1456. Realignment of profit sharing ratio among partners – Method of determination of value of gift arising thereby in the case of partner who has right to share in assets of firm

In exercise of the powers conferred by rule 10(4) of the Gift-tax Rules, 1958 [as amended by the Gift-tax (Second Amendment) Rules, 1976], the Central Board of Direct Taxes hereby direct that the value of a partner’s right to share the profits of the firm without the right to share the assets shall be calculated in the manner specified in the Annexure to this Circular.

Circular : No. 219 [F. No. 333/1/76-GT], dated 30-5-1977.

ANNEX – REFERRED TO IN CLARIFICATION

[Not printed here. The Annexure is the same as given in the Notification No. 301, dated 20-7-1977 (supra)]

JUDICIAL ANALYSIS

APPLIED IN – The above circular was applied in Altaf V. Isani v. Third GTO (1987) 22 ITD 178 (Bom.-Trib.). The Tribunal observed :

“. . . In the matter of valuation of a partner’s right to share profit of a firm, the CBDT has issued instructions in Circular No. 219, dated May 30, 1977. It directs that in a case of business or profession which has been in existence for five years or more, such average annual income shall be the average of the five accounting years immediately preceding the date to which the valuation relates. We, therefore, direct that the GTO shall determine the super-profits taking into consideration the firms’ assessed income in the immediately past four or five years, whichever is feasible and acceptable, as the first step and shall do necessary adjustments for non-recorded items (both credit and debit and capital gains), bearing in mind the Board’s circular.” (p. 185)

EXPLAINED IN – The above notification was explained in CGT v. K. Radhakrishnan Nair [1997] 223 ITR 477 (Ker.), as follows :

“We find staring intrinsic material in the notification itself pinpointing the direction in the situation in which the Tribunal has understood the same notification. The direction of the Central Board of Direct Taxes as is available in the notification itself is to the following effect :

“The Central Board of Direct Taxes hereby directs that the value of a partner’s right to share the profits of the firm without the right to share the assets shall be calculated in the manner specified in the annexure to this circular.

It would be at once clear that the scope of application of the notification is specified sufficiently in the nature of the direction as seen above.

Therefore apart from the consistency of the approach of the Tribunal, taking a note of a solitary dissent without any reasons in support thereto the language of the notification itself makes out the scope and applicability of the notification to situations directly specified therein. . . .” (p. 479)

EXPLAINED IN – The above circular and notification were adversely commented in Mrs. Nalinibai V. Saraf v. ACED [1996] 58 ITD 536 (Coch.), with the following observations :

“14. We have gone through the Circular and Notification issued under the provisions of Gift-tax Act. They speak of the mode of valuation of goodwill in the case of a partner who has only a right to share the profits of a firm without the right to share the assets of the firm. Such a situation does not arise in the instant case. Further, goodwill being an asset of the firm, whether or not the partner is given a share in the goodwill in terms of the partnership deed, the right to a share in the goodwill cannot be denied to him and his interest in goodwill passes on to the surviving partners. To this extent the circular  and the notification in so far as it holds that the partner does not have a right to share in the assets of the firm runs counter to the ratio of the Supreme Court in CIT v. Gangadhar Banerjee & Co. (P.) Ltd. (1965) 57 ITR 176. This apart, the circular and the notification makes a distinction between a firm which is assessed to income-tax (in which case the assessable income should be considered) and a firm which is not assessed to income-tax (in which case the book profit should be taken). We fail to understand the rationale behind such a classification. For all these reasons, we reject the revenue’s argument based on the circular. The assessable income is not a criterion for ascertaining earning capacity of the firm because the commercial profits would be subjected to disallowances, deductions and additions on  several counts including the deeming provisions of the Income-tax Act. . . .” (pp. 549-550).

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