Sohan Pathak And Sons vs Commissioner Of Income-Tax, U.P.

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 47 to 50 of 1952

Decision Date: 23 September 1953

Coram: M. Patanjali Sastri, B.K. Mukherjea, Vivian Bose, Ghulam Hasan, B. Jagannadhadas

In this matter the Supreme Court of India issued its judgment on 23 September 1953. The opinion was authored by Justice M. Patanjali Sastri and was delivered by a bench consisting of Justices M. Patanjali Sastri, B. K. Mukherjea, Vivian Bose, Ghulam Hasan and B. Jagannadhadas. The petition was filed by Sohan Pathak and Sons and the respondent was the Commissioner of Income-Tax for Uttar Pradesh. The case is reported as 1953 AIR 456 and 1954 SCR 158. The statutory framework involved the Excess Profits Tax Act (XV of 1940), specifically sections 4, 5 and 10-A, and the dispute concerned a Hindu undivided family that was engaged in the businesses of money-lending and brocade.

According to the factual findings, on 16 July 1943 the members of the Hindu undivided family carried out a partial partition of the brocade business. In that partition the assets and liabilities of the brocade venture were divided equally among the family members. On the following day the adult members created two separate partnership firms, each admitting minor members to the benefit of the partnership, and continued the brocade trade under two distinct firm names while still retaining their joint status as members of the family. The Income-Tax Officer accepted this partial partition and consequently treated the brocade business of the family as having been discontinued. In contrast, the Excess Profits Tax Officer rejected that view, holding that the primary purpose of the partition was to avoid tax liability. The officer therefore considered the brocade business to be unbroken and made adjustments under section 10-A of the Excess Profits Tax Act by adding to the profits earned by the assessee as a joint family up to the date of partition the profits subsequently earned by the two partnership firms during the chargeable accounting period.

The Court set out its holdings as follows. First, relying on sections 4 and 5 of the Excess Profits Tax Act, the Court observed that the Act cannot be applied to a business that did not generate any profit during the relevant chargeable accounting period. Since the original joint family brocade business had been wound up and had earned no profit in the period in question, the appellants could not be taxed as a Hindu undivided family with respect to that business. Second, the Court clarified that the question of whether the Excess Profits Tax Act applies to a particular business must be determined solely on the basis of section 5, and that section 10-A should be construed to operate only in cases where the business is found to fall within the scope of the Act and a transaction of the type described in that section has actually taken place. Because the old joint family brocade enterprise had been dissolved and was no longer carried on by the joint family during the relevant chargeable accounting periods, the Court concluded that the business could not legally be treated as having continued unbroken for the purposes of section 10-A.

The Court noted that the question before it concerned the application of section 10-A of the Excess Profits Tax Act read together with sections 4 and 5 of the same statute for the relevant chargeable accounting periods. The matter was listed as a civil appellate jurisdiction under Civil Appeals Nos. 47 to 50 of 1952. The appeals were taken from the judgment and decree dated 11 May 1950 of the High Court of Judicature at Allahabad, rendered by Justice Malik C. J. and Justice Bhargava J., in Miscellaneous Case No. 134 of 1949, which was connected with Miscellaneous Case No. 197 of 1948. Counsel for the appellant was G. S. Pathak, assisted by G. C. Mathur, while the respondent was represented by M. C. Setalvad, Attorney-General for India, assisted by G. N. Joshi. The judgment was delivered on 23 September 1953 by Chief Justice Patanjali Sastri. The batch of appeals originated from a reference made by the Income-Tax Appellate Tribunal, Allahabad Bench, to the Allahabad High Court under section 26 of the Excess Profits Tax Act, hereinafter referred to as “the Act.” Although the assessments under challenge pertained to different chargeable accounting periods, the legal issues raised were identical in each appeal.

