JUDGMENT G.C. Bharuka, J.
1. On an application made by the Commissioner of Income-tax under Section 256(1) of the Income-tax Act, 1961 (in short, "the Act"), the Tribunal has referred the following questions of law seeking opinion of this court :
"(i) Whether, on the facts and circumstances of the case, the Tribunal was right in setting aside the order of the Commissioner under Section 263 ?
(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that there was nothing wrong in the asses-see valuing the closing stock at cost instead of at market price ?
(iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that there was no transfer of capital assets of the firm to the partners even though the assessee-firm stood dissolved on December 18, 1987 ?"
2. In order to answer the above questions of law, we need to narrate the relevant facts to the extent those are found necessary for the purpose. The present reference relates to the assessment year 1989-90.
3. Some time in 1939, the late S. Raghuram Prabhu started the business of manufacturing beedies. Subsequently, his brother-in-law, Sri Madhav Shenoy also joined him in the business as a partner. Thus, M/s. Mangalore Ganesh Beedi Works (hereinafter in short, "the firm"), came into existence with effect from March 28, 1940. Thereafter, it was reconstituted from time to time. The last reconstitution of the firm is evidenced by a partnership deed dated June 30, 1982. According to the averments made in the deed, the last reconstitution of the firm became effective from June 6, 1982. According to the deed of partnership, the firm comprised of the following 13 partners :
SI. No. Name of the partners Percentage of share 1. B. Raghurama Prabhu 14.50 % 2. M. Janardhana Rao 7.65 % 3. M. Ananda Rao 7.65 % 4. M. Vinoda Rao 7.50 % 5. M. Pushpalatha, W/o. Subraya Baliga 12.50 % 6. Hemalatha, W/o. Raghunath Shenoy 12.50 % 7. M. Suresh Rao 7.55 % 8. M. Vishwanath Rao 7.55 % 9. M. Ramanatha Rao 2.50 % 10. Jaganath Shenoy 2.50 % 11. Vatsala Shenoy 7.55 % 12. M. Gopinath Shenoy 2.50 % 13. Arathi Shenoy, D/o. M. Janardhana Rao 7.55 % 4. Clause (3) of the partnership deed provides for the duration of the firm. This clause reads as under :
"(3) The duration of the partnership shall be five years in the first instance ; but by mutual agreement the parties hereto may extend the said duration. If during the subsistence of this partnership any of the partners desire to retire from the partnership he or she can do so, if all the other partners agree to the said retirement. However, if all the other partners do not agree to the said retirement, the partner intending to retire shall give six month's notice in writing of his or her intention to retire and on expiration of the period of the said notice the said partner shall cease to be a partner and subject to para. 14 infra from that date all his or her liabilities and rights as a partner of the firm shall come to an end."
5. According to the above Clause (3) of the partnership deed, the partnership was to dissolve on June 5, 1987. But, because of mutual agreement between the partners as provided in the above Clause (3) itself, the duration was extended for a further period of six months, i.e., up to December 5, 1987. Therefore, in terms of Section 39 read with Sections 40 and 42(a) of the Partnership Act, 1932, the firm stood dissolved with effect from December 6, 1987. As a consequence of the dissolution of the firm, the affairs of the firm were required to be wound up in the manner provided in the partnership deed.
6. Clause (16) of the partnership deed has made specific provisions for the manner in which the affairs of the firm were to be wound up after its dissolution. It reads as under :
"(16). If the partnership is dissolved, the going concern carried on under the name of the firm, Mangalore Ganesh Beedi Works, and all the trade marks used in the course of the said business by the said firm and under which the business of the partnership is carried on shall vest in and belong to the partner who offers and pays or two or more partners who jointly offer and pay the highest price therefor as a single group at a sale to be then held as among the partners at which sale nobody other than the partners shall be entitled to bid. The other partners shall execute and complete in favour of the purchasing partner or partners at his/ her or their expense all such deeds, instruments and applications and otherwise aid him/her or them for the registration of his/her name or their names of all the said trade marks and do all such deeds, acts and transactions as are incidental or necessary to the said transferee or assignee partner or partners."
