Partner profit-share reallocation without consideration can amount to a taxable gift, valued by net assets including goodwill.

A mutual reduction in one partner's profit-sharing share, with corresponding increases to the others and no consideration, was treated as a transfer of property amounting to a gift for gift-tax purposes. A partner's profit share is property capable of transfer by mutual consent, and the diminution of that interest with accretion to the others brings the arrangement within the gift-tax concept. For valuation, goodwill was held to be only one component of the partnership assets; the taxable value had to be based on the transferred share in the firm's net assets as a whole, including goodwill, rather than goodwill alone.

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Issues: (i) Whether a mutual reallocation of profit-sharing shares among partners, resulting in diminution of one partner's interest and corresponding increase in the others' interests without consideration, amounts to a transfer and a gift chargeable to gift-tax. (ii) Whether, if taxable, the value of the transfer is to be confined to goodwill or is to be taken as the value of the transferred share in the firm's net assets including goodwill.

Issue (i): Whether a mutual reallocation of profit-sharing shares among partners, resulting in diminution of one partner's interest and corresponding increase in the others' interests without consideration, amounts to a transfer and a gift chargeable to gift-tax.

Analysis: A partner's right to share in the profits of the firm is property capable of transfer by mutual consent between partners. When the profit-sharing ratio is altered so that one partner's share is reduced and the others' shares are correspondingly increased without consideration, there is a diminution of the former partner's interest and an accretion to the interests of the others. Such a realignment constitutes a transfer of property and falls within the concept of gift for gift-tax purposes.

Conclusion: The reallocation of shares amounted to a transfer of property and was liable to gift-tax.

Issue (ii): Whether, if taxable, the value of the transfer is to be confined to goodwill or is to be taken as the value of the transferred share in the firm's net assets including goodwill.

Analysis: Goodwill is only one asset of the partnership. On transfer of a partner's interest, the transferee acquires the partner's share in the residue of the firm's net assets after discharge of debts, advances, and capital. The taxable value must therefore reflect the transferred one-sixth share in the entire net assets of the firm, including goodwill, and not goodwill alone.

Conclusion: The value was not confined to goodwill and had to be reworked on the basis of the transferred share in the firm's net assets including goodwill.

Final Conclusion: The reference was answered in favour of the revenue, with the transaction held to be taxable as a gift and the valuation directed to be recomputed on the correct asset base.

Ratio Decidendi: A mutual reduction of a partner's profit share without consideration is a transfer of property amounting to a gift, and the taxable value of the transferred interest must be assessed by reference to the partner's share in the firm's net assets, including goodwill.

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