1979 (9) TMI 1 - SC - Income Tax

Partnership Firm Dissolution Not a Transfer under Income Tax Act: Supreme Court Ruling

Malabar Fisheries Co. Versus Commissioner of Income-Tax, Kerala

The Supreme Court held that the distribution of assets of a firm upon its dissolution does not constitute a transfer of assets under Section 34(3)(b) of ... Whether the distribution of assets of a firm consequent on its dissolution amounts to a transfer of assets within the meaning of the expression ' otherwise transferred' occurring in s. 34(3)(b) of the I.T. Act, 1961, having regard to the definition of ' transfer ' in s. 2(47) of the Act - held that s. 34(3)(b) of the Act was not applicable Issues Involved:1. Whether the distribution of assets of a firm consequent on its dissolution amounts to a transfer of assets within the meaning of 'otherwise transferred' under Section 34(3)(b) of the Income Tax Act, 1961.2. Interpretation of the definition of 'transfer' under Section 2(47) of the Income Tax Act, 1961 in the context of partnership dissolution.Detailed Analysis:Issue 1: Distribution of Assets on Dissolution as TransferThe primary question raised in these appeals is whether the distribution of assets of a dissolved firm constitutes a transfer of assets under Section 34(3)(b) of the Income Tax Act, 1961. The appellant, a dissolved firm, contended that such distribution does not amount to a sale or transfer. The Income Tax Officer (ITO) had withdrawn the development rebate allowed to the firm, arguing that the firm had transferred its assets within the specified period. The Appellate Assistant Commissioner (AAC) upheld the ITO's decision, but the Income-tax Appellate Tribunal reversed it, citing the Supreme Court's decisions in CIT v. Dewas Cine Corporation and Bankey Lal Vaidya's case, which held that distribution of assets among partners upon dissolution is merely an adjustment of rights and does not constitute a transfer.Issue 2: Definition of 'Transfer' under Section 2(47)The High Court, however, disagreed with the Tribunal, holding that the 1961 Act's definition of 'transfer' in Section 2(47) includes the 'extinguishment of any rights' in capital assets. The High Court opined that the dissolution of a firm extinguishes the firm's rights in its assets, constituting a transfer under Section 2(47). This view was challenged by the appellant before the Supreme Court.The Supreme Court examined whether the dissolution of a firm extinguishes the firm's rights in its assets, thus constituting a transfer under Section 2(47). The Court referred to its earlier decisions in Dewas Cine Corporation and Bankey Lal Vaidya, which clarified that the distribution of assets upon dissolution is an adjustment of rights among partners and does not amount to a transfer. The Court noted that the 1961 Act's definition of 'transfer' includes 'extinguishment of rights,' but emphasized that a partnership firm is not a distinct legal entity separate from its partners. The firm's assets are jointly owned by the partners, and upon dissolution, the distribution of assets is a mutual adjustment of rights, not a transfer.The Court also discussed the nature of a partnership firm and its property under Indian law, which aligns with English law. A firm is not a distinct legal entity, and its property is jointly owned by the partners. Therefore, the distribution of assets upon dissolution does not involve an extinguishment of the firm's rights in its assets.The Supreme Court concluded that Section 34(3)(b) of the Act was not applicable in this case, as the distribution of assets upon dissolution does not amount to a transfer. The appeals were allowed, and the revenue was ordered to pay the costs of the appeals to the appellant.Conclusion:The Supreme Court held that the distribution of assets of a firm upon its dissolution does not constitute a transfer of assets under Section 34(3)(b) of the Income Tax Act, 1961. The Court emphasized that a partnership firm is not a distinct legal entity separate from its partners, and the distribution of assets upon dissolution is a mutual adjustment of rights among the partners, not a transfer. Consequently, the development rebate allowed to the firm could not be withdrawn under Section 34(3)(b). The appeals were allowed, and the revenue was ordered to pay the costs of the appeals to the appellant.