The appellants were a Hindu undivided family comprising four branches, each representing one of the four sons of the deceased Sohan Pathak. The family conducted money-lending and Banaras brocade trade in Banaras under the name Sohan Pathak & Sons. In the assessment for the chargeable accounting period ending on 8 October 1943, the appellants asserted that a partial partition of the family had occurred on 16 July 1943, whereby the Banaras brocade business was divided equally among the four branches. They further contended that on the following day the adult members of the family formed two partnerships, admitting the minor members to the benefits of those partnerships, and thereafter carried on the brocade trade under the firm names Sohan Pathak Girdhar Pathak and G. M. Pathak & Co. The appellants claimed that, after the partition on 16 July 1943, the family as a whole ceased to carry on the brocade business, although the members remained joint in status. Consequently, they argued that the profits earned by the two new partnerships after 17 July 1943 could not be treated as profits of the original joint family business because the partnership businesses were distinct, newly started enterprises that could not, in law or in fact, be regarded as a continuation of the old brocade business. To substantiate this position, the appellants relied heavily on the fact that the Income-Tax Officer had treated the old business as discontinued following the partial partition and had granted relief under section 25(3) of the Indian Income-Tax Act in the assessment of the family as a Hindu undivided family. The Excess Profits Tax Officer, however, rejected the appellants’ claim, holding that the primary purpose of the partial partition and the creation of the two partnerships was to avoid or reduce the appellants’ liability to excess profits tax, and consequently made adjustments to the assessment accordingly.

Under section 10-A of the Excess Profits Tax Act, the assessing authority added to the profits earned by the appellants as a joint Hindu family up to the date of the partial partition the profits made by the two newly formed firms during the relevant chargeable accounting periods. Both the Appellate Assistant Commissioner and the Appellate Tribunal affirmed the finding and the order made by the Excess Profits Tax Officer. However, at the request of the appellants, the Tribunal referred three specific questions to the High Court for determination. The first question asked whether, given that the Income-Tax Officer had accepted the partial partition and had treated the business as discontinued for the purposes of assessment under the Income-Tax Act, the same business could legally be regarded as having continued uninterrupted for the same accounting period under section 10-A of the Excess Profits Tax Act, read with sections 4 and 5 of that Act. The second question concerned whether, in the circumstances of the case, the effect of the partial partition of the Hindu undivided family on 16 July 1943 and the subsequent formation of two separate firms constituted a transaction within the meaning of section 10-A of the Excess Profits Tax Act. The third question sought to determine whether, based on the facts identified by the Tribunal in paragraph 7 of the statement of the case, it was justified to infer that the principal purpose behind the partial partition was to avoid or reduce liability to excess profits tax. The High Court answered these questions against the appellants but granted them leave to appeal to this Court.

At an earlier hearing of these appeals, this Court observed that the material facts relating to the partial partition, the formation of the partnership, and the Tribunal’s findings thereon had not been clearly set out in the Tribunal’s original statement of the case. The Court noted that while the statement of the case in one passage described the old family brocade business as continuing without interruption after the partial partition, another passage referred to the assets of that business having been equally divided among the four branches of the family. Consequently, the Court found that there was no definite finding as to how the partition of the brocade business was actually effected—whether by a division of shares, with each branch holding its share independently while the business continued as a partnership, or by an actual distribution and allotment of specific assets and liabilities among the branches, thereby disrupting the business. Accordingly, by its order dated 12 January 1953, the Court directed that a more precise statement of facts be provided on the points indicated. The Tribunal subsequently submitted a supplementary statement of the case that fully set out the details of the partition arrangement and the constitution of the two firms by the family members after the partition. The statement reveals that

According to the supplementary statement, the majority of the capital together with all of the stock in trade, the cash in hand, the cash in banks, all outstanding amounts as of that date and also the sundry liabilities up to that day were allocated among the fourteen coparceners. Each branch received a four-anna share, as shown in the schedule filed by the assessee and annexed to the statement. This allocation demonstrated that the partition was effected by a specific distribution of both assets and liabilities rather than by a simple division of shares. After the assets and liabilities had been distributed in this manner, two separate partnerships were formed, each of which continued to carry on brocade businesses that were substantially similar to the business previously conducted by the joint family before the partial partition. The record lists the names of the partners in the two firms, and it appears that each firm comprised members representing all four branches of the family. Some of these members were adults and some were minors; the minors were admitted only to the benefits of the partnerships and did not assume any managerial responsibilities.

