MOHANLAL HARGOVINDDAS Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) AT the instance of the assessee, M/s. Mohanlal Har -govinddas, Jawaharganj, Jabalpur, the following two questions of law have been referred to this court by the Income -tax Appellate Tribunal :

(2.) THE assessee is a partnership firm. It had two partners : (1) Smt. Ujjambai, and (2) Shri Parmanandbhai Patel. Later, a third person, by name, Shravankumar, also joined the partnership. Parmanandbhai Patel became partner of the firm on June 21, 1961. He, however, withdrew from the partnership in September, 1963, as he wanted to contest the election of Member of Legislative Assembly which he ultimately won and became a member of the council of Ministers. After relinquishing the office of Minister, Parmanandbhai Patel again joined the firm. When he withdrew from the firm, it was agreed that he shall be paid a sum of Rs. 50,000 per year in lieu of his share of the goodwill of the firm. It may be mentioned that, presumably because Parmanandbhai still wanted to join the firm back on his ceasing to be a member of the council of Ministers in this State, no final settlement of account was done nor was Parmanandbhai paid his share in the assets of the partnership including goodwill. The partnership -firm, after this agreement, claimed deduction of that amount of Rs. 50,000 Alleging that amount to be an expenditure laid out wholly for the purposes of business under the head 'Profits and gains of business or profession'. For the relevant assessment year 1975 -76, a deduction of Rs. 36,292 under this head was claimed because, in the meanwhile, Parmanandbhai had rejoined the partnership -firm. The Income -tax Officer disallowed this claim. The assessee appealed successfully and the Commissioner of Income -tax (Appeals) allowed this deduction under Section 37 of the Income -tax Act, 1961. The Department took up an appeal before the Income -tax Appellate Tribunal and could succeed in persuading the Tribunal to accept that the deduction so claimed was not justified as Parmanandbhai did not contribute anything towards earning of the goodwill of theassessee -firm during his short span as partner in the firm. The Tribunal also observed, while allowing the appeal by the Department and rejecting the assessee's claim, that Parmanandbhai left the firm for good to become a politician and not to indulge in business activity of the firm or in parallel business detrimental to the business of the firm. The Tribunal finally held :

(3.) SECTION 37 of the Income -tax Act, 1961, provides that any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head 'Profits and gains of business or profession'. Such expenditure, however, should not be in the nature of capital expenditure or personal expenses of the assessee. Any expenditure incurred by the assessee can, therefore, be claimed as an allowable deduction under the head 'Profits and gains of business or profession', if the expenditure satisfies two tests : (i) that the expenditure laid out or expended is wholly and exclusively for the purposes of the business and/or profession, and (ii) that it is not in the nature of capital expenditure. That being so, it shall be necessary to always examine and explain the nature of the expenditure incurred to be an allowable deduction to the assessee under the head 'Profits and gains of business or profession' in terms of Section 37. In the present case, what is claimed is a payment to an erstwhile partner of a certain amount in lieu of his share of goodwill in the partnership when, in fact, despite such withdrawal of the partner, the partnership continues, accounts have not been settled between the outgoing partner and the remaining partners and the dues to the outgoing partner have not been ascertained and paid. Section 14 of the Partnership Act lays down that the 'property of the firm' shall include the goodwill of the business. This, however, is subject to any contract between the partners. This when read with Sections 29 and 53 of the Act, gives a clear indication that the goodwill of a partnership firm is as much a property as any other property and has a value. This property can even be bought and sold (section 53 of the Partnership Act). Not only this, such goodwill can be transferred by gift and in that event is chargeable to gift -tax. In CGT v. Chhotalal Mohanlal : [1987]166ITR124(SC) there were three partners of a firm with seven annas, four annas and five annas share, respectively. One of the partners retired. Out of two remaining partners, the share of one was reduced from seven annas to four annas. A third partner was inducted with four annas share and two minor sons of the first partner were admitted to the benefits of the partnership, with a right to a share of 12% and 13%, respectively, in the profits. The question was whether there was a gift by the outgoing partner to his two minor sons under the Gift -tax Act, 1958. The Supreme Court, disagreeing with the decision of the High Court, held that there was a gift by the partner to his sons in respect of a part of the goodwill. In the course of the judgment, the Supreme Court referred to its earlier decision in Khushal Khemgar Shah v. Khorshed Banu Dadiba Boatwalla : [1970]3SCR689 wherein goodwill was held as an asset of a partnership firm. Referring to the two decisions in CGT v. Nani Gopal Mondal : [1984]150ITR469(Cal) and M.K. Kuppuraj v. CGT : [1985]153ITR481(Mad) the Supreme Court held that goodwill is property, that it has money value which can be transferred by gift and may be subject to gift -tax. In this state of law, it may be said without any hesitation that the share of Parmanandbhai in the goodwill of the partnership had money value which, on Parmanandbhai's withdrawal from partnership and on settlement of accounts, would have been paid to him. Instead, the arrangement made between Parmanandbhai and the remaining partners was to permit the partnership to have the full use of goodwill including Parmanandbhai's share therein and instead, to pay Rs. 50,000 per year in lieu of his share in that goodwill. It must, therefore, be held that this expenditure of Rs. 50,000 per year was incurred wholly and exclusively for the purposes of the business of the partnership.