Supreme Court Dismisses Revenue's Appeal in Income Tax Capital Gains Case — Receipt of Money Value of Partner's Share on Dissolution Not Taxable as Capital Gains. Section 12B(1) Income-tax Act, 1922 Requires Sale, Exchange or Transfer; Distribution of Assets by Valuation and Payment of Share Value Does Not Constitute Such Transfer and Falls Outside Capital Gains Tax.

Case Note & Summary

The respondent, the karta of a Hindu undivided family, had entered into a partnership with Devi Sharan Garg to carry on the business of manufacturing and selling pharmaceutical products and literature relating thereto. The partnership was dissolved on July 27, 1946. At the date of dissolution, the assets of the firm, which included goodwill, machinery, furniture, medicines, library and copyright in respect of certain publications, were valued at Rs.2,50,000. The respondent was paid Rs.1,25,000 in lieu of his share, while the business and goodwill were taken over by Devi Sharan Garg. In the assessment proceedings for the assessment year 1947-48, the Income-tax Officer sought to bring Rs.70,000 of the amount received by the respondent to tax as capital gains. The Income-tax Officer, the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal rejected the respondent's contention that no part of Rs.1,25,000 represented capital gains, though the Tribunal reduced the taxable capital gains to Rs.65,000. The Tribunal referred the following question to the Allahabad High Court under Section 66(1) of the Income-tax Act, 1922: whether on a true interpretation of Section 12B(1) the sum of Rs.65,000 had been correctly taxed as capital gains. The High Court answered the question in the negative, in favour of the assessee. The Revenue appealed to the Supreme Court. The central legal issue was whether the receipt by a partner, on the dissolution of a firm, of the money value of his share in the assets of the firm, where the assets were taken over by the other partner at a valuation, amounted to a sale, exchange or transfer of capital assets under Section 12B(1) of the Income-tax Act, 1922, and was therefore liable to capital gains tax. The Revenue contended that the payment of Rs.1,25,000 in lieu of the respondent's share was a sale or transfer of capital assets and relied on the decisions in James Anderson v. Commissioner of Income-tax, Bombay City and Commissioner of Income-tax, Madhya Pradesh, Nagpur & Bhandara v. Dewas Cine Corporation. The assessee, on the other hand, maintained that the transaction was no more than a distribution of the assets of the firm on dissolution and that the receipt of the money value of his share did not constitute a transfer. The Supreme Court, speaking through Shah, C.J., analysed Section 12B(1) and noted that liability to capital gains tax arises only if there is a sale, exchange or transfer of a capital asset. The Court found that there was no sale or exchange of the respondent's share in the capital assets; nor did the respondent transfer his share. The assets were largely incapable of physical division, and the partners agreed that the assets would be taken over by Devi Sharan Garg at a valuation and the respondent would be paid the money value of his share. This arrangement amounted to a distribution of the assets of the firm on dissolution. There was no clause in the partnership agreement providing for the method of dissolution or winding up. The Court emphasised that in the course of dissolution, the assets of a firm may be valued and divided among partners according to their respective shares, either by allotting individual assets or by paying the money value equivalent. Receipt of money by a partner in such circumstances is nothing but receipt of his share in the distributed assets. The respondent received the money value of his share; he did not agree to sell, exchange or transfer that share. Accordingly, the payment was not in consequence of any sale, exchange or transfer of assets. The Court distinguished James Anderson, where an executor had sold shares and securities and distributed the sale proceeds, holding that there the sale produced capital gains; the third proviso to Section 12B(1) meant distribution in specie and not distribution of sale proceeds. In the present case, there was no sale and payment of price, but payment of the value of the share under an arrangement for dissolution and distribution. The Court also relied on Dewas Cine Corporation, which held that the expression 'sale' in its ordinary meaning is a transfer of property for a price, and that adjustment of the rights of partners in a dissolved firm by allotment of its assets is not a transfer for a price. Consequently, the Supreme Court agreed with the High Court that the question referred had to be answered in the negative. The appeal was dismissed with costs.

Headnote

Issue of Consideration

Final Decision

Appeal dismissed with costs; High Court's answer in negative upheld; payment of Rs.1,25,000 (and taxed sum of Rs.65,000) not capital gains under s.12B(1).

Law Points