Holding

Relinquishment of a profit‑loss share on partnership reconstitution does not constitute a taxable gift where the incoming partner’s capital contribution and the partners’ obligations constitute adequate consideration.

Summary

The Sree Narayana Chandrika Trust, a partner in Chandrika Enterprises, saw its profit share fall from 45% to 30% when the firm was reconstituted and a new partner, M.U. Indira, contributed Rs 25,000 for a 12% share. The Gift Tax Officer treated the 15% reduction as a gift and levied tax under the Gift Tax Act, 1958. The assessment was upheld by the Commissioner of Gift Tax (Appeals), the Income Tax Appellate Tribunal and the Kerala High Court. On appeal, the Supreme Court held that although the relinquishment of a share may constitute a transfer, it was not for inadequate consideration because the incoming partner’s capital contribution and the obligation to work in the firm constituted adequate consideration. Consequently, no taxable gift arose under section 4(1)(a) of the Gift Tax Act. The Court allowed the appeal and set aside the High Court’s order.

Issues considered

Whether the reduction of a partner's profit‑loss share on reconstitution of a partnership, in favour of a newly inducted partner, amounts to a taxable gift under section 4(1)(a) of the Gift Tax Act, 1958.
Whether the consideration given (capital contribution and obligation to work) is adequate to preclude the transaction from being treated as a gift.

Legislation cited

Gift Tax Act, 1958s. 16, s. 26(1), s. 4(1)(a), s. 5(2)

Subjects

gift taxpartnership reconstitutionshare relinquishmentinadequate considerationtaxable giftpartnership deedcapital contributionSupreme Court

Judgment

A MIS. SREE NARA YANA CHANDRIKA TRUST
V.

COMMISSIONER OF GIFT TAX, KERALA

APRIL 25, 2003

B [BRIJESH KUMAR AND B.N. SRIKRISHNA, JJ.]

Gift Tax Act, 1958-Section 4(/)(a)-Gift Tax-Relinquishment ofprofit/
loss share by a partner in favour ofnewly inducted partner upon reconstitution
C of the firm-Share of newly inducted partner not proved to be for inadequate
consideration-Held: Such relinquishment does not amount to taxable gift.

Appellant was a partner along with 8 other partners in a firm having
45% profit/loss share in the firm. The partnership was reconstituted
inducting a new partner in the firm who made her contribution towards
D the capital and she was given 12% share. As a result of reconstitution,
shares of all the partners were reshufned and the appellant's share was
reduced from 45% to 30%.

Assessing Officer held that relinquishment of 15% of the share of
appellant-assessee amounted to gift attracting the provisions of Gift Tax
E Act, 1958. Commissioner of Gift Tax (Appeals) dismissed the appeal of the
appellant-assessee. Income Tax Appellate Tribunal held that there was no
gift cxigible to tax as there was complete realignment of shares of all the
partners consequent upon reconstitution of the firm and unless and until
interest of the concerned partner was ascertained and quantified it could
not be said that the consideration for transfer was inadequate and that even
F ifthere was transfer by the assessee in favour of the incoming partner and
the existing partners, inasmuch as the consideration for the transfer cannot
be valued during the subsistence of the partnership, it was not possible to
consider and quantify the question of adequacy or inadequacy for
consideration. On reference, High Court answering the questions against
G the assessee held that Tribunal's holding was not correct. Hence, the present
appeal.

Allowing the appeal, the Court

HELD: I. Although the relinquishment of the share of a profit/loss
H by a partner in favour of the inducted partner may amount to a transfer,
958
SREE NARA YANA CHANDRIKA TRUST"· COM MR. OF GIFT TAX 959

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_,
J
it cannot be said that it ·was for inadequate consideration so as to amount
to a taxable gift within the meaning of section 4(1)(a) of the Gift Tax Act,
1958.
A

2. The value of the services or usefulness of the newly inducted
partner to the firm as partner has not been disputed by the Revenue
authorities. Mere fact that upon reconstitution of the firm the share of one B
partner decreased and that of another increased cannot lead to the
inference that the former had gifted the difference to the incoming partner.
There is no other material placed on record by the Revenue to show that,
in the facts and circumstances of the case, particularly taking into
consideration the obligations of all the partners in the second partnership C
deed, there was inadequate consideration for the reallocation of 12% of
the share in favour of the incoming partner. The contribution towards the
capital, together with the obligation undertaken of sincerely and faithfully
carrying on the business for common advantage of the firm, was adequate
consideration for reallocating the share of the profits and·giving 12% of
the share in favour of the incoming partner. That one of the partners was D
the managing partner and another partner was the administrative head,
did not take away the obligations of the other partners including those of
newly inducted partner which arose generally under the Partnership Act,
as well as under the second partnership deed. 1965-D; 966-C-E]

Commissioner of Gift Tax, Karnataka v. D.C. Shah. Civil Appeal Nos. E
4551-56 of 1984 decided by Supreme Court on 25.9.1996, relied on.