On the basis of these facts, counsel for the appellants argued that the finding of the Excess Profits Tax Officer—that the primary purpose of the partial partition and the creation of the new partnerships was to avoid or diminish the appellants’ excess profits tax liability—was not supported by any material on record. The counsel further submitted that, even assuming the officer had some material to reach such a conclusion, the original Banaras brocade business had in fact been closed down, and therefore the officer lacked authority to assess the profits of that business for the purpose of making adjustments under section 10-A of the Act by adding the profits earned by the two new firms after 17 July 1943. Alternatively, the counsel contended that there was a clear change in the persons carrying on the old business after 16 July 1943; even if the business were considered to have continued, the Hindu undivided family is a “person” within the meaning of section 2(17), distinct from the individuals that comprise it, and consequently, under section 8(1), the business must be deemed, for all purposes of the Act (except for a provision that is not material here), to have been discontinued and a new business to have commenced, with the corresponding legal consequences. The counsel did not argue that the partial partition and the formation of the two partnerships were not “transactions” within the meaning of section 10-A, nor did he maintain that the acceptance of the partition and the allowance of relief by the Income-Tax Officer under section 25(4) of the Income-Tax Act settled the matter for the purposes of section 10-A, as had apparently been suggested in earlier stages of the proceedings. The first contention, however, could be dismissed succinctly because the facts established by the tax authorities and confirmed by the Appellate Tribunal showed that the partial partition and the creation of the partnerships occurred at a time when the profits of the Banaras brocade business were clearly on an upward trajectory.

The evidence indicated that the earnings of the Banaras brocade enterprise were clearly moving upward. When the Court asked the appellants to state the purpose of the partition and the creation of the new partnerships, assuming that the sole objective was not to evade the excess profits tax, they responded that their intention was to safeguard the interests of the minor members. According to their explanation, the minors’ shares in the partnership assets would not be subject to any loss that might arise in the firms, whereas the entire family property would remain exposed to any loss incurred by the family business. The Court found this justification unsatisfactory. First, the need for such protection had not arisen when the family business was generating only modest profits. Second, the structure of the partnerships created an imbalance: each branch received the same 4as. interest, yet the branch that did not include minor members would bear a heavier share of any losses than the branch that lacked adult members, creating a disparity that the appellants’ stated purpose failed to explain. In view of these considerations, the Court concurred with the High Court’s finding that there was ample material to support the Appellate Tribunal’s inference that the principal motive behind the partial partition and the formation of the partnerships was to avoid or reduce the family business’s liability to excess profits tax. The substantive issue remaining for determination was whether, given the factual finding that the original family business had been wound up, its assets and liabilities had been actually distributed among the coparceners, and that it was no longer being conducted by the joint family during the relevant chargeable accounting periods, section 10-A of the Act could still be applied to the case. The first question raised on this point was not properly framed. As already noted, the appellant did not contend that the Income-Tax Officer’s finding of the discontinuance of the old family business barred the Excess Profits Tax Officer from examining the matter. It is now well established that, for the purposes of the Act, a business is treated as a unit of assessment, and section 4 of the charging provisions stipulates that tax is levied on the profits of “any business to which this Act applies.” Section 5 defines the scope of businesses to which the Act applies, describing them as businesses “of which any part of the profits made during the chargeable accounting period is chargeable to income-tax” by virtue of certain specified provisions of the Indian Income-Tax Act, 1922. A proviso to this section excludes from the Act any business “the whole of the profits of which accrue or arise in a Part B State.” Consequently, it is evident that the Act cannot apply to a business that did not earn any profit during the relevant chargeable accounting period. In other words, if a business, having been discontinued, generated no profit in the chargeable accounting period under consideration, no excess profits tax can be imposed on that business.

