if there is no such discontinuance or dissolution. The provisions contemplate that assessment could be made and all the provisions of the Act shall apply to such an assessment. This section refers to the business or profession carried on by a firm which has been discontinued or where the firm is dissolved. The power to make an assessment in such a case is in respect of that period for which the business or profession was carried on by the firm . . . . "

In this connection, it is also apposite to note that section 189 is a machinery section and is not a charging section and it has been enacted for the purposes of continuing for the application of the machinery provision of the assessment and imposition of tax liability already incurred by the firm while in existence or during the course when the business was carried on by the firm. By extending the machinery provision, the substantive levy cannot be effected by charging an entity which is not in existence. It may be noticed that section 189 assumes the continuance of the business or existence of the firm only for the purpose of assessment and not for the purpose of imposing a charge which had not already come into existence before such discontinuance or its dissolution. There is always a time lag between when the tax becomes due and when it crystallizes into a realisable amount. Income-tax is a levy on the income earned during a specified period, viz., a year. Income of the year is known at the end of the year. Hence, on the completion of the previous year when the total income of the assessee for the year becomes known, the levy under the

Act comes into existence. However, its computation and assessment resulting into a crystallized liability takes some time. Moreover, the firm may have incurred other liabilities under the Act while in existence, but proceedings for enforcing such a liability may not have been completed or initiated. It is for that reason that for the purpose of making such charge or levy to which the firm has become subject while in existence effective, a firm which is actually ceased to exist is deemed to exist for the continuity of machinery provision for bringing to the charge such tax and other obligations.

The Supreme Court, while considering the provisions of section 44 under the 1922 Act in C. A. Abraham v. ITO [1961] 41 ITR 425 held :

" Section 44 sets up machinery for assessing the tax liability of firms which have discontinued their business and provides for three consequences, (1) that on discontinuance of the business of a firm, every person who was at the time of its discontinuance a partner, is liable in respect of income, profits and gains of the firm to be assessed jointly and severally, (2) each partner is liable to pay the amount of tax payable by the firm, and (3) that the provisions of Chapter IV, so far as may be, apply to such assessment....In effect, the Legislature has enacted by section 44 that the assessment proceedings may be commenced and continued against a firm of which business is discontinued as if discontinuance has not taken place. It is enacted manifestly with a view to ensure continuity in the application of the machinery provided for assessment and imposition of tax liability notwithstanding discontinuance of the business of firms. By a fiction, the firm is deemed to continue after discontinuance for the purpose of assessment under Chapter IV. "

This is clearly indicative that only those machinery provisions which have been enacted to make the levy of tax effective, which include provision for imposing penalty has been made applicable by deeming the continuance of the business or the firm. For applying substantive provisions for levy of tax, the charge of which comes into existence after discontinuance of the business or dissolution of the firm, as the case may be, no such fiction has been created.

Reliance in this connection was placed by learned counsel for the Revenue on a decision of the Bombay High Court in the case of CIT v. Star Andheri Estate [1994] 208 ITR 573. The decision is founded on construction of section 176(3A) and supposed distinction to be in the scheme of liability in respect of the assessment of a dissolved firm under the law as stood prior to 1958 and the law as it stands now.

For this, the court appeared to follow the Supreme Court decision in Nagarmal Baijnath. v. CIT [1993] 201 ITR 538, and Abraham (C. A.) v. ITO [1961] 41 ITR 425 (SC). Having carefully gone through the report, with utmost respect, we have not been able to persuade ourselves to fall in line.

