Decided on July 27,1982



S. Rajaratnam, Accountant Member - (1.) THESE three departmental appeals arise out of the common order of the Commissioner (Appeals) in the fcase of Pompei Tile Works for the assessment years 1976-77, 1977-78 and 1978-79.
(2.) The assessee is a firm doing business of manufacture and sale of tiles. It is a partnership consisting of (1) Mr. Francis Xavier Denis Pinto, (2) Mr. Harold Charles Pinto, (3) Mr. Cuthbert Joseph Pinto, (4) Mrs. Margaret Pinto and (5) Mrs. Deanna Lobo by a partnership deed dated 1-11-1961. This partnership did provide for a share of 25 per cent to Mrs. Margaret Pinto. Clause 10 of the partnership deed requires that an outgoing partner should give three months' notice of intention in writing and that he would be entitled to the capital account in the books of the firm, the share of goodwill valued in a particular manner and interest on overdue amount from the last balance sheet in lieu of current profits and payment of 50 per cent of the same within a month and balance with interest within a year. It further provided for arbitration under the Arbitration Act, 1940, in the event of disputes between the partners. It appears that there was misunderstanding between the partners sometimes prior to 1-4-1975 due to the alleged non-co-operation of Mrs. Margaret Pinto in signing certain papers for loan and other acts. Mrs. Deanna Lobo also wished to leave the partnership allegedly due to the hostile attitude of Mrs. Margaret Pinto. Partner Mr. Francis Xavier Denis Pinto had also meanwhile died. This resulted in the creation of a fresh partnership by a deed dated 1-4-1975 between the remaining partners (1) Harold Charles Pinto, (2) Cuthbert Joseph Pinto (the partners of the erstwhile firm), (3) David J. Pinto, (4)Paul J.C. Pinto (sons of the deceased) and (5) Mrs. Beatrice Pinto, who stepped into the shoes of Mrs. Deanna Lobo to form a fresh partnership. This partnership deed provided for payment of 25 per cent of the net profits to Mrs. Margaret Pinto before the division of profits between the partners. The remaining partners seem to have taken the view that they were entitled to 'expel' Mrs. Margaict Pinto for her acts of non-co-operation as is evident from the preamble of the new deed. There was no settlement of accounts between Mrs. Margaret Pinto and either the old or the new firm in lieu of her right to share of goodwill or her other shares, if any, in partnership assets. The assessee claimed 25 per cent of the profit credited to her account as a deduction out of its profits. Shortly after the creation of the new partnership with effect from 1-4-1975, Mrs. Margaret Pinto herself died on 14-6-1975. Similar payment was continued to be made for all the three years under consideration to the estate of Mrs. Margaret Pinto. Mrs. Margaret Pinto died without issue. However, she had a number of relatives both on her own side being brothers and sisters and on husband's side being brothers-in-law, nephews, nieces, etc. It appears that there had been a dispute as to the claimants to the estate which is not concluded till date. The short point for consideration is whether the amount credited to her/her estate to the extent of Rs. 35,594 for the assessment year 1976-77, Rs. 17,575 for the assessment year 1977-78 and Rs. 12,674 for the assessment year 1978-79 would be allowed as deduction either by way of diversion by overriding title or as a charge on the profits of the firm. According to the ITO, it is only an application of income and, therefore, not deductible. The Commissioner (Appeals) found that there has been a diversion of income by overriding title. He had cited a number of decisions in support of his view. In the departmental appeal, it is contended that there has been no diversion by overriding title. It is claimed that it is not an expenditure wholly and necessary for purpose of business within the meaning of Section 37 of the Income-tax Act, 1961 ('the Act'). It is further contended that whatever might to the legal position before the death of Mrs. Margaret Pinto on 14-6-1975, there could be no claim to the same extent in the absence of any issues for her. It was claimed that there was actually no obligation on the part of the assessee to make the payment. It was alternatively contended by the learned departmental representative, who repeated these arguments, that the payment, at any rate, is excessive and cannot be allowed to the same extent as claimed. The learned departmental representative took us over the two documents and the case law relied upon by the first appellate authority and sought to distinguish the same on facts. His alternative contention, in short, was that the lady Mrs. Margaret Pinto was merely entitled, if at all, to an interest at 7 per cent of the balance to her credit and that the payment of 25 per cent was not justified in law. Even if it was payable under the new agreement, he argued that it was not wholly and exclusively necessary for the purpose of the business. The learned representative for the assessee relied upon the order of the first appellate authority. He claimed that Mrs. Margaret Pinto was entitled to her share of partnership assets and share of goodwill even in the event of retirement. 