7. It is a matter of record that despite dissolution of the firm, because of differences between the erstwhile partners, the affairs of the firm could not be wound up. So two of the partners of the firm filed a petition before this court under the provisions of Part X of the Companies Act, 1956, for winding up of the affairs of the firm in terms of Section 583(4)(a) thereof. This petition was numbered as C. P. No. 1 of 1988. By order dated November 3/5, 1988, this court permitted the group of partners (7) having controlling interest to continue the business as an interim arrangement till the completion of winding up proceedings. Subsequently, under order dated June 14, 1991, this court framed the scheme for winding up of the affairs of the firm by selling its assets as a going concern. Paragraph 29 of the order contains the scheme. Clauses (i), (iii) and (v) of this scheme are material for the present purposes and accordingly are being reproduced hereunder :
"(i) The dissolved partnership firm--Mangalore Ganesh Beedi Works, as a going concern shall be sold to such of its partner/s, who make/s an offer of a highest price, the same not being less than the minimum (reserved) price of Rs. 30 crores (rupees thirty crores) within July 11, 1991, accepting further liability to pay interest at 15 per cent, per annum towards the amount of the price payable to partner/s from December 6, 1987, till the date of deposit: . . .
(iii) If no offer for purchase of the dissolved partnership firm as a going concern, adverted to in Clause (ii) above, is received within the stipulated time or if any of the offers made by the partner/s is not accepted by the court, the official liquidator shall invite offers for purchase of the dissolved partnership firm as a going concern from the public including the partners by giving publicity in three consecutive issues of two English daily national newspapers which have wide circulation in the country and one Kannada daily newspaper having wide circulation in Karnataka, the time allowed from making offers being at least 45 days between the last publication and the date fixed for receipt of the offers . . .
(v) If the sale of the dissolved partnership firm as a going concern in favour of any partner or partners or an outsider is accepted by the court, such offerer shall, within 60 days from the date of the acceptance of the offer, deposit with the official liquidator the price or such part of the price together with interest on the total amount of the price at 15 per cent, per annum from December 6, 1987, till the date of deposit, which may become liable to be paid to the partner or partners towards their share of the price in the partnership firm together with interest on such amount."
8. Some of the partners of the dissolved firm assailed the above order before the Supreme Court by preferring special leave petition in S. L. P. No. 10680 of 1991 but the same was ultimately dismissed as withdrawn on April 8, 1994.
9. Pursuant to the above scheme framed by this court, several partners either individually or in groups offered their bids. The bid offered by an association of persons comprised of three partners, namely, M. Vishwanath Rao, M. Jaganath Shenoy and M. Gopinath Shenoy (hereinafter referred to the "purchas-ing-AOP") was found to be the highest being of Rs. 92 crores. Therefore, it was accepted by this court vide its order dated September 21, 1994. The said order was to the following effect:
"The highest bid amount of rupees ninety two crores is accepted and the group of persons offering the said amount are directed to deposit within 60 days from today with the official liquidator the entire amount of rupees ninety two crores together with actual profits earned from December 6, 1987, till March 31, 1994, and proportionate profit from April 1, 1994, till the date of deposit in terms of the orders of this court earlier issued in C A. No. 313 of 1994."
10. At the instance of the three partners offering the highest bid, Clause (1) of the order dated September 21, 1994, was amended by a subsequent order dated September 29, 1994. The modified Clause (1) of the order dated September 21, 1994 :
"The highest bid amount of rupees ninety two crores is accepted and the group of partners offering the said amount are directed to deposit that part of the bid amount of rupees ninety two crores which is proportionate to the shares held by the out-going partners together with profits on the same basis from December 6, 1987, till the date of deposit, within a period of 60 days from September 29, 1994, in any of the nationalised banks in the name of the official liquidator. The rest of our order dated September 21, 1994."
11. It may be noticed here that during the pendency of the winding up petition, one of the partners, namely, Sri M. Vinoda Rao, assigned his interest in the dissolved firm in favour of some of the other partners on July 3, 1993. Therefore, the association of persons conducting business remained only of 12 members.
12. Pursuant to the above order, the purchasing-AOP deposited the bid amount on November 17, 1994, with the official liquidator. As per the order passed by this court the assets of the firm as a going concern were to be treated as having been sold to the "purchasing-AOP" on November 20, 1994. It is again a matter of record that the business of the firm along with its assets were handed over by the official liquidator attached to this court to the purchasing-AOP on January 7, 1995, vide his report 10 of 1995 and sale proceeds were distributed by the official liquidator under the orders of this court amongst the out-going partners on February 2, 1995.