At this point, without going into the question whether it is a case of discontinuance of the business distinct from succession or not, it is to be noticed that section 176(3A) envisages two premises ; one that any sum received after discontinuance must be the taxable income of the person who carried on the business, had such sum been received before such discontinuance ; secondly, it renders such receipts taxable in the hands of the recipient. These two things clearly postulate that in the applicability of sub-section (3A) of section 176, the person carrying on the business whose income it would have been had it been received before its discontinuance, and the recipient in whose hands the income is taxable need not be the same. The recipient of such sum would be liable to tax as if it were the income of the recipient in the year of its receipt. While under section 189 a deeming provision has been made for the purpose of making assessment that the business has not been discontinued or the firm has not been dissolved, that is to say, the fiction has been created only for the purpose of applying the machinery provisions in respect of the same assessee under the same status of the firm. Sub-section (3A) of section 176 makes no such deeming provision treating the person who has carried on the business before its discontinuance to be still in existence for the purpose of taxing when in fact it has ceased to exist. If the person receiving the income is the same who carried on the business, the sum so received may be taxed in that person's hands. If the person who receives the income is different from the person who had carried on the discontinued business, in that event, such different person has been made liable and the machinery provisions are applicable to recipient of such sum. No fiction has been created under sub-section (3A) to deem the existence of person who carried on the business prior to its discontinuance. Therefore, the fiction created for the limited purpose of machinery provisions cannot be imported in sub-section (3A) of section 176 to create substantive liability against a non-existing person and extend the machinery provisions to it.

The Supreme Court in Nagarmal's case [1993] 201 ITR 538 had nowhere dwelt on the distinction which the new provision has brought into existence vis-a-vis the provision as it existed before amendment. It has merely noticed that prior to its amendment in 1958, the dissolution of the firm without discontinuance of the business was not included in the applicability of section 44. The court noticed this distinction by quoting both the provisions as they existed prior to 1958 and after 1958. While the provisions prior to 1958 did not refer to the eventuality " where a firm is dissolved " that was confined only to discontinuance of business carried on by the firm or association or dissolution of association of persons. Therefore, what was the ambit and scope of applicability of section 44 to dissolution of an association of persons was extended to the eventuality of firm dissolution also after its amendment. The court in fact was concerned with the assessment of firm which was dissolved. The assessment years were 1946-47 and 1947-48. The firm was dissolved shortly before the close of the accounting year related to the assessment year 1947-48. The assessment in the name of the firm was completed in March, 1951, much before the amendment of 1958 came into existence. It was contended on behalf of assessee that dissolution of the firm was not governed by section 44 as was existing when the assessment was made. The court repelled the contention and said :

" In this case, we are dealing with the situation where the dissolution of the firm resulted in discontinuation of its business. We are not concerned herein with the situation where the firm was dissolved but its business was not discontinued. It is necessary to bear this factual premise in mind. Indeed, on a pointed query from us, counsel for the appellant stated that this was a case where the dissolution resulted in discontinuance of business. The question is whether, in such a case, section 44 does not enable the Income-tax Officer to make an assessment on the dissolved firm. "

The court further quoted with approval the observations of Shah J., in C. A. Abraham v. ITO [1961] 41 ITR 425 (SC), noticed by us hereinbefore.

This makes it abundantly clear that applicability of section 44 was confined to discontinuance of business of the firm, whether as a result of abandoning the business activity or as a result of dissolution.

In fact, the apex court either in C. A. Abraham's case [1961] 41 ITR 425 or in Nagarmal's case [1993] 201 ITR 538 did not deviate from the principle that section 44 is enacted manifestly with a view to ensure continuity in the application of machinery provided for assessment of income of a discontinued business or of a dissolved firm or association of its prediscontinuance or pre-dissolution income.

As we have noticed above, prior to the Amendment Act, 1958, even machinery provisions were not applicable in a case of dissolution without discontinuation. It is only by amendment of section 44 in the 1922 Act, that even in the case of dissolution, with or without manifesting discontinuance of business, the machinery provisions have been made applicable to the assessment of a firm which has ceased to exist. But the court nowhere laid down that the firm continued for the purpose of assessment of income for the period after it has ceased to exist. We are also unable to read any such implication in the observation relied on by the Bombay High Court from C. A. Abraham's case [1961] 41 ITR 425 (SC). With utmost respect, we notice that the state of law enunciated by the Supreme Court that section 44 is enacted in respect of pre-dissolution or pre-discontinuation income in Shivram Poddar's case [1964] 51 ITR 823 (SC) and Raja Reddy Mallaram's case [1964] 51 ITR 285 (SC) was not brought to the notice of the court.