Sunil Siddharthbhai v. Commissioner of Income Tax, Ahmedabad, 156
ITR 509; Commissioner ofGift Tax, Gujarat v. Chhota/al Mohan/a/, 166 ITR
124; B. T. Patil and Sons v. Commissioner of Gift Tax, 247 ITR 589 and F
Commissioner of Gift Tax, Kera/av. P. Gheeverghese Travancore Timbers and
Products, (1972) ITR 83, 403, referred to.

CIVIL APPELLATE JURISDICTION: Civil Appeal. No. 1427 of2001.

From the Judgment and Order dated 24.8.2000 of the Kerala High G
Court in l.T.R. No. 256 of 1997.

T.L.V. Iyer, S. Prasad, R. Gopal Krishnan, Abhay Kumar and S.N. Jha
for the Appellant.

B.B. Ahuja, S. Rajappa and B.Y.B. Das for the Respondent. H
960 SUPREME COURT REPORTS 12003 I 3 S.C.R.

A The Judgment of the Court was delivered "by

SRI KRISHNA, J. The appellant is a charitable institution registered as
-
a public trust which spends its receipts on charitable purposes and is partner
in a finn known as 'Chandrika Enterprises'. By a partnership deed dated
1.4.1980 the appellant was inducted into the said partnership upon contribution
\"'
B of Rs. 1,000 to the total capital of Rs 1,61,000 and given a share of 45% in jl
the profit of the said firm. There were in all 8 partners apart from the appellant
and the partnership deed recited the contribution of each partner towards the J
capital of the firm as also the varying share of profit/loss of each partner. >-

With effect from 1.10.1982 the partnership was reconstituted by a deed dated
c 1.10.1982. A new partner, Smt. M.U. lndira, was inducted into the partnership.
Consequent upon the induction of said new partner, who contributed a sum
of Rs. 25,000 towards the capital, the shares of the profit/loss of all the
partners were reshuffled, being increased in the case of some and reduced
in the case of the others. The share of profit/loss of .each partner prior to
I I.I 0.1982 and thereafter is as under:
...
D
Prior to From Difference
11.10.82 11.10.82.
I. C.N. Purushuthaman 10% 4% -6%

2. Mrs. P. Karthiayani Amma 5% 15% +10%
E
~
.) . C.K. Jinan 10% 25% +15%

4. C.K. Santha 10% 10%

5. C.R. Kesavan Vaidyar 45% 30% -15%
(for and on behalf of Sree ll
F
Narayana Chandrika Trust)

6. M.G. Narayanan 5% 1% -4%

P.I Janardhanan 5% 1% -4%
7.
--.,
G 8. P.R. Rajappan 5% 1% -4% iii
'"
9. M.K. Kumaran 5% 1% -4%

10. M.U. Indira 12% +12%

Clauses 9, I 0 and 11 of the said partnership deed provide that all the
H partners had a right to carry on the business of the firm for the common
SREE NARAYANA CHANDRIKA TRllST 1· COM MR OF GIFT TAX [SRIKRISHNA. J) 96 J

advantage of the firms, though C. K. Jinan (Partner" No.3) was to be the A
managing partner and in overall charge of the affairs of the firm and C.N.
Purushuthaman (Partner no. I) was to be the administrative partner and incharge
of the day to day affairs of the firm and allowed a salary of Rs. 1000 per
month until otherwise decided by other partners. The bank accounts of the
finn were to be operated by the Managing partner C.K. Jinan or administrative B
partner C.N. Purushuthaman. As a result of the reconstitution of the firm
w.e.f. 1.10.1982, the appellant's share in the profit/loss of the firm was reduced
from 45% to 30%.