13. It is also a matter of record that despite dissolution of the firm, for one or the other reason, the business of the firm could not be wound up in terms of Clause (16) of the partnership deed and as noticed above the same was continued even thereafter in the normal way under the supervision and direction of this court. This fact becomes evident from the order dated April 11, 1990, passed by the Division Bench in O. S. A. No. 2 of 1989 wherein it was inter alia held that:
"No doubt, according to the partnership dated June 13, 1982, the partnership was to continue for a period of five years. But, it is not disputed by either side that the partners agreed that the partnership should be continued on the same terms and conditions contained in the deed of partnership for a further period of six months and even after the expiry of the further period of six months, they have continued the business."
14. None of the partners of the erstwhile firm had questioned the correctness of the above finding recorded by this court. From the above facts, it is clear that the assets of the dissolved firm remained as its property till those were sold under the orders of this court in Company Application No. 1 of 1988 on November 20, 1994, wherein the same was purchased by the "purchasing-AOP".
15. Keeping in view the sequence of the events as noticed above, it is quite clear that after the dissolution of the firm/ its business was continued by an association of persons comprised of all the erstwhile 13 partners by using the assets as well as the name of the dissolved firm. Therefore, till the date of dissolution, the name "Mangalore Ganesh Beedi Works" was of the partnership firm. Whereas, after the dissolution, it became the name of the association of persons comprised of all the erstwhile partners of the dissolved firm.
16. Under the aforesaid circumstances, two returns were filed in the same name but under different status. The first return was filed for the period July 1, 1987, to December 18, 1987, in the status of "registered firm". The income declared was Rs. 7,50,49,560. The second return was filed for the period December 19, 1987, to March 31, 1989, in the status of "AOP" declaring an income of Rs. 25,31,64,310. The Assessing Officer accepted the returned income under his order dated May 29, 1991, and February 28, 1992.
17. The Commissioner of Income-tax, being of the opinion that the order dated May 29, 1991, passed by the Assessing Officer in respect of the registered firm was prejudicial to the interests of the Revenue, invoked suo moto revisional powers under Section 263 of the Act. On hearing the assessee after due notice, he took the view that as a result of the dissolution of the firm and passing of the business and assets of the firm to the hands of the AOP there was a transfer in terms of Section 45(4) of the Act which attracted liability of capital gains tax. The Commissioner also held the view that stocks of the dissolved firm were undervalued. He assessed the under valuation at Rs. 24,52,338. After recording these findings, the Commissioner by his order dated March 16, 1994, set aside the assessment order and remanded the case for reassessment.
18. Aggrieved by the above order, the assessee preferred an appeal before the Tribunal. The Tribunal agreeing with the contentions of the assessee held that there was no transfer of capital assets of the firm to the partners so as to attract the provisions of Section 45(4) of the Act and as such according to it, no capital gains tax is leviable on the firm. The Tribunal by relying on the case law on the subject also held that there was nothing wrong on the part of the firm in valuing its closing stock at cost instead of market price as on the date of the dissolution of the firm. In the backdrop of the foregoing facts, the Tribunal has referred the three questions of law reproduced in the first paragraph of this judgment.
19. Before proceeding to answer the question of law relating to capital gains, i.e., question No. (iii), one has to bear in mind that "partnership" as defined in Section 4 of the Indian Partnership Act, 1932, is the relation between persons who have agreed to share the profit of a business carried on by all or any of them acting for all. This relationship may have many other attributes as agreed between the parties and are recognised under the Partnership Act. So far as a relationship in association of persons is concerned, it has not been defined in any statutory provision. But the Supreme Court in the case of N.V. Shanmugham and Co. v. CIT has held that "association of persons" as used under the Income-tax Act means an association in which two or more persons join in a common purpose or common action, and as the words occur in a section which imposes a tax on income, the association must be one, the object of which is to produce income, profits or gains.
20. Now the questions that arise are: (i) whether the partnership can own properties ? and if so, then (ii) whether on its dissolution it ceases to hold the said properties and the partners become owners thereof in specie to the extent of their shares, and (iii) whether despite its dissolution the firm by fiction of law continues to be the owner of the properties till the affairs of the firm are finally dissolved ?
21. So far as the right of the firm to own properties is concerned, Section 14 of the Partnership Act clearly admits this proposition. This section reads as under :
"14. The property of the firm.-- Subject to contract between the partners, the property of the firm includes all property and rights and interests in property originally brought into the stock of the firm, or acquired/ by purchase or otherwise, by or for the firm, or for the purposes and in the course of the business of the firm, and includes also the goodwill of the business.
Unless the contrary intention appears, property and rights and interest in property acquired with money belonging to the firm are deemed to have been acquired for the firm."