'Expulsion', even if justified, cannot defeat her legal rights over the assets, including the goodwill, of the partnership firm. From 1-4-1975, she had ceased to be a partner, according to the new deed. But she was entitled to her share of the assets. The accounts were not settled. In absence of settlement of accounts he claimed that Section 37 of the Indian Partnership Act, 1932, would come into play. The assessee was entitled to have her share of profits whether she had rights fas a partner or not. The fact that she was not a party to the second deed cannot defeat her right. This was precisely the issue that was decided in the case before the Bombay High Court in CIT v. Crawford Bayley & Co. [1977] 106 ITR 884. He also claimed that cest eique trust was created in her favour and that she had enforceable legal claim for her share of partnership profits in view of this document for she was not privy to the contract. He relied upon Section 88 of the Indian Trusts Act, 1882, as supporting his case. He also relied upon some other decisions including a decision of this Tribunal in IT Appeal No. 41 (Bang.) of 1979 dated 13-2-1981 published in the Journal, Direct Tax Planning (May 1981 Issue). The- learned representative further argued that the estate of Mrs. Margaret Pinto stepped into the shoes of the deceased and had the same rights till the accounts due to Mrs. Margaret Pinto in respect of the partnership assets were settled. He further contended that Mrs. Margaret Pinto or her estate was not sharing the profits in the sense of sharing. They were only receiving (compensation for the use of the assets partly owned by Mrs. Margaret Pinto and it was in the nature of compensation measured with reference to the profit rather than amount paid as share of profits. The learned departmental representative tried to distinguish the facts by pointing out that in all these cases the right of the widow or the legal representative to the amount to which they were entitled was stipulated even in the first deed and that was not in dispute. According to him, this made all the difference. We have carefully considered the records as well as the arguments. Here is a case where Mrs. Margaret Pinto, who was a partner, was left out of the new partnership without her consent. However, there was no settlement of accounts at the time when she was 'expelled' from the partnership. According to the document, she was entitled to her share of profits besides share of goodwill. 50 per cent of the amount had to be paid within a month and balance within a year with interest. It is common ground that there was no such settlement. The remaining partners did not deny their liability under the deed dated 1-11-1961 even in the document executed between themselves in the new deed of the new partnership dated 1-4-1975. They had agreed to pay 25 per cent of the profits to Mrs. Margaret Pinto and in the event of loss they stipulated a minimum payment of 6 per cent per annum on the amounts standing to her credit. It is also made amply clear that she was not a partner in the new firm and she had forfeited her right as a partner because of her conduct during the existence of the partnership prior to 1-4-1975. The partnership had even immovable property in the form of a Tiles Factory. The business was continued in the same name, i.e., with goodwill. In other words, the payment to Mrs. Margaret Pinto was not gratuitous. It was in lieu of her right as an erstwhile partner whose account had not been settled. Neither the quantum of payment nor the genuineness has been questioned in the assessment orders. Section 37 of the Partnership Act provides as under : Where any member of a firm has died or otherwise ceased to be a partner and the surviving or continuing partners carry on the business of the firm with the property of the firm without any final settlement of accounts as between them and the outgoing partner or his estate, then, in the absence of a contract to the contrary, the outgoing partner or his estate is entitled at the option of himself or his representatives to such share of the profits made since he ceased to be a partner as may be attributable to the use of his share of the property of the firm or to interest at the rate of six per cent per annum on the amount of his share in the property of the firm : Provided that where by contract between the partners an option is given to surviving or continuing partners to purchase the interest of a deceased or outgoing partner and that option is duly exercised, the estate of the deceased partner, or the outgoing partner or his estate, as the case may be, is not entitled to any further or other share of profits; but if any partner assuming to act in exercise of the option does not in all material respects comply with the terms thereof, he is liable to account under the foregoing provisions of this section. Apart from her right as an outgoing partner, according to the terms of the deed dated 1-11-1961, which at any rate contemplates only retirement and not 'expulsion', Section 37 clearly entitles the outgoing partner to a share in subsequent profits in absence of settlement. As pointed out by the learned departmental representative, such share is at the option of the outgoing partner who may well be content with normal interest on amount due. In the facts and circumstances of the assessee's case, we cannot possibly presume that the outgoing partner, Mrs. Margaret Pinto, had opted to be content with a lesser amount in absence of