The Gift Tax Officer, taking the view that the reduction of the share of
the profit/loss of the appellant from 45% to 30% and re-distribution in favour C
of the other pa1iners amounted to a gift, issued a notice under section 16 of
the Gift Tax Act calling upon the appellant assessee to file a return of a gift.
The assessee filed a return showing the value of taxable gift at nil for the
assessment year 1983-84. By an assessment order dated 31.12.1985 the
Assessing Officer held that relinquishment of 15% of the share of the profits
of the firm by the appellant-assessee amounted to a gift and, therefore, attracted D
the provisions of the Gift Tax Act. He took the average profits of the firm
for the year 1982-83 to 1978-79 at Rs.7,36,650 and, after reducing therefrom
interest on capital @ 12% and managerial remuneration, arrived at 3 years
purchase price at Rs. 21, 16,000. He worked out that 15% of this amount i.e.
Rs. 3, 17,400 had been surrendered without consideration by the assessee. E
Consequently, after giving exemption under section 5(2) he held that amount
of Rs. 23, 12,400 was liable to tax and directed payment of tax thereupon at
Rs. 59,600.

The appellant-assessee challenged the assessment order by appeal before
the Commissioner of Gift Tax (Appeals). Two contentions were urged by the
appellant assessee. First, that there was no goodwill of the firm which was
F
I

capable of being assessed in tenns of money, and second, that inasmuch as
M.U. Indira had made a capital contribution and was inducted as partner,
there was no situation of a gift at all. The appeal was dismissed.

The assessee carried the matter in appeal to the Income Tax Appellate G
Tribunal. Before the tribunal the assessee did not seriously canvas the question
of goodwill and the issue ·was held against the appellant-assessee. The tribunal
took the view that the question, whether there had been a gift of a share by
the assessee in the goodwill of the firm, would depend on whether the value
of the assets of the firm exceeded its total liabilities. Since there was no
material on this aspect of the matter, it would normally be necessary to H
962 SUPREME COURT REPORTS !211113] 3 S.C.R.

A remand the 1natter, but since the assessee was liable to succeed on another
contention there was no need to remand the matter to the Assessing Officer.
The tribunal took note of the fact that the incoming partner, Smt. M.U.
Indira, had contributed Rs. 25,000 as her share of the capital; the usefulness
I
of her service to the firm had not been disputed by the Revenue. Though the
B Revenue was of the view that the incoming partner had been given her share
only on account of the reduction of the share of the appellant, it was only
partly true. The Tribunal pointed out that it was not a case of mere reduction
of the share of the appellant, the difference being allotted to the incoming
pa11ner, but it was a case of complete realignment of the share of all the
partners consequent upon reconstitution of the firm and that unless and until
C interest of the concerned partner is ascertained and quantified it could not be
said that the consideration for transfer is adequate or not. Relying upon the
judgment of this Court in Sunil Siddharthbhai v. Commissioner of Income-
tax, A hmedabad, 156 !TR, 509 the tribunal held that even though there was
a transfer by the assessee in favour of the incoming partner and the existing
partners, inasmuch as the consideration for the transfer, which is the right to
D get the value of his share for the partner, cannot be valued during the
subsistence of the partnership, it was not possible to consider and quantify
the question of adequacy or inadequacy of consideration. In such an event,
it could not be held that there was any gift exigible to tax.

E The Revenue sought for and obtained a reference of the following two
questions to the High Court under Section 26(1) of the Gift Tax Act. The two
questions referred to the High Coutt were:
....
"I. Whether on the facts and in the circumstances of the case the
Tribunal is right in law and fact in holding that even though the
F reconstitution of the firm resulted in the reduction of the share of
profit of the assessee-trust, there was no gift exigible to tax in its
hands?

2. Whether, on the facts and in the circumstances of the case the
Tribunal is right in law and fact in holding that even though there
G was a transfer by the assessee in favour of the incoming partner and
existing partners, the consideration for the transfer could not be
evaluated during the subsistence of the partnership and so the question
of adequacy or inadequacy of consideration could ·not be quantified
and so there was no gift exigible to tax?"
-
H The High Court answered the questions in the negative and against the
SREE NARA \'ANA CHANDRIKA TRUST,. COM MR. OF GIFT TAX ISRIKRISHNA. JJ 963

assessee. The Assessee is in appeal by special leave. A
The learned counsel for the appellant-assessee urged two contentions.
First, that in view of the judgment of this Cou11 in Sunil Siddharthbhai case
supra, as the value of the share of the partnership cannot be ascertained as
on the date of induction of the new partner, and since the adequacy or
inadequacy of consideration cannot be quantified, the same cannot be exigible B
to tax. Second, in any event, on reconstitution of the partnership, where there
is contribution of capital by a new partner and consequent readjustment of
the shares of the profit/loss of the existing partners, it does not result in a
taxable gift since it was obligatory on all the partners to pa11icipate in the
business and do the work of the firm which, taken together with the C
contribution made by the incoming partner, was adequate consideration.