In this connection, it is also relevant to notice that so far as assessment under the Income-tax Act is concerned, the firm is a distinct entity from its partners and for the purpose of assessment, the two cannot be treated as one. In Shivram Poddar's case [1964] 51 ITR 823, 828, the Supreme Court noticed this distinction when it said "...the Income-tax Act recognises a firm for purposes of assessment as a unit independent of the partners constituting it ; it invests the firm with a personality . . . "

Taking any other view would mean holding that a firm once having come into existence continues its existence for the purpose of taxation until it is completely wound up by discharging all its liabilities, realising all its assets and adjustment of its remainder amongst the partners and all proceedings pending for or against such firm have come to a close. That obviously will be contrary to the whole scheme of the Act for creating a legal fiction or beyond the limit of the deeming existence of a firm which has ceased to exist. If that was the effect which was intended to be brought about the provisions would have been simplicitor that the firm shall be deemed to continue to exist unless its affairs are wholly and fully wound up.

Dissolution of the firm is like its demise. After its dissolution what ever happens, may affect its erstwhile partners as its successor in interest but cannot be considered the act of the firm, considering it to be distinct from the partners constituting it. Receipt of sums under award by the parties after the dissolution of firm cannot be taken as receipt by the firm.

Therefore, whether under section 47 of the Partnership Act or under section 189 of the Income-tax Act, the existence of the dissolved firm or continuing of the business by the firm has been assumed for a limited purpose and the fiction cannot be carried beyond the purpose for which it has been enacted.

In CST v. Modi Sugar Mills Ltd. [1961] 2 SCR 189 ; [1961] 12 STC 182, 190, the Supreme Court said :

" A legal fiction must be limited to the purposes for which it has been created and cannot be extended beyond its legitimate field. "

The view was reiterated in Karimtharuvi Tea Estate Ltd. v. State of Kerala [1966] 60 ITR 262 (SC).

As we have come to the conclusion while dealing with questions Nos. 1 and 2 referred at the instance of the assessee, the dissolution of the firm cannot be treated as a device to avoid tax and it is in fact come into existence, as per the deed and also come to the conclusion that by reading all the provisions of section 189(1) read with section 176(3A), the firm cannot be deemed to be in existence in respect of the assessment for any period after its dissolution or deemed to carry on business after it has parted with its business, the further question whether the assessee can be held liable under section 176(3A) by treating the dissolution of the firm to be discontinuance of business by it as distinct from succession and not to draw distinction between the succession and discontinuance for the purpose of section 176(3A), in our opinion, is of academic importance in the present case. Though it was argued in this regard by learned counsel, it was not in dispute that all the authorities are in favour of treating discontinuance of the business and succession of the business as two different exigencies and ordinarily succession of business does not result in discontinuance of the business. However, the contention of learned counsel for the Revenue had been that sub-section (3A) of section 176 covers the same field of operation in respect of the discontinuance of business as is covered by sub-section (4) in respect of the discontinued profession. For the purpose of section 176(3A) discontinuance of business must be that discontinuance of business by the person carrying it on as has been stated in sub-section (4) of section 176 regarding discontinuation or cessation of profession. The case, therefore, must be governed by sub-section (3A) of section 176 for the purpose of treating the receipt of the sum under the award as an income of the assessee. Section 176(3A) clearly postulates that in the case of discontinuance of business if any sum is received thereafter and if it would have been considered as income of the person had it been received by the person carrying on the business before its discontinuance, such sum is to be taxed as income in the hands of the person who receives it. It is not in dispute that for the purpose of income-tax the firm and partners are two distinct entities, the person who carried on the business, which was discontinued, was the firm and the persons who had received the sum under the award are the partners.

