Amount Of Arbitration Award Received By Retiring Partner For Relinquishing Claim In The Firm Is Not Taxable: Bombay High Court

The High Court of Bombay has held that an amount of arbitration award received by a retiring partner for relinquishing its claim in the firm is not a taxable income.

The bench of Justices K.R. Shriram and Dr. Neela Gokhale held that the amount received by a partner under a consent arbitration award for relinquishing its stake in the firm cannot be treated as an ‘income from other sources’ within the meaning of Section 56(1) of the Income Tax Act, 1961 to bring it within the rubric of taxable income. It held that to bring an amount within the fold of Section 56(1), it has to be first shown as income, however, an amount received upon retirement from a firm is not an income. It also held that such an amount also does not fall within the scope of ‘capital gains’.

The Court also held that receipt of an amount in lieu of inheritance or pursuant to family arrangement cannot be charged with tax under the Act as arrangement is an agreement between the members of the same family for the benefit of the family either by compromising doubtful or disputed rights or by preserving the family peace, honour, security and property of the family by avoiding litigation and amounts so received or not exigible to tax.

Facts

M/s. P. N. Writer & Co., a partnership firm, was formed in 1954 by Charles D'Souza and P. N. Writer. The partnership underwent reconstitutions, with the latest deed in 1979.

After Charles D'Souza's demise in 1997, his will bequeathed an additional 5% share to his daughter (the appellant), thereby entitling her to a 25% share in the firm.

In 2005, the appellant learned about a 1997 deed treating her as retired. Disputes ensued, leading to arbitration. The Supreme Court ordered the firm to pay the appellant Rs. 50,000 per month as interim relief.

The 2009 arbitration award stipulated that the appellant relinquished all claims in exchange for Rs. 28 Crores, payable in installments. An initial sum of Rs. 5 lakhs was received. The appellant asserted that the amount was related to her retirement and thus not taxable. Initially, the income tax department accepted this stance.

In 2014, the tax department reopened the case, alleging an escapement of income for the assessment year 2010-2011. This was based on information about the arbitration award and a Supreme Court order from 2007.

The appellant raised objections, stating that the amount was not income but related to her retirement from the firm. The tax department disposed of these objections, citing information from the Assessing Officer of the firm and asserting that the nature of the amount wasn't conclusively proven.

The appellant challenged this order in a writ petition, which was allowed to be withdrawn in 2015 with the clarification that all contentions could be raised again before tax authorities.

Following the withdrawal, the tax department resumed reassessment proceedings, issuing a notice under Section 142(1) of the Income Tax Act. The appellant was asked to justify the amount in terms of business income or capital gains.

The tax department, in 2015, determined the appellant's total income at Rs. 28,18,91,590. It added Rs. 28 Crores as business income under Section 28(iv) or as capital gains, claiming the appellant hadn't retired from the firm.

The appellant appealed the assessment order. During the appeal, the CIT(A) ruled out Section 28(iv) but considered the arbitration award as income from other sources. The Tribunal upheld the reassessment, stating there was prima facie material showing an escapement of income. Aggrieved thereby, the appellant filed an appeal under Section 260A of the IT Act.

Contention of the Parties

Submissions on Behalf of the Appellant:

• • That reassessment proceedings were initiated without fulfilling the jurisdictional pre-conditions in Sections 147 and 148 of the Income Tax Act. This is because, upon receiving Rs. 28 Crores, all claims against the family and the partnership firm were satisfied, and the appellant had no further claims. The amount was received for retirement or relinquishment of rights under the Will, making it non-taxable.
  • That there was no prima facie case presented by the respondent for the belief that income chargeable to tax had escaped assessment. The information from the Assessing Officer of the firm, P. N. Writer & Co., was not fresh and did not establish a link between the information and the belief. Moreover, since the issue of taxability was considered in the Assessment Year 2008-2009 and deemed non-taxable, initiating reassessment for 2010-2011 was a change of opinion, not permissible in law.
  • That the burden lies on the department to prove that the amount received is within the taxing provision. The Revenue failed to discharge this burden. The primary purpose of the amount was the settlement of relinquishment of rights in the partnership firm, with other issues being only incidental.
  • The appellant argued that, historically, amounts received by a partner upon retirement were not chargeable to tax before the insertion of Section 45(4) by the Finance Act 1987. The appellant contended that the amount was received for retirement from the firm, as evidenced by various documents, and Section 45(4) did not apply as it deals with the distribution of capital assets, not a monetary amount.
  • Even if any part of the arbitration award related to inheritance, the appellant argued that, in the absence of Estate Duty or a similar tax, no tax is chargeable. The provisions of Section 56(2)(vii) specifically exclude amounts received pursuant to a bequest from taxation.
  • The appellant contended that the amount received was pursuant to a family arrangement, which is not chargeable to tax. Citing case law, the appellant argued that such arrangements aim to compromise disputed rights or preserve family peace and are not subject to taxation.

Submissions on Behalf of the Respondent:

• • The respondent initially argued that the amount received/receivable by the appellant should be charged under Section 28(iv) of the Income Tax Act. However, this submission was rejected as both the CIT(A) and the Tribunal accepted that Section 28(iv) does not apply to benefits in cash or money.
  • The respondent asserted that the motive behind the payment should determine the category of income. Referring to case law, they argued that the consent terms did not clearly spell out that it was for relinquishing rights under the partnership firm, justifying the Tribunal's conclusion.
  • It was argued that since the appellant retired from the firm, it amounted to a dissolution of the firm, making the amount received upon dissolution chargeable to tax. The Apex Court's decision in Erach F. D. Mehta v. Minoo F. D. Mehta was cited in support.
  • The respondent contended that the amount received by the appellant would be chargeable to tax as "Income from other sources" under Section 56(1) of the Act. They argued that the receipt was a special income and, therefore, taxable.

Analysis by the Court

The court analyzed the jurisdictional pre-conditions for initiating reassessment proceedings under Section 148 of the Act. It emphasized that the Assessing Officer must have a valid belief that the assessee's income has escaped assessment, and this belief should not be based on a change of opinion.

The court found that the jurisdictional pre-conditions were not fulfilled in this case. The reasons for reopening the assessment did not clearly address whether the amount received through arbitration was of an income nature. The belief formed by the Assessing Officer lacked clarity and was contradicted by the information available at the time.

The court also highlighted that the reassessment proceedings seemed to be initiated without a proper belief, aiming to make inquiries or investigations into the facts rather than addressing the belief that income had escaped assessment.

Furthermore, the court examined the nature of the amount received through arbitration. It concluded that the amount was related to the settlement of partnership interests and inheritance rights, making it capital in nature and not chargeable to tax. The court criticized the Tribunal's classification of the amount as "special income," asserting that such a concept has no basis in the law.

In conclusion, the court held in favor of the appellant, stating that the Assessing Officer assumed jurisdiction without fulfilling the necessary pre-conditions, and the amount received through arbitration was not taxable. The appeal was disposed of with no order as to costs.

Case Title: Ramona Pinto v. Deputy Commissioner of Income Tax, Income Tax Appeal No. 2610 of 2018

Date: 08.11.2023

Counsel for the Petitioner: Mr. P.J. Pardiwalla, Senior Advocate a/w. Mr. Nitesh Joshi a/w. Mr. Atul Jasani

Counsel for the Respondent: Mr. Siddharth Chandrashekhar

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