Glimpses of Supreme Court Rulings

Vatsala Shenoy vs. JCIT (2016) 389 ITR 519 (SC)

One S. Raghuram Prabhu started the business of manufacturing beedies in the year 1939. His brother-in-law joined him in the year 1940 and this sole proprietorship was converted into a partnership firm with the name ‘M/s. Mangalore Ganesha Beedi Works’ (hereinafter referred to as the ‘firm’). It was reconstituted thereafter from time to time and lastly on June 30, 1982. Partnership deed dated June 30, 1982 was entered between thirteen persons with the same name. Duration of this firm was five years, which period could be extended by six months. Thereafter, the affairs of the firm had to be wound up as provided in Clause 16 of the Partnership Deed. The firm was dissolved on December 06, 1987 by afflux of time after extending the life of the firm by a period of six months, as per the terms stipulated in the Partnership Deed. However, because of the difference of opinion among the erstwhile partners, the affairs of the firm could not be wound up.

Therefore, two of the partners of the firm filed a petition before the High Court under the provisions of Part X of the Companies Act, 1956 for winding up of the affairs of the firm in terms of section 583(4)(a) thereof. The said petition was registered as Company Petition No. 1 of 1988. Significantly, though the firm stood dissolved on December 06, 1987, and thereafter Company Petition No. 1 of 1988 for the winding up proceedings after dissolution was filed in the High Court, the business of the partnership firm continued because of the interim order passed by the High Court. This was because of the agreement of the partners, as stipulated in the Partnership Deed itself, providing that on dissolution, the firm was to be sold as a continuing concern to that partner(s) who could give the highest price therefor.

Considering the clauses in partnership deed, specific order dated November 05, 1988 was passed by the High Court permitting the group of partners, seven in number, who had controlling interest, to continue the business as an interim arrangement till the completion of winding up proceedings. Ultimately, the orders dated June 14, 1991 were passed in the said company petition for winding up the affairs of the firm by selling its assets as an ‘ongoing concern’. Though this order was challenged by some of the partners by filing special leave petition in Supreme Court, the same was dismissed as withdrawn in the year 1994. In this manner, orders dated June 14, 1991 became final, which had permitted the sale of the firm, as an ongoing concern, to such of its partner(s), who makes an offer of highest price. Reserve price of Rs.30 crore was also fixed thereby mandating that the price cannot be less than Rs.30 crore. The successful bidder was also required to accept further liability to pay interest @ 15% per annum towards the amount of price payable to partners from December 06, 1987 till the date of deposit. In the order dated June 14, 1991, it was also directed that the successful bidder shall deposit the offer price together with interest with the Official Liquidator within a period of sixty days of the date of acceptance of the offer.

On the aforesaid terms, these partners individually or in groups offered their bids. Bid of Association of Persons comprising three partners (hereinafter referred to as ‘AOP-3’), at Rs. 92 crore, turned out to be the highest and the same was accepted by the High Court vide order dated September 21, 1994. AOP-3 deposited this amount of Rs. 92 crore with the Official Liquidator on November 17, 1994 and with the occurrence of this event, assets of the firm were treated as having been sold to
AOP-3 on November 20, 1994. Even actual handing over of the business of the firm along with its assets by the Official Liquidator to the said AOP-3 took place on January 07, 1995.

Since the firm stood dissolved with effect from December 06, 1987, upto December 06, 1987, it is the firm which had filed the income tax returns in respect of the income which it had earned, for payment of income tax thereupon. However, as mentioned above, though the firm was dissolved, but the business continued because of the orders passed by the High Court keeping in view the provisions contained in the Partnership Deed. The income that was earned from the date of dissolution till the date of winding up and when the firm was sold to AOP-3 was assessed at the hands of dominant partners controlling the business activities (seven in number) as “Association of Persons” (AOP), meaning thereby, the income from the business of the said firm December 06, 1987 till winding up was assessed as an AOP. At the same time, these Assessees were also filing their individual returns as well.