Under section 47 of the Partnership Act also, the authority of partners is only to realise the outstandings of the firm and to bind the firm from their accounts relating to the transaction and the assets once realised are available for disbursement amongst the partners in their profit-sharing ratio. But the firm does not continue to exist.

Therefore, assuming that the dissolution of firm amounted to discontinuance of business by the firm and receipts are covered by section 176(3A), the firm having ceased to exist on its dissolution cannot be taxed with the aid of section 189(1). The only persons who could be assessed in respect of the receipts were the partners who had actually received it. This is also strengthened from the fact that sub-sections (3A) and (4) form part of substantive provision while sub-sections (1), (2) and (3) are machinery provisions in the case of business which has been discontinued. Sub-section (3A) and sub-section (4) deal with the receipts of business or profession which has ceased to exist and are received after such cessation either by the person, who was really carrying on the business, or successor in interest who receives. Both sub-sections (3A) and (4) provide for taxing recipients of the sums provided the same would be a taxable income in the hands of the person who may be different from the person receiving it, had it been received before discontinuance of the business or profession. Therefore, even assuming that the receipt of the amounts pursuant to the award by the partners was a receipt of a discontinued business it cannot be taxed in the hands of the firm under sub-section (3A) because the firm having stood dissolved when the amount was awarded it could not have received the sum as a firm. It could have been received only by the partners of the firm and has in fact been so received.

We may also notice here that but for the provision of sub-section (3A) of section 176 any receipt as a result of realising any asset of the firm by the partners would have been a capital receipt in their hands and not taxable. It is only by dint of this provision that if it were income of the firm had it been received by the firm while it carried on the business, it can be taxed in the hands of the partners if the same is received after its discontinuation of business by dissolution of the firm. Under section 176(3A) the sum is deemed to be the income of recipient when received and cannot be treated as income of earlier year. Receipt of sum is the basis of taxation under section 176(3A). In view of this we are not inclined to further carry on the discussion whether the receipts in relation to the claims arising out of construction of the dam at Mazam Irrigation work was a receipt of a discontinued business or of a business which was the subject-matter of succession.

Accordingly, we answer question No. 1 referred at the instance of the Revenue in the affirmative, that is to say, in favour of the assessee and against the Revenue.

The second question referred to us at the instance of the Revenue relates to whether the receipt in question is covered by the provisions of sections 28(iv), 60 and 63 of the Act.

It is apparent that the claim was arising out of terms relating to escalation of cost and extra work allegedly carried out by the assessee. In a way it was an additional remuneration receivable for the work completed by the firm and was a business receipt. Section 28(iv) speaks about the value of any benefit or perquisite, whether convertible into money or not, arising from the business or profession.

The claim for additional consideration under the terms of the agreement on the happening of certain events cannot be termed in any sense of the word a benefit or a perquisite which can be calling for evaluation under section 28(iv). The receipt had it been received by the firm during the continuation of business by it, it would have squarely been covered by section 28(i).

Likewise, the mere reading of sections 60 and 63 leaves no room for doubt that these provisions have no application to the case at hand.

Section 60 provides that all income arising to any person by virtue of a transfer whether revocable or not, where there is no transfer of the asset from which the income arises shall be chargeable to income-tax as the income of the transferor, and shall be included in his total income. Section 63 defines transfer for the purposes of section 60 to include any settlement, trust, covenant, agreement or arrangement. It postulates the rule that transfer of income is taxable in cases where the asset producing the income is not transferred.

When a firm is dissolved and ceased to exist, it ceases to hold any income producing asset, but all its assets including actionable claims, partakes of the character of capital, liable to be disbursed amongst its partners after discharging the debts. Therefore, in the first instance no question of transfer of income arises. Receipts under the award, by the partners after dissolution of the firm would ordinarily be capital receipts in their hands when received, but for the legal fiction created under section 176(3A). It is apparent that under section 176(3A) such receipts become income only when they are received by the recipient and are not treated as income at earlier point of time. Thereafter, when the firm stood dissolved it did not have any income which it could transfer. When the partners received, it was not as a result of the transfer of income, but as a disbursement of assets on dissolution of the firm. Thus, in fact, it was a transfer of the asset of the firm itself to which section 60 read with section 63 have no application.

