Commissioner of Income Tax vs Sherally Meherally and Sons.

Dr. B.P. Saraf, J.—By this reference under s. 256(1) of the IT Act, 1961 (the "Act"), at the instance of the Revenue, the Tribunal has referred the following question of law to this Court for opinion :

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the provisions of s. 187 would not be applicable ?"

The material facts of the case relevant for deciding the controversy in the above question, briefly stated, are as follows :

By a deed of partnership dt. 12th May, 1967. Hussainally Sherally and Roshanali Sherali agreed to carry on the business of firewood and timber in the profits and losses in the ratio of 65 : 35. On 27th June, 1977, Hussainally Sherally died. As a result, the firm stood dissolved. On 5th September, 1977, the sole surviving partner Roshanali Sherali entered into a fresh deed of partnership with the widow of Hussainally Sherally, Smt. Kalsumbai, to carry on the said business in partnership with her. For the asst. yr. 1978-79, two returns of income were filed in respect of the two firms, one for the period from 24th October, 1976 to 27th June, 1977 and the other for the period from 28th June, 1977 to 11th November, 1977, as according to the assessee two different firms existed during these two periods. The ITO did not accept this contention of the assessee as he was of the opinion that the firm did not stand dissolved on the death of one of the two partners and the old partnership firm continued to exist. According to him, it was a case of mere change of constitution of firm as contemplated by s. 187 of the IT Act. He accordingly passed one assessment order in respect of the income of both the firms.

Aggrieved by the above order of the ITO, the assessee appealed to the AAC. The AAC did not agree with the opinion of the ITO. According to him, it was a case of dissolution of the firm and emergence of a new firm. He, therefore, directed the ITO to pass separate orders of assessment for each of the two periods. Revenue appealed against the order of the AAC to the Tribunal. The Tribunal agreed with the AAC and dismissed the appeal of the Revenue. While doing so, the Tribunal observed that the firm as constituted under the partnership deed dt. 12th May, 1967 consisted of two partners and on the death of one of them, it stood dissolved. The Tribunal also observed that there was no agreement between the partners that the firm would continue after the death of one of them and held that in that view of the matter and also under s. 42 of the Partnership Act, the firm stood dissolved on the death of one of the partners. Hence, this reference at the instance of the Revenue.

We have heard Dr. Balasubramanian, learned counsel for the Revenue. We have also heard learned counsel, Mr. Tripathi, who was requested to assist the Court in this matter on behalf of the assessee. We have perused the facts of the case. The uncontroverted factual position is that the partnership firm constituted under the deed of partnership dt. 12th May, 1967 comprised of two partners. One of them died on 27th June, 1977 and a new firm was constituted by a fresh deed of partnership dt. 5th September, 1977 between the sole surviving partner of the old firm and the widow of the deceased partner Hussainally Sherally. The question that arises for consideration is whether it is reconstitution of the firm within the meaning of s. 187 of the Act or it is a case of succession of one firm by another.

We have perused the provisions of ss. 187 and 188 of the IT Act and ss. 31 and 42 of the Indian Partnership Act. On a careful consideration of the same, we are of the clear opinion that the partnership came to an end on the death of one of the two partners and if the successor or legal representative of the deceased partner joined the sole surviving partner thereafter to continue the business in partnership, the partnership between them would be a new partnership. We are supported in our above conclusion by s. 42 of the Partnership Act, which so far as relevant, reads as follows :

"42. Subject to contract between the partners, a firm is dissolved -

.......

(c) by the death of a partner;

....."

Reference may also be made in this connection to s. 31 of the Partnership Act which reads as follows :

"31(1). Subject to contract between the partners and to the provisions of s. 30, no person shall be introduced as a partner into a firm without the consent of all the existing partners."

It is clear from plain reading of the above provision that it applies to a firm of more than two partners. It cannot apply to a firm of two partners because in that case, if one of the two partners dies, the firm automatically comes to an end and thereafter there is no partnership in existence for a third party to be introduced therein. In that view of the matter, it is clear that the Tribunal was right in holding that it was not a case of change of constitution of the firm within the meaning of s. 187 of the IT Act.