22. Further, there cannot be any dispute on the proposition that every dissolution must be in point of time anterior to the final winding up of the firm. Generally, there will be a time gap between the two events. It is evident from the present case as well. The firm was dissolved on December 5, 1987, but the sale of the assets of the firm as a going concern had taken place only on November 20, 1994.
23. For completion of the process of winding up, the Legislature has engrafted Section 47 in the Partnership Act for continuance of the partnership by creating a legal fiction. This section reads as under :
"47. Continuing authority of partners for purposes of winding up.--After the dissolution of a firm the authority of each partner to bind the firm, and the other mutual rights and obligations of the partners, continue notwithstanding the dissolution, so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise :
Provided that the firm is in no case bound by the acts of a partner who has been adjudicated insolvent; but this proviso does not affect the liability of any person who has after the adjudication represented himself or knowingly permitted himself to be represented as a partner of the insolvent."
"According to Section 47 of the Indian Partnership Act, 1932, after the dissolution of a firm, the authority of each partner to bind the firm, and the other mutual rights and obligations of the partners, continue notwithstanding the dissolution, so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution but not otherwise. The word 'transaction' in Section 47 refers not merely to commercial transaction of purchase and sale but would include also all other matters relating to the affairs of the partnership. The completion of a transaction would cover also the taking of necessary steps in connection with the adjudication of a dispute to which a firm before its dissolution is a party."
25. In Saligram's case, , the Supreme Court has further held that (page 1105) :
"The proposition, in our opinion, cannot be disputed that after dissolution, the partnership subsists merely for the purpose of completing pending transactions, winding up the business, and adjusting the rights of the partners ; and for these purposes, and these only, the authority, rights, and obligations of the partners continue (see page 573 of Halsbury's Laws of England, third edition, volume 28)".
26. The Division Bench of the Kerala High Court in the case of Paulson Constructions v. CIT , while dealing with the assessment of the dissolved firm has held that (page 480) :
"Section 47 of the Partnership Act says that on the dissolution of a firm, the authority of each partner to bind the firm and the other mutual rights and obligation of the partners continue notwithstanding the dissolution so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution. Therefore, for realisation of the assets, discharging the liability of the firm and settling the accounts of the partners, etc., the firm will continue to exist despite the dissolution."
27. Similar view has been taken by the Kerala High Court in the case of Joint Receivers of United Film Exhibitors v. CIT .
28. In view of the above statutory provisions and the law laid down by the Supreme Court it appears reasonable to hold that though the firm stood dissolved on December 5, 1987, for a limited purpose of winding up of the affairs of the firm, it continued till its assets and business were sold as a going concern on November 20, 1994. Therefore, the firm continued to hold the properties as owner till November 20, 1994.
29. For the foregoing reasons, we hold that there was no distribution of capital assets of the firm despite its dissolution and therefore the firm could not have been made liable for paying capital gains tax in terms of Section 45(4) of the Act.
30. So far as question No. (ii), regarding valuation of closing stock is concerned, this issue is squarely covered by the judgment of the Supreme Court in the case of A.L.A. Firm v. CIT , wherein it has been held that (headnote) :
"It is settled law that the true trading results of a business for an accounting period cannot be ascertained without taking into account the value of the stock-in-trade remaining at the end of the period.
The proper practice is to value the closing stock at cost. That will eliminate entries relating to the same stock from both sides of the account. To this rule, custom recognises only one exception and that is to value the stock at market value if that is lower. On no principle can one justify the valuation of the closing stock at a market value higher than cost as that will result in the taxation of notional profits the assessee has not realised.
There can be no manner of doubt that, in taking accounts for purposes of dissolution, the firm and the partners, being commercial men, would value the assets only on a real basis, and not at cost or at their other value appearing in the books. The real rights of the partners cannot be mutually adjusted on any other basis."
31. Admittedly, at no point of time, the business which was being carried on by the firm despite its dissolution had been closed during the previous year pertaining to the assessment year in question and the same set of persons continued to carry on the same as an association of persons with the same share ratio. Therefore, the Tribunal was right in holding that there was nothing wrong on the part of the Assessing Officer in valuing the closing stock at cost instead of market price as on the date of dissolution of the firm. Since we have agreed with the finding of the Tribunal on two issues, which were proceeded by the Commissioner of Income-tax to interfere with the order of the Assessing Officer by exercising his suo moto revisional jurisdiction, it has to be held that the Commissioner had erred in setting aside the assessment order.
32. In the result, all the three questions are answered in favour of the assessee and against the Department.