There is yet another aspect of it. Considering the corresponding legislations in England in A. G. Chamberlain v. CIR [1943] 25 TC 317 (HL), Lord Macmillan said :

" This legislation forms part of a code of increasing complexity ... designed to overtake and circumvent a growing tendency on the part of taxpayers to endeavour to avoid or reduce tax liability by means of settlements. Stated quite generally, the method consisted in disposal by the taxpayer of part of his property in such a way that the income should no longer be receivable by him, while at the same time he retained certain powers, over, or interests in, the property or its income. "

The above opinion of Lord Macmillan was quoted with approval by the Supreme Court in Tulsidas Kilachand v. CIT [1961] 42 ITR 1 while it was considering the provisions of section 16 under the 1922 Act, which corresponded to section 60 of the 1961 Act, and expressed its conclusion in the following terms after quoting the aforesaid observations (at page 4) :

" These observations apply also to the section under consideration and the Indian provision is enacted with the same intent and for the same purpose.... Section 16(1)(c) provides that income from assets remaining the property of the settlor or disponer or arising to any person by virtue of a revocable transfer of assets shall be deemed to be the income of the transferor. " (emphasis supplied)

In short, we may say that all income arising to any person by virtue of any transfer, settlement, trust, agreement or arrangement from assets remaining the property of the person who made the transfer is deemed to be the income of the transferor. Retention of property from which income arises is an essential condition for the applicability of section 60. In the case of dissolution of firm in no circumstance the firm can retain the property from which income had arisen, if the firm at all can be treated as transferor.

Looking from any angle, in the facts and circumstances of the present case, section 60 read with section 63 of the Act has no application.

Accordingly, we answer question No. 2 referred at the instance of the Revenue, in the affirmative, that is to say, in favour of the assessee and against the Revenue.

To sum up our answers to the questions referred to us are as under :

Questions referred at the instance of assessee :

" (i) Whether on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the sum of Rs. 1,48,24,876 became taxable in the hands of the firm which according to the assessee stood dissolved through dissolution deed dated August 16, 1984 ?

The answer is the negative, in favour of the assessee and against the Revenue and we hold that the Tribunal was not right in holding that the sum of Rs. 1,48,24,876 received by the partners in pursuance of the interim award and the final award became taxable in the hands of firm which stood dissolved through dissolution deed dated August 16, 1984.

(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the case would be governed by the Supreme Court decision in the case of McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148 and not by the Supreme Court decision in CWT v. Arvind Narottam [1988] 173 ITR 479 and by the Madras High Court decision in the case of M. V. Valliappan v. ITO [1988] 170 ITR 238 ?

We answer the aforesaid question in the negative in favour of the assessee and against the Revenue by holding that the Tribunal was in error in applying the principle enunciated in McDowell's case [1985] 154 ITR 148 (SC).

(iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that even after the income is taxed protectively or with remarks to that effect in the hands of the members of association of persons the same income can be validly taxed again in the hands of the firm constituted by the same members as partners ? "

The question is answered in the affirmative, in favour of the Revenue and against the assessee.

Questions referred at the instance of the Revenue :

" (i) Whether the Appellate Tribunal is right in law and on facts, in holding that the award amount of Rs. 1,48,24,876 is not taxable in the hands of the assessee-firm under the provisions of section 176(3A) read with section 189(1) of the Act ?

We answer the aforesaid question in the affirmative, that is to say, in favour of the assessee and against the Revenue.

(ii) Whether, the Appellate Tribunal is right in law and on facts in holding that the provisions of sections 28(iv), 60 and 63 of the Act were not applicable in the instance case ? "

The question is answered in the affirmative, that is to say, in favour of the assessee and against the Revenue.

No order as to costs.

 

 

 

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