Interpretation of Partnership Deed to ascertain the tax liability

The write up is based on an old Supreme Court Case in the name of Commissioner of Income Tax, Patiala Vs RB Jodha Mal Kuthiala AIR 1966 SC 1433. The statute concerned is Income Tax Act, 1922 as amended by Income Tax (Amendment) Act, 1939 (1939 Act).

Facts of the case: A Hindu Undivided Family called Hakam Mal Tani Mal was doing running business of timber. In 1934, there was partition of the family and five members of the family entered into a partnership deed to continue with the timber business. The partnership business was also dissolved and accounts were settled as on 31/03/1939. However, two partners in the erstwhile firm continued the said business without any break.

On 29/06/1939, the two partners entered into a new partnership deed in which the historical references were recited and agreed to continue the business in the name of RB Jodha Mal. This firm is the assessee in the case. This firm was dissolved in March 1943. The dispute is regarding the applicability of Section 25(4) of the Income Tax Act, 1922 which was introduced by Income Tax (Amendment) Act, 1939 (Act 7 of 1939).

Statute in question: The provision of Sec 25(4) of the Income Tax Act, 1922 is reproduced as follows:

“Where the person who was at the commencement of the Indian Income-tax (Amendment) Act, 1939 (VII of 1939), carrying on any business, profession or vocation on which tax was at any time charged under the provisions of the Indian Income-tax Act, 1918, is succeeded in such capacity by another person, the change not being merely a change in the constitution of a partnership, no tax shall be payable by the first mentioned person in respect of the income, profits and gains of the period between the end of the previous year and the date of such succession, and such person may further claim that the income, profits and gains of the previous year shall be deemed to have been the income, profits and gains of the said period.

Where any such claim is made, an assessment shall be made on the basis of the income, profits and gains of the said period, and, if an amount of tax has already been paid in respect of the income, profits and gains of the previous year exceeding the amount payable on the basis of such assessment, a refund shall be given of the difference.”

The statute confers tax benefit to any person carrying on business which is succeeded by another person (person may be any form of carrying on business). The crucial points for getting the tax benefit were:

Condition 1: on the date of commencement of Act 7 of 1939 the person must be carrying on the business;

Condition 2: The succession of the person should not merely be the change in its constitution.

Where was the dispute?: The dispute with the Income Tax Department was in respect of the fulfillment of the first condition, i.e whether the firm in question was carrying on business on the commencement of the Act 7 of 1939.

Ratio of the case: The Supreme Court dealt with the issue in two phased manner.

Phase 1: When was the Act 7 of 1939 commenced?

The Act 7 of 1939 (the Act) was brought into force on 1st April, 1939. As per Sec 5(3) of the General Clauses Act, 1897 provides that unless the contrary is expressed, a Central Act or Regulation shall be construed as coming into operation immediately on the expiration of the day preceding its commencement. Thus on expiration of the midnight between 31st March and 1st April 1939, the Act came into force. So, the crucial date for determination of the right of the firm was the date of commencement of the Act. The date so determined was 1st April 1939.

Phase 2: Was the firm carrying on business at the commencement of the Act?

In order to get any answer to this, the partnership deed was construed as a whole in the context. The wording of the deed was the text and the historical events of the successive businesses run by different entities provide the context. The construction was made in a manner to effectuate the intention of the parties.

The recital of the deed may be seen as follows:

“Whereas we, the deponents, were partners and shareholders in the firm of Lala Hakam Mal Tani Mal Simla and all the partners of firm Lala Hakam Mal Tani Mal understood and settled their accounts upto the 31st of March 1939, on the 31st of March, 1939, and all the partners have become separate from the 1st of April, 1939, and the business at Abdullapur in the name of firm Hakam Mal Tani Mal and R. B. Jodha Mal Kuthiala has fallen to our share to run which we have by means of an oral agreement constituted a separate partnership styled R. B. Jodha Mal Kuthiala,, Abdullapur from the 1st of April, 1939. Now the said oral (agreement) is being reduced to writing and we agree that……………”

On a reasonable construction of the recital of the partnership deed makes the following points:

1. The partnership stood dissolved from 01/04/1939;
2. The erstwhile partners settled their accounts as on 31/03/1939;
3. The erstwhile firm did no business beyond 31/03/1939;
4. The new partners run the business from 01/04/1939;
5. The intention of the new partners was to run the business of the erstwhile firm in a new name and style.

On that construction, it is very clear that the firm was carrying on business on 01/04/1939, the date of commencement of the Act. As the second condition was not disputed, the necessary desiderata for applicability of Section 25 (4) of the Income Tax Act, 1922 are satisfied.

The firm was thus entitled to get the benefit of Section 25(4) of the Income Tax Act, 1922.