Learned counsel for the Revenue however, contends that the judgment
of this Court in Sunil Siddharthbhai case (supra) is distinguishable as applicable
only to a situation falling under section 45 read with section 48 of the Income
Tax Act, 1961 and in any event the judgment of this Court in Commissioner D
a/Gift Tax Gujarat v. Chhote/al, 166 !TR 124 this Court has found that even
in such a situation the readjustment of the shares of the profit/share amounts
to a taxable gift.

In Sunil Siddharthbhai (supra) the assessee was a partner of a firm and
he made over to the firm certain shares in a company which were held by E
him. These were credited to the partner's capital account in the book of the
firm. The question was whether there was any capital gain which resulted
from the transfer of the shares held by the partner to the firm as its capital
contribution and whether there was any transfer, within the meaning of section
24 of the Income Tax Act, I 96 I, of the shares contributed by the partner as F
capital to the firm. This Court opined that when a partner brings in his
personal assets into the partnership firm as his contripution to the capital he
reduces his exclusive rights to the assets with the other partners of the firm.
Although he may not lose his right in the assets altogether, he enjoys thereafter
an abridged right which cannot be identified with a full right which. he enjoyed
in the assets before it was thrown into the partnership capital. The assets G
which were originally subject to entire ownership of the pa11ner become
subsequently subject to the rights of the other partners in it. To that extent
this Court held that there was a transfer of the assets. On the question as to
whether there was capital gain this Court was of the view that the evaluation
of a partners· interest takes place only upon dissolution of the firm or upon H
964 SUPREME COURT REPORTS j1U03 J 3 S.C.R.

A his retirement therefrom. What was the exclusive interest of the partner in his
personal asset upon its introduction into the partnership firm transforms into
the interest shared with the other.·partners in that asset. Qua that asset, there
is a shared interest. During the subsistence of the partnership, the value of the
interest of each partner qua that asset cannot be isolated or carved out from
B the value of the partner's interest in the totality of the partnership assets. And
in regard to the latter, the value will be represented by his share in the net
assets on the dissolution of the firm or upon the partner's retirement. It was,
hence, held:

"Having regard to the nature and quality of the consideration
which the partner may be said to acquire on introducing his personal
c asset into the partnership firm as his contribution to its capital, it
cannot be said that any income or gain arises or accrues to the assessee
in the true commercial sense which a businessman would understand
as real income or gain."

D Learned counsel for the Revenue relied on the judgment of this Court
in Commissioner of Gift Tax, Gujarat v. Chhotalal Mohan/al 166 ITR 124.
In that case a pa1iner of a partnership firm having retired, two minor sons of
an existing partner were admitted to the benefits of the partnership. This
Court held that relinquishment of the share of an existing partner in favour
of the minors who are admitted to the benefits of the partnership without any
E consideration amounted to a gift by the said partner in favour of the min ors.
The reason was that the goodwill of the firm is the property of the firm and,
upon admission of the two minors to the benefits of the partnership, the right
to the money value of the capital stands transferred. Since th is transfer is
without consideration, insofar as minors are concerned, the transaction would
amount to a taxable gift under the gift tax.
F
The judgment of this Comi in B. T. Patil and sons v. Commissioner of
Gift Tax 247 ITR 589 is also pressed into service by the learned counsel for
the Revenue. This was a case where the assessee partner transferred certain
items of machinery to each of its five partners and debited their accounts
G with the consideration charged therefor. The consideration was on the basis
of the written-down value of the machinery in the books of accounts. Within
a sh011 time the partners floated another pa11nership and brought in the said
machinery as their capital contribution thereto at a value which was almost
three times the written down value. The newly floated pa11nership sold the
machinery to another concern for a still higher price. The Gift Tax Officer
H held that the assessee firm had made a gift of the machinery to each of its
SREE NARAYAN A CHANDRIKA TRUST"· COM MR. OF GIFT TAX [SRI KRISHNA. J.J 965

five partners· for inadequate consideration and, therefore, the transaction was A
assessable to gift tax. This Court distinguished the judgment in Sunil
Siddharthbhai (supra) and held that when there is a dissolution of partnership
or a partner retires and obtains in lieu of his .interest in the firm an asset of
the firm, no transfer is involved for the reason set out in the passage quoted
above. But the position is very different, when, during the subsistence of a B
partnership, an asset of the partnership becomes the asset of only one of the
pai1ners thereof, there is, in such a case, a transfer of that asset by the
partnership to the individual partner. Where such transfer is for less than the
value of that asset, there is a deemed gift to the extent of the difference under
the provisions of section 4(1)(a) of the Gift Tax Act, 1958. Learned counsel
for the Revenue contended that what was said by this Court in 8. T. Patil case C
(supra) was equally applicable to the case of the present appellant before us.