The Assessees filed the return for the Assessment Year 1995-1996. It is in this Assessment Year the assets of the firm were sold as ongoing concern to AOP-3 on September 21, 1994. The Assessing Officer, while making the assessments, bifurcated this Assessment Year into two periods. One period from April 01, 1994 to November 20, 1994 (as AOP of the partners who had continued the business in that capacity in previous years). Second period from November 20, 1994 till March 31, 1995 (as the business was handed over to AOP-3 and the assessment was treated as that of AOP-3). While doing so, the Assessing Officer observed that the entire capital gains on the sale as a going concern of the business of the firm as well as the proportionate profits for the period April 01, 1994 to November 20, 1994, when the controlling AOP was carrying on business as computed in accordance with the order of the High Court in Company Petition No. 1 of 1988, on a notional basis a sum of Rs. 9,57,57,007 should be taxed in the hands of the firm. However, according to the Assessing Officer, to protect interests of the Revenue, the same amounts were included in the assessment of the AOP for the first period.

The income and tax computations were made separately for the two periods in the order of assessment. The Assessing Officer apportioned the consideration among the various assets comprised within the business with further splitting between short term and long term capital gains. While the aforesaid treatment was given to the assessment of the income of the firm, insofar as the Assessees as individuals (partners) were concerned, on the same date the Assessing Officer made assessment in their cases also by including therein the proportionate share from out of Rs. 92 crore (the amount of auction bid) as capital gain at their hands and bifurcated the same into long term and short term gain.

The approach adopted by the Assessing Officer was to take into consideration market value of the assets of the firm, viz. land, building and plant & machinery, which had already been evaluated by the Registered Valuers. The market value of these three assets was Rs. 21,52,90,000. Since total sale consideration at which the firm was sold was Rs. 92 crore, balance amount of Rs. 70,47,10,000 was treated as representing goodwill of the firm which was taxed as long term gain. This mode of arriving at short term and long term capital gain and taxing it accordingly by the Assessing Officer has received the stamp of approval by the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal, as well as the High Court.

The argument of the learned senior Counsel for the Assessees was that since it was a sale of an ongoing concern, it had to be treated as a slump sale within the meaning of section 2(42C) of the Act and, therefore, it was not permissible for the Assessing Officer to assign the amount of Rs. 92 crore into different heads of land, building and machinery and treating balance amount as goodwill. It was a capital asset as an ongoing concern which was sold at Rs. 92 crore and in the absence of provisions relating to mode of computation and deductions at the relevant time, which were inserted subsequently only with effect from April 01, 2000, as per the decision in the case of PNB Finance Limited [307 ITR 75- SC], the consideration was to be treated as capital receipt and no capital gain was payable thereon.

Second submission of the learned senior Counsel for the Assessees pertained to the payment of tax on the income which the business earned from April 01, 1994 till November 20, 1994. The learned Counsel argued that as per the orders of the High Court in the winding up petition, 40% of this income was retained by AOP-3 as a tax component because of the reason that for business income of the earlier years, after the dissolution, the same was taxed as an AOP. Therefore, the individual partners could not be taxed on the said business income in the year in question, as held in Radhasoami Satsang, Saomi Bagh, Agra vs. Commissioner of Income Tax 193 ITR 321 and Commissioner of Income Tax vs. Excel Industries Ltd. 358 ITR 295. His related submission was that in any case this amount was not received by the Assessees as it was retained by AOP-3 and, therefore, tax was not payable by the Assessees.

The Supreme Court held that on the aforesaid facts, it became clear that asset of the firm that was sold was the capital asset within the meaning of section 2(14) of the Act. Once it is held to be the “capital asset”, gain therefrom is to be treated as capital gain within the meaning of section 45 of the Act.