We are supported in our above conclusion by the decision of the Supreme Court in Commissioner of Income Tax, Madhya Pradesh, Nagpur and Bhandara Vs. Seth Govindram Sugar Mills, . That was also a case of partnership comprising of two partners who had entered into partnership representing their joint families. Under cl. (3) of partnership deed, it was provided :

"The death of any of the parties shall not dissolve the partnership and either the legal heir or the nominee of the deceased partner shall take his place in the provisions of the partnership."

The question for consideration of the Supreme Court was whether on the death of one of the partners, his heirs automatically became the partners of the said firm. The Supreme Court, on consideration of the provisions of ss. 42(c) and 31(1) of the Indian Partnership Act, held that the partnership between the two partners came to an end on the death of one of the partners. The Supreme Court repelled the contention of the Revenue in that case a combined reading of ss. 42 and 31(1) of the Partnership Act would lead to the conclusion that the two partners of the firm could by an agreement induct third person into the partnership after the death of one of them. It was observed :

"Sec. 42(c) of the Partnership Act can appropriately be applied to a partnership where there are more than two partners. If one of them dies, the firm is dissolved; but if there is a contract to the contrary, the surviving partners will continue the firm."

The Supreme Court also referred with approval the following observations of Agarwala J. of the Allahabad High Court in Mt. Sughra and Others Vs. Babu, :

"In the case of a partnership consisting of only two partners, no partnership remains on the death of one of them and, therefore, it is a contradiction in terms to say that there can be a contract between two partners to the effect that on the death of one of them the partnership will not be dissolved but will .... Partnership is not a matter of status, it is a matter of contract. No heir can be said to become a partner with another person without his own consent, express or implied.

The Supreme Court referred with approval the following observations of Ramachandra Iyer J. in M.S.V. Narayanan Chettiar Vs. M.S.M. Umayal Achi, :

"... if one of the partners died, there will not be any partnership existing to which the legal representatives of the deceased partner could be taken in. In such a case the partnership would come to an end by the death of one of the two partners, and if the legal representatives of the deceased partner joins in the business later, it should be referable to a new partnership between them."

Reference may also be made in this connection to the latest decision of the Supreme Court in Commissioner of Income Tax, Central-I, Bombay Vs. Empire Estate, Bombay, . That was a case of a firm with more than two partners. The Supreme Court referred to ss. 187 and 188 of the IT Act and s. 42(c) of the Partnership Act and observed :

"Sec. 188 states that where a firm carrying on a business is succeeded by another firm and the case is not covered by s. 187, separate assessments have to be made on the predecessor firm and the successor firm. Sec. 187 says that where, at the time of making an assessment, it is found that a change has occurred in the constitution of a firm, the assessment shall be made on the firm as it is constituted at the time of making the assessment. ''Change in the constitution of the firm'' is defined for the purpose. The relevant part of the definition states that if one or more of the partners cease to be partners in such circumstances that one or more of the persons who were partners of the firm before the change continue as partner or partners after the change, there is a change in the constitution of the firm. These provisions would apply to a firm which survives upon the death of a partner. They would apply to the case of a partnership where a partner dies and the partnership deed provides that death shall not result in the dissolution of the partnership. Such provision is lawful because s. 42 of the Partnership Act contemplates it. If there is no such provision and a partner dies, the partnership stands dissolved. The partnership does not then survive upon the death of the partner. The case is not one of a change in the constitution of the partnership. It falls outside the scope of s. 187. When the surviving partners in such a case continue the business in partnership, s. 188 is attracted for there is a succession of one by another partnership."

Reference may also be made in this connection to the following proviso to s. 187, which has been incorporated w.e.f. 1st April, 1975 :

"Provided that nothing contained in cl. (a) shall apply to a case where the firm is dissolved on the death of any of its partners."

In fact, the controversy in this case stands concluded in favour of the assessee in view of the above proviso itself because this reference pertains to asst. yr. 1978-79 to which the above proviso applies.

For the reasons set out above, the question is answered in the affirmative and in favour of the assessee.

This reference is disposed of accordingly with no order as to costs.

Before parting with this case, we want to record our appreciation for the assistance rendered by Mr. Tripathi.