Facts

Disputes arose between the partners of a partnership firm and as a result of which the assessee retired from the firm. On retirement, the assessee received a certain amount in respect of his share in the partnership including his proportionate share in the value of the goodwill which constituted an asset of the partnership  and thus, liable to be taken  into account in determining the share of each assessee   in the partnership on the date of retirement.

The ITO held that the amount received by the assessee to the extent it included   his proportionate share in the value of the goodwill represented capital gains chargeable to tax under section 45. This was confirmed by the  Commissioner.  The Tribunal however held that goodwill was a self-created asset, which had  cost nothing to the firm and its partners and a “transfer” of it was, therefore, not within the ambit section 45.

The High Court in CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Guj) (HC)  held that when, a partner retires, what he receives is his share in  partnership and not any consideration for transfer of his interest in partnership to continuing partners and therefore, there is no transfer of interest in the partnership assets involved within the meaning of section 2(47). Accordingly, the High Court held that no part of the amount received by any assessee in respect of his share in the value of the goodwill could be regarded ascapital gain chargeable to tax.

Issue

Whether the amount received by a partner from the partnership on retirement by way of his share in the goodwill of the firm was liable to be assessed to tax as capital gains?

View

Interest of a partner in  the partnership is  not interest in  any specific item of the partnership property, rather, it is a right to obtain his share of profits from   time to time during the subsistence of the  partnership and  on  dissolution of the partnership or his retirement from the partnership, to get the value of his  share in the net partnership assets which remain after satisfying the debts and liabilities ofthe partnership. When, therefore, a partner retires from a partnership

and amount of his share in net partnership assets after deduction of  liabilities  and prior charges is determined on taking accounts on footing of notional sale of partnership assets and given to him, what he receives is his share in partnership and not any consideration for transfer of his interest in partnership to continuing partners. His share in the partnership is worked out by taking accounts in the manner prescribed by the relevant provisions of the partnership law and it is this and this only, namely, his share in the partnership which he receives in terms       of money. There is in this transaction no element of transfer of interest in the partnership assets by the retiring partner to the continuing partners. It is true that section 2(47) defines “transfer” in relation to a capital asset and this definition  gives an artificially extended meaning to the term “transfer” by including within  its scope and ambit two kinds of transactions which would not ordinarily constitute “transfer” in the accepted connotation of that word, namely, relinquishment of the capital asset and extinguishment of any rights in it. But,  even in this artificially extended sense, there is no transfer of interest in the partnership assets involved when a partner retires from the partnership. Therefore, even if goodwill is assumed to be capital asset within the chargingprovision enacted in section 45, there is no transfer of interest of any assessee in the goodwill within the meaning of section 2(47) when the assessee retired from the firm.

Held

The Supreme Court dismissed the appeal of the Revenue having regard to the view taken by it in Sunil Siddharthbhai v. CIT [1985] 156 ITR 509. The order of the High Court stood. (AY.1963-64) (CA Nos. 1856 to 1859 of 1973 dt. 12-2-1987.

Editorial: Followed in CIT v. R. Lingmallu Raghukumar (2001) 247 ITR 801 (SC)

and Tribhuvandas G. Patel v. CIT (1999) 236 ITR 515 (SC)

Ratio is applicable even after the introduction of provision of section 45(4) unless any asset belonging to the firm is allotted to the retiring partner. See CIT v. Dynamic Enterprises (2013) 359 ITR 83 (Karn) (HC) (FB), PCIT v. Electroplast Engineers (2019) 263 Taxman 120 (Bom) (HC).

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