According to the Supreme Court, the Assessees, however, were attempting to wriggle out from payment of capital gain tax on the ground that it was a “slump sale” within the meaning of section 2(42C) of the Act and there was no mechanism at that time as to how the capital gain is to be computed in such circumstances, which was provided for the first time by Section 50B of the Act with effect from April 01, 2000. However, in the opinion of the Supreme Court this argument failed in view of the fact that the assets were put to sale after their valuation. There was a specific and separate valuation for land as well as building and also machinery. Such valuation had to be treated as that of a partnership firm which had already stood dissolved.

The Supreme Court further held that as per the definition of slump sale in section 2(42C), sale in question could be treated as slump sale only if there was no value assigned to the individual assets and liabilities in such sale. This had obviously not happened. The Supreme Court observed that not only value was assigned to individual assets, even the liabilities were taken care of when the amount of sale was apportioned among the outgoing partners. Once it was held that the sale in question was not slump sale, obviously section 50B also did not get attracted as this section contained special provision for computation of capital gains in case of slump sale. As a fortiori, the judgment in the case of PNB Finance Limited also was not applicable.

The Supreme Court, in the aforesaid scenario, held that when the Official Liquidator has distributed the amount among the nine partners, including the Assessees herein, after deducting the liability of each of the partners, the High Court had rightly held that the amount received by them was the value of net asset of the firm which would attract capital gain.

The partnership firm had dissolved and thereafter winding up proceedings were taken up in the High Court. The result of those proceedings was to sell the assets of the firm and distribute the share thereof to the erstwhile partners. Thus, the ‘transfer’ of the assets triggered the provisions of section 45 of the Act and making the capital gain subject to the payment of tax under the Act.

Insofar as argument of the Assessees that tax, if at all, should have been demanded from the partnership firm was concerned, the Supreme Court held that on the facts of this case that may not be the situation, the firm had dissolved much before the transfer of the assets of the firm and this transfer took place few years after the dissolution, that too under the orders of the High Court with clear stipulation that proceeds thereof shall be distributed among the partners. 

Insofar as the firm was concerned, after the dissolution on December 06, 1987, it had not filed any return as the same had ceased to exist. Even in the interregnum, it was the AOP which had been filing the return of income earned during the said period. In this context, the Court also noted the detailed observations of the High Court which, interalia, explained the effect of sale of business conducted by the court among the partners under clause 16 of the partnership deed as : “once the partnership is dissolved, the partners would become entitled to specific share in the assets of the firm which is proportionate to their share in sharing the profits of the firm and they are placed in the same position as the tenants in common and for the purpose of dissolution and u/s. 47 of the Indian Partnership Act, 1932…”…”.. it is clear that the order passed by the assessing authority confirmed in the first appeal and by the Income-tax Appellate Tribunal (Special Bench) holding that the appellants as erstwhile partners are liable to pay capital gain on the amount received by them towards the value of their share in the net assets of the firm are liable for capital gains u/s. 45 of the Act. The said finding is justified..”

Advert to the second argument, the Supreme Court noted that it had been argued that insofar as income of the firm in the Assessment Year in question was concerned, it could not be taxed at the hands of the Assessees. According to the Supreme Court, there was merit in this submission.

First, and pertinently, it was an admitted case that 40% of the said income was allowed by the High Court to be retained by the successful bidder (AOP-3) precisely for this very purpose. This 40% represented the tax which was to be paid on the income generated by the ongoing concern being run by the Association of Persons, as authorised by the High Court. Secondly, in the previous years, the Department had taxed the AOP and this procedure had to continue in the Assessment Year in question as well.

According to the Supreme Court, the High Court had dealt with this aspect very cursorily, without taking into consideration the aforesaid aspects. The High Court dealt with the issue as to how the business income/revenue income was to be treated/calculated, but the question of taxability at the hands of the Assessees has not been touched upon at all.

The Supreme Court allowed the appeals partly only to the extent that business income/revenue income in the Assessment Year in question was to be assessed at the hands of AOP-3, in terms of the orders of the High Court, as AOP-3 retained the tax amount from the consideration which was payable to the Assessees and it was AOP-3 which was supposed to file the return in that behalf and pay tax on the said revenue income.