anything to suggest such an option. It is reasonable to presume that a person would take advantage of a more beneficial term. In fact, in absence of settlement of accounts, even the amount due is not settled. At any rate, as pointed out earlier, there is no dispute about the genuineness of the payment. As pointed out by the Bombay High Court in Crawford Bayley & Co.'s case (supra), the fact that Mrs. Margaret Pinto is not a party to the second deed does not make her helpless. She has an enforceable right though there is no privity of contract between her and the new partnership. The amount that has been provided for her arises in lieu of her right under the old partnership deed. Hence, there is a consideration and, therefore, an enforceable right. This title to her share is not as a partner any longer after 1-4-1975 but merely as a person entitled to compensation for the use of her assets, i.e., her share of assets including goodwill. Hence, the compensation is not a share of profits as a partner even as pointed out by the learned representative for the assessee. Such a payment was treated as a payment by diversion of overriding title by the Bombay High Court. Even the other decisions cited by the learned representative for the assessee are to the same effect, though the facts in each case are different. As for the argument that the estate of Mrs. Margaret Pinto would not be entitled to any share after her death merely because she has no issue, it is rather naive. She had left a number of close relatives to contend for her property after her death. It makes no difference that she herself had no issue of her own. The legal heirs entitled to the estate of late Mrs. Margaret Pinto would step into her shoes from the date of her death till there is a settlement of accounts between the estate and the partnership firm. It appears that there had been such a settlement in a later year. The learned representative also referred to Section 88 of the Trusts Act 1882, for the proposition that the partnership firm was holding and managing the share of the partnership assets belonging to Mrs. Margaret Pinto in a fiduciary capacity and that they are bound to compensate for the same. It is not necessary to elaborate on this point from this angle. There is, no doubt, whatsoever that Mrs. Margaret Pinto was entitled to compensation in view of the partnership deeds which makes her right a contractual one. In view of Section 37 of the Partnership Act there is a statutory charge on the assets of the partnership firm. In fact the second partnership deed stipulates to the same effect. There is also a fiduciary'responsibility on the part of the erstwhile co-partners to ensure pecuniary compensation in absence of settlement of accounts. Since there is nothing brought on record to suggest that 25 per cent share which is the same as she had prior to her 'expulsion' is in any manner excessive in absence of any settlement of account, we are not in a position to entertain the alternative argument that the payment is excessive with reference to the stipulation in the first deed of 7 per cent interest for 50 per cent of balance due for payment within one year. This provision is a dead letter in absence of any payment Mrs. Margaret Pinto would have, at any rate, been entitled to market rate of interest not only on the amount standing to her credit, but also on her share of goodwill even as provided in the first deed. Hence, having satisfied ourselves that the payment was both contractual and statutory, the only further question is whether [there has been an overriding title. The payment was made by virtue of the provision in the partnership deed itself. There cannot, therefore, [be any doubt that the payment is in the nature of diversion of overriding title even as held in very similar circumstances in the cases of Crawford Bayley & Co. (supra), CIT v. Nariman B. Bharucha & Sons [1981] 130 ITR 863 and CIT v. C.N. Patuck [1969] 71 ITR 713 (Bom.) by following the principle laid down by the Supreme Court in the case of CIT v. Sitaldas Tirathdas [1961] 41 ITR 367. Though the facts in each case are different as pointed out by the learned departmental representative, the rationale of all these decisions would lead to one and only one conclusion that the payment to Mrs. Margaret Pinto is diversion of profits by overriding title. Even otherwise, we are not in a position to accept the claim that the payment is not wholly and exclusively for the purpose of business. On facts found by us, the payment had been made in order to retain complete right over the assets of the partnership firm in order to earn profits. If the payment had not been made, the business could have been brought to a standstill unless and until her share due under the partnership deed had been paid of. It would have been allowable even under Section 37 of the Act. We are not able to find any material to suggest that the payment is merely an application of income. No authorities were also cited on behalf of the revenue though serious attempt was [made to show that the authorities cited in favour of taxpayer were not on all fours with the facts of the assessee's case.
(3.) UNDER the circumstances, we have to uphold the order of the first appellate authority for all the three years and dismiss the departmental appeals.;

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