Undrawn partnership profits retain their character on dissolution and remain taxable as income, not capital receipt.

On dissolution of a partnership, undrawn profits do not lose their character as profits merely because the firm has ended. The dissolution account only determines what is due to partners by way of capital and profits; it does not convert profits into capital. An outgoing partner remains entitled to receive his share of profits as profits, unlike a shareholder on winding up. Accordingly, the sum received as interest on capital employed in business was treated as profit and was assessable to tax under Section 4(2) of the Indian Income Tax Act, 1922.

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Issues: Whether the sum of Rs. 38,305 received on dissolution of a partnership, being interest on capital employed in business, was a capital receipt or a profit assessable to tax under Section 4(2) of the Indian Income Tax Act, 1922.

Analysis: The sum in question represented interest on capital earned by the partner before dissolution. A dissolution account merely ascertains what is due to the partners for capital and what is due for profits; it does not convert undrawn profits into capital. Unlike a shareholder on winding up, an outgoing partner is entitled to receive his share of profits as profits, and such character is not altered by the dissolution. The payment was therefore received in India as profits and was liable to assessment.

Conclusion: The amount of Rs. 38,305 was a receipt of profits and not a capital receipt, and it was assessable under Section 4(2) of the Indian Income Tax Act, 1922.

Final Conclusion: The appeal succeeded and the reference was answered in favour of taxation of the amount as assessable income.

Ratio Decidendi: On dissolution of a partnership, undrawn profits retain their character as profits and do not become capital merely because the partnership comes to an end.

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