Firm Liable To Pay Tax On Distribution Of Capital Assets On Dissolution And Not Partner: Bombay High Court

The Bombay High Court has held that, as per Section 45(4) of the Income Tax Act, assuming that there was a distribution of capital assets upon dissolution of the firm, it is the firm and not the partner who has to pay the tax.

The bench of Justice K. R. Shriram and Justice Dr. Neela Gokhale has observed that the amount of Rs. 28 crores can be considered the amount received by a partner upon retirement from the firm and is not chargeable to tax.

In FY 2009–10, Justice S. P. Bharucha, Chief Justice of India (Retd.), serving as the only arbitrator, decided an arbitration judgment of Rs. 28 crore in favour of the assessee, resolving a dispute with her brother and other family members stemming from her late father's will. The dispute began in 2005 when the assessee learned that her brothers had reconstituted the firm and that she had retired in 1997. Despite this, the assessee insisted that she was still a partner, and the matter was sent to arbitration, where the assessee waived all of her rights against the firm in exchange for an upfront payment of Rs. 7 crore in 2009, with an additional Rs. 3 crore to be paid annually for a period of seven years.

The return was approved in the scrutiny assessment for AY 2010–11 even though the assessee failed to declare the Rs. 7 crore that they got upon leaving the partnership firm as income for taxation. Reassessment procedures were started, claiming that revenue totalling Rs. 7 crores had escaped assessment.

The assessment was completed by adding Rs. 28 crore as capital gains or, alternatively, as business income under Section 28(iv). It was decided that even in the event that the consent terms had been said differently, the assessee had not retired and the whole amount had not been applied to retirement. Because it was a settlement of composite rights, CIT (A) determined that it was taxable as income from other sources. The arbitration award was retained by ITAT as special income.

The petitioner contended that mere reference in the reasons recorded to the consent terms and the arbitration award would never form the basis of a belief that income chargeable to tax had escaped assessment unless the department made out a prima facie case in the reasons that the amount received or receivable by the appellant under the arbitration award was of an income nature, which burden has not been discharged.

The department held that the amount received or receivable by the appellant would be chargeable to tax as “income from other sources”. Section 56(1) provides that income of every kind that is not to be excluded from the total income under the Act is to be charged to tax under the head income from other sources if it is not chargeable under any other heads. Hence, the receipt has to be first of an income nature for it to be assessed as under the residual head.

The court has quashed the reassessment on the basis that the reasons for reopening were vague and incomplete, as there was no mention of the taxability of the arbitration award as income.

Counsel For Petitioner: P.J. Pardiwalla

Counsel For Respondent: Siddharth Chandrashekhar

Case Title: Ramona Pinto Versus Deputy Commissioner of Income Tax

Case No.: INCOME TAX APPEAL NO.2610 OF 2018

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