Although it may be possible to say in the appellant's case that
relinquishment of the share ofa profit/loss by partner in favour of the inducted
partner may amount to a transfer, we are unable to accept the contention that
it was for inadequate consideration so as to amount to a taxable gift within D
the meaning of section 4(1 )(a) of the Gift Tax Act. The learned counsel for
the assessee has drawn our attention to the judgment of the Karnataka High
Court in D.C. Shah v. Commissioner of Gift Tax, Karnataka 134 ITR 493.
That was also a case where, upon reconstitution of the firm, an incoming
partner who contributed certain amount of capital was given a share in the E
pa11nership which was relinquished in his favour by an existing partner. The
High Court held that having regard to the nature and constitution of a firm
and the implication of the judgment of the Supreme Coui1 in Gheevarghese
case (1972) !TR 83, 403 a mere reallocation of shares would not result in a
gift. The fact that there was some contribution by the incoming partners
coupled with the obligation under the partnership deed upon the incoming F
partner to participate in the business and work for it diligently would constitute
adequate consideration. There was an obligation upon all the partners to
work for the progress of the business, albeit for administration convenience
or overall guidance one of them might have been nominated as a managing
partner, but that does not mean that the service to be rendered by other G
partners was either negligible or in any way diminished or could be left out
of account. Hence, it was held that there was adequate consideration for the
transfer by way of reallocation of shares. The judgment in DC Shah supra
came to be appealed to this Court at the instance of the Revenue. The appeal
came to be disposed of by this Court by a judgment in Civil Appeal Nos.
4551-56 of 1984 on September 25, 1996, wherein it was held "that the share H
966 SUPREME COURT REPORTS [2003 I 3 S.C.R.

A of one partner is decreased and that of another partner correspondingly
increased does not le1d to the inference that the fonner had gifted out to the
latter. The profit sharing ratio in a firm can vary for a number of reasons,
among them the ability of partners to devote time to the business of the firm.
The gift of a partner's share to another partner has to be established by
B relevant evidence. The onus of doing so is on the Revenue. It has not been
discharged in the present case."

The facts found in the present case are that the incoming partner (M.U.
Indira) had contributed Rs. 25,000 towards her share of the capital. The value
of her services or usefulness to the firm as partner has not been disputed by
C the Revenue authorities. As pointed out by this Court in D.C. Shah case
(supra) the mere fact that upon reconstitution of the firm the share of one
partner decreased and that of another increased cannot lead to the inference
that the former had gifted the difference to the incoming partner. There is no
other material placed on record by the Revenue to show that, in the facts and
circumstances of the case, particularly taking into consideration the obligations
D of all the partners in the partnership deed dated I. IO. I982, there was inadequate
consideration for the reallocation of I2% of the share in favour of the incoming
partner. In our view, the contribution of Rs. 25,000 towards the capital together
with the obligations undertaken of sincerely and faithfully carrying on the
business for common advantage of the firm was adequate consideration for
E reallocating the share of the profits and giving I 2% of the share in favour of
the incoming partner M.U. Indira. That C.K. Jinan was the managing partner
and C.N. Purushuthaman was the administrative head, did not take away the
obligations of the other partners including those of M.U. Indira which arose
generally under the Partnership Act, as well as under the partnership deed
dated I. I0.1982.
F
We are of the view that even assuming that there was a transfer of I2%
of the share profit/loss in favour of the incoming partner M.U. Indira by the
appellant assessee, it was not a situation of transfer for inadequate consideration
so as to amount to a taxable gift within the meaning of section 4( I )(a) of the
Gift Tax Act, I958.
G
In the result, we answer the question no. I against the Revenue and in
favour of the assessee. In view of our answer thereto, it is not necessary to
answer the second question. The appeal is accordingly allowed and the
judgment of the High Court is set aside. There will be no order as to costs.

H K.K.T. Appeal allowed.