In this case the Court observed that the old joint family business in Banaras brocade could not be treated as a business within the meaning of the Act, and consequently the appellants were not liable to be taxed as a Hindu undivided family for that business. The learned Attorney-General, however, contended that this conclusion could not be sustained because of the operation of section 10-A of the Act, which provides as follows: “10-A. Transactions designed to avoid or reduce liability to excess profits tax.-(1) Where the Excess Profits Tax Officer is of the opinion that the main purpose for which any transaction or transactions was or were effected—whether before or after the passing of the Excess Profits Tax (Second Amendment) Act, 1941—was the avoidance or reduction of liability to excess profits tax, he may, with the previous approval of the Inspecting Assistant Commissioner, make such adjustments as respects liability to excess profits tax as he considers appropriate so as to counteract the avoidance or reduction of liability to excess profits tax which would otherwise be effected by the transaction or transactions.” The Attorney-General argued that this provision authorises the Excess Profits Tax Officer to disregard any transaction whose primary purpose was to avoid or reduce liability to excess profits tax, treating such transactions as though they had never occurred. Accordingly, the partial partition of the family assets and the subsequent formation of partnerships were characterised as transactions undertaken chiefly to avoid or reduce excess profits tax liability, and the Officer was said to have authority to assess the appellants’ old family business in Banaras brocade on the basis of its continued existence during the relevant chargeable accounting periods.

The Court declined to accept that contention. It held that if, under section 4 read together with section 5 of the Act, the old joint family business cannot be regarded as a business “to which this Act applies,” then section 10-A, being a provision of the same Act, cannot apply to that business either. The Court further explained that the learned Attorney-General’s submission—that sections 4 and 5 must be read in conjunction with section 10-A to determine whether the Act applies to a particular business—is erroneous. The Court clarified that the initial question of whether the Act applies to a given business must be resolved solely by reference to section 5, which defines the scope of the Act. Section 10-A should be interpreted as operating only in cases where the business is already established to fall within the ambit of the Act and where a transaction of the type described in section 10-A has been carried out. The Attorney-General conceded that if a person who had been paying excess profits tax transferred the business to a Part B State, the Officer would not be empowered to invoke section 10-A to make adjustments on the ground that the business continued to operate in the same place, because such an action would contravene the express prohibition contained in the proviso to section 5. The Court therefore rejected the argument that section 10-A could be used to assess the appellants’ former family business despite its exclusion from the Act under sections 4 and 5.

The Court observed that once a business was transferred to a Part B State, the Excess Profits Tax Officer did not have the authority to rely on section 10-A to make adjustments on the ground that the assessee had continued to operate the business in the same location as before the transfer, even if the transfer had been carried out primarily to avoid or reduce the excess profits tax liability. The Attorney-General conceded that such an action by the Officer would contravene the explicit prohibition contained in the proviso to section 5, and he did not dispute the correctness of the Bombay High Court’s decision in Commissioner of Excess Profits Tax, Bombay City v. Moholal Maganlal. The Court rejected the notion that the present case could be distinguished from the Bombay case on a principle of difference, noting that in both situations the Act was rendered inapplicable by section 5. Consequently, the reasoning of the learned judges in the Bombay case—that when the Act does not apply to a particular business there is no liability to excess profits tax and therefore no question of avoiding or reducing tax liability under section 10-A—applied equally to the case before the Court and would lead to the same outcome. The Attorney-General also referred to the proviso to section 2(5), which states that all businesses to which the Act applies carried on by the same person shall be treated as one business for the purposes of the Act. The Court found that this provision could only operate with respect to businesses to which the Act is applicable and could not affect the present issue, thereby leaving the matter unchanged. The Court further noted that it was unnecessary to consider the alternative argument based on section 8(1) of the Act.

The Court allowed the appeals and set aside the answer rendered by the High Court to question No 1, substituting its own finding. In light of the factual determination that the old joint-family business dealing in Banaras brocade had been wound up and was no longer carried on by the joint family during the chargeable accounting periods in question, the Court held that the same business could not lawfully be regarded as having continued unbroken for those periods for the purposes of section 10-A read with sections 4 and 5 of the Excess Profits Tax Act. The judgment of the High Court was otherwise left intact. The appellants were awarded costs of the appeals, and a single set of advocates’ fees was ordered. The appeals were thus allowed. The Court recorded that the agent for the appellants was Naunit Lal and the agent for the respondent was G. H. Rajadhyaksha.