Court rules redistribution of profit shares as taxable gift under Gift-tax Act; exempt under section 5(1)(xiv)

The court held that the reduction in the assessee's share of profits and the increase in his partners' shares constituted a taxable gift under the Gift-tax Act. The redistribution of profit shares was deemed a transfer of property, making it chargeable to tax. However, the court found the gift exempt under section 5(1)(xiv) as it was made in the course of carrying on a business and for bona fide business purposes. The court rejected the department's arguments, affirming the Tribunal's decision in favor of the assessee and awarding costs.

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Issues Involved:
1. Whether the reduction in the share of profits of the assessee and the corresponding increase in the shares of his partners constituted a taxable gift under the Gift-tax Act for the assessment year 1965-66.
2. Whether the gift was exempt under section 5(1)(xiv) of the Gift-tax Act.

Detailed Analysis:

Issue 1: Taxable Gift
The primary question was whether the reduction in the assessee's share of profits from 40% to 25% and the corresponding increase in the shares of the other two partners constituted a taxable gift under the Gift-tax Act. The Tribunal initially held that such reconstitution of the partnership, resulting in the reduction of one partner's share and the enhancement of others, did not result in a gift exigible to tax. This view was based on its earlier decisions.

However, this court referenced previous judgments, notably Commissioner of Gift-tax v. V. A. M. Ayya Nadar [1969] 73 ITR 761 (Mad), which established that a partner's right to share in the profits is a valuable right and capable of transfer. The court held that the redistribution of profit shares involved a transfer of property, diminishing the assessee's interest and increasing the value of the shares held by the other partners, thereby constituting a gift chargeable to tax. This reasoning was supported by subsequent decisions in Commissioner of Gift-tax v. A. M. A. Abdul Rahman Rowther [1973] 89 ITR 219 (Mad) and Commissioner of Gift-tax v. K. P. S. V. Doraiswamy Nadar [1973] 91 ITR 473 (Mad).

Thus, the court concluded that the Tribunal was wrong in its general proposition and answered the first question in the negative, against the assessee.

Issue 2: Exemption under Section 5(1)(xiv)
The second question was whether the gift fell within the exemption provided under section 5(1)(xiv) of the Gift-tax Act. This section exempts gifts made in the course of carrying on a business, provided they are made bona fide for the purpose of such business.

The Tribunal found that the gift was made during the course of carrying on the business and was bona fide for business purposes. The court examined the evidence, including the partnership deeds and the reasons for the redistribution of profits. The partnership deed dated January 1, 1964, cited the first partner's need to devote more attention to a new business, Mekala Talkies, as a reason for reducing his share of profits. The Tribunal concluded that this redistribution was for the effective and profitable working of the partnership firm and was not suggested to be for any mala fide purpose.

The court also reviewed relevant Supreme Court decisions, such as Commissioner of Gift-tax v. Dr. George Kuruvilla [1970] 77 ITR 746 (SC) and Commissioner of Gift-tax v. Gheevarghese [1972] 83 ITR 403 (SC), which emphasized the necessity for a gift to have a relationship with the carrying on of the business and to be made for business purposes. The court found that, unlike in those cases, the evidence in the present case supported the Tribunal's conclusion that the gift was bona fide and for business purposes.

The court rejected the department's argument that the reasons given in the partnership deeds of 1962 and 1964 were not genuine, noting that the business of Mekala Talkies had only commenced after the 1962 deed. Therefore, the Tribunal's acceptance of the reasons in the 1964 deed was justified.

Lastly, the court dismissed the department's new argument regarding the goodwill of Norton & Co., noting that this issue was not raised before the authorities or the Tribunal and thus could not be considered.

Consequently, the court answered the second question in the affirmative, in favor of the assessee, and awarded costs to the assessee, fixing counsel's fee at Rs. 500.

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