Insofar as the appeals preferred by the Revenue were concerned, they arose out of the protected assessment which was made at the hands of the partnership firm. As the Supreme Court upheld the order of the Assessing Officer in respect of payment of capital gain tax by the Assessees, these appeals were rendered otiose and were disposed of as such.

Note: The above judgment is based on the peculiar facts of that case and specific provisions of the partnership deed as well as earlier orders of the High Court and the Apex Court. As such, this should be read and understood in that context.

2.    Advance Tax – In cases where receipt is by way of salary, deduction u/s. 192 is required to be made and no question of payment of advance tax could arise in such cases and thus provisions for interest for default of advance in payment of advance tax (section 234B) and for deferment of advance tax (section 234C) would have no application

Ian Peter Morris vs. ACIT (2016) 389 ITR 501 (SC)

The Appellant-Assessee along with three others had promoted a company, namely, “Log in Systems Innovations Private Limited” (the acquiree company) in the year 1990. The said company was acquired by one Synergy Credit Corporation Limited (the acquirer company). The Appellant was offered the position of executive director in the acquirer company for a gross compensation of Rs. 1,77,200 per annum. This was by a letter for an offer of appointment dated October 8, 1993. On October 15, 1993, an acquisition agreement was executed between the acquirer company and the acquiree company on a going concern basis for a total consideration of Rs. 6,00,000. On the same date, i.e., October 15, 1993, a non-compete agreement was signed between the Appellant-Assessee and the acquirer company imposing a restriction on the Appellant from carrying on any business of computer software development and marketing for a period of five years for which the Appellant-Assessee was paid a sum of Rs. 21,00,000. The question that arose in the proceedings commencing with the assessment order was whether the aforesaid amount of Rs. 21 lakh was on account of “salary” or the same was a “capital receipt”.

The Assessing Officer held it to be an addition to salary for the Assessment Year 1994-95. The Commissioner of Income-tax (Appeals) held it to be a capital receipt not exigible to tax. The Tribunal reversed the order of the first appellate authority and held it to be revenue receipt covered by the provisions of section 17(1)(iv). The Tribunal sustained the levy of interest u/s. 234B and 234C as consequential in nature. The High Court upheld the order of the Tribunal.

The Appellant-Assessee filed a Special Leave Petition before the Supreme Court. A limited notice was issued confining the scrutiny of the court to correctness of levy of interest as ordered/affirmed by the High Court.

The aforesaid limited notice, therefore, had to be understood to have concluded the issue with regard to the nature of the receipt, namely, that the same was salary.

The Supreme Court held that a perusal of the relevant provisions of Chapter XVII of the Act (Part A, B, C and F of Chapter XVII) would go to show that against salary a deduction, at the requisite rate at which income tax is to be paid by the person entitled to receive the salary, is required to be made by the employer failing which the employer is liable to pay simple interest thereon.

The provisions relating to payment of advance tax is contained in Part “C” and interest thereon in Part “F” of Chapter XVII of the Act. In cases where receipt is by way of salary, deduction u/s. 192 of the Act is required to be made. No question of payment of advance tax under Part “C” of Chapter XVII of the Act can arise in cases of receipt by way of “salary”. If that is so, Part “F” of Chapter XVII dealing with interest chargeable in certain cases (section 234B – Interest for defaults in payment of advance tax and section 234C–Interest for deferment of advance tax) would have no application to the present situation in view of the finality that has to be attached to the decision that what was received by the Appellant-Assessee under the non-compete agreement was by way of salary. The Supreme Court allowed the appeals for the aforesaid reasons. The Supreme Court set aside order of the High Court so far as the payment of interest u/s. 234B and section 234C of the Act was concerned.

Note: The above judgment should now be read with the proviso to section 209(1) inserted by the Finance Act, 2012 w. e. f 1/4/2012.